S. 206, A Bill to Repeal the Public Utility Holding Company Act of 1935
By Isaac C. Hunt, Jr.
Commissioner, U.S. Securities & Exchange Commission
Before the Before the Senate Subcommittee on Securities and Investment, Committee on Banking, Housing and Urban Affairs
March 29, 2001
Chairman Enzi, Ranking Member Dodd, 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") about S.206, a bill that would repeal the Public Utility Holding Company Act of 1935 and establish a more limited regulatory framework covering public utility holding companies. The SEC continues to support repeal of the Public Utility Holding Company Act of 1935 ("1935 Act" or "PUHCA"). Repeal, however, should be accomplished in a manner that eliminates duplicative regulation while also preserving important protections for consumers of utility companies in multistate holding company systems.
During the first quarter of the last century, misuse of the holding company structure led to serious problems in the electric and gas industry. 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. The 1935 Act was enacted to address these problems.1 Because of its role in addressing issues involving securities and financings, the SEC was charged with administering the Act. In the years following the passage of the 1935 Act, the SEC worked to reorganize and simplify existing public utility holding companies in order to eliminate abuses.
By the early 1980s, however, 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. Changes in the accounting profession and the investment banking industry also had provided investors and consumers with a range of protections unforeseen in 1935. The SEC therefore concluded that the 1935 Act had accomplished its basic purpose and that many of its remaining provisions were either duplicative or were no longer necessary to prevent the recurrence of the abuses that had led to the Act's enactment. The SEC thus unanimously recommended that Congress repeal the Act.2
II. THE SEC'S STUDY AND THE CURRENT ENVIRONMENT
For a number of reasons - including the potential for abuse through the use of a multistate holding company structure, related concerns about consumer protection, and the lack of a consensus for change - repeal legislation was not enacted during the early 1980s. Because of continuing change in the industry, however, the SEC continued to look at ways to administer the statute more flexibly.
In response to continuing changes in the utility industry during the early 1990s, and the accelerated pace of those changes, in 1994, then-Chairman Arthur Levitt directed the SEC's Division of Investment Management 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. The purpose of the study was to identify unnecessary and duplicative 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.3
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. The staff's Report outlined the history of the 1935 Act, described the then-current state of the utility industry as well as the changes that were taking place in the industry, and again recommended repeal of the 1935 Act. The Report also outlined and recommended that the Commission adopt a number of administrative initiatives to streamline regulation under the Act.
The utility industry in the United States has continued to undergo rapid change since publication of the report. Some of these changes have been facilitated by Congress. Specifically, as a result of recently-created statutory exemptions, registered holding companies are now free to own exempt wholesale generators and foreign utilities and to engage in a wide range of telecommunication activities.4 In addition, the SEC has implemented many of the administrative initiatives that were recommended in the Report.5
There has nonetheless been increased activity under the 1935 Act, especially in the area of mergers and acquisitions, corporate restructuring, diversification and affiliate transactions. The industry has also experienced an accelerating pace of initiatives at the state level to foster competition and the implementation of initiatives at the FERC to address open transmission and related structural issues. Finally, the internationalization of the industry has continued. In addition to the foreign investments of U.S. utilities, during the past two years, three British utility companies have acquired American utilities and subsequently registered under the Act.6 A Canadian utility has also announced its plans to acquire a utility in the United States.7 At the same time, problems have arisen in the electric industry. The electricity shortages, price increases and rolling blackouts experienced in California represent some of the most severe problems. Specifically, in California, acute supply shortages, opposition and legal impediments to new power plant construction and high natural gas prices have driven wholesale electricity prices to extraordinary levels. The two largest California utilities have not been allowed to pass wholesale price increases through to consumers and, as a result, are experiencing severe liquidity problems. They have stated publicly that they may file for bankruptcy. Some industry experts, as well as a number of press reports, have speculated that other areas of the country may experience similar problems this summer. With these issues further complicating already complex questions, energy reform legislation is again being considered in this Congress. Repeal of PUHCA is once again part of this discussion.
III. CURRENT 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. S. 206 would repeal the Act on a stand-alone basis.
Based on the findings in the Report as well as the continuing pace of change in the utility industry, the SEC has recommended, and continues to recommend, that Congress repeal the 1935 Act. The SEC does not have a preference as to whether the Act is repealed on a stand-alone basis or as part of broader, energy-related legislation. However, the SEC does recommend the 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.
As the Report stated, 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, however, a continuing need to protect consumers.
Although deregulation is changing the way utilities operate in some states, electric and gas utilities have historically functioned as monopolies whose rates are regulated by state authorities. Some regulators subject these rates to greater 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. Thus, so long as electric and gas utilities continue to function as monopolies, the need to protect against this type of cross-subsidization 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.
S. 206 represents a form of this type of conditional repeal - the type of conditional repeal that the SEC has endorsed. In particular, S. 206 would provide the FERC with the right to examine books and records of holding companies and their affiliates that are relevant to costs incurred by associate utility companies, in order to protect ratepayers. S. 206 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 effective discharge of the state commission's responsibilities in connection with a pending proceeding. Finally, S. 206 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. S. 206 thus accomplishes many of the goals of the conditional repeal advocated by the SEC.
Repealing the Act is not, however, a magic solution to the current problems facing the U.S. utility industry. While PUHCA repeal can be viewed as part of the needed response to the current energy problems facing the country, repeal of the Act will not directly affect the supply of electricity in the United States. Indeed, in 1992, as part of the Energy Policy Act, Congress amended the Act to remove most restrictions on the ability of registered and exempt holding companies as well as nonutility companies to build, acquire and own generating facilities anywhere in the United States. As a result, a number of registered holding companies now have large subsidiaries that own generating facilities nationwide. Repeal of the Act would instead remove provisions that prohibit utility holding companies from owning utilities in different parts of the country and that prevent non-utility businesses from acquiring regulated utilities.
Repeal of the Act would thus likely have the greatest impact on both the continuing consolidation of the utility business as well as the entry of new companies into the utility business. As outlined above, the SEC's primary concern with repeal is how consumers will be protected in this new environment. The SEC urges that S. 206 be amended to include provisions giving the FERC the authority it needs to oversee transactions among affiliates in holding company systems. 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. Nonetheless, 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.
The current situation in California illustrates this need. California's problems have been caused by, among other things, the need to construct additional generating capacity and perhaps additional transmission facilities. It is unclear whether repeal of the 1935 Act would have any real effect, positive or negative, on these problems. However, another component of California's problems is the precarious financial condition of the state's utilities. While the cost of acquiring power has had a significant impact on the financial condition of California's utilities, there have been suggestions in the press and elsewhere that these utilities' financial problems were exacerbated by their holding companies' decisions to use the profits of their regulated utility subsidiaries to finance investments in unregulated businesses. Regardless of whether these suggestions are true - the holding companies that own California's utilities are currently exempt from most provisions of the 1935 Act and are thus largely unregulated by the SEC - the potential for abuses of this type demonstrates the need to give state and/or federal regulators unfettered access to the books and records of holding companies so that they can develop a full understanding of the types of transactions occurring within the holding company. Moreover, because similar types of abuses can occur through affiliate transactions that cross-subsidize unregulated businesses with the profits of regulated utilities, regulators need the authority to review and analyze all transactions within a holding company system and prohibit those that pose unreasonable risks for utility ratepayers. The SEC therefore continues to support a broader grant of authority to the FERC to oversee these types of transactions including, if the FERC deems it appropriate, the authority to pre-review and pre-approve affiliate transactions.
Questions have also arisen about how the Act, if not repealed, will impact the FERC's ability to implement its plans to restructure the control of transmission facilities in the United States.8 As a result of FERC's plans, many utilities will cede operating control - and in some cases, actual ownership - of their transmission facilities to newly-created entities. The status of these entities as well as the status of utility systems that own stakes in them raise a number of issues under the Act.
While the SEC believes it has the necessary authority under the Act to deal with the issues created by the FERC's restructuring without impeding that restructuring, repeal of the Act would resolve the issues. In the absence of repeal, however, there are potential amendments to the Act that would permit the SEC more efficiently to deal with regulatory conflicts and other issues of this type. In both the Report and in prior testimony, the SEC has suggested that if Congress chooses not to repeal the Act, it could grant the agency broad exemptive authority similar to that we currently have under the other Acts that we administer.9 Although an expansion of the SEC's exemptive authority under the Act would not achieve the economic benefits of simplifying the federal regulatory structure and would continue to enmesh the SEC in difficult issues of energy policy, it would provide the SEC with a greater ability to respond quickly and appropriately to changes in the industry and the regulatory environment.
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.
|1 || 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 (statement of SEC).
|3 || The study focused primarily on registered holding company systems, of which there were, at the time of the study, 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 119, 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, 2000, the twenty-six registered holding companies owned 214 electric and gas utility subsidiaries, with operations in 44 states, and in excess of 1500 non-utility subsidiaries. In financial terms, as of December 31, 2000, the thirty registered holding companies owned more than $404 billion of investor-owned electric and gas utility assets and received in excess of $160 billion in operating revenues. The thirty registered holding companies represent over 40% of the assets and revenues of the U.S. investor-owned electric utility industry, and almost 50% of all electric utility customers in the United States.
|4 || Sections 32 and 33 of the Act, which were added to it by the Energy Policy Act of 1992, permit, subject to certain conditions, the ownership of exempt wholesale generators and foreign utility companies. Section 34, which was added by the Telecommunications Act of 1996, permits holding companies to acquire and retain interests in companies engaged in a broad range of telecommunications activities.
|5 || 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. 26667 (Feb. 14, 1997), 62 FR 7900 (Feb. 20, 1997) (adopting Rule 58)). In addition, the Report recommended and the SEC has implemented changes in the administration of the Act that would permit a "shelf" approach for approval of financing transactions. For example, during calendar year 2000, all eleven of the new registered holding companies received multi-year financing authorizations that included a wide range of debt and equity securities. The Report also recommended a more liberal interpretation of the Act's integration requirements which have been carried out in our merger orders. 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. Six state public utility commissions participated in the last three audits of the books and records of registered holding companies.
|6 || The three British companies that have made acquisitions in the United States and are currently registered under the Act are National Grid Group plc, Scottish Power plc and PowerGen plc. See Holding Co. Act Release No. 27154 (Mar. 15, 2000) (authorizing National Grid's acquisition of New England Electric System); Holding Co. Act Release No. 27166 (Apr. 14, 2000) (authorizing National Grid's acquisition of Eastern Utility Associates); Holding Co. Act Release No. 27290 (Dec. 6, 2000), corrected by Holding Co. Act Release No. 27292 (Dec. 7, 2000) (authorizing Scottish Power to engage in certain financing transactions following its acquisition of PacifiCorp and registration under the Act); Holding Co. Act Release No. 27291 (Dec. 6, 2000) (authorizing PowerGen's acquisition of LG&E Energy Group); Holding Co. Act Release No. 27312 (Dec. 21, 2000) (authorizing proxy solicitation in connection with National Grid's proposed acquisition of Niagara Mohawk).
|7 || Emera Inc., the owner of Nova Scotia Power, has announced a deal to acquire Bangor Hydro-Electric Company and has applied for an order approving the transaction. See SEC File No. 70-9087 (application filed Nov. 6, 2000).
|8 || See FERC Order 2000, "Regional Transmission Organizations," 65 FR 810 (Jan. 6, 2000) (codified at 18 C.F.R. § 35.34).
|9|| The SEC's current exemptive authority under the 1935 Act is considerably narrower than the exemptive authority under other 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, 15 U.S.C. § 78mm. Section 28 of the Securities Act of 1933, 15 U.S.C. § 77z-3, grants the Commission similar exemptive authority, but permits it to exercise it only pursuant to a rulemaking.