Briefing Paper

Briefing Paper REPEAL OF THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935: IMPLICATIONS AND OPTIONS FOR STATE COMMISSIONS The National Regulatory Research Institute August 2006 Robert Burns, Esq. Michael Murphy, Esq. Senior Institute Attorney Graduate Research Associate EXECUTIVE SUMMARY

Repeal of the federal Public Utility Holding Company Act of 1935 (PUHCA 1935) is perhaps the most far-reaching provision in the Energy Policy Act of 2005 (EPAct 2005) regarding the future structure of the electricity industry and its markets. The repeal removes statutory and regulatory barriers to industry consolidation, conglomeration, and diversification. The PUHCA of 2005 (PUHCA 2005) replaces comprehensive regulation by the Securi- ties and Exchange Commission (SEC) with much narrower authority for federal and state access to books and records. It allows both the Federal Ener- gy Regulatory Commission (FERC) and state utility commissions to review affiliate transactions and to deal with cost allocations and cross subsidies. Repeal is expected to encourage investment in electric utility infrastructure, but it may open up potential abuses where utilities under state jurisdiction are part of larger holding companies. Most state commissions have authority to deal with affiliate transactions, cost allocation, and cross-subsidy issues. Many state commissions are reviewing their authority to regulate holding company affiliates to decide whether existing protections are sufficient or whetherad- ditional state legislation or commission regulation is needed to fill the void. In particular, ring-fencing provisions are desirable to prevent potential corporate abuse, whether the abuse is easily definable or subtle. This paper reviews approaches for providing more expansive state authority for commission access to books and records, as well as requirements that might be incorporated in statutes, commission regulations, or merger orders to insulate public utilities from holding company abuses. State commissions have what might be viewed as a continuum of options. For the sake of exposition, this report identifies three approaches once a state has carefully reviewed its statute(s), existing authority, and existing merger conditions. First, a state commission may find that it can address ring-fencing to insulate a company from the holding company on a case-by-case basis relying on existing commission authority. The second approach calls for ring- fencing statutes or rulemakings but does not include limits on utility diversification. The third approach attempts to re-create the PUHCA 1935, including strictures on diversification, which might be the most problematic from the viewpoint of encouraging investment in electric utility infrastructure.

Contents Introduction 2 Three General State Approaches to Ring-Fencing 14 Background 2 Summary and Conclusions 26 Implications of 7 Appendix A - Key Provisions of The Public Util- 28 Repeal ity Holding Company Act of 2005 Traditional State 10 06-12 Authority — The Starting Point INTRODUCTION BACKGROUND

Repeal of the federal Public Util- PUHCA 1935 The PUHCA 1935 was ity Holding Company Act of 1935 repealed by the EPAct (PUHCA 1935) is perhaps the most Congress enacted PUHCA 1935 to 2005. far-reaching provision in the Energy combat market imperfections inher- Policy Act of 2005 (EPAct 2005) re- ent in holding company structure garding the future structure of the elec- and operations. Congress found tricity industry and its markets. The investors and energy consumers repeal removes statutory and regula- may be adversely affected when any tory barriers to industry consolidation, of 11 enumerated evils emerged. conglomeration, and diversification They are: at the possible expense of consumers and investors. Repeal is expected to • investors cannot obtain adequate in- encourage investment in electric util- formation to appraise the f i n a n - ity infrastructure, but it may open up cial position or earning power of the potential abuses where utilities under issuers because of the absence of state jurisdiction are part of larger uniform standard accounts holding companies. Many state com- • securities are issued without the con- missions are reviewing their author- sent of the states ity to regulate holding company af- • securities are issued on the basis of filiates to decide whether existing fictitious or unsound asset v a l u e s protections are sufficient or wheth- bearing no fair relationship to the er state legislation or commission amount invested or earning power rulemaking is needed to fill the void. of the properties, and on the basis of paper profits from inter-com- This research report lays out broad pany transactions or in anticipation options for state commissions, includ- of excessive revenues from utility ing extended examples of three quite subsidiaries different approaches that represent • securities that require the utility to alternatives that range from highly support an overcapitalized s t r u c - restrictive on holding company op- ture and tend to prevent voluntary erations to less comprehensive and rate reductions are issued anticipatory. It begins with a brief • utility subsidiaries are subject to ex- history of PUHCA and the new stat- cessive charges for services, ute and federal framework, discusses construction work, equipment, and the implications of repeal, gives an materials, or enter into transac- overview of where states are starting tions where arm’s length bargaining from and what to look for in their ex- is absent and free competition is isting statutes and rules, and provides restrained the three examples. The report ends • service, management, construction, with a summary and conclusions. and other contracts involve the

�� Section 1(a) of PUHCA, 15 U.S.C. �§��79(a). �� Section 1(b) of PUHCA, 15 U.S.C. §�79(b)��

The National Regulatory Research Institute allocation of charges among utility needed for the ratemaking process and subsidiaries in different states so as for other regulatory needs. It also al- to make effective state regulation lows separation of utility property and difficult activities from non-utility operations. • control of utility subsidiaries affects Most states require approval before the accounting practices, r a t e s , utilities are allowed to issue major dividends, and other policies of such securities. States tend to monitor the companies so as to complicate and issuance of securities so that the util- obstruct state regulation ity does not become overcapitalized • control of utility subsidiaries is ex- given its assets, and now bond cov- Repeal of PUHCA 1935 erted through disproportionate in- enants also prevent overcapitalization. was urged to encourage vestment the infusion of capital, • the growth and extension of holding PUHCA 2005 a central goal of EPAct companies bear no relation to econ- 2005. omy of management and operation Repeal of PUHCA 1935 was urged to or coordination of related operating encourage the infusion of capital into properties the electric and gas industries, a cen- • there is a lack of [economy of] effec- tral goal of EPAct 2005. It is hoped tive public regulation that PUHCA 1935 repeal will lead • there is a lack of economies in rais- to economically efficient consolida- ing capital. tion of the electric and gas industries. Without geographic limitations on The main thrust of PUHCA 1935 to holding companies, cross-commodity eliminate the 11 evils was limits on constraints, the requirement of vertical holding company ownership of geo- integration, and barriers that limited graphically remote utilities and re- diversification to related industries, strictions on diversification beyond the the industry will be free to take advan- electric and gas utility industries. Sev- tage of economies of both scope and enty years later, it is fair to say many scale, and new investment opportuni- of the evils identified by Congress no ties will be created. Market consoli- longer exist or are controlled through dation and investment by new diver- other forms of regulation. The Sar- sified entities are expected to lead to banes-Oxley Act addresses the issues portfolio diversity and vertical as well of corporate responsibility, account- as horizontal diversification. Scale ing oversight, financial disclosure, and economies, to the extent they exist, auditing requirements. There are Uni- can lead to unit cost reduction, leading form Systems of Accounts that provide to more competitive costs. Portfolio for the reporting of regulated utility diversity can lower risk or, by creat- accounting information on a uniform ing options, make risk more manage- and consistent basis. Use of a Uniform able. Greater diversification can also System of Accounts provides regula- create market position opportunities. tors and other parties with information Technically, in repealing PUHCA 1935, Congress in Section 1263 of �� Section 1(b) of PUHCA, 15 U.S.C. ��§�� 79(b). EPAct 2005 substituted a new Public �� The Sarbanes-Oxley Act of 2002, Public �L��aw Utility Holding Company Act of 2005 107-204, 116 Stat. 745 (30 July 2002).

The National Regulatory Research Institute (PUHCA 2005). PUHCA 2005 is is subject to terms and conditions as much more limited than the original, may be necessary and appropriate to however. The broad authority of the safeguard against unwarranted disclo- Securities and Exchange Commission sure to the public of any trade secrets (SEC) under PUHCA 1935 to regulate or sensitive commercial informa- public utility holding companies is tion. Federal district courts located replaced primarily with statutory pro- in the state of the state commission visions dealing with access to books have jurisdiction to enforce compli- and records for both state commis- ance with state access to books and sions and the Federal Energy Regu- records pursuant to PUHCA 2005. latory Commission (FERC) ( EPAct 2005 Sections 1264 and 1265). Both The savings provision in EPAct 2005 The broad authority of the SEC under state commissions and the FERC have Section 1265 provides that, under oth- PUHCA 1935 is replaced the ability to check affiliate transac- erwise applicable state laws, state com- primarily with access tions (Section 1267). And both state missions are allowed to gain access to to books and records commissions and the FERC have the books and records. State commissions for FERC and state authority to deal with cost alloca- are also not precluded from exercising commissions. tions and cross-subsidies. For the their authority under otherwise appli- analysis in this paper, it is also im- cable laws to determine whether a util- portant that PUHCA 2005 authorizes ity company may recover in its rates the states and federal agencies to pro- any costs of an activity performed by tect utility customers with “other- an affiliate, or any costs of goods or wise applicable law” (Section 1269). services acquired by the utility from the affiliate. There is another savings To use the authority to access books provision in PUHCA 2005 pursuant to Both FERC and state and records under PUHCA 2005, state EPAct 2005 section 1267 that makes commissions have commissions having jurisdiction over this clear. A state commission could authority to check a public utility company in a holding obtain books and records through affiliate transactions, company must make a written request exercise of its own authority pursu- cost allocations, and for the records, wherever located, ant to state statute, commission rule, cross-subsidies. needed of the holding company or an or order. Such state authority might affiliate or associate company. The be broader than the federal access to written request must be for records books and records discussed above. that have been identified in reasonable detail in a proceeding before the state EPAct 2005 Section 1275 contains commission. The state commission an explicit savings provision that al- must have determined that the records lows state commissions to continue are relevant to costs incurred by the to exercise their authority under oth- public utility and are necessary for the erwise applicable law to deal with effective discharge of the responsibili- cost allocation and cross-subsidy is- ties of the commission with respect to sues. PUHCA 2005 repeals the Ohio the proceeding. However, the production of the records under PUHCA 2005 �� EPAct 2005, �§��1265. �� See appendix A for the key provisions of the EPAct 2005, �§��1267(b). Public Utility Holding Company Act of 2005. �� EPAct 2005, �§��1275(c).

The National Regulatory Research Institute Power decision and provides FERC paying the FERC established rate.12. with authority to allocate the cost of non-power goods or administrative FERC Rules and management services provided by an associate company organized for On Dec. 8, 2005, the FERC issued a FERC has issued final that specific purpose to a public util- final rule that amended its regulations rules implementing ity within the same holding company to implement the repeal of PUHCA EPAct 2005. system. Before PUHCA 2005 and as 1935 and enact the relevant provi- a result of Ohio Power, the author- sions of EPAct 200513. The rule ex- ity to make this allocation resided in empts several persons, entities, and the SEC, and FERC was required to types of transactions from the fed- accept cost allocations filed with and eral books and records requirements accepted by the SEC. EPAct Section of PUHCA 2005. It also confirms 1275 of PUHCA 2005 can be triggered that the FERC plans to use its exist- at the election of the holding company ing powers under the Federal Power system or any state commission hav- Act to police affiliate transactions. ing jurisdiction over such a public utility. 10 When FERC makes such a State utility commissions, both in- cost allocation, under the Nantahala dividually and through the National and Gulf States rulings, state commis- Association of Regulatory Commis- sions are required to abide by and flow sioners (NARUC), commented on through the costs from such alloca- several issues in the FERC’s Notice tions. This is a version of the filed rate of Proposed Rulemaking (NOPR).14 doctrine, which holds that FERC-ap- The commenting state utility commis- proved cost allocations between affili- sions asked, among other things, that ated companies may not be subject to the FERC explicitly incorporate state reevaluation in state ratemaking pro- commission authority over transac- ceedings.11 However, under Kentucky tions in their states into its regulations West Virginia Gas and Pike County, and explicitly confirm that the FERC preemption arises under a FERC ap- access to information under Section proved filed tariff only when the 1264 does not preempt state com- FERC approval diminished the buy- ing utility’s discretion, such that the �� See Kentucky West Virginia Gas Co. v. Pa. Pub. Util. Comm’n, 837 F.2d 600, 609 (3d Cir. utility had no option other than buy- 1988); and Pike County Light & Power Co. v. Pa. ing the FERC-jurisdictional service or Pub. Util. Com’n, 465 A.2d 735, 737-38 (1983). �� FERC, Repeal of the Public Utility Hold- ing Company Act of 1935 and Enactment of the Public Utility Holding Company Act of 2005, 18 Ohio Power Co. v. FERC, 954 F. 2d (DC Cir. CFR Parts 365 & 366 (Docket No. RM05-32-000, 1992), cert. denied, 498 U.S. 73 (1992). Order No. 667), Issued 8 December 2005 (Final �� EPAct 2005, �§��1275(b). Rule). 11 Nantahala Power & Light Co. v. Thornburg, �� FERC, Repeal of the Public Utility Holding 476 U.S. 953 (1986); see also Mississippi Power Company Act of 1935 and Enactment of the Pub- v. Miss. Ex rel. Moore, 487 U.S. 354 (1988) (when lic Utility Holding Company Act of 2005, 70 Fed. FERC orders a retail utility to take an action or Reg. 55,805, NOPR RM05-32-000 (2005). The limits the utility’s ability to take an action, states state utility commissions that commented on the may not set retail rates as if the utility had a choice NOPR were: Arizona, Georgia, Indiana, Missouri, of action). Gulf States Util. Co. v. Federal Power Ohio, Oklahoma, Wisconsin, and the California Commission, 411 U.S. 747 (1973). Electricity Oversight Board.

The National Regulatory Research Institute mission access under Section 1265.15 commissions to continue to receive States were concerned that, despite notices of investigations of public the language in Section 1265, because utilities. The FERC did not respond to Ring-fencing insulates Section 1264 does not contain a sav- a recommendation that a joint fed- regulated utilities ings clause preserving state access, eral/state board be utilized to develop from credit risks and language was needed in its regulations ring-fencing rules. corporate abuse by clearly maintaining state access to com- unregulated parent and pany books and records. In response FERC concluded that it would not re- affiliate companies. to FERC’s request for comments on quire formal filings of cost allocation the adoption of rules on cross-subsidi- agreements,18 in which case the filed zation, encumbrances of utility assets, rate doctrine, discussed above, might diversification, and structural -sepa not apply. Nevertheless, in the case ration, state commissions suggested of a utility system, the FERC’s cost that the FERC adopt several minimal allocation determination could be ring-fencing measures.16 Ring-fenc- binding and, perhaps preemptive, if ing refers to measures taken to insulate a holding company system or a state regulated public utilities from credit with a utility in a holding company risks and corporate abuse by unregu- system requests a determination. The lated parent companies or affiliates FERC has not decided at this time within a holding company system. whether such a cost allocation determination has a preemptive effect and The FERC in its order agreed that the FERC has not required that all there is no inherent conflict between cost allocation agreements be filed. state and federal access to information, and federal access should not Concerning the possibility of the preempt state commission access to FERC taking proactive measures to information. Nonetheless, the FERC prevent potential corporate abuses, declined to adopt any regulatory text FERC determined that EPAct 2005 on this point.17 The FERC’s reply to did not grant it the authority to issue the NOPR comments further stated additional ring-fencing rules. Noting that issues related to preemption are that federal and state commissions more appropriately addressed on a already have some authority to imple- case-by-case basis. The FERC also ment ring-fencing measures, the FERC rejected proposals to allow state opted to monitor industry activities without taking any immediate action.19 �� See Arkansas PSC Comments at 21, Missouri PSC Comments at 26-27, NARUC Reply Comments at 3-4, Indiana Utility Regulatory On April 24, 2006, FERC issued Or- Commission Comments at 6. der 669-A, in which the Commission �� State utility commission comments suggested set out its policies for the review of that the FERC adopt additional rules to protect against cross-subsidization and diversification. merger applications under Federal See Missouri PSC Comments at 30-32. NARUC urged the FERC to prohibit holding companies �� FERC, Repeal of the Public Utility Holding from encumbering the assets of public utilities. Company Act of 1935 and Enactment of the Pub- NARUC Comments at 13-14. See also Ohio PUC lic Utility Holding Company Act of 2005, 18 CFR Comments at 6-8 and Arkansas PSC Comments at Parts 365 & 366, Order 667 (Issued December 8, 24-32. 2005). �� Final Rule at 105. �� Final Rule at 241.

The National Regulatory Research Institute Power Act section 203 as amended. In industries with high barriers of entry, Although discussion of FERC’s merg- such as those involved in electric and er authority goes beyond the scope gas industry infrastructure, an increase of this report, it is worth noting that in market concentration might tend to FERC will consider, in many circum- lead to increased prices. The potential stances, whether a proposed transac- for higher prices can sometimes lead tion will result in cross-subsidization to increased investment in an industry. of a non-utility associate company or Further, with the relaxation of restric- pledge or encumbrance of utility as- tions on holding companies, a larger sets for the benefit of an associate pool of potential investors is available.21 company, unless that cross-subsidization, pledge, or encumbrance will In spite of all intervening statutory be consistent with the public interest. and regulatory changes since PUHCA FERC will make these determinations 1935, three major problem areas re- Three major problem on a case-by-case basis. In many cas- main when dealing with holding com- areas remain: es if a transaction involves any public panies today: transfer pricing between 1. transfer pricing, utility with captive customers within affiliates; the problems of cost alloca- 2. cost allocation, and a holding company, the holding com- tion and cross-subsidization; and cor- 3. cross-subsidization. pany must report state actions or con- porate financial abuse that is -some ditions related to the transaction with times subtle and hard to pin down. an explanation as to why the transaction does not result in cross-subsidiza- Transfer Pricing tion.20 The FERC Order supplements but does not supplant state commis- Whenever a utility and its subsidiary sion regulation of cost allocation, af- or affiliate engage in transactions with filiate transactions, cross-subsidiza- each other, there is an incentive for the tion, and corporate financial abuse. subsidiary or affiliate to charge above- market or above-cost prices for goods Implications of Re- or services, counting on the utility to be peal able to pass through the expense in its rates. This is less than an arm’s-length The repeal of PUHCA 1935 means that transaction and passing through of the federal jurisdiction to provide broad cost might adversely affect customers, oversight over holding companies and particularly captive customers who as their utility and non-utility affiliates a practical matter do not have choice. has been greatly reduced. The relax- Hence, there is a moral hazard created ation of federal regulation is meant by the holding company structure that to stimulate mergers and the creation allows costs to be shifted to a utility of holding company systems. Further consolidation in these industries will �� The�� FERC’s and states’ authority to review, condition, approve, or disapprove mergers and lead to greater market concentration. consolidation based on increased market concentration goes beyond the scope of this report. However, this report does deal with other prob- �� FERC Order 669-A, Transactions Subject to lems that might remain when dealing with holding FPA Section 203, 18 CRF Parts 2 and 33 (Issued companies. As noted below, in some cases merger April 24, 2006). authority can be used to address these concerns.

The National Regulatory Research Institute and to its captive customers. There is ate transactions, when a utility bought also the potential problem of favorit- from an affiliate, the affiliate -trans ism by the utility toward its affiliate, action was set at the lower of cost or particularly if the affiliate provides market price. When a utility sold to a factor of production that the utility an affiliate, the transaction was set at can acquire more cheaply somewhere the greater of cost or market. PUHCA else.22 The problem might exist even 1935 limited these transactions to if the affiliate charges at cost and at cost. While state commissions have State commissions or below market. Under various state dealt with affiliate transactions in the have dealt with affiliate codes of conduct dealing with affili- past, the repeal of PUHCA 1935 ex- transactions, but the pands the number and type of entities �� The�� FERC dealt with affiliate transactions in that might have affiliate transactions number and type of Ameren Energy Generating Company and Union entities involved have Electric Company, d/b/a AmericanUE, Opinion with the state’s jurisdictional utility. increased. No. 473, Opinion and Order Affirming Initial Decision in Part, Denying Request for Rehearing Cost Allocation and Cross- and Announcing New Guidelines for Evaluating Section 203 Affiliate Transactions, 108 FERC Subsidies para. 61,081 (July 29, 2004). The FERC accepts three examples of how to demonstrate a lack of Problems of cost allocation and the po- affiliate abuse: (1) evidence of direct head-to-head competition between affiliated and unaffiliated tential for cross-subsidies arise when- suppliers; (2) evidence of the prices that non-af- ever a utility and its subsidiary and/or filiated buyers were willing to pay for similar affiliate share joint and common- ad services from the affiliate; and (3) “benchmark” evidence of prices, terms, and conditions of ministrative, capital, or operating costs. sales made by non-affiliate sellers. These are Such are commonplace in a holding now supplemented by four solicitation guide- company environment. Indeed, they line principles. They are (1) transparency – the competitive solicitation process should be open are necessary to create synergies that and fair; (2) definition – the product or products could benefit both ratepayers and in- sought through the competitive solicitation should vestors. While joint and common be precisely defined; (3) evaluation – evaluation criteria should be standardized and applied equally costs may be desirable because they to all bids and bidders; and (4) oversight – an might create synergies, they must be independent third party should design the solicita- allocated properly to make certain that tion, administer bidding, and evaluate bids prior to the company’s selection. Given the subsequent costs are not shifted from competitive, enactment of PUHCA 2005 and FERC Order 665, unregulated utility or non-utility mar- supra, an interesting issue might be whether the kets to the regulated utility. Under the affiliate transaction guidelines of Opinion 473 continue to be of general applicability or whether they PUHCA 1935, cost allocation for reg- are limited to purchasing power. In Order 665, istered holding companies and their FERC states it will not require any entities that are affiliates was determined by the SEC. currently using the SEC’s “at-cost” standard for traditional centralized service companies to switch to our “market” standard. With respect to tradi- As noted above, under PUHCA 2005 tional, centralized service companies that use the a holding company system or a state “at-cost” standard, FERC will apply a presumption that “at cost” pricing of the non-power goods with a utility in a holding company and services they provide to public utilities within system can request a FERC cost allo- their holding company is reasonable, but persons cation. While it may be that such a may file complaints if they believe that use of cost pricing results in cost that are above market price. FERC cost allocation determination FERC will retain its existing “market” standard would be binding, perhaps preemptive, for non-power goods or services between special purpose subsidiaries and public utilities.

The National Regulatory Research Institute the FERC has not decided at this time Impact on Risk that such a cost allocation determination would be preemptive. FERC has Financial abuse that affects the per- also decided that it will not require all ceived risk of a utility is more subtle cost allocation agreements to be filed. but can be just as harmful. For example, if the utility provides an affili- Financial Abuse ate supplier with an assured (or likely) customer, then the riskiness of the af- PUHCA 1935 prevented financial filiate or subsidiary decreases and the abuse through comprehensive perceived riskiness of the utility could corporate and financial regulation increase. An additional problem is of registered holding companies that the utility’s stand-alone cost of The repeal of PUHCA 1935 opens the door to and their affiliates. Repeal opens equity cannot be easily isolated with- some forms of financial the door to financial abuse, some out knowing with certainty the relative abuse. forms of which are obvious and risk of its corporate subsidiaries and others that require more explanation. affiliates. Wall Street tends to view Financial abuse definitely, blatantly, holding companies as a package; and and obviously occurs when utility yet, for purposes of ratemaking (in- assets or revenue streams are used cluding calculating the utility’s stand- as collateral for upstream or affiliate alone cost of equity and cost of debt) loans. Another obvious form of state commissions may be unable to financial abuse would be the use isolate the jurisdictional utility’s risk of the utility as a cash cow for the from that of the holding company. holding company or its affiliates. Utility dividends or working capital Purchased Power Costs are moved elsewhere in the holding company system and not available Another subtle form of financial abuse to the utility when needed for is the effect that a holding company utility investment to maintain safe, structure can have on purchased pow- adequate, and reliable service. In er costs. If the utility has an affiliate many instances, bond indenture or subsidiary from which it can pur- covenants protect against these more chase power, that affiliate transaction blatant abuses. But such protection might be advantageous to the affiliate. does not always exist, as evidenced This goes beyond the typical prob- by the attempted Western Resources lems of affiliate transactions because financial abuse that was nipped in of the added shifting of risk from the the bud by the Kansas Corporation affiliate to the utility, unless the- pur Commission in 2002 on the chased power contract is firm without grounds that a proposed corporate recourse to unusual market events, restructuring would leave utility including an increase in wholesale operations saddled with non-utility debt, threatening reliable service to 23 turing by Western Resources, Inc. (November customers. 2002), enforcing a previous Commission order dated July 20, 2001. �� Kansas Corporation Commission, Order 51, Order Requiring Financial and Corporate Restruc-

The National Regulatory Research Institute power prices. For example, the af- that support technological innova- filiate power producer might have an tions of unregulated subsidiaries or assured customer during slack periods affiliates within the holding- com of demand, but if the wholesale prices pany. While these might speed the go up, then the affiliate can engage in adoption of certain demand side economic withholding from its util- and /or supply side options, techno- ity affiliate and resell its power at the logical innovation will be corralled higher spot price. This shifts the mar- to favor the activities of affiliates. Each state commission ket risk from the affiliate producer to must balance consumer protection and the the utility and its captive ratepayers. The point of marching through the possibility of additional parade of major potential abuses investment in electric Managerial Expertise that can occur due to PUHCA repeal utility infrastructure. is to raise the many concerns for ei- Another avenue for abuse is the excess ther the FERC or state commissions reassignment of managerial expertise. to consider in protecting consumers. While normal utility operations allow for employee cross-fertilization with Traditional State Au- re-assignments over time to develop thority – The Start- experience, excess reassignment oc- ing Point curs in a holding company structure as the best managers tend to seek out as- Each state commission must address signments to unregulated activities, as for itself how it evaluates the existing those activities can produce the greatest balance of consumer protection against profits and lead to the greatest rewards. Most state commissions the possibility of additional invest- have exercised some ment in electric utility infrastructure Synergistic Benefits authority over holding (particularly transmission and distri- companies. bution) with repeal of PUHCA 1935. Still another subtle effect is the po- We have identified three critical areas tential loss of synergistic benefits that may be neglected with repeal: from too much diversification within transfer pricing, cost allocation and holding companies. Industrial orga- cross-subsidies, and various flavors nizational theory supports vertical in- of financial abuse. This section of the tegration of the utility industry to re- report discusses the authority states duce transaction costs unless greater typically have with regard to holding savings could be acquired from com- companies and suggests some capabil- petitive suppliers. Too much diversi- ities to look for in reviewing state stat- fication can eliminate the cost savings utes and regulations. In the following from holding company structures that section we give examples of choices were vertically integrated and oper- states have made or are considering. ated as a single integrated system. Most state commissions have tradi- Technological Innovation tionally exercised authority over registered holding companies and have act- Finally, the holding company struc- ed in a manner that supplemented SEC ture can lead to utility expenditures

10 The National Regulatory Research Institute regulation. Some states have decades filiate transactions. This authority ex- old statutes that explicitly exert state ists whether or not a holding company authority over the formation of hold- is involved. In the case of affiliate ing companies or changes of control of transaction statutes, some commis- utilities.24 Most commissions have au- sions require the transactions to have thority to review the business relation- prior approval by the commission. ships between an electric utility and its subsidiaries and affiliates on a periodic Using existing authority, commissions basis, mostly during rate proceedings. can disallow all affiliate transactions State commissions have authority over until the utility proves them to be just State commissions retail rates, and most state commis- and reasonable, because there is no generally have sions also have authority to approve presumption of prudence in an affili- authority over retail utility mergers and acquisitions,25 to ate transaction. If implemented, this rates, utility mergers, approve long-term utility financing, requires further commission retroac- long-term financing, and over affiliate codes of conduct. tive oversight of the utility. If not well affiliate codes of And even before the PUHCA 1935 re- implemented, regulation becomes in- conduct, and affiliate peal most state commissions had their effective. There are other similar ex- transactions. own independent authority to gain ac- isting commission tools such as com- cess to the books and records of util- mission denial of dividend payments ity subsidiaries, affiliates, and holding to the utility. But it might be fairer to companies. In these statutes as well as the utility entity and holding company in ad hoc proceedings state commis- if they know in advance the rules they sions have exercised a variety of levels are expected to follow. Credit rat- of control over holding companies.26 ing agencies take this point of view.

Cost Allocation and Cross- Transfer Pricing Subsidies

All state commissions except Nebras- Nearly all state commissions have au- ka, which has only publicly owned thority to deal with affiliate transac- electric and gas utilities, address af- tions, cost allocation issues and cross- subsidies. Access books and records �� For example, Hawaii Rev. Stat. §�417E�� (1982); underpins the ability to effectuate this Conn. Gen. Stat. § 16-47 (1981); Del. L. §215(d); authority. And some states use this Wis Ch. 85-79 § 5(3); Ill. Pub. Util. Act Art. VII §7-204; Okla. Stat. tit 17, §191; Ohio House Bill independent authority to require peri- 821 (1986); Oreg. §757.015: Ark. Stat. Ann. § 73- odic filing of affiliate transactions and 142.2(a); N.J.S.A. 48:2-51.1; Me. Rev. Stat. Tit. cost allocation manuals by the utility, 35, §104 (1982); N.M. Stat. Ann. §62-3-3 (1982). For further information, see infra, fn.25 & 26. its affiliate, and its holding company. �� State commission merger review authority statutes and codes can be found in the National Financial Abuse Regulatory Research Institute’s Blue Pages at http://www.nrri.ohio-state.edu/bluepages. �� For a full discussion of state regulation of Although commission authority con- holding companies, including existing state cerning cost allocation, cross-subsi- statutes, see Hawes, Utility Holding Companies, chapter 4 and Robert E. Burns et al., Regulating dization, and transfer pricing is com- Electric Utilities with Subsidiaries, NRRI 85-16 mon, most state commissions have (January 1986).

The National Regulatory Research Institute 11 not been concerned as to whether they • Periodic ring-fencing reports30 have authority to protect against cor- • Access to company books and re- porate abuses, such as those just de- cords. scribed above. PUHCA 2005 lacks a grant of additional authority for fed- Separate Corporate Entity eral agencies and the states to deal with the potential corporate financial The requirement that regulated utili- abuses. States may use their other- ties maintain a separate corporate Commissions might wise applicable authority to protect entity distinct from non-regulated want to look at their consumers to deal with and to pro- affiliates can make it easier to dis- existing authority. tect against potential corporate abuse. tinguish between regulated utility Commissions might wish to look at activities and the non-utility related their existing authority to require: activities of non-regulated affiliates. • That regulated utilities maintain a Such a corporate structural separa- separate corporate entity, e s p e - tion makes it easier to identify po- cially a special purpose entity dis- tential corporate financial abuse. tinct from non-regulated a f f i l i - ates27 Board of Directors and Management • The utility to have its own board of directors and management The requirement that the utility have • Separate utility accounts and books its own board of directors and man- from those of affiliates agement serves three functions. First, • Independent cash management and it insulates the utility from its hold- debt for utilities ing company and allows the state • Commission approval before securi- regulator to send clear signals to the ties can be issued utility management about the expec- • Limits on dividends tations of the regulator. Second, it • Restrictions on upstream loans can allow the utility to operate sepa- • Limits on loans to money pools, loan rately should the utility holding com- guarantees, and inter-company ad- pany system become insolvent or vances28 go bankrupt. Third, an independent • Minimum equity requirements29 management could help to offset any

equity capital to fall below 48 percent of the total �� Many of these measures relate to protecting PGE capital without Commission approval.” In the integrity of utility companies. They are listed the Matter of the Application of Enron Corp., individually because they may be used separately. Order No. 97-196. �� The Public Service Commission of Kentucky �� For example, the Wyoming Public Service protected the Union Light Heat and Power Commission (Wyoming PSC) required that Company’s (ULH&P’s) credit rating by requiring PacifiCorp file an annual detailed affiliate that: “42. ULH&P will not guarantee the credit of transactions report in its Order No. 20000-EA-98- any of its affiliates unless specifically approved by 141 (Condition 30). Such reports could also be the Commission; and 43. All debt at the New Duke required to include information relating to ring- Energy and Cinergy levels will be non-recourse fencing measures. The Wyoming PSC went on in to ULH&P.” In the Matter of Joint Application of Condition 30 to require that “ScottishPower and Duke Energy Corp…, Case No. 2005-00228. PacifiCorp will not assert regulatory preemption �� For example, the Public Utility Commission of by [the] United Kingdom or foreign regulators.” Oregon Condition 6 required that “PGE [Portland General Electric Company] shall not make any distribution to Enron that would cause PGE’s

12 The National Regulatory Research Institute tendency for there to be excessive re- consider this authority desirable in assignment of management expertise. a holding company context, so that during periods when the utility might Separate Accounts and Books need internally generated capital or working capital for maintenance or The requirement that there be sep- construction, the utility’s dividends arate utility accounts and books are not excessive. While stockhold- from those of the affiliates also al- ers expect utility dividends, they lows the commission to better check should not be set at such a level that A commission’s for financial abuse as well as to the holding company and its affiliates authority to access check cross-subsidies, cost misal- are treating the utility as a cash cow. books and records is locations, and affiliate transactions. the primary lever for Loans gaining information Cash Management and Utility Debt about holding State commissions might find it useful companies. Independent cash management and to have the authority to place restric- utility debt is necessary to provide tion on upstream loans and to limit that the utility is not unduly influ- utility loans. Unrestricted upstream enced by the financial transactions loans can have the effect of transfer- of its holding company and that the ring risks from an unregulated utility riskiness of holding company af- to the utility and its ratepayers. Up- filiate activities is not transferred stream loans should be carefully moni- to the utility and its ratepayers. tored by state commissions and should be allowed only when related to util- Issuance of Securities ity-related activities that the utility and its ratepayers will benefit from. Like- Many state commissions have wise, limits might need to be placed on existing authority to approve the is- the amount and types of utility loans. suance of long-term debt and equity by the utilities. Not all commissions Equity Requirements have authority to require approval of short-term debt. Requiring commis- State commissions might wish to sion approval to issue securities can place minimum equity requirements help to head off corporate financial on its utility. The commission needs abuse. Commissions can make cer- to be concerned that the utility might tain that debt, equity, and other securi- become overleveraged, raising its risk ties issued by the utility are for proper and its cost of capital. The commis- utility purposes and not to support the sion also needs to be concerned about activities of an unregulated affiliate. the utility’s credit rating for the sake of investment in future infrastructure. Dividends Also, the state commission must be concerned that long-term purchased Some commissions have existing power contracts are not entered into authority to place limits on the divi- with affiliates. Such long-term - con dends of a utility. Commissions might

The National Regulatory Research Institute 13 tracts might be treated on the finan- access books and records as well as to cial markets as the equivalent of debt. require periodic ring-fencing reports.

Access to Books and Records Three General State Approaches to Ring- A commission’s authority to ac- Fencing cess books and records is the primary lever for gaining information and understanding the utility holding As state commissions examine meth- company’s operations and potential ods by which they can best protect abuses. State commissions can only utility consumers against potential be effective if they have adequate and corporate abuse, they are attempting to timely access to books and records. strike an appropriate balance between Given the recognition of continued the Congressional intent that PUHCA state authority to regulate affiliate 1935 be repealed in order to encour- There are three general transactions and to deal with cost al- age investment in the electric and gas approaches to ring- location and cross-subsidies, state ac- infrastructure and the Congressional fencing: cess to books and records is critical. authorization to exercise their state 1. case-by-case via jurisdiction to protect utility consum- merger review While states can rely on access to ers. Encouraging investment and 2. ring-fencing with books and records pursuant to section consumer protection are state goals diversification and 1265 of PUHCA 2005, commissions as well as federal ones but could be 3. state mini-PUHCA somewhat in conflict. Policy options statutes. might find the restrictiveness of its provisions cumbersome. In particular, the may be viewed as occurring along a requirement that books and records be continuum from most encouraging to identified in reasonable detail in a pro- investors and least anticipatory of new ceeding before the state commission consumer protection needs to least seems to presume that the commission encouraging to investment and most already has enough information to be protective of consumers. Commis- able to identify the books and records sions already have many legal arrows that are relevant to costs in the pro- in their quivers to assure that they can ceeding. In reality, state commissions attract infrastructure investment and may require periodic, perhaps annual, provide consumer protection. How filings of affiliate transactions and rel- proactive a commission wishes to be evant cost allocation manuals before in pursuing new options at the state a state proceeding or investigation is level depends on its evaluation of the filed in order to be able to identity in existing balance. If it finds that exist- reasonable detail any additional books ing law and commission rules appear and records that might be needed. For to be sufficient, the commission will this reason it might be desirable to likely wish to handle new cases indi- have more expansive state authority to vidually (the first option). If it finds that PUHCA 1935 repeal leaves gaps, the commission can either take an incremental approach of filling holes, without imposing new state limits on

14 The National Regulatory Research Institute diversification (the second option), or proactive approach. Addressing con- it can opt to promote a full-blown ini- sumer protection simply using existing tiative to enact a state-level version of commission authority might require the PUHCA 1935 (the third option). constant commission vigilance. State This section of the report discusses an commissions might also find it difficult Oregon merger review that represents to monitor every financial transaction the first approach, a Maryland staff pro- that could lead to a definite or subtle posal that exemplifies the second, and corporate abuse unless there are exist- Wisconsin’s “mini-PUHCA” the third. ing reporting requirements and rules of the road to lay out expectations. If a state finds that it is already at an appropriate balance, and the right ap- A state might choose statutes and/or proach is case-by-case, a merger pro- commission regulations that lay out Most state commissions posal presents the opportunity to for- ring-fencing provisions without pro- have the authority mally address the issues created by the hibiting diversification, choosing a to approve or deny repeal of PUHCA 1935.31 Most state balance that provides consumer pro- mergers. commissions have the authority to re- tection while allowing infrastructure view and approve or deny proposed investment from outside the industry. mergers32 and can include ring-fenc- The Maryland Public Service Com- ing conditions in their merger ap- mission staff proposed such a regula- provals. Using a commission’s con- tory approach. A statutory approach ditioning authority when addressing offering the greatest protection from mergers provides an opportunity to corporate financial abuses would in- deal with the utility, the holding com- clude: (1) structural restrictions that pany, and its affiliates in a straight- maintain public utilities as separate forward and predictable manner. The entities, as well as the requirement Oregon Public Utility Commission that public utilities maintain separate provides an example of case-by-case accounts; (2) state utility commission ring-fencing through merger review. access to the books and records of companies in a holding company sys- Some states might identify gaps in tem with company reporting require- existing authority and choose a more ments; (3) requirement of commission authorization for securities offerings, �� EPAct 2005 also amended the FERC’s merger dividends, and distributions; (4) re- review authority under FPA §203. EPAct 2005 strictions on affiliate transactions; (5) §1289 increased the minimum threshold value for guarantees that public utilities will not transactions subject to FPA §203 to $10 million, requires the FERC to make cross-subsidization be involved in any bankruptcy pro- findings, and required the FERC to promulgate ceedings of parents or affiliates; and new merger and acquisition review rules. The (6) clear penalties for violations. Pen- new rules were set out in the FERC Order 669 Transactions Subject to the Federal Power Act alties might range from the imposition Section 203, issued 23 December 2005, 18 CFR of monetary penalties for violations Parts 2 & 33. to ratepayer reimbursement to forced �� Except Florida, Michigan (indirect), Montana, and Nebraska. Indiana has no authority over divestiture and restructuring. Another mergers involving holding companies. Commis- possibility has been practiced in Vir- sions in these states might seek merger authority ginia, where penalties have been es- or legislation authorizing ring-fencing authority.

The National Regulatory Research Institute 15 tablished for companies whose bond is an Iowa corporation. MEHC’s larg- ratings have fallen below a set amount. est investor is Berkshire Hathaway.

Finally, other states might opt for Statutory Authority greater authority, essentially passing state “mini-PUHCA” statutes that The Oregon Legislative Assembly cod- provide state commissions with au- ified the state’s interest in non-utility thority to review all transactions and businesses controlling public utilities: to limit holding company diversifi- “the protection of customers of public cation. The model for this approach utilities…is a matter of fundamental is the Wisconsin PUHCA statute, statewide concern…an attempt by a arguably the most comprehensive person not engaged in the public util- state consumer protection statute. ity business in Oregon to acquire the power to exercise any substantial in- Case-by-Case through Merger fluence over the policies and actions Review: Public Utility Commission of an Oregon public utility which of Oregon provides heat, light or power could The Public Utility result in harm to such utility’s custom- Commission of Oregon State public utility commissions have ers, including but not limited to the has employed the case- used merger reviews to implement degradation of utility service, higher by-case approach. ring-fencing very effectively. A re- rates, weakened financial structure cent example of ring-fencing within and diminution of utility assets.34” existing commission authority that might be of interest is the Public Util- Within this general policy, the Or- ity Commission of Oregon’s (Oregon egon PUC has statutory authority to PUC’s) merger approval proceed- regulate the acquisition of an Oregon ing for MidAmerican’s application utility. An entity interested in acquir- to acquire PacifiCorp.33 PacifiCorp is ing an Oregon utility must first apply a vertically integrated electric utility at the commission. The general stan- serving retail customers in six states: dard for approval of MEHC’s applica- California, Idaho, Oregon, Utah, tion for authority to exercise influence Washington, and Wyoming. Thus, over a utility in Oregon is a net ben- six state commissions were involved efits test.35 To meet the test, the trans- in approving the acquisition. Oregon action should not harm customers and had a particularly keen interest in the must not impose a detriment to Or- transaction because PacifiCorp is an egon citizens as a whole. The poten- Oregon corporation. MidAmerican tial benefits and harms resulting from Energy Holding Company (MEHC) the proposed merged organization are weighed against the utility as current- �� In the Matter of MidAmerican Energy Holdings ly configured.36 The commission may Company Application for Authorization to Acquire Pacific Power & Light, dba PacfiCorp, Public Util- ity Commission of Oregon Docket No. UM 1209 �� Oregon Revised Statutes �§��757.506. (MEHC Application). �� Oregon Revised Statutes �§��757.511. �� In re Oregon Electric Company, Order 05- 114 at 18. The�� Oregon net benefits standard is a legal test. Both the transaction costs and the other harms and benefits are weighed. The OPUC

16 The National Regulatory Research Institute condition an order authorizing an ac- annual report detailing affiliate inter- quisition upon specific requirements.37 ests and transactions is required.43 The Public Utility Commission of Oregon In Oregon, the commission has further has employed these statutes and regula- statutory authority to impose ring- tions to require ring-fencing provisions fencing measures that protect against in MEHC’s acquisition of PacifiCorp. affiliate transaction abuses, misallo- The Public Utility cation of costs and cross-subsidies, Separate Corporate Structure Commission of and financial abuses. The commission Oregon required ring- regulates the issuance of utility securi- MEHC will wholly own PacifiCorp if fencing provisions ties.38 Commission approval must be the acquisition is successful, but indi- in MidAmerican’s obtained before a utility may guaran- rectly. A special purpose entity—PPW acquisition of PacifiCorp. tee another’s debt.39 Approval is also Holdings LLC (PPW)—will be set up required for the sale of utility proper- as a ring-fencing measure.44 This type ty.40 The commission regulates affiliate of special purpose corporate structure transactions, and approves contracts serves to separate the regulated utility between utilities and affiliates.41 Com- from its parent and affiliates and helps mission rules set out the procedure for to prevent corporate financial abuse, approving affiliate transactions.42 An while making it easier to track affiliate transactions and cross-subsidies. PPW derived the standard from their statutory authority will serve to ring-fence PacifiCorp to allow mergers that are in the public interest. The net benefits standard is very similar to the no by maintaining a separate credit rat- harm standard, but a bit stricter. The transaction ing and bankruptcy remoteness. PPW must create a tangible benefit that is substantial will be a legally separate intermedi- enough to outweigh the risks of the transaction. The transaction must be more than neutral. It must ate holding company between MEHC improve the status quo for citizens. The benefits and PacifiCorp as a direct subsidiary and costs need not be economic, nor do costs need of MEHC. It will receive an equity to be transactions costs. The commission looks at the totality of the circumstances. Thus, each infusion from the sale of MEHC pre- transaction must be looked at on a case-by-case ferred stock to Berkshire Hathaway basis. and other equities to third parties, but �� In addition to the statutory requirements, the Oregon Administrative Rules §860-027-0200 will have no debt of its own. The sole set out information that must be provided to the purpose of PPW is to own the com- commission with an application to acquire an mon equity of PacifiCorp. PPW will energy utility. The rule requires, among other things, a schedule detailing capital structure, an have an independent director, whose explanation of how bond rating and capital costs consent will be required to place PPW will be affected, an organizational structure listing or PacifiCorp into bankruptcy. PPW affiliate interests, a description of the cost allocation method, a description of any plans to sell or will require PacifiCorp to maintain pledge utility assets, and a copy of any existing separate assets, books, and employees, or proposed agreement between the energy utility and will prohibit the commingling of and any businesses that will become affiliated interests. assets. The non-recourse structure of �� Oregon Revised Statutes �§§�� 757.405 – 757.415. PPW prevents liabilities of MEHC or �� Oregon Revised Statutes § 757.440. its subsidiaries from being charged to �� Oregon Revised Statutes § 757.485. �� Oregon Revised Statutes �§§�� 757.490 - PacifiCorp. The credit of PacifiCorp or 757.495. �� Oregon Administrative Rules �§§�� 860-027-0040 �� Oregon Administrative Rules § 860-027-0100. – 860-027-0044. �� MEHC Application, Stipulation, Appendix 1.

The National Regulatory Research Institute 17 Simplified diagram showing the holding company structure—both Berkshire Hatha- way and MEHC have other subsidiaries. Gray boxes represent holding companies; yellow represent operating companies. Source: Authors’ construct

PPW cannot be used to satisfy the ob- in its stead. MEHC agrees to waive ligations of, or be used as security for the right to dissolve PPW, even in the the debt of MEHC. Likewise, neither event of bankruptcy. Furthermore, PPW nor PacifiCorp may acquire the PPW can only file for bankruptcy or A special purpose obligations of MEHC or its affiliates. insolvency with unanimous written corporate entity was consent of everyone on the board, established to separate the regulated utility Two additional provisions directly including the independent director. from its parent and address the reasons for establishing affiliates. a special purpose entity. To protect In addition to creating a ring-fenced the credit rating of PacifiCorp, the corporate entity, MEHC made several PPW operating agreement may not sets of commitments in its applica- be modified without the approval of tion to acquire PacifiCorp. Some of the independent director and a written the commitments apply to all of the confirmation by each relevant rating concerned states (these commitments agency that the change will not result will be referred to by number); other in the downgrade or withdraw of any commitments are specific to Oregon rating assigned by it to PacifiCorp’s (referred to by a number preceded debt. The second purpose of PPW is to by an O, e.g., O1, O2).45 These com- protect PacifiCorp from being drawn mitments address three categories into a bankruptcy of MEHC. PPW can of concern: (1) those relating to the only be dissolved upon the entry of a holding company system, (2) the fi- judicial decree. If MEHC is dissolved, nancial stability of the utility, and (3) PPW will have at least one person who will automatically become a member �� MEHC Application, Stipulation, Exhibit 1.

18 The National Regulatory Research Institute effects on the operations of the utility. such methods must comply with. Com- mitment O3 provides that MEHC and Holding Company System Commit- PacifiCorp will interpret Oregon stat- ments utes to require commission approval of any contract between PacifiCorp and Commitments that relate to the hold- any affiliate of Berkshire Hathaway or ing company system include several MEHC. Commitment O4 states that allowing access to information in Or- MEHC and PacifiCorp will interpret egon. These commitments provide in- Oregon statutes to require commission dependent authority for a more expan- approval of any transaction resulting sive state access to books and records, in a merger of PacifiCorp with another The commission allowing the Oregon PUC to better public utility, without regard to wheth- required provisions to monitor to prevent affiliate transaction er that public utility provides service protect the regulated abuse and cross-subsidies. Commit- in Oregon. Commitments 16 and O13 utility’s financial ment 3 requires PacifiCorp to maintain exclude the costs of the merger trans- stability and credit separate accounts in Portland, Oregon. action from PacifiCorp’s accounts. rating. Commitment 4 allows for commission access to all books and records that re- Financial Stability Commitments late to transactions between PacifiCorp and its affiliated interests or that are Another group of commitments relate otherwise relevant to the business of to the financial stability of PacifiCorp PacifiCorp. Berkshire Hathaway is and the associated issue of diversifi- bound by this provision. Berkshire cation. These commitments provide Hathaway is also bound by Commit- some protection against corporate fi- ment 17, which grants state utility nancial abuse. Commitment 11 pro- commissions unrestricted access to all hibits diversification of PacifiCorp, written information provided by and but not MEHC or its other affiliates to credit rating agencies that pertains from holding diversified businesses. It to PacifiCorp or MEHC. Commit- also makes all of the commitments ap- ment 6 allows the commission or its plicable to the ring-fencing provisions agents to audit the accounting records for PPW. Commitment 15 obligates of MEHC and its subsidiaries that are MEHC and PacifiCorp maintain sepa- the bases for charges to PacifiCorp. rate debt and preferred stock, and for Several provisions allow the Oregon PacifiCorp to maintain its own credit commission to regulate the portion of rating. MEHC and PacifiCorp also the multi-state utility located in Or- commit in Commitment 18 that the lat- egon. Commitment 9 prohibits cross- ter will not make any dividends to PPW subsidization between regulated and or MEHC that reduce PacifiCorp’s non-regulated businesses or between common equity capital below 48.25% any regulated businesses and requires of its total capital without commission PacifiCorp and MEHC to comply with approval. Commitment 20 prohibits all applicable commission orders and PacifiCorp from making loans, trans- rules. Commitment 14 calls for com- ferring funds, or pledging any assets mission approval of cost allocation in favor of MEHC, Berkshire Hatha- methods and sets out principles which way, or their respective subsidiaries

The National Regulatory Research Institute 19 without commission approval. In ad- pose and implement, upon commis- dition, Commitment 21 bars MEHC sion approval, provisions sufficient to and PacifiCorp from advocating for prevent PPW and PacifiCorp from be- a higher cost of capital compared to ing pulled into an MEHC bankruptcy. what PacifiCorp’s cost of capital would have been, employing commission Operational Commitments standards, absent MEHC’s ownership. A final group of commitments concern The Oregon specific commitments the operations of PacifiCorp. Commit- also contain provisions concerning ment 1 requires MEHC and PacifiCorp the financial stability of PacifiCorp. to maintain existing customer service Commitment O14 provides that, in the guarantees and performance stan- event of a ratings downgrade by two or dards through 2008. Commitment 45 more rating agencies of PacifiCorp’s extends the commitment until 2011, long-term debt within a year of the and requires commission approval for acquisition, the assumed yield for any modifications. Commitments O20- incremental debt issued by PacifiCorp O22 oblige MEHC and PacifiCorp to will by reduced by 10 basis points for fund programs to benefit low-income each notch that PacifiCorp is down- customers. Commitment 47 requires graded. Moreover, if that debt issued MEHC to maintain adequate staffing is recalled and refinanced, PacifiCorp in each state. Commitment O2 directs agrees to hold customers harmless. MEHC to maintain PacifiCorp’s cor- Commitment O15 prohibits PPW porate headquarters in Oregon and to from having any debt in its capital ensure that senior management person- structure immediately following the nel in Oregon have authority to make closing of the transaction. It further decisions on behalf of PacifiCorp. provides that the consolidated capi- MEHC and PacifiCorp commit to rate tal structure of PPW will not contain credits totaling $142,500,000 through common equity capital below 48.25%. 2010 in O7 (described in detail in O8- MEHC also commits to providing O12). PacifiCorp and MEHC - com The commission’s the commission 30 days prior notice mit to invest in renewable resources goal was bankruptcy if PPW intends to issue debt. Com- in Commitments 39, 40, O23, O25, remoteness for the mitment O18 bars PacifiCorp from O26, O27, and O28. They also com- utility. making dividends to PPW or MEHC mit to emissions reduction control if PacifiCorp’s unsecured debt rating measures in 41, 42, 43, O31, and falls below BBB- by S&P of Fitch O32. Finally, MEHC and PacifiCorp (Baa3 by Moody’s). Bankruptcy re- commit in O33 not to support be- moteness is the goal of O17, which re- fore 2016 any legislation in Oregon quires MEHC to obtain a non-consoli- to eliminate or impair retail access. dation opinion demonstrating that the ring-fencing around PPW is sufficient Discussion of Approach to prevent PPW and PacifiCorp from being pulled into an MEHC bankrupt- Developing ring-fencing measures cy. If the ring-fencing provisions are for a merger on a case-by-case ba- insufficient, MEHC commits to pro- sis might sometimes be problematic.

20 The National Regulatory Research Institute First, during a merger approval pro- financial abuse, structural separation, ceeding, there are usually many is- and restrictions on affiliate transac- sues on the table. Often the entities tions. Like the approach that re-cre- desiring the merger offer to trade some ates many of the PUHCA 1935 provi- conditions to obtain merger approval. sions at the state level, ring-fencing Usually, an immediate rate decrease helps to maintain a utility company’s The Maryland Public and/or a rate freeze is offered as a credit rating by separating it from Service Commission potential condition. State commis- parents or affiliates. Because this ap- has employed ring- sions might find it difficult to insist on proach also requires rules imposed by fencing while allowing ring-fencing provisions for long-term statute or regulations, it supplies the diversification. consumer protection when immediate certainty of being proactive. This also rate relief or short-term service qual- distinguishes it from the case-by-case ity guarantees are offered, perhaps in approach. its stead. Second, conditioning mergers on a case-by-case basis could cre- An intermediate approach between us- ate an uneven playing field within a ing existing commission authority in a state. This can be particularly trouble- merger proceeding and enacting ring- some in retail choice states. Inconsis- fencing statutes has been proposed by tent merger conditions can also create staff members of the Maryland Public an uneven playing field in wholesale Service Commission. In an analysis markets. To ensure that ring-fenc- of ring-fencing measures, the com- ing measures taken in merger reviews mission staff concluded that existing are consistent, state commissions commission authority combined with might have a policy in place before proposed affiliate transaction regula- proceedings are initiated and might tions and the adoption of an annual treat prior merger cases as precedent. ring-fencing report would adequately protect utilities and their customers.46 Ring-Fencing with Diversification In attempting to devise ring-fencing Allowed: Maryland Public Service measures that operate in a proactive Commission manner without unduly burdening the operation of utilities and their relation- The second general approach states might take to fill in gaps in existing �� Andrew�� N. Beach et al., Maryland Commis- legislation is ring-fencing that con- sion Staff Analysis of Ring-Fencing Measures tinues to allow utility diversification. for Investor-Owned Electric and Gas Utilities, The NRRI Journal of Applied Regulation, vol. 3, Unlike the mini-PUCHA approach December 2005, pp. 1-12. outlined below, ring-fencing places few restrictions on the establishment of a utility holding company or on diversification. Rather, the focus is on preserving the financial status of a utility within a holding company system. A variety of measures can be employed to ring-fence a utility, including protections against corporate

The National Regulatory Research Institute 21 ships within holding company systems, state utilities.53 Commission autho- the staff members determined that re- rization is also required for a utility quiring an annual ring-fencing report to assume or guarantee a debt pay- could provide an opportunity to act on able more than a year after issuance.54 a weakness in a utility’s ring-fence on a case-by-case basis before an event Maryland’s public utility statute also The Maryland PSC 47 staff recommended: affects the utility’s service or rates. mandates a set of reporting require- • reviewing existing The approach of the Maryland comments. Utilities must file annual authority mission staff can be summarized as: reports containing information re- • amending regulations • review existing commission author- garding corporate structure and debt where necessary ity holdings55, information concerning • proactive ring- • amend regulations where necessary stock and indebtedness56, informa- fencing and • employ ring-fencing authority in a tion on business activities of the util- • no prohibitions on proactive manner ity and its affiliates,57 and about the holding company • no prohibitions on holding company relationships of officers and directors diversification. diversification are included. with a utility, parent, or affiliate.58

Statutory Authority Maryland’s Electricity Industry Re- structuring Act contains several pro- The general regulatory powers granted visions addressing affiliate transac- to the Maryland Public Service Com- tions59. Utilities may not give undue mission (PSC) by the Public Utility or unreasonable preference to affili- Companies Article of the Annotated ates.60 The statute calls on the PSC to Code of Maryland include provisions require affiliate codes of conduct.61 The commission proposed new relevant to ring-fencing. The PSC has It also requires functional, opera- regulations to general and supervisory regulatory tional, structural, or legal separation strengthen consumer authority over utilities in Maryland.48 of regulated and non-regulated busi- protection. The PSC also has the power to exam- nesses.62 Furthermore, the PSC is ine books and records.49 The PSC has empowered to conduct investigations the authority to set just and reason- into any anti-competitive conduct.63 able rates for utilities.50 The PSC has some authority over cost allocation Draft Regulations manuals as well.51 More specifically, a utility may not assign, lease, or trans- The PSC’s regulations also pro- fer a franchise or a right conferred by that franchise without permission �� Annotated�� Code of Maryland �§§�� 5-203, 6-101, 52 6-102, 6-103, 6-104. from the PSC. The Maryland stat- �� Annotated�� Code of Maryland § 5-203. utes also place some restrictions on �� Annotated�� Code of Maryland § 6-205. securities and debt transactions of �� Annotated�� Code of Maryland § 6-207. �� Annotated�� Code of Maryland § 6-208. �� Annotated�� Code of Maryland § 6-209. �� Annotated�� Code of Maryland § 7-501 et seq. � Id. at p. 2. �� Annotated�� Code of Maryland § 7-501(b)(3)(i). �� Annotated�� Code of Maryland �§§�� 2-112, 2-113. �� Annotated�� Code of Maryland �§§�� 7-505(b)(10), �� Annotated�� Code of Maryland § 2-115. 7-505(b)(13). �� Annotated�� Code of Maryland § 4-102. �� Annotated�� Code of Maryland § 7- �� Annotated�� Code of Maryland § 4-208. 505(b)(10)(iii). �� Annotated�� Code of Maryland § 5-202. �� Annotated�� Code of Maryland § 7-514.

22 The National Regulatory Research Institute vide ring-fencing measures consis- • a list of shared corporate officers and tent with the statute. In addition, other key personnel the PSC has proposed draft subtitle • a corporate risk assessment indicat- 49 to the Code of Maryland Regula- ing financial exposure tions to strengthen consumer protec- • description of regulated company’s tion. These draft provisions would set capital structure and that of its The Maryland PSC out rules regarding loans, guarantees, affiliates required an annual and asset transactions between utili- • a description of limitations placed ring-fencing report. ties and affiliates. The draft regula- on non-utility asset investments tions would require utilities to record • a summary of financing secured by asset transactions over a specified the assets of, or guaranteed by, value with affiliates in their financial the regulated company on behalf of records based on asymmetric pricing non-regulated entities to the extent permitted by law. Restric- • identify all shared assets tions would be placed on loans or debt • indicate any defaults of material ob- guarantees to affiliates. A cost alloca- ligations or bankruptcy filings tion manual would also be required. by affiliates • a description of any protections Staff Proposal that exist between the regulated company and non-regulated affili- The PSC staff recommends that the ates that mitigate the risk of the PSC require an annual ring-fenc- regulated company in the event of a ing report.64 The report would re- bankruptcy of an affiliate. semble Oregon’s affiliate transaction report, but with a broader scope. Discussion of Approach Ten items of content are suggested. Structural constraints that maintain Information Required in Ring-Fenc- public utilities as separate entities ing Report within a holding company system combined with ring-fencing measures pro- The staff of the Maryland PSC rec- vide strong security for utilities. Such ommends an annual report that would measures at a minimum include re- provide the information needed to de- strictions on affiliate transactions such termine whether a utility is adequately as cross-subsidization, cost allocation, separated within the holding company and transfer pricing, as well as state system. The report would include: utility commission access to books and records. Credit ratings services • a complete organizational chart prefer this approach because it pro- • a description of ring-fencing mea- vides the greatest degree of certainty.65 sures If adequate ring-fencing measures are in place, credit rating services will not

�� See the Appendix in Andrew�� N. Beach et al., Maryland Commission Staff Analysis of Ring- 65 See e.g., Sharon Bonelli, “Ring-Fencing,” Fencing Measures for Investor-Owned Electric PowerPoint presentation, 2005. A copy of and Gas Utilities, The NRRI Journal of Applied this document is available at http://www.nrri. Regulation, vol. 3, December 2005, pp. 1-12. ohio-state.edu/dspace/handle/2068/621.

The National Regulatory Research Institute 23 link parent and affiliate debt with that affiliates.69 A distinctive feature of of a utility. Under PUHCA 1935, the Wisconsin’s approach is the asset cap credit rating of registered holding com- provision. This provision limits public panies tended to be higher than com- utility investment in non-utility busi- panies that were exempt from PUHCA nesses to 25%.70 Furthermore, within 1935. This method also provides cer- three years after it is formed, a hold- tainty because it is preemptive; state ing company may not have non-utility regulators do not need to wait for a rate affiliate assets exceeding 40% of that case or a merger review to look into 25%.71 These provisions limiting hold- affiliate transactions, ownership trans- ing company diversification distin- Wisconsin has a mini- fers, diversification, and other matters. guish Wisconsin’s approach from the PUHCA statute. other two models described above. In State Mini-PUHCAs: Ring- this sense, Wisconsin’s state PUHCA Fencing with Diversification goes beyond ring-fencing the utility Restrictions: Wisconsin Public to restrict the actions of other enti- Service Commission ties in the holding company system.72

The third general approach that Discussion of Approach states can take to protect jurisdictional utilities and their ratepayers is A potential disadvantage of a state to re-create some of the provisions of PUHCA with ring-fencing measures PUHCA 1935 in a state statute, includ- is that some might be hesitant to in- ing limits on utility diversification. vest in public utilities located there. Strong protections for jurisdictional Wisconsin has perhaps the most utilities and their ratepayers limit complete statutory model of a “mini- PUHCA.” Wisconsin’s Utilities � Id. §196.795(5)(c) & (d). � Id. §196.795(6m)(b). Holding Company Act includes a � Id. §196.759(6m)(b)(3). requirement of public service com- �� Section 196.795(6m)(b) states that the sum of mission approval before any per- the assets of all nonutility affiliates in a holding company system may not exceed the sum of the son acquires more than 10% of the following: a) 25% of the assets of all public utility outstanding voting securities of a affiliates in the holding company system engaged public utility holding company.66 in the generation, transmission or distribution of electric power; b) a percentage of the assets, as Holding companies systems are pro- determined by the commission, which may be hibited from operating in a manner more, but may not be less than 25% of all public that materially impairs the credit of utility affiliates in the holding company system engaged in providing utility service other than 67 any public utility. The commission the generation, transmission or distribution of may regulate the issuance of securi- electric power; c) for any public utility affiliate ties by utilities.68 Public utilities are which is in the holding company system and which engages in more than one type of utility also prohibited from lending to or service, a percentage of assets equal to the amount guaranteeing the debts of parents or of the public utility affiliate’s assets devoted to public utility service, other than the generation, transmission and distribution of electric power, �� Wisconsin�� Statutes �§��196.795(3). multiplied by a percentage, as determined by the � Id. §196.795(5)(g). commission, which may be more, but may not be � Id. §§196.795(5)(a) & (b), 201.01(2), and less than 25%, plus 25% of all remaining assets of 201.03(1). such public utility affiliate.

24 The National Regulatory Research Institute the flexibility of holding companies. in policing its public utilities to protect The Wisconsin statutes were chal- the welfare of ratepayers.”74 The stat- lenged in the federal courts by a hold- utes were not unconstitutional on their A federal court of appeals held that, ing company dissatisfied with them. face because they imposed equal bur- with one exception, dens on Wisconsin and foreign com- Wisconsin’s mini- The legal challenge to the Wisconsin panies. The court balanced the burden PUHCA statute was statutes was mainly based on concerns of obtaining commission approval constitutional. with the commerce clause of the feder- for certain acts and the prohibition of al constitution. A utility holding com- other acts against the benefits of the pany filed suit against the Wisconsin statutes to public utilities and their Public Service Commission arguing ratepayers, particularly the protection that the relevant Wisconsin statutes vi- against cross-subsidization and decep- olate the commerce clause. The federal tive cost allocations. The judges de- district court granted summary judg- termined that the benefits outweighed ment in favor of the commission. On the burdens, stating that: “The need to appeal, the 7th Circuit Court of Appeals prevent abuses made possible by the held that, with one exception, the Wis- presence of a holding company is ex- consin statutes were constitutional.73 tremely important and imperative for the proper functioning of any regulato- The commerce clause of the United ry scheme. The dangers inherent in the States Constitution grants the U.S. mere existence of utility holding com- Congress the authority to regulate panies render a great need for struc- interstate commerce. A corollary of tural regulation of those companies.”75 this rule is the negative or “dormant” commerce clause. The dormant com- Although the law seems settled in merce clause provides that states may this area, the repeal of PUHCA 1935 not discriminate against or burden in- might renew arguments that state stat- terstate commerce. Where a state law utes with similar provisions violate the is not unconstitutional on its face, the commerce clause. Opponents of regu- courts employ several tests to bal- lation might argue that EPAct 2005 ance state interests with the burden preempts some state authority because on interstate commerce. The 7th Cir- the PUHCA 2005 affects a commerce cuit judges determined that a statu- clause analysis for the purposes of tory provision mandating an in-state determining whether a federal statute corporation was unconstitutional. The has a preemptive affect.76 Pursuant to other challenged provisions (limits on diversification, securities regulation, � Id. at page 910. and takeover provisions) were all held � Id. at page 918. to be constitutional. The judges stated �� Because of the savings provisions in PUHCA 2005, it is clear that Congress does not intend the that “Wisconsin clearly has an interest FERC to occupy the field. Concurrent regulation is envisioned. Even so, some might argue that there are commerce clause limitations on state reg- 73 Alliant Energy Corp. v. Bie, 330 F.3d 904 ulation of holding companies. A commerce clause (7th Cir. Wisconsin 2002), U.S. Supreme Court analysis is a balancing test, which is set out in Pike certiorari denied, 124 S.Ct. 1077 (2004) and v. Bruce Church, Inc., 397 U.S. 537 (1970): “In 124 S.Ct. 1047 (2004). The U.S. Supreme Court determining the validity of state statutes affect- denied certiorari without comment. ing interstate commerce….when the state statute

The National Regulatory Research Institute 25 PUHCA 2005, both the U.S. Congress a proper balance and to fill in any gaps and FERC have encouraged consolida- in authority. Most state commissions tion and diversification in the electrici- already have authority to deal with ty industry. States might argue that the affiliate transactions, cost allocation benefits of state regulation of holding issues, and cross-subsidies. Most companies still outweigh the burdens state commissions have independent that might be imposed on interstate authority over access to books and commerce. Nonetheless, states should records that underpins the ability to carefully draft any statutes regulating effectuate this authority. State com- utility holding companies to ensure missions might examine their own that a balance is struck between state independent authority to books and interests and interstate commerce. records to determine whether to require periodic filing of affiliate trans- Summary and Conclu- actions and cost allocation manuals by sions the utility, its affiliate, and its holding company. Where additional authority Each state commission of a ring-fencing nature may be need- must determine its EPAct 2005 repealed PUHCA 1935, replacing it with the much narrower ed, it is to prevent potential obvious existing authority and and subtle corporate financial abuse. which approach it authority of PUHCA 2005. Each state wishes to take. commission must address for itself how it wishes to balance the need to In many cases, state merger statutes assure consumer protection against allow states to pursue a case-by- the possibility of additional invest- case approach by conditioning the ment in electric utility infrastructure merger. In such cases, state commis- (particularly transmission and distri- sion conditioning authority is used bution) that the repeal is expected to to provide ring-fencing measures in stimulate. We have identified three order to protect consumers from af- critical areas that may be neglected filiate transaction abuse, cross-sub- with repeal of PUHCA 1935: transfer sidies, and, most importantly, po- pricing, cost allocation and cross-sub- tential corporate financial abuse. sidies, and various flavors of financial An alternative, more proactive statu- abuse. A self-assessment of existing tory and/or regulatory approach to authority will establish the baseline ring-fencing offering the greatest pro- for consideration of what a state com- tection from corporate financial abuses mission might need to do to both strike would include: (1) structural restrictions that maintain public utilities as separate entities that maintain sepa- regulates evenhandedly to effectuate a legitimate rate accounts; (2) state utility commis- local public interest and its effects on interstate sion access to the books and records commerce are only incidental, it will be upheld unless the burden imposed on interstate commerce with company reporting requirements; is clearly excessive in relation to the putative local (3) requirement of commission au- benefit. If a legitimate local purpose is found, then thorization for securities offerings, the question becomes one of degree. .. the extent of the burden that will tolerated will depend … dividends, and distributions; (4) re- on the nature of the local interest involved and on strictions on affiliate transactions; (5) whether it could be promoted as well with a lesser guarantees that public utilities will impact on interstate activities.”

26 The National Regulatory Research Institute not be involved in any bankruptcy aging new infrastructure investment. proceedings of parents or affiliates; and (6) clear penalties for violations.

These two ring-fencing approaches provide greater predictability for investors and also might provide consumer protection while at the same time en- hancing infrastructure investment opportunities so long as diversified entities face no direct barrier to investing.

A third approach that attempts to re- create the PUHCA 1935 might be the most problematic from the viewpoint of encouraging investment in electric utility infrastructure. State enactment of PUHCA 1935 style provisions not only provide a highest degree of consumer protection against corporate abuse, but can also inhibit much of the investment community from purchasing an equity interest in a regulated utility.

Until there is more experience concern- State commissions ing where a proper balance between can play their role providing for consumer protection and as “laboratories of encouraging infrastructure investment democracy”. is established, state public utility commissions can play their role as “laboratories of democracy” with decentral- ized public policy experiments where each state attempts to reach the right balance taking into consideration its own local conditions and preferences. As states gain more experience, useful next steps might be to catalog state statutory authorities and ring-fencing provisions. Given the possible moral hazard that ratepayers face should there be cross-subsidies, abusive affiliate transactions, or corporate abuse, there is a clear state interest and benefit in being able set the proper balance between consumer protection and encour-

The National Regulatory Research Institute 27 APPENDIX A: KEY PROVISIONS (c) HOLDING COMPANY SYS- OF THE PUBLIC UTILITY HOLD- TEMS.—The Commission may ING COMPANY ACT OF 2005 examine the books, accounts, memoranda, and other records of TITLE XII—ELECTRICITY any company in a holding company system, or any affiliate thereof, as the Subtitle F—Repeal of PUHCA Commission determines are relevant to costs incurred by a public utility § 1261. SHORT TITLE. or natural gas company within such This subtitle may be cited as the holding company system and neces- ‘‘Public Utility Holding Company Act sary or appropriate for the protection of 2005’’. of utility customers with respect to jurisdictional rates. (d) CONFIDEN- § 1264. FEDERAL ACCESS TO TIALITY.—No member, officer, or BOOKS AND RECORDS. employee of the Commission shall (a) IN GENERAL.—Each holding divulge any fact or information that company and each associate company may come to his or her knowledge thereof shall maintain, and shall make during the course of examination of available to the Commission, such books, accounts, memoranda, or other books, accounts, memoranda, and records as provided in this section, other records as the Commission de- except as may be directed by the termines are relevant to costs incurred Commission or by a court of compe- by a public utility or natural gas tent jurisdiction. company that is an associate company of such holding company and neces- § 1265. STATE ACCESS TO sary or appropriate for the protection BOOKS AND RECORDS. of utility customers with respect to (a) IN GENERAL.—Upon the writ- jurisdictional rates. ten request of a State commission (b) AFFILIATE COMPANIES.— having jurisdiction to regulate a pub- Each affiliate of a holding company lic-utility company in a holding com- or of any subsidiary company of a pany system, the holding company holding company shall maintain, and or any associate company or affiliate shall make available to the Commis- thereof, other than such public-utility sion, such books, accounts, memoran- company, wherever located, shall pro- da, and other records with respect to duce for inspection books, accounts, any transaction with another affiliate, memoranda, and other records that— as the Commission determines are (1) have been identified in reasonable relevant to costs incurred by a public detail in a proceeding before the State utility or natural gas company that is commission; an associate company of such holding (2) the State commission determines company and necessary or appropri- are relevant to costs incurred by such ate for the protection of utility cus- public-utility company; and tomers with respect to jurisdictional (3) are necessary for the effective rates. discharge of the responsibilities of the State commission with respect to

28 The National Regulatory Research Institute such proceeding. of 1978 (16 U.S.C. 2601 et seq.); (b) LIMITATION.—Subsection (a) (2) exempt wholesale generators; or does not apply to any person that is (3) foreign utility companies. a holding company solely by reason (b) OTHER AUTHORITY.—The of ownership of one or more qualify- Commission shall exempt a person ing facilities under the Public Utility or transaction from the requirements Regulatory Policies Act of 1978 (16 of section 1264 (relating to Federal U.S.C. 2601 et seq.). access to books and records) if, upon (c) CONFIDENTIALITY OF IN- application or upon the motion of the FORMATION.—The production of Commission— books, accounts, memoranda, and (1) the Commission finds that the other records under subsection (a) books, accounts, memoranda, and shall be subject to such terms and other records of any person are not conditions as may be necessary and relevant to the jurisdictional rates of a appropriate to safeguard against public utility or natural gas company; unwarranted disclosure to the public or of any trade secrets or sensitive com- (2) the Commission finds that any mercial information. class of transactions is not relevant (d) EFFECT ON STATE LAW.— to the jurisdictional rates of a public Nothing in this section shall preempt utility or natural gas company. applicable State law concerning the provision of books, accounts, memo- § 1267. AFFILIATE TRANSAC- randa, and other records, or in any TIONS. way limit the rights of any State to (a) COMMISSION AUTHORITY obtain books, accounts, memoranda, UNAFFECTED.—Nothing in this and other records under any other subtitle shall limit the authority of the Federal law, contract, or otherwise. Commission under the Federal Power (e) COURT JURISDICTION.—Any Act (16 U.S.C. 791a et seq.) to re- United States district court located quire that jurisdictional rates are just in the State in which the State com- and reasonable, including the ability mission referred to in subsection (a) to deny or approve the pass through is located shall have jurisdiction to of costs, the prevention of cross-sub- enforce compliance with this section. sidization, and the issuance of such rules and regulations as are necessary § 1266. EXEMPTION AUTHORITY. or appropriate for the protection of (a) RULEMAKING.—Not later than utility consumers. 90 days after the effective date of this (b) RECOVERY OF COSTS.—Noth- subtitle, the Commission shall issue a ing in this subtitle shall preclude the final rule to exempt from the require- Commission or a State commission ments of section 1264 (relating to from exercising its jurisdiction under Federal access to books and records) otherwise applicable law to determine any person that is a holding company, whether a public utility company, solely with respect to one or more— public utility, or natural gas company (1) qualifying facilities under the may recover in rates any costs of an Public Utility Regulatory Policies Act activity performed by an associate

The National Regulatory Research Institute 29 company, or any costs of goods or in activities or transactions in which services acquired by such public-util- it is legally engaged or authorized to ity company from an associate com- engage on the date of enactment of pany. this Act, if that person continues to comply with the terms (other than an § 1268. APPLICABILITY. expiration date or termination date) Except as otherwise specifically of any such authorization, whether by provided in this subtitle, no provision rule or by order. of this subtitle shall apply to, or be (b) EFFECT ON OTHER COMMIS- deemed to include— SION AUTHORITY.—Nothing in (1) the United States; this subtitle limits the authority of the (2) a State or any political subdivision Commission under the Federal Power of a State; Act (16 U.S.C. 791a et seq.) or the (3) any foreign governmental author- Natural Gas Act (15 U.S.C. 717 et ity not operating in the United States; seq.). (4) any agency, authority, or instru- (c) TAX TREATMENT.—Tax treat- mentality of any entity referred to in ment under section 1081 of the Inter- paragraph (1), (2), or (3); or nal Revenue Code of 1986 as a result (5) any officer, agent, or employee of transactions ordered in compli- of any entity referred to in paragraph ance with the Public Utility Holding (1), (2), (3), or (4) acting as such in Company Act of 1935 (15 U.S.C. 79 the course of his or her official duty. et seq.) shall not be affected in any manner due to the repeal of that Act § 1269. EFFECT ON OTHER REG- and the enactment of the Public Util- ULATIONS. ity Holding Company Act of 2005. Nothing in this subtitle precludes the Commission or a State commission § 1275. SERVICE ALLOCATION. from exercising its jurisdiction under (a) DEFINITION OF PUBLIC UTIL- otherwise applicable law to protect ITY.—In this section, the term ‘‘pub- utility customers. lic utility’’ has the meaning given the term in section 201(e) of the Federal § 1270. ENFORCEMENT. Power Act (16 U.S.C. 824(e)). The Commission shall have the same (b) FERC REVIEW.—In the case of powers as set forth in sections 306 non-power goods or administrative or through 317 of the Federal Power Act management services provided by an (16 U.S.C. 825e–825p) to enforce the associate company organized spe- provisions of this subtitle. cifically for the purpose of providing such goods or services to any public § 1271. SAVINGS PROVISIONS. utility in the same holding company (a) IN GENERAL.—Nothing in this system, at the election of the system subtitle, or otherwise in the Public or a State commission having juris- Utility Holding Company Act of diction 1935, or rules, regulations, or orders over the public utility, the Commis- thereunder, prohibits a person from sion, after the effective date of this engaging in or continuing to engage subtitle, shall review and authorize

30 The National Regulatory Research Institute the allocation of the costs for such goods or services to the extent relevant to that associate company. (c) EFFECT ON FEDERAL AND STATE LAW.—Nothing in this section shall affect the authority of the Commission or a State commission under other applicable law. (d) RULES.—Not later than 4 months after the date of enactment of this Act, the Commission shall issue rules (which rules shall be effective no earlier than the effective date of this subtitle) to exempt from the requirements of this section any company in a holding company system whose public utility operations are confined substantially to a single State and any other class of transactions that the Commission finds is not relevant to the jurisdictional rates of a public utility.

The National Regulatory Research Institute 31 The National Regulatory Research Institute 1080 Carmack Road Columbus, Ohio 43210-1002 Phone: 614-292-9404 Fax: 614-292-7196 www.nrri.ohio-state.edu

This report was prepared by the National Regulatory Research Institute (NRRI) with funding provided by the member commissions of the National Association of Regulatory Utility Commissioners (NARUC). The views and opinions of the authors do not necessarily express or reflect the views, opinions or policies of the NRRI, NARUC or NARUC member commissions.

32 The National Regulatory Research Institute