TESTIMONY OF COMMISSIONER ISAAC C. HUNT, JR. U.S. SECURITIES AND EXCHANGE COMMISSION BEFORE THE SUBCOMMITTEE ON ENERGY AND POWER UNITED STATES HOUSE OF REPRESENTATIVES MAY 6, 1999 Chairman Barton, Ranking Member Hall, and Members of the Subcommittee: I am pleased to have this opportunity to testify before you on behalf of the Securities and Exchange Commission ("SEC"). The SEC continues to support repeal of the Public Utility Holding Company Act of 1935 ("1935 Act"). Repeal should be done in a manner that eliminates duplicative regulation while also preserving important protections for customers of utility companies in multistate holding company systems. 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 1980's, 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 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 efforts 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 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 Federal Energy Regulatory Commission ("FERC") and the state public utility commissions relating to affiliate transactions, audits and access to books and records, for the continued protection of utility consumers. There are several reasons why the SEC supports conditional repeal of the 1935 Act. As the Report indicates, portions of the 1935 Act, such as those 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 companies 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 Repeal of the 1935 Act may be accomplished either separately or as part of a more comprehensive package of energy reform legislation. Four bills have been introduced in both Houses of Congress that provide for the repeal of the 1935 Act, either as part of comprehensive energy restructuring or on a stand-alone basis. H.R. 1587, introduced by Congressman Stearns on April 27, 1999, and H.R. 667, introduced by Congressman Burr on February 10, 1999 (collectively, the "House Bills"), would repeal the 1935 Act as part of broader energy-related legislation.[5] For example, the House Bills 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 House Bills 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 House Bills 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 House Bills accomplish many of the goals of the conditional repeal contemplated by the SEC. As the SEC has stated in testimony on bills introduced in the last Congress to repeal the 1935 Act, the House Bills do not give the FERC the authority it needs to oversee transactions among affiliates in holding company systems and, in this respect, do not reflect the SEC's preferred legislative option.[6] Provisions granting access to books and records provide the FERC and the state commissions with the authority they need to identify affiliate 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. The SEC notes that the Report recommended a transition period of 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 biennially. The SEC would have no objection to a longer transition period. 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 1935 Act to the SEC. The SEC believes that complete repeal, the second legislative option, is premature, because the monopoly power of the industry has not yet been completely erased and because of 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 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.[7] 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 regulatory structure.[8] Further, this option would continue to enmesh the SEC in difficult issues of energy policy. The SEC understands that many believe that repeal of the 1935 Act should be accomplished as part of a more comprehensive package of energy reform legislation. 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 part of a larger legislative initiative. V. MARKET POWER ISSUES The continuing efforts to restructure the utility industry raise major competitive issues related to the "market power" of utilities. The 1935 Act was intended to address, among other things, the concentration of control of ownership of the public- utility industry. These issues were considered by the SEC's staff in the Report. Section 10(b)(1) of the Act requires the SEC to disapprove a utility acquisition if it will tend toward concentrated control of public-utility companies in a manner detrimental to the public interest or the interest of investors or consumers.[9] Traditionally, the SEC's analysis of utility acquisitions under section 10(b)(1) includes consideration of federal antitrust policies.[10] More specifically, the anticompetitive ramifications of an acquisition have traditionally been considered in light of the fact that public utilities are regulated monopolies subject to the ratemaking authority of federal and state administrative bodies.[11] However, the SEC is not the only agency that reviews the potential anticompetitive effects of utility acquisitions. In many instances, proposed utility acquisitions are subject to FERC and state approval. Like the SEC, the FERC must consider antitrust implications of matters before it.[12] In addition, the potential anticompetitive effects are also reviewed by the Department of Justice or the Federal Trade Commission. In recent years, the SEC has looked to all these regulators for their expertise in certain operational issues, including competitive issues. In particular, in matters where the combined entity resulting from a merger would have control of key transmission facilities and of surplus power. Although the SEC does independently assess the transaction under the standard of the 1935 Act, we have generally relied upon the FERC's greater expertise regarding issues related to utility competition. The Court of Appeals for the District of Columbia Circuit has stated that "when the SEC and another regulatory agency both have jurisdiction over a particular transaction, the SEC may `watchfully defer' to the proceedings held before -- and the result reached by -- that other agency."[13] Therefore, repeal of the 1935 Act is unlikely to effect how market power issues are reviewed at the federal level. While the 1935 Act provides an additional layer of regulatory approval for certain utility mergers, the Commission's reliance, where appropriate, on other regulators for the key market power determination, make its review of market power issues largely redundant. VI. ADMINISTRATIVE ACTION The SEC continues to support a comprehensive approach to reform of the 1935 Act. The SEC has implemented many of the numerous administrative initiatives that were recommended in the Report to streamline regulation.[14] Despite the effects of these initiatives, changes in the utility industry are resulting in increased activity under the 1935 Act, especially in the area of mergers and acquisitions, diversification and affiliate transactions. Hence, continuation of the 1935 Act in its present form will require additional resources. Moreover, during 1998, mergers resulted in the formation of three new registered holding companies. 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 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. **FOOTNOTES** [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). [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 1935 Act, to acquire and retain interests in companies engaged in a broad range of telecommunications activities. [4]: The study focused primarily on registered holding company systems, of which there are currently nineteen. 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, 1998, the nineteen registered holding companies owned more than $170 billion of electric utility assets, approximately 25 percent of all assets owned by investor-owned electric utilities. Electric utilities owned by registered holding companies served 26.4 million customers, or approximately 22% of all electric customers in the United States. [5]: S.516, which was introduced in the Senate on March 3, 1999, would also repeal the 1935 Act as part of broader energy-related legislation. S.313, which was introduced in the Senate on January 27, 1999, would repeal the 1935 Act on a stand-alone basis. The 1935 Act repeal provisions in the Senate and House bills are, in substance, the same, except that H.R. 1587, among other things, would exempt from its provisions holding companies currently exempt from registration under the 1935 Act. These differences may require further analysis. [6]: See The Public Utility Holding Company Act of 1997: Hearings on S. 621 Before the Senate Comm. on Banking, Housing, and Urban Affairs, 105th Cong., 1st Sess. (1997) (testimony of Isaac C. Hunt, Jr. Commissioner, SEC); and Regarding Repeal of the Public Utility Holding Company Act of 1935: Hearings on S. 621 Before the Senate Comm. on Energy and Natural Resources, 105th Cong., 1st Sess. (1997) (testimony of Barry Barbash, Director, Div. of Investment Management, SEC). [7]: 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 transaction 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 and Exchange Act of 1934, as recently amended by the National Securities Markets Improvement Act of 1996, 15 U.S.C. § 78mm (same). [8]: 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 were the subject of that decision. [9]: The SEC must also consider whether the purchase price is reasonable; whether the purchase will unduly complicate the capitalization of the resulting system; and whether the transaction will serve the public interest by tending toward the economic and efficient development of an integrated public-utility system. [10]: Municipal Electric Association v. SEC, 413 F.2d 1052, 1056-07 (D.C. Cir. 1969) (section 10(b)(1) analysis "must take significant content" from "the federal anti-trust policies"), cited in City of Holyoke v. SEC, 972 F.2d 358, 363; Environmental Action, Inc. v. SEC, 895 F.2d 1255, 1260 (9th Cir. 1990) ("Federal antitrust policies are to inform the SEC's interpretation of section 10(b)(1)"). [11]: Entergy Corp., Holding Co. Act Release No. 25952 (Dec. 17, 1993), citing Northeast Utilities, Holding Co. Act Release No. 25221, request for reconsideration denied, Holding Co. Act Release No. 26037 (Apr. 28, 1994), remanded sub nom. Cajun Electric Power Cooperative, Inc. v. SEC, 1994 WL 704047 (D.C. Cir. Nov. 16, 1994). [12]: See Gulf States Utilities Co., v. FPC, 411 U.S. 747 (1973). [13]: Madison Gas and Electric Company v. SEC, 168 F.3d 1337, (D.C. Cir. 1999); City of Holyoke v. SEC, supra note 10, citing Wisconsin's Environmental Decade, Inc. v. SEC, 882 F.2d 523 (D.C. Cir. 1989). [14]: 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 the 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.