NARUC COMMITTEE ON ELECTRICITY:

1
NARUC COMMITTEE ON ELECTRICITY

• PUHCA REPEAL

2
NARUC COMMITTEE ON ELECTRICITY

• PUHCA REPEAL
• Robert Burns

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

18
NARUC COMMITTEE ON ELECTRICITY

• PUHCA REPEAL
• Brent Gale

19
Regulated Utility M AAfter PUHCA Repeal
Brent E. Gale Senior Vice President MidAmerican
Energy Company

• Committee on Electricity
• NARUC Winter Meetings
• February 14, 2006

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 AWith 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
FERCs 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

33
NARUC COMMITTEE ON ELECTRICITY

• PUHCA REPEAL
• Diana Moss

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 EnforcementPost-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

41
NARUC COMMITTEE ON ELECTRICITY

• PUHCA REPEAL
• Julie Cannell

42
Implications of PUHCA RepealAs 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 MA
• Opinions on PUHCA
• FERCs 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 MA

• Almost all investors believe or accept state
  regulators review of MA
• 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 MA

• Concerns with oversight
• Confiscation of economic value/required givebacks
• Protracted time for approvals
• Immediate rate cuts arent realistic

47
Investor Perceptions of PUHCA Repeal
Analysts Thoughts on PUHCA

• Essentially benign, a non-event
• Federal and universally applicable
• Didnt save anyone, nor push anyone over the edge
• A companys strategy trumps PUHCA. If the
  strategy is inherently conservative, it will be
  so even without PUHCA.

48
Investor Perceptions of PUHCA Repeal FERCs
Broadened Merger Authority

• Generally viewed benignly
• The jurys still out.
• Positives (related to FERC)
• Understands the markets
• Has a history of consistency
• Supportive of maintaining industrys financial
  health

49
Investor Perceptions of PUHCA Repeal FERCs
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 isnt 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 industrys consolidation potential
• Hurt consumers through reducing economies of
  scale possibilities
• Limit markets 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 rolehopefully
  constructivein MA approval process
• FERCs 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
57
NARUC COMMITTEE ON ELECTRICITY

• PUHCA REPEAL
• Hon. Ray Baum

58
NARUC Winter Committee Meeting
Mergers and Ring Fencing Issues An Oregon
Perspective
Oregon Public Utility Commission Ray Baum,
Commissioner
February 14, 2006
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 Agencys View on Regulatory Regulation

• Standard Poors
• 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
Rating Agencys View on Regulatory Regulation
(continued)

• Standard Poors
• Parent company's nonregulated businesses matter.
• Utilities can be insulated by
• Restricting dividends
• Restricting loans to affiliates and
• Fair pricing of transactions with affiliates.

63
Oregon Statutes and Rules

• Oregons 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 PGEs and Enrons
  long-term debt rating.
• PacifiCorp has similar ring fencing provisions.
• Other States may not have the same authority.

64
Oregon Statutes and Rules (continued)
Oregon Revised Statutes Oregon Revised Statutes
protect customers from potential abuses in
utility/affiliate transactions. These statutes 

• Define affiliated interest.
• Require approval before an utility may guarantee
  another's (long-term) indebtness. 
• Require approval of stock and bond issuance.

65
Oregon Statutes and Rules (continued)

• 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.  

66
Oregon Statutes and Rules (continued)

• 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.

67
Oregon Ring Fencing - PGE

• PGE is Oregons 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 Enrons 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
• Full access to information requirements and
  review of inter-corporate transactions involving
  PGE.
• Maintain separate long-term debt and preferred
  stock ratings.
• Common equity portion of at least 48.
• PGE must notify the Commission of certain
  dividends and distributions to Enron

69
Oregon Ring Fencing PGE (continued)

• Portland General Electric Enron
• Prohibition on allocations or direct charges from
  Enron to PGE without Commission authorization.
• Restrictions on Enron's access to PGE's power,
  natural gas assets, or excess pipeline capacity.
• Not allowed to seek a higher cost of capital than
  it would have been authorized absent the merger.

70
Oregon Ring Fencing PGE (continued)

• 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 Enrons bankruptcy.

71
Oregon Ring Fencing PGE (continued)
Oregon Electric Utility Companys proposed
acquisition of PGE

• Application was denied by the Commission.
  Concerns included potential harms resulting from
• Harms Related to Oregon Electrics Long-term Debt
• Short-Term Ownership
• Transaction Terms were not Final
• Lack of Transparency Parent was a private
  investment firm

72
Oregon Ring Fencing PGE (continued)
Portland General Electric Stock Distribution

• 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.

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
• Maintain separate accounting system.
• Keep all financial books and records at its
  Portland, Oregon headquarters.
• Access to records of ScottishPower pertaining to
  transactions to PacifiCorp and all its affiliated
  interest.
• Authority to audit accounting records of
  ScottishPower and its unregulated subsidiaries
  that are bases for charges to PacifiCorp.

75
Oregon Ring Fencing PacifiCorp (continued)

• PacifiCorp Scottish Power
• Maintain a minimum common equity ratio of 35
  (ramping up to 40)
• Maintain separate long-term debt and preferred
  stock ratings and provide notice of certain
  distributions from PacifiCorp to Scottish Power.
• PacifiCorp not allowed to seek a higher cost of
  capital than it would have been authorized absent
  the merger.

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).

77
NARUC COMMITTEE ON ELECTRICITY

• PUHCA REPEAL