UNITED STATES OF AMERICA
BEFORE THE
SECURITIES AND EXCHANGE COMMISSION
Request for Comments on ) Registered Public-Utility ) File No. S7-30-99 Holding Companies ) Release No. 35-27110
COMMENTS OF CONSUMER INTERVENORS
The Commission has issued a Concept Release seeking comments on the legality and desirability of acquisitions of U.S. utilities by foreign entities. The Consumer Intervenors1 hereby submit their response.
Persons on whom communications concerning this proceeding should be served are:
Scott Hempling, Esq.
David Lapp, Esq.
417 St. Lawrence Dr.
Silver Spring MD 20901
(301) 681-4669 (tel.)
(301) 681-7211 (fax)
Larry Frimerman
Chairman, NASUCA Electricity Committee
Federal Liaison, Ohio Consumers' Counsel
77 S. High Street, 15th Floor
Columbus, Ohio 43266-0550
David W. Penn
Deputy Executive Director
American Public Power Association
2301 M. Street NW 32d Floor
Washington, D.C. 20037-1484
Introduction
Entry of foreign owners can play a positive role in increasing the diversity and accountability of the U.S. electric industry. Diversity of ownership has marked the industry from its beginnings: a mix of investor-owned utilities, private consumer-owned utilities (i.e., cooperatives), and municipal, state and federal utilities. This diversity has allowed experimentation, franchise and benchmark competition, citizen choice, and service to consumers who, to this day, might otherwise be without electricity. More diversity in ownership can continue these benefits, provided that this ownership is accountable.
In the Public Utility Holding Company Act ("PUHCA" or "Act"), foreign acquirers are subject to the same requirements of economic and efficient integration, prohibition against undue complexity and concentration of control, and other statutory criteria as domestic acquirers. The Commission should resist calls for excluding "foreigners," particularly from domestic utilities who would prefer to limit entry into their markets.
Acquisition by foreign entities does raise a set of concerns warranting special attention. While foreign and domestic acquirers are subject to the same statutory standards, the application of those standards must take into account real factual differences. To the extent facts relating to foreign acquirers differ from those of domestic acquirers, the application of the statutory standards may vary. We address this possibility in Part I. Part II explains that the limitations in the statute's "integrated public-utility system" tests apply to foreign acquirors just as they do to domestic acquisitions.
Under no circumstances should our comments be construed as unwelcoming. As consumers and competitors of U.S. utilities, the signatories know well the dangers of insufficient diversity and accountability in our industry. Change, including change in ownership, can benefit all.
I. Acquisitions of U.S. Utilities by Foreign Companies, Where Legally Permissible, Require Special Regulatory Attention
The electric industry is part of our nation's infrastructure. Its control must be in hands that are capable and accountable. Seven features or possible effects of foreign ownership will require special methods of accountability and review. These seven features are:
1. National Security Concerns
2. Control of the Physical Infrastructure
3. Access to Books and Records
4. Interaffiliate Transactions
5. Determination of Cost of Capital
6. Protection Against Diminution of Competition
7. Gaps Between Regulatory Jurisdictions
Each feature is discussed in turn.
A. National Security Concerns
Ownership of a U.S. utility means ultimate control of all or part of a transmission network, generation and distribution resources. This control must be in the hands of entities whose loyalty and accountability to this nation, its economy and the health and safety of its citizens, is unquestioned. A foreign company is likely to have its Board of Directors comprised of members whose loyalty and accountability reside elsewhere.
Nations' loyalties change. The prospect of foreign ownership means that control of essential infrastructure is in the hands of an entity that can change from friend to foe. This possibility warrants special attention. Clearly, all steps must be taken to assure the reliability of the utility networks from possible actions that are counter to the interests of this country.
The risk of divided loyalty arising from international political differences may also be manifested through behaviors similar to those contemplated from "functional diversification." In the functional diversification situation, the utility customer faces financial risk because those responsible for utility operations face incentives, created by the utility's other investments, to sacrifice the customer's welfare for some other purpose. In this situation, we have traditional protections intended to insulate the utility business from these risks. The foregoing concepts can serve the same function in the context of ownership diversification represented by foreign acquisition.
We do not profess any special understanding of national security policy, international trade or foreign relations generally. Moreover, we wish not to take positions that, while reasonable as protections of the nation's electric and natural gas infrastructure, might be seen as unreasonable from these other perspectives. Consequently we offer the suggestions below for discussion, with the hope that those with more knowledge in these other areas can adapt our views as necessary to achieve ends which are compatible both with our electric and gas industry goals and our nation's other goals.
Specifically, the Commission should consider adopting one or more of the following conditions applicable to acquisitions by foreign entities:
1. The acquirer must identify a local management team, with full authority to commit the company on matters otherwise considered jurisdictional to state commissions and FERC.
2. The aquirer must specify all types of management decisions, potentially affecting the local utility, that would be made by people other than the local management team.
3. The acquirer must enter into a relationship with a trustee, approved by the state regulators and FERC, which trustee would have the authority and obligation to take control of assets critical to reliability upon a finding by the state regulators or FERC that such a change in control is warranted by a lapse in performance or loyalty.
4. There should be certification by state regulators, FERC and the relevant reliability councils that the acquirer and the local management team have the experience and ability to operate the assets to be acquired.
5. There should be certification of membership in all required reliability councils.
6. There should be certification of membership in and transfer of control to a regional transmission organization (for more on this topic, see Part I.B below).
7. There should be a certification that neither the acquirer nor any of its headquarters management team has any record of violating laws or regulations.
8. There should be firewalls assuring that employees with operational responsibility for key infrastructural assets are independent of other parts of the organization to the extent deemed satisfactory by state regulators and FERC.
B. Control of the Physical Infrastructure
The nation's transmission grid, while physically interconnected, historically has been owned piecemeal by individual utilities. FERC's Order 20002 correctly recognizes that the planning, construction, operation, maintenance and pricing of transmission facilities should occur on a regional basis, even if ownership remains dispersed.
This new policy should apply to foreign acquirers. The unification of transmission policy within a region will lend predictability and stability during a time of rapid ownership change. Participation by foreign acquirers in a FERC-approved regional transmission organization or and/or natural gas pipeline should be a condition of any Commission finding that the acquisition satisfies the "economical and efficient development" test of Section 10(c)(2).
C. Access to Books and Records
The mantra "competition is here" is not reality. For many product and geographic markets, competition is not here. The physical services of distribution and transmission remain subject to franchises which, for the most part, are legally exclusive. In at least half the states, moreover, the political process has not produced a consensus to substitute competition in generation supply for monopoly regulation. In these states, electricity still is provided primarily by vertically integrated monopolies.
Most states that have enacted competition statutes still permit a continuing and prominent role for the incumbent electric utility. In addition to continuing to control the physical infrastructure of distribution and transmission facilities, the incumbent utility is generally permitted, directly or through an affiliate, to provide competitive services, "default" service, or both. As the lone entity in the market providing both competitive and noncompetitive services, the incumbent utility has an incentive and opportunity to grant its competitive affiliate favorable access to resources used for the noncompetitive businesses, to the detriment of competition and the captive customers of the noncompetitive businesses.
To reduce these risks, regulators need access to books and records. As long as some markets remain noncompetitive, consumer protection depends on regulation. Regulation in turn depends on data. Data -- in the form of financial books and records -- will not be useful if they are not accessible.
Foreign ownership of domestic utilities raises at least four distinct issues of data access. These four issues suggest four possible conditions on acquisition by foreign companies. Specifically:
1. Physical availability of records: Records deemed necessary by the state regulator or FERC must be located physically in the United States and available during normal business hours. If a particular state jurisdiction wishes to require a copy of such records, or any part thereof, be available within the state, the SEC's approval of the acquisition should be conditioned on compliance.
2. Physical availability of personnel: Records alone do not inform unless explanation is available. The acquirer should therefore be required to comply with any state or FERC requirements that personnel familiar with the records be reasonably available.
3. Currency clarity: Books of foreign companies will not necessarily be kept in U.S. currency. Some means of translation will be necessarily
4. Language issues: For reasons similar to those described above, books must be maintained in English.
D. Interaffiliate Transactions
Acquisition of a U.S. utility by a foreign holding company is likely to result in a corporate structure in which interaffiliate transactions take place. Interaffiliate transactions will create risks as long as two current features of the utility, presently prevalent, remain: (1) certain utility services remain noncompetitive services; and (2) entities that provide noncompetitive services are permitted to provide competitive services, directly or through an affiliate.
The two main risks are: (a) customers of noncompetitive services bear the cost of subsidizing competitive services; and (b) certain providers of competitive services have unearned advantages because of their affiliation with a provider of noncompetitive services. A policy on interaffiliate transactions therefore must have two goals: prevent cross subsidies by customers of noncompetitive services, and prevent unearned competitive advantages for competitive affiliates of the providers of noncompetitive services.
The general policy on interaffiliate transactions consistent with the foregoing goals is:
1. where the regulated utility buys from an affiliate, the price should be the lower of book cost or market.
2. where the regulated utility sells to an affiliate, the price should be the higher of book or market price.
Among economic regulators, these pricing principles have been long held and widely applied. Yet the Commission's present practices fail to reflect them. The Commission remains tied to a so-called "at cost" principle that is consistent with neither ratepayer protection nor effective competition, because it both fails to garner for ratepayers the market rewards commensurate with their historic contribution to utility costs, while allowing the utility's competitive affiliate to receive advantages not available to unaffiliated competitors. Until the Commission re-orients its policies on interaffiliate pricing, the undersigned organizations will be concerned about any acquisition trend that increases the number of transactions between competitive and noncompetitive affiliates of the same corporate family.
A holding company's foreign status complicates these problems of interaffiliate transactions in at least three ways:
1. Key to the appropriateness of the transaction is the transaction price. Currency differences and changing exchange rates will make that price will be hard to determine.
2. There may be nonprice benefits or costs which enter into the transaction. Distance, language and communication complexities will make such benefits and costs difficult to detect and evaluate.
3. Parties might gain the timing of inter-affiliate transactions to gain exchange rate advantages.
These concerns suggest the following conditions:
1. The Commission should limit interaffiliate transactions to which the U.S. utility is a party to those which the state regulators and FERC have verified (a) will be at prices reflecting the appropriate interaffiliate pricing rules stated above; and (b) do not have nonprice terms or conditions inconsistent with such rules.
2. All such transactions should be reported in U.S. dollars.
E. Determination of Cost of Capital
A utility's cost of capital is affected by risk. There are many types of risks. One is the risk that management's technical performance will fall below regulatory expectations and provoke penalties. Another is that the utility's financial performance falls below expectations. In either case, investors concerned about performance will demand a higher return on their capital to compensate for their concerns about the future.
A foreign acquirer brings this set of risks to its acquired U.S. utility. While an investor in a U.S. utility is familiar with these risks generically, he or she is less familiar with how to analyze them in an international context. For example, the U.S. investor will be unfamiliar with the types of foreign government regulation, including what types of performance lapses produce what types of regulatory response. Moreover, like any business entity, the foreign entity will be subject to political risks -- including the risk that the company's product or its mode of production will become a source of controversy. The typical U.S. investor is less familiar with foreign political risks than U.S. political risks. This difference in familiarity will cause the U.S. investor to demand a higher return to compensate for the unknown risk.
The foregoing risks are traditional risks whose foreign applications are unfamiliar to the investor. Foreign acquisitions also bring nontraditional risks. Currency risk is one. Another is the risk that the general political and trade relationships between the U.S. government and the foreign government, friendly at the time of the acquisition, become unfriendly.
Where the acquired U.S. utility provides a noncompetitive, regulated service, this determination is a task for a state regulator (unless the noncompetitive service is unbundled transmission service, in which case the rate regulator is the Federal Energy Regulatory Commission). Traditional techniques available to rate regulators allow them to determine the cost of capital associated with the regulated business only, insulating the customer from risks associated with unrelated business from which he or she does not benefit.
The foregoing considerations all complicate the determination of the cost of capital for ratemaking purposes. The new types of foreign risks, and the potential complexity of the corporate and capital structures used by foreign acquirer, will be unfamiliar to the state and FERC rate regulator. The Commission therefore must condition any acquisition, assuming it otherwise satisfies the statutory tests, on a certification by the affected state regulators and FERC that they have in place the techniques and resources necessary to determine the regulated cost of capital accurately. This certification should be required annually.
In addition to taking into account these special considerations applicable to state and FERC rate regulators, the Commission must consider its direct jurisdictional obligations. The foregoing risks boil down to a new type of diversification risk. Even where the acquirer is primarily an electric or gas company, its non-U.S. business activities will have little relationship to the U.S. utility activities. In this context, the Commission should apply the "functional relationship" test of Section 11(b)(1) (where it applies due to the post-acquisition holding company's "registered" status), and permit the affiliation only where the foreign activities are not so unrelated to the U.S. activities as to cause management distraction, or investor or customer confusion.
F. Protection Against Diminution of Competition
PUHCA Section 10(b)(1) requires rejection of an acquisition that "tend[s] towards interlocking relations or the concentration of control of public-utility companies, of a kind or to an extent detrimental to the public interest or the interest of investors or consumers...."
An acquisition of competing or potentially competing electric companies raises concerns under this section. One might argue that the first acquisition by a foreign company, of a single vertically integrated utility in the U.S., does not raise competition concerns because the acquirer and acquiree do not compete in the same market. That reasoning is incorrect. Given the prospect and potential for retail competition, foreign company entry into our markets -- as new retail players rather than as acquirers of existing players -- is a possibility. Thus an acquirer can be a potential competitor, even if the acquirer is foreign.
While there may be benefits to changing the leadership of certain U.S. electric companies through foreign acquisition, there also are benefits to introducing new players into retail markets that are at risk of becoming concentrated before they even have become competitive. If foreign investors find the U.S. electricity and natural gas market attractive, they should find it attractive because of the possibility of competing on the merits and winning new customers, not because of the possibility of "buying customers" through the acquisition of an existing vertically integrated monopoly. The Commission should take these factors into account in assessing whether a foreign acquisition "tends towards ... concentration of control."
In any event, a foreign entity's first acquisition is not necessarily its last. The prospect of future foreign acquisitions is made more worrisome by the Commission's historic inaction on acquisitions. In the past few years, the "second generation" of U.S. mergers has begun, where the merging companies are themselves the product of mergers occurring in the past ten years. After 40 years of relative stability, a consolidation process has begun whose end state is unknown. However, until now, the Commission has not availed itself of the opportunity to use the unique jurisdiction Congress has vested in it: the jurisdiction to prevent acquisitions that "tend towards interlocking relations or the concentration of control of public-utility companies, of a kind or to an extent detrimental to the public interest or the interest of investors or consumers...." In not a single acquisition in the past 15 years has the Commission exercised serious independent review.
We think it would be incorrect for the Commission suddenly to apply seriously Section 10(b)(1) to acquisitions by foreign companies but not U.S. companies. The best way to assure that acquisitions by foreign companies do not tend toward a concentration of control is to apply this standard to all acquisitions. In doing so, the Commission must look at each acquisition not in isolation. It must consider not only whether the particular acquisition concentrates markets, but whether it precludes other forms of entry that would de-concentrate markets. It must consider the long-term effects, including whether one acquisition will lead to other acquisitions. Only in this way can the Commission pursue a policy, described in the Introduction, of welcoming diversity to our industry while ensuring that this diversity plays a positive role.
Finally, the Commission should not continue to avoid its responsibilities under Section 10(b)(1) by citing the "increasing internationalization of the energy business," as it does in its Concept Release. This vague phrase fails to explain or address the technical analysis of markets necessary to determine the effect of an acquisition on competition. Whether an acquisition concentrates a market requires a determination of the geographic and product boundaries of the market, a measurement of market shares and an examination of entry barriers. The analysis is fact-based and specific. References to the "internationalization of the energy business" describe investment strategies, not customer options.
G. Gaps Between Regulatory Jurisdictions
In the present U.S. electric industry, major jurisdictional responsibility for reliability and adequacy of electric service rests with state commissions. State statutes requiring review of changes in control are the chief means by which states assess the appropriateness of these changes and the fitness of new franchisees. The states' responsibility is not exclusive. FERC indirectly acts in these areas through its jurisdiction over transmission. FERC acts on changes in control when the transaction constitutes, under Section 203 of the Federal Power Act, a disposition of facilities subject to the jurisdiction of that Act.
The state statutes and the Federal Power Act were enacted many years ago, without full knowledge of the different types of transactional structures. In recent years, a number of acquisitions have used corporate structures that are not subject to review by state commissions; others have avoided FERC review. In still other situations, multiple jurisdictions have had authority to review but have not addressed particular issues. For example, the FERC frequently asserts it will not review the effect of a merger on retail competition unless requested by a state commission. On more than one occasion, the state commission with jurisdiction over the merger has neither asked FERC to review the effects on retail competition nor undertaken such review itself. Thus there are gaps in either jurisdiction, actual review, or both.
These gaps are of increased concern where the acquirer is foreign. For some foreign acquirers, there is no track record, easily accessible to state regulators, concerning past performance, including responsiveness to customers and regulators. For example, state regulators frequently approve mergers without specific findings on the merger's effect on retail competition. In this context, certain Commissions have stated that if a market power problem arises after a merger, they can address the problems at that time rather than impose protective conditions on the merger approval. Without necessarily agreeing with this approach to regulation, we think the confidence level a state commission can have, as to its ability to "undo" a merger years after its consummation, is lower when the initial acquirer is foreign. For a state commission to order a foreign company to divest certain business or assets in the U.S. is well beyond present practices, and the consequences of such an action are not easy to predict.
Under these circumstances, special review is necessary to assure a record of past accountability and a likelihood of future accountability. This Commission therefore should require certification by the regulators in each affected state that the statutory authority, resources and ability exists to address all issues of consumer protection, reliability and competition.
II. The Limitations of the Statute's "Economic and Efficient Development" and "Integrated Public-Utility System" Tests Apply to Foreign Acquisitions Just As They Do to Domestic Acquisitions
Part I explained that acquisitions of U.S. utilities by foreign companies, where legally permissible, require special regulatory attention. This Part II addresses whether these acquisitions will be legally permissible to begin with.
The legal difficulties faced by foreign acquirers flow from the Act's central tests:
1. Section 10(c)(2) states that the Commission shall not approve acquisition "unless the Commission finds that such acquisition will serve the public interest by tending towards the economical and efficient development of an integrated public-utility system."
2. Section 11(b)(1) requires the Commission to "limit the operations of the holding company system ... to a single, integrated public-utility system, and to such other businesses as are reasonably incidental, or economically necessary or appropriate to the operations of such integrated public-utility system...."
3. Section 2(a)(29)(A) defines "single integrated public-utility system," as applied to an electric utility company, as
a system consisting of one or more units of generating plants and/or transmission lines and/or distributing facilities, whose utility assets, whether owned by one or more electric utility companies, are physically interconnected or capable of physical interconnection and which under normal conditions may be economically operated as a single interconnected and coordinated system confined in its operations to a single area or region, in one or more States, not so large as to impair (considering the state of the art and the area or region affected) the advantages of localized management, efficient operation, and the effectiveness of regulation....
In this Part II, we explain how these tests should apply to acquisitions of U.S. utilities by foreign entities. We offer three interrelated conclusions:
a. The "Economic and Efficient Development" Test of Section 10(c)(2) Will Preclude Most Foreign Acquisitions Where There are Two or More Utility Affiliates in the Post-Acquisition Holding Company Structure
b. The "Single Area or Region" Test of Section 2(a)(29)(A) Will Preclude or Limit Many Acquisitions by Foreign Companies Using the Holding Company Form
c. Foreign Holding Companies Will Be Unlikely to Qualify For Any of the Section 3(a) Exemptions, Thereby Requiring "Registered" Status Which Precludes Owners Who are Diversified
A. The "Economic and Efficient Development" Test of Section 10(c)(2) Will Preclude Most Foreign Acquisitions Where There are Two or More Utility Affiliates in the Post-Acquisition Holding Company Structure
1. Through Section 9, Section 10(c)(2) Applies to Acquisitions, the Result of Which is Two or More Public Utilities in the Corporate Family
Section 10(c)(2) applies to acquisitions of public utility securities and assets when the acquisition falls within the criteria of Section 9(a). Section 9(a)(2) applies where a person other than a registered holding company makes an acquisition, and the result of the acquisition is that the acquirer is an affiliate of two or more public utilities. Section 9(a)(2) is known as the "two bite" rule.3
In the context of foreign acquisitions, the application of the Section 10(c)(2) "economical and efficient development" test applies when the foreign holding company will, after the acquisition, own more than one U.S. public utility company. Review under Section 10(c)(2) is not required if the foreign owner, after the acquisition, controls only one public utility (its "one bite").
2. The "Economical and Efficient Development" Test of Section 10(c)(2) Requires Integration of Physical Operations
Section 10(c)(2) requires the Commission to disapprove an acquisition "unless" it finds, "affirmatively," Electric Energy, Inc., 38 S.E.C. 658, 668 (1958), that the acquisition will "serve the public interest by tending toward the economical and efficient development of an integrated public-utility system." The Section 10(c)(2) review requirement can be separated into two components. First, the acquisition must lead to a "single integrated public utility system," as defined under Section 2(a)(29)(A). Second, it must enhance the physical operations of the integrated public-utility system, by making the system "more economical and efficient."
Under the first part of the test, the assets of the post-acquisition company should be "physically interconnected or capable of physical interconnection," and "under normal conditions" the companies should be "economically operated as a single interconnected and coordinated system confined in its operations to a single area or region." Section 2(a)(29)(A). The "normal conditions" under which the system will be economically operated must be demonstrated by "facts shown in the record." General Public Utilities Corporation, 32 S.E.C. 807, 825 (1951).
The second part of the Section 10(c)(2) test requires that the Commission find that the acquisition will create operational gains in utility service. It is a physical test of operational improvements, requiring more than "a showing of efficiencies and economies by virtue of the affiliation" to give "meaning to the language of section 10(c)(2)." Union Electric Co., 45 S.E.C. 489, 494 (1974). Even if savings are not "precisely quantifiable," there still must be "a demonstrated potential for economies." Centerior Energy Corp., HCAR No. 24073, 35 S.E.C. 769, 775 (Apr. 29, 1986).
Evidence of integration would include, for example, economic savings from the deferral of new plant construction, joint economic coordination of power dispatch, improved coordination of off-peak power generation and rationalization of generating capacity. Centerior Energy Corp., HCAR No. 24073, 35 S.E.C. 769 (Apr. 29, 1986)
Centerior Energy continued an emphasis on physical integration that has existed from the early days of the Act. In North American Co., 11 S.E.C. 194, 242 (1942), the Commission has stated that in an integrated system,
"the generation and/or flow of current within the system may be centrally controlled and allocated as need or economy directs, and [the system] is operated as a unit. Thus, even though we find physical interconnection exists or may be effected, evidence is necessary that in fact the isolated territories are or can be so operated in conjunction with the remainder of the system that central control is available for the routing of power within the system."
See also Federal Light & Traction Co., 15 S.E.C. 675, 680 (1940) (single system did not exist where the transmission line connecting the two corporate entities "will not coordinate -- in the normal operational sense -- the [company's] properties, but will provide for certain of its properties additional sources of purchased power").
3. The Commission's Recent Approvals of Acquisitions That Do Not Integrate Physical Operations Should Not Apply Prospectively
In recent cases, the Commission has concluded that geographically distant utilities constitute an integrated system even though there are few apparent operational efficiencies. These recent decisions have required few, if any, operational efficiencies as a result of the affiliation between the public utility companies.
One example is NIPSCO Industries, Release Nos. 35-26975, 70-9197 (Feb. 10, 1999). The Commission there permitted a gas-electric utility operating exclusively in Indiana to acquire a gas public utility operating in Maine and New Hampshire. Despite the vast distance between the utilities, the Commission found the combined operations were integrated, based primarily on the companies' anticipated common source of gas supply from sources in Texas and Louisiana and their proposed combination of gas supply departments. See also Sempra Energy, Release Nos. 35-26971. 70-9333 (Feb. 1, 1999)(authorizing acquisition combining separate utility operations in California and North Carolina based on common source of gas supply).
These recent decisions misapply Congress' requirement of physical integration, approving cross-continental acquisitions of the very type Congress intended to ban. The Commission should not apply these decisions to prospective acquisitions, whether or not they involve foreign utility companies.
4. The Requirement of Integrated Physical Operations Precludes Most Acquisitions by Foreign Companies Where Section 9 Applies
Correctly interpreted, the integration test requires operational, physical integration. There cannot be operational, physical integration across continents or across oceans. Where Section 9 requires approval under Section 10(c)(2)'s economical and efficient operations test (i.e., when the result of the acquisition will be to make the acquirer an affiliate of two or more public utility companies -- see Section 9(a)(2)), such acquisitions are impermissible.
B. The "Single Area or Region" Test of Section 2(a)(29)(A) Will Preclude or Limit Many Acquisitions by Foreign Companies Using the Holding Company Form
An integrated public utility system is a system which, among other things, is "confined in its operations to a single area or region." This "single area or region" standard is a distinct criterion of an integrated public-utility system "that must be met before the Commission can find that an integrated public-utility system will result from a proposed acquisition." Environmental Action, Inc. v. S.E.C., 895 F.2d 1255, 1263 (D.C. Cir. 1990) (citing In re Electric Energy, Inc., 38 S.E.C. 658, 668 (1958)).
Size alone can be determinative of whether the "single area or region" standard is met. The Commission has observed that "when extremely large sections are considered .... distance alone may be definitive." Middle West Corp., Release No. 4846 (Jan. 25, 1944). See also Cities Service Power & Light, Release No. 4489 (Aug. 18, 1943) ("[T]erritory as vast as that covered by the States of Wyoming, Colorado, New Mexico and Arizona," spanning 900 miles from north to south, is not a single area or region under Section 2(a)(29)).
When size has not been determinative, the Commission has considered various other economic and business factors in the assessment of what constitutes a single area or region. Some factors considered include: industrial and business activity in the territories, marketing, transportation facilities, and basic geographical characteristics. Middle West Corp., supra (finding integration based on similar geographical characteristics and similar economic subsistence).
A "single area or region" makes most foreign acquisitions, where the acquirer owns utility properties, legally impossible. Unless the foreign acquirer's utility properties are located adjacent to the to-be-acquired U.S. utility properties (such as acquisitions by a Canadian company of utilities in the northern U.S.), the resulting system will not be "confined in its operations to a single area or region." In particular, the test cannot be met when the post-acquisition system consists of parts separated by an ocean.
C. Foreign Holding Companies Will Be Unlikely to Qualify For Any of the Section 3(a) Exemptions, Thereby Requiring "Registered" Status Which Precludes Owners Who are Diversified
Section 3(a) permits the SEC to exempt holding companies from the provisions of the Act if they meet the criteria of one of five exemptions. These exemptions largely will be unavailable to a foreign acquirers.
The first exemption is for holding companies in which all the utility operations are "predominantly intrastate in character" and which "carry on their business substantially within one state." Section 3(a)(1). The second exemption is available to holding companies that are predominantly public utilities with operations that "do not extend beyond the state in which it is organized and States contiguous thereto." Section 3(a)(2). Neither of these two exemptions will be available to foreign acquirers which, by definition, will not be organized in the state of the U.S. utility operations.
The other three exemptions similarly will be unavailable for most acquisitions of U.S. utilities by foreign entities. Under the third exemption of Section 3(a)(3), the holding company must only be "incidentally" a holding company, not primarily engaged in utility operations, and the holding company and its affiliates cannot derive a material amount of their income from U.S. utility operations. The fourth exemption is for temporary holding companies. The final exemption of Section 3(a)(5) will not be available for any significant acquisitions of U.S. utilities by foreign entities because a qualifying holding company cannot derive a material part of its income from its U.S. utility operations.
The absence of exemption means that a foreign acquirer with substantial non-utility business interests would have to divest them before acquiring a U.S. utility. The reason is as follows: Because the foreign acquirer will not qualify for an exemption under Section 3(a), it will be a registered holding company. This registered status will require the acquirer to comply with, among other provisions, the prohibition on diversification erected in Section 11(b)(1) (limiting "the operations of the holding company system ... to a single, integrated public-utility system, and to such other businesses as are reasonably incidental, or economically necessary or appropriate to the operations of such integrated public-utility system....").
The Concept Release acknowledges that the integration requirements establish a formidable barrier to the ownership of U.S. utilities by foreign utility holding companies. The Commission suggests, however:
Section 33 is neutral on its face with respect to the ownership of a FUCO by a foreign holding company. [foonote omitted]. It is thus possible to construe section 33(c)(1) to allow a foreign holding company to qualify its foreign utility operations as a FUCO, and the foreign holding company to acquire a U.S. utility without regard to the integration of the foreign and domestic operations.
The Commission's reasoning, if correct, does not alter the importance of PUHCA's provisions where they apply. Where the acquisitions by a foreign company trigger provisions of PUHCA, the Commission should apply the statute faithfully, according to the conditions and standards discussed above.
Respectfully submitted,
February 4, 2000
Scott Hempling
David Lapp
Attorneys for Consumer Intervenors
February 4, 2000
1 Consumer Intervenors consists of the following organizations: Air Conditioning Contractors of America; Alliance Against Utility Competition in Orleans Parish; American Public Power Association; Consumer Federation of America; National Association of State Utility Consumer Advocates; National Alliance for Fair Competition; National Association of Plumbing, Heating and Cooling Contractors; National Electrical Contractors Association; Public Citizen; and Small Business Alliance.
2 Regional Transmission Organizations, 89 F.E.R.C. para. 61,285, Docket No. RM99-2-000; Order No. 2000 (Dec. 20, 1999)(final rule).
3 Specifically, Section 9(a)(2) prohibits, unless they have been approved by the Commission under Section 10, direct or indirect acquisitions of any securities of a public utility company, if the acquiror is an affiliate, or will be an affiliate as a result of the acquisition, of any other public utility, as defined in Section 2(a)(11)(A). Subsection 2(a)(11)(A) defines an affiliate as "any person that directly or indirectly owns, controls, or holds with power to vote, 5 per entum or more of the outstanding voting securities" of the utility company.