MANAGING REGULATORY RISK IN A POSTPUHCA WORLD

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MANAGING REGULATORY RISK IN A POST-PUHCA WORLD

• MACQUARIE SECURITIES
• 2007 UTILITIES INFRASTRUTURE CONFERENCE
• VAIL, CO
• FEBRUARY 13, 2007

ROBERT W. GEE PRESIDENT GEE STRATEGIES GROUP LLC
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PUHCA 101(The 1935 Act)

• No significant utility state regulation existed
• PUHCA enacted to address financial abuses
  facilitated by complex holding company structures
  and interlocking directorates resulting in
  numerous utility insolvencies and little
  accountability
• Required simplified, limited holding company
  system
• Utility activities limited to a single,
  geographically integrated public utility system
  and to such other businesses as are reasonably
  incidental, or economically necessary or
  appropriate to the operations of the integrated
  system
• Imposed significant recordkeeping and filing
  requirements before the Securities and Exchange
  Commission

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The Case for PUHCA Repeal

• Over time, PUHCAs restrictions were deemed as
  not reflecting either the market structure or
  regulatory policy priorities affecting the
  modern electric power industry
• Geographic integration requirement
  counterintuitive to blunt growth of market power
• States had assumed greater ratepayer protection
  role
• Over 2 decades, SEC favored its repeal
• Perception grew that repeal was necessary to
  eliminate arcane, duplicative, and unduly
  burdensome regulations that disserved the
  interest of the consuming public by hindering
  needed investment
• FERC and states would be better equipped to
  protect ratepayers, and not the SEC which is
  focused on investor protection

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Just when you thought the war was over, the
battleground shifted . . .
To the states

• PUHCA repealed in Energy Policy Act of 2005
  Victory Declared!
• Because PUHCA repeal premised on adequacy of
  state authority to protect ratepayers from
  holding company abuses, states were invited to
  address any perceived regulatory gap
• Result most states have yet to act, but several
  are becoming increasingly assertive Arkansas,
  California, New Jersey, and Kansas (pending)
• Whether this signals a trend is premature
• Are we witnessing a proliferation of
  Mini-PUHCAs a la Wisconsin?

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New State Post-PUHCA Measures

• Structural corporate separation of utility,
  affiliates, and holding companies
• California mandated by rule
• Kansas Staff recommendation
• New Jersey Staff recommendation
• Maintenance and retention of separate books and
  records for utility and holding company
  affiliates (Arkansas California)
• Ringfencing to protect utility credit quality
• Arkansas under certain conditions, can order
  termination of relationship between utility and
  its affiliate if shown to impair utilitys credit
  quality to below BB (S P) or Ba1 (Moodys)
• Kansas Staff proposal to prohibit utility from
  issuing long-term debt to fund non-utility
  activities, investments, or businesses
• New Jersey Staff proposal would empower Board,
  among other things, to limit or cease payment of
  dividends or holding company if capital of
  utility is found impaired

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New State Post-PUHCA Measures (cont.)

• Caps on non-utility diversification by utility or
  utility holding company akin to Wisconsin
  Mini-PUHCA
• Arkansas -- 10 percent of the book value of the
  total assets of the public utility and all its
  affiliates
• New Jersey 25 percent of utility and
  utility-related assets, with latitude to seek
  increase to 35 percent under certain conditions
• Restrictions on transactions or sharing of
  services/personnel between utility and holding
  company affiliates
• California limitations on use of common key
  corporate officers, and personnel for regulatory
  affairs, legal, lobbying
• Arkansas prohibition of affiliate transactions
  where utility provides to or shares with
  affiliate any financial resource or financial
  benefit
• Disclosure of total compensation for executive
  officers (and those making gt250K/yr. in base
  salary), including proportion paid, directly or
  indirectly, by ratepayers (California)

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Corporate Governance Oversight An Emerging Issue

• New Jersey Staff proposes to require utility
  annually to certify that
• 40 percent of its directors are independent
  (i.e., not directors of both the electric or gas
  public utility and its public utility holding
  company system)
• It has process in place for selecting new
  directors and such process identifies New Jersey
  residency, employment and/or other significant
  ties with the State of New Jersey (New Jersey
  Qualification)
• If less than 40 percent, made a good faith effort
  in meeting New Jersey Qualification
• Californias rule -- Indirect effort at
  governance oversight via required disclosure of
  share of executive compensation attributable to
  utility ratepayers infers utility executive
  decisions driven by superseding business
  priorities of holding company and/or affiliates

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Common Drivers for State Post-PUHCA Measures

• A strong preference for ex ante versus ex post
  sanctions generic rules versus case-by-case
  determinations
• Skepticism of effectiveness of existing
  ratemaking authority to prevent harm to
  ratepayers from cross-subsidization or risk of
  non-utility diversification
• Desire for more rigorous oversight over matters
  previously left to management discretion
• Not persuaded that new rules would chill
  investment

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Lessons for Investors (thus far)

• State commissions inclination to impose controls
  influenced by variety of factors
• Prior history of utility conduct (e.g., abuses
  affecting utility creditworthiness)
• General mistrust of utility ownership by large
  multi-state holding companies or by out-of-state
  interests
• Activist regulatory culture
• Commissions relationship to legislature and/or
  Governors
• No two commissions are identical, but they talk
  to one another
• Investors should continue to monitor state
  actions to see how this evolves

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Robert W. Gee President Gee Strategies Group
LLC 7609 Brittany Parc Court Falls Church, VA
22304 U.S.A. 703.593.0116 703.698.2033
(fax) rwgee_at_geestrategies.com www.geestrategies.co
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