April 9, 2001
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
RE: File No. S7-05-01 - Notice of Proposed Rules Concerning Registered Holding Company Investments in Foreign Utility Companies
We are submitting this comment letter on behalf of Entergy Corporation ("Entergy") and Alliant Energy Corporation ("Alliant Energy," and together with Entergy, the "Companies") in response to the Commission's request for comments on certain proposed rules under the Public Utility Holding Company Act of 1935, as amended (the "Act").1 Entergy and Alliant Energy are registered electric utility holding companies under the Act. Both Companies currently hold investments in "exempt wholesale generators" ("EWGs") and/or "foreign utility companies" ("FUCOs"), as defined in Sections 32 and 33 of the Act, respectively.
Proposed Rule 55 sets forth the conditions under which a registered holding company could acquire an interest in a FUCO without the need to apply for, or receive, prior Commission approval. The current rule proposal includes several additional conditions that were not contained in Rule 55 as it was originally proposed in 1993. Proposed Rule 56 would clarify the status of a subsidiary company of a registered holding company that is formed to hold an interest in a FUCO. The proposed amendment to Rule 87 would essentially require prior Commission approval in order for a subsidiary company of a registered holding company to sell goods or services to or purchase goods or services from a FUCO or EWG that is an associate company. The Commission is also inviting comments on the advisability of allowing registered holding companies to qualify foreign operations as a FUCO.
The Companies generally question the need for Rule 55 and also believe that the additional conditions in the reproposed rule are unnecessary. The Companies also believe that the proposed amendment to Rule 87 is unnecessary and over broad. The Companies have no objection to proposed Rule 56. Set forth below are specific comments on those aspects of the proposed rules with which the Companies wish to take issue.
Section 33(c)(1) of the Act directs the Commission to promulgate rules "regarding registered holding companies' acquisition of interests in foreign utility companies which shall provide for the protection of the customers of a public utility company which is an associate company of a foreign utility company and the maintenance of the financial integrity of the registered holding company system." The Commission has interpreted this provision as a directive to adopt rules defining the conditions or circumstances under which an acquisition of an interest in a FUCO would require specific approval under Sections 9 and 10 of the Act. As originally proposed in 1993, Rule 55 would have required prior Commission approval for an acquisition of an interest in a FUCO if, among other things, a registered holding company's "aggregate investment" in FUCO's and EWG's would exceed 50% of its consolidated retained earnings or if any of the circumstances specified in Rule 53(b) were applicable.
Under proposed Rule 55(a), a registered holding company may not acquire an interest in a FUCO unless certain conditions are satisfied, including the requirement that the board of directors of the company has adopted "FUCO Investment Procedures" and reviewed and approved each FUCO investment, and that no more than 2% of the employees of the holding company's domestic utility render services at any one time to EWGs and FUCOs in which the holding company has an interest. Even if these conditions are met, proposed Rule 55(b) provides that Commission approval for each FUCO investment would be required if the registered holding company's "investment"2 in FUCOs and EWGs exceeds 50% of its consolidated retained earnings "or such greater amount as may be authorized by the Commission by order under[Rule 53(c)]" (the proposed "FUCO Investment Limitation"), or if any one of five other "events" has occurred. These include three events that are identical to those now contained in Rule 53(b), plus two additional events that the Commission explains are intended to provide an added measure of protection for domestic public utility ratepayers.
1. The Board Review Requirement.
Rule 55(a) would appear to require that every registered holding company adopt a set of formal procedures for evaluating risks associated with investments in FUCOs. While we assume that all registered holding companies have in place a process or procedures for evaluating the risks associated with both foreign and domestic investments, it seems unnecessary for the Commission to take the unprecedented measure of imposing corporate governance rules on a discrete group of companies - registered holding companies. Corporate governance is a matter of state law. Under most state laws, the board of directors of a company may delegate certain board functions to a committee of the board, and action by a duly constituted committee is deemed to be action by the board itself. It is fairly typical for a company to delegate the ability to make investment decisions below a specified dollar amount to a finance committee or similar committee of the board or to a particular officer or officers. Delegation of such decision making authority is frequently essential in order to enable registered holding companies to react to market conditions in a timely manner and, thereby to achieve the statutory purpose of the Energy Policy Act of 1992 (the "Entergy Policy Act") to facilitate investments in FUCOs.
Proposed Rule 55(a), however, could be construed to require that the full board of directors of a registered holding company review and approve each investment in a FUCO, even in the case of an immaterial new investment or acquisition of additional securities of a FUCO that the holding company already owns. The proposed rule could also be construed to require the registered holding company to undertake a new risk analysis and assessment (in accordance with the "FUCO Investment Procedures") in instances where (i) it is simply acquiring additional securities of an existing FUCO subsidiary to provide working capital for the FUCO's on-going business (or in support of previously reviewed and approved strategies), and (ii) the amount of the additional investment is relatively insubstantial. Accordingly, the Companies recommend that proposed Rule 55(a) be revised to clarify that (i) a board of directors may delegate its duties and responsibilities in accordance with applicable state law and applicable corporate governance documents, and (ii) that adherence to the proposed "FUCO Investment Procedures" and related risk mitigation findings is not required in order to acquire additional securities of an existing FUCO subsidiary under the circumstances described above.
2. The FUCO Investment Limitation.
It is unclear why the Commission perceives a need at this time to impose a limit on FUCO investments. As the Commission itself notes, as a matter of administrative practice over the past eight years, the financing limitation under Rule 53(a)(1) has been applied to the issuance of securities for the purpose of financing investments in both EWGs and FUCOs. Thus, the 50% consolidated retained earnings test in Rule 53(a) (or such greater amount as the Commission has authorized under Rule 53(c)) is already a limitation on the amount of proceeds of financing that a holding company may use to make investments in FUCOs. One consequence of using the same 50% consolidated retained earnings test that is applicable to financing to limit the amount that may be invested in FUCOs and EWGs together is that it appears to unnecessarily limit the use of what the Commission refers to as "available funds"3 to acquire interests in FUCOs. Thus, if a registered holding company were to reinvest earnings from its subsidiaries or the proceeds of a sale of a different kind of a non-utility subsidiary (e.g., an "exempt telecommunications company") in a FUCO, the investment would apparently count against the investment limit in proposed Rule 55(b)(vi), even though no new recourse financing is involved.
A much more fundamental objection to the proposed FUCO Investment Limitation is that it continues to use consolidated retained earnings as the yardstick against which a prudent level of investment is measured. As the Commission itself recognizes, however, almost every holding company with an active EWG/FUCO investment program has sought and obtained an order from the Commission permitting it to exceed the 50% consolidated retained earnings limitation on financing, and some of these orders have authorized levels of EWG/FUCO financing that are several hundred percent of consolidated retained earnings. A careful reading of these orders shows convincingly that there is almost no correlation between a registered holding company's consolidated retained earnings and levels of investments in EWGs and FUCOs in terms of predicting the likely impact of EWG/FUCO investments on the financial integrity of a holding company system or on domestic utility ratepayers.
Thus, the Commission's "experience" in this area since 1993 is that the 50% consolidated retained earnings test is simply much too low and that consolidated retained earnings is not, and never has been, a particularly "accurate measure of the continued financial health of the holding company system."4 As explained in its release adopting Rule 53, the 50% consolidated retained earnings test was chosen from among other financial ratios that were considered as the most likely to preserve the holding company's capital for investment in its domestic public utility operations when needed.5 And yet, as shown in application after application, holding companies do not project the need to make any significant equity investments in their domestic utility subsidiaries. In fact, as electric utility restructuring proceeds throughout the country, many utilities are exiting the generation business entirely, and many utilities will also likely sell their transmission assets to independent transmission companies in order to carry out the purposes of the Federal Energy Regulatory Commission's ("FERC's") Order 2000. Thus, the principal justification for the 50% consolidated retained earnings test - to preserve holding company capital for investment in its domestic utility subsidiaries - is even less compelling today than it was in 1993.
To the contrary, to the extent that registered holding companies have announced plans to invest in new generating plants in the United States, those investments will largely be made through subsidiary EWGs. These domestic investments are crucial to the future supply of energy in this country, and serve the same purpose as that previously served when the traditional vertically integrated utilities accounted for most new power plant construction. Yet neither Rule 53 nor proposed Rule 55 makes any distinction between domestic EWG investments and investments in FUCOs and foreign EWGs. Importantly, under proposed Rule 55(b)(1)(vi), an investment in a domestic EWG would count against the FUCO Investment Limitation just the same as an investment in a FUCO or foreign EWG. Accordingly, even if the Commission concludes that some form of aggregate investment limitation is necessary to protect the interests of domestic customers (in addition to the financing limitation under Rule 53 (a)), the Companies submit that investments in domestic EWGs (or at least in new domestic EWG projects) should be excluded from consideration.
Another assumption that the Commission made in choosing retained earnings over other measures of financial performance is that losses from EWG and FUCO investments would be reflected currently in earnings and therefore serve as an early warning of financial deterioration of the holding company system. However, experience clearly shows that other factors have had a much more pronounced negative impact on retained earnings of holding companies, such as "stranded cost" write-offs and charges against earnings for unrecovered costs by their domestic utility subsidiaries. The situation currently faced by California's two largest electric utilities is illustrative. Both Edison International and PG&E Corporation, which are exempt holding companies, are experiencing severe financial stress due to the inability of their regulated California utility subsidiaries (Southern California Edison Company and Pacific Gas and Electric Company ("PG&E"), respectively) to pass through to their retail customers the high cost of purchased power. Both holding companies have indicated that they expect to take substantial charges against earnings for the fourth quarter of 2000, and PG&E recently filed for bankruptcy. Yet both Edison International and PG&E Corporation have diversified, through unregulated subsidiaries, in other businesses, including EWGs and FUCOs, and these investments have apparently been successful. Nevertheless, if Edison International and PG&E Corporation were registered holding companies, they would be precluded by Rule 53 from financing investments in new EWGs and FUCOs, even though they may have the ability to issue securities for that purpose, and proposed Rule 55 would preclude new investments in FUCOs, regardless of the source of funds.
The application of the purchase method of accounting to many of the recent mergers is another example of why a test based on consolidated retained earnings produces an erroneous and misleading picture of the financial integrity of a holding company system. Under the purchase method, the retained earnings of the acquired utility company is essentially eliminated (i.e., recharacterized as additional paid-in capital). This is purely an accounting convention that has nothing to do with financial performance and is therefore a meaningless predictor of a holding company's ability to raise new capital.
While these are examples of events that can have a significant negative impact on retained earnings, they tell us nothing about the financial health of a holding company system or its ability to finance domestic utility operations. In any event, if the Commission's concern is with being able to detect an erosion in the financial integrity of a registered holding company due to poor performance of EWGs and FUCOs, then the third condition in Rule 53(b), which is repeated verbatim in proposed Rule 55(b)(1)(iii), should suffice.6
The Companies therefore strongly urge the Commission to consider, as part of this rulemaking, adoption of a different financial measurement in place of the 50% consolidated retained test, both for purposes of proposed Rule 55 and Rule 53. Although the Companies have no particular test in mind, they urge consideration of a test that is based on consolidated capitalization. Should the Commission decline this suggestion, then it is respectfully requested that proposed Rule 55, as well as Rule 53, be revised to increase the current 50% limit to at least 100% and, in addition, to eliminate or exclude investments in domestic EWGs (or at least in new domestic EWG projects) from the investment and financing limitations under those rules. Without these changes, registered holding companies, as a class, would be penalized for investing through EWGs in domestic wholesale generation projects, because any dollar invested in a domestic EWG would simply reduce the amount that could be invested in a FUCO under proposed Rule 55. The Companies submit that such a result would be fundamentally inconsistent with the purposes sought to be achieved by the Energy Policy Act, especially at a time when many regions of the country are experiencing severe shortages in electricity supplies.
3. The Additional Conditions.
In addition to the three events that are already contained in Rule 53(b), proposed Rule 55(b) would require a registered holding company to obtain Commission approval for each FUCO investment if the holding company has reported any increase in retail rates of its utility subsidiaries to compensate it for losses or inadequate returns on FUCO investments, or if any "Significant Subsidiary" of the holding company that is a public utility has a debt rating from a nationally recognized statistical rating organization that is below investment grade. While the first of these additional conditions is not particularly problematic, the second one is too broad, for two reasons. First, consistent with conditions that are routinely included in financing applications filed under the Act, if a "Significant Subsidiary" has any rated debt, it should be sufficient for purposes of proposed Rule 55(b) that such debt have an investment grade rating from only one nationally recognized statistical rating organization. Otherwise, a holding company could be "blackballed" by just one rating organization, even though a "Significant Subsidiary's" debt has an investment grade rating from a different organization. Second, the proposed condition should be revised to refer only to the senior debt of a "Significant Subsidiary." In this regard, the Companies understand that there are instances in which subordinated or junior debt of utility subsidiaries may be rated below investment grade, yet there is a market for these securities.
Moreover, for reasons that have already been addressed, the Companies believe that the underlying assumption of Rule 55(b), namely, that a below investment grade rating on the debt of a "significant" public utility subsidiary is evidence that the holding company systems' financial integrity is at risk, is flawed. Logically, since the holding company, and not its utility subsidiaries, is the source of capital for investments in FUCOs, the Commission should be concerned only with the holding company's debt rating, if any.
Lastly, the Commission is also requested to clarify that nothing in proposed Rule 55(b) is intended to imply that every "Significant Subsidiary" in fact must have a debt rating.
4. Reporting Requirements Under Form U-57
Form U-57 is currently required to be filed by any company which is or proposes to become a FUCO. Pursuant to proposed Rule 55, a registered holding company that makes a FUCO investment must, within ten day of the investment, also file a statement on Form U-57, with the Commission (and serve copies of the form on each federal, state or local regulator having jurisdiction over the rates of any system public utility company). The information required to be reported primarily involves a description of the FUCO being acquired and the type and amount of the investment (including guarantees) in the FUCO. The Companies do not question that the reporting of this information may assist the Commission and other regulatory commissions in ensuring that customers of associate public utility companies are adequately protected. However, as the Commission itself recognizes, the Form U-57, as proposed to be amended, requires registered holding companies to file on a transaction-by-transaction basis essentially the same information which is already required to be provided on an annual basis pursuant to Item 9 of the Form U5S. The Companies disagree with the Commission's position that the reporting of this information on a transaction basis (as opposed to annually) will "enhance [the Commission's] ability, as well as the ability of the state commissions, to monitor, regulate, and, in the case of the state commissions, provide [the Commission] comments and recommendations concerning the foreign utility activities of registered holding companies." To the contrary, the Companies believe that reporting the subject information annually pursuant to the Form U5S is more than adequate to safeguard the interests intended to be protected under the Act and that requiring such information to be separately reported for each transaction is unnecessary and burdensome (from the perspective of the registered holding company, as well as the staff of the Commission). In the event that the Commission, nevertheless, elects to implement the proposed Rule 55 reporting requirements, the Companies request the Commission to clarify that Form U-57 is required to be filed only in connection with the initial investment in a FUCO (and not in connection with any subsequent acquisition of securities or other interests in an existing FUCO subsidiary).
5. 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. 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 over broad 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, the Companies believe that it should, at a minimum, be limited to transactions between EWGs and FUCOs and the domestic public utility subsidiaries of a registered holding company.
6. Limitations on Businesses of a FUCO.
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. It must be assumed that Congress consciously and purposely did not impose an "exclusivity" requirement on FUCOs, as it did on EWGs. Likewise, Congress did not confer any authority on the Commission to make any "determination" of FUCO status, as it did in Section 32 with respect to determinations of EWG status by the FERC. Accordingly, the Companies do not believe that the Commission has any statutory authority to adopt a rule that would limit the businesses of a FUCO by creating a new definition that is narrower than the statutory definition and/or by otherwise imposing artificial limits on FUCO operations. In addition, the Companies do not believe that the qualification of "other" foreign businesses as FUCOs "poses risks to the protected interests under the Act" in light of the limitations/conditions on FUCO investments otherwise incorporated in proposed Rule 55 (as well as in Rule 53).
In the event that the Commission rejects this point of view, the Companies encourage the Commission to take a reasoned approach in any rule it may adopt that takes into account the existing industry structure in a given country. For example, if it is usual and customary for gas and electric utilities in a particular country to also own or operate water distribution, waste treatment, transit, telecommunications, appliance marketing and similar kinds of utility or energy-related businesses, then these activities should be allowed, without any limit. This was the approach taken by the Commission in the National Grid Group case. Further, the Companies believe that whatever restrictions the Commission may wish to impose on the allowable businesses of a FUCO, those restrictions should apply equally to U.S. registered holding companies and those registered companies that are organized outside the U.S., as well as to existing and after-acquired businesses.
The Companies appreciate having the opportunity to comment on the proposed rules and hope that the Commission finds these comments to be useful. The Companies would be pleased to respond to any further questions that the Commission may have on these comments.
Andrew F. MacDonald
|1||Entergy is filing a separate letter containing supplemental comments on proposed Rule 55(b)(1)(v).|
|2||Subsection (b)(1)(vi) of proposed Rule 55 uses the term "investment," rather than "aggregate investment," the term used in Rule 53. It is unclear whether this change in terminology is intended to have any substantive effect.|
|3||In its release proposing Rule 53, the Commission noted that Commission approval would not be needed for a registered holding company to acquire and finance the operations of EWGs using "available funds." See Proposed Rules and Forms Relating to Exempt Wholesale Generators and Foreign Utility Companies ("1993 Rulemaking Proposal"), 58 FR 13719 (Mar. 15, 1993), n. 11. Proposed Rule 55 appears to eliminate any distinction between financing proceeds and "available funds" that may be used to invest in FUCOs.|
|4||See 1993 Rulemaking Proposal, supra n. 3, 58 FR at 13721.|
|5||See Adoption of Rules, Forms and Form Amendments Relating to Exempt Wholesale Generators and Foreign Utility Companies, 58 FR 51488 at 51492 (October 1, 1993).|
|6||If, in its prior fiscal year, a registered holding company reports operating losses attributable to EWGs and FUCOs exceeding 5% of its consolidated retained earnings, then it would lose the benefit of the partial safe harbor under Rule 53, and under proposed Rule 55 would also need to obtain Commission approval for any FUCO acquisition.|