TESTIMONY OF COMMISSIONER ISAAC C. HUNT, JR. CONCERNING THE FUTURE OF THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935 U.S. SECURITIES AND EXCHANGE COMMISSION BEFORE THE SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS THE COMMITTEE ON COMMERCE UNITED STATES HOUSE OF REPRESENTATIVES OCTOBER 7, 1999 Chairman Oxley, Ranking Member Towns, 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. In the years following passage of the 1935 Act, the SEC worked to reorganize and simplify existing public utility holding companies in order to eliminate abuses. 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 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] **FOOTNOTES** [1]: 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]: 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]: 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. 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 impetus for the study was the changing landscape in public utility regulation noted above, and the SEC's increasing 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, 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, the Commission released a report ("Report") of the staff's findings made during the study. 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. The SEC supports conditional repeal of the 1935 Act for several reasons. 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. There is a continuing risk that these monopolies, if left unchecked, could charge higher rates and use the additional funds to subsidize affiliated non-utility businesses to boost their competitive positions in other markets ("cross-subsidization"). As long as electric and gas companies continue to function as monopolies, the need to protect against the cross-subsidization of nonutility businesses will remain. An effective way to guard against cross-subsidization is audits of books and records and federal oversight of affiliate transactions. Utility rates are regulated by state authorities, and regulators vary in the degree of scrutiny they give these rates. 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. Several bills have been introduced in both Houses of Congress during the current session that provide for the repeal of the 1935 Act, either as part of comprehensive energy restructuring or on a stand-alone basis. Five bills have been introduced in the House of Representatives (collectively, the "House Bills"). H.R. 2363, introduced on June 25, 1999 by Congressman Tauzin, Congressman Towns and several other members of Congress, would repeal the 1935 Act on a stand-alone basis. Four bills, including H.R. 1828, introduced by Chairman Bliley and Congressman Dingell (by request) on May 17, 1999, and H.R. 2050, introduced by Congressman Largent and Congressman Markey on June 8, 1999, would repeal the 1935 Act as part of broader energy-related legislation.[5] The House Bills share many common provisions. 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 also would 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 structure could prepare for the new framework. The House Bills accomplish many of the goals of the conditional repeal advocated by the SEC.[6] As the SEC stated in testimony on similar 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.[7] Provisions granting access to books and records provide the FERC and the state commissions with the authority they need to identify affiliate transactions, review their terms and evaluate their effects on utility costs and rates. However, the potential for cross-subsidization and consequent detriment to consumers remains, and the SEC believes it is important that the FERC 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 The SEC Staff Report proposed two other legislative options: 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 is premature, because the monopoly power of the industry has not yet been completely eradicated and current state regulation varies. 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 over a year 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.[8] An expansion of exemptive authority would not, of course, achieve the economic benefits of conditional or unconditional repeal of the 1935 Act, nor would it simplify the federal regulatory structure.[9] Further, this option would continue to enmesh the SEC in difficult issues of energy policy. The SEC understands that many believe repeal of the 1935 Act should be accomplished as part of a more comprehensive package of energy reform legislation. 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. **FOOTNOTES** [4]: 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 100, 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]: H.R. 1587, introduced by Congressman Stearns on April 27, 1999, and H.R. 667, introduced by Congressman Burr on February 10, 1999, would also repeal the 1935 Act as part of comprehensive energy-related legislation. Three Senate bills (S.516, S.1284 and S.1047) would repeal the 1935 as part of broader energy-related legislation. Another Senate bill, S.313, would repeal the 1935 Act on a stand-alone basis. The 1935 Act repeal provisions in the Senate bills are substantially the same as those in the House Bills other than for the provisions of H.R. 1587 and H.R. 2050 discussed below. [6]: There are some differences among the House Bills. For example, H.R. 1587, among other things, would exempt from its provisions holding companies currently exempt from registration under the 1935 Act. More significantly, H.R. 2050 provides that the 1935 Act would remain in effect for any holding company system that has a public utility subsidiary that provides retail electric or gas service in two or more states in which a state regulatory authority has not provided notice of retail competition pursuant to section 152 of the Public Utility Regulatory Policies Act of 1978 or which has not otherwise required distribution utilities to provide open access service. Repealing the 1935 Act on a company-by-company basis, based on a determination of the status of state initiatives, presents complexities and uncertainties that require further analysis. [7]: 7 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). See also Testimony of Commissioner Isaac C. Hunt, Jr., Commissioner, SEC, before the Subcomm. on Energy and Power, the House Comm. on Commerce, 106th Cong., 2nd Sess. (1999). [8]: 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). [9]: 9 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. V. ADMINISTRATIVE ACTION The SEC continues to support a comprehensive approach to reform of the 1935 Act. The SEC has implemented many of the administrative initiatives that were recommended in the Report to streamline regulation.[10] Despite the effects of these initiatives, developments 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. These developments include the accelerating pace of initiatives at the state level to implement competition, the FERC's leadership in addressing open transmission and related structural issues, and the increasing internationalization of the utility industry. For example, two foreign utilities have recently announced plans to acquire U.S. utility systems. The acquisitions, if completed, would result in two foreign registered holding companies. These developments raise additional challenges in applying the Act to an industry that bears little resemblance to that which existed in 1935. Moreover, during 1998, mergers resulted in the formation of three new registered holding companies. The SEC expects that several holding companies will be required to register under the Act in the near future. Hence, 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 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) resolution of 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** [10]: 10 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. Finally, the Report recommended that the Commission exercise more flexibility in granting exemptions from registration under section 3(a) of the Act, based on the facts and circumstances in each situation and, particularly, assurances from affected state commissions concerning effective state regulation. The Commission has issued three orders based on this approach. NIPSCO Industries, Inc., Holding Co. Act Release No. 26975 (February 10, 1999)(section 3(a)(1)); Houston Industries Incorporated, Holding Co. Act Release No. 26744 (July 24, 1997)(section 3(a)(2)); and AES, Inc., Holding Co. Act Release No. 27063 (Aug. 20, 1999), motion to reconsider pending, (section 3(a)(5)).