[SEAL of the SEC] TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U.S. SECURITIES AND EXCHANGE COMMISSION REGARDING REPEAL OF THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935 AND RELATED MATTERS BEFORE THE COMMITTEE ON ENERGY AND NATURAL RESOURCES UNITED STATES SENATE JUNE 24, 1997 U. S. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 ======END OF PAGE 1====== TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U. S. SECURITIES AND EXCHANGE COMMISSION EXECUTIVE SUMMARY The Securities and Exchange Commission ("SEC") supports repeal of the Public Utility Holding Company Act of 1935 ("1935 Act"), conditioned on preserving certain of the portions of the 1935 Act that provide important protections for consumers. The 1935 Act was 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. However, the 1935 Act has become redundant in many respects, as a result of prudent administration of the statute and the development and evolution of other state and federal regulation. 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. The SEC staff, at the direction of Chairman Arthur Levitt, undertook a study of the regulation of public utility holding companies in the summer of 1994. 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. The SEC recommended that Congress consider three legislative options, based on the analysis and conclusions contained in the Report. The first 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 would achieve the economic benefits of unconditional repeal, and yet also preserve the ability of states to protect consumers. S. 621, which was recently reported out of the Committee on Banking, Housing, and Urban Affairs, would repeal the 1935 Act on a stand-alone basis, and is consistent with most of the key elements of the first legislative option recommended by the SEC. S. 621 would provide 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. ======END OF PAGE 2====== The SEC is aware that some interested parties believe that it is more appropriate to consider repeal of the 1935 Act as part of a comprehensive package of energy reform legislation. Several such bills have been introduced in both houses of Congress. The SEC respectfully defers to the judgment of Congress as to whether the public interest is better served by separate repeal or by repeal as part of a larger legislative initiative. The June 1995 Report also recommended, pending legislative action, that the SEC implement administrative reforms to streamline regulation and reduce regulatory burden and delay under the 1935 Act, consistent with its principles and requirements. Rule 58, adopted by the SEC in February 1997, is the cornerstone of this administrative reform effort. The rule eliminates the requirement of prior SEC review of registered holding company investments in companies engaged in activities previously found by the SEC to be closely related to the utility business, subject to certain limitations and reporting requirements. ======END OF PAGE 3====== TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U. S. SECURITIES AND EXCHANGE COMMISSION BEFORE THE COMMITTEE ON ENERGY AND NATURAL RESOURCES UNITED STATES SENATE JUNE 24, 1997 Chairman Murkowski and Members of the Committee: I am pleased to have this opportunity to testify before you on behalf of the Securities and Exchange Commission ("SEC"). As expressed in previous testimony before various House and Senate committees, the SEC continues to support efforts to repeal the Public Utility Holding Company Act of 1935. I. INTRODUCTION The electric and gas utility industry had developed serious problems in the first quarter of the century through the misuse of the holding company structure.<(1)> The 1935 Act was enacted to address these problems. Reorganization and simplification of existing public utility holding companies in order to eliminate those abuses was a major part of the SEC's work in the years following passage of the 1935 Act. In the early 1980s, the SEC unanimously recommended that Congress repeal the statute.<(2)> 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 <(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). ======END OF PAGE 2====== otherwise were no longer necessary to prevent recurrence of the abuses that led to its enactment. Many aspects of 1935 Act regulation had become redundant: state regulation had expanded and strengthened since 1935, and the SEC had enhanced its regulation of all issuers of securities, including public utility holding companies. 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 of protections unforeseen in 1935. Because the potential for abuse through the use of multistate holding company structures, and related concerns about consumer protection, continued to exist, and because of a lack of consensus for change, repeal legislation was not enacted in the early 1980s. Since that time, however, the SEC has continued its effort to administer the 1935 Act flexibly to accommodate developments in the industry while adhering to the basic purpose of the statute. In addition, Congress has created a number of statutory exceptions to the regulatory framework of the 1935 Act.<(3)> II. THE SEC'S STUDY In response to continuing changes in the utility industry in recent years, and the accelerated pace of those changes, Chairman Arthur Levitt <(3)> Most recently, Congress enacted the Telecommunications Act of 1996. Pub. L. No. 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. ======END OF PAGE 3====== directed the SEC's Division of Investment Management in 1994 to undertake a study, under the guidance of then-Commissioner Richard Y. Roberts, to examine the continued vitality of the 1935 Act. The study was undertaken as a result of the developments noted above and the SEC's continuing need to respond flexibly in the administration of the 1935 Act. Its purpose 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)> 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 during the course of the study. In June 1995, a report of the findings made during the study ("Report") was issued. Based on these findings, the SEC has recommended, and continues to recommend, that Congress repeal the 1935 Act. At the same time, however, the SEC also recommends enactment of 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. <(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. As of December 31, 1996, for example, these companies owned more than $126 billion of electric utility assets, approximately 21 percent of all assets owned by investor-owned electric utilities. ======END OF PAGE 4====== There are several reasons why the SEC supports conditional repeal of the 1935 Act. As the Report indicates, portions of the 1935 Act, governing issuance of securities, acquisition of other utilities, and acquisition of nonutility businesses by registered holding companies, largely duplicate other existing regulation and controls imposed by the market. Nevertheless, there is a continuing need to ensure the protection of consumers. Electric and gas utilities have historically functioned as rate- regulated monopolies, and 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"). 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. The best means of guarding against cross-subsidization is likely to be audits of books and records and federal oversight of affiliate transactions. Utility rates are regulated by state authorities, and some regulators subject these rates to stricter scrutiny than others. 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 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. PROPOSALS TO REPEAL THE 1935 ACT ======END OF PAGE 5====== Repeal of the 1935 Act may be accomplished either separately or as part of a more comprehensive package of energy reform legislation. S. 621, which was recently reported out of the Senate Committee on Banking, Housing, and Urban Affairs, would repeal the 1935 Act on a stand-alone basis, eliminating duplicative regulation while preserving important protections for customers of utility companies in multistate holding company systems. The legislation incorporates most of the SEC's recommendations with respect to the future of public utility holding company regulation, and 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 bill, like its predecessor, S. 1317, accomplishes many of the goals of the conditional repeal contemplated by the SEC. S. 621 does not give the FERC the authority it needs to oversee transactions among affiliates in holding company systems and, in this respect, does not reflect the SEC's first legislative option. The bill's provisions granting access to books and records provide the FERC and the state commissions with the authority they need to identify affiliate ======END OF PAGE 6====== transactions and their terms and effects on utility costs and rates. However, the potential for cross-subsidization and consequent detriment to consumers remain, and the SEC believes that it is important for the FERC to have the flexibility to engage in more extensive regulation, if necessary. As a result, the SEC continues to support 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. As was the case with S. 621's predecessor, S. 1317, the SEC shares the concerns addressed by the legislation and supports the goals that it seeks to achieve. At a hearing on the bill held before the Senate Committee on Banking, Housing, and Urban Affairs on April 29, 1997, at which Commissioner Isaac C. Hunt, Jr., testified for the SEC, several committee members stated that repeal of the 1935 Act should be accomplished as part of a more comprehensive package of energy reform legislation. Several such proposals have been introduced and are under consideration in both houses of Congress. Repeal of the 1935 Act could also be considered as part of this overall reform. The SEC respectfully defers to the judgment of Congress as to whether the public interest is better served by separate repeal of the 1935 Act or repeal as a part of a larger legislative initiative. IV. OTHER RECOMMENDATIONS Two other legislative options were recommended by the SEC staff Report: 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, the second legislative option, is premature, because of the remaining industry monopoly power and the ======END OF PAGE 7====== 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 protect utility consumers in holding company systems to the same extent as they are protected by the 1935 Act. Complete repeal, like conditional 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, <(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; and section 36 of the Securities Exchange Act of 1934, as recently amended by the National Securities Markets Improvement Act of 1996, 15 U.S.C.  78mm. ======END OF PAGE 8====== or simplify the federal regulatory structure.<(6)> Further, this option would continue to enmesh the SEC in difficult issues of energy policy. V. ADMINISTRATIVE ACTION The SEC continues to support a legislative approach to reform of the 1935 Act, either on a stand-alone basis or as part of a comprehensive energy reform package. Pending Congressional action, however, the SEC has begun to implement many of the administrative initiatives that were recommended in the Report to streamline regulation.<(7)> The <(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, 506 U.S. 981 (1992). See Registered Holding Company Transactions: Hearing on the 1992 Ohio Power Decision Before the Subcomm. on Energy and Power of the House 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 recommended 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) (proposing rule 58) and No. 26667 (Feb. 14, 1997), 62 FR 7900 (Feb. 20, 1997) (adopting rule 58)). In addition, the Report recommended 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 recommended an increased focus upon auditing regulated companies and assisting state and local regulators in obtaining access to books, records and accounts. ======END OF PAGE 9====== cornerstone of these administrative reforms is rule 58 under the 1935 Act, which was adopted by the SEC on February 14, 1997.<(8)> Rule 58 exempts from the requirement of prior SEC approval the acquisition by a company in a registered holding company system of an interest in a company engaged in specified energy-related activities, subject to certain reporting requirements and investment limitations. The types of activities in which the acquired company may engage have been approved by the SEC in prior cases, in which they were found to satisfy the standards of the 1935 Act. Rule 58 does not permit unlimited diversification into businesses that are not related to the energy business or that have never been considered under the requirements of the Act. Instead, it codifies prior orders and permits investments of a type already examined and approved under the 1935 Act's standards, without the need for repeated SEC review of similar transactions. Rule 58 is typical of the type of regulatory reform recommended by the Report -- it streamlines regulation and reduces regulatory burden and delays, within the framework of the requirements of the 1935 Act. Despite the effects of these initiatives, changes in the utility industry are resulting in increased activity under the 1935 Act, in the areas of mergers and acquisitions, diversification and affiliate transactions, for example, and continuation of the 1935 Act in its present form will require additional resources. The options of conditional repeal or an expansion of the SEC's exemptive authority also raise the issue of resources. At present, sixteen full-time professional SEC employees are <(8)> Holding Co. Act Release No. 26667; 62 FR 7900 (Feb. 20, 1997). ======END OF PAGE 10====== 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, (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. * * * The SEC takes seriously its duties to administer faithfully the letter and spirit of the 1935 Act, and is committed to promoting the fairness, liquidity, and efficiency of the United States securities markets. By supporting conditional repeal of the 1935 Act, the SEC hopes to reduce unnecessary regulatory burdens on America's energy industry while providing adequate protections for energy consumers.