to be a public private and utility hold- ing com- the repeal of PUHCA pany subject to PUHCA’s ex- David A. Fine and David N. Wang, regulates many aspects of the op- pansive restrictions Ropes & Gray LLP erations of registered holding compa- and regulations. Further, nies, as well as their and PUHCA prohibits any person from ac- he repeal of the Public Utility affiliates. For example, a registered quiring 5 percent or more of the voting Act of holding company may only issue se- securities of a public utility if it already T1935, effective Feb. 8, 2006, is curities with the SEC’s approval and holds more than 5 percent of another likely to have a profound effect on in- compliance with an extensive set of public utility without prior SEC ap- vestment in the electric utility sector. rules relating to the type and amount of proval. This is known in the industry as The elimination of PUHCA’s burden- equity and debt securities that may be the “two-bite rule.” some regulations and severe opera- issued. PUHCA also limits the types The two-bite rule also provided a tional and geographic restrictions will of businesses in which a registered trap for the unwary institutional inves- encourage investment and acquisitions holding company may invest. The Act tor. For example, Cascade Investment by a greater number of non-utility regulates loans, service arrangements LLC, an investment vehicle formed companies, including and other transactions within the by founder , had firms and hedge funds that had previ- holding company system; to apply to seek SEC approval after ously been effectively precluded from payments by the holding company; acquiring an ownership interest in investing in this industry. In addition, political contributions and lobbying; 5 percent or more of the voting PUHCA’s repeal will now allow com- binations among electric utility compa- nies, opening up new investment opportunities for private investors. A major piece of New Deal legis- lation passed in the wake of the Great Depression, PUHCA was enacted in 1935 to curb the abuses of large public utility holding companies with concen- trated market power. Before PUHCA, many holding company systems cre- ated risky financial structures by le- veraging up their utility subsidiaries and using the proceeds to invest in higher-risk and speculative ventures. Many of the subsidiaries went bank- rupt as a result of their highly leveraged , causing significant losses for investors. Effective regula- tion by individual states was extremely difficult because almost 75 percent of the electricity generation companies in the United States were controlled by 13 holding companies, creating complex holding company pyramids across sev- eral states. and establishes certain director dis- securities of more than one publicly PUHCA requires public utility qualification standards. traded utility company purely for in- holding companies with multi-state The definition of a holding com- vestment purposes. utility operations to register with the pany subject to PUHCA is quite broad. Certain exemptions to PUHCA Securities and Exchange Commission Absent an exemption, any company apply. For example, holding and (SEC) and comply with a comprehen- that owns, controls or holds 10 percent companies that are pre- sive federal framework of regulation or more of the outstanding voting se- dominately intrastate in character and administered by the SEC. PUHCA curities of a public utility is presumed whose business is conducted intra-

Reprinted with revisions to format, from the November/December 2005 edition of ELECTRIC LIGHT & POWER Copyright 2005 by PennWell Corporation state are exempt from PUHCA. Also prior SEC approval under the two- isting generation facilities that have exempt are holding companies whose bite rule. values in excess of $10 million and utility operations do not extend be- Moreover, the repeal of PUHCA that are used for interstate electricity yond the state in which it is organized eliminates the geographic and opera- wholesale sales and over which FERC and in contiguous states. Still other ex- tional restrictions that required a pub- has wholesale ratemaking jurisdiction. emptions allow ownership of certain lic utility holding company system to Furthermore, the 2005 Act enhanc- energy efficient generation facilities, constitute a single, integrated public es the FERC standard of review. Previ- generation companies that sell power utility system. This meant that the ously, FERC would approve transac- only at the wholesale level, and foreign public utility within the system tions if they were “consistent with the utility companies. had to be physically interconnected, public interest.” As a result of the 2005 Due to the limited nature, both capable of economic operation as a Act, FERC will also need to assure in substance and number, of avail- single coordinated system confined that the proposed transaction “will not able exemptions, private investors to a single geographic area or region result in cross-subsidization of a non- motivated to invest in the public util- that is not so large as to impair the utility associate company” unless such ity sector had to resort to complex advantages of localized management, cross-subsidization is in the public in- and burdensome ownership struc- efficient operation and effective regu- terest. The new language allows FERC tures to avoid regulation as a holding lation. This change increases the pos- more flexibility in considering merger company. For example, in the first sibility of benefits while underscoring a concern significant private equity investment among non-contiguous utilities there- over cross-subsidization, or the poten- in the electric utility industry, Berk- by facilitating within the tial to transfer benefits from ratepayers shire Hathaway successfully acquired utility industry. Much of the capital to to shareholders through transactions an interest in MidAmerican Energy effect these mergers and acquisitions involving unregulated affiliates. Holding Company only after estab- may come from the private equity While PUHCA’s repeal opens up lishing a fairly complex ownership sector. For example, Warren Buffett many exciting investment and acquisi- structure in which Berkshire purchased has reported that tion opportunities for private investors, only 9.9 percent of MidAmerican’s would be willing to invest $10 billion in the short-run much remains uncer- voting , but owned 81 percent of to $15 billion into the energy sector if tain with respect to the soon-to-be its overall equity, including preferred PUHCA was repealed. reshaped regulatory landscape. FERC stock that allowed Berkshire to elect The Energy Policy Act did more must still issue rules to implement two of 10 MidAmerican directors and than repeal PUHCA. It transferred the new 2005 Public Utility Holding have veto rights over certain material new authorities to the Federal Energy Company Act provisions and submit corporate transactions. The balance Regulatory Commission. The Act to Congress detailed recommenda- of the voting common stock was held provides FERC and state utility com- tions and conforming amendments by individuals, including Walter Scott, missions with access to books and to federal law necessary to carry out Jr., a member of Berkshire’s Board of records of holding company systems the new PUHCA subtitle. Moreover, Directors, who controls approximate- to the extent relevant to the costs in- while SEC oversight of utilities will ly 88 percent of the voting interest in curred by its public-utility companies. decrease, state regulators are likely to MidAmerican. The 2005 Act also provides FERC with play an increasingly active role in the The Energy Policy Act of 2005, additional merger review authority, consideration of utility merger and signed by President Bush on Aug. 8, review over generation acquisitions, acquisition transactions. Still, once 2005, repeals PUHCA and amends an enhanced standard of review, and FERC adopts rules to implement the the Federal Power Act, effective significant authority to impose civil Energy Policy Act of 2005, it is likely Feb. 8, 2006. Under the new regime, penalties over expressed prohibition that significant investment by private non-utility investors interested in of market manipulation. investors will flow to our nation’s elec- purchasing utilities or investing in With respect to merger review, tric utility infrastructure, paving the other utility assets, such as trans- the 2005 Act increases the thresh- way for exciting investment opportu- mission facilities, will no longer old for FERC approval required for nities that were previously unavailable have to adopt complex and burden- the sale, lease or disposition of utility to private investors. some ownership structures to avoid facilities and the purchase or acquisi- onerous PUHCA regulation and tion of securities of utility companies David A. Fine is a partner and registration requirements and SEC from $50,000 to $10 million. Signifi- co-head of the energy and utilities review of proposed transactions. cantly, no threshold applies for the practice group at Ropes & Gray. David Passive institutional investors will merger or consolidation of such public N. Wang is an associate in the corpo- be free to invest in publicly traded utility facilities. Additionally, FERC rate department at Ropes & Gray. securities of more than one pub- approval is now required for the lic utility company without seeking purchase, lease or acquisition of ex-