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3 The National Regulatory Research Institute Robert E. Burns, Senior Research Specialist 2006 NARUC Winter Meeting February 14, 2006 Washington, DC PUHCA Repeal: Basic Overview

4 Before the PUHCA of 1935 Like baseball, the holding company is an American invention Originally, at common law, a corporation did not have the power to own the stock of another corporation except in satisfaction of debt of as a preliminary step toward a merger. Special legislative charters, beginning in 1832 with railroad, then 1860s with telephone companies allowed holding companies on a case-by-case basis

5 Before the PUHCA of 1935 - continued In 1888 New Jersey amended its General Corporation Law to permit holding companies By 1932 49 percent of investor owned electric utilities owned by three holding companies.

6 Before the PUHCA of 1935 - continued Early holding companies’ corporate structure relied on pyramiding. Many also had pyramided securities – all dependent on the earnings of the electric utility operating company The collapse of 1929 lead to lower earnings of electric utility operating companies The lower operating company earnings had a snowballing effect – the leveraging worked to push fixed securities into default

7 Purpose of the PUHCA of 1935: Eliminate Evil Congress enacted the PUHCA of 1935 to eliminate eleven evils that adversely affected investors and consumers: –Investors cannot obtain adequate information to appraise the financial position or earning power of issuers because of the absence of a Uniform System of Accounts –Securities are issued without consent of the states

8 Purpose of the PUHCA of 1935: Eliminate Evil - continued The PUHCA was enacted - continued –Securities are issued on the basis of fictitious or unsound asset values bearing no relationship to the amount invested or the earning power of the properties, and on the basis of paper profits from intercompany transactions or in anticipation of excessive revenues from utility subsidiaries

9 Purpose of the PUHCA of 1935: Eliminate Evil - continued The PUHCA was enacted - continued –Securities that require the utility to support an overcapitalized structure and tend to prevent voluntary rate reductions are issued –Utility subsidiaries are subject to excessive charges for services, etc… or enter into transactions where arm’s length bargaining is absent and free competition is restrained

10 Purpose of the PUHCA of 1935: Eliminate Evil - continued The PUHCA was enacted - continued –Service, management, construction, and other contracts involve the allocation of charges among utility subsidiaries in different states so as to make effective state regulation difficult –Control of utility subsidiaries affects the accounting practices, rates, dividends, and other policies of such companies so as to complicate and obstruct state regulation

11 Purpose of the PUHCA of 1935: Eliminate Evil - continued The PUHCA was enacted - continued –Control of utility subsidiaries is exerted through disproportionate investment –The growth and extension of holding companies bears no relation to economy of management and operation or the integration and coordination of related operating properties –There is a lack of effective public regulation –There is a lack of economies in raising capital

12 1935 PUHCA Regulation Originally, unless a holding company fell into one of five exemptions, it became a registered holding company Registered holding companies were required to operate as an integrated system and were subject to comprehensive reporting and financial requirements and restrictions

13 1935 PUHCA Regulation The most important of the original exemptions was the intrastate holding company exemption Later exemptions were created for qualifying facilities, exempt telephone companies, and exempt wholesale generators.

14 What Has Changed There is a Uniform System of Accounts There are stricter accounting and reporting standards and disclosure requirements– ’33 + ’34 Securities Acts + Sarbanes-Oxley There are independent financial analysts to protect investors More effective state regulation to protect consumers

15 Effect of the Repeal of PUHCA of 1935 Holding company structures that would have triggered the comprehensive SEC regulatory requirements as a registered holding company are now permitted Formerly exempt holding companies and formerly registered holding companies are treated in the same matter

16 What Has Not Changed Problem of affiliated transactions Problem of cross-subsidies/cost misallocation Need to access books and records The need to address possible risk shifting and financial abuse

17 The PUHCA of 2005 The PUHCA of 2005 provides access to books and records and allows states and the FERC to deal with both affiliate transactions and cross-subsidies to deal with the first three problems States might consider whether there is a need to address potential risk shifting and financial abuse through “ring-fencing” the operating utility –Merger and acquisition conditioning authority –Separate legislation or rulemaking


19 Regulated Utility M & A After PUHCA Repeal Committee on Electricity NARUC Winter Meetings February 14, 2006 Brent E. Gale Senior Vice President MidAmerican Energy Company

20 This presentation has been prepared by Brent E. Gale, Senior Vice President – Legislation & Regulation of MidAmerican Energy Company. The document reflects his opinions and conclusions and not necessarily those of MidAmerican Energy Holdings Company or MidAmerican Energy Company.

21 Regulated Utility M & A With PUHCA Investment from outside the industry was discouraged Non-contiguous M & A were discouraged, exacerbating market power concerns and limiting transactions that were otherwise economic SEC affiliate transaction rules sometimes conflicted with state objectives [Ohio Power] For the few registered holding companies, non-utility investments were restricted

22 Impacts of PUHCA Repeal The universe of potential utility investors will be increased But, regulated utility merger and acquisition activity will remain constrained: –State and federal approvals are still required –Activities and profits are regulated –Merger savings are usually passed through to customers –Acquisition premiums are typically disallowed unless offset by reductions in regulated revenue requirements States gain authority regarding access to information FERC gains greater merger & oversight authority

23 States New & Continuing Role States have clear authority to access books & records of the utility, its holding company and its affiliates to the extent they are relevant to public utility costs States will continue to regulate mergers & acquisitions of public utilities, utility rates and operations, disposition of utility assets, affiliate transactions and utility interests in non-utility businesses States are exercising the ability to impose conditions regarding affiliate transactions, financial reporting and ring fencing

24 FERC’s New & Continuing Role Registration of public utility holding companies (and granting of exemptions) Regulation of securities issuances by public utilities Increased merger review authority Regulation of cost allocations from service companies Authority over maintenance of books, accounts & records by holding companies and subsidiaries

25 Areas of State & Federal Activity Access to information Affiliate transactions Financial reporting Separation of the utility from the holding company (ring fencing)

26 Access to Information Information concerns have three dimensions –FERC & state access to books and records –Access to other information relevant to regulated utility operations –Record retention EPAct 2005 –FERC and states authorized access to books and records –FERC and states authorized access to information relevant to regulated business –FERC anticipates a separate rulemaking to address specifics within the year States are considering additional conditions

27 Affiliate Transactions Provision of services “at cost” by traditional service companies will continue to be assumed by FERC to be reasonable, but will be open to challenge FERC will apply its current affiliate transaction standards to other affiliate transactions within holding companies –Higher of cost or market for purchase from utility –Lower of cost or market for sales by utility States are considering and imposing conditions While FERC declined to adopt a rule regarding cross- subsidization, believing most states have adequate authority to deal with this issue, it will monitor the need for such a rule FERC determined its existing cash management rules provide adequate protection

28 Financial Reporting Simplified Form 60 filing (including cost allocations) replaces SEC reporting requirements, and is based on information FERC believes is necessary for effective regulation SEC standard corporate reporting continues FERC Form 1 reporting continues Level of reporting needed (including Uniform System of Accounts) will also be considered in a separate rulemaking Future financings will be authorized by FERC instead of SEC; existing authorizations will be honored States are requiring information

29 Purpose of Ring-Fencing Ring fencing places an independent corporate entity between the utility and the holding company Restrictions are placed on the utility and independent entity that isolate the utility from potential financial problems at the holding company and affiliates

30 Ring Fencing - Separation The independent corporate entity: Has its own Board of Directors with at least one Independent Director Cannot be subject to merger, reorganization, dissolution or bankruptcy without Independent Director consent Conducts its own business through its own offices Keeps its own books and records Keeps its assets and liabilities separate from other entities in the holding company

31 Ring Fencing - Limitations The independent corporate entity cannot: Assume liabilities for others Permit encumbrance of its assets Make loans or advances to acquire debt, stock or securities Change its name Allow the utility to distribute dividends unless its credit metrics meet specified targets

32 Examples of Additional Financial Conditions Imposed by States Utility to maintain separate accounting systems Utility to maintain separate debt and preferred stock and associated ratings Notice if utility is to be merged or assets sold Notice of dividends or increase in dividends Notice of changes in ring-fencing provisions


34 “Competition Policy After PUHCA” Diana L. Moss, Ph.D. Vice-President and Senior Fellow American Antitrust Institute NARUC Winter Committee Meetings Panel on PUHCA Repeal Washington, D.C. February 14, 2005

35 Major Issues After PUHCA Identifying competitive problems potentially bigger doses of traditional harms in horizontal and vertical merger contexts Revisiting enforcement rebalancing the roles of regulation and antitrust encouraging thorough, independent agency review Refocusing policy putting merger efficiency claims to the test improving market structure

36 Identifying Competitive Problems A possible wave of bigger mergers: between (1) geographically disparate companies and (2) complex vertical or conglomerate combinations Already concentrated markets: due to the 1990s merger wave that concentrated regional markets Stronger anticompetitive incentives: to control price and exclude competitors Difficult remedy issues: that limits enforcement flexibility and choices

37 Identifying Competitive Problems (cont.) Exercise of market power: requires: (1) ability--control of resources and (2) incentive--profitable strategy and results in adverse affects on price and quantity Horizontal mergers: increase market concentration raise concerns about withholding through coordinated or unilateral action Vertical mergers: link ownership of resources in complementary markets raise concerns about: (1) raising rivals’ costs and foreclosure, (2) anticompetitive coordination, and (3) evasion of rate regulation

38 Revisiting Enforcement: Pre-Repeal FERC reliance on: market shares and concentration applicant-filed analysis conduct-based remedies DOJ/FTC focus on: competitive effects (e.g., coordination or unilateral effects) confidential discovery structural remedies State emphasis on: ratepayer protections deference to FERC analysis, findings, or remedies

39 Revisiting Enforcement: Post-Repeal FERC as involved as before: little deviation from past focus, even with new authorities with increasingly bigger transactions, runs risk of becoming another STB DOJ/FTC more involved: see Exelon/PSEG comparative advantage in dealing with complex competitive issues (strategic motivation, coordination, and vertical issues) States challenged: lack the legal-economic resources necessary for adequate analysis may need help (training and support)

40 Refocusing Policy Learning from the past: most mergers do not prove up the claimed benefits (see: Sherer, Kwoka and Pollitt) Raising the bar: the greater the anticompetitive effects, the larger should be the countervailing efficiencies (merger-specific, cognizable, passed through to consumers) Focusing on market structure: structural reforms will facilitate more competitive markets


42 Implications of PUHCA Repeal: As Assessment of Investor Perceptions Presentation to the Electricity Committee NARUC Winter Meetings Washington, D.C. February 14, 2006 Julie M. Cannell, President J.M. Cannell, Inc.

43 Investor Perceptions of PUHCA Repeal: Overview  Outlook for further industry consolidation  State regulatory oversight of M&A  Opinions on PUHCA  FERC’s enhanced merger authority  State regulators’ potential responses to PUHCA repeal

44 Investor Perceptions of PUHCA Repeal: Consolidation Backdrop  More consolidation is widely anticipated  Valuations at more reasonable levels than in merger go-go years; more realism regarding merger premiums  New potential investors  Deal shapes may change  Concerns about state regulators’ approval

45 Investor Perceptions of PUHCA Repeal: State Regulatory Oversight of M&A  Almost all investors believe or accept state regulators’ review of M&A  Desired factors with oversight: – Fairness in evaluation – Recovery of merger premiums – Only one controlling entity to review the deal – Regulators able to see positives in a combination – Applying incentives – Limiting judgments to the no harm/benefit test

46 Investor Perceptions of PUHCA Repeal: State Regulatory Oversight of M&A  Concerns with oversight: – Confiscation of economic value/required givebacks – Protracted time for approvals – Immediate rate cuts aren’t realistic

47 Investor Perceptions of PUHCA Repeal: Analysts’ Thoughts on PUHCA  Essentially benign, a non-event  Federal and universally applicable  Didn’t save anyone, nor push anyone over the edge  A company’s strategy trumps PUHCA. If the strategy is inherently conservative, it will be so even without PUHCA.

48 Investor Perceptions of PUHCA Repeal: FERC’s Broadened Merger Authority  Generally viewed benignly  “The jury’s still out.”  Positives (related to FERC): – Understands the markets – Has a history of consistency – Supportive of maintaining industry’s financial health

49 Investor Perceptions of PUHCA Repeal: FERC’s Broadened Merger Authority  Negatives: – Potential for over-exercise of power – Concern of succumbing to political pressure – Increasing jurisdictional tension with state regulators  Neutral views: – A “non-event, ” continuing spirit of previous legislation – Authority had to go to somebody – FERC is an independent body

50 Investor Perceptions of PUHCA Repeal: State Regulators’ Potential Responses Ring Fencing  Analysts have mixed opinions  Portland General cited as an excellent example  Depends on how mechanisms are structured

51 Investor Perceptions of PUHCA Repeal: State Regulators’ Potential Responses Ring Fencing ( continued )  Positives – Provides financial protection from unregulated activities – Limits downside exposure to investors and consumers – Can provide comfort to state regulators

52 Investor Perceptions of PUHCA Repeal: State Regulators’ Potential Responses Ring Fencing ( continued )  Negatives: – Limits the ability of markets to work – Can be so restrictive it isn’t helpful – Can pose a cost to ratepayers – Has a potential negative impact on holding companies and other affiliates

53 Investor Perceptions of PUHCA Repeal: State Regulators’ Potential Responses Mini-PUHCAs  Many investors view unfavorably, others have mixed or neutral views  Negatives: – Limit industry’s consolidation potential – Hurt consumers through reducing economies of scale possibilities – Limit market’s ability to function – Introduce territorial issues – Increase industry complexity

54 Investor Perceptions of PUHCA Repeal: State Regulators’ Potential Responses Mini-PUHCAs (continued)  Mixed views : – State-by-state issue – Depends on individual circumstances, levels of requirements, and parameters  Neutral opinions : – Regulators desire consistency – Becomes a legal question: strong rules, laws needed  Only one positive cited: could prevent LBOs

55 Investor Perceptions of PUHCA Repeal: Summary  Further industry consolidation widely anticipated  State regulators have a role—hopefully constructive—in M&A approval process  FERC’s broadened merger authority generally considered benign  Properly constructed ring-fencing mechanisms can help protect regulated utilities  Mini-PUHCAs not a desirable response to PUHCA repeal

56 Q & A


58 Public Utility Commission OREGON Mergers and Ring Fencing Issues: An Oregon Perspective February 14, 2006 NARUC Winter Committee Meeting Oregon Public Utility Commission Ray Baum, Commissioner

59 What is Ring Fencing?  Purpose – To isolate the utility from negative financial impacts created by affiliates: To ensure the utility maintains a strong credit rating and is able to attract capital. To prevent the utility from cross-subsidizing non-regulated utilities. To ensure regulators’ access to accurate information

60 Overview  Customers expect utilities to be protected from non-utility business risks.  Utilities need strong financial ratings to operate efficiently and acquire needed resources.  Ring fencing can provide such protection.  Ring fencing isolates the utility from the financial status of its affiliates.

61 Rating Agency’s View on Regulatory Regulation Standard & Poor’s  Rating agencies weigh heavily state regulatory policies. “Any action that state regulators take that provides support (whether legal, regulatory, financial or operational) to the utility and/or isolates the utility (most importantly financial obligations) from its parent company will be positive for credit.”

62 Standard & Poor’s  Parent company's nonregulated businesses matter.  Utilities can be insulated by: Restricting dividends; Restricting loans to affiliates; and Fair pricing of transactions with affiliates. Rating Agency’s View on Regulatory Regulation (continued)

63 Oregon Statutes and Rules  Oregon’s statutes and administrative rules enable effective ring fencing provisions. PGE was able to maintain investment grade ratings even after Enron filed bankruptcy.  Nine notch differential between PGE’s and Enron’s long-term debt rating. PacifiCorp has similar ring fencing provisions. Other States may not have the same authority.

64  Define affiliated interest.  Require approval before an utility may guarantee another's (long-term) indebtness.  Require approval of stock and bond issuance. Oregon Statutes and Rules (continued) Oregon Revised Statutes Oregon Revised Statutes protect customers from potential abuses in utility/affiliate transactions. These statutes:

65 Oregon Revised Statutes  Require approval for the purchase of property or stocks of one utility by another.  Require approval for utilities to contract with affiliated interests, when the utility is the buyer of goods, services, and assets.  Oregon Transfer Pricing Policy (Rule): Services provided by affiliate to utility  Priced at lower of cost and market. Services provided by utility to affiliate  Priced at higher of cost or market. Oregon Statutes and Rules (continued)

66 Oregon Revised Statutes  Require approval for mergers and acquisitions of Oregon utilities. Any acquisition or merger requires:  Net Benefit for Utility customers.  No harm to Oregon citizens on a whole. Oregon Statutes and Rules (continued)

67 Oregon Ring Fencing - PGE  PGE is Oregon’s largest utility and serves 767,000 customers.  Since 1997, Commission has reviewed five applications to acquire PGE: UM 814 – Enron Merger (Approved) UM 967 – Sierra Pacific Acquisition (Approved; Never completed due to SEC requirements) UM 1045 – NW Natural Acquisition (Withdrawn due to Enron’s bankruptcy filing) UM 1121 – TPG Acquisition (Denied) UM 1206 – PGE Stock Distribution (Approved)

68 Oregon Ring Fencing – PGE (continued) Portland General Electric - Enron  Ring fencing conditions included: 1. Full access to information requirements and review of inter-corporate transactions involving PGE. 2. Maintain separate long-term debt and preferred stock ratings. 3. Common equity portion of at least 48%. 4. PGE must notify the Commission of certain dividends and distributions to Enron

69 Oregon Ring Fencing – PGE (continued) Portland General Electric – Enron 5. Prohibition on allocations or direct charges from Enron to PGE without Commission authorization. 6. Restrictions on Enron's access to PGE's power, natural gas assets, or excess pipeline capacity. 7. Not allowed to seek a higher cost of capital than it would have been authorized absent the merger.

70 Additional Ring Fencing Approved  The Golden Share Commission approved the issuance of a $1.00 Par Junior Preferred Stock. Created an “ independent director. ” Prevented Enron from forcing PGE to file for bankruptcy. Avoided future downgrades of PGE's bond ratings due to Enron ’ s bankruptcy. Oregon Ring Fencing – PGE (continued)

71  Application was denied by the Commission. Concerns included potential harms resulting from: Harms Related to Oregon Electric’s Long-term Debt Short-Term Ownership Transaction Terms were not Final Lack of Transparency – Parent was a private investment firm Oregon Ring Fencing – PGE (continued) Oregon Electric Utility Company’s proposed acquisition of PGE

72  Enabled PGE to again be a publicly traded utility. PGE approved to issue 62,500,000 shares of new PGE common stock and cancel existing stock owned by Enron.  Ring fencing provisions included mirrored those already in place for PGE, except where no longer applicable. Notice of dividends concurrent with public announcement. Minimum equity requirements are reduced as the percentage of equity held by the “Reserve” is reduced. Oregon Ring Fencing – PGE (continued) Portland General Electric – Stock Distribution

73 Oregon Ring Fencing - PacifiCorp PacifiCorp  Second largest Oregon utility and serves approximately 527,000 customers.  Recent mergers/acquisitions involving PacifiCorp: UM 918 – Scottish Power UM 1209 – Mid-America Energy Holding Company

74 Oregon Ring Fencing – PacifiCorp (continued) PacifiCorp – Scottish Power  Ring fencing conditions adopted: 1. Maintain separate accounting system. 2. Keep all financial books and records at its Portland, Oregon headquarters. 3. Access to records of ScottishPower pertaining to transactions to PacifiCorp and all its affiliated interest. 4. Authority to audit accounting records of ScottishPower and its unregulated subsidiaries that are bases for charges to PacifiCorp.

75 PacifiCorp – Scottish Power 5. Maintain a minimum common equity ratio of 35% (ramping up to 40%) 6. Maintain separate long-term debt and preferred stock ratings and provide notice of certain distributions from PacifiCorp to Scottish Power. 7. PacifiCorp not allowed to seek a higher cost of capital than it would have been authorized absent the merger. Oregon Ring Fencing – PacifiCorp (continued) A pre-merger order placed a $200,000,000 (aggregated) ceiling on loans that PacifiCorp could make to affiliates.

76 Oregon Ring Fencing Conclusions  Ring fencing evolves over time.  Separation of books and records;  Greater specificity to Minimum Equity Requirements; and  Golden Share (PGE), Independent Director (PacifiCorp).



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