==========================================START OF PAGE 1====== TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U.S. SECURITIES AND EXCHANGE COMMISSION REGARDING S. 1317, A BILL TO REPEAL THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935 BEFORE THE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS UNITED STATES SENATE JUNE 6, 1996 U. S. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 ==========================================START OF PAGE 2====== TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U. S. SECURITIES AND EXCHANGE COMMISSION EXECUTIVE SUMMARY Senate Bill 1317, which would repeal the Public Utility Holding Company Act of 1935 ("1935 Act") and establish a more limited regulatory framework covering public utility holding companies, eliminates duplicative and burdensome regulation but, at the same time, affords important protections to consumers. The Securities and Exchange Commission shares the concerns addressed by the legislation and supports the goals that it seeks to achieve. The bill incorporates the key elements of the recommendations of the SEC concerning the future regulation of public utility holding companies. The 1935 Act was New Deal legislation, enacted to address and correct abusive practices that had developed in the electric and gas utility industry in the first quarter of the century, to the detriment of investors, consumers and the public interest. As a result of prudent administration of the 1935 Act, and the development and evolution of other state and federal regulation, the 1935 Act has become largely redundant. Moreover, the regulation contemplated by the Act to address the problems of a different era may prevent companies from responding effectively to the changes now occurring in the utility industry, changes that are bringing into question the continuing validity of a monopoly-based model of regulation. In the summer of 1994, the SEC staff, at the direction of Chairman Arthur Levitt, undertook a study of the regulation of public utility holding companies. The study culminated in a June 1995 Report of the SEC staff that proposed a range of legislative and administrative measures to eliminate unnecessary regulatory burdens on public utility holding company systems. Based on the analysis and conclusions contained in the Report, the SEC recommended last year that Congress consider three legislative options. The preferred option is repeal of the 1935 Act, accompanied by the creation of additional authority at the state and federal level to permit the continued protection of consumers through examination and oversight of transactions between or among holding company affiliates by the Federal Energy Regulatory Commission ("FERC"), and through access to books and records by the FERC and state utility commissions. The SEC believes conditional repeal is a preferred course of action because it would achieve the economic benefits of unconditional repeal, and yet also preserve the ability of states to protect consumers. ==========================================START OF PAGE 3====== Senate Bill 1317 largely implements the option recommended by the SEC, by providing the FERC and the state regulators with broad authority to inspect books and records of companies in holding company systems. The bill does not, however, adopt the SEC's recommendation that the FERC have discretion to exercise jurisdiction over affiliate transactions, including prior review and approval of such transactions in appropriate circumstances. The SEC continues to believe that such authority is necessary to shield consumers from the potential abuses that may be involved in affiliate transactions. ==========================================START OF PAGE 1====== TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U. S. SECURITIES AND EXCHANGE COMMISSION BEFORE THE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS UNITED STATES SENATE JUNE 6, 1996 Chairman D'Amato and Members of the Committee: I appreciate this opportunity to testify before you on behalf of the Securities and Exchange Commission ("SEC") regarding Senate Bill 1317, a bill to repeal the Public Utility Holding Company Act of 1935 ("1935 Act") and to establish a more limited regulatory framework covering public utility holding companies. The bill would significantly eliminate regulation that duplicates other federal and state regulation while, at the same time, it would offer important protections for customers of utility companies in multistate holding company systems. The SEC shares the concerns addressed by the legislation and supports the goals that it seeks to achieve. The legislation is largely consistent with the recommendations of the SEC with respect to the future of public utility holding company regulation. I. INTRODUCTION The 1935 Act was New Deal legislation, enacted to address grave problems that had arisen in the electric and gas utility industry in the first quarter of the century through the misuse ==========================================START OF PAGE 2====== of the holding company structure.-[1]- A major part of the SEC's work in the years following passage of the 1935 Act involved the reorganization and simplification of existing public utility holding companies in order to eliminate those abuses. In the early 1980s, the SEC evaluated the results of its administration of the 1935 Act and unanimously recommended that Congress repeal the statute.-[2]- The SEC based its recommendation primarily upon improvements in the state and federal regulation of public utility holding companies and other related developments. The SEC noted that state regulation had expanded and strengthened since 1935. In the almost 50 years since the 1935 Act became law, the SEC had enhanced its regulation of all issuers of securities, including public utility holding companies. As a result, many aspects of regulation under the 1935 Act were redundant. In addition, institutional investors such as pension funds and insurance companies had become more sophisticated and demanded more detailed information from all issuers of securities than was previously available. Changes in the accounting profession and the investment banking industry also had provided investors and consumers with a range -[1]- These abuses included inadequate disclosure of the financial position and earning power of holding companies, unsound accounting practices, excessive debt issuances and abusive affiliate transactions. See 1935 Act section 1(b), 15 U.S.C.  79a(b). -[2]- See Public Utility Holding Company Act Amendments: Hearings on S. 1869, S. 1870 and S. 1871 Before the Subcomm. on Securities of the Senate Comm. on Banking, Housing, and Urban Affairs, 97th Cong., 2d Sess. 359-421 (1982) (statement of SEC). ==========================================START OF PAGE 3====== of protections unforeseen in 1935. The SEC concluded that the 1935 Act had accomplished its basic purpose and that its remaining provisions, to a large extent, either duplicated other state or federal regulation or otherwise were no longer necessary to prevent recurrence of the abuses that led to its enactment. Repeal legislation was not enacted, however, due in part to the continued potential for abuse through the use of multistate holding company structures, related concerns about consumer protection, and the lack of consensus for change. Throughout the 1980s and into this decade, the SEC has continued its effort to administer the 1935 Act flexibly to accommodate developments in the industry within the limits of the statute. II. THE SEC'S STUDY In recent years, the pace of change in the utility industry has accelerated significantly. Congress has played a major role in the restructuring of the industry that is now underway, and has created a number of statutory exceptions to the regulatory framework of the 1935 Act.-[3]- In view of these developments and the SEC's continuing need to respond flexibly in the administration of the 1935 Act, Chairman Arthur Levitt directed the SEC's Division of Investment Management in 1994 to undertake a study, under the guidance of then-Commissioner ---------FOOTNOTES---------- -[3]- Most recently, Congress enacted the Telecommunications Act of 1996. Pub. L. 104-104, 110 Stat. 56 (1996). The Telecommunications Act permits registered holding companies, without prior SEC approval under the Act, to acquire and retain interests in companies engaged in a broad range of telecommunications activities. ==========================================START OF PAGE 4====== Richard Y. Roberts, to examine the continued vitality of the statute. The purpose of the study was to identify unnecessary and overlapping regulation, and at the same time to identify those features of the statute that remain appropriate in the regulation of the contemporary electric and gas industries.-[4]- During the course of the study, the SEC staff worked with representatives of the utility industry, consumer groups, trade associations, investment banks, rating agencies, economists, state, local and federal regulators, and other interested parties. A report of the findings made during the study ("Report") was issued in June 1995. Based on these findings, the SEC has recommended, and continues to recommend, that Congress repeal the 1935 Act, but at the same time enact legislation to provide necessary authority to the FERC and the state public utility commissions relating to affiliate transactions, audits and access to books and records, for continued protection of utility consumers. ---------FOOTNOTES---------- -[4]- The study focused primarily on registered holding company systems, of which there are currently fifteen. The 1935 Act was enacted to address problems arising from multistate operations, and reflects a general presumption that intrastate holding companies and certain other types of holding companies which the 1935 Act exempts and which now number more than one hundred, are adequately regulated by local authorities. Despite their small number, registered holding companies account for a significant portion of the energy utility resources in this country. In 1995, for example, these companies owned more than $124 billion of electric utility assets, almost twenty percent of all assets owned by investor-owned electric utilities. ==========================================START OF PAGE 5====== The SEC supports this legislative option for several reasons. As the Report indicates, regulation under the 1935 Act that affects the ability of holding company systems to issue securities, acquire other utilities, and acquire nonutility businesses is largely redundant in view of other existing regulation and controls imposed by the market. There is a continuing need, however, to ensure the protection of consumers. Electric and gas utilities have historically functioned as monopolies whose rates are regulated by state authorities. Some regulators subject these rates to stricter scrutiny than others. There is a continuing risk that a monopoly, if left unguarded, could charge higher rates and use the additional funds to subsidize affiliated businesses in order to boost its competitive position in other markets ("cross-subsidization"). Thus, so long as electric and gas utilities continue to function as monopolies, the need to protect against the cross-subsidization of nonutility businesses will remain. In view of the sophistication of contemporary securities regulation and analysis by the public and private sectors, the best means of guarding against cross- subsidization is likely to be audits of books and records and federal oversight of affiliate transactions. A survey of state regulation, undertaken in conjunction with the study, revealed that the states may not have adequate authority to perform audit and review functions with respect to multistate holding companies. The provisions of the 1935 Act provide significant assistance to these states in their effort to ==========================================START OF PAGE 6====== protect utility consumers. Earlier efforts to repeal the 1935 Act may have failed because they did not address this potential "regulatory gap" in consumer protection. III. SENATE BILL 1317 Senate Bill 1317 accomplishes many of the goals of the conditional repeal contemplated by the SEC. The bill would provide the FERC with the right to examine books and records of registered holding companies and their affiliates that are relevant to costs incurred by associated utility companies, in order to protect ratepayers. The legislation would also provide an interested state commission with access to such books and records (subject to protection for confidential information), if they are relevant to costs incurred by utility companies subject to the state commission's jurisdiction and are needed for the effective discharge of the state commission's responsibilities in connection with a pending proceeding. Finally, the bill would provide a transition period in which states, utilities and other parties affected by the change in the regulatory regime could prepare for the new regime. The Senate bill does not reflect the SEC's preferred legislative option, however, in one respect: it does not give the FERC broad authority to oversee transactions among affiliates in holding company systems. Although the bill's provisions granting access to books and records go far to provide the FERC ==========================================START OF PAGE 7====== and the state commissions with the authority they need to identify affiliate transactions and their terms and effects on utility costs and rates, the SEC supports a broader grant of authority to the FERC to oversee these transactions, including, if the FERC deems it appropriate, prior review and approval of affiliate transactions. Because the potential for cross- subsidization and consequent detriment to consumers remain, it is important for the FERC to have the flexibility to engage in more extensive regulation, if necessary. The SEC notes with respect to the transition period that the Report recommended that such a period be at least one year in duration. The National Association of Regulatory Utility Commissioners has since suggested that a longer period is necessary, in view of the fact that many state legislatures only meet once every two years. The SEC would have no objection to a longer transition period. IV. OTHER RECOMMENDATIONS The Report recommended, and the SEC endorsed, two other legislative options for the Congress to consider. These options were complete repeal of the 1935 Act and a grant of broader exemptive authority under the Act to the SEC. The SEC believes that complete repeal is premature, in view of the remaining industry monopoly power and the inconsistent pattern of state regulation described above. Some commentators contend, however, that the states have the ability, if they choose to exercise it, to create regulatory structures that will ==========================================START OF PAGE 8====== protect utility consumers in holding company systems to the same extent as they are protected by the 1935 Act. Like conditional repeal, complete repeal would require a reasonable transition period. As noted above, some states may need a period of at least two years to enact new legislation or to add resources to meet the additional regulatory burden that would accompany unconditional repeal of the 1935 Act. The third option is to provide the SEC with more authority to exempt holding company systems from the requirements of the 1935 Act.-[5]- An expansion of exemptive authority would not, of course, achieve the economic benefits of conditional or unconditional repeal of the 1935 Act, or simplify the federal ---------FOOTNOTES---------- -[5]- The SEC's current exemptive authority is considerably narrower than the exemptive authority under other federal securities laws. A model of broader exemptive authority is contained in section 6(c) of the Investment Company Act of 1940, 15 U.S.C.  80a-6(c), which grants the SEC the authority by rule or order to exempt any person or transactions from any provision or rule if the exemption is necessary or appropriate in the public interest and consistent with the protection of investors. See also section 206A of the Investment Advisers Act of 1940, 15 U.S.C.  80b-6a (same). ==========================================START OF PAGE 9====== regulatory structure.-[6]- Further, this option would continue to enmesh the SEC in difficult issues of energy policy. V. ADMINISTRATIVE ACTION Pending Congressional action, the SEC has begun to implement many of the numerous administrative initiatives that were recommended in the Report.-[7]- The SEC continues, however, to support a more comprehensive approach to reform of the 1935 Act, such as that reflected in S. 1317. The options of conditional repeal or an expansion of the SEC's exemptive authority raise the issue of resources. At -[6]- In the past, the SEC has testified before Congress with respect to concerns that arose after the decision by the U.S. Court of Appeals for the District of Columbia Circuit in Ohio Power v. FERC, 954 F.2d 779 (D.C. Cir.), cert. denied, 113 S.Ct. 483 (1992). See Registered Holding Company Transactions: Hearing on the 1992 Ohio Power Decision Before the Subcomm. on Energy and Power of the House of Representatives Comm. on Energy and Commerce, 103d Cong., 2d Sess. 35-48 (1994) (testimony of Richard Y. Roberts, Commissioner, SEC). The legislative repeal options discussed above would eliminate the problem of conflicting SEC and FERC decisions that was the subject of that decision. Enhanced exemptive authority would not address such problems unless the SEC, through the exercise of its exemptive powers, were to cease issuing orders affecting the pricing of goods. -[7]- The Report recommends rule amendments to broaden exemptions for routine financings by subsidiaries of registered holding companies (see Holding Co. Act Release No. 26312 (June 20, 1995), 60 FR 33640 (June 28, 1995)) and to provide a new exemption for acquisition of interests in companies that engage in energy-related and gas-related activities (see Holding Co. Act Release No. 26313 (June 20, 1995), 60 FR 33642 (June 28, 1995)). In addition, the Report recommends changes in administration of the Act that would permit a "shelf" approach for approval of financing transactions, relax constraints on utility acquisitions and streamline the approval process for such transactions. The Report also recommends an increased focus upon auditing regulated companies and assisting state and local regulators in obtaining access to books, records and accounts. ==========================================START OF PAGE 10====== present, fourteen full-time professional SEC employees are employed in the administration of the 1935 Act. Their work includes (1) analysis and disposition of various transactions for which the 1935 Act requires prior SEC authorization and status issues under the Act, (2) status issues under the 1935 Act, (3) audits of holding company systems and related companies, and (4) drafting and implementation of rulemaking proposals to reflect changes in the utility industry and in financial regulation. Repeal of the 1935 Act would not achieve significant cost savings for the federal government, particularly if some of these responsibilities were carried out by the FERC. Expanded exemptive authority, on the other hand, could require greater resources, in view of the need to evaluate and implement broad requests for exemptive relief. Because changes in the utility industry are resulting in increased activity under the Act, in the areas of mergers and acquisitions, diversification and affiliate transactions, for example, continuation of the 1935 Act in its present form will also require additional resources. * * * The SEC is committed to promoting the fairness, liquidity, and efficiency of the United States securities markets. It also takes seriously its duties to administer faithfully the letter and spirit of the 1935 Act. By supporting conditional repeal of the 1935 Act, the SEC hopes to reduce unnecessary regulatory burdens on America's energy industry while providing adequate ==========================================START OF PAGE 11====== protections for energy consumers.