Cinergy Corp. ("Cinergy"), a Delaware corporation and registered holding company ("RHC") under the Public Utility Holding Company Act of 1935, 15 U.S.C. § 79a et seq. (the "Act"), is submitting these comments in response to the Commission's recent notice of proposing rulemaking concerning the acquisition and ownership by RHCs of foreign utility companies ("FUCOs").1
The centerpiece of the FUCO NOPR is proposed Rule 55, a "safe harbor" permitting investments in EWGs and FUCOs equal to 50% of consolidated retained earnings ("50% Cap"), if specified conditions are met. Proposed Rule 56 clarifies the status of special-purpose subsidiaries formed to hold interests in FUCOs. Rule 87 would be amended to require prior Commission approval for transactions involving sales of goods or services between EWGs and FUCOs and associate companies. Form U-57 would also be amended to require disclosure of information regarding financing of the FUCO acquisition, including the purchase price. Finally, the Commission solicits comments on the advisability of possible limitations on the ability of a holding company to qualify foreign operations as a FUCO.
Cinergy believes that Rule 55 is unnecessary, in that there is already a safe harbor rule, Rule 53, governing investments in both EWGs and FUCOs. Rule 55 carries over the same 50% Cap as Rule 53 and all of its other conditions and restrictions. Thus to that extent it is merely a "cut and paste," duplicating constraints in effect since 1993. However, Rule 55 also imposes new conditions applicable strictly to FUCO investments, such as a requirement that a RHC's board of directors review and approve each FUCO investment (whatever the size) and make enumerated findings, and a provision foreclosing the 50% safe harbor for non-investment grade domestic utility affiliates. These new restrictions are unwarranted. Rule 53 and the terms and conditions of Commission orders issued to those RHCs authorized to invest at levels above the 50% Cap are more than adequate to address concerns relating to financial integrity and protection of domestic consumers. Although touted as affording RHCs "greater flexibility and fewer administrative burdens,"2 plainly Rule 55 would have exactly the opposite effect, imposing new administrative barriers to FUCO investments, even as "[t]he utility business is rapidly evolving into a global industry."3
The overriding impetus for proposed Rule 55 appears to be not a concern that the Rule 53 conditions do not adequately address financial integrity and consumer protection considerations, but rather a desire to conform to the "letter" of Section 33(c)(1), which directs the Commission to promulgate rules regarding RHCs' acquisitions of interests in FUCOs.4 To resolve this technical issue, the Commission could simply amend Rule 53 to make explicit that its scope covers issuances of securities to finance not just EWG but also FUCO investments. That would square the language of Rule 53 with the Commission's settled practice of applying the rule for investments in both EWGs and FUCOs.
At the same time that it considers such a clarifying amendment to Rule 53, the Commission should revisit certain of the substantive restrictions contained in the rule, which experience or industry developments have shown to be inappropriate or outmoded. In particular, Cinergy recommends that the Commission (i) use a different benchmark than retained earnings (such as consolidated capitalization) as the yardstick for safe harbor investments; (ii) increase the safe harbor investment ceiling to accommodate the deregulation of electricity generation in the U.S. and growing demand; and (iii) exclude from "aggregate investment" any generating facilities transferred from a utility subsidiary to an EWG associate company.
Rule 53 should further be revised to permit a FUCO or foreign EWG to keep its books and records in conformity with local accounting standards, so long as those standards are sufficient to enable the Commission to determine whether transactions between the FUCO/EWG and other companies in the RHC system comply with the Act's requirements. Cinergy also recommends that the audit requirements of Form U5S be revised to eliminate the requirement for separate audited financial statements for majority-owned EWGs and FUCOs. At a minimum, audited financial statements should not be required for small investments.
Regarding the other proposals, Cinergy supports proposed Rule 56, but requests further clarification. Would this type of FUCO need to file a Form U-57? The proposed amendment to Rule 87 is unnecessary and over-inclusive, given the existing restriction on services by domestic utility affiliates contained in Rule 53. The proposed change to Form U-57 requiring disclosure of the purchase price, which is typically confidential and proprietary to the buyer and seller, is inappropriate.
Finally, concerning permissible activities of a FUCO, the statutory definition imposes no "exclusivity" requirement, unlike the EWG provisions enacted as part of the same legislation. So long as a FUCO satisfies the statutory criteria, and any other businesses it conducts are of a type that the Commission or Congress have found consistent with the Act's restrictions on diversification, or that otherwise are customary for foreign utilities in that country, there should be no restriction, limit or condition imposed by the Commission regarding the eligibility of that company for FUCO status.
These points are further discussed below.
1. Proposed Rule 55
A. The Commission's Proposal
Under proposed Rule 55, a RHC may not acquire an interest in a FUCO unless certain conditions are satisfied. Essentially the conditions are those specified in Rule 53 plus several additional conditions that would apply uniquely to FUCO investments.
All of the conditions of existing Rule 53 - which by their terms already apply no less to FUCO than to EWG investments - would be incorporated into proposed Rule 55 (in certain cases supplemented with additional restrictions), namely: (1) the 50% Cap;5 (2) the books and records requirement of Rule 53(a)(2);6 (3) the requirement of Rule 53(a)(4) limiting the provision of services by employees of associate domestic utility companies;7 (4) the requirement of Rule 53(a)(4) that the RHC submit copies of relevant filings under the Act to affected state commissions, among others;8 and (5) each of the three conditions set forth in Rule 53(b) identifying adverse financial developments affecting the RHC system or its EWG or FUCO investments.9
The "additional" safe harbor conditions proposed in Rule 55 - i.e., conditions not merely duplicative of Rule 53, but pertaining solely to FUCO investments - are (a) that the RHC's board of directors has adopted procedures designed to analyze the risks of investing in foreign jurisdictions and has reviewed and approved each FUCO investment;10 (b) that any ratings in effect from a nationally recognized statistical rating organization in respect of debt securities of any "significant subsidiary" of the RHC that is a public utility company be at least investment grade;11 and (c) that within the last three years the RHC has not obtained increases in rates to retail customers in order to recover inadequate losses or returns on its FUCO investments.12
The conditions of proposed Rule 55 operate differently depending on whether the RHC has an order in effect from the Commission permitting investments in EWGs and FUCOs at a level greater than the 50% Cap. If it does not, but if the RHC complies with all the conditions in paragraphs (a), (c) and (d) of proposed Rule 55, and none of the events described in subparagraph (b)(1) has occurred (collectively, the "Rule 55 50% Conditions"), it can make investments in EWGs and FUCOs in an amount equal to the 50% Cap, "without the need to apply for or receive [Commission] approval."13 On the other hand, if a RHC already has an order from the Commission permitting an aggregate investment in EWGs and FUCOs at a level greater than the 50% Cap, it does not need to meet all the Rule 55 50% Conditions in order to continue to make FUCO investments. However, it must comply with the condition concerning board of directors' review procedures, among other conditions.
Where the safe harbor conditions of proposed Rule 55 are not met, and the RHC must obtain specific Commission authorization, the rule sets out a standard for Commission approval substantially identical to that contained in Rule 53(c). The RHC must "affirmatively demonstrate" that its proposed FUCO investments will not have a substantial adverse impact on the financial integrity of the RHC system or on any utility subsidiary thereof or its customers or on the ability of state commissions to protect the same.14
B. Cinergy Comments
i. Proposed Rule 55 is unnecessary; Rule 53 covers investments in both EWGs and FUCOs, addressing concerns related to domestic ratepayers and financial integrity
Fundamentally, Cinergy believes that proposed Rule 55 is unnecessary. There is already, and has been for approaching eight years, a "safe harbor" rule covering investments in EWGs and FUCOs, Rule 53. Most of Rule 55 would simply repackage the existing conditions of Rule 53. To the extent it includes new conditions, Cinergy objects to these new tests.
As noted earlier, the primary driver for re-proposing Rule 55 appears to be a purely technical concern. Specifically, in adding the FUCO provisions to the statute, Congress directed the Commission to promulgate rules "regarding [RHCs'] acquisition of interests in [FUCOs] which shall provide for the protection of the customers of a public utility company which is an associate company of a [FUCO] and the maintenance of the financial integrity of the [RHC] system."15 A similar directive accompanied the EWG provisions, except there the Commission was directed to act by a specific deadline, within six months of enactment of the provisions.16
Although Rule 53 on its face applies only to financings by a RHC related to EWG acquisitions, the Commission's consistent practice has been to apply the rule to financings by a RHC related to FUCO acquisitions as well. For as the Commission has explained, "[a]lthough foreign utility operations raise unique issues for the administration of the Act, we believe that the relevant considerations are generally those identified in section 32(h)(6) [the statutory provision pursuant to which Rule 53 was adopted], relating to the preservation of capital for domestic utility operations, the effect of foreign utility company investments upon the daily operations of the domestic utility subsidiaries, and the possible effect upon domestic ratepayers."17 Indeed, the actual conditions and other substantive provisions of Rule 53, like the 50% Cap, apply expressly to both EWGs and FUCOs. The Commission's commonsensical approach has been sustained on review.18
Therefore, with reference to the directive set forth in Section 33(c)(1), the Commission could reasonably take the position that it has already adopted a rule (Rule 53) with respect to RHC acquisitions not merely of EWGs but also FUCOs. However, if the Commission feels that continuing to rely on its administrative practice is not sufficient under a narrow, literal reading of Section 33(c)(1), then Cinergy recommends that, rather than adopting Rule 55, the Commission amend Rule 53 to add clarifying language (specifically, in the first sentence of paragraph (a) before the enumerated conditions and in paragraph (c)) making explicit that the rule covers RHC financings related not only to EWG but also to FUCO acquisitions.
Cinergy acknowledges that Rule 55 is proposed as a safe harbor with respect to Commission review of the FUCO acquisition itself (i.e., review under Sections 9(a) and 10 of the Act), as opposed to (or in addition to) a safe harbor with respect to Commission review of any securities issued by a RHC to finance the acquisition of a FUCO (i.e., review under Sections 6(a), 7 and 12(b) of the Act). However, to the extent that Rule 55 would regulate the acquisition directly, rather than the financing thereof, the proposal contravenes the express terms of Section 33 (as well as the general scheme of the Energy Policy Act amendments to the Act) and therefore would exceed the Commission's rulemaking authority.19 Again, the Commission can fully comply with the directive in Section 33(c)(1) to adopt rules regarding RHC acquisitions of interests in FUCOs either (i) by relying on its established approach under Rule 53 or (ii) by making the suggested clarifying amendments to Rule 53.
ii. The additional restrictions of proposed Rule 55 are unwarranted
As noted, most of proposed Rule 55 simply repackages existing conditions or restrictions contained in Rule 53. Three new conditions, however, would apply exclusively to FUCO investments:
A RHC that investments in FUCOs pursuant to the 50% Cap must satisfy all three of these additional conditions. A RHC that has or obtains an order from the Commission permitting investments in EWGs and FUCOs at a level greater than the 50% Cap must comply with the Board Review Condition, but not the other two.
Cinergy objects to imposing new "safe harbor" conditions to investments in FUCOs. Cinergy believes that the existing conditions of Rule 53 and particular orders issued to RHCs permitting them to invest at levels greater than 50% of consolidated retained earnings are more than adequate to address concerns relating to preservation of system financial integrity and protection of domestic utility customers. The additional restrictions would simply further impede the ability of RHCs to compete on a level playing field with other companies that are not subject to regulation under the Act.
Regarding the Board Review Condition, Cinergy believes it is inappropriate for the Commission to regulate the manner in which a RHC determines whether to invest in a FUCO or EWG. It may be taken as a given that every RHC, like other substantial business enterprises, has procedures for systematically evaluating potential capital investments and their risks, including if applicable for EWG and FUCO investments. Those procedures may vary from company to company. The question is one of internal corporate governance, a matter of state law involving the responsibilities of directors. Directors typically have both the ability under state law, and the practical need, to delegate to and rely upon committees of the board, corporate officers and employees, subject to the directors' fiduciary duty of care. It is commonplace for directors to delegate investment decisions below a certain dollar threshold to investment or finance committees of the board, or even, if the potential investment is de minimis, to designated executive officers or business unit heads. Cinergy follows just such a process in respect of its investments, including EWG and FUCO investments. Cinergy has described these investment procedures in detail to the Commission (see application-declaration in File No. 70-9577). In addition, for some RHC systems with large nonutility holdings, an intermediate holding company's board of directors may have significant responsibility for managing and making investment decisions regarding acquisitions of EWGs and FUCOs, subject to the ultimate responsibility of the RHC's board of directors.
In contrast to this flexible approach otherwise available under state corporate law, Rule 55 as proposed would impose a rigid, "one size fits all" rule, mandating that the ultimate parent company's board of directors involve itself directly in reviewing and approving each FUCO investment, whatever the size. (Cinergy presumes that the condition would apply only to future investments after the rule's adoption.) At a minimum, the Commission should modify this condition, so that it expressly takes into account the ability of a board of directors to delegate duties and responsibilities consistent with state law. More fundamentally, Cinergy urges the Commission to reconsider the appropriateness of this condition, involving regulation of internal corporate governance procedures, which would seem best left to the reasonable discretion of the board of directors.
Cinergy also objects to both the Utility Ratings Condition and the Rate Increase Condition. There are already three tests set out in Rule 53(b), each of which would be incorporated into Rule 55 verbatim, that are specifically directed at adverse financial developments impacting the RHC system or its EWG or FUCO investments. Specifically, for the 50% safe harbor to be available (under either Rule 53 or proposed Rule 55), there must not have occurred any of the following: (i) a bankruptcy of the RHC or any significant subsidiary (unless a plan of reorganization has been confirmed), (ii) a recent decline of 10% or more in the RHC's consolidated retained earnings, or (iii) operating losses in the previous fiscal year equal to at least 5% of consolidated retained earnings attributable to the RHC's investments in EWGs and FUCOs.23 These tests need no supplementing; they already significantly qualify the availability of the 50% safe harbor and inject significant uncertainty into the business planning of RHCs that invest in EWGs and FUCOs.
In addition, the Rate Increase Condition is unnecessary given that, as just shown, there is already a safe harbor condition directly tied to losses on EWG and FUCO investments. Moreover, the possibility of any RHC actually succeeding in obtaining a retail rate increase "in order to recover losses or inadequate returns on FUCO investments"24 is at best remote.
Finally, none of the "100% orders" cited in the FUCO NOPR included a condition corresponding to the Utility Ratings Condition.25 If that test is unnecessary as a condition to investing at the 100% level, with its more rigorous review standard, surely it is inappropriate as a further restriction on investing within the 50% safe harbor, at a much lower level. If the Commission nonetheless determines to implement this novel condition, the condition should be revised to make clear that it applies only to senior rated debt of a "significant" public utility subsidiary, and furthermore, that the test is satisfied if at least one nationally recognized statistical rating organization that rates such senior debt rates it investment grade.
iii. The Commission should overhaul the 50% Cap
The current rulemaking affords the Commission an opportunity to revisit certain aspects of Rule 53 in light of its experience in administering the Energy Policy Act amendments to the Act and recent industry developments.
As discussed below, the Commission should reconsider its 50% of retained earnings test for safe harbor investments in EWGs and FUCOs, whether pursuant to Rule 53 or proposed Rule 55. A more appropriate yardstick is consolidated capitalization, as under Rule 58. In addition, the safe harbor level of permitted investments should be increased to reflect the increasing deregulation of generation in the United States and the concomitant growing importance to the nation of domestic EWGs in ensuring adequate supplies of electricity. Finally, any investment by a RHC in connection with a transfer of generating facilities owned by a utility subsidiary to an affiliated EWG should be excluded from "aggregate investment."
As noted earlier, proposed Rule 55 would permit RHCs to invest an amount equal to 50% of consolidated retained earnings in EWGs and FUCOs, without the need to apply for and receive Commission approval, if all the conditions of the rule are satisfied. This is the same 50% safe harbor investment limitation as that included in Rule 53. The initial series of orders issued by the Commission to RHCs under Rule 53(c), permitting aggregate investments in EWGs and FUCOs at a level greater than 50% of retained earnings, were likewise pegged to retained earnings, authorizing those companies to invest an amount equal to 100% of consolidated retained earnings.26
Notably, however, that trend has not continued with respect to more recent orders issued by the Commission permitting RHCs to invest in EWGs and FUCOs in amounts greater than that permitted under the Rule 53 safe harbor. Specifically, the Commission authorized Cinergy in June 2000 to invest an additional $1 billion in EWGs and FUCOs,27 and in December 2000 authorized Exelon Corp. to invest up to $4 billion in EWGs and FUCOs, superseding an order issued just the preceding month authorizing Exelon to invest up to $2 billion in EWGs and FUCOs.28 None of these more recent orders tied the permitted investment level in EWGs and FUCOs to consolidated retained earnings. Indeed, the $4 billion investment authority granted to Exelon was equivalent to approximately 4500% of Exelon's pro forma June 30, 2000 consolidated retained earnings of $89 million.
These orders recognize that tying authority to invest in EWGs and FUCOs to a fraction or multiple of retained earnings is problematic. In the first place, the Commission's experience has shown that there is little, if any, correlation between a RHC's consolidated retained earnings and levels of investments in EWGs and FUCOs in terms of predicting the likely impact of these investments on the financial integrity of a holding company system or on domestic ratepayers.
Second, in adopting Rule 53, the Commission chose retained earnings over other measures of financial performance to gauge prudent levels of investment in EWGs and FUCOs because, it explained, no other financial measure (like consolidated capitalization or consolidated assets) would so directly reflect losses from EWGs and FUCOs. Such an "early warning" system was deemed important, since these were new entities, with potential risks that could be significant. In practice, however, other factors generally have had a much greater negative impact on holding company retained earnings, particularly write-offs incurred by utility subsidiaries in connection with state deregulation and application of the purchase method of accounting to certain merger transactions. Events such as these, moreover, do not necessarily reflect any deterioration in the financial health of the holding company system. But the result under the 50% safe harbor (and the 100% orders) is to reduce or eliminate the ability to continue to make EWG or FUCO investments, even though those investments may be performing well and the holding company's financial integrity may be unimpaired. If the Commission's concern is to identify an erosion in the financial integrity of the RHC due to losses from EWG and FUCO investments, it can do that directly, via the safe harbor condition expressly tied to the non-occurrence of significant operating losses attributable to EWG or FUCO investments.29
In light of these factors, including the recent orders issued to Cinergy and Exelon discussed above, it is surprising that the Commission would propose a safe harbor investment limitation for proposed Rule 55 based on retained earnings. Cinergy recommends that the Commission abandon tying permitted levels of investment in EWGs and FUCOs to retained earnings. With respect to the safe harbor investment level permitted under Rule 53 (and if adopted Rule 55), the Commission should consider using consolidated capitalization as the financial benchmark, as under Rule 58. Although EWGs and FUCOs were novel entities back in 1993, that is clearly no longer the case today. In this era of increasing globalization, deregulation and competition in the utility industry, EWGs and FUCOs are no less integral to many RHCs' business strategies than the power marketers and other "energy-related companies" falling under Rule 58. And in the United States, EWGs have become vital to the nation's power supply, as discussed in the next paragraph.
Beyond discarding retained earnings as the financial measurement for RHC "safe harbor" investments in EWGs and FUCOs, in favor of consolidated capitalization, the Commission should consider setting a level of safe harbor investments that is substantially larger than the 50% of retained earnings test, which under both Rule 53 and proposed Rule 55 lumps together FUCOs with domestic and foreign EWGs. State deregulation of the electric utility industry is transforming the electric generation business in the United States from a regulated utility business to a nonutility EWG business. Increasingly, pursuant to state deregulation or strategic decisions, traditional vertically integrated electric companies are "exiting" the generation business altogether, selling off their power plants, and continuing their regulated business as smaller, "pipes and wires" companies. In their place, EWGs are emerging as increasingly crucial players in the U.S. generation business. To serve the nation's growing demand and need for reliable electricity supplies, RHCs must not be hampered under an artificially low safe harbor from investing in new or divested generation facilities, which increasingly are held outside the regulated utility as nonutility EWG assets. Given this sea change, the Commission should retool the existing "safe harbor" investment ceiling, at a minimum dramatically increasing the ceiling for investments in U.S. EWGs.
Likewise, the Commission should exclude entirely from "counting" under the "aggregate investment" definition of Rule 53 any direct or indirect investment by a RHC in connection with the transfer, pursuant to state deregulation or otherwise, of generating facilities owned by any of its utility subsidiaries to EWG affiliates. By definition, these transactions involve not investments by the holding company system in newly acquired or developed facilities, but rather internal reorganizations of assets that the holding company system already owns, may well have owned for decades, and will continue to own upon completion of the internal transfer or "disaggregation." The assets are simply moving from the regulated to the nonregulated side of the holding company's business, consistent with state deregulation or to better deploy the assets to maximize their value. Indeed, in anticipation of electric industry restructuring, in 1995 the Commission's staff recommended that such transactions be exempted entirely from the Act.30
iv. The Commission should modify its books and records and audited financial statement requirements applicable to EWGs and FUCOs
Proposed Rule 55 would require RHCs to maintain books and records and prepare financial statements with respect to FUCO investments in the manner prescribed by Rule 53.31
However, in the FUCO NOPR the Commission also requests comments on whether these requirements should be modified in any respect, including in particular whether the Commission should permit a FUCO's books and records to be maintained in accordance with local accounting standards, so long as those standards enable the Commission to assess whether transactions between the FUCO and other companies in the RHC system comply with the Act's requirements.32
Cinergy believes that such a modification is entirely appropriate. To implement it, the applicable provisions of Rule 53 should be modified, so that "majority-owned" FUCO or foreign EWG subsidiaries are subject to no more onerous requirements in respect of books and records and preparation of financial statements than those currently applicable thereunder to FUCOs and foreign EWGs in which the RHC owns 50% or less of the voting securities.
In addition, Cinergy recommends that Form U5S be modified to eliminate the requirement for separate audited financial statements for each majority-owned EWG or FUCO subsidiary. If not eliminated altogether, the requirement should at least be modified to take into account materiality and cost considerations. Given that under the current rule a RHC is not required to furnish audited financial statements for a FUCO or EWG in which it has invested $1 billion, but has only a 50% voting interest, it appears inequitable to require audited financial statements for a FUCO or EWG in which the RHC may have invested a relatively nominal sum, merely because it holds a greater than 50% voting interest.
a. Existing requirements/books and records and financial statements
Rule 53 requires a RHC to maintain or prepare, and afford the Commission access to, books and records and financial statements with respect to its EWG and FUCO investments. For U.S. EWGs and majority-owned foreign EWGs and FUCOs, the books and records and financial statements must be kept or prepared in conformity with U.S. generally accepted accounting principles ("GAAP"). For foreign EWGs or FUCOs in which the RHC owns 50% or less of the voting securities, the books and records and financial statements may be kept or prepared "according to a comprehensive body of accounting principles other than GAAP," subject to certain conditions.33
The Annual Report on Form U5S requires, in addition to the other requirements of that form for audited financial statements, that the RHC furnish audited financial statements for its majority-owned EWGs and FUCOs.
b. Proposed modifications
Although as proposed Rule 55 would simply carry over the existing books and records provisions of Rule 53 (with certain minor additions), the Commission also requests input on the advisability of modifying those requirements:
For example, should the rule permit the FUCO to keep its books and records in conformity with local accounting conventions (rather than U.S. generally accepted accounting principles, as required by certain provisions of rule 53) if the local accounting system permits us to determine whether transactions between the FUCO and the other companies in the holding company system comply with the Act's standards?34
In a word, it should. If the local accounting system is sufficient to enable the Commission to identify whether transactions between the FUCO (or foreign EWG) and other companies in the same RHC system meet the Act's standards, there is no policy reason for requiring the RHC to maintain and prepare duplicate books and financial statements for that foreign entity complying with U.S. GAAP. Domestic ratepayers would not be adversely affected and the RHC would avoid potentially significant costs that serve no useful purpose.
Rule 53 already provides for such deference to local accounting conventions, but only where the RHC owns 50% or less of the voting securities of the particular FUCO or foreign EWG. If the RHC owns more than 50%, the books and records must be kept per U.S. GAAP. But at least where the local accounting standards enable the Commission to determine whether transactions between the foreign entity and U.S. affiliates meet the Act's standards, the question of majority ownership seems beside the point.
One way to implement this change would be to modify the applicable provisions of Rule 53 (i.e., paragraph (a)(2)(ii) and (iii)), such that "majority-owned" FUCO or foreign EWG subsidiaries of the RHC are subject to the same requirements in respect of books and records and preparation of financial statements as those currently applicable thereunder to FUCOs and foreign EWGs in which the RHC owns 50% or less of the voting securities.
Beyond the proposed change just discussed concerning Rule 53, Cinergy also recommends, for much the same reasons, that the Commission consider discontinuing the requirement with respect to the Annual Report on Form U5S that the RHC furnish audited financial statements for each of its majority-owned EWGs or FUCOs. Such financial statements are required to be audited in accordance with auditing standards generally accepted in the United States. This auditing requirement can represent a significant or disproportionate cost in the case of a majority-owned EWG or FUCO subsidiary in which the RHC has a small aggregate investment.
For example, Cinergy has a number of majority-owned U.S. EWG and FUCO subsidiaries that generate electricity through wind-powered turbines. These entities generate relatively modest amounts of electricity and Cinergy has made correspondingly modest investments in these entities (in many cases less than $5 million per company). The requirement for audited financial statements for such small investments can negatively impact the profitability of these investments.
Cinergy believes that it should be sufficient under the Form U5S to include the audited consolidated financial statements required to be filed with the RHC's Annual Report on Form 10-K. If the Commission determines not to eliminate altogether the requirement for audited financial statements for majority-owned EWGs and FUCOs, the Commission should at least consider revising the requirement to take into account of the size of the RHC's investment. If the investment is small (e.g., under $5 million), no separate audited financial statements should be required for that entity, whether or not the RHC owns 50% or more of its voting securities.
2. Proposed Rule 56
Under proposed Rule 56, a RHC's subsidiary that is engaged exclusively in the direct or indirect ownership of the securities, or an interest in the business, of one or more FUCOs "shall be deemed a foreign utility company." As the Commission explains, the rule would "clarif[y] the status" of such subsidiaries, in that they themselves would be considered FUCOs "and a [RHC] could acquire such a company on the same terms and conditions that it could acquire the underlying FUCO."35
Cinergy supports proposed Rule 56 but requests further clarification. Inasmuch as the rule would "deem" such a company to be a FUCO, would it be necessary for that company itself, or the RHC on behalf of that company, to file a notification of FUCO status on Form U-57? If so, proposed Rule 56 should expressly so state to avoid uncertainty, and the Form U-57 should be modified to make clear that such an intermediate company qualifies. Although the Commission proposes a number of changes to Form U-57 (see below), the proposed changes do not address this point.
The Commission should also clarify that not only a RHC subsidiary but also an affiliate thereof (as defined in Section 2(a)(11)(B) of the Act) falls within the scope of proposed Rule 56. This clarification is consistent with the EWG definition.
3. Proposed Amendment to Rule 87
In 1993, the Commission decided, for good reason, not to adopt any amendment to Rule 87 to deal specifically with inter-company transactions with EWGs and FUCOs, and it should not adopt the re-proposed amendment now.
The Commission does not provide any specific reasons why, with the passage of time, additional rules to restrict affiliate transactions with EWGs and FUCOs are needed, acknowledging rather that the amendment "may be unnecessary."36 The 2% limitation in Rule 53(b), which is repeated in proposed Rule 55(a), already limits the number of employees of domestic utility subsidiaries that can render services to EWGs and FUCOs. Further, the amendment is overbroad because it would require Commission approval for service and sales contracts between EWGs and FUCOs and a holding company's other non-utility subsidiaries. Thus, if the rule amendment is adopted, it should be limited to transactions between EWGs and FUCOs and domestic utility affiliates.
4. Proposed Amendments to Form U-57
Cinergy has several suggestions pertaining to the changes the Commission proposes in respect of Form U-57, the FUCO notification form.
As noted earlier, proposed Rule 55 would require that a RHC notify the Commission of a FUCO investment on Form U-57 within 10 business days of making the investment. Cinergy proposes that the deadline of 10 business days be replaced by 30 calendar days. Registered holding companies are already subject to a myriad of filing and reporting obligations under the Act. The additional time here would enable this new filing deadline to be better integrated with the panoply of existing certificates and reports that need to be filed by a RHC under the Act and otherwise.
The Commission proposes to revise the Form U-57 to require disclosure of the purchase price paid by a RHC for its FUCO interest. Cinergy objects to public disclosure of the purchase price for each FUCO it acquires. In general, that is proprietary, confidential information. Cinergy is not now required under the Act to disclose even to the Commission the purchase price paid for EWGs or FUCOs it acquires (although depending on the materiality of the acquisition, public disclosure may be required for substantial transactions pursuant to the federal securities laws). In many transactions, for competitive reasons and other legitimate considerations, both the buyer and the seller decline to disclose the financial terms of the transaction. There are already a raft of requirements in Rule 53, and in financing orders issued to RHCs that invest in EWGs and FUCOs outside the Rule 53 safe harbor, that address the Section 32 and 33 concerns related to financial integrity and protection of domestic ratepayers. There is no legitimate purpose served in requiring registered companies to publicly disclose the purchase price for each FUCO in which they invest. Only competitors would benefit from that requirement.
In addition, the Commission proposes to add a new Item 4 to Form U-57, dealing with the FUCO's books and records. It would require, first, that the RHC identify the "location" of the books and records required by Rule 53. And by filing the form, the RHC would "undertake that it will provide the Commission or its representatives with access to these books and records in the United States, at such place as the Commission may reasonably request."
Cinergy questions why Item 4 is necessary. Quite apart from Form U-57, Rule 53 already requires RHCs to afford the Commission access to such books, records and financial statements of its EWGs and FUCOs as the Commission may request. Further, proposed Rule 55 would buttress or clarify this affirmative obligation, requiring the RHC to make these materials available to the Commission or its representatives "in the United States, at such place as the Commission may reasonably request." Given that there is already an affirmative obligation, the proposed undertaking in the form is superfluous.
Nor does it seem particularly germane or meaningful to require the RHC to specify the "location" of the books and records. Normal business practice would suggest that the books and records of the FUCO would be located at its business offices, the location of which is already required to be disclosed in the form. But regardless of where those books and records are located, both Rule 53 and proposed Rule 55 require the RHC to afford access to the books and records to the Commission upon its request; Rule 55 would clarify that the access is to be provided in the United States, again regardless of where the books and records normally reside.
5. Possible Limitations on Other Businesses of a FUCO
The Commission also seeks comment on the advisability of possible limitations on the ability of a holding company to qualify a foreign company as a FUCO if it engages in a variety of business activities.
Section 33(a) does not by its terms limit the operations of a FUCO "exclusively" to generation, transmission or distribution of electricity or retail distribution of gas, nor does it confer on the Commission any express authority to promulgate rules that would define a FUCO or limit the businesses of a FUCO. By contrast, Section 32(a) defines an EWG as, inter alia, any person engaged "exclusively" in the business of owning or operating one or more eligible facilities and selling electricity at wholesale. The EWG and FUCO provisions were enacted as part of the same legislation. It must be assumed that Congress acted purposefully when it chose to include an "exclusivity" restriction in the one definition, but not the other, companion definition.
In construing this broad definition, then, the Commission must not undermine or contravene its scope or the intent of Congress, which clearly anticipate that a FUCO may engage in other businesses. So long as a FUCO satisfies the affirmative statutory criteria, and any other businesses it conducts are of a type that the Commission or Congress have found consistent with the Act's restrictions on diversification, or that otherwise are customary for foreign utilities in that country, there should be no restriction, limitation or condition imposed by the Commission regarding the eligibility of that company for FUCO status.
By: /s/ William J. Grealis
Executive Vice President/
Chief of Staff
Dated: April 6, 2001
|1||See HCAR No. 35-27342, 2001 SEC LEXIS 201, Feb. 1, 2001 ("FUCO NOPR"). Any references herein to "exempt wholesale generators" ("EWGs") and "foreign utility companies" or "FUCOs" refer to such terms as defined in Sections 32 and 33 of the Act, respectively.|
|2||FUCO NOPR, supra, 2001 SEC LEXIS 201, at *57-58.|
|3||Id. at *8.|
|4||Section 33(c)(1) directs the Commission to adopt rules "regarding registered holding companies' acquisition of interests in [FUCOs] which shall provide for the protection of the customers of a public utility company which is an associate company of a [FUCO] and the maintenance of the financial integrity of the registered holding company system."|
|5||Compare Rule 53(a)(1) with proposed Rule 55(b)(1)(vi).|
|6||See proposed Rule 55(c).|
|7||See proposed Rule 55(a)(3).|
|8||See proposed Rule 55(d). A new requirement is that a RHC that makes a FUCO investment must, within 10 business days of making the investment, file a notification thereof on Form U-57 with the Commission. Cinergy comments on this proposed filing deadline below, in connection with the proposed changes to Form U-57.|
|9||See proposed Rule 55(b)(1)(i), (ii) and (iii).|
|10||See proposed Rule 55(a)(1) and (2).|
|11||See proposed Rule 55(b)(1)(v).|
|12||See proposed Rule 55(b)(1)(iv).|
|13||FUCO NOPR, supra, 2001 SEC LEXIS 201, at * 63.|
|14||See proposed Rule 55(b)(2).|
|15||See Section 33(c)(1), 15 U.S.C. § 79z-5b(c)(1).|
|16||See Section 32(h)(6), 15 U.S.C. § 79z-5a(h)(6).|
|17||See HCAR No. 25757, 1993 SEC LEXIS 530, March 8, 1993 (originally proposing Rule 55), at *21 (footnote omitted).|
|18||See Campaign for a Prosperous Georgia v. S.E.C., 149 F.3d 1282 (11th Cir. 1998), at n. 1 ("Rule 53 discusses only financings related to EWGs, but the SEC has consistently applied the rule to FUCO financings as well, and the parties do not question that application.").|
|19||Compare Section 33(c)(1), 15 U.S.C. § 79z-5b(c)(1) ("Notwithstanding any provision of this Act except as otherwise provided under this section, a registered holding company shall be permitted as of the date of enactment of this section (without the need to apply for, or receive approval from the Commission) to acquire and hold the securities or an interest in the business, of one or more foreign utility companies. [emphasis added]") with Section 33(c)(2), 15 U.S.C. § 79z-5b(c)(2) ("The issuance of securities by a registered holding company for purposes of financing the acquisition of a foreign utility company, the guarantee of securities of a foreign utility company by a registered holding company, the entering into service, sales, or construction contracts, and the creation or maintenance of any other relationship between a foreign utility company and a registered holding company, its affiliates and associate companies, shall remain subject to the jurisdiction of the Commission under this Act. [emphasis added].") Likewise, the EWG provisions conform exactly to this limited exemption from prior Commission approval requirements for RHC investments in FUCOs (see Section 32(g) and (h), 15 U.S.C. §§79z-5a((g) and (h)). Accord Campaign for a Prosperous Georgia v. S.E.C., supra, 1998 U.S. App. LEXIS 18634, at **5 ("While the 1992 amendments expanded covered companies' ability to acquire EWG's and FUCO's, they left intact the requirement that those companies obtain SEC approval of any financings used to secure such acquisitions. [citation omitted]").|
|20||See proposed Rule 55(a)(1) and (2).|
|21||See proposed Rule 55(b)(1)(v).|
|22||See proposed Rule 55(b)(1)(iv).|
|23||See Rule 53(b)(1), (2) and (3); compare with proposed Rule 55(b)(1)(i), (ii) and (iii).|
|24||See proposed Rule 55(b)(1)(iv).|
|25||See FUCO NOPR, supra, 2001 SEC LEXIS 201, at n. 27. "100% orders" refers to Commission orders permitting the RHC to make an aggregate investment in EWGs and FUCOs equal to 100% of consolidated retained earnings. The 100% orders cited in the FUCO NOPR are Southern Co., HCAR Nos.. 26501 (Apr. 1, 1996) (order) and 26646 (Jan. 15, 1997) (denying request for reconsideration), aff'd, Campaign for a Prosperous Georgia v. S.E.C., 149 F.3d 1282 (11th Cir. 1998); Central and South West Corp., HCAR No. 26653 (Jan. 24, 1997); GPU, Inc., HCAR Nos. 26773 (Nov. 5, 1997) (order) and 26779 (Nov. 17, 1997) (opinion); Cinergy Corp., HCAR No. 26848 (Mar. 23, 1998); American Electric Power Co., Inc., HCAR No. 26864 (Apr. 27, 1998); New Century Energies, Inc., HCAR No. 26982 (Feb. 26, 1999).|
|26||See footnote 25, supra.|
|27||See Cinergy Corp., et al., HCAR No. 27190, June 23, 2000.|
|28||See Exelon Corporation, et al., HCAR Nos. 27296, Dec. 8, 2000, and 27266, Nov. 2, 2000.|
|29||See Rule 53(b)(3); see also proposed Rule 55(b)(1)(iii).|
|30||In its 1995 Report entitled "The Regulation of Public-Utility Holding Companies," the Commission's Division of Investment Management recommended, "[w]ith a view to the proposed disaggregation of the electric utility industry," that the Commission "should consider rules to exempt a corporate restructuring that does not result in the addition of new utility operations." Id. at xiii.|
|31||See proposed Rule 55(c).|
|32||FUCO NOPR, supra, 2001 SEC LEXIS 201, at * 43.|
|33||See Rule 53(a)(2).|
|34||FUCO NOPR, supra, 2001 SEC LEXIS 201, at * 43.|
|35||Id. at *46.|
|36||Id. at *51.|