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U.S. Securities and Exchange Commission


(Release No. 35-27695; 70-9793)

FirstEnergy Corp., et al

Supplemental Order Authorizing System Service Company, System Services, Utility Company Services; Reservation of Jurisdiction

June 30, 2003

FirstEnergy Corp., ("FirstEnergy"), FirstEnergy's service company subsidiary, FirstEnergy Service Company ("ServeCo"), Ohio Edison Company ("Ohio Edison"), The Cleveland Electric Illuminating Company ("Cleveland Electric"), The Toledo Edison Company ("Toledo Edison"), American Transmission Systems, Incorporated ("ATS"), Jersey Central Power & Light Company ("JCP&L"), Pennsylvania Electric Company ("Penelec"), Metropolitan Edison Company ("Met-Ed"), Pennsylvania Power Company ("Penn Power"), York Haven Power Company ("York Haven"), The Waverly Electric Power & Light Company ("Waverly" and together "Electric Utilities"), and Northeast Ohio Natural Gas Corp. ("Northeast," with the Electric Utilities, "Utility Subsidiaries" and collectively, "Applicants") all located in Akron, Ohio, have filed with the Securities and Exchange Commission ("Commission") a post-effective amendment, under section 13(b) of the Public Utility Holding Company Act, as amended ("Act") and rules 54, 88, 90, and 91 under the Act, to a previously filed application ("Application"). The Commission issued a notice of the underlying Application on August 31, 2001 (HCAR No. 27435).

I. Background

By order dated October 29, 2001 (HCAR No. 27459) ("Merger Order"), as supplemented by orders dated November 8, 2001 (HCAR No. 27483) and December 23, 2002 (HCAR No. 27628), the Commission authorized a merger ("Merger") between FirstEnergy and GPU, Inc. ("GPU"), a Pennsylvania corporation. The Merger became effective on November 7, 2001, with FirstEnergy as the surviving entity, and FirstEnergy registered under the Act as a holding company on the same day. As a result of the Merger, FirstEnergy directly or indirectly owns all of the outstanding common stock of ten electric utility subsidiaries, Ohio Edison, Cleveland Electric, Toledo Edison, ATS, JCP&L, Penelec, Met-Ed, Penn Power, York Haven, and Waverly, which together provide service to approximately 4,300,000 retail and wholesale electric customers in a 37,200 square-mile area in Ohio, New Jersey, New York and Pennsylvania. In addition, FirstEnergy owns one gas utility subsidiary, Northeast Ohio Natural Gas Corp. ("Northeast" and with the Electric Utilities, "Utility Subsidiaries"), which provides gas distribution and transportation service to approximately 5,000 customers in central and northeast Ohio. FirstEnergy also directly or indirectly holds investments in numerous nonutility subsidiaries that are engaged in a variety of energy-related, exempt, or otherwise functionally related nonutility businesses ("Nonutility Subsidiaries" and together, with the Utility Subsidiaries, "Subsidiaries").

FirstEnergy also directly owns all of the issued and outstanding common stock of FirstEnergy Service Company ("ServeCo"), which was organized in 2001 in order to become a new service company subsidiary of FirstEnergy. FirstEnergy previously owned GPU Service, Inc. ("GPU Service"), a Pennsylvania corporation, which was formerly a direct service company subsidiary of GPU and was merged into ServeCo as of June 1, 2003.

Under the Merger Order, the Commission granted FirstEnergy a temporary exemption under its rules in order to enable FirstEnergy to continue to provide common corporate services to the FirstEnergy system until all of the service functions performed by FirstEnergy and GPU Service have been consolidated in ServeCo. The Merger Order specified that ServeCo would begin at least minimal operations within 90 days following closing of the Merger, and that all service functions of FirstEnergy and GPU Service would be transferred to ServeCo not later than February 1, 2003. By Supplemental Order dated January 31, 2003 (HCAR No. 27647), the Commission authorized an extension of time until June 1, 2003 for full compliance of ServeCo's activities in order to coincide with FirstEnergy's implementation of its SAP Enterprise IT Solution project. By Supplemental Order dated June 2, 2003 (HCAR No. 27682) ("June 2 Order"), the Commission granted an additional one month extension to June 30, 2003, authorizing the FirstEnergy System to continue its service company activities during this period. Since June 1, 2003, ServeCo has been functioning as the FirstEnergy system service company in accordance with the policies and procedures described below.

ServeCo's authorized capitalization consists of 850 shares of common stock with no par value, of which one (1) share is issued, outstanding and held by FirstEnergy. ServeCo will derive substantially all of its needs for additional working capital from borrowings under FirstEnergy's nonutility money pool as authorized in the Merger Order and/or additional equity investments by FirstEnergy under rule 45(b)(4) or rule 52(b), as applicable.

II. Current Request

Applicants request approval for: (1) the consolidation of service functions in ServeCo; (2) ServeCo's policies and procedures, (3) the ServeCo service agreement ("Service Agreement")1 to be entered into with FirstEnergy, each of the Utility Subsidiaries, and each other associate company in the FirstEnergy system that requests services from ServeCo, (4) services to be rendered by Utility Companies to other Utility Companies under a utility service agreement ("Utility Service Agreement") through August 1, 2006,2 and (5) reserve jurisdiction over JCP&L's participation in the Service Agreement until completion of the record.

Applicants request that ServeCo provide its associate companies with services in the following departments: administrative services, business development, call center, claims, communications, controllers, corporate and shareholder services, corporate affairs and community involvement, credit management, energy delivery and customer service, economic development, enterprise risk management, FirstEnergy technologies, technology and support services, governmental affairs, human resources, industrial relations, information technology, insurance services, internal audit, investment management, investor relations, legal, performance planning, rates and regulatory affairs, real estate, supply chain, transmission & distribution technical services, treasury and workforce development.3

Applicants commit that services rendered by ServeCo will be rendered at cost in accordance with rules 90 and 91 and that the costs of services provided by ServeCo will be directly assigned, distributed or allocated by work order numbers (or equivalent cost collectors, collectively, "Workorders") in accordance with the SEC's Uniform System of Accounts for Mutual Service Companies and Subsidiary Service Companies ("Uniform System of Accounts"). The primary basis for charges to associate companies is the direct charge method. Applicants state that other costs that are not directly assigned, including overheads, other general administrative costs, and the costs of operating ServeCo as a separate corporate entity, will be allocated to associate companies using one or a combination of the methods of allocation. Applicants state that ServeCo will maintain its accounts, cost-accounting procedures and other records in accordance with the requirements of the Uniform System of Accounts.

A. Proposed Cost Allocation Methodology

Applicants propose that ServeCo categorize costs of services provided to affiliates into three primary categories: (1) directly assignable costs ("Directly Assignable Costs") represent expenses incurred for activities and services exclusively for the benefit of one affiliate, and in many respects, are captured through individual department Workorder systems for specific project billing purposes; (2) directly attributable costs ("Directly Attributable Costs") represent expenses incurred for activities and services that benefit more than one affiliate and which can be assigned using direct measures of costs causation; and (3) indirect costs ("Indirect Costs"). Applicants state that a portion of ServeCo's expenses will not be directly related to specific current operations or functions of individual Subsidiaries. Accordingly, Applicants propose to develop formulae that recognize the overall contribution of ServeCo to both the current and future operations of the FirstEnergy system. After all Directly Assignable Costs and Directly Attributable Costs have been made, the remaining Indirect Costs in each department in ServeCo will be fairly and equitably allocated among FirstEnergy and the Subsidiaries.

Applicants state that FirstEnergy has invested capital for infrastructure over many years in the Utility Subsidiaries so that they may develop the support services necessary to serve their customers. Applicants identify costs associated with these infrastructure investments (e.g., accounting and human resources systems, telephone circuits and other communications equipment, mainframe CPU, printers and data storage development tools and client servers and storage not dedicated to the competitive unit) as Indirect Costs. Applicants propose that these Indirect Costs be allocated among all of FirstEnergy's Subsidiaries using a multi-variable formula, which gives weight to more than one measure of the size of the various Subsidiaries' operations within the FirstEnergy system. Applicants state that this formula is not intended to effect, and will not result in, the allocation of these Indirect Costs exclusively to the Utility Subsidiaries.

Applicants state that ServeCo will direct charge its associate companies for all costs of products and services where possible in accordance with rule 90(b). Applicants further state that the costs of products and services provided by ServeCo that cannot be charged directly to the Subsidiary or Subsidiaries receiving the product or service will be allocated among all Subsidiaries and FirstEnergy, where applicable, by utilizing one of the methods described below. Applicants state that the key determinants in assigning the allocation methods were the business operations of the Subsidiary or Subsidiaries receiving the benefit of the product and service, and the associated cost driver for each product and service. Applicants propose to utilize eighteen methods of allocation for charging a share of the Indirect Costs to the Subsidiaries benefiting from the particular product or service being provided.4

Applicants commit that ServeCo will maintain its accounts, cost-accounting procedures and other records in accordance with the requirements of the Uniform System of Accounts and will file an annual report on Form U-13-60 in accordance with rule 94.

As provided in the Merger Order, and for so long as FirstEnergy remains a "registered holding company" under the Act, Applicants commit that no change in the organization of ServeCo, the type and character of the companies to be serviced, the methods of allocating costs to associate companies, or in the scope or character of the services to be rendered subject to section 13 of the Act, or any rule, regulation or order thereunder, shall be made unless and until ServeCo shall first have given the Commission written notice of the proposed change not less than 60 days prior to the proposed effectiveness of any such change. If, upon the receipt of any such notice, the Commission shall notify ServeCo within the 60-day period that a question exists as to whether the proposed change is consistent with the provisions of section 13 of the Act, or of any rule, regulation or order thereunder, then the proposed change shall not become effective unless and until Applicants shall have filed with the Commission an appropriate declaration regarding the proposed change and the Commission shall have permitted such declaration to become effective.

B. Services by Utility Subsidiaries to Each Other

Applicants state that FirstEnergy organizes and conducts Ohio Edison, Toledo Edison, Cleveland Electric, and Penn Power ("Ohio Region Utilities") operations on a regional basis.5 These regions operate and are managed as separate business units. Applicants assert that this regional structure focuses on moving accountability and decision making closer to customers with an emphasis on decentralized operations and providing cost effective, high-quality service to customers. Because of this decentralized, regional approach, Applicants request authority to provide certain regional support services (such as Human Resources, Workforce Development and Business Services) accounted for in the appropriate Ohio Region Utility for a time not to extend past August 1, 2006 ("Authorization Period"). Applicants state, for example, in the case of their activities in Western Region - Ohio and Eastern Region - Ohio, the employees who must provide service to more than one legal entity will continue to charge their time in a fair and equitable manner to all Ohio Region Utilities within that region, rather than be accounted for in the ServeCo. Applicants state that of the approximately 5,500 employees in nine Regions, less than 70 employees provide the "regional" support services discussed herein. Applicants state that the total amount charged for services under these arrangements for the year 2002 was approximately $3.4 million and that this amount is estimated based on average wages including fringes utilizing the hours estimated by each utility providing the services.

In addition, Applicants state that from time to time, one Ohio Region Utility may request other services from another Ohio Region Utility. Applicants commit that these services will be provided at cost in accordance with rules 90 and 91 and billed to the receiving Ohio Region Utility at cost as set forth in accordance with a utility-to-utility service agreement ("Ohio Region Utility Service Agreement"). Applicants expect that most of the services provided under the Ohio Region Utility Service Agreement will be direct charged and that other costs not directly assigned will be allocated to the Ohio Region Utility benefiting from the service, utilizing formulae specified in the Ohio Region Utility Service Agreement.

Applicants state that none of the services provided under the Ohio Region Utility Service Agreement are services that would typically be provided by mutual service companies approved by the Commission in accordance with rule 88 under the Act. Applicants maintain that these services will not encroach upon, or be duplicative of, the services provided by ServeCo and are not proper services for ServCo to provide as a mutual service company. Applicants commit that no decision-making functions will be offered under Ohio Region Utility Service Agreement.

C. Internal Audit Procedures

Applicants state that the Internal Audit division ("IA") of FirstEnergy has undertaken a five-phase audit of ServeCo that is expected to take place over the next three to five years. Phase I, which has been completed, was a proactive review of ServeCo's processes, approaches, assessment tables and cost allocation methodologies. Applicants state that at the completion of this phase of the audit, which was prior to the SAP implementation, IA concluded that the cost allocation methodologies were consistent with management intent and followed the guidelines set forth in Exhibit A to the Service Agreement.

Applicants state that Phase II, which is expected to be completed by September 4, 2004, is a detailed review to ensure that the ServeCo employees are implementing processes and inputting charges correctly to comply with the Act. This phase is scheduled to begin in late 2003 or early 2004. Applicants state that the multiple factor allocation formula will be reviewed to determine if the five percent charged to FirstEnergy is a reasonable amount so that FirstEnergy is allocated a fair and equitable amount of ServeCo's charges.

Applicants state that Phase III, which is expected to begin by October 1, 2004, will be a review of the ServeCo allocation methods, a review and validation of ServeCo's billing methodologies. Applicants state that IA will review ServeCo's budget process including its cost controls, cost accountability, reports, budget variances and the role of operating company management in the budgeting process. Additionally, Applicants state that IA will also review tax allocations in this phase of the audit.

Applicants state that Phase IV, which is expected to begin by January 1, 2005, will consist of a review of benchmarking data to determine whether pricing of services is at an appropriate level and whether the quality of services that are provided is adequate. Finally, Applicants state that Phase V will be a review of the Service Agreement vis-à-vis the scope of service described therein and the actual services provided.

Under the Merger Order, FirstEnergy was authorized to utilize the proceeds of authorized financing to increase its "aggregate investment," as defined in rule 53(a), in exempt wholesale generators ("EWGs") and foreign utility companies ("FUCOs"), as defined in sections 32 and 33 of the Act, to $5 billion. FirstEnergy states that it is in compliance with all requirements of rule 53(a) except clause (1). At March 31, 2003, the combined "aggregate investment," as defined in rule 53(a), of FirstEnergy in EWGs and FUCOs, was approximately $1.31 billion. Although FirstEnergy's aggregate investment exceeds the 50% "safe harbor" limitation contained in rule 53, FirstEnergy's aggregate investment is below $5 billion limit authorized in the Merger Order. In addition, FirstEnergy states that it complies with the record-keeping requirements of rule 53(a)(2) and the employee limitation under rule 53(a)(3); FirstEnergy further states that it will comply with the limitation under rule 53(a)(4) concerning the submission of copies of certain filings under the Act to retail regulatory commissions. Finally, none of the circumstances described in rule 53(b) has occurred or is continuing. FirstEnergy represents that there has been no material adverse impact on its consolidated capitalization resulting from FirstEnergy's investments in EWGs and FUCOs since the date of the Merger Order and that the proposed transactions will not have any material impact on FirstEnergy's capitalization. Further, Applicants state that since the date of the Merger Order, FirstEnergy's investments in EWGs and FUCOs have contributed positively to its level of earnings, other than for the negative impact on earnings due to FirstEnergy's writedowns of its investments in Avon Energy Partners Holdings ("Avon") and Empresa Distribuidora Electrica Regional S.A. and affiliates ("Emdersa").6 Applicants also state that since the date of the Merger Order, and, after taking into account the effects of the Merger, there has been no material change in FirstEnergy's level of earnings from EWGs and FUCOs.

FirstEnergy estimates that the additional fees, commissions and expenses incurred or to be incurred in connection with the proposed transaction will not exceed $25,000.

Applicants state that the New Jersey Board of Public Utilities ("NJBPU") has jurisdiction over the proposed Service Agreement, as it relates to NJCP&L. NJBPU has not yet made a determination regarding the Service Agreement. Accordingly, Applicants request that the Commission reserve jurisdiction with respect to JCP&L's participation in the Service Agreement and extend the interim authority granted in the June 2 Order with respect to JCP&L until the NJBPU approves JCP&L's participation in the Service Agreement. The Pennsylvania Pubic Utility Commission ("PPUC") has jurisdiction under its affiliate interests statutes over the proposed Service Agreement, as it relates to the Utility Subsidiaries that are subject to regulation by those commissions. On February 4, 2003, the PPUC approved the Service Agreement. Applicants state that no other State commission, and no Federal commission, other than this Commission has jurisdiction over the proposed transaction.

Due notice of the filing of the Application has been given in the manner described in rule 23 under the Act, and no hearing has been requested of or ordered by the Commission. On the basis of the facts in the record, the Commission finds that, except as to those matters over which jurisdiction is reserved, the applicable standards of the Act and rules under the Act are satisfied, and no adverse findings are necessary.

IT IS ORDERED under the applicable provisions of the Act and the rules under the Act, that, except as to those matters over which jurisdiction is reserved, this Application is granted and permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24, in particular rule 24(c)(2), under the Act.

IT IS FURTHER ORDERED that jurisdiction be reserved over the approval of JCP&L's participation in the Service Agreement, pending completion of the record.

For the Commission, by the Division of Investment Management, pursuant to delegated authority.

Margaret H. McFarland
Deputy Secretary


1 The proposed Service Agreement is filed with the Application as Exhibit N-7.

2 The proposed Utility Service Agreement is filed with the Application at Exhibit N-8.

3 Applicants describe these departments in more detail in Exhibit A to the Service Agreement.

4 These methods are described in detail in Exhibit A to the Service Agreement.

5 Applicants state that there are nine regions in three states: Western Region - Ohio; Northern Region - Ohio; Central Region - Ohio; Southern Region - Ohio; Eastern Region- Ohio; Western Region - Pennsylvania; Eastern Region - Pennsylvania; Northern Region - New Jersey; and Central Region - New Jersey. Each region has a "Regional President", as well as a management and support team that reports to the Regional President. Applicants state that for the most part, each region is entirely within a particular Utility Subsidiary's service territory. However, two regions - Western Region - Ohio and Eastern Region - Ohio -- include parts of several Utility Subsidiaries. Western Region - Ohio, includes all of Toledo Edison and 990 square miles of Ohio Edison's service territory in Sandusky, Ohio. The Eastern Region - Ohio covers the eastern 2,517 square miles of Ohio Edison, 661 square miles of Cleveland Electric and all 1,112 square miles of Penn Power.

6 At the time of the Merger Order, FirstEnergy identified certain former GPU EWG and FUCO investments for divestiture within one year. Among those identified were Avon, a holding company for Midlands Electricity plc, an electric distribution business in the United Kingdom and GPU Emdersa, an electric distribution business in Argentina. In May 2002, FirstEnergy sold 79.9% of its interest in Avon, and in the fourth quarter of 2002, recorded a $50 million charge ($32.5 million net of tax) to reduce the carrying value of its remaining 20.1% interest. Additionally, FirstEnergy did not reach a definitive agreement to sell Emdersa as of December 31, 2002, and therefore, the Emdersa assets could no longer be treated as "assets pending sale" on the FirstEnergy consolidated balance sheets. On November 1, 2002, FirstEnergy began consolidating the results of Emdersa's operations in its financial statements. In the fourth quarter of 2002, FirstEnergy recorded a one-time, after-tax charge of $88.8 million (comprised of $104.1 million in currency transaction losses arising principally from U.S. dollar denominated debt, offset by $15.3 million of operating income). In addition to the currency transaction losses, FirstEnergy recognized a currency translation adjustment in other comprehensive income of $91.5 million as of December 31, 2002. These accounting charges, in the aggregate, resulted in a $212.8 million decrease in FirstEnergy's consolidated capitalization of $21.55 billion as of December 31, 2002, which amount includes short-term borrowings.



Modified: 08/05/2003