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Commission Notice:
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For the Twelve Months Ended
September 30, 1999 (in $ millions)
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NEES, through a series of mergers, will become an indirect, wholly owned subsidiary of National Grid under an Agreement and Plan of Merger dated as of December 11, 1998 (the "Merger Agreement") by and among National Grid, NGG Holdings LLC, a Massachusetts limited liability company, and NEES.11 The Merger Agreement providesthat the NEES shareholders will receive $53.75 per share in cash for their NEES shares.12 This cash payment will increase by $0.003288 per share, up to a maximum price of $54.35 per share, for each day completion of the Merger is delayed after November 3, 1999, the six-month anniversary of the date on which NEES shareholders approved the Merger.13
The Merger Applicants estimate that total cash payable to NEES shareholders (the "Cash Consideration") will be approximately $3.2 billion. In view of the price escalation provisions of the Merger Agreement, however, the exact amount of the Cash Consideration will depend upon the date that the Merger occurs, as well as the number of NEES shares outstanding at that time. The Merger Applicants estimate that their fees and expenses in connection with the Merger will be approximately $54.2 million.
National Grid will hold its interest in NEES through both foreign and domestic Intermediate Holding Companies.14 The Intermediate Holding Companies and the NEES Group are sometimes referred to below as the "U.S. Subsidiaries." The Merger Applicantsstate that Intermediate Holding Companies are used to avoid the loss of U.K. tax relief for foreign taxes paid on profits repatriated to the U.K. and to minimize taxes on the repatriation of U.S. Subsidiary profits to the U.K. The status of the Intermediate Holding Companies under the Act is discussed further in Part II.C.2.a. of this Order.
As discussed in greater detail below, the Merger Applicants state that the Merger will result in substantial benefits to the electric utility industry and consumers in the Northeast by combining National Grid, a foreign holding company that has expertise in operating in a competitive environment, with NEES, a domestic holding company that is well-positioned to compete in a deregulating market. The anticipated benefits of the Merger are discussed further in Part II.C.3. of this Order.
The Merger Applicants state that National Grid will obtain the Cash Consideration of approximately $3.2 billion required to pay NEES shareholders through a combination of bank borrowings ("Merger-Related Debt") and existing cash sources.15 The Merger Applicants expect that the bank loans will be extended under a fully committed credit facility ("Bank Credit Facility") entered into on March 5, 1999. Under the Bank Credit Facility, six banks will lend up to $2.75 billion.16 In addition, the facility will make an additional 250 millionpounds sterling available to National Grid for working capital purposes.
Borrowings under the Bank Credit Facility will have a maturity of three to five years. The loans will be full recourse obligations of National Grid and will be neither guaranteed by, nor secured by any assets of, the U.S. Subsidiaries or any subsidiary of National Grid which directly or indirectly owns equity securities of NEES.
The pro forma consolidated capital structure of National Grid following the Merger is discussed in Part II.B.3.a of this Order.
The shareholders of NEES and National Grid, respectively, have approved the Merger.
The Connecticut Commission, the New Hampshire Commission and the Vermont Commission have granted necessary approvals.17 While the express approvals of the Massachusetts Commission and the Rhode Island Commission are not required, these regulators have provided us with letters certifying that they have the authority and resources necessary to protect ratepayers.
The FERC unconditionally approved the Merger by order dated June 16, 1999.18 On December 10, 1999, the NRC approved the transaction insofar as it involved the transfer of licenses related to various nuclear power plants in which NEP has an interest.19 The Merger Applicants were informed on April 29, 1999 that the Committee on Foreign Investments in the United States ("CFIUS") had concluded that there were no issues of national security with respect to the Merger to warrant an investigation under the Exon-Florio Provisions of the Omnibus Trade and Competitiveness Act of 1988 and that action under the Exon-Florio Provisions had concluded.20 The Merger Applicants, on March 31, 1999, made the applicable filings with the Antitrust Division of the U.S. Department of Justice and the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended ("HSR Filings"). The applicable waiting period expired on April 9, 1999.
The Merger Application requests us to approve a service agreement that will govern services that will be provided to the NEES Group by its affiliates after the Merger. This agreement is described in Appendix C of this Order.
The Financing Application requests us to approve: (1) external financings of National Grid (including the Merger-Related Debt) in an aggregate amount not to exceed $2 billion (the "Aggregate Limitation"), (2) guarantees by National Grid of the obligations of U.S. Subsidiaries in an aggregate amount not to exceed $2 billion, and (3) the extension of the NEES Group's existing financing authorizations ("Existing Financing Authority"), in each case, through May 31, 2003 (the "Authorization Period"). The external financings are more fully described in Part III and Appendix E of this Order, and the Existing Financing Authority is more fully described in Appendix D of this Order.
In addition, the Financing Application requests authorization for various other transactions and arrangements during the Authorization Period, all of which are more fully described in Part III and Appendix E of this Order. These authorizations include granting National Grid the authority to finance additional investments in exempt wholesale generators ("EWGs") and FUCOs.21 The amount of new securities that may be issued to finance further investments will not exceed an additional fifty percent of National Grid's consolidatedretained earnings at any one time during the Authorization Period.22 In addition, the Financing Applicants request authority for: (1) the payment by the NEES Subsidiaries of dividends out of unearned or capital surplus, (2) the implementation by certain of the U.S. Subsidiaries of a tax allocation agreement, and (3) a limited waiver from the requirement that financial statements of certain non-U.S. subsidiaries of National Grid be prepared in conformity with Regulation S-X.
II. The Merger and Related Matters
A. Introduction: Foreign Holding Companies Under the Act
The Merger Applicants request our approval, under sections 9(a)(2) and 10 of the Act, of National Grid's acquisition of NEES and its subsidiaries, as well as our approval of several other transactions related to the Merger. Before we consider the specific requests for approval under the Act, we must first consider three fundamental questions raised by the Merger Application:
Does the Act prohibit the acquisition of a U.S. public utility by a foreign holding company?
Does the Act prohibit a foreign holding company from registering under the Act?
Will National Grid's foreign utility subsidiaries be "public-utility companies" for purposes of the Act, and thus subject to the Act's integration requirements?
We answered this first question in Gaz Metropolitain, Inc., in which we authorized a Canadian holding company to acquire a Vermont gas utility and granted the Canadian holding company an exemption from registration under section 3(a)(5) of the Act.23 In response to the argument that certain provisions of the Act should be construed narrowly to preclude the acquisition because "a foreign holding company is less susceptible to regulation in this country than a domestic company," we stated:
The Act contains no prohibition against foreign holding companies as such. Indeed, nothing in the Act prevents a foreign company that does not own or control public utility or holding company securities from acquiring the securities of a domestic public utility company.
We then determined that the acquisition satisfied applicable statutory standards – that is, that the acquisition of the Vermont gas utility by the foreign holding company would not, among other things, "be detrimental to the public interest or the interest of investors or consumers or the proper functioning of [the] holding company system."
In Gaz Metropolitain we granted the holding company an exemption from registration under section 3(a)(5) of the Act. We have not previously considered whether a foreign holding company may make an acquisition that would require it to register under the Act.
Just as the Act does not, by its terms, prohibit the acquisition of a U.S. utility by a foreign holding company, neither does it expressly preclude a foreign holding company frombecoming a registered holding company.24
The Act's silence on this issue is hardly surprising. It appears that Congress, in 1935, did not foresee ownership of a domestic utility by a holding company domiciled outside the United States. Indeed, because the Act places structural and geographic limitations upon public-utility holding company systems, there was little need to consider the issue. Section 11 of the Act generally limits a registered holding company to ownership of a single "integrated public-utility system," defined in terms of a group of naturally-related operating properties.25 Under section 2(a)(29) of the Act, an integrated public-utility systemmust, among other things, consist of utility assets that "are physically interconnected or capable of physical interconnection" and be "confined in its operations to a single area or region, in one or more States . . . ."26
For many years, it was generally assumed that the integration provisions of the Act would preclude a U.S. registered holding company from owning both domestic and foreign utility properties, especially if the foreign utility operations were located in a country not contiguous to the United States.27 For virtually identical reasons, the integration provisions were understood to bar a holding company with foreign utility operations from acquiring a U.S. utility.28
Given that the Act does not expressly bar a foreign holding company fromregistering, we do not believe that we should reject an acquisition of a U.S. utility by a foreign holding company that will result in its being required to register under the Act if the acquisition will otherwise satisfy the requirements of the Act, including the integration requirements. The issue, then, is whether, given its substantial foreign utility operations, National Grid will satisfy the Act's integration standards after it acquires NEES. If it cannot, we may not approve the acquisition under section 10(c)(1), which prohibits us from approving an acquisition that is "detrimental to the carrying out of the provisions of section 11." As noted above, section 11 generally requires us to limit the operations of a registered holding company system to "a single integrated public-utility system." The combination of the electric operations of National Grid Company and those of the NEES Utility Subsidiaries would not constitute an integrated system within the meaning of section 2(a)(29) because, among other things, the resulting system would not be "physically interconnected or capable of physical interconnection."29 The Merger would therefore not meet the Act's standards unless National Grid Company's non-U.S. utility properties are nonutility properties for purposes of the Act.
The status of National Grid's foreign subsidiaries under the Act turns on whether National Grid Holdings (the subholding company for these subsidiaries) is a "foreign utilitycompany" or FUCO under section 33 of the Act. Section 33 was added to the Act by the Energy Policy Act of 1992 ("Energy Policy Act").30 Section 33 provides that a FUCO is not a public-utility company, and is therefore not subject to the Act's integration provisions.31 Section 33(a)(3) defines the term "foreign utility company" to mean any company that –
(A) owns or operates facilities that are not located in any State and that are used for the generation, transmission, or distribution of electric energy for sale or the distribution at retail of natural or manufactured gas for heat, light, or power, if such company –
(i) derives no part of its income, directly or indirectly, from the generation, transmission, or distribution of electric energy for sale or the distribution at retail of natural or manufactured gas for heat, light, or power within the United States; and
(ii) neither the company nor any of its subsidiary companies is a public utility company operating in the United States; and
(B) provides notice to the Commission, in such form as the Commission may prescribe, that such company is a foreign utility company.32
If National Grid Holdings is a FUCO, it is exempt from all provisions of the Act except as provided in section 33(a)(1), and it is not, for any purpose under the Act, deemedto be a public-utility company under section 2(a)(5), notwithstanding that it will be a subsidiary of a registered holding company, National Grid.
We note, first, that National Grid Holdings appears to meet the criteria for being a FUCO under section 33(a)(3).33 The Merger Applicants state that National Grid Holdings does not directly or indirectly own or operate any U.S. facilities that are used for the generation, transmission, or distribution of electric energy for sale. The Merger Applicants also state that National Grid International Limited, the only National Grid subsidiary that has U.S. operations through U.S. subsidiaries, derives no part of its income, directly or indirectly, from these activities. In addition, the Merger Applicants state that neither National Grid Holdings nor any of its subsidiary companies is a public-utility companyoperating in the United States.34
Section 33 does not expressly bar a FUCO owned by a foreign holding company from claiming FUCO status.35 Section 33(c)(1) can be read to permit a foreign holding company to qualify its foreign utility operations as a FUCO and to acquire a U.S. utility without regard to the integration of the foreign and domestic utility operations.
In adopting the Energy Policy Act, Congress does not appear to have directly addressed this possibility. Instead, the legislative history of the Energy Policy Act emphasizes that the legislation was designed to enable U.S. companies to respond to foreign and domestic opportunities for utility investments. The legislative history is silent as to whether section 33 was intended to be a vehicle for foreign investment in the United States utility industry.
We do not believe that Congress silence concerning a foreign company's eligibility to claim FUCO status precludes this result, so long as the company's FUCO status is consistent with the fundamental purpose of the Act to protect consumers and investors. Section 1(c) of the Act directs us to interpret all the provisions of the Act to "meet the problems and eliminate the evils" that the Act is intended to address. We must therefore consider whether approving the Merger could lead to a recurrence of abuses that the Act is intended to prevent, or would be detrimental to the protected interests under the Act, i.e., the publicinterest and the interests of investors and consumers.
Recognizing that this issue is one of first impression that could have implications for other acquisitions, we recently published a concept release soliciting comments on this application of section 33 of the Act and generally on the registration and regulation of foreign holding companies (the "Concept Release").36 A wide range of regulators, businesses, industry and consumer advocacy groups, and individuals responded to our request for comments.37 Only one of these commenters specifically concluded that foreign holdingcompanies were inconsistent with the Act.38 The others concluded that acquisitions of U.S. utilities by foreign holding companies were not prohibited by the Act. Several raised useful comments concerning how foreign holding companies could be effectively regulated under the Act and addressed the need for foreign and domestic holding companies to be subject to even-handed regulation. As discussed in Part II.D. of this Order, individual consumers and investors expressed some concern over foreign ownership of U.S. utilities.
In this matter, we conclude that the application of section 33 to National Grid Holdings would not undermine the policies of the Act or be detrimental to the protected interests.39 First, we note that National Grid will register under the Act. The need for direct regulation of the holding company is a basic premise of the Act.40 The registrationprovisions of the Act reflect Congress determination that there should be federal regulation of a holding company that operates a multistate utility system. Federal regulation was necessary, Congress believed, to facilitate effective state regulation.41
As a registered holding company, National Grid will be regulated in the same manner and to the same degree as other U.S.-domiciled registered holding companies.42 Moreover, National Grid has taken affirmative steps to assure that we will be able to exercise our jurisdiction. National Grid and each of its present and future directors and officers who is not a U.S. resident will appoint an agent in the United States to accept service of process in any suit, action or proceeding before us or any appropriate court to enforce the provisions of the statutes that we administer. National Grid will provide our staff access to the books, records and financial statements, or copies, of any of its subsidiaries, in English, as we may require.
Of overriding importance to us is the question of whether the Merger, and National Grid's FUCO Investment, will adversely affect state regulation of the NEES Group. The Act was designed to address the problems that the holding company structure presented to effective state regulation in the 1920s and 1930s.43 It also does not appear that the Mergerand National Grid's FUCO Investment will adversely affect state regulation of the NEES Group. All requisite state approvals in connection with the Merger have been obtained. Each state commission that currently has authority over the NEES Utility Subsidiaries has represented to us that it will continue to have authority over the rates, services and operations of those companies. In addition, the appropriate state regulatory commission of each state in which the NEES Utility Subsidiaries provide retail service has informed us that it has adequate authority and resources to protect consumers and that it intends to exercise its authority after the Merger. Massachusetts Electric, Narragansett, Granite State, Nantucket and NEP will remain subject to the jurisdiction of the FERC. As discussed in more detail in Part II.C.1. of this Order, there does not appear to be any concern that the Merger will "impair . . . the effectiveness of regulation . . . " that the Act is designed to promote.
National Grid, unlike most of the other companies currently registered under the Act, will be predominantly foreign in terms of the location of its assets and sources of its revenues.44 We therefore have also given careful consideration to the question of whether National Grid's FUCO Investment is of such magnitude as to raise concerns under section 33 of the Act.45 We note that neither the Act nor our rules places any quantitative limitationon the amount that a registered holding company may invest in FUCOs. Rule 53, of course, sets forth the circumstances precluding a finding that a security issued to finance the acquisition of an EWG is not, among other things, reasonably adopted to the earning power or security structure of the holding company. In general terms, the rule establishes a safe harbor. This "safe harbor" does not apply when a holding company's investment in EWGs and FUCOs exceeds 50% of the holding company's consolidated retained earnings. However, registered holding companies are not prohibited from investing more than 50% of consolidated retained earnings in EWGs and FUCOs. Under these circumstances, the holding company, instead of relying on the rule 53 safe harbor, must demonstrate that the issuance of the security will not have certain adverse consequences on the financial integrity of the holding company system, or on its utility subsidiaries, customers or the ability of state commissions to protect these subsidiaries. We discuss National Grid's ability to meet this burden in Part III.B.1.b. of this Order.
Moreover, it does not appear that the Merger is designed to divert personnel and capital from NEES to National Grid's operations. As discussed in Part II.C.3. of this Order, the Merger appears to be designed to allow the NEES System to benefit from National Grid's experience in operating a transmission system in a competitive power supply environment.
We also note that National Grid has developed other structural safeguards designed to limit the risk that financial problems arising in its FUCO Investment will have an adverseeffect on U.S. ratepayers and security holders of the NEES Group. For example, National Grid will limit the use of employees of the NEES Utility Subsidiaries in its FUCO operations. National Grid has also committed that it will not seek recovery in higher rates to NEES ratepayers for any losses or inadequate returns that may be associated with its non-NEES investments.
Finally, as discussed in greater detail below, the Merger satisfies the standards of the Act as we have traditionally applied them. The Merger Applicants argue, persuasively, that consumers will receive substantial benefits from the transaction. The abuses that the Act was designed to address do not appear to be present in this transaction.
In view of these considerations, we find that National Grid Holdings may claim FUCO status. As a result, National Grid Holdings and all of its subsidiaries, including National Grid Company, will be exempt from regulation and retainable by National Grid under section 33(a)(1) of the Act. It does not appear that approving a transaction that will result in National Grid registering under the Act would contravene the purposes or policies of the Act or be detrimental to the protected interests.
Having determined that treating National Grid Holdings as a FUCO is not inconsistent with the basic policies of the Act, we now turn to analyzing whether the Merger satisfies the standards of the Act applicable to acquisitions.
B. Applicable Standards for Approving the Merger: Section 10(b)
Section 10(b) requires us to approve the Merger unless we make adverse findings under three specific standards.
Section 10(b)(1) requires that we not approve the acquisition if we find that it will "tend towards interlocking relations or the concentration of control of public-utility companies, of a kind or to an extent detrimental to the public interest or the interest of investors or consumers." Although we are primarily concerned under the Act with the structure of public-utility holding company systems, our analysis under section 10(b)(1) includes consideration of federal antitrust policies.46 The anticompetitive ramifications of an acquisition are considered in light of the fact that public utilities are regulated monopolies subject to the ratemaking authority of federal and state administrative bodies.47
In considering whether an acquisition satisfies the standards of section 10(b)(1) in previous merger applications, we have exercised "watchful deference" to the analysis of other federal and state regulators that considered antitrust policies in connection with the merger.48 We have done so here. The Merger Applicants made HSR Filings with the Antitrust Division of the U.S. Department of Justice and the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. The applicable waiting period has expired.
In addition, the FERC fully considered the competitive impact of the Merger undersection 203 of the Federal Power Act.49 The FERC determined that the transaction does not raise competitive concerns and noted that no intervenor argued to the contrary. The FERC agreed with the Merger Applicants that a screen analysis was unnecessary because NEES and National Grid clearly do not have facilities or sell relevant products in common geographic markets. The FERC concluded that, "[a]s a result, the proposed merger does not eliminate a competitor and therefore raises no potential horizontal competitive concerns. We also find that because Applicants do not supply inputs used to produce electricity products and do not sell electricity products in common geographic markets, the merger raises no vertical competitive concerns."50
We note also that the Merger will merely create a new holding company over anexisting holding company system.51 It will not result in a consolidation of U.S. public utilities. In view of all these considerations, we do not find that the Merger will tend toward "the concentration of control of public-utility companies, of a kind or to an extent detrimental to [the protected interests]" within the meaning of section 10(b)(1) of the Act.
Section 10(b)(2) requires that we not approve the acquisition if we find that the consideration paid in connection with the acquisition is "not reasonable or does not bear a fair relation to the sums invested in or the earning capacity of the utility assets to be acquired . . . ." NEES shareholders will receive the Cash Consideration – at least $53.75 per share (or approximately $3.2 billion in the aggregate).52
Based upon our review, we are satisfied that the Cash Consideration is not unfair or unreasonable within the meaning of section 10(b)(2). The Merger Application explains that the Cash Consideration is the result of arm's-length negotiations between National Grid and NEES. The Merger Applicants state that these negotiations were preceded by months of due diligence, analysis and evaluation of the assets, liabilities and business prospects of the respective companies, which were described in detail in NEES' proxy statement seeking shareholder approval of the Merger ("NEES Proxy Statement").53 The Merger Applicants also cite the opinions of their investment bankers, Merrill Lynch, Pierce, Fenner & SmithIncorporated ("Merrill Lynch"), which provided an opinion to NEES, and Rothschild and Dresdner Kleinwort Benson, which provided an opinion to National Grid, that the consideration is fair, from a financial point of view, to the holders of NEES common stock and National Grid ordinary shares and in line with comparable utility mergers.
The Merger Applicants also provided quarterly price data, high and low, for NEES common stock for the period from 1996 to 1998. The high price of the stock during this period (prior to the announcement of the Merger) was $44 5/16, during the fourth quarter of 1998 (the low price during that quarter was $40 5/16). The low price during 1996-1998 period was $31, during the fourth quarter of 1996 (the high price during that quarter was $35 5/8). As noted above, the closing price per share of NEES common stock, as reported on the New York Stock Exchange-Composite Transaction, was $43 on December 11, 1998, the last full trading date before the public announcement of the Merger. The base price to be paid in the Merger, $53.75, is 125% of that share price. The NEES Proxy Statement also discusses other information that Merrill Lynch took into account in formulating its opinion, including the premiums over market price paid to shareholders in other utility acquisitions and other bases for comparing the fairness of the Cash Consideration to other transactions. The Cash Consideration is within the range of values paid to shareholders in these transactions.
Based on this data, we do not have any basis to conclude that the consideration to be paid in the Merger is unfair or unreasonable. There also is no basis to conclude that the consideration to be paid does not bear a fair relation to the earning capacity of the utility assets to be acquired within the meaning of section 10(b)(2). As discussed above, thepurchase price was arrived at after arm's-length bargaining between National Grid and NEES. Moreover, the terms of the financing arrangements related to the Merger suggest that financial institutions have concluded that National Grid will have the earnings capacity to meet its obligations after the Merger. It does not appear that National Grid will be required to divert additional resources from the NEES Group in order to meet these obligations. As discussed in Part III.B.2. of this Order, the Applicants anticipate that the dividends paid by NEES after the Merger will continue at substantially the same rate as they did prior to the Merger.54
Mr. Russell G. Gilmore, an individual shareholder of NEES, requests that we deny the Merger Application. We discuss several of Mr. Gilmore's concerns in Part II.D. of this Order but we address here his concern that the Merger is not financially fair to NEES shareholders, particularly its small, longtime shareholders. Mr. Gilmore does not argue that the price itself is unfair (although he does question whether Merrill Lynch had conflicts of interest that raise questions concerning its assessment of the fairness of the price). Rather, his major concern appears to be with the tax burden that the Merger will impose on small shareholders. He refers in particular to NEES shareholders who took advantage of the tax laws from 1984 to 1987 to defer taxes on the reinvestment of quarterly dividends in additional shares, and who will now have to compute their capital gains tax on the disposition of the shares in the Merger at a zero-cost basis.
The tax consequences of the Merger for any particular investor or group of investorswill vary depending upon the investor's tax situation. It would therefore be impracticable for us to incorporate the tax consequences of the Merger for any specific investor into our analysis of the fairness of the Merger.55 Moreover, as a general matter the Act does not require us to consider the desirability of terms other than those that the merger partners have negotiated. Rather, the Act requires us to approve an acquisition if we determine that the transaction satisfies the standards of section 10 of the Act. As discussed above, we have determined that the proposed acquisition satisfies the statutory requirements.
On the basis of the record in this matter, we conclude that no adverse finding is required under section 10(b)(2).56
Section 10(b)(3) of the Act requires us to approve a proposed acquisition unless we find that it would "unduly complicate the capital structure of the holding-company system of the applicant" or would "be detrimental to the public interest or the interest of investors or consumers or the proper functioning of such holding-company system." We have consideredthe anticipated capital structure of the National Grid System following the Merger and have concluded that a negative finding under section 10(b)(3) is not warranted. a. Capital Structure of the National Grid System
Set forth below is a table showing the pro forma consolidated capital structure of the National Grid System after the Merger.57
| National Grid ($ mm) |
National Grid (%) |
NEES ($ mm) |
NEES (%) |
Pro Forma Combined ($ mm) |
Pro Forma Combined (%) |
|
|
Short-term |
404 |
6.7% |
39 |
1.4% |
443 |
4.7% |
Long-term |
3,133 |
52.3% |
1,059 |
38.8% |
6,492 58 |
68.7% |
Preferred |
- |
- |
20 |
0.7% |
20 |
0.2% |
Minority |
1 |
- |
39 |
1.4% |
40 |
0.4% |
Common |
2,454 |
41.0% |
1,578 |
57.7% |
2,454 |
28.5% 59 |
Total |
5,992 |
100% |
2,735 |
100% |
9,449 |
100% |
With the exception of the Special Share, this capital structure does not involve the introduction of multiple classes of securities (such as preferred stocks and multiple classes ofdebt securities) that differ from the capital structure of domestic holding companies.60 As discussed in Part II.C.2.b. below, the Special Share will not result in an unfair distribution of voting power among security holders of the National Grid System.
As a wholly owned indirect subsidiary of National Grid following the Merger, NEES and the NEES Subsidiaries will retain their current capital structure. The Merger Applicants state that neither NEES nor any of the NEES Subsidiaries will incur any additional indebtedness or issue any securities to finance any part of the Merger. Except for the anticipated conversion of NEES from a business trust into a corporation, the Merger and the related corporate and financing measures will not affect the corporate structure or current financial obligations of the NEES Group.
The capital structure of the National Grid System will differ somewhat from domestic registered companies because National Grid's ownership interest in NEES will be held through the Intermediate Holding Companies. While this structure is novel for holding ownership interests in U.S. utilities, as discussed in Part II.C.2.a. of this Order, it is similar to structures that U.S. holding companies have used to hold their foreign investments. Moreover, the Intermediate Holding Companies will not be used as vehicles to make National Grid's capital structure more complex. The Intermediate Holding Companies will be wholly owned by National Grid and will have no public or private institutional equity or debt holders. The Intermediate Holding Companies will be capitalized with equity and/ordebt, all of which will be held by either National Grid or an Intermediate Holding Company. The ultimate U.S. parent of NEES, National Grid General Partnership, will be capitalized with both equity and debt, which will be held by one or more of the Intermediate Holding Companies.
We therefore do not find that the Merger would unduly complicate the capital structure of the National Grid System.
b. Effect Upon the Protected Interests and System Functioning
We do not find that the Merger would be detrimental to the public interest, the interests of investors or consumers, or the proper functioning of the NEES System. The Merger Applicants anticipate that the proposed Merger will benefit New England consumers and enhance the functioning of the NEES integrated system. The FERC, the NRC, the Vermont Commission, the Connecticut Commission and the New Hampshire Commission have granted necessary approvals. The Massachusetts Commission and the Rhode Island Commission have issued letters to us certifying that they have the authority and resources to protect ratepayers. Granite State and NEP have made representations to the New Hampshire Commission that the Merger will not adversely affect their rates, terms, service or operations. In addition, National Grid has committed that it will not seek recovery in higher rates to NEES ratepayers for any losses or inadequate returns that may be associated with its non-NEES investments. Finally, the Merger is expected to have no adverse effect on the rights of holders of the outstanding preferred stock and debt securities of the NEES Group.
In view of these considerations, we do not find that the Merger would be detrimental to the protected interests or the proper functioning of the National Grid System.
Section 10(c) provides that we cannot approve an acquisition under certain circumstances. It requires, among other things, that we find that the acquisition:
As discussed below, we find that the Merger will satisfy these standards.61
Section 11(b)(1) of the Act, referenced in section 10(c), generally limits a registered holding company to ownership of a single integrated public-utility system and to such nonutility businesses as are "reasonably incidental, or economically necessary or appropriate to the operations of" the integrated system, based on a Commission finding that the nonutility businesses are "necessary or appropriate in the public interest or for the protection of investors or consumers and not detrimental to the proper functioning of such system or systems." We have interpreted section 11(b)(1) to require the existence of a functional relationship between the nonutility activities and the core utility business of the registeredholding company.62
The requirements of section 11(b)(1) are satisfied in this matter. Following the Merger, National Grid will own a single integrated utility system, i.e., the NEES System. The Merger will not affect the NEES System, which will continue to be "a single interconnected and coordinated system confined in its operations to a single area or region, in one or more States, not so large as to impair . . . the advantages of localized management, efficient operation, and the effectiveness of regulation."63 As discussed below, the Merger Applicants state that the Merger may result in the NEES System operating with greater efficiencies. Based on the views expressed by state regulators, we are satisfied that the Merger will not impair the effectiveness of state regulation. The NEES System will continue to operate under localized management, based in Massachusetts.64 Two current members of the NEES board of directors who are U.S. citizens will join the National Grid board of directors.
Moreover, National Grid's preexisting utility operations will be held by a FUCO, National Grid Holdings, and will thus be nonutility interests for purposes of the Act. Because National Grid Holdings will be a FUCO after the Merger, its retention by National Grid will be consistent with section 11(b)(1)'s requirement that nonutility businesses be "(A)consistent with the operation of a single integrated public utility system, within the meaning of section 11; and (B) reasonably incidental, or economically necessary or appropriate to the operations of an integrated public utility system, within the meaning of section 11."65
Section 11(b)(2) of the Act requires us to ensure that "the corporate structure or continued existence of any company in the holding-company system does not unduly or unnecessarily complicate the structure, or unfairly or inequitably distribute voting power among security holders, of such holding-company system." Section 11(b)(2) also directs us to require each registered system company "to take such action as the Commission shall find necessary in order that such holding company shall cease to be a holding company with respect to each of its subsidiary companies which itself has a subsidiary company which is a holding company," in other words, to eliminate "great-grandfather" holding companies.
a. Post-Merger Corporate Structure: The Intermediate Holding Companies
As a result of the interposition of the Intermediate Holding Companies between National Grid and NEES (the "upper structure"), it would appear that National Grid will be a holding company with respect to a subsidiary which "itself has a subsidiary company which is a holding company." We do not believe, however, that this corporate structure implicates the abuses that section 11(b)(2) was designed to address. We have concluded that the existence of the Intermediate Holding Companies will not contravene the requirements of section 11(b)(2).
The Merger Applicants state that it is common practice for U.K.-based multinational corporations to hold their non-U.K. subsidiaries through one or more intermediary companies incorporated under the laws of European Union member states. This ownership structure is utilized to avoid the loss of U.K. tax relief for foreign taxes paid on profits repatriated to the U.K., and to minimize taxes on the repatriation of foreign subsidiary profits.66
Under the proposed structure, no outside third-party will have an interest in the Intermediate Holding Companies. The Intermediate Holding Companies will have no outside security holders, lenders or customers. The Intermediate Holding Companies will be capitalized with equity and/or debt, all of which will be held by either National Grid or an Intermediate Holding Company. The ultimate U.S. parent of NEES will be capitalized with both equity and debt, which will be held by one or more of the Intermediate Holding Companies.
In contrast, the corporate structure that section 11(b)(2) was intended to eliminate was the pyramiding of holding-company groups. The practice of pyramiding typically involved the interposition of one or more holding companies between the ultimate parent holding company and the operating companies, and the issuance, at each level of the structure, of different classes of debt or stock with unequal voting rights. Various abuses that Congress sought to remedy by the Act were traceable in large measure to the use of the pyramidingdevice.67
The Intermediate Holding Companies will not serve as a means by which National Grid seeks to diffuse control of the NEES Group. Rather, these companies will be created as special-purpose entities for the sole purpose of helping the parties to capture economic efficiencies that might otherwise be lost in a cross-border transaction. The Merger Applicants further note that U.S. registered holding companies use similar structures in connection with their foreign investments.68
Nor will the upper structure affect the operations of the NEES Group. There will be no change in the corporate organization of the NEES Group (other than the intended change in organization of NEES from business trust to corporation) or the financing transactionsundertaken by NEES Group companies.69 Neither NEES nor any NEES Subsidiary will borrow or issue any security or pledge any assets to finance the Merger. Implementation of the proposed transaction structure should not result in an unduly complicated capital structure of the NEES Group, to the detriment of the protected interests. In addition, as discussed above, the Intermediate Holding Companies may also offer structural advantages to protect consumers.
On the facts of this matter, we think that it is appropriate to "look through" the Intermediate Holding Companies (or to treat the Intermediate Holding Companies as a single company) for purposes of the analysis under section 11(b)(2) of the Act.70 Accordingly, we do not find it necessary to require the elimination of the Intermediate Holding Companies to ensure that the corporate structure of the post-Merger system or continued existence of any system company "does not unduly or unnecessarily complicate the structure" of the NationalGrid System.71
b. Post-Merger Distribution of Voting Power
Section 11(b)(2) also directs the Commission to ensure "that the corporate structure or continued existence of any company in the holding-company system does not . . . unfairly or inequitably distribute voting power among security holders, of such holding-company system."
In this matter, there are no direct or indirect shareholders of NEES with whom National Grid would share voting power. None of the Intermediate Holding Companies, including NEES, will have any public or private institutional equity or debt holders. Although certain of the NEES Subsidiaries have, and will continue to have, publicly issued preferred stock and long-term debt, the terms of these securities will not be altered or modified or otherwise affected by the Merger or the proposed transaction structure. Accordingly, we do not find that the Merger raises any issue of unfair or inequitable distribution of voting power among National Grid security holders.
There is one unique aspect of National Grid's corporate structure which warrants further discussion. National Grid has a Special Share that is currently owned by the U.K.Government. The Special Share may only be held by the U.K. Government or persons acting on its behalf. It is a single non-voting share that prevents amendments to National Grid's Memorandum and Articles of Association. Those documents in turn restrict certain classes of persons from owning more than a prescribed shareholding in National Grid (as the indirect holder of the transmission license for England and Wales held by National Grid Company). In particular, companies that trade electricity in England and Wales may not own more than 1% of the shares of National Grid, and no party may own more than 15%. The Special Share restricts the ability of National Grid to transfer control of the Transmission License to a third party without the consent of the holder of the Special Share. We agree with the Merger Applicants that these rights do not create an inequitable distribution of voting power of the kind that section 11(b)(2) is intended to prevent. Rather, the Special Share is a means for the U.K. government to protect a regulatory objective – the preservation of the status of National Grid as an independent provider of transmission services in the United Kingdom.72 We therefore find that the Special Share is not inconsistent with section 11(b)(2).73
Section 10(c)(2) of the Act provides that we cannot approve the Merger unless wefind that it will "ten[d] towards the economical and the efficient development of an integrated public-utility system." The Merger Applicants identify various benefits that they anticipate from the Merger, which, they state, satisfy this statutory standard.
The Merger Applicants state that they contemplate benefits from the Merger in two categories. First, National Grid will bring to bear its expertise in providing the infrastructure, dispatch and power exchange necessary for a more efficient New England power supply market. As holder of the only transmission license for England and Wales, National Grid Company is obliged to facilitate competition in the generation and supply of electricity and to offer terms for connection to, and use of, its transmission system to those who request it. National Grid has developed valuable expertise as a result of its combined role of transmission system owner and operator in the U.K. An important feature of this role is the management of transmission congestion limitations. These limitations may result from the thermal capability of power lines or from voltage and system stability considerations. National Grid has developed a multi-faceted approach to managing these constraints. National Grid states that it has significantly reduced costs to suppliers and end-use consumers in the U.K. through the development of its independence from generation and supply. Working with British regulators, National Grid developed an incentive rate structure which allowed it to share in the benefits of meeting certain performance goals related to reliability and the management of the physical limitations of the transmission network. This experience will be relevant to the needs of the NEES System.
The Merger Applicants state that the Merger will enable National Grid to apply itsexperience to the New England electric industry at a time of restructuring.74 The Merger Applicants state that NEES is well-positioned to compete because it has divested most of its generation assets and operates in states where deregulation initiatives are advanced.75 They further assert that National Grid will have the resources and incentive to focus on, and maximize, transmission and distribution opportunities. The NEES Utility Subsidiaries will be able to apply National Grid's skills to improve overall transmission and distribution system operations. This advantage will provide more electricity suppliers with access to customers, thereby increasing competition. This, in turn, should reduce customers' power supply costs.76 The Merger Applicants note that their combination is fully consistent with the FERC's interest in proposed regional transmission organizations.
Second, the Merger Applicants state that the Merger itself will result in savings and efficiencies that will benefit consumers. NEES and National Grid are currently evaluating measures to eliminate duplication and implement best practices. Over time, National Grid's significantly larger scale, in both financial and operational terms, is expected to enhance NEES' ability to use new developments in transmission and distribution technology,information systems, and capital markets.77 These advantages should permit the combined company to provide customers with high quality transmission and distribution services at reasonable costs.
We have previously determined that an acquisition that places a new holding company over an existing integrated system can provide advantages that will tend to produce economies and efficiencies in utility operations and benefit both utility ratepayers and investors.78 The Merger Applicants state that these benefits will begin to be realized almost immediately. Other benefits that will be realized from the Merger are not quantifiable at the present time. As we have noted, however, "specific dollar forecasts of future savings are not necessarily required; a demonstrated potential for economies will suffice even when these are not precisely quantifiable."79 The Merger therefore satisfies the standards of section 10(c)(2).
D. Comments Received on the Merger Application
Three individual shareholders of NEES, Mr. Russell G. Gilmore, Mr. Alfred Lazowand Ms. Jean Solvith, submitted comments on the application.80 We also received letters from Mr. William Freeman, Ms. Allison Allfrey, Mr. David E. Seymour and Ms. Marilyn K. Seymour, and Ms. Virginia C. Mathewson. These individuals did not state whether they have a tangible interest in the Merger. Except for Mr. Gilmore, the individual commenters did not specify whether they were commenting on the Merger Application or the Concept Release.81 In view of the novel issues raised by the Merger Application, we will consider the issues they raised.
As discussed in Part II.B.2. of this Order, Mr. Gilmore requests that we deny the application because the Merger is unfair to small shareholders. Mr. Gilmore also requests that we deny the application for two other reasons.
First, Mr. Gilmore believes that Merrill Lynch may have a conflict of interest as the eleventh-largest shareholder of NEES. Mr. Gilmore further notes that the NEES Board may have an interest in the Merger because of employment contracts they may enter into, or termination payments they may receive, in connection with the Merger. He states that this situation is not in the best interest of small shareholders.
The Merger Applicants state that Merrill Lynch's potential conflicts of interest and the financial interests of the NEES executives were fully described in the NEES ProxyStatement. The Merger Applicants observe that, with this information, the shareholders of NEES overwhelmingly approved the Merger. Approximately 94% of the voted shares, representing 75% of all outstanding shares of NEES, were in favor of the Merger. Approximately 20% and 25% of NEES shares were owned by individual investors holding less than 2,000 and 5,000 shares, respectively, as of December 31, 1998.
We do not believe that Mr. Gilmore's concerns over these potential conflicts warrant a hearing on the Merger Application. Mr. Gilmore does not relate the conflicts of interest which he identifies to the reasonableness of the terms of the Merger for purposes of section 10 of the Act. He does not assert that Merrill Lynch's ownership of NEES shares or the payments to the NEES executives resulted in the terms of the Merger being less favorable to NEES shareholders than they otherwise might have been. As discussed in Part II.B.2. of this Order, the price being paid in the Merger appears to be reasonable based on various objective criteria, including the market price prior to the Merger.82
Second, Mr. Gilmore expresses discomfort at the prospect of foreign ownership of a domestic utility. Ms. Allfrey and Mr. Freeman share this concern. Ms. Allfrey states, "It is shortsighted to put control of public utilities in foreign hands."
Mr. Gilmore specifically mentions national security concerns, particularly with respect to a certain property of Narragansett that is located near a property where General Dynamics assembles parts for nuclear submarines.83 He requests that we exercise ourauthority and "obtain the information from [CFIUS] and make a recommendation to [it] according to the Commission's findings of the facts."84
This particular concern goes to the review of the Merger by CFIUS.85 The Director of the Office of International Investment, Department of the Treasury described CFIUS' role in a letter to Mr. Gilmore dated August 4, 1999. The letter explains that CFIUS reviews and, if necessary, investigates, foreign acquisitions of U.S. businesses to determine their national security implications. If the President determines that a foreign acquisition threatens national security, the statute gives the President broad authority to suspend or prohibit the transaction.
As noted previously, the Merger Applicants were informed on April 29, 1999 that CFIUS concluded that there were no issues of national security with respect to the Merger to warrant an investigation.86 In view of the role of CFIUS, we do not believe that it isnecessary for us to consider, in this matter, whether national security concerns implicate the Act's public interest standard.87
To the extent that these individuals have raised issues of law under the Act, we are able to address them on the basis of the record before us. None has requested a hearing. (Mr. Gilmore has requested an opportunity to be heard if a hearing is held.) It is well settled that evidentiary hearings are required only when there exists a genuine issue of material fact.88 The proponent of the hearing must make a minimal showing that material facts are in dispute; the intervenor cannot rely on bald or conclusory allegations that a dispute exists.89 On the basis of our review, we are satisfied that no hearing is needed in this matter.
III. Proposed Financing Transactions and Arrangements
A. Summary of Requested Authorizations
National Grid proposes to issue equity and debt securities, subject to various conditions and in amounts that, except as noted below, would not exceed the Aggregate Limitation ($4 billion) at any one time outstanding during the Authorization Period (through May 31, 2003). The Aggregate Limitation includes amounts borrowed under the BankCredit Facility, as discussed in Part I.B.2. above.
The Financing Applicants note that the issuance of debt is subject to certain objective conditions that are intended to ensure the financial integrity of National Grid and the NEES Group. Our authorization of the Financing Application is subject to several conditions and limitations, including:90
(1) National Grid will maintain its long-term debt rating at an investment grade level as established by a nationally recognized statistical rating organization;91
(2) The National Grid System will maintain a ratio of Consolidated Earnings Before Interest, Taxes, Depreciation and Amortization to Net Interest Payable of not less than 3:1 and a ratio of Consolidated Total Net Debt to Consolidated Earnings Before Interest, Taxes, Depreciation and Amortization not to exceed 4.75:1;92
(3) National Grid will maintain the common stock equity of NEES on a consolidated basis and the NEES Utility Subsidiaries, individually, at a minimum of 35% of total capitalization, a percentage higher than our normal standard of 30%;93 and
(4) National Grid will cause its consolidated common equity percentage expressed as a percentage of consolidated total capitalization, measured on a book value US GAAP basis, to be 28.5% or above at the time the Merger is completed and thereafter during the Authorization Period, and 30% or above by March 31, 2002 and thereafter.
The types and terms of securities that National Grid may issue during the Authorization Period are described more fully in Appendix E to this Order. Particular types of securities are subject to maximum amounts (all subject to the Aggregate Limitation):94
Ordinary Shares – not to exceed $500 million ("Equity Limitation")
95
Preferred Securities – not to exceed $100 million
Debt Securities:
Bank Debt – not to exceed $3 billion
Commercial Paper – not to exceed $3 billion
Convertible Bonds – not to exceed $1 billion
Nonconvertible Bonds – not to exceed $3 billion
In addition, National Grid seeks authorization to issue guarantees. The guarantees would not be subject to the Aggregate Limitation, but would instead be subject to a separate$2 billion limit, based on the amount at risk.
Finally, as described in greater detail below, National Grid seeks authorization to engage in additional EWG and FUCO financings for the purpose of additional investments in these entities ("FUCO Financings").
NEES and certain NEES Subsidiaries are currently authorized under various orders (the "Existing Financing Authorizations"), described in Appendix D to this Order, to engage in certain financings. The Financing Applicants request that we extend the term of these Existing Financing Authorizations through the Authorization Period. The Financing Applicants also request that we authorize financing transactions among the Intermediate Holding Companies and National Grid. The details of these new authorizations are also described in Appendix E.
The Financing Applicants request authority for the NEES Subsidiaries to pay dividends out of additional paid-in-capital and to enter into a Tax Allocation Agreement. The Financing Applicants also request a waiver from rule 26(a)(1) (governing the preparation of financial statements of subsidiaries) for any existing subsidiary of National Grid Holdings organized outside the United States. Finally, as discussed in Exhibit E, the Financing Applicants seek authorization to make changes to the terms of capital securities and to form financing entities that would issue securities authorized by this Order or an applicable exemption under the Act.
B. Discussion of Proposed Financing Transactions and Other Requests
The proposed financing transactions and other arrangements are variously subject to sections 6(a), 7, 9(a), 10, 12(b), 12(c), 32 and 33 of the Act and rules 42, 43, 45, 52, 53 and 54. We have reviewed the proposed transactions and find that the requirements of the Act are satisfied. We wish to address, in particular, certain of the proposed financing transactions by National Grid, the Financing Applicants' proposed payment of dividends out of capital or unearned surplus, the proposed Tax Allocation Agreement and the waiver from rule 26(a)(1).
The proposed issuance and sale of debt securities by National Grid is subject to sections 6 and 7 of the Act. These sections place various limitations on the types of securities that registered system companies may issue. In addition, section 7 provides that we cannot authorize the issuance of a security if we find, among other things, that the security:
In addition, insofar as the proposal concerns the issuance of securities for purposes of financing the acquisition of one or more EWGs ("EWG Financings"), the transactions are subject to section 32(h)(3) of the Act and rule 53, adopted under section 32(h)(6). Similarly, insofar as the proposal concerns the FUCO Financings, the transactions are subject to section33(c)(2) of the Act.
a. Merger-Related Debt and Senior Securities; Adequacy of Equity Capitalization
National Grid proposes to issue the Merger-Related Debt and other senior securities. Section 7(c) of the Act addresses the kinds of securities that a registered holding company may issue, subject to the standards of section 7(d). Section 7(c)(1), which specifies the types of securities a registered holding company may issue, omits long-term unsecured debt securities.96 Section 7(c)(2)(D) provides an exception for securities that are issued "for necessary and urgent corporate purposes of the [registered holding company] where the requirements of [section 7(c)(1)] would impose an unreasonable financial burden upon the [registered holding company] and are not necessary or appropriate in the public interest or for the protection of investors or consumers." National Grid states that a restriction against parent-level debt would create an unreasonable financial burden that is not necessary or appropriate in the public interest or for the protection of investors or consumers because itmay interfere with National Grid's ability to implement an optimal capital structure for its business, including the financing of the Merger.
We recently concluded in another matter that section 7(c)(2)(D) permits the issuance of other securities for purposes which the holding company finds to be "compelling or crucial to its operations, whether utility or non-utility."97 We stated that the concern that holding company debt could create greater pressure to milk public-utility ratepayers could be addressed through section 7(d).98 Section 7(d) provides that we may not approve the issuance of a security if, among other things, it is not reasonably adapted to the securities structure or earnings power of the issuer.
In considering whether the standards of section 7(d) are satisfied in this matter, we considered that National Grid's equity ratio may, at the time of the Merger, be as low as 28.5%. This equity ratio is somewhat lower than the 30% that we have traditionally viewed as adequate.99 The Financing Application states that National Grid's capitalization ratio is not a true measure of its financial strength. This assertion is supported by the credit rating agencies, which have indicated that National Grid's debt, which currently has a "AA" rating from Standard & Poor's and an A1 rating from Moody's, will be rated "A" after the Merger(well within the range of U.S. utility companies).100 More importantly, National Grid has undertaken to bring its equity ratio to and maintain it at or above 30% by March 31, 2002 and has agreed to be subject to a number of other conditions that suggest that its equity ratio will be adequate.101 We find that the proposed issuances and sales of long-term debt, preferred securities and equity satisfy the standards of section 7(d). In reaching this conclusion, we have subjected the requested authorizations to the scrutiny that we give to applications requesting additional authority to issue securities to invest in EWGs and FUCOs, where the "safe harbor" of rule 53 is unavailable.
b. EWG and FUCO Financings
National Grid has adopted a corporate structure that separates its FUCO Investment from its U.S. utility operations. The organization of foreign activities under National Grid Holdings, and U.S. utility activities under NEES, reflects National Grid's intent to develop these two business areas in a financially independent manner. As a general matter, National Grid intends to fund its FUCO activities at the level of its first-tier subsidiary, National Grid Holdings. Under certain circumstances, however, it may be desirable from time to time for National Grid to provide some investment capital or credit support for FUCO acquisitions or operations. To that end, National Grid is seeking authority to finance additional EWG and FUCO investments and operations in an aggregate amount of up to 50% of its consolidatedretained earnings at any one time outstanding during the Authorization Period.102 Based on the pro forma consolidated retained earnings of National Grid after the Merger, this authorization would allow National Grid to invest an additional $874 million in EWGs and FUCOs.103 The additional investment would result in an aggregate investment of approximately 252%, or approximately $4,406 million.
National Grid cannot rely upon the safe harbor of rule 53 because of its significant existing FUCO Investment.104 In addition, it does not satisfy the conditions of rule 53(a) concerning books and records.105 Accordingly, it is appropriate to analyze National Grid's proposal, insofar as it concerns EWG Financings, under rule 53(c), in addition to sections 6 and 7 and rule 53(b). As noted by the Court of Appeals for the District of Columbia Circuit, an EWG Financing that does not satisfy the threshold test - - expressed in rule 53(a) as a "no substantial adverse impact test" – is outside the safe harbor of rule 53 and, under rule 53(c), is subject to heightened scrutiny, both for substantial adverse impact on thefinancial integrity of the system and for adverse impact on any system utility or its ratepayers or state regulatory authorities.106 As we have in the past, we are also analyzing the Financing Application, insofar as it concerns FUCO Financings, under rule 53, in addition to sections 6 and 7. Rule 53 addresses the considerations identified in section 32(h)(6), which we believe are also relevant to the FUCO Financings.107
The Financing Application states that the use of proceeds from its issuance of debt and equity securities to invest in EWGs and FUCOs, and National Grid's issuance of guarantees in connection with these investments, will not have a substantial adverse impact on the financial integrity of the National Grid System. In support of this assertion, the Financing Application notes the following:
(1)National Grid's credit rating is currently ranked AA by Standard & Poor's;108
(2)During each of the past five years, income from National Grid Company's operations has contributed positively to National Grid's overall earnings;109 and
(3)None of the conditions described in rule 53(b) exists.110
The Financing Applicants state that the soundness of National Grid's financial structure and the lack of risk to U.S. ratepayers are further demonstrated by its commitment to satisfy the various conditions in the Financing Application reflecting its financial strength.111
The Financing Applicants further state that the proposed EWG and FUCO Financings will not have an adverse impact on any of the NEES Utility Subsidiaries or their ratepayers, or on the ability of interested state commissions to protect utilities and their customers. In support of this contention, the Financing Application states the following:
(1)The NEES Utility Subsidiaries are insulated from the direct effects of EWG and FUCO investments. None of the NEES Utility Subsidiaries will extend its credit or pledge its assets to any EWG or FUCO in which National Grid owns an interest. National Grid further commits not to seek recovery in retail rates for any failed investment in, or inadequate returns from, an EWG or FUCO investment;
(2)NEES' commercial paper is rated A-1 by Standard & Poor's and Prime-1 by Moody's. The long-term debt of Massachusetts Electric, Narragansett and NEP is rated AA-, A1; AA-, A1; and A+, A1 by Standard & Poor's and Moody's, respectively;112
(3)The NEES Utility Subsidiaries currently have in place financial facilities that are adequate to support their operations;113
(4)National Grid has complied with and will continue to comply with rules 53(a)(3) and 53(a)(4);114 and
(5)National Grid will provide the information required by Form 20-F to permit us to monitor the effect of National Grid's FUCO investments on National Grid's financial condition.
In addition, the Financing Application states that National Grid's successful operation of a national, high-voltage transmission system should demonstrate its sound management skills and expertise, particularly with respect to foreign utility operations.
With respect to new EWG or FUCO ventures, the Financing Application states that National Grid subjects all project proposals to stringent reviews, including consideration of business, financial, regulatory, environmental and legal risks. Once development of a project is undertaken, milestones are established to ensure that continuing expenditures are producing acceptable results. In addition, project teams are established to identify the major technical, financial, commercial and legal risks associated with a particular project and risk mitigation strategies.
Based on these factors, we find that National Grid has made the requisite showing under rule 53(c).
As a result of the accounting treatment of the Merger, the retained earnings of NEES and the NEES Subsidiaries will be effectively reset to zero as if they were new companies, with the balance being reflected in paid-in-capital.115 For this reason, the Financing Applicants request authorization to pay dividends out of the additional paid-in-capital account up to the amount of the NEES Subsidiaries' aggregate retained earnings just prior to the Merger and out of earnings before the amortization of the goodwill after the Merger. In no case would dividends be paid, however, if the common stock equity of NEES as a percentage of total capitalization was below 35% on a consolidated basis.
Section 12(c) and rule 46(a) make it unlawful for a registered holding company or subsidiary to declare or pay a dividend in contravention of rules or orders that we may prescribe "to protect the financial integrity of companies in holding-company systems, to safeguard the working capital of public-utility companies, to prevent the payment of dividends out of capital or unearned surplus, or to prevent the circumvention of the provisions of [the Act]." Congress intended section 12(c) to prevent the "milking of operating companies in the interest of the controlling holding company groups" and to safeguard the working capital of the public-utility companies.116
Rule 46(a) prohibits a registered holding company from paying dividends out of capital or unearned surplus "except pursuant to a declaration . . . and . . . order of the Commission[.]" In determining whether to permit a registered holding company to pay dividends out of capital surplus, we are guided by the standards of section 12(c).117 We consider various factors, including: (1) the asset value of the company in relation to its capitalization; (2) the company's prior earnings; (3) the company's current earnings in relation to the proposed dividend; and (4) the company's projected cash position after payment of a dividend.118 Further, the payment of the dividend must be "appropriate in the public interest" and in the best interests of the security holders.119
In support of their request, the Financing Applicants state the following:
(1)The Financing Applicants anticipate that NEES' cash flow after the Merger will not differ significantly from its pre-Merger cash flow and that earnings before the amortization of goodwill ("Gross Earnings"), therefore, should remain stable after the Merger. Applicants intend that dividends paid out of post-Merger earnings will continue to reflect a dividend payout ratio of between 60% and 100% of Gross Earnings, based on a rolling 5-year average. In addition, to assure that the U.S. Utility Subsidiaries have sufficient cash to support their businesses, the Financing Applicants will not cause any of the U.S. Utility Subsidiaries to pay more than 80% of its Gross Earnings as dividends, based on a rolling 5-year average;120
(2)The projected cash position of NEES and its Utility Subsidiaries after theMerger will be adequate to meet the obligations of each company. As of September 30, 1999, NEES had cash balances of $201 million on a consolidated basis. The amortization of goodwill is a non-cash expense that will not affect the cash flow of the companies in the NEES Group. It is anticipated that each company will have sufficient cash to pay dividends in the amounts contemplated;
(3)NEES' commercial paper is rated A-1 by Standard & Poor's and Prime-1 by Moody's. The long-term debt of Massachusetts Electric, Narragansett and NEP is rated AA-, A1; AA-, A1; and A+, A1 by Standard & Poor's and Moody's, respectively;
(4)NEES has a favorable history of prior earnings and a long record of consistent dividend payments; and
(5)After the Merger, and after giving effect to the pushdown of goodwill, NEES' common stock equity as a percentage of total capitalization will be 75%, substantially in excess of the traditional levels of equity capitalization that the Commission has authorized for other registered holding-company systems. Applicants' commitment to maintain the capitalization of NEES at or above 35% common stock equity on a consolidated basis should result in a capital structure consistent with industry norms. As of September 30, 1999, the NEES Utility Subsidiaries had approximately $1.05 billion of long-term debt, representing 42% of the net book value of utility assets. This debt position is substantially less than that required by traditional electric utility indenture covenants, which limited secured debt to no more than 60% of utility property additions.
The Financing Applicants' request to pay dividends from capital surplus therefore does not contravene the intent of section 12. The Applicants' proposal is motivated by exceptional circumstances, i.e., the "push down" of goodwill, and is clearly not the type of situation that section 12 is designed to address. We are satisfied that granting the requested authorization will not be detrimental to the financial integrity or working capital of the NEES Utility Subsidiaries.
The Financing Applicants request approval of a proposed Tax Allocation Agreementfor the allocation of consolidated tax among certain of the U.S. Subsidiaries, specifically, National Grid General Partnership ("NGGP") and the NEES Group, following the Merger. Our approval is necessary under section 12(b) of the Act and rule 45(a) because the exemption from the requirement of a declaration provided by rule 45(c) is unavailable.
Rule 45(a) provides that a registered system company must file a declaration and receive an order before it may lend or extend credit to, indemnify, or make any donation or capital contribution to any system company. Rule 45(c) provides that a declaration under rule 45(a) is not required for the filing of a consolidated tax return that is filed under a tax allocation agreement that satisfies the requirements of rule 45(c). Under rule 45(c), the filing of a consolidated tax return by a registered holding company and its subsidiaries under a tax allocation agreement entitles the consolidated tax to be apportioned among the members of the registered system in proportion to either every member's taxable income or separate tax return. The rule permits holding company subsidiaries to make payments to other subsidiaries in exchange for the allocation of tax losses – but not to the holding company. In contrast, the proposed Tax Allocation Agreement provides for payments to be made to one of the Intermediate Holding Companies, NGGP, in exchange for the tax benefits of the interest related to the Merger-Related Debt.121
The Financing Applicants explain that National Grid may suffer an increased U.K. taxliability without the Tax Allocation Agreement. U.K. corporate law considers each company as a separate entity, regardless of whether a company is a wholly owned subsidiary of another.122 Each company is also taxed separately. The U.K. does not have a system of consolidated groups. If one company in a group has a loss for tax purposes, it may "surrender" that loss to another member and thereby reduce the receiving company's taxable profits by the amount of the loss surrendered.
The Financing Application states that payment for the tax losses is necessary for two reasons. First, because the companies are separate entities for corporate law purposes, and because a tax loss that is not surrendered is available to reduce future taxable profits and thus tax liabilities, a loss is considered to be an asset. The Financing Applicants state that payment for losses is generally made to avoid the possibility that transfer of a potentially valuable asset – the losses – be voided under creditor protection laws.
In addition, payment for the losses may be necessary to assure that the holding company will receive appropriate tax credits under U.K. law for non-U.K (i.e., U.S.) taxes paid on subsidiary operations. In this sense, the Tax Allocation Agreement is not used to allocate the tax paid, but to compute the amount of post-tax profits for determining the amount of U.K. tax credits available to National Grid. For example, when a U.K. company receives a dividend from a U.S. subsidiary, it is subject to a U.K. tax on the dividend but is given a credit for the U.S. tax borne on the profits out of which the dividend has been paid. The amount of the U.K. tax credit is based on the proportion of the dividend to the "relevantprofits" of the subsidiary. If the relevant profits exceed the amount of the dividend, the full amount of the potential tax credit – the amount of the U.S. taxes paid – will not be available. By paying for the tax losses, the U.S. subsidiary will reduce its relevant profits to the point that a full credit for U.S. taxes can be taken.
The Tax Allocation Agreement is designed to permit NGGP to receive current payment if a "separate return limitation" is observed; that is, the NEES Utility Subsidiaries' tax payments and tax allocation payments together will not exceed their tax payments on a separate return basis. The Financing Applicants provide an illustration of the operation of this limitation. Assume that NGGP will pay interest of $132 million per year to National Grid. Also assume that the NEES Utility Subsidiaries owe $76.2 million of taxes prior to their "acquisition" of National Grid General Partnership's tax losses. As a result of the transfer of the tax losses, the tax liability of the NEES Utility Subsidiaries would be reduced by $46.2 million (35% of $132 million – the applicable U.S. corporate tax rate). Under the proposed Tax Allocation Agreement, the NEES Utility Subsidiaries would make a payment of $46.2 million to NGGP to leave their total tax expense the same as it would be on a separate return basis.
It does not appear that approval of the Tax Allocation Agreement would lead to abuses that section 12 is intended to prevent, and therefore approval will not be detrimental to the NEES Group and its consumers. The "separate return" limitation will assure that the NEES' Utility Subsidiaries tax liability will not be higher than it otherwise would have been. In addition, the Financing Applicants note that the conditions applicable to our authorization with respect to dividend payments will provide additional protections. Consequently, the TaxAllocation Agreement does not provide a means for a foreign parent holding company to "milk" the U.S.-organized companies.
In addition, because the NEES Group has no obligation with respect to the Merger-Related Debt and the debt does not affect the NEES Group's financial position or credit, it is not inappropriate to exclude these companies from the benefits of the tax consequences arising out of the debt. Accordingly, we approve the use of the Tax Allocation Agreement.123
The Merger Applicants also request a waiver from the requirement of rule 26(a)(1) under the Act, regarding the maintenance of financial statements in conformity with Regulation S-X. The Applicants state that, due to National Grid's extensive foreign holdings, significant additional work and expense would be required for the holding company to prepare consolidated financial statements in conformity with Regulation S-X.
The exemption would apply only to existing subsidiaries of National Grid Holdings that are organized outside of the U.S. Any new foreign subsidiary that engages in foreign utility operations will maintain its financial statements in accordance with U.S. GAAP or reconcile the financial statements to U.S. GAAP in the same manner as required by Form 20-F. National Grid or the new foreign subsidiary will also file Form U-57.
We believe that it is appropriate to grant the requested waiver. The reportingrequirements of this Order, together with the reconciliation of financial statements to U.S. GAAP should enable us to oversee the operations of the National Grid System companies, including intrasystem transactions.
The Merger Applicants will file Form U5S annually within 120 days of the close of National Grid's fiscal year. In addition, as required by the Securities Exchange Act of 1934 and the Securities Act of 1933, respectively, National Grid will file Form 20-F (a semiannual report containing earnings information), a report within 60 days of the end of National Grid's second fiscal quarter containing consolidating financial statements of NEES and the NEES Subsidiary Companies, and reports on Form 6-K containing material announcements as made.
To maintain a consistent presentation of financial information, National Grid's Form U5S filing will present the holding company's consolidated financial statements in the format required by Form 20-F, i.e., U.K. GAAP format reconciled to U.S. GAAP. In addition, the Merger Applicants propose that the Form U5S filing will contain: (1) U.S. GAAP financial statements for all the NEES Group companies; and (2) U.S. GAAP financial statements or financial statements in the format required by Form 20-F for (a) National Grid Holdings, on a consolidated basis, and (b) the Intermediate Holding Companies. Form U5S filings will state amounts in U.S. dollars.
National Grid will also provide the following supplemental information in its annual Form U5S filing:
(1)The amount of any income tax credit and/or income tax liability incurred during the previous fiscal year by National Grid General Partnership (a) as a result of any Merger-Related Debt; and (b) as a result of any other income source or expense;
(2)A description of how the income tax credit and/or income tax liability was calculated and allocated to all companies included in the consolidated tax return, showing all of National Grid General Partnership's interest costs and any assumptions used in the calculation;
(3)A description of how any Merger-Related Debt flows through all Intermediate Holding Companies;
(4)A description of the amount and character of any payments made by each Intermediate Holding Company to any other National Grid System company during the reporting period; and
(5)A statement that the allocation of tax credits and liabilities was conducted in accordance with the Tax Allocation Agreement in effect and filed as an exhibit to the Form U5S.
We believe that these reporting requirements, together with the other reporting requirements in this Order and the Form 20-F reconciliation, will enable us to oversee the operations of the National Grid System companies, including intrasystem transactions.
We have carefully examined the Merger Application and the Financing Application under the applicable standards of the Act, and have concluded that the proposed transactions are consistent with those standards. We have reached these conclusions on the basis of the complete record before us.
No federal or state commission other than this Commission has jurisdiction over the proposed transactions, other than as discussed above. As noted above, Merger Applicants state that fees and expenses in connection with the Merger will be approximately $54.2 million. Financing Applicants state that fees and expenses in connection with the proposed financing transactions will be approximately $30 million.
Due notice of the filing of the Merger Application has been given in the mannerprescribed in rule 23 under the Act, and no hearing has been ordered by the Commission. Upon the basis of the facts in the record, it is hereby found that the applicable standards of the Act and rules thereunder are satisfied, and that no adverse findings are necessary:
It is ordered, under the applicable provisions of the Act and rules thereunder, that the application, as amended, be, and it hereby is, granted immediately, subject to the terms and conditions prescribed in rule 24 under the Act and to the reporting requirements set forth in Appendix C and below.
Due notice of the filing of the Financing Application has been given in the manner prescribed in rule 23 under the Act, and no hearing has been requested of, or ordered by, the Commission. Upon the basis of the facts in the record, it is hereby found that the applicable standards of the Act and rules thereunder are satisfied, and that no adverse findings are necessary:
It is ordered, under the applicable provisions of the Act and rules thereunder, that the application-declaration, as amended, be, and it hereby is, granted and permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24 under the Act and to the following:
Rule 24 certificates will be provided to the Commission within 90 days after the end of National Grid's fiscal year and within 60 days of the end of its second fiscal quarter and will contain the following information:
(1)The principal amount, interest rate, term, number of shares, market price per share, sales price per share (if other than market price) and aggregate proceeds, as applicable, of any securities issued by National Grid during the reporting period, including securities issued to dividend reinvestment plans and employee benefit plans;
(2)The amount of guarantees issued during the reporting period by National Grid, the name of the beneficiary of the guarantee and the terms and purpose of the guarantee;
(3)National Grid's aggregate investment, as defined under rule 53, in EWGs and FUCOs as of the end of the reporting period in dollars and as a percentage of National Grid's consolidated retained earnings, and a description of EWG and FUCO investments made during the reporting period;
(4)The aggregate amount of securities and the aggregate amount of guarantees issued and outstanding by National Grid since the date of this Order, including any Merger-Related Debt;
(5)A list of the securities issued by the Intermediate Holding Companies during the reporting period, including principal amount, interest rate, term, number of shares and aggregate proceeds, as applicable, with the acquiring company identified;
(6)The amount and terms of any short-term debt issued by any NEES Utility Subsidiary, and a list of the deposits and withdrawals by any NEES Subsidiary from the NEES Group Money Pool (as defined in Appendix D) during the reporting period;
(7)The amount and terms of any nonexempt financings consummated during the period by any U.S. Utility Subsidiary during the reporting period;
(8)The amount and terms of any nonexempt financings consummated by any NEES Nonutility Subsidiary during the reporting period;
(9)A retained earnings analysis of each company in the NEES Group detailing gross earnings, goodwill amortization, dividends paid out of each capital account, and the resulting capital account balances at the end of the reporting period;
(10)A table showing, as of the end of the reporting period, the dollar and percentage components of the capital structures of National Grid, National Grid Holdings, each Intermediate Holding Company, and each NEES Group company;
(11)Copies of National Grid's filings on Form 20-F and semiannual reports to shareholders; and
(12)As applicable, all amounts shall be expressed in pounds sterling and converted to U.S. dollars and shall be presented in accordance with the U.S. GAAPreconciliation requirements of Form 20-F. In particular, the semiannual reports provided in rule 24 filings under this Order shall be organized so that all columns showing amounts in pounds sterling in financial statements or tables are accompanied by parallel columns showing U.S. dollar amounts.
By the Commission.
Jonathan G. Katz
Secretary
1 National Grid is a public-utility holding company by reason of its ownership of a U.K. public-utility company and other foreign utility properties. Although the legislative history of the Act indicates that Congress was concerned exclusively with abuses of holding-company systems in the United States, the defined terms of the Act have been interpreted broadly enough to extend the provisions of the Act to entities located and doing business anywhere in the world. See, e.g., Okin v. SEC, 154 F.2d 27, 29 (2d Cir. 1946).
National Grid is currently exempt from registration under the Act by rule 5. Rule 5, adopted in 1941 under section 3(a)(5) of the Act, provides an exemption from registration to a holding company that is organized under foreign law and owns no U.S. utility assets. Section 3(a)(5) permits us to exempt from registration under the Act any holding company that does not, directly or indirectly, derive a material part of its income from "a company or companies the principal business of which within the United States is that of a public-utility company."
2 National Grid has a small number of American Depositary Shares ("ADSs") in the U.S. which trade as ADRs and are principally held by U.S. institutions. ADSs, in the aggregate, account for less than 1% of National Grid's publicly issued shares.
3 National Grid Report on Form 20-F dated October 4, 1999. The Merger Applicants describe the Special Share, a non-voting share owned by the U.K. government, as a means to preserve National Grid's status as an independent provider of transmission services. The Special Share has been referred to as the "Golden Share." See Part II.C.2.b. of this Order for a discussion of the Special Share.
4 Unless otherwise indicated, all financial information concerning National Grid and its consolidated subsidiaries presented in this Order is based upon U.S. Generally Accepted Accounting Procedures ("U.S. GAAP"). The figures for revenues, net income and assets were translated into dollars using a rate of $1.60 equals one pound sterling. Consistent with U.S. GAAP, National Grid's share of joint ventures and associates' businesses is included in net income and assets, but excluded from revenues.
5 Appendix A to this Order is a corporate organization chart showing National Grid and its subsidiaries after the Merger. [Webmaster Note: Appendix A is a PDF file]
6 The NEES Nonutility Subsidiaries are described in Appendix B to this Order.
NEES has entered into an agreement to acquire all of the outstanding common stock of Eastern Utilities Associates ("EUA"), a registered holding company, which has electric utility operations in Massachusetts and Rhode Island. See Holding Co. Act Release No. 27105 (Nov. 19, 1999) (notice). The completion of the EUA acquisition is not conditioned on the completion of the Merger.
7 NEES also holds a 0.8% ownership in Unitil Corporation, a registered holding company. NEES acquired the interest in 1992 in exchange for its interest in Fitchburg Gas and Electric Company when that company was acquired by Unitil Corporation. See UNITIL Corp., Holding Co. Act Release No. 25524 (Apr. 24, 1992).
8 NEP is also a holding company by reason of its ownership of more than 10% of Vermont Yankee Nuclear Power Corporation, the operator of the Vermont Yankee nuclear facility. NEP also has minority interests in Yankee Atomic Electric Company, Maine Yankee Atomic Power Company and Connecticut Yankee Atomic Power Company, all of which have permanently ceased operations. NEP is exempt from registration by order under section 3(a)(2) of the Act. See Yankee Atomic Electric Co., Holding Co. Act Release No. 13048 (Nov. 25, 1955); Connecticut Yankee Atomic Power Co., Holding Co. Act Release No. 14968 (Nov. 15, 1963).
9 NEP and Narragansett are members of the New England Power Pool ("NEPOOL"). Massachusetts Electric, Nantucket and Granite State participate in NEPOOL through NEP.
10 NEP is subject to regulation by the Maine Public Utilities Commission for certain purposes, but not as a public-utility company.
11 In the Merger, NEES will merge with NGG Holdings, LLC, with NEES as the surviving corporation. NEES will then be merged again into another limited liability company, with the latter as the surviving entity, which in turn will merge into NGG Holdings, Inc., aMassachusetts corporation, with NGG Holdings, Inc. as the surviving entity. NEES' outstanding shares will be cancelled and NEES will become an indirect wholly-owned subsidiary of National Grid. See Appendix A to this Order. Thus, the form of organization of NEES will change from a Massachusetts business trust to a Massachusetts corporation. The modification of NEES' form may result in a different corporate name. All references to NEES after consummation of the Merger refer to NEES and its corporate successor. [Webmaster Note: Appendix A is a PDF file]
12 Shares held by NEES as treasury stock (other than treasury shares held to satisfy certain benefit obligations) and shares held by NEES Subsidiaries or by National Grid System companies will not be converted into cash.
13 NEES' shareholders approved the Merger on May 3, 1999.
14 The foreign Intermediate Holding Companies are two U.K. entities, National Grid (US) Holdings and National Grid (US) Investments, and two Luxembourg entities, National Grid (Ireland) 1 Limited and National Grid (Ireland) 2 Limited. The domestic Intermediate Holding Companies are National Grid General Partnership and NGG Holdings, Inc.
15 As of September 30, 1999, National Grid had cash deposits on hand of $2.432 billion. National Grid also intends to finance NEES' proposed acquisition of EUA through a combination of borrowings under the Credit Facility described below and internal cash resources.
16 The facility is available to National Grid, its wholly owned U.K. subsidiaries other than National Grid Company, and other National Grid subsidiaries as the banks may approve in writing. The Merger Applicants state that they expect that, after other banks are added to the facility, more than 70 banks may extend loans under the Bank Credit Facility.
17 NEP has a small amount of transmission in Vermont and therefore is deemed to be a Vermont public utility. While the Vermont Commission has no regulatory jurisdiction over NEP's operations, it does have authority under state law to approve the Merger. The Vermont Commission issued its order approving the Merger on June 15, 1999.
The Connecticut Commission has jurisdiction over the Merger because of NEP's minority ownership interest in the Millstone III Nuclear Power Plant. The Connecticut Commission issued its order on June 30, 1999.
The New Hampshire Commission, which has jurisdiction over Granite State and NEP, approved the Merger by order dated October 4, 1999.
18 See New England Power Co., et al., 87 FERC ¶ 61,287 (June 16, 1999) (the "FERC Order").
19 In the Matter of Northeast Nuclear Energy Co., Order Approving Application Regarding Merger of New England Electric System and the National Grid Group Plc, Dkt. No. 50-423 (Dec. 10, 1999), and In the Matter of North Atlantic Energy Service Corp., Order Approving Application Regarding Merger of New England Electric System and the National Grid Group Plc, Dkt. No. 50-443 (Dec. 10, 1999).
20 See Re: CFIUS Case 99-16: The National Grid Group plc (UK)/New England Electric System, attached as Exhibit L-1 to the Merger Application. "[S]ection 721 of the Defense Production Act authorizes the President or the President's designee to review certain mergers, acquisitions and takeovers which could result in foreign control of persons engaged in interstate commerce in the United States. Executive Order 12661, signed December 27, 1988, designates [CFIUS] to receive notices and initiate investigations under section 721." The role of CFIUS is also discussed in Part II.D. of this Order.
21 This authorization is discussed in Part III.B.1.b. of this Order. National Grid's FUCO Investment is also discussed in Part II.A.3. of this Order.
22 As of September 30, 1999, 50% of National Grid's consolidated retained earnings on a U.S. GAAP basis would have been $874 mi