[Senate Hearing 107-521]
[From the U.S. Government Printing Office]



                                                        S. Hrg. 107-521

EFFECTS OF SUBTITLE B OF S. 1766 TO THE PUBLIC UTILITY HOLDING COMPANY 
                                  ACT

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

  TO EXAMINE THE EFFECTS OF SUBTITLE B OF S. 1766, AMENDMENTS TO THE 
   PUBLIC UTILITY HOLDING COMPANY ACT, ON ENERGY MARKETS AND ENERGY 
                               CONSUMERS

                               __________

                            FEBRUARY 6, 2002


                       Printed for the use of the
               Committee on Energy and Natural Resources

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               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii              FRANK H. MURKOWSKI, Alaska
BYRON L. DORGAN, North Dakota        PETE V. DOMENICI, New Mexico
BOB GRAHAM, Florida                  DON NICKLES, Oklahoma
RON WYDEN, Oregon                    LARRY E. CRAIG, Idaho
TIM JOHNSON, South Dakota            BEN NIGHTHORSE CAMPBELL, Colorado
MARY L. LANDRIEU, Louisiana          CRAIG THOMAS, Wyoming
EVAN BAYH, Indiana                   RICHARD C. SHELBY, Alabama
DIANNE FEINSTEIN, California         CONRAD BURNS, Montana
CHARLES E. SCHUMER, New York         JON KYL, Arizona
MARIA CANTWELL, Washington           CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware           GORDON SMITH, Oregon

                    Robert M. Simon, Staff Director
                      Sam E. Fowler, Chief Counsel
               Brian P. Malnak, Republican Staff Director
               James P. Beirne, Republican Chief Counsel
                 Leon Lowery, Professional Staff Member
             Howard Useem, Senior Professional Staff Member


                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Bingaman, Hon. Jeff, U.S. Senator from New Mexico................     1
Campbell, Hon. Ben Nighthorse, U.S. Senator from Colorado........     3
Craig, Hon. Larry E., U.S. Senator from Idaho....................     4
Hemmingway, Roy, Chairman, Oregon Public Utility Commission, 
  Salem, OR......................................................    17
Hempling, Scott, Attorney at Law, Silver Spring, MD..............    41
Hunt, Isaac C., Jr., Commissioner, U.S. Securities and Exchange 
  Commission.....................................................     7
Johnson, Hon. Tim, U.S. Senator from South Dakota................     6
Marlette, Cynthia A., General Counsel, Federal Energy Regulatory 
  Commission.....................................................    24
Murkowski, Hon. Frank H., U.S. Senator from Alaska...............     4
Shelby, Hon. Richard C., U.S. Senator from Alabama...............     2
Sokol, David L., Chairman and CEO, MidAmerican Energy Holdings 
  Company, Des Moines, IA........................................    33
Thomas, Hon. Craig, U.S. Senator from Wyoming....................     4
Wyden, Hon. Ron, U.S. Senator from Oregon........................     3

                               APPENDIXES
                               Appendix I

Responses to additional questions................................    83

                              Appendix II

Additional material submitted for the record.....................    91

 
EFFECTS OF SUBTITLE B OF S. 1766 TO THE PUBLIC UTILITY HOLDING COMPANY 
                                  ACT

                              ----------                              


                      WEDNESDAY, FEBRUARY 6, 2002

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 9:32 a.m., in 
room SD-366, Dirksen Senate Office Building, Hon. Jeff 
Bingaman, chairman, presiding.

           OPENING STATEMENT OF HON. JEFF BINGAMAN, 
                  U.S. SENATOR FROM NEW MEXICO

    The Chairman. Why do we not go ahead with the hearing?
    This is a hearing to examine the effects of the repeal of 
the Public Utility Holding Company Act of 1935 on energy 
markets and energy consumers and whether the recent events, 
particularly related to the collapse of Enron, raise concerns 
that there are protections that are afforded by PUHCA that need 
to remain in place. And the obvious question is whether the 
legislation that we are preparing to consider on the Senate 
floor has adequate protections in it. Senator Daschle and I 
have introduced a bill that contains a repeal of PUHCA, but 
there are many issues that continue to be raised about the 
adequacy of the protections against some of the abuses involved 
with the Enron collapse.
    It may seem unusual to people to be having a hearing on 
this type of major provision in legislation so late in the 
process or so soon before we actually get to consideration of a 
bill on the floor, but I do think that questions that have been 
raised justify us going ahead with the hearing.
    The Holding Company Act clearly creates barriers to entry 
into the electricity and the gas businesses. That was a purpose 
of the legislation. Obviously, as we move to a market-based 
industry, rather than a monopoly-based industry, the 
appropriateness of maintaining those barriers has been brought 
into question.
    There are protections for consumers and shareholders as 
well in the Public Utility Holding Company Act, and many of 
those do not constitute barriers to entry. I think there is a 
consensus that those should be preserved in some form, and the 
question is whether we have the right form. We have provisions 
in the bill that we have proposed that are intended to replace 
some of the key provisions in PUHCA and to supplement existing 
authority in order that we can assure that consumers are 
adequately protected if PUHCA is repealed.
    We want to hear from the witnesses today about the adequacy 
of the provisions we have included in our proposed bill, if 
there is something else that is needed before Congress proceeds 
to consider repeal of PUHCA, and what the effect of all of this 
will be on the structure of the electricity market in 
particular, the electricity industry in particular, in the 
future.
    I believe, although Senator Murkowski is not here, the 
prime sponsor of the bill to repeal PUHCA in the Banking 
Committee, a bill which has been reported out of the Banking 
Committee with a substantial vote, is here, and that is Senator 
Shelby. And I was going to ask him to make any short statement 
he would like before we got to the witnesses.

       STATEMENT OF HON. RICHARD C. SHELBY, U.S. SENATOR 
                          FROM ALABAMA

    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Chairman, as you have just said, the Senator Banking 
Committee reported S. 206, the Public Utility Holding Company 
Act of 2001, favorably by a vote of 18 to 1.
    I appreciate your calling this hearing, Mr. Chairman, and 
welcome the opportunity to clarify and reinforce the need for 
reform of the Public Utility Holding Company Act of 1935 that 
we know as PUHCA.
    If the purpose of this hearing, Mr. Chairman, is to bring 
to light the problems with Enron and their business practices 
and how PUHCA could have saved the day, then I think this 
hearing is misguided and inappropriately timed. If, Mr. 
Chairman, on the other hand, the goal is to highlight the 
realities of PUHCA, in light of Enron's collapse, then I think 
that we should take this opportunity to distinguish fact from 
fiction just to be sure we are all working with the same 
information.
    It has long been my belief that PUHCA has become a barrier 
to innovation and competition in the utility industry. Numerous 
studies have found that the conduct that gave rise to the act 
has all but disappeared, and since PUHCA's inception in 1935, 
comprehensive Federal securities regulations have been 
developed that, in essence, duplicate those required by the 
act. At the same time, changes in the industry have brought 
into question the continuing relevance of a monopoly-based 
model of regulation.
    Mr. Chairman, I believe the facts clearly show that Enron's 
collapse had nothing to do with the Public Utility Holding 
Company Act of 1935. Enron, for example, was not subject to the 
registration requirements of PUHCA. The SEC had numerous 
opportunities to review Enron's activities to determine whether 
or not the provisions of PUHCA applied to them.
    After close review and consideration of the act, the SEC 
either issued no-action letters, which I would interpret to 
mean the SEC did not believe Enron was engaging in activities 
covered under the Public Utility Holding Company Act, or they 
issued a single-State exemption, which was clearly provided for 
under the law. I am pleased, Mr. Chairman, that Commissioner 
Hunt is here to detail for us what PUHCA was intended to do, 
under what circumstances it was intended to apply, and how it 
was ultimately implemented.
    For more than a decade, industry, regulators, Congress, and 
consumer groups have called for repeal and/or reform of PUHCA. 
I appreciate this opportunity to review PUHCA and clarify the 
need for reform.
    Mr. Chairman, I want to thank you for allowing me to make a 
statement out of turn on this issue, and I believe this will be 
a good hearing.
    I have a conflict, Mr. Chairman, that requires me to leave, 
but I hope you have a long and interesting hearing.
    The Chairman. Thank you.
    I am told that some of the other members here wanted to 
make short statements. Let me just call on them, if they do. 
Senator Wyden, did you wish to make any statement?

           STATEMENT OF HON. RON WYDEN, U.S. SENATOR 
                          FROM OREGON

    Senator Wyden. I would and I will be very brief, Mr. 
Chairman.
    I am anxious to explore this issue because a coalition of 
consumer groups recently has raised some very troubling 
questions in a letter to our committee about how Enron avoided 
regulation under PUHCA. These groups asserted that if Enron had 
been regulated as a holding company under the act, the collapse 
of Enron might have been avoided.
    Whether one supports or opposes PUHCA, the law is still on 
the books. It is Congress' job, not that of the regulators, to 
decide whether it ought to be repealed or not. So, I want to 
see how it was that Enron was able to fly under the regulatory 
radar screen. I think we need to examine whether there was 
proper enforcement of the law, whether there was a adequate 
review when Enron self-certified that it qualified for 
exemption under PUHCA.
    So, there are a number of questions I want to ask the 
witnesses about this, and I appreciate your holding this 
hearing so promptly, Mr. Chairman.
    The Chairman. Very good. Senator Campbell, did you wish to 
make a short statement?

          STATEMENT OF HON. BEN NIGHTHORSE CAMPBELL, 
                   U.S. SENATOR FROM COLORADO

    Senator Campbell. Very short, Mr. Chairman. Thank you for 
holding this hearing.
    Repeating, PUHCA has been discussed and criticized for 
several years, and I think we have done six or eight hearings 
in this committee on it. In fact, many PUHCA critics argue that 
the 66-year-old act amounts to an outdated, burdensome, and 
duplicative set of regulations. They believe that existing 
State regulation over retail sales, Federal oversight of 
wholesale transmission, and existing antitrust regulations 
provide sufficient security for the ratepayers. Others strongly 
argue that PUHCA should not be repealed. They believe that the 
Public Utility Holding Company Act is the only regulation that 
effectively prohibits companies from risky investments and 
under-capitalization that could hurt ratepayers.
    I, like many of the members of this committee, tend to 
support limited government involvement because I think all 
parties can act more efficiently without too much government 
involvement. But surely the government's oversight should be 
streamlined as much as possible.
    I am also concerned that streamlining government oversight 
to some degree might harm consumers. This year, of course, the 
Enron debacle has added a new twist to our hearings that we did 
last year, but I like Senator Shelby think we should probably 
not focus on whether to repeal PUHCA solely in terms of the 
Enron situation.
    It is well documented that Enron was an exempted company 
because it was a trading company, owning only one utility in 
Oregon. Some might argue that if Enron was not exempted from 
PUHCA, then sufficient government oversight would have 
prevented the company's collapse. I think that is not only 
highly unlikely, but I think that this line of argument takes 
us away from the central focus of whether PUHCA should be 
repealed because it has outdated its usefulness.
    In any event, I am looking forward to the hearing and I 
appreciate your calling it. Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Senator Thomas, did you have any statement you wish to 
make?

         STATEMENT OF HON. CRAIG THOMAS, U.S. SENATOR 
                          FROM WYOMING

    Senator Thomas. Thank you, Mr. Chairman. I just agree with 
the Senator that hopefully this is not an Enron hearing. I hope 
it is on PUHCA. That is what we are talking about.
    The Chairman. Let me ask. Senator Craig, did you have any 
statement you wish to make?

        STATEMENT OF HON. LARRY E. CRAIG, U.S. SENATOR 
                           FROM IDAHO

    Senator Craig. I wish to associate myself with the remarks 
of the Senators from both Alabama and Colorado. Let us have the 
hearing. Let us talk PUHCA.
    The Chairman. Senator Hagel, did you have any statement?
    Senator Hagel. I have never heard of Enron, Mr. Chairman.
    [Laughter.]
    Senator Hagel. I look forward to hearing the witnesses. 
Thank you.
    The Chairman. Senator Murkowski, did you have a statement 
you wish to make?

      STATEMENT OF HON. FRANK H. MURKOWSKI, U.S. SENATOR 
                          FROM ALASKA

    Senator Murkowski. Thank you, Senator Bingaman. I 
appreciate the opportunity to address this subject once again. 
We have had this before the committee for an extended period of 
time. This topic began long before my chairmanship, and 
hopefully under your chairmanship, we can dispose of it.
    I think it is fair to recognize that PUHCA was created in 
1935 to address abuses associated with power generation. Since 
that time, we have had a number of layers of regulatory 
oversight that I feel address the concerns that we have in the 
oversight responsibility of the committee.
    I noted when I came in the reference to Enron. I think I 
would echo that the cause of Enron's demise was primarily due 
to bad business judgment, bad accounting practices, fundamental 
lack of honesty and control within the management. It was not 
because there were not enough regulations. PUHCA, specifically, 
had absolutely nothing to do with these matters. With or 
without PUHCA, Enron would have gone bankrupt. I do not think 
there is any question about that. Crooks rob banks because that 
is where the money is, and even though there are laws against 
it, it still occurs.
    Now, I think it is curious that we are having a debate on 
the eve of the Senate taking up a comprehensive energy bill, in 
which we believe PUHCA reform should be included. It has been 
around a long time, as I have said. It is well understood. This 
committee held extensive hearings in the 104th, 105th, 106th, 
and early on in the 107th Congress on electricity and the 
implications of PUHCA repeal.
    Incidentally, PUHCA repeal has been reported out by the 
Banking Committee four times since 1995. There is joint 
referral, with the Banking Committee on that issue. In fact, it 
is the Banking Committee's jurisdiction.
    PUHCA repeal in the Daschle bill, which is pending, is word 
for word, from the Banking Committee's reported bill, which was 
reported out by a bipartisan vote of 19 to 1. The Banking 
Committee fully understands the issue. It was not willing to 
create a super-PUHCA at FERC to replace an antiquated PUHCA at 
the SEC.
    Had our committee held a business meeting, I venture that 
we would have agreed with the Banking Committee. But that was 
not allowed to happen. As a consequence, Senator Bingaman and I 
have had a discussion about this. I indicated I was for PUHCA 
reform. He feels that it is necessary to have this hearing to 
examine it even further. The consequences of Enron as a 
probable cause of this I can only reflect on with some 
conjecture.
    In any event, I would hope that this hearing today does not 
stop the momentum on PUHCA reform. I have supported PUHCA 
repeal on its merits. It is supported by the Bush 
administration. It is a key part of their national energy plan. 
PUHCA repeal was also reported by the Clinton administration, 
the Clinton administration. It was a key part of their 
electricity legislation.
    PUHCA repeal is both pro-competitive and pro-consumer. 
PUHCA repeal does not eliminate consumer protections. It was 
President Clinton's Securities and Exchange Commission that 
recommended repeal of PUHCA. That recommendation was endorsed 
by President Clinton and his FERC.
    To meet consumer demands, we must get rid of the 
regulations that prevent companies from responding to changing 
market conditions. We have seen changing market conditions over 
the last year in power generation. To meet consumer needs, we 
have to get rid of those unnecessary regulations. I feel that 
participants in the electric power industry are deterred from 
taking competitive actions out of fear of becoming tangled up 
with PUHCA.
    How does this prevent companies from competing in the sense 
of benefitting consumers? Some assert that PUHCA repeal will 
allow consumers to be harmed. I find that false, and I would 
hope that somebody might be able to enlighten me this morning. 
FERC will retain authority and responsibility for wholesale 
electric rates. Wholesale rates can go up only if allowed by 
FERC. States retain authority and responsibility for retail 
electric rates. Retail rates can go up only if allowed by State 
regulatory authorities. What is wrong with that? PUHCA repeal 
does not diminish these authorities. There is no so-called 
regulatory gap created by PUHCA repeal. Moreover, the Banking 
Committee language guarantees Federal and State regulators 
access to utility books and records necessary to protect 
consumers.
    In addition, nothing in this language prevents other 
regulatory agencies from protecting consumers, whether it be 
the Federal Trade Commission, the U.S. Department of Justice, 
and the State antitrust.
    I have had these three principles for good electric 
legislation, which has been coined by professional staff. One, 
we must deregulate where we can. Two, we must streamline where 
we cannot deregulate. Three, we must not stand in the way of 
States' efforts to address local concerns and needs. I think 
PUHCA repeal advances all of these three principles.
    My position is clear. I will not support any electricity 
title that does not include PUHCA repeal. In addition, I will 
not support any electricity title that replaces PUHCA with more 
draconian regulations.
    Finally, PUHCA is 66 years old. It was designed to cure the 
problems of a long-gone, depression-era industry structure.
    It is time to retire PUHCA.
    The Chairman. Senator Johnson, did you have any opening 
statement?
    Senator Johnson. Mr. Chairman, I have a statement, but I am 
going to simply submit it for the record. And I look forward to 
the testimony of the panel.
    The Chairman. Okay.
    [The prepared statement of Senator Johnson follows:]

         Prepared Statement of Hon. Tim Johnson, U.S. Senator 
                           From South Dakota

    Mr. Chairman, this is an important and timely hearing on PUHCA. The 
Enron situation has brought new attention to PUHCA, its effectiveness, 
and whether it is still needed in a competitive energy environment.
    For years, PUHCA has been attacked as a law that is outdated for 
today's more competitive environment, and that it is a relic of 
Depression-era laws. In response, there have been continuous attempts 
to repeal PUHCA. I have always believed that this must be approached 
cautiously. Today's energy world is not a truly competitive 
environment. There is competition on the wholesale market but very 
little competition in the retail market. In addition, some states have 
enacted electricity restructuring, but others have not, leaving a 
unevenness to the competition in the field. I have always been 
concerned about undue concentration and believe that we must have 
enough safeguards to ensure that sustainable, competitive markets are 
in place.
    As you all know, S. 1766 includes provisions to repeal PUHCA but 
also included provisions that would strengthen merger review, 
strengthen FERC's ability to review market-based rates, and increase 
market transparency. At the time of the bill's introduction in 
December, there appeared to be a fair amount of consensus that this was 
a good approach to take if PUHCA was to be repealed.
    However, the Enron collapse has resulted in another review of PUHCA 
repeal and has raised new questions. As an exempt holding company, some 
of PUHCA's stricter rules would not have applied to Enron. On the other 
hand, perhaps if PUHCA was not in place, Enron would have expanded its 
utility business far beyond what it did, causing even greater havoc on 
customers and employees.
    We must look at this issue very carefully before decisions are made 
because there are substantive arguments on both sides of this issue. 
Protecting consumers is of paramount importance and we must consider 
whether PUHCA continues to play an important role there. We must also 
must consider whether PUHCA's presence is creating more barriers than 
are necessary to enter electricity markets. We also must consider 
whether additional safeguards are needed either on the state and/or 
federal level to ensure that the activities of electricity utilities 
and entities are properly reviewed.
    Mr. Chairman, there is not much time before the Senate is due to 
consider the energy legislation but holding this hearing is an 
important opportunity to hear the viewpoints of those concerned. There 
are strong views on both sides on this issue and the only way to move 
forward is to find some consensus. Ultimately, the needs of energy 
consumers are the most important factor in this debate. The only way to 
protect consumers is to determine the most rational solution. It is 
clear that this is your goal and I pledge to work with you and the rest 
of the Senate in the coming weeks to help achieve consensus that helps 
our consumers.

    The Chairman. We have five very distinguished witnesses 
here. Let me introduce them all and then we will just call on 
them in the order that I introduce them and give them each 
about 10 minutes. If they could try to summarize their main 
points, they do not need to take 10 minutes, but they have got 
that long if they want to.
    First, the Honorable Isaac C. Hunt, Jr., who is a 
Commissioner with the Securities and Exchange Commission, is 
here to speak on behalf of the Securities and Exchange 
Commission.
    Next is the Honorable Roy Hemmingway, who is Chairman of 
the Oregon Public Utility Commission, in Salem, Oregon.
    Next, Ms. Cynthia Marlette, who is the General Counsel for 
the Federal Energy Regulatory Commission.
    Mr. David Sokol, who is the chairman and CEO of MidAmerican 
Energy Holdings Company in Des Moines, Iowa.
    And Mr. Scott Hempling, who is an attorney at law in Silver 
Spring, Maryland.
    We appreciate their being here. Why do we not just proceed 
in that order? Mr. Hunt, why do you not begin and we would be 
anxious to hear your point of view.

        STATEMENT OF ISAAC C. HUNT, JR., COMMISSIONER, 
            U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Hunt. Thank you. Good morning, Chairman Bingaman, 
ranking member Murkowski, and members of the committee. I am 
Commissioner Isaac Hunt of the U.S. Securities and Exchange 
Commission.
    I am pleased to have this opportunity to testify before you 
on behalf of the SEC regarding the provisions in title II of S. 
1766, the Energy Policy Act of 2002, which would repeal much of 
the Public Utility Holding Company Act of 1935.
    As you know, for almost 20 years, the SEC has consistently 
supported repeal of those provisions of PUHCA that either 
duplicate laws administered by other regulators or that are no 
longer necessary. Since I last testified on PUHCA repeal in 
December, the magnitude of the Enron debacle and the harm that 
Enron's collapse has tragically inflicted on the company's 
investors and employees has become clearer. Congress and 
various regulatory agencies, including the SEC, are 
appropriately investigating what happened at Enron, why it 
happened, and what should be done to prevent Enron-like 
debacles in the future.
    As we continue to investigate and learn from the events 
surrounding that collapse, we remain open-minded and, of 
course, would reconsider our views on conditional PUHCA repeal 
if warranted. Currently, however, we are not aware of anything 
that would cause us to conclude that there is reason to abandon 
our longstanding support for conditional PUHCA repeal.
    Before discussing the SEC's current views on PUHCA, it is 
useful to review the history of the SEC's longstanding support 
of repeal. As you know, PUHCA was enacted in 1935 in response 
to abuses that had occurred in the gas and electric industry 
during the first quarter of the last century. These abuses 
included misuse of the holding company structure, inadequate 
disclosure of the financial position and earning power of 
holding companies, unsound accounting practices, excessive debt 
issuances, and abusive affiliate transactions. The 1935 act was 
enacted to address these problems.
    In the early 1980's, however, the SEC concluded that many 
aspects of the 1935 act duplicated other State and Federal 
regulation. In addition, changes in the investment banking 
industry had provided investors and consumers with additional 
protections unforeseen in 1935. The SEC, thus, unanimously 
recommended that Congress repeal the 1935 act.
    However, repeal legislation was not enacted during the 
1980's.
    In response to accelerating changes in the utility industry 
during the early 1990's, in 1994, then-Chairman Arthur Levitt 
directed the SEC's staff to undertake a study of the 1935 act. 
The resulting report both recommended repeal and identified 
areas in which the Commission could adopt administrative 
initiatives to streamline regulation under the 1935 act.
    Currently, as I have indicated, the Commission continues to 
support repeal of PUHCA as long as repeal is accomplished in a 
way that gives the Federal Energy Regulatory Commission and 
State regulators sufficient authority to protect utility 
consumers. Not surprisingly, however, in light of recent 
events, there are those who are now asking whether Enron's 
collapse should cause those who support PUHCA repeal to 
reconsider.
    As I stated at the beginning of my testimony, the harm that 
Enron's collapse has tragically inflicted on that company's 
investors and employees is now readily apparent.
    Enron is currently an exempt holding company under PUHCA. 
When Enron acquired Portland General Electric in 1998, it 
claimed an exemption under our rule 2 under PUHCA as an 
intrastate holding company. Enron was able to claim this 
exemption because it was incorporated in Oregon, Portland 
General, its only utility subsidiary, was incorporated in 
Oregon, and Portland General's utility operations were located 
in Oregon. Enron recently agreed to sell Portland General to 
Northwest Natural Gas, a transaction that is subject to 
Commission approval under PUHCA.
    In 1994, Enron Power Marketing Inc., a subsidiary of Enron, 
received a no-action letter from the staff in our Division of 
Investment Management in which the staff agreed not to 
recommend enforcement action against Enron Power if it engaged 
in power marketing activities without its or Enron's 
registering under the 1935 act. In its request for no-action 
relief, Enron Power argued that the contracts, books, records, 
and other materials underlying its power marketing activities 
were not ``facilities used for the generation, transmission, or 
distribution of electric energy for sale;'' that the power 
market subsidiary was, therefore, not an electric company for 
purposes of PUHCA; and that Enron was, thus, not a utility 
holding company for purposes of PUHCA. Enron Power's request 
stated that at the time other companies were already engaged in 
similar power marketing activities. The staff gave Enron Power 
the requested no-action relief. Since that time, the staff has 
given analogous no-action relief to approximately 20 other 
companies.
    With respect to PUHCA, as we continue to investigate and 
learn from the events surrounding Enron's collapse, we remain 
open-minded and, of course, will reconsider our views on repeal 
if warranted. Currently, however, it appears that the tragic 
collapse of Enron is not a result of its classification or lack 
of classification as a public utility holding company.
    Enron is a tragedy for the entire system of disclosure 
regulation.
    All investors, including investors in the public utility 
holding companies, are entitled to a regulatory system that 
produces disclosure that is meaningful and intelligible. To 
address flaws in the current system, we are considering ways to 
ensure that investors receive more current disclosure, better 
disclosure of trend and evaluative data, and clear and 
informative financial statements.
    Likewise, in order to prevent our system of accounting from 
being abused, whether by public utility holding companies or 
other types of companies, we are working to establish a better 
system of private regulation of the accounting profession and 
to make sure that the Federal Accounting Standards Board, or 
FASB, responds expeditiously and clearly to establish needed 
accounting standards.
    As I stated earlier, we as a commission continue to believe 
that Congress should repeal PUHCA in a way that ensures the 
protection of utility consumers.
    First, FERC and the State regulators should be given 
additional authority to monitor, police, and regulate affiliate 
transactions. As long as the electric and gas utilities 
continue to function as monopolies, there will be a need to 
protect against cross-subsidization. The best means of guarding 
against such cross-subsidization is likely to be audits of 
books and records and Federal oversight of affiliate 
transactions. Any move to repeal PUHCA should include 
provisions giving FERC and State regulators the necessary tools 
to engage in this type of oversight. In addition, Congress 
should consider giving FERC the authority to issue rules 
prohibiting or limiting those types of affiliate transactions 
that it concludes are inherently abusive.
    Second, repeal of PUHCA would remove barriers that now 
exist to consolidation within the utility industry, as well as 
barriers that prevent diversified, non-utility companies from 
acquiring utilities. Removal of these restrictions may raise 
competitive issues related to the market power of utilities. 
Although PUHCA gives the SEC authority to review the potential 
anti-competitive effects of utility acquisitions, in recent 
years the SEC has looked to other regulators, such as FERC, the 
Department of Justice, and the Federal Trade Commission, for 
their expertise in assessing competitive issues, an approach of 
``watchful deference'' to the work of our fellow regulators.
    Therefore, repeal of PUHCA is unlikely to affect how market 
power issues are reviewed at the Federal level. Nonetheless, 
because repeal of PUHCA may increase consolidation in the 
utility industry, Congress could conclude that provisions such 
as section 202 of S. 1766 are necessary to give FERC sufficient 
authority to ensure that what consolidation does occur in the 
utility industry does not harm consumers.
    Third, I know that Congress and others are considering 
other types of consumer protections in the utility area. For 
example, there has been discussion of whether FERC needs 
additional ratemaking authority in the wholesale electricity 
markets. Likewise, there has been discussion of whether FERC or 
the Commodity Futures Trading Commission should be given 
additional authority to oversee trading in energy-related 
derivatives to prevent manipulation. While I recognize that it 
is important for Congress to consider issues of these types, 
the SEC does not have statutory authority to regulate utility 
rates under PUHCA. Likewise, PUHCA does not give the SEC 
authority to attempt to prevent manipulation in the energy 
trading markets. The SEC therefore lacks the expertise to 
express a view on whether reforms are needed in these two just-
mentioned areas.
    Finally, repealing the act should not be viewed as a magic 
solution to the current problems facing the U.S. utility 
industry. For example, because the act does not currently limit 
investment in generation facilities, repeal would not directly 
affect the supply of electricity in the United States. Instead, 
repeal of the act would eliminate regulatory restrictions that 
prohibit utility holding companies from owning utilities in 
different parts of the country and that prevent non-utility 
businesses from acquiring regulated utilities.
    Repeal of the act would also eliminate any impediment that 
exists to other regulators' attempts to modernize regulation of 
the utility industry. For example, during the past year, 
questions have arisen about how the act will impact the ability 
of FERC to implement its plans to restructure the control of 
transmission facilities in the United States. While we believe 
that we have the necessary authority under the act to deal with 
the issues created by FERC's restructuring, without impeding 
that restructuring, repeal of the act would, nonetheless, 
effectively resolve those issues.
    This example, however, raises the broader issue of the 
relationship between FERC's and the SEC's regulation of the 
utility industry. FERC is clearly the agency that Congress 
intended to take the lead role in regulating the utility 
industry. The SEC, in contrast, as you know, is primarily 
devoted to regulating the securities markets. Although we 
always attempt to work together with FERC to ensure that, to 
the extent possible, our regulation of utility holding 
companies under PUHCA does not impede FERC's ability to 
regulate the utility industry, sometimes conflict is 
inevitable. Given this, if Congress chooses not to repeal 
PUHCA, we believe that responsibility for that act, whether in 
its current form or in a modified form, should be transferred 
from the SEC to FERC. Given the nature of FERC's 
responsibilities and its expertise in regulating the utility 
industry, it is simply in a better position to balance the 
goals of PUHCA and the other statutes it administers and 
thereby regulate the utility industry in a more consistent and 
effective manner.
    The SEC takes seriously its duties to administer faithfully 
the letter and spirit of the 1935 act and is committed to 
promoting the fairness, liquidity, and efficiency of the U.S. 
securities markets. By supporting conditional repeal of the 
1935 act, the SEC hopes to reduce unnecessary regulatory 
burdens on America's energy industry, while providing adequate 
protections for energy consumers.
    Thank you, Mr. Chairman. I would be glad to try to answer 
any questions you might have.
    [The prepared statement of Mr. Hunt follows:]

        Prepared Statement of Isaac C. Hunt, Jr., Commissioner, 
                   Securities and Exchange Commission

                            I. INTRODUCTION

    Chairman Bingaman, Ranking Member Murkowski, and Members of the 
Committee: I am pleased to have this opportunity to testify before you 
on behalf of the Securities and Exchange Commission (``SEC'') regarding 
the provisions in Title II of S. 1766, the Energy Policy Act of 2002, 
that would repeal much of the Public Utility Holding Company Act of 
1935 (``PUHCA'' or ``the Act''). As you know, for almost twenty years 
the SEC has consistently supported repeal of those provisions of PUHCA 
that either duplicate laws administered by other regulators or that are 
no longer necessary. The SEC has always stressed, however, that in 
order to protect the customers of multistate, diversified utility 
holding companies, it is necessary to give the Federal Energy 
Regulatory Commission (``FERC'') and state regulators authority over 
the books and records of holding companies and authority to regulate 
their ability to engage in affiliate transactions. Since I last 
testified on PUHCA repeal in December, the magnitude of the Enron 
debacle, and the harm that Enron's collapse has tragically inflicted on 
the company's investors and employees, has become clearer. Congress and 
various regulatory agencies, including the SEC, are appropriately 
investigating what happened at Enron, why it happened and what should 
be done to prevent Enron-like debacles in the future. As we continue to 
investigate and learn from the events surrounding Enron's collapse, we 
remain open-minded and, of course, would reconsider our views on 
conditional PUHCA repeal if warranted. Currently, however, I am not 
aware of anything that would cause us to conclude that there is reason 
to abandon our longstanding support for conditional PUHCA repeal.

                             II. BACKGROUND

    Before discussing the SEC's current views on PUHCA, it is useful to 
review the history of the SEC's longstanding support of repeal. PUHCA 
was enacted in 1935 in response to abuses that had occurred in the gas 
and electric industry during the first quarter of the last century.\1\ 
The abuses included misuse of the holding company structure, inadequate 
disclosure of the financial position and earning power of holding 
companies, unsound accounting practices, excessive debt issuances, and 
abusive affiliate transactions.
---------------------------------------------------------------------------
    \1\ See 1935 Act section 1(b), 15 U.S.C. Sec. 79a(b).
---------------------------------------------------------------------------
    The 1935 Act addressed these problems by giving the Commission 
authority over various practices of holding companies, including their 
issuance of securities and their ability to engage in affiliate 
transactions. The Act also placed restrictions on the geographic scope 
of holding company systems and limited registered holding companies to 
activities related to their gas or electric businesses. Because of its 
role in addressing issues involving securities and financings, the SEC 
was charged with administering the Act. In the years following the 
passage of the 1935 Act, the SEC worked to reorganize and simplify 
existing public utility holding companies in order to eliminate abuses.
    In the early 1980s, however, the SEC concluded that many aspects of 
the 1935 Act regulation had become redundant. Specifically, state 
regulation had expanded and strengthened since 1935, and the SEC had 
enhanced its regulation of all issuers of securities, including public 
utility holding companies. The SEC therefore concluded that the 1935 
Act had accomplished its basic purpose and that many of its remaining 
provisions were either duplicative or were no longer necessary to 
prevent the recurrence of the abuses that had led to the Act's 
enactment. The SEC thus unanimously recommended that Congress repeal 
the Act.\2\
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    \2\ See Public Utility Holding Company Act Amendments: Hearings on 
S. 1869, S. 1870 and S. 1871 Before the Subcomm. On Securities of the 
Senate Comm. On Banking, Housing, and Urban Affairs, 97th Cong., 2d 
Sess. 359-421 (statement of SEC).
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    For a number of reasons--including continuing concern about the 
potential for abuse through the use of a multistate holding company 
structure, related concerns about consumer protection, and the lack of 
a consensus for change--repeal legislation was not enacted during the 
early 1980s. Because of continuing change in the industry, however, the 
SEC continued to look at ways to administer the statute more flexibly.
    In response to accelerating changes in the utility industry during 
the early 1990s, in 1994, then-Chairman Arthur Levitt directed the 
SEC's Division of Investment Management to undertake a study, under the 
guidance of then-Commissioner Richard Y. Roberts, to examine the 
continued vitality of the 1935 Act. The study was undertaken as a 
result of the developments noted above and the SEC's continuing need to 
respond flexibly in the administration of the 1935 Act. The purpose of 
the study was to identify unnecessary and duplicative regulation, and 
at the same time to identify those features of the statute that remain 
appropriate in the regulation of the contemporary electric and gas 
industries.\3\
---------------------------------------------------------------------------
    \3\ The study focused primarily on registered holding company 
systems. There were, at the time of the study, 19 such systems. The 
1935 Act was enacted to address problems arising from multistate 
operations, and reflects a general presumption that intrastate holding 
companies and certain other types of holding companies, which the 1935 
Act exempts and which now number 119, are adequately regulated by local 
authorities. Despite their small number, registered holding companies 
account for a significant portion of the energy utility resources in 
this country. As of September 30, 2001, the 27 registered holding 
systems (which included 35 registered holding companies) owned 133 
electric and gas utility subsidiaries, with operations in 44 states, 
and in excess of 2500 nonutility subsidiaries. In financial terms, as 
of September 31, 2001, the 27 registered holding company systems owned 
more than $417 billion of investor-owned electric and gas utility 
assets and received in excess of $173 billion in operating revenues. 
The 27 registered systems represent over 40% of the assets and revenues 
of the U.S. investor-owned electric utility industry and almost 50% of 
all electric utility customers in the United States.
---------------------------------------------------------------------------
    The SEC staff worked with representatives of the utility industry, 
consumer groups, trade associations, investment banks, rating agencies, 
economists, state, local and federal regulators, and other interested 
parties during the course of the study. In June 1995, a report of the 
findings made during the study (``Report'') was issued. The staff's 
Report outlined the history of the 1935 Act, described the then-current 
state of the utility industry as well as the changes that were taking 
place in the industry, and again recommended repeal of the 1935 Act. 
The Report also outlined and recommended that the Commission adopt a 
number of administrative initiatives to streamline regulation under the 
Act.
    Since the report was published, the utility industry in the United 
States has continued to undergo rapid change. Congress has facilitated 
many of these changes. For example, as a result of various amendments 
to the Act, any company, including registered and exempt holding 
companies, is now free to own exempt wholesale generators and foreign 
utilities and to engage in a wide range of telecommunications 
activities.\4\ In addition, the SEC has implemented many of the 
administrative initiatives that were recommended in the Report.\5\ In 
sum, during the past decade, while the SEC has continued to support 
repeal of the Act, we have also recognized that we need to administer 
it faithfully, while streamlining and adding flexibility to the 
regulatory structure where permitted by the Act.
---------------------------------------------------------------------------
    \4\ Sections 32 and 33 of the Act, which were added to it by the 
Energy Policy Act of 1992, permit, subject to certain conditions, the 
ownership of exempt wholesale generators and foreign utility companies. 
The impact of section 32 on the electricity industry is discussed in 
more detail below. Section 34, which was added by the 
Telecommunications Act of 1996, permits holding companies to acquire 
and retain interests in companies engaged in a broad range of 
telecommunications activities.
    \5\ The Report recommended rule amendments to broaden exemptions 
for routine financings by subsidiaries of registered holding companies 
(see Holding Co. Act Release No. 26312 (June 20, 1995), 60 FR 33640 
(June 28, 1995)) and to provide a new exemption for the acquisition of 
interests in companies that engage in energy-related and gas-related 
activities (see Holding Co. Act Release No. 26667 (Feb. 14, 1997), 62 
FR 7900 (Feb. 20, 1997) (adopting Rule 58)). In addition, the Report 
recommended and the SEC has implemented changes in the administration 
of the Act that would permit a ``shelf'' approach for approval of 
financing transactions. For example, during calendar year 2000, all 
eleven of the new registered holding companies received multi-year 
financing authorizations that included a wide range of debt and equity 
securities. The Report further recommended a more liberal 
interpretation of the Act's integration requirements which has been 
carried out in our merger orders. The Report also recommended an 
increased focus upon auditing regulated companies and assisting state 
and local regulators in obtaining access to books, records, and 
accounts. Six state public utility commissions participated in the last 
three audits of the books and records of registered holding companies.
---------------------------------------------------------------------------

                          III. REPEAL OF PUHCA

A. The Commission's Continuing Support of Repeal

    As I have stated, the Commission continues to support repeal of 
PUHCA, as long as repeal is accomplished in a way that gives the FERC 
and state regulators sufficient authority to protect utility consumers. 
Not surprisingly, however, in light of recent events, there are those 
who are now asking whether Enron's collapse should cause those who 
support PUHCA repeal to reconsider.
    As I stated at the beginning of my testimony, the harm that Enron's 
collapse has inflicted on the company's investors and employees is now 
readily apparent. The SEC, various other regulatory agencies and the 
Congress are now all investigating what happened at Enron, why it 
happened and what should be done to prevent Enron-like debacles in the 
future. These investigations are not only appropriate, but are 
necessary if the implications of Enron for a broad range of policy 
issues are to be fully understood. Currently, however, I am aware of 
nothing with regard to Enron that would change our opinion on PUHCA 
repeal.
    Enron is currently an exempt holding company under PUHCA. When 
Enron acquired Portland General Electric in 1998, it claimed an 
exemption under rule 2, 17 C.F.R. Sec. 250.2, as an intrastate holding 
company. Enron was able to claim this exemption because it was 
incorporated in Oregon; Portland General, its only utility subsidiary, 
was incorporated in Oregon; and Portland General's utility operations 
were located in Oregon. Enron recently agreed to sell Portland General 
to Northwest Natural Gas, a transaction that is subject to Commission 
approval under PUHCA.
    In 1994, Enron Power Marketing Inc. (``EPMI''), a subsidiary of 
Enron, received a no-action letter from staff in the SEC's Division of 
Investment Management in which the staff agreed not to recommend 
enforcement action against EPMI if it engaged in power marketing 
activities without it or Enron registering under the Act. In its 
request for no-action relief, EPMI argued that the contracts, books and 
records and other materials underlying its power marketing activities 
were not ``facilities used for the generation, transmission, or 
distribution of electric energy for sale'' (see PUHCA Sec. 2(a)(3)), 
that the power market subsidiary was therefore not an ``electric 
utility company'' for purposes of PUHCA, and Enron was thus not a 
utility holding company for purposes of the Act. EPMI's request stated 
that, at the time, other companies were already engaged in similar 
power marketing activities. The staff, without necessarily concurring 
in EPMI's legal analysis, gave EPMI the requested no-action relief. The 
staff has given analogous no-action relief to approximately twenty 
companies.\6\
---------------------------------------------------------------------------
    \6\ Since that time, the Commission has given exempt and registered 
holding companies the authority necessary to engage in power marketing 
as a nonutility activity. For example, rule 58, 17 CFR Sec. 250.58, 
which was adopted in early 1997, permits registered holding companies 
to engage in ``[t]he brokering and marketing of energy commodities, 
including but not limited to electricity, natural or manufactured gas 
and other combustible fuels'' as a permitted nonutility activity.
---------------------------------------------------------------------------
    As Chairman Pitt testified before a House Subcommittee earlier this 
week, the speed and tragic consequences of Enron's collapse demonstrate 
the need for a variety of reforms in our administration of the 
securities laws that the Chairman and others at the SEC have been 
discussing in recent months. All investors, including investors in 
public utility holding companies, are entitled to a regulatory system 
that produces disclosure that is meaningful and intelligible. To 
address flaws in the current system, we are considering ways to ensure 
that investors receive more current disclosure, better disclosure of 
``trend'' and ``evaluative'' data, and clear and informative financial 
statements. Likewise, in order to prevent our system of accounting from 
being abused, whether by public utility holding companies or other 
types of companies, we are working to establish a better system of 
private regulation of the accounting profession and to make sure that 
the FASB responds expeditiously and clearly to establish needed 
accounting standards.
    Enron is a tragedy for our entire system of disclosure regulation. 
What happened to investors of Enron should be prevented from happening 
to investors in any company. However, the tragic collapse of Enron is 
not a result of its classification or lack of classification as a 
public utility holding company.

B. Affiliate Transactions and Cross-Subsidization

    Thus, we continue to believe that repeal of PUHCA will not 
sacrifice any needed investor protections. As we have testified in the 
past, however, we continue to believe that, in order to provide needed 
protection to utility consumers, the FERC and state regulators should 
be given additional authority to monitor, police, and regulate 
affiliate transactions.
    Specifically, although deregulation is changing the way utilities 
operate in some states, electric and gas utilities have historically 
functioned as monopolies whose rates are regulated by state 
authorities. Some regulators subject these rates to greater scrutiny 
than others. There is a continuing risk that a monopoly, if left 
unguarded, could charge higher rates and use the additional funds to 
subsidize affiliated businesses in order to boost its competitive 
position in other markets. Because repeal of PUHCA would eliminate 
existing restrictions on both the size of utility holding companies and 
their ability to engage in non-utility activities, this risk may be 
magnified if holding company systems become bigger and more complex. 
Thus, so long as electric and gas utilities continue to function as 
monopolies, the need to protect against this type of cross-
subsidization will remain. The best means of guarding against cross-
subsidization is likely to be audits of books and records and federal 
oversight of affiliate transactions. Any move to repeal PUHCA should 
include provisions giving the FERC and state regulators the necessary 
tools to engage in this type of oversight.
    As we testified last year with respect to S. 206, the bill upon 
which the PUHCA repeal provisions of S. 1766 appear to have been based, 
S. 1766 represents a form of this type of conditional repeal. In 
particular, S. 1766 would provide the FERC with the right to examine 
books and records of holding companies and their affiliates that are 
relevant to costs incurred by associate utility companies, in order to 
protect ratepayers. S. 1766 would also provide an interested state 
commission with access to such books and records (subject to protection 
for confidential information), if they are relevant to costs incurred 
by utility companies subject to the state commission's jurisdiction and 
are needed for effective discharge of the state commission's 
responsibilities in connection with a pending proceeding. S. 1766 thus 
gives the FERC and state regulators the ability to review affiliate 
transactions after-the-fact and to exclude unjustified costs arising 
from affiliate transactions from a utility's rate base. While this is a 
significant power, and one we believe that state and federal rate 
regulators should possess, we also believe that Congress should 
consider giving the FERC the authority to use its rulemaking authority 
to prohibit or limit on a prospective basis those types of affiliate 
transactions that it concludes are so abusive that they should not be 
allowed.

C. Market Power Issues

    Repeal of PUHCA would remove barriers that now exist to 
consolidation within the utility industry as well as barriers that 
prevent diversified, non-utility companies from acquiring utilities. 
Removal of these restrictions may raise competitive issues related to 
the ``market power'' of utilities. PUHCA was intended to address, among 
other things, the concentration of control of ownership of the public-
utility industry. In particular, section 10(b)(1) of the Act requires 
the SEC to disapprove a utility acquisition if it will tend toward 
concentrated control of public-utility companies in a manner 
detrimental to the public interest or the interest of investors or 
consumers.\7\ Traditionally, the SEC's analysis of utility acquisitions 
under section 10(b)(1) includes consideration of federal antitrust 
policies.\8\ More specifically, the anticompetitive ramifications of an 
acquisition have traditionally been considered in light of the fact 
that public utilities are regulated monopolies subject to the 
ratemaking authority of federal and state administrative bodies.\9\
---------------------------------------------------------------------------
    \7\ The SEC must also consider whether the purchase price is 
reasonable; whether the purchase will unduly complicate the 
capitalization of the resulting system; and whether the transaction 
will serve the public interest by tending toward the economic and 
efficient development of an integrated public-utility system.
    \8\ Municipal Electric Association v. SEC, 413 F.2d 1052, 1056-07 
(D.C. Cir. 1969) (section 10(b)(1) analysis ``must take significant 
content'' from ``the federal anti-trust policies''), cited in City of 
Holyoke v. SEC, 972 F.2d 358, 363; Environmental Action, Inc. v. SEC, 
895 F.2d 1255, 1260 (9th Cir. 1990) (``Federal antitrust policies are 
to inform the SEC's interpretation of section 10(b)(1)'').
    \9\ Entergy Corp., Holding Co. Act Release No. 25952 (Dec. 17, 
1993), citing Northeast Utilities, Holding Co. Act Release No. 25221, 
request for reconsideration denied, Holding Co. Act Release No. 26037 
(Apr. 28, 1994), remanded sub nom. Cajun Electric Power Cooperative, 
Inc. v. SEC, 1994 WL 704047 (D.C. Cir. Nov. 16, 1994).
---------------------------------------------------------------------------
    However, the SEC is not the only agency that reviews the potential 
anticompetitive effects of utility acquisitions. In many instances, 
proposed utility acquisitions are subject to FERC and state approval. 
Like the SEC, the FERC must consider antitrust implications of matters 
before it.\10\ In addition, the potential anticompetitive effects of 
utility acquisitions are independently reviewed by the Department of 
Justice or the Federal Trade Commission.
---------------------------------------------------------------------------
    \10\ See Gulf States Utilities Co., v. FPC, 411 U.S. 747 (1973).
---------------------------------------------------------------------------
    In recent years, the SEC has looked to all these regulators for 
their expertise in assessing operational and competitive issues, 
particularly in situations in which the combined entity resulting from 
a merger would have control of key transmission facilities and of 
surplus power. Thus, although the SEC does independently assess the 
transaction under the standards of PUHCA, we have generally relied upon 
the FERC's greater expertise regarding issues related to utility 
competition. The Court of Appeals for the District of Columbia Circuit 
has stated that ``when the SEC and another regulatory agency both have 
jurisdiction over a particular transaction, the SEC may `watchfully 
defer' to the proceedings held before--and the result reached by--that 
other agency.'' \11\
---------------------------------------------------------------------------
    \11\ Madison Gas and Electric Company v. SEC, 168 F.3d 1337, (D.C. 
Cir. 1999); City of Holyoke v. SEC, supra note 10, citing Wisconsin's 
Environmental Decade, Inc. v. SEC, 882 F.2d 523 (D.C. Cir. 1989).
---------------------------------------------------------------------------
    Therefore, repeal of PUHCA is unlikely to affect how market power 
issues are reviewed at the federal level. While PUHCA provides an 
additional layer of regulatory approval for certain utility mergers, 
the Commission's reliance, where appropriate, on other regulators for 
the key market power determination make its review of market power 
issues largely redundant. Nonetheless, because repeal of PUHCA may 
increase consolidation in the utility industry, Congress could conclude 
that provisions such as section 202 of S. 1766 are necessary to give 
the FERC sufficient authority to ensure that what consolidation does 
occur in the utility industry does not harm consumers.

D. Other Consumer Protection Issues

    I know that Congress and others are considering other types of 
consumer protections in the utility area. For example, there has been 
discussion of whether the FERC needs additional ratemaking authority in 
the wholesale electricity markets. Likewise, there has been discussion 
of whether the FERC or the Commodity Futures Trading Commission should 
be given additional authority to oversee trading in energy-related 
derivatives to prevent market manipulation. While I recognize that it 
is important for Congress to consider issues of these types, the SEC 
does not have statutory authority to regulate utility rates under 
PUHCA. Likewise, PUHCA does not give the SEC authority to attempt to 
prevent manipulation in the energy trading markets. The SEC therefore 
lacks the expertise to express a view on whether reforms are needed in 
these areas.

E. PUHCA Repeal and National Energy Policy

    Repealing the Act is not, however, a magic solution to the current 
problems facing the U.S. utility industry. PUHCA repeal can be viewed 
as part of the needed response to the current energy problems facing 
the country--notably, the Administration's recent report on energy 
policy includes a recommendation that PUHCA be repealed.\12\ But repeal 
of the Act will not have any direct effect on the supply of electricity 
in the United States. The Act does not, for example, currently place 
significant restrictions on the construction of new generation 
facilities. As part of the Energy Policy Act, Congress amended the Act 
in 1992 to remove most restrictions on the ability of registered and 
exempt holding companies (as well as companies not otherwise subject to 
PUHCA) to build, acquire and own generating facilities anywhere in the 
United States. These types of facilities--exempt wholesale generators 
or ``EWGs''--are not considered to be electric utility companies under 
PUHCA, and, in fact, are exempt from all provisions of PUHCA. The only 
limitation that remains under PUHCA is one imposed by Congress on 
registered holding companies' investments in EWGs--namely, that a 
registered company may not finance its EWG investments in a way that 
may ``have a substantial adverse impact on the financial integrity of 
the registered holding company system.'' \13\ In short, the Energy 
Policy Act removed restrictions on the ability of registered and exempt 
holding companies to build, acquire and own generating facilities 
anywhere in the United States. As a result, a number of registered 
holding companies now have large subsidiaries that own generating 
facilities nationwide. Numerous other companies not subject to the Act 
have also entered the generation business.\14\
---------------------------------------------------------------------------
    \12\ See National Energy Policy: Report of the National Energy 
Policy Development Group at 5-12 (May 2001) (recommending the reform of 
``outdated federal electricity laws, such as the Public Utility Holding 
Company Act'').
    \13\ While no Commission approval is required for the acquisition 
of an EWG as a result of the Energy Policy Act, Commission approval is 
required, for example, before a registered holding company can issue 
securities to finance the acquisition of, or guarantee securities 
issued by, an EWG. Under the Energy Policy Act, Congress directed the 
SEC to adopt rules with respect to registered holding companies' EWG 
investments. Pursuant to these requirements, in 1993 the SEC adopted 
rules 53 and 54 to protect consumers and investors from any substantial 
adverse effect associated with investments in EWGs. Rule 53 created a 
partial safe harbor for EWG financings. Rule 53 describes circumstances 
in which the issue or sale of a security for purposes of financing the 
acquisition of an EWG, or the guarantee of a security of an EWG, will 
be deemed not to have a substantial adverse impact on the financial 
integrity of the system. For transactions outside the Rule 53 safe 
harbor, a registered holding company must obtain SEC approval of the 
amount it wishes to invest in EWGs. The standards that the SEC uses in 
assessing applications of this type are laid out in Rule 53(c).
    \14\ See, e.g., National Energy Policy: Report of the National 
Energy Policy Development Group at 5-11 (May 2001) (noting that 
``[m]ost new electricity generation is being built not by regulated 
utilities, but by independent power producers'').
---------------------------------------------------------------------------
    Instead, repeal of the Act would eliminate regulatory restrictions 
that prohibit utility holding companies from owning utilities in 
different parts of the country and that prevent nonutility businesses 
from acquiring regulated utilities. In particular, repeal of the 
restrictions on geographic scope and other businesses would remove the 
impediments created by the Act to capital flowing into the industry 
from sources outside the existing utility industry. Repeal would thus 
likely have the greatest impact on both the continuing consolidation of 
the utility business as well as the entry of new companies into the 
utility business.
    Repeal of the Act would also eliminate any impediments that exist 
to other regulators' attempts to modernize regulation of the utility 
industry. For example, during the past year, questions have arisen 
about how the Act will impact the ability of the FERC to implement its 
plans to restructure the control of transmission facilities in the 
United States.\15\ Specifically, in order to ``ensure that electricity 
consumers pay the lowest price possible for reliable service,'' the 
FERC recently implemented new regulations designed to create 
``independent regionally operated transmission grids'' that are meant 
to ``enhance the benefits of competitive electricity markets.'' \16\ As 
a result of FERC's new regulations, many utilities will cede operating 
control--and in some cases, actual ownership--of their transmission 
facilities to newly-created entities. The status of these entities, as 
well as the status of utility systems or other companies that invest in 
them, raise a number of issues under the Act. Most prominently, it has 
been asserted that the limits the Act places on the other businesses in 
which a utility holding company can engage will create obstacles for 
nonutility companies that may wish to invest in or operate these new 
transmission entities. While the SEC believes it has the necessary 
authority under the Act to deal with the issues created by the FERC's 
restructuring without impeding that restructuring, repeal of the Act 
would nonetheless effectively resolve these issues.
---------------------------------------------------------------------------
    \15\ See FERC Order 2000, ``Regional Transmission Organizations,'' 
65 FR 810 (Jan. 6, 2000) (codified at 18 C.F.R. Sec. 35.34).
    \16\ Order 2000, 65 FR at 811.
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    This example, however, raises the broader issue of the relationship 
between the FERC's and the SEC's regulation of the utility industry. 
The FERC is clearly the agency that Congress intended to take the lead 
role in regulating the utility industry. The SEC, in contrast, is 
primarily devoted to regulating the securities markets. Although we 
always attempt to work together with the FERC to ensure that, to the 
extent possible, our regulation of utility holding companies under 
PUHCA does not impede their ability to regulate the utility industry, 
sometimes conflict is inevitable. Given this, if Congress chooses not 
to repeal PUHCA, we believe that responsibility for the Act, whether in 
its current form or in a modified form, should be transferred from the 
SEC to the FERC. Given the nature of the FERC's responsibilities and 
its expertise in regulating the utility industry, it is simply in a 
better position to balance the goals of PUHCA and the other statutes it 
administers, and thereby regulate the utility industry in a more 
consistent and effective manner.

                                * * * *

    The SEC takes seriously its duties to administer faithfully the 
letter and spirit of the 1935 Act and is committed to promoting the 
fairness, liquidity, and efficiency of the United States securities 
markets. By supporting conditional repeal of the 1935 Act, the SEC 
hopes to reduce unnecessary regulatory burdens on America's energy 
industry while providing adequate protections for energy consumers.

    The Chairman. Thank you very much, Commissioner Hunt.
    Let me go ahead with Mr. Hemmingway. We appreciate your 
being here, and go right ahead with your testimony.

 STATEMENT OF ROY HEMMINGWAY, CHAIRMAN, OREGON PUBLIC UTILITY 
                     COMMISSION, SALEM, OR

    Mr. Hemmingway. Mr. Chairman, members of the committee, my 
name is Roy Hemmingway. I am the chairman of the Oregon Public 
Utility Commission. I am here today on behalf of the National 
Association of Regulatory Utility Commissioners, commonly known 
as NARUC. I appreciate the opportunity to testify before you 
today, and I wish to have my written remarks included in the 
record and I will summarize those written remarks.
    NARUC supports the provisions found in S. 1766, sections 
223 through 228, as they pertain to reform of the Public 
Utility Holding Company Act and increasing Federal and State 
access to books and records, as well as moving Federal 
responsibility over holding companies to the Federal Energy 
Regulatory Commission.
    In 1935, Congress enacted PUHCA in response to widespread 
financial abuse of electric and gas consumers and investors by 
multistate holding companies. Incidentally, the Holding Company 
Act was signed into law almost simultaneously with the Federal 
Power Act, which created the Federal Power Commission, which 
eventually became FERC.
    PUHCA had three basic goals: to simplify corporate 
structure of utility companies so that they would aid Federal 
and State regulatory efforts; second, to focus utility 
management on the efficient operation of an integrated utility 
company operating in a limited geographic area and restricting 
diversification; and three, to protect utility consumers and 
investors through the disclosure of appropriate information, 
limitations on issuance of securities and guarantees, and 
regulation of inter-affiliate contracting practices within 
holding company systems.
    There have been three significant changes to PUHCA in 
recent years. In the Public Utility Regulatory Policies Act of 
1978, PURPA, Congress exempted owners of cogeneration and small 
powerplants from PUHCA's restriction on ownership of generating 
facilities. In 1992, in the Energy Policy Act, Congress 
exempted owners of any powerplant selling power exclusively at 
wholesale or an owner of a utility operating in a foreign 
country from the same restrictions. And in the 
Telecommunications Act of 1996, Congress amended PUHCA to allow 
utility holding companies to own subsidiaries providing 
telecommunications.
    PUHCA, for the last 65 years, has been the principal 
determinant of the structure of the electric and natural gas 
utility industries. Repeal of PUHCA, although it is appropriate 
today, will require the addition of regulatory tools to prevent 
shifts in the structure of those industries from negatively 
affecting the consumers whom we as State commissioners are 
sworn to protect.
    The energy utility industries today are the least 
concentrated major industries in the Nation. Over 100 different 
investor-owned utilities serve electricity customers and about 
200 natural gas utilities serve customers today. There is no 
question that creating so many simply structured, 
geographically distinct entities was in the public interest 6 
decades ago. These small companies were easier to regulate, 
were big enough to capture the economies of scale of the day, 
and provided greater assurance of responsiveness to local needs 
than did the absentee owners of their predecessor holding 
companies.
    Repeal of PUHCA will likely lead to greater consolidation 
of the energy utility industry. As more local companies merge, 
more of their costs become federally jurisdictional and States 
lose some of their regulatory power. This shift away from State 
jurisdiction is happening in any case in the electricity 
industry, as increasing amounts of electricity are traded in 
the federally regulated wholesale market, relative to the 
State-regulated, utility-owned generation.
    Today, it is questionable whether the industry structure 
mandated by the Holding Company Act is appropriate for a 
national electricity system characterized by active competitive 
markets. If the Holding Company Act is repealed, the Federal 
Government will no longer be mandating this industry structure 
that has resulted in so many relatively small utility companies 
that are geographically distinct. And States have some concerns 
about greater consolidation and greater complexity that is 
likely to result even if PUHCA repeal is a desired result. As a 
State commissioner, I have concerns about diversification into 
non-utility areas, about utilities dealing with affiliated 
interests, and the potential cross-subsidization of these 
interests from the regulated enterprises.
    Access to books and records by State and Federal regulators 
of all the affiliates of a holding company is a very important 
tool for regulators in dealing with complex corporate 
structures involving utilities.
    In addition, continuing my authority as a State regulator 
over mergers and strengthening FERC's authority over mergers is 
an important aspect of what needs to be done if PUHCA is 
repealed.
    Finally, I think it is difficult to predict what will 
happen in the electricity and natural gas industries once PUHCA 
is repealed. The degree of consolidation and concentration that 
may result is not possible to predict today, and the problems 
that may result I think are not possible to predict. So, I urge 
this committee and the Congress to continue to monitor these 
industries. The Department of Justice, the Federal Trade 
Commission also should be actively involved in monitoring the 
developments in these industries if PUHCA is repealed.
    That concludes my testimony, Mr. Chairman. I will be happy 
to answer questions at the appropriate time.
    [The prepared statement of Mr. Hemmingway follows:]

 Prepared Statement of Roy Hemmingway, Chairman, Oregon Public Utility 
                         Commission, Salem, OR

    Mr. Chairman and Members of the Committee: My name is Roy 
Hemmingway. I am the Chairman of the Oregon Public Utility Commission. 
I am here today on behalf of the National Association of Regulatory 
Utility Commissioners, commonly known as NARUC. I greatly appreciate 
the opportunity to appear before the Senate Committee on Energy and 
Natural Resources and I respectfully request that NARUC's written 
statement be included in today's hearing record as if fully read.
    NARUC is a quasi-governmental, nonprofit organization founded in 
1889. Its membership includes the State public utility commissions for 
all States and territories. NARUC's mission is to serve the public 
interest by improving the quality and effectiveness of public utility 
regulation. NARUC's members regulate the retail rates and services of 
electric, gas, water and telephone utilities. We have the obligation 
under State law to ensure the establishment and maintenance of such 
energy utility services as may be required by the public convenience 
and necessity, and to ensure that such services are provided at rates 
and conditions that are just, reasonable and nondiscriminatory for all 
consumers.
    NARUC supports the provisions found in S. 1766, sections 223 
through 228 as they pertain to reform of the Public Utility Holding 
Company Act (PUHCA) and increasing Federal and State access to books 
and records as well as moving Federal responsibility to the FERC. 
Access to books and records required to verify transactions directly 
affecting a companies regulated utility operations is of vital 
importance to State commissions. Requests for such books and records by 
a commission, its staff, or its authorized agents should be deemed 
presumptively valid, material, and relevant, with the burden falling to 
the company to prove otherwise.
    Additionally, the company should be required to commit to providing 
an audit trail for all corporate and affiliate transactions that impact 
the companies regulated utility operations. This would give a great 
deal of access to the State Commission for information that will be 
needed to audit affiliated activities of a company on a going-forward 
basis. More importantly, this will greatly diminish the burden of a 
State Commission and its staff to have to prove each time requested, 
the need to gain access to the books and records. On the other hand, 
the companies are protected from potential requests for access to books 
and records not pertaining to utility operations. Thus, these 
provisions have a symmetry which balances the regulators need to see 
with the companies' need to protect.
    In 1935, Congress enacted PUHCA in response to widespread financial 
abuse of electric and gas consumers and investors by multistate holding 
companies. PUHCA had three basic goals. (1) To simplify the corporate 
structures of utility holding companies to aid State and Federal 
regulatory commissions in their efforts to regulate the rates and 
services of their utility subsidiaries; (2) To focus utility management 
on the efficient operation of an integrated utility company operating 
in a limited geographic area and to restrict diversification into non-
utility activities; and (3) To protect utility consumers and investors 
through the disclosure of appropriate information, limitations on 
issuance of securities and guarantees, and regulation of inter-
affiliate contracting practices within holding company systems.
    There have been three significant changes to PUHCA in recent years. 
In the Public Utility Regulatory Policies Act of 1978, Congress 
exempted owners of cogeneration and small power plans from PUHCA's 
restrictions on ownership of generating facilities. In the Energy 
Policy Act of 1992, Congress exempted owners of any power plant selling 
power exclusively at wholesale or any owner of a utility operating in a 
foreign country from the same restrictions. In the Telecommunications 
Act of 1996, Congress amended PUHCA to allow utility holding companies 
to own subsidiaries providing telecommunications service.
    I want to focus now on three issues regarding repeal of PUHCA. 
These are issues around industry structure, utility diversification, 
and utility transactions with affiliates.

                           INDUSTRY STRUCTURE

    PUHCA, for the last 65 years, has been the principal determinant of 
the structure of the electric and natural gas utility industries. 
Repeal of PUHCA, although it may well be appropriate today, will 
require the addition of regulatory tools to prevent shifts in the 
structure of those industries from negatively affecting consumers.
    The energy utility industries are today the least concentrated 
major industries in the nation. Over a hundred different investor-owned 
electric utilities and about 200 natural gas utilities serve customers 
today. There is no question that creating so many simply structured, 
geographically distinct entities was in the public interest six decades 
ago. These small companies were easier to regulate, were big enough to 
capture the economies of scale of the day, and provided greater 
assurance of responsiveness to local needs than did the absentee owners 
of their predecessor holding companies.
    Repeal of PUHCA will likely lead to greater consolidation in the 
energy utility industry. As more local companies merge, more of their 
costs become federally jurisdictional, and states lose some of their 
regulatory power. This shift away from state jurisdiction is happening 
in any case in the electricity industry, as increasing amounts of 
electricity are traded in the federally regulated wholesale market 
relative to state-regulated, utility-owned generation.
    Today, it is questionable whether the industry structure mandated 
by PUHCA is appropriate for a national electricity system characterized 
by active competitive markets. Repeal of the structural requirements of 
PUHCA, coupled with FERC review of mergers, will allow for the market 
to decide the appropriate level of industry concentration without 
bringing too much risk of concentrations of market power.
    Regardless of the changing industry structure, states need access 
to the books and records of the holding company, so that they can 
effectively regulate the retail utility.

                            DIVERSIFICATION

    Shortly after the enactment of the Energy Policy Act of 1992, which 
allowed electric utilities significant latitude to invest in non-
utility and foreign activities, utilities began to diversify their 
investments in these non-utility and foreign ventures. Since this was 
new territory for State regulators as to how to protect consumers from 
the risk of these diversification efforts, some State regulators looked 
to negotiate ``Chinese wall'' agreements with the companies to be filed 
with the SEC. These agreements contained protective safeguards for 
utility customers from the risks associated with diversification 
through provisions for transfer pricing among affiliates on a basis 
other than cost, for access to books and records of affiliates, and for 
auditing transactions between utility and non-utility affiliates.
    State commissions are responsible for protecting ratepayers from 
the risks associated with diversification by utilities and their 
holding companies into non-utility businesses and associated with 
future acquisitions by these entities of additional utility and non-
utility businesses. Although it has become common practice for electric 
utilities to diversify into non-utility and foreign businesses, this 
diversification carries more risk than the core regulated utility 
business. NARUC believes that this risk should not be borne or shifted 
to the customers of the regulated utility, since the beneficiaries of 
these investments are the shareholders.
    Currently, absent a negotiated agreement, when a company falls 
under the PUHCA, rather than having direct authority over financial 
transactions, cost allocations, and affiliate transactions, State 
Commissions are relegated to applying for relief as a party before the 
Securities and Exchange Commission (SEC), and the SEC rarely if ever 
holds hearings under PUHCA. Thus, the SEC staff makes its 
recommendations to the SEC based on the exchange of paper pleadings 
among parties and bypasses the traditional evidentiary process. In 
general, the registered holding company structure creates opportunities 
for regulatory forum shopping, in that, if a registered holding company 
and its subsidiaries do not receive the cost recovery result they want 
from State regulators, they can ingeniously find a way to make the 
costs at issue subject to the SEC's jurisdiction under PUHCA by 
creating a company in which to house such costs or moving such costs to 
a common service company or by some other means.
    Additionally, regulation by the SEC under PUHCA has been greatly 
relaxed since the 1980s with regard to its interpretation to meet 
changing circumstances in the industry. The SEC staff, which is at a 
minimal level, is not adequate to conduct compliance audits of the 
numerous registered holding companies under its jurisdiction, while the 
number of registered holding companies has increased significantly in 
recent years. In fact, the SEC staff has, in the past, solicited the 
help of State regulatory auditors in these undertakings. However, 
States may not always benefit from participating in such joint audits 
with the SEC. Participating State auditors could have difficulty 
obtaining confidential data from the company being audited because the 
company can protest as to whether the State had clear authority to 
access this data.
    In sum, the SEC cannot and does not adequately protect retail 
customers from the risks of diversification by holding companies and 
their affiliate enterprises.

                      TRANSACTIONS WITH AFFILIATES

    Section 13 of PUHCA and related regulations generally govern the 
oversight by the SEC of contracts for goods and services among 
affiliated companies. Section 13, and the implementation of Section 13 
by the SEC, is inadequate for addressing abusive affiliate 
transactions. The allocation of common overhead costs anticipated to be 
consolidated as a result of the merger would fall under the regulation 
of the SEC under PUHCA, including the use of the ``at cost'' standard 
for affiliate transactions, regardless of whether the SEC requires the 
creation of a separate service company to house these common overhead 
functions.
    As I alluded to earlier, abusive affiliate transactions, including 
intercompany loans and stock issuances and price gouging, led to the 
enactment of PUHCA in the first place. Although most of these abuses 
were cleaned up as a result of PUHCA's passage, there is still ample 
opportunity for registered holding companies to pass off bad business 
decisions to the regulated utility side of their businesses. Thus, 
there is a concern that the SEC's ``at cost'' standard can prevent 
State regulators from exercising meaningful authority over the prudence 
of a utility's business dealings with its affiliated companies. If 
these affiliates happen to be in non-utility businesses, the 
possibility of cross-subsidization of unregulated activities by 
regulated utilities also arises.
    PUHCA insured that affiliate transactions could occur only at cost, 
thus slamming the lid on affiliates charging prices way above cost to 
their sister utility companies for goods and services. There have been 
cases where the ``cost'' of an affiliate for a good or service exceeds 
what a utility could buy the same good or service for in the market. 
For example, suppose that a registered holding company creates a 
subsidiary to buy real estate and lease it back to its affiliate 
utility subsidiaries. Suppose that the real estate subsidiary leases 
the building to the utility subsidiaries for $10 million annually, 
which is cost. Under the SEC's ``at cost'' rule for affiliate 
transaction pricing, the regulated utility subsidiaries would pay and 
charge their ratepayers $10 million annually, without reference to the 
current market for similar real estate in the area. If the same utility 
subsidiaries could lease office space for $5 million annually in the 
local market, then under the ``at cost'' rule for affiliate 
transactions, ratepayers would be subsidizing the activities of the 
real estate subsidiary. These circumstances are very similar to those 
in the Ohio Power case, where the utility subsidiary was forced to pay 
the costs of coal from its affiliated coal company, which exceeded 
market coal prices by 30 percent. Thus, affiliate transactions can 
raise the issue not only of imprudent decision-making, but also of 
handcuffing state regulators under pre-emption by the SEC under PUHCA.
    In conclusion, NARUC believes that Congress should reform PUHCA in 
the manner proposed in S. 1766, but in doing so, should allow the 
States to protect the public through maintaining effective oversight of 
holding company practices and expanding State access to holding company 
books and records, independent of any similar authorities granted to 
the federal regulatory bodies. NARUC also believes that given recent 
events, FERC and the States ought to be given greater access to 
corporate documents to conduct investigations into financial dealings 
than is contemplated in S. 1766. Each time statutory exemptions were 
made to PUHCA, safeguards to protect utility consumers were included. 
The enhanced State and Federal access to data and information we have 
suggested will provide consumer protection safeguards in an environment 
without the PUHCA safety net as we know it today. Additionally, I have 
attached to this statement, a copy of NARUC's National Electricity 
Policy, adopted at our Annual Convention held last November. This 
document presents NARUC's positions on those issues that help to frame 
the PUHCA debate. Thank you for your attention, I look forward to your 
questions.

                         *    *    *    *    *

                  NARUC's National Electricity Policy

                         I. GENERAL PRINCIPLES

    The nation's energy policy should assure adequate, reasonably 
priced, reliable, safe, and environmentally sound electricity. To 
achieve this goal, Federal legislation should:

    1. Encourage additional fuel- and technology-diverse supply 
resources to meet the nation's growing energy demands;
    2. Promote demand-side management to achieve the most efficient use 
of electricity;
    3. Provide for reliability standards and their enforcement;
    4. Assure open and effective regional wholesale markets;
    5. Minimize the environmental impacts of energy generation, 
delivery and use; and
    6. Respect, preserve and strengthen the States' traditional roles 
in regulating distribution systems, planning, siting approval, 
reliability assurance, and consumer protection.

 II. DIVERSE, PLENTIFUL AND ENVIRONMENTALLY RESPONSIBLE ENERGY SUPPLIES

    A. Congress should encourage environmentally responsible 
electricity generation and the increased use of renewable energy 
technologies as a tool to achieve fuel diversity and greater energy 
security.
    B. Congress should encourage domestic exploration and production of 
new natural gas supplies and expansion of natural gas transmission and 
delivery infrastructure in an environmentally sound manner at 
reasonable costs, but should avoid an over-reliance on natural gas for 
new electric generation.
    C. Coal fuels a significant portion of the nation's electric power 
and is expected to do so for the foreseeable future. However, because 
of coal's air emissions, it is important that Congress and States work 
together to reduce such air emissions and encourage development of low 
?polluting central station generation, including clean-coal technology.
    D. Congress or the Administration should increase the efficiency 
for licensing and relicensing processes of hydroelectric and nuclear 
facilities, without compromising substantive environmental and safety 
standards.
    E. Although nuclear facilities create long-term radioactive waste 
problems, they should continue to play an important part of our 
national electric supply portfolio because they provide a significant 
portion of the nation's electricity supply and do not produce air 
emissions.
    F. Congress needs to fulfill its commitment to provide the long-
term storage of spent nuclear fuel very quickly. To accomplish this, 
Congress should ensure that the Nuclear Waste Fund revenue and 
appropriations are managed responsibly and used only for the 
establishment of a permanent repository. Pending development of a 
permanent repository, it is better to store spent fuel at one (or more) 
central location(s) on an interim basis than to leave it at reactor 
sites.
    G. The States support ongoing and renewed efforts to maintain the 
security of nuclear power plants and prevent the proliferation of 
weapons-grade byproducts.
    H. Congress should enact legislation to lift the Public Utility 
Regulatory Policies Act's mandatory purchase requirement, but should 
allow the States to determine appropriate measures to protect the 
public interest in resource acquisition and to address mitigation and 
cost recovery issues associated with these contracts.

                         III. DEMAND MANAGEMENT

    A. Congress should promote energy efficiency programs through 
increased funding, tax credits, and the setting of increasingly more 
efficient national building codes and standards for motors, lighting 
and appliances.
    B. Congress should promote planning strategies for maintaining a 
proper balance between supply and load that includes demand-side 
management techniques (including price-responsive demand mechanisms), 
intermittent and renewable resources, conservation/energy efficiency 
programs, as well as traditional supply and transmission options.
    C. Congress should continue to provide funding for energy 
efficiency and conservation for low and moderate income consumers 
through programs that provide education, weatherization, housing 
improvements, installation of higher efficiency appliances, and similar 
usage reduction measures.

       IV. RTOS, RELIABILITY, PLANNING & DELIVERY INFRASTRUCTURE

A. Regional Transmissions Organizations
    1. Congress should require the FERC, in cooperation with the 
States, to determine boundaries, structure, and functions for regional 
transmission organizations (RTO).
    2. Congress should require the FERC to give RTOs sufficient 
authority to perform regional grid management, expansion, and efficient 
system operations that are built and operated in the most economical, 
reliable and environmentally acceptable way to realize short-term as 
well as long ?term reliability and facilitate efficient wholesale 
market transactions.
    3. Congress should require the FERC to recognize States' rights to 
active participation in RTO governance. This would include development 
(and revision) of market rules, reliability and planning, access to RTO 
market monitoring information, development, with federal authorities, 
of market power mitigation programs.
B. Long-Term Planning
    1. Congress should require that RTOs or other regional bodies have 
sufficient authority to conduct long term planning for their regions 
and, working with the States and transmission owners, implement long-
term planning that should:

          (a) Take into account fuel diversity including renewables 
        resources;
          (b) Recognize the need for new investment in generation and 
        transmission facilities that provides adequate reserve margins;
          (c) Assure that reliability is not compromised by resource 
        imbalances;
          (d) Reduce any decisional role for entities with unreasonable 
        generation or transmission market power;
          (e) Include broad public participation and collaboration 
        among market participants and third party participation in 
        offering competitive alternatives such as demand-side and 
        distributed generation options;
          (f) Develop a cost allocation method that is objective, non-
        discriminatory, weighs environmental and societal risk, and 
        associates costs with benefits;
          (g) Allow the use of competition, subject to appropriate 
        regulatory oversight, to encourage robust wholesale markets; 
        and
          (h) Assure adequate resources in all regions of the nation.

    2. Congress should support the States' authority over local 
distribution utilities to provide interconnection arrangements for 
self-generation and generation units that utilize the local 
distribution network.
C. Reliability
    1. Congress should mandate compliance with industry-developed 
reliability standards on the bulk power system that includes adequate 
reserve margins and preserves the authority of the States to set more 
rigorous standards when deemed to be in the public interest.
    2. Congress should ensure that States continue to have the 
authority to establish effective price signals that allow consumers to 
choose alternative levels of reliability and power quality.
D. Delivery Infrastructure
    1. States should retain authority to site electric facilities, 
while Congress should support the States' authority to negotiate and 
enter into cooperative agreements or compacts with federal agencies and 
other States to facilitate the siting and construction of electric 
transmission facilities as well as to consider alternative solutions to 
such facilities, such as distributed generation and energy efficiency.
    2. Congress should pursue policies that promote and ensure pipeline 
safety, and streamline existing siting processes to increase 
administrative efficiency, including the coordination of all federal, 
State and local participation in these processes, without compromising 
substantive environmental and safety standards.

                           V. ENERGY MARKETS

A. Access to Information
    1. Congress should recognize that States implementing competitive 
retail markets and those with traditional regulatory structures, and 
Federal, State and regional agencies and organizations overseeing the 
development of wholesale energy markets require comprehensive and 
timely market information. Congress should adopt policies that 
safeguard public access to information necessary to enable the 
monitoring of these markets, while also providing protection for 
information demonstrated to be commercially, or otherwise, sensitive.
B. Retail Markets
    1. Congress should not interfere with the States' authority over 
all aspects of retail service including the authority to determine just 
and reasonable retail rates, and those retail rates designed to 
encourage reductions in peak demand and to encourage demand-side 
management options.
    2. Congress should not mandate retail electricity competition.
C. Wholesale markets
    1. Congress should require the FERC to promulgate clear and 
consistently applied market rules that foster investment in generation, 
transmission and demand-side management resources.
    2. Congress should mandate effective and independent monitoring of 
the wholesale electricity markets and empower the relevant States and 
federal agencies with authority to investigate, enforce, and remedy 
problems resulting from the exercise of market power or other abusive 
behavior that distorts market operations. Such remedies should include 
the use of structural remedies, codes of conduct, or affiliate rules.
    3. Congress should preserve a State's ability to require that a 
utility's retained generation be used to serve native load.

                      VI. ENVIRONMENTAL PROTECTION

    A. Congress should assure that State and federal energy and 
environmental policies be coordinated and complementary.
    B. Congress should address all air emissions from all electric 
power generation in ways that: 1) minimize adverse environmental 
impacts; 2) are comprehensive and synchronized to reduce regulatory 
costs; 3) rely, to the extent possible, on market-based trading 
mechanisms, and 4) identify, to the extent possible, the net impact of 
resource decisions, including external factors, on public health, the 
environment and the economy.
    C. Congress should assist States and utilities to establish 
programs to phase out power plants grandfathered under the Clean Air 
Act with facilities that utilize clean coal technology or by other 
means, in a way that preserves the integrity of the bulk power system 
and minimizes the economic impact on local areas.

                        VII. CONSUMER PROTECTION

    A. Congress should not limit State authority to prescribe and 
enforce laws, regulations or procedures regarding consumer protection.
    B. Congress should reinforce the States' authority to require all 
load serving entities to disclose generation sources and accompanying 
environmental impacts.
    C. Congress should address the preservation of public benefits in 
any electric industry restructuring legislation. Societal costs and 
benefits should be studied prior to the adoption of any particular 
implementation or funding mechanism.
    D. Congress should require regional transmission organizations, 
system operators, reliability counsels and other regional agencies to 
adopt policies that allow public access to information necessary to 
enable adequate monitoring of energy markets, while also providing 
protection for information demonstrated to be commercially sensitive.
    E. Congress should reform the Public Utility Holding Company Act 
(PUHCA), but, in doing so, should allow the States to protect the 
public through maintaining effective oversight of holding company 
practices and expanding State access to holding company books and 
records, independent of any similar authorities granted to the federal 
regulatory bodies.

    The Chairman. Thank you very much.
    Ms. Marlette, why do you not go right ahead?

  STATEMENT OF CYNTHIA A. MARLETTE, GENERAL COUNSEL, FEDERAL 
                  ENERGY REGULATORY COMMISSION

    Ms. Marlette. Thank you, Mr. Chairman, and members of the 
committee. My name is Cynthia Marlette, and I am General 
Counsel of the Federal Energy Regulatory Commission. I 
appreciate the opportunity to be here today to discuss the 
effects of repealing the Public Utility Holding Company Act of 
1935 and whether, if PUHCA is repealed, the provisions of S. 
1766 are sufficient to ensure competitive energy markets and 
provide adequate customer protection.
    I appear here today as a commission staff witness and I do 
not speak on behalf of the commission or any one of the 
commissioners.
    At this critical stage in the evolution of the electric 
utility industry, it is important to take all reasonable 
measures to support the development of competitive energy 
markets and to provide appropriate incentives for electric and 
natural gas infrastructure to meet this Nation's energy needs. 
Legislative reform, including repeal or reform of PUHCA, would 
help to more rapidly accomplish the goal of wholesale power 
competition which the Congress endorsed a decade ago in the 
Energy Policy Act of 1992. However, any legislative reform must 
ensure adequate protection of electric and natural gas 
ratepayers from abuse of market power and inappropriate 
affiliate cross-subsidization.
    PUHCA, as it currently exists, may actually impede 
competitive markets and appropriate competitive market 
structures. In particular, it encourages greater geographic 
concentrations of generation ownership which may increase 
market power. Further, it may cause unnecessary regulatory 
burdens for utilities who seek to form or join regional 
transmission organizations, or RTO's, and it could serve as a 
significant disincentive for investments in independent for-
profit transmission companies which are RTO's or which operate 
under an RTO umbrella.
    PUHCA should be repealed or reformed so long as the 
following matters are addressed. First, Congress should ensure 
that the FERC and State regulatory authorities have adequate 
access to the books and records of all members of public 
utility holding company systems when that information is 
relevant to their statutory ratemaking responsibilities. 
Second, any exemptions from a new holding company act should be 
crafted narrowly. While it may be appropriate to grandfather 
previously authorized activities or transactions, no holding 
company should be exempt from affiliate abuse or market power 
oversight.
    The PUHCA repeal provision of S. 1766, as introduced on 
December 5, 2001, in conjunction with other provisions in the 
bill would, from the FERC regulatory standpoint, help remove 
remaining competitive barriers and provide additional 
regulatory tools to create and sustain competitive wholesale 
power markets and to protect wholesale customers. If PUHCA if 
not repealed, the Congress needs to close the current 
regulatory gap, which was created by a 1992 court decision 
interpreting PUHCA, which impairs the FERC's ability to protect 
customers of registered holding companies from affiliate abuse 
and cross-subsidization.
    I appreciate the opportunity to be here, and I would be 
happy to answer any questions the members may have.
    [The prepared statement of Ms. Marlette follows:]

      Prepared Statement of Cynthia A. Marlette, General Counsel, 
                  Federal Energy Regulatory Commission

    Mr. Chairman and Members of the Committee: Good morning. My name is 
Cynthia A. Marlette, and I am General Counsel of the Federal Energy 
Regulatory Commission (FERC or Commission). Thank you for the 
opportunity to appear here today to discuss the effects of repealing 
the Public Utility Holding Company Act of 1935 (PUHCA) and whether, if 
PUHCA is repealed, the provisions of S. 1766 are sufficient to ensure 
competitive energy markets and provide adequate customer protection. I 
appear today as a Commission staff witness and do not speak on behalf 
of the Commission or any Commissioner.
    In light of the Commission's primary statutory mission and 
expertise in regulating interstate transmission and rates charged in 
wholesale energy markets, my comments today focus on wholesale customer 
(ratepayer) protection. They do not address whether any provisions of 
PUHCA or other legislative measures are necessary to protect the 
interests of shareholders or employees of electric or gas holding 
companies or their subsidiaries or affiliates. I defer to other 
agencies with greater expertise on these important issues.
    At this critical stage in the evolution of the nation's electric 
industry, it is important to take all reasonable measures to support 
the development of competitive energy markets and to provide 
appropriate incentives for electric and natural gas infrastructure to 
meet our nation's energy needs. Legislative reform, including repeal or 
reform of PUHCA, would help to more rapidly accomplish the goal of 
wholesale power competition which the Congress endorsed a decade ago in 
the Energy Policy Act of 1992. As I will discuss further in my 
testimony, the PUHCA repeal provisions of S. 1766 in conjunction with 
other provisions in the bill would, from the FERC's regulatory 
standpoint, help remove remaining competitive barriers, provide 
additional regulatory tools to sustain competitive wholesale power 
markets, and ensure adequate protection of electric and natural gas 
ratepayers from abuse of market power and inappropriate cross-
subsidization.
    We are now at a pivotal juncture in the development of competitive 
power markets, and it is appropriate for the Congress to reexamine the 
framework for regulating electric utilities, including unnecessary 
restrictions that PUHCA places on the activities of certain 
participants in these power markets. Although PUHCA was enacted to 
protect against corporate structures that could harm investors and 
ratepayers, today some of PUHCA's restrictions may actually impede 
competitive markets and appropriate competitive market structures, 
harming ratepayers and shareholders in the long run.
    Since the legislative debate on PUHCA repeal began before the 
Congress almost six years ago, two major events have caused policy 
makers to more carefully examine PUHCA repeal and the adequacy of 
regulatory tools and protections under existing law and under various 
pending legislative proposals. These events are the California energy 
crisis and the recent collapse of Enron with its devastating effects on 
shareholders and employees. Both events have heightened scrutiny of 
competitive markets and the appropriate regulatory framework for the 
future of the electric industry. However, the majority of industry 
observers, including the Commission, continue to support competitive 
power markets, rather than traditional cost-based regulation, as the 
best means of serving energy customers in the long run.
    In past testimony, FERC witnesses have raised no objection to 
repeal or reform of PUHCA, so long as certain ratepayer issues are 
addressed. Today, we continue to take the position that PUHCA needs to 
be repealed or reformed, so long as the following matters are 
addressed:

   First, Congress should ensure that the FERC and state 
        regulatory authorities have adequate access to the books and 
        records of all members of all public utility holding company 
        systems when that information is relevant to their statutory 
        ratemaking responsibilities. This is necessary to prevent 
        affiliate abuse and subsidization by electricity and natural 
        gas ratepayers of the non-regulated activities of holding 
        companies and their affiliates.
   Second, any exemptions from a new holding company act should 
        be crafted narrowly. While it may be appropriate to grandfather 
        previously authorized activities or transactions, no holding 
        company should be exempt from market power and affiliate abuse 
        oversight.
   Third, if Congress retains any existing PUHCA functions and 
        transfers them from the SEC to the FERC, instead of repealing 
        PUHCA in its entirety and replacing it with broader access to 
        books and records, Congress needs to provide FERC with staff 
        and administrative support necessary for us to carry out the 
        additional responsibilities.

    Title II of S. 1766, as introduced on December 5, 2001, adequately 
addresses the above substantive concerns with respect to PUHCA reform. 
Title II of S. 1776 also provides additional regulatory tools to help 
promote a competitive marketplace for electric energy and protect 
wholesale customers. We believe these new provisions would 
significantly enhance the Commission's current authority under the 
Federal Power Act (FPA) to create and sustain competitive power markets 
and ensure customer protection. The one matter that is not addressed in 
S. 1766, and which would help promote a competitive marketplace and 
avoid potentially lengthy litigation, is a clarification of the 
Commission's authority to require regional transmission organizations 
(RTOs) where it finds RTOs to be in the public interest. RTOs will 
broaden regional energy markets, allow greater market efficiencies and 
eliminate remaining discrimination in transmission access and grid 
operations.

                               BACKGROUND

    Under current law, the two major federal statutes affecting 
electric utilities are PUHCA and the FPA. Both statutes were enacted as 
part of the same legislation in 1935 to curb widespread financial 
abuses that harmed electric utility investors and electricity 
customers. While there is overlap in the matters addressed by these 
Acts, they each have different public interest objectives. The areas of 
overlap in the two statutes, and specific issues raised if PUHCA is 
repealed or amended, are described in detail in the Attachment to this 
testimony. As a general matter, however, the Securities and Exchange 
Commission (SEC) regulates registered public utility holding companies 
under PUHCA while FERC regulates the operating electric public utility 
and gas pipeline subsidiaries of the registered holding companies under 
the FPA and Natural Gas Act (NGA). The agencies often have 
responsibility to evaluate the same general matters, but from the 
perspective of different members of the holding company system and for 
different purposes. The FERC focuses primarily on a transaction's 
effect on utility ratepayers. The SEC focuses primarily on a 
transaction's effect on corporate structure and investors.
    In June 1995, the SEC issued a report entitled ``The Regulation of 
Public-Utility Holding Companies'' and recommended that Congress 
conditionally repeal PUHCA and enact certain ratepayer safeguards in 
its place. We agree with a fundamental premise of the SEC's report that 
rate regulation at the federal and state levels has become the primary 
means of ensuring ratepayer protection against potential abuse of 
monopoly power by utilities that are part of holding company systems.
    We also believe that PUHCA, in its current form, may actually 
encourage market structures that impede competition. In particular, 
under PUHCA acquisitions by registered holding companies generally must 
tend toward the development of an ``integrated public-utility system.'' 
To meet this requirement, the holding company's system must be 
``physically interconnected or capable of physical interconnection'' 
and ``confined in its operations to a single area or region.'' This 
requirement tends to create greater geographic concentrations of 
generation ownership, which may increase market power and diminish 
electric competition.
    In addition, PUHCA may cause unnecessary regulatory burdens for 
utilities who, in compliance with Commission policy and regulations, 
seek to form or join RTOs. RTOs will provide the major structural 
reform needed in the electric industry to mitigate market power and 
operate an efficient, reliable transmission system. These institutions 
will operate, or both own and operate, the interstate transmission grid 
within their regions, provide transmission services on an open, non-
discriminatory basis, and perform regional transmission planning. They 
may be non-profit independent system operators (ISOs), or they may be 
for-profit transmission companies (transcos), or a combination of the 
two. The cornerstone requirement for the institutions, however, is that 
they be independent from power market participants, i.e., independent 
from those that own, sell or broker generation. Under PUHCA, any entity 
that owns or controls facilities used for the transmission of electric 
energy--such as an RTO--falls within the definition of public utility 
company, and any owner of ten percent or more of such a company would 
be a holding company and potentially could be required to become a 
registered holding company. This could serve as a significant 
disincentive for investments in independent for-profit transcos that 
qualify as RTOs or that operate under an RTO umbrella.

           REVIEW OF S. 1766 TITLE II ELECTRICITY PROVISIONS

S. 1766 PUHCA Amendments
    Title II, Subtitle B, of S. 1766 would repeal PUHCA and, in its 
place, enact the Public Utility Holding Company Act of 2002. The new 
Act would do five major things:

   provide the FERC with access to books and records of holding 
        companies and their associate and subsidiary companies, and of 
        any affiliates of holding companies or their subsidiaries 
        (section 224);
   give state commissions that have jurisdiction over a public 
        utility company in a public utility holding company system 
        access to books and records of a holding company, its 
        associates or affiliates (section 225);
   require the FERC to promulgate a final rule, no later than 
        90 days after enactment, to exempt from the books and records 
        access requirements of section 224 any person that is a holding 
        company solely with respect to one or more: qualifying 
        facilities under the Public Utility Regulatory Policies Act of 
        1978; exempt wholesale generators; or foreign utility companies 
        (section 226);
   provide that nothing in the Act precludes the FERC or a 
        state commission from exercising its jurisdiction under 
        otherwise applicable law to determine whether a public utility 
        or natural gas company may recover in rates any costs of an 
        activity performed by an associate company, or any costs of 
        goods or services acquired from an associate company (section 
        227); and
   grandfather activities in which a person is legally engaged 
        or authorized to engage on the effective date of the new act 
        (section 231).

    With these protections in place, and with the Commission's other 
regulatory authorities under the FPA in place, we do not believe that 
the S. 1766 PUHCA provisions would impair or diminish protection of 
wholesale ratepayers.
    If PUHCA is not repealed, however, Congress should address what has 
come to be called the Ohio Power regulatory gap, which was created by a 
1992 court decision and which is discussed in greater detail in the 
Attachment to this testimony. Briefly, in a decision by the United 
States Court of Appeals for the District of Columbia Circuit, Ohio 
Power Company v. United States, 954 F.2d 779 (D.C. Cir. 1992), the 
court held that if a public utility subsidiary of a registered holding 
company enters into a service, sales or construction contract with an 
affiliate company, the costs incurred under that affiliate contract 
cannot be reviewed by FERC. The court reasoned that because the SEC has 
to approve the contract before it is entered into, FERC cannot examine 
the reasonableness or prudence of the costs incurred under that 
contract. FERC must allow the costs to be recovered in wholesale 
electric rates, even if the utility could have obtained comparable 
goods or services at a lower price from a non-affiliate.
    The Ohio Power decision has left a gap in rate regulation of 
electric utilities. The result is that utility customers served by 
registered holding companies under PUHCA have less rate protection than 
customers served by non-registered systems. If PUHCA is repealed, as in 
S. 1776, this problem will be solved. If the contract approval 
provisions of PUHCA are retained, however, this regulatory gap should 
be closed to restore FERC's ability to regulate the rates of utilities 
that are members of registered holding company systems.
S. 1766 Federal Power Act Amendments
    In addition to the PUHCA repeal provisions in Subtitle B of S. 
1766, Subtitle A of S. 1766 contains several amendments to Part II of 
the FPA: Electric Utility Merger Authority (Section 202 of Subtitle A). 
Commission authority over mergers and other corporate dispositions 
under FPA section 203 would be clarified or expanded to include 
authority over: an electric public utility's purchase, lease or other 
acquisition of existing facilities for the generation of electric 
energy or for the production or transportation of natural gas; a merger 
of a holding company whose holding company system includes a 
transmitting utility or an electric utility company with another 
holding company whose holding company system includes a transmitting 
utility, electric utility company or gas utility company; and any 
merger, sale, lease or disposition of generation-only facilities. In 
addition, the value of facilities covered by FPA section 203 would be 
increased from $50,000 to $1 million before Commission review would be 
triggered.
    Thus, while overlapping SEC-FERC merger review would be eliminated 
by the repeal of PUHCA, the Commission's review authority would be 
clarified or strengthened under the new S. 1766 provisions. This would 
provide effective Federal oversight over corporate structures that 
include FPA public utilities, and the effect of such structures on 
wholesale competition and rates. Market-based Rate Authority (Section 
203 of Subtitle A). In making a determination of whether market-based 
rates are just and reasonable and not unduly discriminatory or 
preferential, the Commission would be required to consider whether: the 
seller and its affiliates have adequately mitigated market power; 
whether the sale is made in a competitive market; whether market 
mechanisms such as power exchanges and bid auctions function 
adequately; the effect of demand response mechanisms; the effect of 
mechanisms or requirements to ensure adequate reserve margins; and such 
other considerations as the Commission may deem appropriate. Further, 
if the Commission finds under section 206 of the FPA that a market-
based rate is not just and reasonable, it would determine the just and 
reasonable rate and order such other action as would in the judgment of 
the Commission adequately ensure a just and reasonable market-based 
rate.
    While this provision directs the Commission to consider matters 
which it already has authority to consider under the existing FPA, it 
would appear to give the Commission significant new authority to order 
whatever remedies are necessary (``such other action'') to ensure 
reasonable rates, once the Commission has completed its rate 
investigation. Refund Effective Date (Section 204 of Subtitle A). The 
refund effective date under an FPA section 206 investigation could be 
as early as the date a complaint is filed or the date the Commission 
issues a notice of intention to initiate an investigation. This would 
provide greater refund protection for customers and a stronger 
deterrence against overpricing by generators. Transmission 
Interconnections (Section 205 of Subtitle A). The Commission would be 
directed to establish, by rule, technical standards and procedures for 
interconnection. Transmitting utilities that are not regulated as 
public utilities (e.g., governmental and most electric power 
cooperative entities) would be required to interconnect upon 
application by a power producer or on the Commission's own motion.
    This provision would strengthen the existing FPA section 210 
interconnection authority of the Commission. It also would reduce 
procedural costs for new generators and transmitting utilities alike 
and lower overall electricity costs by helping efficient new generators 
get interconnected to the transmission grid more quickly. Open Access 
by Unregulated Transmitting Utilities (Section 206 of Subtitle A). The 
Commission would have authority to require open access transmission 
services by unregulated (governmental and most rural electric power 
cooperative) transmitting utilities at rates comparable to what they 
charge themselves and terms and conditions comparable to what public 
utilities must offer. The Commission would be required to exempt small 
entities, entities that do not own or operate transmission facilities 
necessary for operating an interconnected transmission system, or 
entities that meet other criteria that the Commission determines to be 
in the public interest. The Commission would have authority to remand 
rates to an unregulated transmitting utility.
    This provision would help eliminate a major barrier to creating a 
seamless national power grid, by allowing the Commission to require 
open access over the approximate one-third of the transmission grid 
which currently is beyond the Commission's open access authority under 
sections 205 and 206 of the FPA. At the same time, the provision 
recognizes the unique circumstances of governmental and rural 
cooperative utilities and allows flexibility (e.g., remand of rates 
that are not just and reasonable) in asserting narrow transmission 
jurisdiction. This measure should produce transmission cost savings for 
many customers by reducing or eliminating pancaked transmission rates 
and discriminatory terms and conditions of transmission service and 
interconnection. Electric Reliability Standards (Section 207 of 
Subtitle A). The Commission would be required to establish and enforce 
one or more systems of mandatory electric reliability standards. It 
could certify one or more self-regulatory reliability organizations 
which may include the North American Electric Reliability Council, one 
or more regulated reliability councils, one or more RTOs, or any 
similar organization to monitor and enforce compliance. This would 
benefit customers by ensuring that there is Federal public interest 
oversight over electric industry reliability activities, and creating 
the ability to mandate compliance with what are now voluntary 
standards. Market Transparency Rules (Section 208 of Subtitle A). The 
Commission would be required to issue rules establishing an electronic 
information system to provide information, on a timely basis, about the 
availability and price of wholesale electric energy and transmission 
services to the Commission, state commissions, buyers and sellers of 
wholesale electric energy, users of transmission and the public. The 
Commission would require each RTO to provide statistical information 
about available capacity and capacity constraints on the transmission 
facilities operated by the RTO and also would require each broker, 
exchange or other market-making entity to provide statistical 
information about the amount and sale price of sales it transacts of 
electric energy at wholesale in interstate commerce. This information 
would have to be posted on the Internet. The Commission would be 
required to exempt from disclosure commercial or financial information 
that it determines to be privileged, confidential or otherwise 
sensitive.
    These provisions would help prevent potential litigation about the 
Commission's ability to require market information disclosure where 
appropriate. They would improve market transparency through better 
electronic dissemination of information about trades in the energy 
markets and the transfer capabilities of the transmission 
infrastructure. The measures would help the Commission establish sound 
competitive wholesale markets by validating and broadening the agency's 
authority to compel such reporting and information dissemination. They 
also would help the Commission and financial market regulators and 
players to better monitor individual companies' participation and 
diminish the ability of any individual player to misbehave or 
misrepresent in the marketplace. There are two cautions, however:
    First, while the S. 1766 provisions address actual trades, they do 
not appear to address at least two of the issues at the heart of 
Enron's situation--how the Enron companies handled and reported the 
risks and valuation underlying the trades they were conducting, and how 
they represented the value of the trades flowing through their 
platforms as corporate revenue. Those are broader financial reporting 
and regulation issues that are outside the scope of the Commission's 
jurisdiction and expertise.
    Second, there is a difficult balance to be struck between 
information that must be disclosed to make markets work and information 
that is commercially proprietary. It is clearly to the public benefit 
to implement rules that disclose more information and improve market 
transparency, but it is not always easy in practice to find the 
appropriate point between reasonable information disclosure and 
protection. S. 1766's requirement to exempt commercial or financial 
information that the Commission determines is privileged, confidential 
or otherwise sensitive appears to give the Commission sufficient 
discretion on this important matter. Access to Transmission by 
Intermittent Generators (Section 209 of Subtitle A). The Commission 
would be required to ensure that all transmitting utilities provide 
transmission service to intermittent generators in a manner that does 
not penalize such generators for characteristics that are inherent to 
intermittent energy resources and are beyond the control of such 
generators.
    These provisions would allow more renewable energy to be integrated 
into market operations at lower operating costs. This would enhance 
customers' ability to choose more environmentally clean energy sources. 
Enforcement (Section 210 of Subtitle A). The entities that could file a 
complaint under the FPA would be expanded to include electric 
utilities, and the entities against whom a complaint could be filed 
would be expanded to include transmitting utilities. Similarly, the 
Commission would have authority to investigate whether transmitting 
utilities have violated the FPA. The Commission's civil penalty 
authority under FPA section 316A ($10,0000 per day per violation) would 
be extended to cover any violation under Part II of the FPA.
    The Commission currently has very limited civil penalty authority 
under section 316A of the FPA. This provision would significantly 
expand the Commission's ability to enforce Part II of the Act which 
would in turn enhance the Commission's ability to bring the benefits of 
competitive electric markets to customers.

                        S. 1766 PURPA AMENDMENTS

    Subtitle C of S. 1766 would amend some of the provisions currently 
under the FERC's jurisdiction under the Public Utility Regulatory 
Policies Act of 1978: Termination of Mandatory Purchase and Sale 
Requirements (Section 244 of Subtitle C.) The mandatory purchase and 
sale requirements of PURPA (between qualifying facilities (QFs) and 
electric utilities) would be terminated; contracts existing on date of 
enactment would be grandfathered; and statutory ownership limitations 
for qualifying facilities would be eliminated.
    These provisions would eliminate statutory requirements which are 
inconsistent with today's competitive power markets but, at the same 
time, would not disrupt expectations associated with pre-existing 
contracts. Net Metering (Section 245 of Subtitle C). Electric utilities 
would be required to make net metering service available upon request 
to an electric customer that the electric utility serves. The 
Commission would be permitted to adopt by rule control and testing 
requirements for on-site generating facilities and net metering 
systems, in addition to the other requirements in the statute, if the 
Commission determines they are necessary to protect public safety and 
system reliability.

                               CONCLUSION

    Legislative reform, including repeal or reform of PUHCA, would help 
to more rapidly accomplish the goal of wholesale power competition. 
However, any repeal of PUHCA must ensure adequate protection of 
ratepayers, including state and federal regulator access to books and 
records of holding company members. The PUHCA repeal provisions of S. 
1766 in conjunction with other provisions of the bill would, from the 
FERC's regulatory standpoint, help remove remaining competitive 
barriers and provide additional regulatory tools to sustain competitive 
wholesale power markets and protect wholesale and retail customers.
    Thank you again for the opportunity to be here today. I would be 
happy to answer any questions you may have.

              Attachment Testimony of Cynthia A. Marlette

          EXISTING STATUTORY FRAMEWORK: FERC/SEC JURISDICTION

    The FERC's primary function under the FPA is ratepayer protection. 
The FERC regulates public utilities as defined in the FPA. These 
include individuals and corporations that own or operate facilities 
used for wholesale sales of electric energy in interstate commerce, or 
for transmission of electric energy in interstate commerce. The FERC 
does not regulate all utilities. For example, publicly-owned utilities 
and most cooperatives are exempt from our traditional rate regulatory 
authority.
    The FERC ensures that rates, terms and conditions for wholesale 
sales of electric energy and transmission are just, reasonable and not 
unduly discriminatory or preferential. In addition, the FERC has 
responsibilities over corporate mergers and other acquisitions and 
dispositions of jurisdictional facilities, transmission access, certain 
issuances of securities, interlocking directorates, and accounting. In 
exercising its responsibilities, the Commission must take into account 
any anticompetitive effects of jurisdictional activities.
    There is overlap in the jurisdiction of the FERC and the SEC. As a 
general matter, the SEC regulates registered utility holding companies 
whereas the FERC regulates the operating electric utility and gas 
pipeline subsidiaries of the registered holding companies. The agencies 
often have responsibility to evaluate the same general matter, but from 
the perspective of different members of the holding company system and 
for different purposes. The FERC primarily focuses on the impact of a 
transaction on utility ratepayers. The SEC, on the other hand, 
primarily focuses on the impact of a transaction on corporate structure 
and investors.
    There are four major areas of overlap in the jurisdiction of the 
FERC and the SEC with respect to regulation of the electric industry:

          (1) Accounting--The SEC has authority to establish accounting 
        requirements for every registered holding company, and every 
        affiliate and subsidiary of a registered holding company. Many 
        of these companies are public utilities that are also under the 
        FERC's jurisdiction and subject to its accounting requirements.
          (2) Corporate regulation--The SEC must approve the 
        acquisition of a public utility's securities by a registered 
        holding company. The FERC must approve the disposition or 
        acquisition of jurisdictional facilities by a public utility.
          (3) Rates--The SEC must approve service, sales and 
        construction contracts among members of a registered holding 
        company system. The FERC must approve wholesale rates 
        reflecting the reasonable costs incurred by a public utility 
        under such contracts.
          (4) PUHCA Exemptions--Under the PUHCA section 32 amendment 
        contained in the Energy Policy Act of 1992, the FERC must 
        determine whether an applicant meets the definition of exempt 
        wholesale generator, and thus is exempt from the Holding 
        Company Act. With minor exceptions, the SEC continues to make 
        PUHCA exemption determinations under the pre-Energy Policy Act 
        PUHCA provisions as well as under the new section 33 of PUHCA 
        (concerning foreign utility companies).

    Congress recognized the overlap in FERC-SEC jurisdiction when it 
simultaneously enacted PUHCA and the FPA in 1935. It included section 
318 in the FPA, which provides that if any person is subject to both a 
requirement of the FPA and PUHCA with respect to certain subject 
matters, only the requirement of PUHCA will apply to such person, 
unless the SEC has exempted such person from the requirements of PUHCA. 
If the SEC has exempted the person from the PUHCA requirement, then the 
FPA will apply.
    During the half-century following enactment of PUHCA and the FPA, 
there were no significant problems resulting from the overlap in FERC-
SEC jurisdiction, until a series of court decisions involving the 
wholesale rates of the Ohio Power Company. Under the last of these 
court decisions, a 1992 decision by the United States Court of Appeals 
for the District of Columbia Circuit (Ohio Power Company v. FERC, 954 
F.2d 779 (D.C. Cir. 1992) (Ohio Power)), the FERC does not have the 
extent of rate jurisdiction which it previously thought it had over 
public utility subsidiaries of registered electric utility holding 
companies.
    Under the 1992 Ohio Power decision, if a public utility subsidiary 
of a registered holding company enters into a service, sales or 
construction contract with an affiliate company, the costs incurred 
under that affiliate contract cannot be reviewed by the FERC. The SEC 
has to approve the contract before it is entered into. However, the 
FERC cannot examine the reasonableness or prudence of the costs 
incurred under that contract. The FERC must allow those costs to be 
recovered in wholesale electric rates, even if the utility could have 
obtained comparable goods or services at a lower price from a non-
affiliate.
    This decision has left a major gap in rate regulation of electric 
utilities. The result is that utility customers served by registered 
holding companies have less rate protection than customers served by 
non-registered systems. If PUHCA is repealed, the Ohio Power problem 
goes away. This is a significant advantage of S. 1766, introduced 
December 5, 2001. S. 1766 would repeal PUHCA and enact a new, more 
limited law that does not give rise to an Ohio Power problem. Short of 
repeal of PUHCA, however, the existing regulatory gap needs to be 
addressed.

             ISSUES RAISED IF PUHCA IS REPEALED OR AMENDED

    There are several ratepayer protection issues on which Congress 
should focus in considering PUHCA legislation. S. 1766 adequately 
addresses these issues. An important aspect of ratepayer protection is 
preventing affiliate abuse and the subsidization by ratepayers of the 
non-regulated activities of non-utility affiliates. These issues can 
arise in virtually every area of the FERC's responsibilities. In the 
case of public utilities that are members of holding companies, there 
are increased opportunities for abuses. There are several reasons for 
this.
    First, registered holding companies have centralized service 
companies that provide a variety of services (e.g., accounting, legal, 
administrative and management services) to both the regulated public 
utility operating companies in the holding company system, and to the 
non-regulated companies in the holding company system. The FERC's 
concern in protecting ratepayers is that when the costs of these 
service companies are allocated among all members of the holding 
company system, the ratepayers of the public utility members bear their 
fair share of the costs and no more; ratepayers should not subsidize 
the non-regulated affiliates of the public utilities.
    Thus far, FERC has had few, if any, problems with inappropriate 
allocations of service company costs. The services provided by the 
centralized service companies have been relatively limited. In recent 
years, however, there has been a substantial increase in the services 
being performed by these types of service company affiliates. In many 
registered company systems, the majority of the costs of operating and 
maintaining the operating utilities' systems, which previously were 
incurred directly by each individual utility, are now being incurred by 
the service company and billed to the public utility under SEC-approved 
allocation methods. These costs can be significant for ratepayers. This 
means that rate regulatory oversight of service company allocations is 
imperative.
    A second concern involves special purposes subsidiaries. In 
addition to the centralized service companies, registered holding 
companies increasingly are forming special purpose subsidiaries that 
contract with their public utility affiliates to supply services, as 
well as goods and construction. This can include fuel procurement, 
services such as operation of power plants, telecommunications, and 
construction of transmission lines and generating plants.
    The FERC's primary concern with affiliate contracts for goods and 
services is that utilities not be allowed to flow through to electric 
ratepayers the costs incurred under affiliate contracts if those costs 
are more than the utility would have incurred had it obtained goods or 
services from a non-affiliate. As discussed earlier, under the 1935 
PUHCA the FERC cannot provide adequate protection to ratepayers served 
by registered systems because of the 1992 Ohio Power court decision.
    The Commission recently has made some progress in protecting 
customers served by registered holding companies by using its 
conditioning authority over registered holding company public utilities 
that seek approval to sell power at market-based rates. The Commission 
has said that if such utilities want to sell at market-based rates, 
they must agree not to purchase non-power goods and services from an 
affiliate at an above-market price; they must agree that if they sell 
non-power goods and services to an affiliate, they will do so at the 
higher of their cost or a market price. However, the Commission's 
market rate conditioning authority is not enough to protect all 
registered system ratepayers against abusive affiliate contracts. Short 
of repeal of PUHCA, legislation is needed to fully remedy the 
regulatory gap.
    According to the SEC's 1995 report, service companies render over 
100 different types of services to the operating utilities on their 
systems, with non-fuel transactions aggregating approximately $4 
billion annually. This growth adds to the potential for ratepayer 
subsidies involving both the centralized and the special-purpose 
service companies.
    Another reason for heightened concern regarding affiliate abuses in 
all holding company systems, both registered and exempt, is the large 
number of holding company subsidiaries that engage in non-utility 
businesses. According to the SEC 1995 report, since the early 1980's 
the number of non-utility subsidiaries of registered companies had 
quadrupled to over 200. The trend in exempt companies is also likely to 
be significant as well. The sheer number of non-utility business 
activities brings greater potential for improper allocation of 
centralized service company costs to the non-utility businesses (i.e., 
electric ratepayers subsidizing the non-utilities' fair share of the 
costs). It also increases the opportunities for affiliate contracting 
abuses.
    To protect against affiliate abuse and cross-subsidization, federal 
and state regulators must have access to the books, records and 
accounts of public utilities and their affiliates. Under section 301 of 
the FPA (and section 8 of the Natural Gas Act), the FERC has 
substantial authority to obtain such access. It can obtain the books 
and records of any person who controls a public utility, and of any 
other company controlled by such person, insofar as they relate to 
transactions with or the business of the public utility. This, however, 
may not necessarily reach every member of the holding company. Thus 
far, there has been no significant problem in obtaining access to books 
and records and in monitoring and protecting against potential abuses. 
However, the SEC's regulatory role with respect to registered systems 
has been an added safeguard.
    It is critical that both state and federal regulators have access 
to books and records of all companies in a holding company system that 
are relevant to costs incurred by an affiliated utility. This is 
equally true with respect to both registered and exempted holding 
company systems. If Congress modifies or repeals PUHCA, it should 
clearly confirm the FERC's mandate and authority to ensure that 
ratepayers are protected from affiliate abuse. Similarly, we encourage 
Congress to be mindful of concerns expressed by state commissions and 
provide states with appropriate access to relevant books and records of 
all holding company systems.
    In addition to the above ratepayer protection concerns, there are 
several other matters that should be considered in analyzing PUHCA 
reform. These include future corporate structures in the electric 
industry, diversification activities, and the issuances of securities 
affecting public utilities.
    As mentioned earlier, the FERC must approve public utility mergers, 
acquisitions, and dispositions of jurisdictional facilities. This is an 
area in which the Commission has overlapping jurisdiction with the SEC, 
but also an area in which in some instances there is no overlap. 
Jurisdictional facilities under the FPA are facilities used for 
transmission in interstate commerce, or for sales for resale in 
interstate commerce. FERC has claimed jurisdiction over transfers of 
jurisdictional sales contracts but has disclaimed jurisdiction over 
dispositions that solely involve physical generation facilities. It 
appears that most state regulators have authority to regulate 
dispositions of physical generation assets. Further, such dispositions 
or acquisitions would be subject to the antitrust laws.
    The FERC does not have any explicit jurisdiction to approve or 
disapprove diversification activities of public utilities or holding 
companies. Thus, if PUHCA were repealed, the only federal oversight of 
diversification activities of holding companies or their public utility 
members would be through FERC auditing of books and records. However, 
the SEC does not directly review public utility diversification 
activities of other holding companies and public utilities, and this 
has not posed any significant problems in the FERC's protection of 
ratepayers. In addition, many state commissions regulate 
diversification by public utilities that sell at retail.
    A final area involves issuances of securities. The FERC must 
approve issuances of securities by public utilities that are not 
members of registered holding company systems, unless their security 
issuances are regulated by a state commission. Because the majority of 
states regulate issuances by public utilities, the FERC does not 
regulate most public utilities' issuances. If PUHCA were repealed, it 
appears that there would be no federal review and approval of issuances 
of securities by holding companies or their public utility members. The 
SEC can more appropriately address whether any federal oversight is 
necessary in this area.

    The Chairman. Thank you very much.
    Mr. Sokol, why don't you go right ahead?

  STATEMENT OF DAVID L. SOKOL, CHAIRMAN AND CEO, MIDAMERICAN 
            ENERGY HOLDINGS COMPANY, DES MOINES, IA

    Mr. Sokol. Thank you, Mr. Chairman.
    MidAmerican Energy Holding Company is a diversified 
international energy company headquartered in Des Moines, Iowa, 
with approximately $13 billion in assets. Our largest investor 
is Berkshire Hathaway, one of the only AAA-rated industrial 
companies in the United States.
    I would like to commend you for your persistence in working 
to include electricity modernization provisions in the Senate 
energy bill. S. 1766 addresses critical issues that only 
Congress can fix, covering such areas as reliability, changes 
to PURPA, FERC jurisdiction over transmission assets, PUHCA 
reform, a more thorough FERC merger review policy, and other 
consumer protection measures and information transparency 
requirements.
    As you requested, I will focus on PUHCA and the specific 
issues you have asked me to address which include consumer 
protection, barriers to investment in market entry, and 
appropriate forums for regulatory oversight.
    These issues are closely linked. 10 years ago, Congress 
passed the Energy Policy Act of 1992 in order to encourage open 
competitive wholesale electricity markets. PUHCA, passed in 
1935 at the height of the depression, remains a significant 
impediment to that goal.
    Our largest investor, Warren Buffett, has stated that he 
would intend to invest up to $15 billion in the industry once 
PUHCA is repealed or modified. Sadly, we have not invested in 
the United States for the last 2 years, but we have now 
purchased our second United Kingdom utility for $1.5 billion 
last summer. It is absurd that PUHCA's barriers to entry limit 
the ability of high credit quality investors like Berkshire 
Hathaway from investing in the U.S. utility market, thus 
forcing us to look overseas where we can invest more freely.
    There are really two stories before this committee today. 
The first is what actually happened to energy markets as a 
result of the Enron collapse, and the second is the story that 
is often spun by those who have long opposed market 
modernization measures.
    On the first story, at your hearing on this topic last 
week, there was consensus that energy markets responded to the 
Enron collapse with little, if any, disruption. The lights 
stayed on, natural gas flowed, and the consumer prices did not 
rise. This was true for the broad markets and for the consumers 
of Enron's regulated subsidiary, thus proving a point that 
PUHCA reform supporters have been making for almost 20 years. 
Aggressive, effective State and Federal regulation are the true 
keys to consumer protection.
    It is hard to imagine a company collapsing more swiftly or 
completely than Enron, yet the customers of its subsidiary, 
Portland General Electric, have been unaffected by that 
bankruptcy. This is the result of the effect of State and 
Federal regulation and the ability of State PUC commissioners 
to oversee issues of utility financing and cost recovery.
    Now, the second story, what did not happen with Enron, 
first Enron was not working to build a multistate insulate 
utility empire as has been reported. To the contrary, it had 
been looking to sell Portland General for over the past 2 
years. In fact, Enron probably would not even have been in the 
regulated utility business at the time of its collapse if PUHCA 
had not hampered its efforts to exit the business.
    And why is that? PUHCA artificially and materially limits 
the number of buyers for any utility to those utilities that 
can meet the law's physical integration provisions. For 
example, we were approached 2 years ago by Enron about buying 
Portland General, and in fact we concluded that we wanted to 
buy them but could not because of the PUHCA restrictions.
    That is what is wrong with PUHCA. It did nothing to help or 
to protect Portland General, and to the contrary, by blocking 
high credit worthy companies like ourselves, PUHCA has limited 
Enron's options so that it is now selling the company to a 
local gas utility based upon a very highly leveraged financial 
structure. This is one of the core problems of the statute. It 
serves as a barrier to entry of investment and results in 
market concentration. This arcane and counterproductive 
requirement also limits California's options as the State 
considers how best to recapitalize its utilities.
    Second, Enron did not lobby for PUHCA repeal. It was a 
leading opponent of stand-alone PUHCA legislation and testified 
before Congress numerous times that it would only support PUHCA 
repeal as a tradeoff for concessions that it wanted. This 
committee should also be aware that in the most recent 
congressional testimony by Enron on electricity policy, Enron 
opposed enhanced access to books and records, provisions that 
we and most in this industry have long favored.
    Third, Enron did not receive any special exemptions from 
PUHCA. Enron received two PUHCA exemptions from the SEC and 
both were clear cases under the law. The first was a statutory 
exemption provided to more than 50 holding companies whose 
utility operations are located primarily in a single State. And 
the second exemption concerned a question of whether a power 
marketer should be considered a public utility under PUHCA. The 
issue here was also simple. Just because you engage in energy 
trading does not make you a public utility subject to PUHCA. If 
it did, then virtually every investment bank in America that 
participates in the energy markets would also be subject to 
PUHCA. The SEC decision was clearly correct under the facts and 
the laws.
    And what about charges the Enron collapse could have been 
prevented had the company somehow been subjected to PUHCA? 
Since it is clear that Enron was properly an exempt holding 
company under PUHCA, this charge could only be true to the 
extent that Congress intends to pass a new law like PUHCA and 
apply it to every publicly traded company in America. If, as it 
has been reported, a company is willing to violate the '33 and 
the '34 securities acts, shred documents requested by Congress, 
engage in highly questionable accounting practices, knowingly 
mislead investors, and ultimately drive itself into bankruptcy, 
why would PUHCA have somehow protected those shareholders?
    American business executives must be held criminally and 
financially accountable for their illegal activities. We do not 
tell a teenager who steals from a convenience store that he can 
go scot-free if he just returns half of what he stole. Why 
should we adopt different standards for corporate executives 
and auditors?
    It may also be necessary to strengthen certain financial 
laws and regulations, but those changes need to be applied to 
all publicly traded companies not just to a small subset of 
companies in one industry.
    And at the same time, it may be appropriate to address the 
oversight of the energy futures trading activities. FERC 
Chairman Wood is moving aggressively to bring transparency and 
vibrant competition to the wholesale electric market. Some 
think he is moving too quickly; others believe he is moving too 
slowly. But few would disagree with his goal or the benefits 
that consumers will gain. This market will never achieve the 
depth, the transparency, and the level of competition we all 
seek if PUHCA's barrier to entry and investment remain in 
place.
    The reasons why you must eliminate the anti-competitive and 
anti-consumer aspects of PUHCA are clear.
    PUHCA's arbitrary limitations hurt consumers. Just last 
month, the D.C. Circuit Court of Appeals, relying on PUHCA's 
single region and physical integration requirement, remanded 
the SEC's approval of a large utility merger between AEP and 
Central and Southwest that would have produced consumer 
savings, acknowledged by the court, of $2.1 billion.
    The law's ownership restrictions keep capital out of one of 
this country's most critical industries at a time when the 
transmission sector alone requires tens of billions of dollars 
of new investment.
    The law's counterproductive requirements of interconnection 
and geographic proximity foster regional concentration, which 
runs directly counter to 50 years of antitrust law and economic 
theory.
    PUHCA hinders FERC's ability to establish large, multistate 
regional transmission organizations.
    And lastly, foreign companies are not restricted by PUHCA's 
physical integration provisions, and this gives them an 
advantage on their first bite entry into U.S. markets and sends 
American dollars overseas.
    Your bill strikes the proper balance on PUHCA reform. It 
repeals the outdated provisions and strengthens consumer 
protections. It endorses FERC policy and modern antitrust law 
by recognizing that ownership of utility assets should not be 
artificially concentrated, and that high credit quality 
companies should be permitted to enter the market. At the same 
time, it strengthens the books and records provisions of the 
law.
    If you provide regulators with better tools to protect 
consumers and provide more access to the marketplace by high 
quality companies, you will strengthen the U.S. electricity 
market.
    You cannot fix PUHCA by tinkering around its edges. The SEC 
concluded in 1995 that PUHCA had accomplished its goals by 
1952. It is time to repeal this law's antiquated and arbitrary 
physical integration requirements and its ownership 
limitations. At the same time, you can replace PUHCA with 
enhanced books and records authority and other consumer 
protections, as recommended by the chairman, and move the 
country forward to a competitive pro-consumer market.
    Thank you.
    [The prepared statement of Mr. Sokol follows:]

  Prepared Statement of David L. Sokol, Chairman and CEO, MidAmerican 
                  Energy Holdings Co., Des Moines, IA

    Thank you, Mr. Chairman. MidAmerican Energy Holdings Company is a 
diversified, international energy company headquartered in Des Moines, 
Iowa with approximately $11 billion in assets. Our largest investor is 
Berkshire Hathaway, one of the only AAA-rated companies in the United 
States.
    The Company consists of four major subsidiaries: CE Generation 
(CalEnergy) a global energy company that specializes in renewable 
energy development in California, New York, Texas and the West, as well 
as the Philippines; MidAmerican Energy Company, an electric and gas 
utility serving the states of Iowa, Illinois, South Dakota and a small 
part of Nebraska; Northern Electric, an electric and gas utility in the 
United Kingdom; and HomeServices.com, a residential real estate company 
operating throughout the country.
    I'd like to commend you for your persistence in working to include 
electricity modernization provisions in the Senate energy bill. We 
cannot pass a national energy plan for the new century while leaving in 
place a regulatory system that was already outdated at the end of the 
last. Your bill does not seek to do everything, but it does critical 
things that only Congress can do, among these are:

          1. Establishing a mandatory, enforceable electric reliability 
        regime
          2. Replacing the outdated PURPA mandatory purchase 
        requirement with measures to promote distributed generation and 
        standardize interconnection procedures
          3. Bringing all owners of significant transmission assets 
        under FERC jurisdiction to create a more seamless interstate 
        system
          4. Adopting a variety of consumer protection measures and 
        information transparency requirements
          5. Replacing the PUHCA law of 1935 with enhanced regulatory 
        access to the books and records of all utility holding 
        companies while adopting a more thorough merger review policy

    This package represents a consensus of those who have worked 
actively in support of legislation for many years and will result in a 
modernized electric infrastructure that will benefit consumers while 
providing for fair competition.
    As the American economy begins to recover, demands on our electric 
system will increase once again, and if we have not moved forward with 
the critical elements of market modernization, consumers may once again 
pay the price for an outdated system. At the same time, we should 
recognize that the pending recovery is tenuous and take steps to 
encourage the markets and American consumers that there is bipartisan 
support for positive, pro-investment initiatives.
    In your invitation to testify, you specifically asked me to comment 
on a number of issues related to the PUHCA law, including issues of 
consumer protection, barriers to investment and market entry, and 
appropriate forums for regulatory oversight.
    These three issues are unavoidably linked. Ten years ago, Congress 
passed the Energy Policy Act of 1992 in order to create open, 
competitive wholesale electricity markets so that investors, not 
consumers, would bear the risks associated with capital-intensive, 
electric generation investment. That is when PUHCA changed from being 
primarily a nuisance for companies to a burden for consumers.
    By keeping investment dollars out of the industry and perpetuating 
market fragmentation, PUHCA contributed to the failure of our electric 
infrastructure to keep pace with the demands of the growing competitive 
wholesale market. MidAmerican's largest investor, Warren Buffett, has 
publicly announced his intention to invest as much as $15 billion in 
the industry once PUHCA is repealed. However, PUHCA's barriers to entry 
prevent him from making these investments, particularly in transmission 
and distribution assets.
    Last year, I testified in both the Senate and the House of 
Representatives as to how PUHCA blocked MidAmerican from making major 
investments in the California utilities that could have helped 
stabilize their financial positions during the early part of the energy 
crisis. PUHCA's ownership limitations and physical integration 
requirements stood in the way.
    PUHCA is also complicating attempts by the company to make a major 
expansion of our geothermal development in the Imperial Valley in 
Southern California. While we have begun a smaller project, we cannot 
undertake any expansion that would require us to build significant new 
transmission facilities to bring this power to the grid without 
potentially running afoul of PUHCA.
    Some have claimed in recent contacts to the SEC that one cannot 
invest in a regulated utility asset and also make good non-utility 
investments. No law can make a good investor or a bad investor. Nor 
should any law determine that a person who invests in one industry 
should not be able to invest in another provided there are no conflicts 
of interest.
    PUHCA and those who support its predetermined limitations on who 
can invest in this industry take a shortsighted approach. The way to 
protect consumers is not to maintain a Chinese wall around investment 
in this industry it is to maintain effective separation of the 
financing and rate structures of regulated utilities and their assets 
and any affiliated operations.
    There has not been much good news in energy markets in recent 
months, and even conservatively managed traditional utilities are 
feeling financial pressure. This will make it harder than ever for the 
industry to raise capital and build new infrastructure. And, as 
consumers in California and the West experienced in recent years, 
market failure is the ultimate anti-consumer result.
    PUHCA is not, and never was designed to be primarily a consumer 
protection statute. The overwhelming focus of the law is on preventing 
corporate malfeasance that harms investors. By eliminating financial 
abuses, Congress certainly expected that consumers would benefit, but 
PUHCA does not address rates, and the implementing agency, the SEC, has 
no rate setting function or expertise.
    Simply put, if the issue is protecting consumers from unfair rates, 
FERC and the states have developed the expertise over almost seventy 
years to perform these functions. The SEC has absolutely no rate-
setting function and has emphasized this fact on many occasions before 
Congress.
    On the issue of cross-subsidies, the appropriate protection against 
cross-subsidization is the books and records access provided in the 
bill. Using my own company as an example, if the state of Iowa had 
concerns that MidAmerican Energy was inflating rates in our retail 
electric or gas tariffs to support a competitive business in some other 
state, under the bill, state regulators would have an explicit right in 
federal court to gain access to the books and records of any affiliated 
business in any other state that had conducted business with the 
utility.
    At the same time, the Committee should be wary of attempts to make 
FERC some type of super-regulator of retail rates in all fifty states 
in the name of stronger protections against cross-subsidization. FERC's 
expertise is wholesale rates. State commissions are closest to the 
details of retail rate-setting and capital structure decisions. 
Muddying the water on this fairly clear distinction would be a recipe 
for disaster. We've already seen during the California crisis the 
debilitating impact that finger-pointing between Washington and the 
states can have on effective regulation. We should not go down that 
road.
    The only rate-related provision of PUHCA relates to ``at cost'' 
pricing. While the law seeks to ensure that utilities and their 
affiliates do not engage in inter-affiliate pricing schemes to inflate 
consumer costs, the ``at cost'' requirement in the PUHCA law actually 
limits the ability of state and federal regulators to require 
registered holding companies to price some goods and services at the 
lower of ``at cost'' or market rates.
    Much of this ground has been well-covered in recent years. That is 
why the PUHCA provisions included in this bill have been part of 
virtually every electricity modernization bill introduced in the last 
several Congresses, have enjoyed the support of the last four 
Administrations and the regulatory agencies that enforce the laws, and 
passed the Senate Banking Committee earlier this year by a 19-1 vote.
    What has changed then?
    We are here this morning because a few long-time opponents of 
updating the PUHCA law have made new claims arising from the Enron 
collapse. It's worth noting that one of these advocates stated last 
December that he could support the electricity provisions of this bill 
in its present form. But, I suppose that Enron fell, and opportunity 
knocked.
    There are really two stories before this Committee today. The first 
is the story of what actually happened to energy markets as a result of 
the Enron collapse. These events should reassure the Committee that you 
should move forward with this legislation.
    The second story is the one spun by those who have long opposed 
market modernization measures. It poses a series of events that did not 
happen and attempts to force supporters of PUHCA legislation to prove 
that these events could not have happened. Taken to its logical 
conclusion, this ``expand PUHCA'' agenda would require Congress, FERC 
and the states to unravel more than a decade's efforts to create open, 
vibrant and transparent energy markets.
    The reason why this is so is instructive. Virtually every element 
of modern competitive electricity markets exists either as an explicit 
statutory exemption from PUHCA or as a result of regulatory 
determinations that gave flexible interpretations to PUHCA.
    A ``fundamentalist'' view of PUHCA, that every electric or gas 
company that sells on the grid should be registered, would result in 
complete market concentration, elimination of the marketing industry 
and gutting of the EWG exemption since almost all EWGs rely on either 
an affiliated marketing company or independent marketers to sell 
competitive electricity.
    Let's start with the first story. What happened to energy markets 
as a result of the Enron collapse?
    At your hearing on this topic last week there was consensus that 
energy markets responded to the Enron collapse with little, if any, 
disruption. The lights stayed on, natural gas flowed, and consumer 
prices did not rise. This is true not only for the markets generally, 
but also for wholesale and retail customers of Enron's subsidiaries.
    In December, all four FERC Commissioners testified before the House 
Energy and Air Quality Subcommittee that electric and gas markets had 
responded to the Enron collapse with remarkable resiliency. Chairman 
Wood repeated that assessment before this committee last week, along 
with independent market analysts, market participants and a 
representative of the state regulators.
    In fact, the situation of the customers of Enron's retail electric 
and gas pipeline subsidiaries proves the argument that PUHCA 
legislation supporters have been making for almost twenty years, which 
is that aggressive, effective state and federal regulation are the true 
keys to consumer protection, not a statute that deals primarily with 
details of corporate structure.
    It's hard to imagine a company collapsing more swiftly or more 
completely than Enron, yet the customers of Portland General and 
Northern Natural Gas, Florida Gas Transmission, Transwestern Pipeline 
and North Border Partners have been unaffected by the bankruptcy.
    PGE's assets and operations have both regulatory and contractual 
safeguards. PGE has its own legal identity as a corporation, separate 
from Enron. It owns its own assets, and its management runs day-to-day 
operations, and its financial health is in good standing, as confirmed 
recently by several securities rating services.
    This is the result of effective state and federal rate regulation 
and the ability of state commissions to oversee issues of utility 
financing and cost recovery. This is where real consumer protection 
occurs in electric and gas markets.
    On the separate issue of whether Enron had been manipulating 
forward electricity markets, I commend the Committee for bringing these 
concerns to light.
    In December, I met with members and staff on both sides of the 
aisle of the House Energy and Commerce Committee and shared my view 
that if there was any part of Enron's energy assets that had the 
potential for abuse, it was that company's domination of the ``mark-to-
market'' exchange.
    The allegations that Enron may have manipulated forward markets are 
troubling, and I encourage the Committee to pursue these further.
    However, I am not aware of any way these issues could be linked to 
PUHCA. For those who argue that this shows that the Enron collapse did 
impact energy markets, I would respond that, if these allegations are 
proven true, it appears to have affected them in a positive direction 
for consumers.
    Let's now look at the second story, what did not happen.

1. Enron was not working to build a multi-state Insull-like utility 
        empire
    To the contrary, it was looking to sell Portland General. In fact, 
Enron probably would not even have been in the regulated utility 
business at the time of its collapse if PUHCA had not hampered its 
efforts to exit that business.
    Why? PUHCA artificially limits the number of potential buyers of 
any utility to non-utilities and those utilities who can meet the law's 
physical integration requirements. The physical integration requirement 
demands that two utility systems must be capable of interconnection to 
be legally combined under PUHCA. This is one of the core problems of 
PUHCA. It serves as a barrier to entry and investment and results in 
market concentration.
    This arcane and counterproductive requirement also limits 
California's options as the state considers how best to recapitalize 
its utilities.

2. Enron did not lobby for PUHCA repeal
    It was a leading opponent of stand-alone PUHCA legislation and 
testified before Congress that it would only support PUHCA repeal as a 
trade-off for concessions it wanted.
    Enron's overall policy position with regard to traditional 
utilities can perhaps best be described as disqualify and dominate: 
Work to keep asset-backed utilities out of emerging energy markets, 
then dominate those markets.
    The Committee should also be aware that in its most recent 
congressional testimony on electricity policy, Enron opposed enhanced 
access to books and records, provisions that we have long favored.
    On July 22, 1999, Enron's Executive Vice President Steven J. Kean 
testified before the House Energy and Power Subcommittee, ``we have 
concerns that H.R. 2363 creates unneeded regulatory oversight of 
affiliated companies that have no need for additional regulation of 
their books and records.''
    Supporters of PUHCA modernization and reform want more competitors 
in the marketplace, not fewer, and support giving federal and state 
regulators more tools to protect consumers.

3. Enron did not receive special exemptions from PUHCA
    Enron received two PUHCA exemptions from the SEC. Both were clear 
cases under the law.
    The first was a statutory exemption provided to more than 50 other 
holding companies whose utility operations are primarily located in a 
single state.
    The second exemption concerned the question of whether a power 
marketer should be considered a ``public utility'' under PUHCA. PUHCA 
defines an ``integrated public-utility system'' as, ``a system 
consisting of one or more units of generating plants and/or 
transmission lines and/or distributing facilities, whose utility 
assets, whether owned by one or more electric utility companies, are 
physically interconnected or capable of interconnection.''
    The claim that the ``no action'' letter Enron received for Enron 
Power Marketing Inc. constituted a special exemption for Enron that 
ultimately allowed the company to escape regulatory scrutiny is the 
entire basis for the claim before the Committee today. However, for the 
SEC to have found otherwise would have required it to find that the 
assets of marketers--office equipment, paper contracts, and computer 
data--are ``facilities'' of public utilities comparable to generating 
plants and transmission lines.
    This raises the interesting question of how these types of 
``facilities'' could meet PUHCA's ``physical integration'' requirement. 
Obviously, they could not, and no other decision by the SEC seems 
supportable under either the facts or the clear definition in the law.
    More importantly, had the SEC decided otherwise, the entire power 
marketing industry would probably not have developed.
    It's hard to think of any single decision that would have had a 
more negative impact on consumers and competitive wholesale markets.

4. What about the other exemption mentioned in the New York Times?
    This exemption, to the Investment Company Act of 1940--not PUHCA--
is the exemption that some have claimed allowed Enron to engage is some 
activities that played a significant role in the company's collapse.
    This appears to raise some genuine issues--but these issues have 
nothing to do with PUHCA, and attempts to use the Investment Company 
Act exemption as a way to derail electricity modernization are clearly 
opportunistic.

5. But couldn't the Enron collapse have been prevented had Enron 
        somehow been subjected to PUHCA?
    Since it's clear Enron should not have been considered a registered 
holding company, this could only be true to the extent that Congress 
would apply PUHCA-like financial regulations to every other publicly-
traded company, energy or non-energy. There is nothing unique about the 
energy industry concerning Enron's financial activities.
    If, as has been reported, a company is willing to risk violating 
the '33 and '34 Securities Acts, shred congressionally requested 
documents, engage in highly questionable accounting practices, 
knowingly mislead investors, and ultimately drive itself into 
bankruptcy, why would we believe that PUHCA would somehow protect its 
shareholders.
    Congress can and should conduct a thorough review of all the 
accounting, bookkeeping, pension and corporate governance issues raised 
by this scandal. In some cases, laws and regulations may need to be 
strengthened. But these changes should be applied to all publicly-
traded companies, not to a small subset of companies in one industry.
    FERC Chairman Wood is moving aggressively to bring the wholesale 
electric energy market to an end-state of transparency and vibrant 
competition. Some are concerned that he is moving too quickly; others 
may believe he is moving too slowly. Few would disagree with his goal 
of achieving that end-state or the benefits that consumers will gain 
when we get there.
    In his testimony before the Committee last week, he said, ``If 
Congress'' policy goal is to promote wholesale energy competition and 
new infrastructure construction, then reform of the Public Utility 
Holding Company Act of 1935 (PUHCA), supplemented with increased access 
by the Commission to the books and state regulators to certain books 
and records, will help energy consumers. Energy markets have changed 
dramatically since enactment of PUHCA, and competition, where it 
exists, is often a more effective constraint on energy prices. In the 
65 years since PUHCA was enacted, much greater state and federal 
regulation of utilities and greater competition have diminished any 
contribution PUHCA may make toward protecting the interests of utility 
consumers.''
    This is not just the view of Chairman Wood, but also all the 
members of the Commission, and all his predecessors in the last decade. 
They have understood that this market will never achieve the depth, 
transparency and level of competition we all seek if PUHCA's barriers 
to entry and investment remain in place. The reasons why you must 
eliminate the anti-competitive and anti-consumer aspects of PUHCA are 
simple:
    PUHCA's arbitrary limitations hurt consumers. Just last month, The 
D.C. Circuit Court of Appeals remanded the SEC's approval of a large 
utility merger that would provide consumers and the companies involved 
more than $2 billion in savings, based solely on concerns related to 
PUHCA's single region and physical integration requirements.
    While some have claimed that this decision represented some form of 
victory for consumer interests, I disagree. Quoting from the ruling, 
the Court wrote, ``According to Petitioners, the Commission erred in 
accepting (the two companies') projections that the proposed merger 
would produce approximately $2.1 billion in cost savings. We disagree. 
We owe considerable deference to the Commission's assertion that it 
`reviewed the assumptions and methodologies that underlie' the 
projections and found them `reasonable and consistent with . . . 
precedent.' Moreover, Petitioners point to no evidence or expert 
testimony supporting their assertion that the companies' calculations 
were flawed.''
    The law's ownership restrictions keep capital out of one of this 
country's most critical industries at a time when needs in the 
transmission sector alone will require tens of billions of dollars in 
new investment. As I mentioned before, Mr. Buffett has publicly stated 
his intent to invest as much as $15 billion in the industry if PUHCA is 
repealed.
    The law's counterproductive requirements of interconnection and 
geographic proximity foster regional concentration, directly counter to 
50 years of antitrust law. As I mentioned during testimony in the House 
last year, one of the ironies of PUHCA is that the only other utility 
that MidAmerican could purchase without running afoul of the Act are 
the utility assets of the only other investor-owned utility in the 
state.
    As representatives of FERC have testified on numerous occasions, 
PUHCA hinders their ability to establish large, multi-state regional 
transmission organizations.
    PUHCA also provides foreign companies which are not restricted by 
the physical integration standard an advantage on their ``first bite'' 
entry into the U.S. market and, at the same time, sends overseas 
American dollars that could be invested here. In view of the series of 
negative events that have buffeted this sector beginning with the 
crisis in California and the West, the overall economic downturn and 
the negative financial impact of the Enron collapse on much of the 
sector, I believe we could see a substantial increase in this trend in 
the next several years.
    Congress cannot fix PUHCA by tinkering around its edges. The 
physical integration requirement and ownership limitations that are 
it's main problems are embedded in the statute's core. You can, 
however, replace PUHCA with enhanced books and records authority and 
the other consumer protection measures recommended by Chairman Bingaman 
and move the country forward toward a competitive, pro-consumer market.

    The Chairman. Thank you very much.
    Mr. Hempling, you are the cleanup witness here on this 
panel. Go right ahead.

STATEMENT OF SCOTT HEMPLING, ATTORNEY AT LAW, SILVER SPRING, MD

    Mr. Hempling. Thank you, Mr. Chairman and members of this 
committee. My name is Scott Hempling. My law practice 
represents many of those who are beneficiaries of the Public 
Utility Holding Company Act, State commissions and consumers. 
Repealing the act, without substituting modern regulatory tools 
will leave those interests unprotected.
    Repeal of the act, they say, in competition will flourish. 
Let us examine this argument.
    At the Federal level, in the summer of 2000, the electric 
industry moved from the back pages of the business section to 
the front pages of the main section. The California price hikes 
that summer were the natural culmination of 20 years of 
carelessness in the analysis of wholesale markets, in the 
design of mechanisms to make those markets work, and in the 
design of consumer protections for when those markets do not 
work.
    Consider the shifting rationales supporting FERC's foray 
into market pricing since the late 1970's. First, the rationale 
was to increase supplies. Then the rationale was to increase 
performance and coordinating services. Then the rationale was 
to compensate utilities for new risks. Then the rationale was 
to stabilize the weaker companies. And then came two new 
rationales: first, that energy pricing was justified by a 
competitive market; and next, that market pricing was necessary 
to attract entry into a non-competitive market. Notice the 180 
degree turn in the last two rationales. Both cannot be correct. 
Yet, for over 20 years, all of these rationales were accepted 
by the Federal Energy Regulatory Commission.
    To its credit, the present FERC is bringing these issues 
forward openly and forthrightly. Recent issuances from the FERC 
on market analysis and refunds reveal how significant were the 
past errors and how difficult is the work ahead. But no one 
knows how long it will take to make wholesale markets work.
    Concerning regional transmission policy, core to the 
competitiveness of wholesale markets, anyone not recently freed 
from solitary confinement knows that, after 30 years of 
discussion, almost every issue remains on the table: 
independence for market participants, geographic scope and 
configuration, operational authority, short-term liability 
authority, tariff administration design, congestion management, 
parallel path flow, ancillary services, market monitoring, 
inter-regional coordination. While the present FERC has made 
dramatic progress in the past 7 months, this FERC would be the 
first to admit that the date on which all markets will be 
served by RTO's that are independently governed, efficiently 
priced, reliably operated, and publicly accountable is known by 
no one. In both these areas, market pricing and transmission, 
the present FERC is grappling with the problems and alternative 
solutions, but no one objective can credibly pinpoint the date 
on which these defects will disappear.
    On multistate mergers, the industry consolidation is 
accelerating, but FERC merger policy has failed to hold mergers 
to the efficiency tests which would be required in a 
competitive market. Specifically, the FERC does not compare a 
proposed merger to alternative outlets for investment. It does 
not, in comparing costs and benefits, take into account 
acquisition costs, but instead focuses only on implementation 
costs and accounts as benefits coordination savings which could 
be obtained without a merger. That's at the FERC level.
    At the State level, significant barriers to wholesale 
competition remain. Utilities are still retail monopolies 
almost everywhere. Retail ratemaking, using techniques in place 
for most of the last century, still induces utilities to favor 
the rate-basing of their own plants rather than buying on the 
wholesale market, and there is a market trend toward 
questioning construction at the State level by independent, 
out-of-state entrepreneurs. Even perfect Federal policies 
cannot create wholesale competition when State policies 
discourage wholesale competitors.
    These facts should not surprise us because for most of this 
century the Government has given to a select set of 
corporations exclusive control over some of the Nation's most 
important assets, facilities for the generation, transmission, 
and distribution of electricity. So, despite the talk of 
competition, most utilities retain exclusive franchises to sell 
at retail, plus control of the transmission highways, plus 
influence over who will compete to sell generation in their 
service territories, plus influence over who will compete to 
provide demand site management services, still plus the right 
to sell generation to other service territories inside and 
outside the United States.
    Our electric utilities have what economists call market 
power, the power to prevent competitive markets from working. 
The Public Utility Holding Company Act is a statute about 
market power. Repealing the statute, without addressing the 
problem of market power, is contrary to competition.
    Let us now look more closely at some of the arguments for 
repeal. The Holding Company Act addressed mergers with a simple 
rule: only those mergers justified by improvement in physical 
operations would be permitted and then only if those mergers 
did not cause concentration of control or produce a complex 
capital structure or otherwise harm the public interest. So, in 
1935, the Congress blocked all non-integrating acquisitions 
because it saw no possible benefit from them. Neither wholesale 
competition nor retail competition was evident at the time.
    Today we want more wholesale competitors, so there is a 
legitimate question about the value today of the Holding 
Company Act's prohibition on non-integrating acquisitions. And 
in 1992, in the Energy Policy Act, Congress eliminated the 
prohibition for wholesale generators.
    That brings us to the question of retail competition. In 
those States where retail competition is legally authorized, it 
is true today that the Holding Company Act's prohibition on 
non-integrating acquisitions limits the number of players in 
that market to those whose physical operations are integrated 
with that market. A retail customer shopping there would be 
better served with more players. Thus, the question whether to 
relax the Holding Company Act's ban on non-integrating 
acquisitions in this specific context is worth considering, and 
the legislative treatment I explain in my testimony makes room 
for such an adjustment.
    But this reasoning does not apply at all in a retail market 
for which competition has not been authorized. In that non-
competitive context, the Holding Company Act presents a barrier 
not to competitive entry but to monopolistic acquisition. That 
distinction deserves emphasis. There is a significant 
difference between financial entry and competitive entry. The 
acquisition by one monopolist by another is a change in 
control, not an increase in competition. To call this entry and 
then to criticize the Holding Company Act because it blocks 
market entry is to misuse the term. It is entry into a new 
market from the perspective of the acquirer seeking new captive 
customers, but it is not a new competitive entrant from the 
perspective of those captive customers for the simple reason 
that there is no competition.
    Turning to S. 1766, the central themes of the Holding 
Company Act remain relevant today: preventing utility 
acquisitions that are not justified by efficiencies, limiting 
speculative investments, prohibiting inter-affiliate 
transactions, and restricting unsound practices. Therefore, 
acquisitions need to be continued on findings that they are the 
product of a competitive market, that they produce measurable, 
guaranteed benefits for the ratepayers of both the acquirer and 
the acquiree, that they do not weaken the financial strength of 
either the acquirer or the acquiree, and that they do not 
deprive existing utility customers of the benefits associated 
with their past contributions.
    Title II of S. 1766 makes important contributions by 
clarifying the FERC's jurisdiction over mergers and by 
emphasizing care in the granting of sellers the right to charge 
market-based rates. But with the repeal of the Holding Company 
Act, the commission will need more substantial affirmative 
authority so as to screen in those acquisitions which promote 
efficiency and competition and screen out those acquisitions 
which do not.
    Congress should transfer the regulatory responsibilities 
concerning the Holding Company Act to FERC. There seems to be 
consensus on that subject, for while FERC has not always 
pleased all its constituents and while it has used 
methodologies for merger review and market pricing that are 
disconnected from economic logic, it has remained publicly 
committed to the Federal Power Act.
    The Public Utility Holding Company Act has not enjoyed 
comparable respect. 20 years ago, the SEC took the position 
that the act no longer was necessary because regulators could 
protect the consumer, and the agency held to this position 
firmly, right through the era of nuclear cost overruns, right 
through the era of savings and loan failures, through the era 
of the bankruptcies of three multi-billion dollar utilities, 
right through to 1996 when FERC officially discovered, 2 
decades later than everyone else, that transmission owners 
exercised market power in generation markets, and even through 
the California market failure, that transferred billions of 
dollars from customers to generators.
    Now the rationale has shifted. If regulators do not protect 
the consumer, competition will. Yet FERC, the very agency to 
which the SEC claims to defer, acknowledges the difficulties in 
implementing competition.
    A world without the Holding Company Act. What would it look 
like? Without the Holding Company Act or its modern 
replacement, we would have a world of unreviewed acquisitions 
of retail monopolies, unlimited mixing of businesses which 
serve captive customers businesses, which take their risks into 
competitive markets, and no advanced reviews of the prudence of 
securities issuances. All this would take place in a world in 
which most retail customers have no competitive choices and in 
which the Nation's chief electric regulator acknowledges that 
wholesale competition is a work in progress.
    We can do much better. We can relax the integration 
requirement, as other witnesses have pointed out. We can put 
limits on diversification, but allow it upon a showing of 
customer benefit and competitive improvement. And we can 
establish clear obligations in FERC to apply economic 
efficiency and competitive market standards to mergers.
    That brings me to Warren Buffett who wants to enter the 
industry. He is more than welcome. He can come in as an exempt 
wholesale generator under the Energy Policy Act. He can buy an 
unlimited number of generation companies anywhere in the 
country without review. He can come in as a retail marketer or 
broker under rule 58 of the SEC. He cannot come in at this time 
and acquire existing monopoly assets. Let me emphasize. There 
are three ways he can enter the industry. The first two ways, 
he would be subject to what everybody argues is heated 
competition. In the third way, he can come in as a monopolist. 
Who would not complain about a statute that prevented him from 
picking up monopoly assets and selling to customers who have no 
choice but to buy his product? But even in this third way, Mr. 
Buffett should not be denied. If he can show that his entry is 
the product of competition, real competition, where he has to 
fight tooth and nail to win the favor of the ratepayers that he 
seeks to serve, then in my mind we should amend the Holding 
Company Act to let him in.
    In closing, the electric industry lacks effective 
competition in many markets. Congress cannot nurture 
competition by giving free rein to companies which for a 
century have avoided competition, and Congress cannot protect 
consumers by confusing financial entry with competitive entry. 
To repeal the Holding Company Act without establishing a modern 
regulatory regime, one that conditions acquisitions on real 
competition and attentive regulation, is to allow dominant 
incumbents to exploit unearned advantages. Calling the result 
competition is good fiction but it is not good policy.
    Thank you for the opportunity to present this testimony. I 
look forward to your questions.
    [The prepared statement of Mr. Hempling follows:]

      Prepared Statement of Scott Hempling, Attorney at Law, 
                   Silver Spring, MD

    Mr. Chairman and Members of the Committee:
    My name is Scott Hempling. I am the principal in a law firm which 
advises public and private sector clients involved in regulated 
industries, particularly state regulatory commissions and organizations 
of consumers or consumer representatives. I have represented clients in 
many cases under the Public Utility Holding Company Act of 1935 
(PUHCA), before the Securities and Exchange Commission (SEC) and the 
U.S. Court of Appeals. I have testified before this and other 
Congressional committees many times on PUHCA and other electric 
industry matters. My testimony today reflects my own views, and not 
necessarily those of any past or current client.

                 I. INTRODUCTION: IS COMPETITION HERE?

    Proponents of PUHCA repeal assert that ``competition is here,'' or, 
that competition will be here once the Act is gone. These statements 
suffer from a lack of precision. Competition remains elusive, and those 
seeking to implement it struggle with a long list of unresolved issues, 
at both the FERC and state levels.

A. Competition Remains Elusive
    For most of the last century, the combined actions of federal and 
state policymakers have given a selected set of companies the exclusive 
power to own the strategic assets of the electric industry: generation, 
transmission and distribution.
    In two major efforts, Congress tried to stimulate a substantial 
nonutility presence in the generation sector. The Public Utility 
Regulatory Policies Act of 1978, and the Energy Policy Act of 1992, 
created categories of wholesale generating companies that would avoid 
``electric utility'' status under PUHCA. Avoiding PUHCA meant that 
anyone could acquire any number of these generating companies in any 
location, using any corporate structure, unaffected by the various 
PUHCA requirements.\1\ The PUHCA repeal sought today, in the name of 
competition, was largely granted in 1978 and 1992 for the wholesale 
generating sector.
---------------------------------------------------------------------------
    \1\ The exception is the limit on the share of a PURPA ``qualifying 
facility'' that can be owned by a utility.
---------------------------------------------------------------------------
    PUHCA repeal at wholesale has not brought effective competition at 
wholesale. Despite some inroads by independent companies, most 
generation remains concentrated in traditional utilities or their 
affiliates. As discussed in Part I.B and C. below, we face a long 
struggle before electric generation looks like the competitive 
commodity markets that characterize wheat, soybean and pork bellies.
    In the meantime, those who control generation are exploiting their 
advantages. Mergers of utilities with market power have become almost 
routine. These efforts at ``strategic positioning'' might be benign in 
a competitive environment. But in an industry infected with market 
power in every major asset and service segment, these mergers are 
biasing markets against competition for years to come.
    Under these conditions, the repeal of PUHCA, on a stand-alone 
basis, can only make matters worse. Freeing dominant incumbents to 
acquire others may improve their own standing, but it will not improve 
the electric industry. It will burden further our regulators, and the 
customers they try to protect.
    As discussed in Part I.B below, the Federal Power Act, in its 
design by Congress in 1935 and in its implementation by the Federal 
Energy Regulatory Commission (FERC) today, has serious gaps. Meanwhile, 
state regulators are striving to keep up with today's changes. But 
state regulation was a tool designed primarily to regulate local 
utilities and local transactions. The number and complexity of 
multistate transactions today pose real difficulties for State 
regulation. Many state commission staffs are struggling with the 
burdens of rate cases, intervention in FERC proceedings concerning 
mergers and transmission access, as well as the numerous changes in the 
gas and telecommunications industries.

B. The Implementation Struggle at FERC
    On three key issues--measuring competitiveness, regional 
transmission service and mergers--the industry and its regulators lack 
a common understanding and commitment.

            1. Measuring Competitiveness
    The California price spikes of 2000 were the natural culmination of 
20 years of carelessness in the (a) analysis of wholesale markets, (b) 
design of mechanisms to make those markets work and (c) design of 
consumer protections for when those markets do not work.
    Consider the shifting rationales supporting FERC's departure from 
cost-based ratemaking since the late 1970's:

          --desire to increase supplies
          --increase performance in coordination services
          --desire to compensate for new risks
          --financial stabilization of weaker companies
          --market pricing is justified by a competitive market
          --market pricing is necessary to attract entry into a 
        noncompetitive market

    The sixth rationale was offered by many generators during the 
California summer and repeated by the then-FERC Chairman. Notice the 
180 degree turn from the preceding rationale. Only one of those 
rationales can be lawful. Yet both rationales, and most others 
rationales offered by applicants over the past 20 years, were accepted 
by the Commission, although not without dissent.
    To its credit, the present FERC is bringing these issues forward, 
openly and forthrightly. Recent issuances on market analysis and 
refunds reveal how significant were the past errors and how difficult 
is the work ahead.

            a. Recent Actions on Market Measurement
    There finally has been official recognition of the illogic plaguing 
the ``hub and spoke'' and ``delivered price test'' approaches to market 
measurement, and the need to replace them. On the subject of ``hub and 
spokes'' method, FERC itself has explained its deficiencies:

          An accurate assessment of the effect on markets depends on an 
        accurate definition of the markets at issue. The Commission's 
        current analytic [hub-and-spoke] approach defines geographic 
        markets in a manner that does not always reflect accurately the 
        economic and physical ability of potential suppliers to access 
        buyers in the market. . . .
          A drawback of this method of defining geographic markets is 
        that it does not account for the range of parameters that 
        affect the scope of trade: relative generation prices, 
        transmission prices, losses, and transmission constraints. 
        Taking these factors into account, markets could be broader or 
        narrower than the first- or second-tier entities identified 
        under the hub-and-spoke analysis. . . .
          Another concern with the [hub-and-spoke] approach . . . is 
        its analytic inconsistency. It defines the scope of the market 
        to include the directly interconnected utilities that are 
        accessible due to the applicants' open access tariff, but does 
        not expand the market to recognize the access afforded by other 
        utilities' tariffs. This was acceptable before open access was 
        established as an industry-wide requirement for public 
        utilities.

Merger Policy Statement, Docket No. RM96-6-000, 61 Fed. Reg. 68595 at 
68599 (Dec. 30, 1996) (emphasis added).
    Yet FERC, until about two months ago (about five years after 
acknowledging its serious defects), continued to apply the ``hub and 
spoke'' test to all applications for market-based pricing.
    Then, on November 20, 2001, FERC came to terms with the fact that 
market-based rates had been approved for entities able to exercise 
market power. AEP Power Marketing, Inc., 97 F.E.R.C. para. 61,219 (Nov. 
20, 2001) (order on triennial market power updates and announcing new, 
interim generation market power screen and mitigation policy). That day 
the Commission issued an order replacing its ``hub and spokes'' test 
for market pricing with a new interim test called the Supply Margin 
Assessment (SMA). The Commission stated that it had concluded that, 
``because of significant structural changes and corporate realignments 
that have occurred and continue to occur in the electric industry, our 
hub-and-spoke analysis no longer adequately protects customers against 
generation market power in all circumstances.''
    Under the SMA, FERC will ask whether the applicant for market 
pricing has an amount of capacity which exceeds the supply margin 
(excess of supply over peak demand) in the prospective buyer's control 
area, taking into account transmission constraints. Where it finds that 
the seller controls supply resources exceeding the supply margin, FERC 
will conclude that the applicant seller is in a position to exercise 
market power and may limit the buyer to a ``split savings'' price 
rather than a market price.
    FERC's November 20 order applied the new test in pending cases for 
renewal of market rate authority involving American Electric Power Co., 
Entergy Corp. and the Southern Cos. Within the control areas of each of 
the companies, the Commission found that the companies could exercise 
market power ``because [their] generation is needed to meet the 
market's peak demand.'' The Commission therefore imposed mitigation 
measures.

            b. Recent Actions on Refunds
    Only in the last two months has the Commission moved to establish 
an express refund mechanism that protects consumers from market rates 
which, while perhaps just and reasonable at the time they were 
authorized, might become unjust and unreasonable later due to a decline 
in competitive forces. See Investigation of Terms and Conditions of 
Public Utility Market-Based Rate Authorizations, 97 F.E.R.C. para. 
61,220 (Nov. 20, 2001) (order establishing refund effective date and 
proposing to revise market-based rate tariffs and authorizations). The 
proposed order would amend all market rate tariffs to clarify that 
where FERC finds that a seller with market rate authority has acted 
anti-competitively, FERC may issue a refund order. The order indicates 
that in ordering refunds the Commission will focus on two types of 
anti-competitive behavior--physical or economic withholding of 
supplies.
    In short, the present FERC is struggling, openly and determinedly, 
to solve, on many fronts at once, a set of problems that has smoldered 
for years. But this very struggle is cause for caution. As hardworking 
and determined as they are, the present FERC Commissioners, like any 
prudent regulators, likely would hesitate to name a date on which they 
expect to see effective competition in all wholesale markets.

            2. Regional Transmission Service
    As to regional transmission policy, anyone not recently freed from 
solitary confinement knows that after 30 years of discussion almost 
every issue remains on the table:

                  --Independence from market participants
                  --Geographic scope and configuration
                  --Operational authority
                  --Short-term reliability authority
                  --Tariff administration and design
                  --Congestion management
                  --Parallel path flow
                  --Ancillary services
                  --Market monitoring
                  --Transmission planning and expansion
                  --Interregional coordination

    While the present FERC has made major progress in the past 7 
months, this FERC would be the first to admit that the date on which 
all markets will be served by RTOs that are independently governed, 
efficiently priced, reliably operated and publicly accountable is known 
by no one.

            3. Mergers
    Under Section 203 of the Federal Power Act, the FERC must 
disapprove mergers that are not consistent with the public interest. 16 
U.S.C. 824b. Beginning in 1985, a process of consolidation began and 
accelerated in the second half of the 1990s. Mergers are now routine; 
yet there has been neither consensus nor clarity concerning FERC's 
merger analysis. Merger review at FERC remains economically 
indefensible. This conclusion follows from four merger principles that 
have emerged from various FERC cases:

          a. The public interest is protected if costs do not exceed 
        benefits, even though there might be other mergers or other 
        investments which can produce the same benefits at a lower 
        cost.
          b. In comparing costs to benefits, FERC disregards 
        acquisition cost and counts only implementation cost.\2\
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    \2\ One would not buy a rental property merely because the expected 
rent exceeded the costs necessary to rehabilitate and maintain the 
space for tenants. One would buy the property only if the expected rent 
exceeded these implementation costs plus the acquisition cost.
---------------------------------------------------------------------------
          c. The FERC counts as ``benefits'' coordination savings which 
        could be obtained without a merger.
          d. The FERC counts as ``benefits'' elimination of pre-merger 
        imprudence.

    Put simply, the present merger review standards do not distinguish 
efficient mergers from inefficient mergers. In a competitive market, a 
merging partner employing this analytical casualness would lose its 
shirt; in a regulated monopoly setting, the shirts are the customers'. 
This policy, applied repeatedly for 16 years, has done long-term damage 
to the cause of competition. There remains no process, either 
competitive or regulatory, that distinguishes combinations based on 
efficiency from combinations based on market share maintenance or 
market dominance.

C. The Implementation Struggle at the State Level
    The problem of wholesale competition is not FERC's alone. The most 
pro-competitive FERC policies will not produce wholesale competition if 
entry is blocked in other ways. Several clouds appear, not only on the 
horizon but directly overhead:
    1. Accommodating utility preference for self-construction: Few 
states have policies mandating that retail utility monopolies purchase 
their needs on the wholesale market. Leaving the choice with the 
vertically integrated utility creates strong bias favoring vertical 
integration and disfavoring wholesale competition.
    Only occasionally is it in a utility's interest to forego 
construction (which would add to its rate base and therefore add to its 
profit), in favor of purchasing power from others (which assigns the 
profit to the generator and makes the utility a mere cost conduit).
    2. State concerns with independent generation: Most states work 
mightily to attract physical investment: investment which creates jobs, 
broadens the tax base and, in the case of exporting industries, 
increases the state's trade surplus. In the case of new non-utility 
generation, this practice does not seem to exist; in fact the trend is 
in the opposite direction. An increasing number of states are 
questioning the benefits of allowing generation construction by 
companies that do not have firm loads, or who have customers located 
outside the state. In some instances, legal and political opposition to 
such construction has come from the incumbent utilities, who do not 
want competitors to gain a beachhead in their home markets. In other 
instances, there is legitimate concern from citizens wishing to avoid 
excess construction. Some seek to limit construction of generation in a 
state to plants intending to serve load in that state, even though such 
``hoarding'' of in-state benefits and obstruction of interstate trade 
is a per se violation of the Commerce Clause of the U.S. Constitution. 
See New England Power Co. v. New Hampshire, 455 U.S. 31 (1982) 
(invalidating state law, which preserved benefits of state 
hydroelectric power for in-state consumers, because the law was 
``designed to gain an economic advantage to in-state consumers'' to the 
detriment of consumers out of state).
    The opposition to new generation, whether strategic or citizen-
based, legitimate or illegitimate, has similar effect: it discourages 
competitive entry.
    These two examples--utility preference for utility construction and 
state concerns with independent generation--indicate that the interest 
in wholesale competition has limits, when the costs of that competition 
are felt close to home, or when the losing competitor might be the home 
team. The best RTO policies in the world will not bring us wholesale 
competition, if state policies obstruct new generators. RTOs without 
generation entry means highways without traffic.

D. Overview of this Testimony
    The central facts discussed above--that competition remains elusive 
and that its success depends on FERC and the states getting dozens of 
decisions right--establish the proper context in which to consider 
change to PUHCA. This testimony does not argue against any change to 
PUHCA. Instead, it describes the conditions which must be in place 
before amendment or repeal, so that persistent market power does not 
harm the consumer or impede progress to effective competition.
    This testimony has five remaining sections.
    Part II describes how PUHCA's major themes remain relevant today.
    Part III recommends that Congress modernize certain PUHCA 
protections, and transfer the regulatory responsibility to FERC.
    Part IV shows the how the arguments for stand-alone repeal lack a 
factual basis.
    Part V underscores the continuing relevance of PUHCA, and the need 
for a federal corporate structure statute, by explaining that proper 
application of PUHCA would have identified and prevented Enron's ill-
fated activities.
    Part VI concludes this testimony by describing the consequences of 
a world without a federal corporate structure statute for the electric 
industry.

             II. PUHCA'S MAJOR THEMES REMAIN RELEVANT TODAY

    Congress passed PUHCA to protect the public, investors, and 
consumers from utility holding company abuses. Congress identified 
several categories of abuses and acted comprehensively to address them. 
Today we still have the risk of abuse, and we still have the public, 
investors and consumers to protect from abuse. Most of the themes of 
the Act remain relevant today, including:

          a. Prevent acquisitions that are not justified by operational 
        efficiencies
          b. End abusive inter-affiliate transactions
          c. Restrict unsound financial practices

    I discuss these main themes next. For each of the three themes, I 
will explain the original purpose, describe how the statute addresses 
it and show that the original purpose remains necessary.

A. Prevent Acquisitions Unrelated to Operational Efficiencies
    Original Purpose: Congress was concerned about acquisitions 
motivated by acquisitiveness rather than operational efficiencies. 
These acquisitions produced complex holding companies structures aimed 
at milking the individual utilities and their customers, using 
techniques that state regulators could not police. Congress concluded 
that such holding company ``activities extending over many States are 
not susceptible of effective control by any State and make difficult, 
if not impossible, effective State regulation of public-utility 
companies.'' Section 1(a). Congress saw a need to require holding 
companies to maintain a focus on the core business of utility service 
to captive consumers, limit financial risks to ratepayers, and protect 
businesses in unregulated industries from anti-competitive cross-
subsidies.
    Tools: Review of Utility Acquisitions: Congress adopted geographic 
restrictions on the growth and extension of holding companies by 
precluding utility holding company acquisitions where the acquired 
utility is not physically integrated (the ``integration'' requirement) 
and coordinated with existing utility properties. Section 2(a)(29)(A).
    Congress further required that utility acquisitions create new 
operational and managerial efficiencies. Acquisitions under the Act 
must therefore create positive operational benefits. Section 10(c)(2).
    Congress prohibited acquisitions of utility assets where the 
acquisition will ``tend towards interlocking relations or the 
concentration of control of public-utility companies, of a kind or to 
an extent detrimental to the public interest or the interest of 
investors or consumers.'' Section 10(b)(1).
    Congress restricted registered holding companies to engaging in 
businesses ``reasonably incidental, or appropriate to the operations'' 
of the public utilities. Section 11(b)(1).
    Non-registered or ``exempt'' holding companies may diversify into 
other businesses only to the extent that such diversification is not 
``detrimental to the public interest, or the interest of investors or 
consumers.'' Section 3(a).
    Current Relevance: In most states retail electric and gas customers 
remain unable to shop. They are no less captive today than they were in 
1935. Even in states where retail competition has been adopted, 
effective competition is largely absent. At the same time, the 
industry, after several decades of quiet following breakups mandated by 
PUHCA, has regained much of its pre-1935 concentration and complexity. 
Many holding companies have dozens of affiliates, many of them making 
investments worldwide. This growth in affiliates has had little to do 
with improving service to customers.

B. End Unreasonable or Abusive Inter-affiliate Transactions
    Original Purpose: Utility holding companies exploited utility 
operating companies through financial mismanagement, taking advantage 
of the inability of state regulators to analyze complex and multistate 
transactions.
    Tools: Review of Inter-affiliate Transactions: Congress sought to 
ensure that holding companies could not use service, management, 
construction, and other contracts to allocate charges among 
subsidiaries in different states so as to obstruct effective state 
regulation. In Section 13 Congress prohibited registered holding 
companies from entering into contracts for services and goods (other 
than power, which is regulated by FERC) without SEC approval.
    In Section 12, Congress placed strict limits, and in some cases 
outright bans, on certain financial transactions between utilities, 
their holding companies and other subsidiaries. For example, a 
registered holding company cannot borrow from its subsidiary utilities. 
Sec. 12(a). Other limitations apply to a holding company's loans to its 
subsidiaries and payments of dividends. All transactions are covered by 
Commission rules concerning fair accounting treatment, maintenance of 
competitive conditions, disclosure of interests, and other ``public 
interest'' factors. Sec. 12(f).
    Current Relevance: Industry consolidation, combined with an 
increase in use of ``service'' companies that provide non-power goods 
and services to the various utility operating companies of a holding 
company system, means that consumers continue to be at risk from their 
jurisdictional utility's transactions with affiliates. State regulators 
do not have the ability and resources, and in some cases may lack 
authority, to review the many transactions between affiliates of 
utility holding companies. Further, without federal intervention state 
regulators may be unable to access the books and records necessary to 
review the costs of an inter-affiliate transaction.

C. Restrict Unsound Financial Practices
    Original Purpose: Congress in 1935 found public harm from 
speculative and unsound securities issuances. Prior to the Act, holding 
companies issued securities based on inflated capital structures, 
fictitious or unsound asset values, pyramidal structures, and other 
market manipulations. Congress thus intended PUHCA to address the 
adverse consequences to the public ``when . . . securities are issued 
upon the basis of fictitious or unsound asset values having no fair 
relation to the sums invested in or the earning capacity of the 
properties and upon the basis of paper profits from inter-company 
transactions, or in anticipation of excessive revenues from subsidiary 
public-utility companies.'' Section 1(b)(1).
    Tools: Review of Financing: Without SEC approval, a registered 
holding company or its subsidiary may not issue or sell any stock, or 
exercise any privilege or right to alter the priorities, preferences, 
voting power, or other rights of the holders of an outstanding security 
of the company. Sec. 6(a). (There are various exceptions, including for 
private offerings, short-term securities, and others.)
    In reviewing a holding company or its subsidiary's filing for 
approval, the SEC must ensure, under Sec. 7(d), that:

   issuance or sale of the security does not jeopardize the 
        security structure of the holding company system;
   the security is reasonably adapted to the issuer's earning 
        power;
   the type of financing is necessary or appropriate to the 
        economical and efficient operation of the issuer's business;
   the fees and commissions paid are reasonable;
   where the security is a guaranty of, or assumption of 
        liability on, a security of another company, the declarant is 
        not taking an improper risk; and
   the terms and conditions of the issuance or sale are not 
        detrimental to the public interest or the interest of investors 
        or consumers.

    If a State informs the SEC that State laws applicable to the 
transaction have not been complied with, SEC must reject the 
transaction. (Section 6(g)).
    For utility acquisitions, the SEC must find that the amount paid 
bears a fair relation to the sums invested in, and earning capacity of, 
the underlying utility assets. (Section 10(b)(2)).
    Relevance of Financing in the Current Industry Structure: As the 
Enron events demonstrate, federal disclosure statutes do not prevent a 
holding company or its subsidiaries from undertaking securities 
transactions which conceal the underlying value of the company. PUHCA's 
financial reviews do more than disclose; they apply a reasonableness 
test to assure that financial commitments are commensurate with utility 
service needs.

III. CONGRESS SHOULD MODERNIZE CERTAIN PUHCA PROTECTIONS, AND TRANSFER 
                THE REGULATORY RESPONSIBILITIES TO FERC

    Although PUHCA's main themes remain relevant, the statutory devices 
do not fit the industry today as well as they did in 1935. Some of 
these devices can be eliminated, while others must be modernized. This 
section describes the challenges posed by utility restructuring today, 
and then presents prerequisites for PUHCA repeal, including conditions 
on mergers and acquisitions, and on the mixing of utility and non-
utility businesses. I then argue that Congress should transfer 
responsibility for the modernized protections from the SEC to FERC. 
Finally, I analyze the provisions of Title 2 of S. 1766.

A. The Challenge of Utility Restructuring Today
    Mergers between monopolies are different from mergers in 
competitive industries. Competitive industries lack captive customers. 
Customers ill-served by an expensive merger can shop elsewhere. 
Customers of a regulated monopoly have no choice.
    PUHCA addressed mergers with a bold stroke: only those mergers 
justified by improvement in physical operations would be permitted, and 
then only if those mergers did not cause a concentration of control, 
produce a complex capital structure or otherwise harm the public 
interest. See Section 10 of PUHCA. The effect of Section 10 was to 
block acquisitions or mergers involving companies that could not, 
because of physical separation, coordinate their electric operations 
after the merger.
    The 1935 Congress blocked all non-integrating acquisitions because 
it saw no possible benefit from them. Neither wholesale competition nor 
retail competition was evident at the time. Today, we have a policy of 
promoting wholesale competition and, in some states, retail 
competition. Competition works best if there is a substantial number of 
entrants in each market. Especially when a market is dominated by the 
incumbent as many present markets are, a marked increase in the number 
of viable competitors is a prerequisite for real competition.
    This need for new viable competitors raises a legitimate question 
about the value today of PUHCA's prohibition on non-integrated 
acquisitions. It is fair to say that until 1992, PUHCA's prohibition, 
if enforced, limited the number of new competitors in any market to 
those entities that operate physically only in that market. In 1992, 
Congress, intending to promote wholesale competition, removed this 
prohibition if the acquired company was an ``exempt wholesale 
generator,'' that is, a company that owned a generator, which company's 
exclusive business was the sale of electricity at wholesale. Thus, with 
respect to wholesale competition, PUHCA does not present any 
prohibition on entry, and has not for almost 10 years. Utilities and 
non-utilities own many wholesale generation companies throughout the 
nation, on a non-integrated basis.
    That brings us to the question of retail competition. In those 
states where retail competition is legally authorized, PUHCA's 
prohibition on non-integrating acquisitions normally would limit the 
number of players in that market to those whose physical operations are 
integrated with that market. However, in 1997 the SEC promulgated Rule 
58, 17 C.F.R. 250.58. Rule 58 allows registered holding companies to 
create or acquire retail electricity marketing and brokering companies 
as well as other energy-related companies, provided these companies do 
not own utility assets and provided the aggregate investment in such 
energy-related companies does not exceed the greater of $50 million or 
15% of the consolidated capitalization of the registered holding 
company. Thus, market entry at retail already is accommodated by SEC 
rule. What is not accommodated is the non-integrated acquisition of 
utility assets. Such acquisition could not increase competition where 
the assets are monopoly assets, like transmission and distribution. In 
that noncompetitive context, PUHCA presents a barrier not to 
competitive entry, but to financial entry.
    This distinction warrants emphasis. There is a dramatic difference 
between financial entry and competitive entry. The acquisition of one 
monopolist by another is a change in control, not an increase in 
competition. To call this ``entry,'' and thus to criticize PUHCA 
because it ``blocks market entry,'' is to misuse the term. It is 
``entry into a new market'' from the perspective of the acquirer 
seeking new captive customers. But it is not a ``new competitive 
entrant'' from the perspective of those captive customers, for the 
simple reason that there is no competition.
    There is one circumstance under which the acquisition of distant 
monopoly assets might benefit the public: when the acquisition is the 
result of a competitive auction process designed to identify the most 
efficient and innovative provider of monopoly services. For that 
circumstance, some relaxation of the integration requirement is worth 
considering, under the specific conditions discussed next.\3\
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    \3\ In all acquisition situations, including those in this 
subsection and the subsequent ones. the entity actually performing the 
acquisition may be a utility or an affiliate of the utility. If there 
is a utility with captive customers anywhere in the acquirer's 
corporate structure, these principles should apply. Corporate form 
should not create customer risk.
---------------------------------------------------------------------------
    Also, the regulator should be authorized to waive some or all of, 
these prerequisites where the customers of the acquirer and acquiree 
participate in markets subject to vigorous retail competition. In that 
context, the protection can come from the market rather than 
regulators.

B. Prerequisites for PUHCA Repeal
            1. Conditions on Mergers and Acquisitions Involving 
                    Utilities
    The many PUHCA protections can be distilled into 5 modern 
prerequisites to the approval of a merger or acquisition involving 
utilities. Each is discussed next.

    a. The acquisition must be the product of a competitive market; and 
must not reduce the effectiveness of competition in the acquirer's or 
acquiree's present or likely future markets.

    The typical utility merger is not the product of real competitive 
forces; it is the product of two companies, each with 100% market share 
at retail, creating a combination which itself has 100% market share at 
retail; and then persuading regulators to accept it. True competitive 
market forces are not involved.
    When the merging companies themselves, because of their retail 
franchises, are not subject to strong competitive forces, there is only 
one way for the merger itself to be the product of real competitive 
forces: create competition for the monopoly franchise. The regulators 
of the potential acquiree must host an auction, allowing multiple 
companies to bid for the right to acquire. Only through this bidding 
process can we identify the most efficient combination, the one most 
likely to lower costs and increase quality.
    This bidding process would reverse the economic positions of the 
typical utility merger. In the typical utility merger, the acquiring 
company bids for the acquiree's shareholders, paying the price they 
demand. This process increases the cost of the merger to the acquirer. 
That increased cost either causes ratepayers to pay higher rates, or 
causes a decline in service quality due to the financial pressure. In 
contrast, bidding for the franchise means bidding for the favor of the 
ratepayers. That means the bidders are offering lower prices, better 
services and more accountability, relative to the status quo. And that 
is exactly what should happen in competition.
    The requirement that the acquisition must be a product of a 
competitive market also means that both the acquiree and the acquirer 
should be subject to the maximum competitive forces allowed by law. 
Assuming no retail competition, wholesale competition must be vigorous 
in both the acquirer's and the acquiree's markets. Wholesale 
competition will be vigorous only if there is a functioning, 
independently governed regional transmission organization offering 
efficiently priced transmission and ancillary services; low barriers to 
entry for new generators and demand side management service companies; 
and clear market mechanisms for demand side options.

    b. The acquisition should produce measurable, guaranteed benefits 
for ratepayers of both the acquirer and acquiree, by significantly 
increasing the quality of service or decreasing the cost to consumers 
of electric service.

    Unlike an adjacent acquisition, which may produce operational 
efficiencies from joint operations, a distant acquisition free of 
PUHCA's integration requirement offers a less obvious ``upside'' to 
existing ratepayers. The public does not benefit if the only reason or 
effect of a merger is to increase the monopoly territory controlled by 
a single company. If the acquirer can show that it will run the utility 
better, then replacing one franchisee with another can benefit the 
public. That standard applies in a competitive market; it is no less 
appropriate in a retail monopoly context.

    c. The acquisition should not weaken the financial strength of the 
acquirer or acquiree.

    Where an acquisition is motivated by acquisitiveness rather than 
customer service, there can be a tendency to overpay for the merger 
(that is, overcompensate the departing shareholders relative to the 
real savings produced by the merger). The result is a financially 
weakened company, less able to invest internally for innovation, and 
more likely to seek government assistance in the form of rate 
increases. The regulator therefore needs to assure that the purchase 
price bears a reasonable relationship to the underlying costs and 
benefits of the combination.

    d. The acquirer should compensate its existing ratepayers, at a 
market price, for the use of any resources which facilitate the 
acquisition or assist the acquired business, to the extent such 
ratepayers have borne the economic burdens associated with such 
resources.

    When acquiring a new company, a utility may use resources for which 
ratepayers have paid. These resources might include valuable employees 
and equipment. Although these assets are owned nominally by the 
utility, the ratepayers have borne the associated economic risk, at 
least where the cost of the asset has been included in rates even 
though the market value of the asset might be lower. If the utility 
were able to make use of these assets without compensating the 
ratepayers at market value, the utility would be obtaining a reward 
from assets for which ratepayers bore the risk. This mismatch of risk 
and reward harms not only the existing ratepayers (by causing them to 
bear costs without realizing benefits), but also the effectiveness of 
competition (since the utility's competitors would not have had captive 
ratepayers to bear the cost of the assets involved). Requiring the 
utility to pay market price ensures that the utility is held to a 
market standard.

    e. The acquiring utility may recover its acquisition cost from its 
existing utility customers, to the extent of tangible, measurable 
savings created for those customers.

    This commonsense financial management applies to traditional 
utility investments, as well as in competitive markets. It prevents the 
acquirer from paying an artificially high price and then recovering 
that high price from ratepayers. It subjects the utility to the type of 
cost discipline that is imposed by effective competition. Under 
effective competition, the competitive market sets the price. An 
acquirer can recover its acquisition premium only if its post-
acquisition costs are low enough to leave a margin with which to pay 
off the premium.

            2. Conditions on the Mixing of Utility and Non-Utility 
                    Businesses
    a. The Problem: With real retail competition almost nonexistent and 
wholesale competition uneven, customers remain vulnerable to their 
suppliers' business risks. Prominent among these risks is the risk of 
non-utility diversification.
    The business risks associated with utility diversification are 
well-known. Utility holding company diversification has fared 
poorly.\4\ Among the prominent examples was the failed investment by 
Pinnacle West, the holding company for Arizona Public Service, in a 
savings and loan institution. The failure resulted in Pinnacle West 
having to borrow several hundred million dollars from insurance 
companies to pay off bank depositors. As collateral for the loan, 
Pinnacle West pledged its only significant asset: Arizona Public 
Service.
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    \4\ According to one commentator, the results were ``horrendous in 
the aggregate and . . . satisfactory to disastrous for individual 
utilities.'' C. Studness, ``Earnings From Utility Diversification 
Ventures,'' Public Utility Fortnightly 28-29 (September 1, 1992).
---------------------------------------------------------------------------
    Absent regulatory review of diversification, utility management has 
the incentive and opportunity to use ratepayer resources for 
shareholder ends. In a competitive market, ratepayers can protect 
themselves from such management decisions by shopping elsewhere. Absent 
a competitive market, protection must come from a neutral regulator.
    The other side of the coin, distinct from the ratepayer harm, is 
the harm to competition in the industries entered by utilities or their 
affiliates. Utilities (typically through unregulated affiliates or 
subsidiaries) now routinely sell appliances; provide plumbing, heating, 
and cooling equipment and service contracts; engage in insulation work 
and sales of storm windows and doors; and provide outdoor lighting and 
interior lighting fixtures. Utilities also have entered the real 
estate, security and alarm monitoring markets, telecommunications, and 
related energy markets such as energy management and energy monitoring.
    Exacerbating the problem is the proliferation of multi-state 
operations in which utility affiliates are engaged. Consider a holding 
company system, based in State X, that operates mechanical and 
electrical contracting affiliates in several other states. A non-
affiliated competitor based in State Y, and injured as a result of 
cross-subsidization, may lack standing to file a complaint with the 
commission in State X because he is not a ratepayer of the subsidizing 
utility; meanwhile, his own state commission would not likely have 
jurisdiction over a non-utility affiliate of an out-of-state utility.
    Further, a public utility's monopoly franchise may impart an 
ability and a legal right to gather customer site information regarding 
energy use, including a complete profile of each customer with respect 
to billing and credit history. Such information can be accessed or made 
available to unregulated affiliates while being withheld from non-
affiliated competitors.
    b. Solutions: The mixing of utility and non-utility business can 
occur in one of two ways: a utility acquires a non-utility business, or 
a non-utility business acquires a utility business. In each of these 
contexts, the diversification should be subject to standard regulatory 
techniques which anticipate and respond to the risks. Those techniques 
fall into five categories:
    (i) Advance Review: Advance federal review of financing where 
effective State review does not exist, or where such review is 
requested by a State commission.
    (ii) Financing Requirements: Required use of non-recourse (i.e., 
non-recourse to the holding company or any affiliate other than the 
affiliate undertaking the business) financing for all non-utility 
investment, and a ban on inter-affiliate loans or guarantees from the 
utility to the non-utility business. Non-utility businesses should pass 
the market test: they should be financeable by the market on their own 
merits.
    (iii) Protections Against Excess Business Risks: To protect against 
excess business risks, there should be caps on diversified investment, 
and type-of-business and place-of-business reviews.
    (iv) Protections Against Cross-Subsidies: A cross-subsidy occurs 
when utility ratepayers incur costs which benefit the non-utility 
affiliate, and the non-utility affiliate does not compensate the 
utility adequately. The problem of cross-subsidy exists whenever a 
single corporation, or corporate family, operates in monopoly and 
competitive worlds.

          --Where the utility purchases goods or services from its 
        affiliate, the proper compensation rule is ``the lower of 
        market or fully allocated book.''
          --Where the utility sells goods or services to its affiliate, 
        the proper rule is market price.

    (v) Access to Information: The regulators should have

          access to books and records of the utility and all its 
        affiliates, to the extent such access is relevant to the 
        protection of ratepayers.
          access to the books and records of any third party who is or 
        will become a joint venturer of the utility or any affiliate of 
        the utility, to the extent such access is relevant to the 
        protection of ratepayers.\5\
---------------------------------------------------------------------------
    \5\ As with the merger review standards, the regulator should be 
authorized to waive some or all of these prerequisites where the 
customers of the acquirer and acquiree are subject to vigorous retail 
competition. In that context, the protection can come from the market 
rather than regulators.
---------------------------------------------------------------------------

            3. Arguments Against Diversification Review
    Some attack diversification review as ``anti-business.'' This 
attack misperceives the purpose of regulation. The purpose is to assure 
that diversified investment pays its own way, and succeeds or fails on 
its merits, rather than by relying on ratepayer resources. This 
principle aligns completely with economic efficiency and business 
prudence.
    Shareholders who view appropriate utility regulation as 
inconsistent with their overall financial objectives can pursue those 
objectives by investing in diversified enterprises separately from 
their utility investment. They do not need the option of investing in 
competitive businesses through their investment in the utility.
    Some have argued that the diversification of a company's business 
portfolio strengthens the company and therefore produces ratepayer 
benefits. This reasoning misunderstands the nature of regulation. 
Regulation permits a prudent regulated monopoly to earn a fair rate of 
return. If a company is performing below par in its monopoly business, 
the solution is to improve its performance, not seek solace in other 
investments.

            4. The Necessity for a Federal Role
    Some have argued that PUHCA is no longer necessary--and needs no 
modern federal replacement--because state regulators can protect 
consumers. This argument fails for four real-world reasons.
    a. Many states lack the authority to investigate the sources of 
risk: the investment practices or financial condition of affiliates 
which are not utilities or which are located out of state.
    b. Some investment errors are too large to correct through 
ratemaking disallowance, because that disallowance could place the 
utility in financial jeopardy and endanger service.
    c. A registered holding company can use its multistate status to 
avoid effective regulation of inter-affiliate transactions. In Ohio 
Power v. FERC, 954 F.2d 779 (D.C. Cir.), cert. denied, 113 S.Ct. 483 
(1992), the Court of Appeals for the D.C. Circuit held, among other 
things, that the FERC (and, by implication, States) could not disallow 
from rates the costs incurred by Ohio Power, a utility subsidiary of a 
registered holding company, in purchasing coal from its subsidiary, 
even though the costs exceeded the market price.
    The types and magnitude of inter-affiliate transactions are almost 
unlimited. Most registered holding companies already have one or more 
subsidiaries which provide goods and services to the utility 
subsidiaries. These arrangements have included coal mines and other 
fuel sources, computer services, billing, power supply planning, expert 
witnesses, legal services, buildings and land. More recently, some 
utility subsidiaries have transferred traditional functions--such as 
nuclear plant operations--to these companies.
    d. The multistate nature of electricity markets requires a 
multistate review of the effect on competition. The policing of market 
power is not a single-state task because the exercise of market power 
is increasingly a multistate phenomenon. Market power obtained in one 
State, even legitimately, can be leveraged into market power in another 
State.
    Moreover, in the acquisition by a multistate utility company of a 
new utility--and almost all mergers are multistate there often are one 
or more states lacking authority over the transaction. For example, 
when CSW proposed to acquire El Paso, the transaction certainly would 
have had an affect on the ratepayers of Arkansas, Mississippi and 
Louisiana, but these states did not have proceedings. Similarly, when 
Entergy acquired Gulf States, those states in which Gulf States did not 
operate did not have proceedings. Although the acquisition by the 
holding company serving Arkansas of a utility doing business elsewhere 
certainly could affect Arkansas ratepayers, there was no state statute 
making it clear that the Arkansas Commission would have jurisdiction to 
review the transaction to protect Arkansas ratepayers.

C. Responsibility for the Modernized Protections Should Lie With the 
        FERC

            1. The SEC's Staffing Situation
    Although FERC has not always pleased all its constituents, and has 
in the past used methodologies for merger review and market pricing not 
based in economic logic (see Part I.B), it has remained publicly 
committed to its statute.
    The Public Utility Holding Company Act has not enjoyed comparable 
respect. More than twenty years ago, the SEC took the position that the 
Act no longer was necessary because markets and other regulators 
protect the consumer and the investor. The agency has held to this 
position through the era of nuclear cost overruns, the savings and loan 
failures, the bankruptcies of several utilities, utility 
diversification, the ``discovery'' that transmission owners exercised 
market power in generation markets, and even through the California 
price spike troubles of Summer 2000. Untroubled by the facts on the 
ground, the SEC has held firm.
    It is unclear which is the cause and which the effect. But roughly 
contemporaneous with its repeal position has been a staffing 
arrangement that is not commensurate with its statutory obligations. My 
focus is not on work ethic or dedication, but on professional 
expertise. Here are five concerns:

          a. The analysis of large scale operational relationships 
        requires expertise in engineering. The SEC's PUHCA has no 
        engineers; it has had none for years.
          b. The analysis of the competitive effect of mergers on the 
        many affected electric markets, both product markets and 
        geographic markets, demands expertise in economics at the 
        highest level. The SEC's PUHCA office has no economists; it has 
        had none for years.
          c. The analysis of the risks associated with diversification 
        conducted by well over 100 utility holding companies demands 
        expertise in business management, including risk assessment, 
        business strategy assessment, and managerial organization and 
        effectiveness. The SEC's PUHCA office has no business 
        management specialists.
          d. The review of inter-affiliate sales of goods and services 
        (Section 13) requires expertise in the pricing and procurement 
        of a host of products--fuels, accounting services, nuclear 
        operations services, real estate costs--literally any business 
        activity affecting the production of electric service. The 
        SEC's PUHCA office has no business procurement specialists.
          e. The review of internal and external financial transactions 
        of over 15 multi-billion dollar registered holding company 
        systems, some with global operations, would strain even a large 
        staff. The SEC must review issuances of securities (Sections 6 
        and 7), inter-affiliate loans (Section 12), and capital 
        structure (Sections 10(b) and 11(b)). Literally thousands of 
        transactions occur involving billions of dollars. The SEC's 
        PUHCA office has one accountant.

            2. The Statutory Application Problems
    The SEC also has issued a series of opinions that vary dangerously 
from the intent and language of the statute. The most prominent example 
is the integration requirement.
    The Act allows holding acquisitions of public utilities only if the 
acquisition produces a single ``integrated public-utility system,'' see 
Sections 11(b)(1) and 2(a)(29)(A); \6\ and only if the acquisition 
``serves the public interest by tending towards the economical and 
efficient development of an integrated public-utility system.'' Section 
10(c)(2). As utilities have sought to expand their reach, the 
Commission has left behind these principles and accommodated their 
proposals. The Courts have sometimes upheld the Commission and other 
times reversed it; but the trend is unmistakably towards consolidation 
and away from the competition-protective and consumer-protective 
features of the statute. Some examples follow.
---------------------------------------------------------------------------
    \6\ There are exceptions to the ``single system'' rule in Section 
11(b)(1)(A), (B) and (C) not relevant here.
---------------------------------------------------------------------------
    In WPL Holdings, Inc., 40 S.E.C. 634 (1988) the SEC disregarded the 
economical and efficient development test of Section 10(c)(2) when it 
approved an addition of a corporate holding company where there was no 
evidence of increased operational efficiencies resulting from the 
acquisition. The court of appeals reversed. Wisconsin's Environmental 
Decade v. S.E.C., 882 F.2d 523 (D.C. Cir. 1989) (finding that the SEC 
decision ``plainly gives no effect to the express language of the 
statute, which permits the SEC to approve acquisition of a utility only 
when the Commission has found that the acquisition `tend[s] towards' 
the economical and efficient development of an integrated system). The 
Commission on remand found financial efficiencies.
    Furthermore, in 1988 the Commission found that a utility holding 
company's participation in power plant construction consortium met the 
statutory requirement for integration despite the minimal interactions 
the plant would have with the utility. Order Authorizing Acquisition of 
Common Stock of New Electric Generating Company, Release No. 35-24566 
(Jan. 28, 1988), aff'd Environmental Action v. S.E.C., 895 F.2d 1255 
(9th Cir. 1990). The Commission concluded that the facilities would be 
coordinated even though there was no certainty that the public utility 
would purchase power from the plant being acquired. The SEC based its 
Section 10(c)(2) finding that there would be new economies resulting 
from the acquisition on the utility's apparent need for power several 
years after the acquisition.
    In WPL Holdings, Inc., 66 SEC Docket 2256 (Apr. 14, 1998), aff'd 
Madison Gas and Electric Co. v. S.E.C., 168 F.3d 1337 (D.C. 1999), the 
SEC approved under the integration standard the merger of several 
utility holding companies with utilities operating in Wisconsin, 
Minnesota, Iowa and Illinois. The commission found that the assets met 
the statutory requirement of interconnection even though the Iowa and 
Minnesota assets were separated from the Wisconsin and Illinois assets, 
with the only connection being a 3-year contract for transmission 
service and the companies' plan to build a transmission line in the 
future. The progression of the SEC's effort to deprive the statutory 
interconnection requirement of meaning is evident from a chronology of 
its decisions prior to WPL Holdings.\7\
---------------------------------------------------------------------------
    \7\ Conectiv, Inc., Release Nos. 35-26832, 70-9069, 1998 SEC LEXIS 
326, *29 (Feb. 25, 1998) (approving use of contractual rights to 
transmission ``when the merging companies are members of a tight power 
pool''); New Century Energies Inc., Holding Co. Act Release No. 35-
26748, 1997 SEC LEXIS 1583, *41-42 (Aug. 1, 1997)(approving under 
interconnection standard a contract for transmission service pending 
the planned construction of a physical tie within five years of the 
merger); Unitil Corp., 50 S.E.C. 961, 1992 SEC LEXIS 1016 (April 24, 
1992) (lines could be built to connect the facilities located eight 
miles apart, but were unnecessary for coordination given the third-
party contractual arrangements); Northeast Utilities, 50 S.E.C. 427, 
1990 SEC LEXIS 3898, *48 (Dec. 21, 1990) (finding integration 
requirement satisfied where transmission contract was for at least ten 
years, and where companies were located within highly integrated power 
pool); Centerior Energy Corp., 49 S.E.C. 472, 1986 SEC LEXIS 1655, * 16 
(April 29, 1986) (merger partners owned the transmission facilities as 
tenants in common and the contract had ``no termination date and 
remain[ed] in effect as long as the [generation facilities acquired] 
are in existence); Electric Energy, Inc., 38 S.E.C. 658, 668-671, 1958 
SEC LEXIS 807, *25-29 (Nov. 28, 1958) (acquisition of a single power 
plant where applicants had contractual use of necessary transmission 
facilities for the entire life of the acquired plant); New England 
Electric System, 38 S.E.C. 193, 198, 1958 SEC LEXIS 620, *12 (Feb. 20, 
1958) (finding that ``the necessary interconnections would be 
constructed forthwith if the present [transmission contract] 
arrangements with the non-affiliate companies were terminated'') 
(emphasis added).
---------------------------------------------------------------------------
    Most recently, on January 18, 2002, the U.S. Court of Appeals 
vacated and remanded the Commission's approval of a merger between 
American Electric Power and Central & South West Corporation. Nat. 
Rural Elec. Coop. Ass'n v. S.E.C., No. 00-1371 (D.C. Cir. Jan. 18, 
2002).\8\ The AEP merger created the nation's largest registered 
holding company, with utility properties extending from Virginia in the 
east, to Michigan in the north, to Texas in the southwest. The service 
territories of the operating utilities of AEP and CSW are separated by 
several hundred miles at their closest point. The only proposed 
``physical'' connection between the two system was a one-way 
transmission contract for a token amount of electric capacity--less 
than one percent of the combined systems' generating capacity. The 
Commission's approval of the AEP-CSW merger culminated more than 20 
years of SEC decisions approving virtually any proposal placed before 
it by utility holding companies coming under its purview.
---------------------------------------------------------------------------
    \8\ This law firm represented the petitioners in this case.
---------------------------------------------------------------------------
    The Court vacated the SEC's approval of the AEP merger on two 
grounds. First, the Court ruled that the SEC failed to explain how a 
one-way transmission contract could meet the interconnection 
requirement of the Public Utility Holding Company Act. The Commission 
also said the agency had failed to explain how its interconnection 
ruling was consistent with prior agency decisions, calling the SEC's 
explanation of its prior decisions ``peculiar.'' Second, the Court 
ruled that the SEC erred in finding that the merged company satisfied 
the ``single area or region'' requirement of PUHCA Section 2(a)(29)(A). 
The Court found that the SEC had failed to cite any evidence in support 
of its ``single region'' finding, and that the agency's method of 
analyzing the single region requirement was flawed. Given these errors, 
the Court said ``the Commission's decision that New AEP meets the 
region requirement cannot withstand even the most deferential review.'' 
Slip Op. at 8.

B. Comments on S. 1766
    With this backdrop, I would like to comment on Title 2 of S.1766. 
Title 2 seeks to set forth the key prerequisites for competitive 
evolution and consumer protection. It is a solid beginning step. I 
offer some comments below on provisions relating to mergers and market-
based rates.

            1. Electric Utility Mergers (Section 202 of S. 1766)
    a. Inclusion of important merger transactions: The bill correctly 
attempts to clarify the universe of transactions which require 
Commission approval. It appears, however, that several types of 
transactions are missing.
    First, the language does not seem to address the type of 
acquisition where the acquiree is a retail seller but does not own 
generation. Such an acquisition can endanger the nascent retail 
competition efforts in some states. These acquisitions are likely to be 
multistate in nature, and one or more states might lack jurisdiction 
under state law. Moreover, some states that have reviewed retail 
mergers have said they will not look at the merger's effect on retail 
competition because they have not yet authorized competition, even 
where the very parties to the merger have defined their objective as 
``getting ready for retail competition.''
    Second, although the language does create FERC jurisdiction where 
the acquiree has generation, transmission and distribution facilities, 
it is not clear that FERC is obligated to assess the effect of the 
merger on retail competition. FERC's Merger Policy Statement 
establishes the odd principle that it will review such effect if the 
state commission requests. FERC's obligation to review the retail 
effects in all cases should be clear in the statute.
    Third, concerning the phrase in new 203(a)(1)(C), ``purchase, 
acquire, or take any security of any other public utility'': consider 
amending it to add, after ``security,'' the phrase ``any indicia of 
ownership or control,'' since there may be forms of control like 
partnership shares, or leases, that do not come within the definition 
of ``security.''
    Fourth, new section 203(a)(2) correctly clarifies FERC jurisdiction 
over mergers at the holding company level. But for purposes of this 
section, ``holding company'' should be defined to include structures, 
such as partnerships, in which the device by which ownership or control 
of companies or assets is achieved is not through stock but through 
other means.
    b. Standards applicable to the merger: The amendments to Federal 
Power Act Section 203 should include standards applicable to the 
merger. Under PUHCA, an acquisition is allowed only after a finding 
that it produces operational efficiencies, and does not tend toward a 
concentration of control or create capital structure or corporate 
structure complexities. As discussed in Part I.B above, FERC's review 
of mergers does none of this, except for a review of competitive 
effects on generation and transmission, and that review has been uneven 
due to uncertainty of market concentration measures. Moreover, FERC's 
competition review does address the merger's effect on the incumbents' 
ability to protect their retail monopolies against future retail 
competition, even as merging companies often give as a reason for 
merging the need to ``prepare for retail competition.'' FERC's 
approach, in short, fails to screen out mergers that are not the 
product of, and contributors to, real competition.
    As explained above, moreover, FERC's review does not distinguish 
adequately efficient from inefficient mergers. The result has been an 
accelerated consolidation process in our industries that has set back 
substantially the cause of wholesale competition that FERC is trying to 
achieve elsewhere.

            2. Market-Based Rates (Section 203 of S. 1766)
    a. Prerequisites for market-based rates: Before authorizing market-
based rates, the bill requires the Commission to ``consider'' various 
features of the market. These features are the correct features to 
consider. But the bill does not establish prerequisites to market-based 
rates. It does not equate ``just and reasonable rates'' with ``rates 
which are the product of a fully competitive market.'' Under present 
law, some have argued that supra-competitive rates charged in a 
noncompetitive market are just and reasonable because they will attract 
new suppliers and thus make the market competitive. Under this 
formulation, consumers are not an interest to protect from the absence 
of competition, but a source of funds used to create competition. As 
discussed in Part I.B above, moreover, the Commission's past 
methodologies on determining market competitiveness are deeply flawed, 
by its own admission; and the Commission only now is beginning a new 
inquiry into the correct methodology. There is not a consensus about 
what are the minimum features of a competitive market, or about what 
prices should look like in such a market. Given this uncertainty, the 
legislation should be clear that vigorous competition is a prerequisite 
to market rates.
    b. Demand response mechanisms: The bill deserves special praise for 
making clear that the adequacy of demand response is central to the 
effectiveness of competition. In the past 20 years, excess attention 
has been paid to creating incentives to suppliers, and insufficient 
attention to the demand side.
    c. Refunds: The bill should codify FERC's recent policy of 
establishing, at the time it grants an applicant authorization for 
market rates, that the right to charge those rates lasts only as long 
as the rates are just and reasonable. With this approach, refunds can 
be made back to the date on which the rates became unjust and 
unreasonable, rather than the date on which someone filed a complaint 
alleging that the rates were unjust and unreasonable. There can be a 
significant time lapse between the time that (a) the market power is 
exercised to make the rates unjust and unreasonable, and (b) that 
exercise is noticed by someone and brought to the Commission's 
attention.
    d. Litigation costs: It costs money to bring a complaint to the 
Commission. The complainant has the burden of proof, and it requires 
lawyers and market experts to create that proof and carry it through 
the litigation process. If successful complainants could recover their 
litigation costs it would reduce the large disincentive to bringing 
information to the Commission. Just and reasonable rates are the 
seller's obligation and the Commission's duty. The customer should not 
bear the cost of making the statute work. This feature could be 
eliminated later, when competitive markets are the norm.

        IV. ARGUMENTS FOR STANDALONE REPEAL LACK A FACTUAL BASIS

    To construct a logical argument for repeal, one must assert that 
the conditions requiring these protections no longer exist; 
specifically, that (a) consumers are protected, either by effective 
competition or careful regulation; and that (b) investors are 
protected, by their knowledge and their sophistication. As explained 
throughout this testimony, these assertions are inaccurate.
    A. There is virtually no retail competition; and wholesale 
competition is ineffective in many places and endangered in all places, 
due to:

          --the absence of regional transmission pricing and planning;
          --the absence of a coherent merger policy that distinguishes 
        efficient from inefficient mergers and that stops mergers which 
        would damage wholesale or retail competition; and
          --the absence of any feasible way to identify a real date 
        when reliable wholesale competition will exist.

    B. Wholesale rate regulation is uncertain, due to the absence of a 
consensus methodology and procedure on market pricing
    C. Retail rate regulation is burdened by under-staffing and the 
inherent difficulties of regulating, state-by-state, multistate 
companies. Some argue that ``States can use ratemaking disallowances 
and other devices to protect the consumer.'' Not when the company 
already is weakened by its errors. Not a year goes by when some 
investor group does not argue that a rate increase is necessary ``to 
save the company.'' For example, when Pinnacle West had to borrow 
hundreds of millions of dollars to pay off depositors of its failed 
savings and loan affiliate, it had no choice but to pledge as 
collateral its only asset: the stock of Arizona Public Service. Had the 
State regulators tried to prevent this pledging, the outcome might have 
been worse. On the other hand, had the SEC acted on a timely basis to 
limit Pinnacle West's investments, the problems would not have 
occurred.
    D. Securities regulation largely focuses on disclosure, not on 
prevention of abuse. On this subject, the following two statements 
appeared in the same testimony supporting repeal of PUHCA:

          ``The SEC retains full authority over securities functions.''
          `` `Our securities laws are, in the main, nearly seventy 
        years old, and reflect a time, and a state of technology, light 
        years away from what we now confront daily.' '' (quoting SEC 
        Chairman-designate Harvey L. Pitt, Testimony before the Senate 
        Banking Committee)

Testimony of David L. Sokol before the House Subcommittee on Energy and 
Air Quality, Committee on Energy and Commerce (July 27, 2001). Both 
views cannot be correct.
    We need to assure the workability of our federal securities laws 
before we can rely on them as a basis for repealing PUHCA's reviews. In 
any event, as discussed in Part I, federal securities laws focus on 
disclosure only. PUHCA's protections are different: they focus on the 
quality of financial activities, and their appropriateness to an 
industry characterized by captive customers and unsophisticated, small 
investors seeking stable investments.
    At the state level, state commissions generally review security 
issuances of utilities within their jurisdictions, but not issuances by 
holding companies or by non-utility companies associated with such 
utilities. The need for such review is underscored by the failures of 
exempt holding company diversification in the 1980s. Utilities are 
affected by such failures, both in their credit standing and in their 
access to capital.
    Other factors argue for continued federal review. Some states lack 
authority to review financings by non-utility affiliates, and not all 
utilities have worked with State commissions and State legislatures to 
furnish this authority. Moreover, where utilities have mismanaged costs 
or taken risks with negative results, regulation tends to hesitate. The 
ultimate penalty in a competitive market, bankruptcy or takeover by a 
stronger company, causes regulatory uncertainty that regulators often 
prefer to avoid. There is a concern, for example, that the bankruptcy 
court will require payments to certain creditors, and then preempt 
state ratemaking to ensure that ratepayers are the source of these 
payments. The risk of this type of event can discourage state 
commissions from requiring companies to bear the costs of their own 
risks. Given this uncertainty of ``back-end'' accountability, ``front-
end'' accountability in the form of advance review of financial risks 
is critical.
    These factors support establishing federal minimum standards for 
the quality of financing, applied and monitored at the federal level.
    Assuming there is a federal role in financial reviews, that role 
should be consolidated with the financial reviews conducted by FERC 
under the Federal Power Act.
    E. Reliance on antitrust law is misplaced. Antitrust is aimed at 
markets that are competitive, protecting them from anti-competitive 
behavior. Antitrust does not address well markets that are 
monopolistic, where actions entrench the incumbents further. The 
purpose of advance regulatory review is to act as a ``first line of 
defense,'' preventing market power problems before they infect a 
market.
    Also: Who would address the problem through the federal antitrust 
laws? Antitrust lawsuits are expensive. An individual consumer lacks 
the resource, and attorneys general must reserve their resources for 
blockbuster cases like Microsoft and tobacco. They often can be brought 
only ``after the fact.''

    V. ENRON: PROPER APPLICATION OF PUHCA WOULD HAVE IDENTIFIED AND 
                 PREVENTED ENRON'S ILL-FATED ACTIVITIES

    Enron's acquisition of Portland General Electric, a utility, made 
Enron a ``holding company'' under PUHCA. Enron Corp., a global holding 
company, then obtained an ``intrastate'' exemption from the Act under 
Section 3(a)(1). Without that exemption, Enron's financial dealings and 
diversification efforts would have come under the full purview of the 
Act. More than likely, the Act, if conscientiously applied, would have 
limited or even prohibited the arrangements that apparently led to its 
bankruptcy. I explain here the process by which it obtained the 
exemption, and highlight the PUHCA provisions which the exemption 
allowed Enron to escape.\9\
---------------------------------------------------------------------------
    \9\ This discussion focuses on Enron's exemption from registration, 
obtained under Section 3 and Rule 2 of the Act, not on its receipt of 
``no-action letters'' stating that its brokering and marketing 
activities do not make it a ``gas utility company'' or an ``electric 
utility company'' under the Act because those businesses do not involve 
electric or gas ``facilities'' as defined by the Act. Enron Power 
Marketing, Inc., SEC No-Action Letter (Jan 5; 1994).
---------------------------------------------------------------------------
A. The Exemption Process
    Section 3 of the Act authorizes the SEC to exempt a holding company 
from provisions of the Act if the holding company satisfies one of the 
five exemptions described in Section 3(a)(1)-(5). The SEC has used this 
authority to exempt qualifying companies from all provisions of the Act 
except the pre-acquisition review standards of Sections 9 and 10. The 
key condition on a continued exemption is the ``unless and except'' 
clause of Section 3(a), which says an exemption is available

          . . . unless and except insofar as [the SEC] finds the 
        exemption detrimental to the public interest or the interest of 
        investors or consumers . . .

    Section 3(c) also allows the Commission to revoke an exemption if 
it ``finds that the circumstances which gave rise to the issuance of 
such order no longer exists.''
    The most common of the five examples is the ``intrastate'' 
exemption of Section 3(a)(1), which directs the SEC to issue an 
exemption if--

          such holding company, and every subsidiary company thereof 
        which is a public-utility company from which such holding 
        company derives, directly or indirectly, any material part of 
        its income are predominantly intrastate in character and carry 
        on their business substantially in a single State inwhich such 
        holding company and every such subsidiary company thereof are 
        organized. . . .

    Although Enron is a global holding company with worldwide 
businesses, hardly ``intrastate in character'' and clearly doing 
business ``substantially'' in more than a single state, it obtained 
exempt holding company status under the intrastate exemption of Section 
3(a)(1). The process for obtaining an exemption is as follows: An 
intrastate holding company make seek a Section 3(a)(1) exemption in two 
ways. It may obtain an official Commission order upon application under 
section 3; or it may self-claim an exemption by filing under the SEC's 
Rule 2, 17 C.F.R. sec. 250.2. Rule 2(a)(1) allows a company to obtain 
the exemption afforded by section 3(a)(1) by filing annual claim of 
exemption on form U-3A-2. Form U-3A-2 is a 2-page form seeking basic 
information about the holding company and its operations. No Federal 
Register notice is given to the public and no opportunity to comment 
afforded. The claim must be renewed by annual filings on or before 
March 1 of each year.
    A claim to an exemption under Rule 2 is subject to Rule 6, 17 
C.F.R. sec. 250.6. Under Rule 6, the exemption may be terminated by a 
registered letter from the Commission stating that a question exists 
about the holding company's entitlement to the exemption. A company 
receiving a termination letter has 30 days to either register under the 
Act or file a formal application for an exemption which, if filed in 
good faith, exempts the company from the Act until the Commission 
issues a final order.
    On rare occasion, and in the very distant past (decades ago), the 
Commission has questioned a Rule 2 claim of exemption. However, we 
found no modern decisions indicating any such Commission activity.
    Moreover, the Commission has no procedure by which a customer can 
file a complaint for revocation of an exemption should it become 
``detrimental to the public interest, or the interest of investors or 
consumers,'' as forbidden by Section 3. In the two situations where 
such a complaint has been filed, both involving extraordinarily serious 
situations, the Commission has taken no action.
    Specifically, in May 1990, the Arizona Corporation Commission filed 
a complaint asking the Commission to revoke the intrastate exemption of 
Pinnacle West, the holding company Arizona Public Service Company. 
Pinnacle West had invested in Merabank, a savings and loan institution. 
The failure of that institution in the late 1980s forced Pinnacle West 
to borrow several hundred million dollars to bail out the depositors. 
As collateral for that loan, Pinnacle West pledged its only asset: 100% 
of the stock of Arizona Public Service.\10\ The Commission took no 
action on the complaint. Also, last July the California Attorney 
General filed a complaint seeking revocation of the intrastate 
exemption for Pacific Gas & Electric as a result of its financial 
troubles. The Commission again has not acted.
---------------------------------------------------------------------------
    \10\ The witness was counsel to the Arizona Commission in that 
matter.
---------------------------------------------------------------------------
B. Should Enron Have Received ``Exempt'' Status Under the Act?
    There are two avenues by which the SEC could have found that Enron 
should not have been an exempt holding company.
    First, the SEC could have refused the exemption to begin with. 
Enron clearly did not meet the requirements of Section 3(a)(1). Enron 
Corp., the holding company, although organized in the state of Oregon 
(the state from which it derived a material part of its income from its 
Oregon public utility subsidiary, Portland General Electric), has 
holdings and business activities throughout the United States and 
abroad. The business of Enron Corp. is not ``predominantly intrastate 
in character,'' and Enron Corp. does not ``carry on [its] business 
substantially in a single State.'' Enron Corp. is global in character 
and does business substantially in many states.
    Second, the SEC could have found Enron's exemption would be, or had 
become, detrimental to the public interest or the interests of 
investors or consumers. Had the SEC investigated Enron's business 
activities during the exemption period, either before granting the 
exemption or as part of a periodic review, it should have been able to 
identify business dealings causing the detriment. But Enron's exempt 
status, plus the absence of any SEC review of exempt holding companies 
for detriment, meant that the statutory protections were not operating.

C. Customer and Investor Protections From Which Enron Was Exempt
    Had Enron been treated as a registered holding company, those 
activities leading to its present state would have been curbed or 
prohibited, assuming the Act were applied conscientiously. 
Specifically:
    Limitations on Utility Diversification: The off-shore financial 
transactions reported to be responsible for Enron's collapse should not 
have occurred if Enron had been treated as a registered holding 
company, because:

          Section 11(b)(1) limits the operations of registered holding 
        companies and their subsidiaries to ``businesses [that] are 
        reasonably incidental, or economically necessary or appropriate 
        to the operations'' of their public utility operations. The SEC 
        has interpreted the section 11(b)(1) language to permit non-
        utility businesses that are only ``functionally related'' to 
        the utility business.
          Section 11(b)(2) requires the elimination of unnecessary 
        corporate complexities and inequitable voting power among 
        security holders. Specifically, the section requires the 
        Commission to ``ensure that the corporate structure or 
        continued existence of any company in the holding-company 
        system does not unduly or unnecessarily complicate the 
        structure, or unfairly or inequitably distribute voting power 
        among security holders, of such holding-company system.''

    Regulatory Review of Accounting and Financing: Regardless of 
whether Enron's offshore transactions would been barred by the 
diversification provisions applicable to registered holding companies, 
Enron's excesses would have faced the prohibitions and limits of 
Sections 6 and 7:

          Sections 6 and 7 govern the issuances of securities of RHCs 
        and their subsidiaries. Section 6 requires SEC approval of most 
        issuances and sales of securities by registered holding 
        companies and their subsidiaries, and section 7 establishes 
        specific guidelines for the SEC to follow in approving such 
        issuances and sales.
          Section 7 prescribes standards for the type and amount of 
        securities for the registered holding company and its 
        subsidiaries. Section 7(d), for example, requires that a 
        security be reasonably adapted to the earning power of the 
        issuing company and to the capital structure of the company and 
        the holding-company system. Registered holding companies and 
        their subsidiaries must also obtain SEC approval before 
        acquiring any securities, utility assets, or any other interest 
        in any business.

    In sum, sections 6 and 7 demand much more than the accounting 
standards and private review standards that were applied to Enron's 
investments.
    Regulatory Review of Inter-affiliate Relations: PUHCA Sections 12 
and 13 would have required the SEC to police transactions among the 
various Enron affiliates.

          Section 13 governs service, sales and construction contracts 
        between system service companies and associate companies in the 
        same holding company system.
          Section 12 polices inter-affiliate transactions in loans and 
        other securities, requiring arms length relations between 
        affiliated companies.
          Section 12 also precludes registered holding companies from 
        borrowing or receiving any extension of credit or indemnity 
        from a public utility subsidiary. It also gives the SEC 
        rulemaking authority over other types of affiliate transactions 
        such as: intra-system loans; declaration and payment of 
        dividends; acquisition, retirement or redemption of a company's 
        own securities; disposal of assets and securities; solicitation 
        of proxies in connection with holding company and subsidiary 
        company securities; books, records, disclosures of interest, 
        duration of contracts; and similar matters concerning affiliate 
        transactions. From press reports, it would appear that many of 
        Enron's financial dealings would have fallen under these 
        standards applicable to registered holding companies.

VI. CONCLUSION: THE CONSEQUENCES OF A WORLD WITHOUT A FEDERAL CORPORATE 
                           STRUCTURE STATUTE

    The repeal of the Public Utility Holding Company Act, with no 
change in other statutes, would allow:
    A. Acquisitions by utilities of other utilities, undisciplined by 
market forces and without adequate review of

                  --the costs and benefits to present and future 
                consumers,
                  --the effects on retail prices and retail 
                competition, and
                  --the effects on wholesale prices and wholesale 
                competition.

    The risk of consolidation would be less if there were (1) 
comprehensive, nondiscriminatory and efficient retail competition; or 
(2) predictable, low-cost and efficient franchise competition. Both (1) 
and (2) are largely nonexistent, leaving the retail sector subject to 
utility market power. Unlimited and unreviewed retail acquisitions 
could increase this market power, thereby contradicting the claims that 
``competition is here.''
    B. Unlimited mixing of utility and non-utility businesses, where 
the risks of business failure are borne in part or in whole by 
consumers who are prohibited by law from shopping, subject only to 
post-failure regulatory devices of proven insufficiency; while 
ratepayer obtain none of the benefits.
    C. Unlimited inter-affiliate transactions between the utility 
serving captive customers, and affiliates needing utility resources 
paid for by those customers.
    D. Unlimited use of corporate structures that transfer ratepayer-
funded assets to deregulated companies.
    E. Unlimited use of corporate structures that cause Federal Power 
Act preemption of state review of the prudence or economic value of 
utility historic investments.\11\
---------------------------------------------------------------------------
    \11\ See Mississippi Power & Light v. Mississippi ex rel. Moore, 
487 U.S. 354 (1988) (holding that where FERC issued an order allocating 
a specific portion of the costly Grand Gulf nuclear plant to a utility, 
the state could not regulate the utility as if it had bought a lesser 
portion); Nantahala Power & Light v. Thornburg, 476 U.S. 953 (1986) 
(holding that FERC order allocating a portion of a low-cost 
hydroelectric plant to a utility preempted the state from treating the 
utility as if it were entitled to a higher portion of the hydropower 
than FERC had assigned)
---------------------------------------------------------------------------
    F. Entry by utilities with government-granted market power into 
potentially competitive industries, while continuing to use resources 
financed by customers who lack competitive options.
    The electric industry lacks effective competition in many markets. 
Congress cannot nurture competition by giving free rein to companies 
which for a century have avoided competition. And Congress cannot 
protect consumers by confusing financial entry with competitive entry. 
To repeal PUHCA without establishing a modern regulatory regime--one 
that conditions acquisitions on real competition and attentive 
regulation--is to allow dominant incumbents to exploit unearned 
advantages. Calling the result ``competition'' is good fiction, but it 
is not good policy.
    Thank you for the opportunity to present this testimony. I look 
forward to any questions from the Committee.

    The Chairman. Well, thank you very much. Thank you all for 
your testimony. I think it has been very useful.
    Let me try to understand the differences in point of view 
that have been expressed here. I think it is fair to say that 
each of the first four witnesses essentially agreed with the 
proposition that we should repeal the Public Utility Holding 
Company Act and, at the same time, grant to FERC additional 
authority to protect consumers in some of the ways that 
currently are contemplated under the Public Utility Holding 
Company Act but are not working very well. That is sort of the 
impression that I am getting from the first four witnesses.
    Now, Mr. Hempling's testimony is somewhat different, but he 
does take the position that, as I understand it--and this is on 
page 14 of your testimony--that Congress should modernize 
certain PUHCA protections and transfer regulatory 
responsibilities to FERC. So, there is no disagreement among 
any of the witnesses about the wisdom of transferring these 
responsibilities under PUHCA to FERC. Is that a fair statement? 
Do you agree with that, Mr. Hempling?
    Mr. Hempling. That is correct, sir.
    The Chairman. So, the real question then is, if these 
responsibilities to protect consumers and to oversee and insure 
against abuses in the utility business is transferred to FERC, 
what should the protections still be, what should the authority 
and the direction to FERC be to carry that out?
    And that is where we have disagreement, as I understand it. 
And I need to try to understand better precisely what those 
disagreements are about the responsibilities that we are going 
to put on FERC. Mr. Sokol, did you have a comment?
    Mr. Sokol. I would only add to your comment, Senator, and 
then try to answer the question. I think that not only 
transferring a great deal of that opportunity to FERC but also 
to the States. The States deserve the right to have greater 
access to books and records, affiliate transactions, et cetera, 
because with all due respect to a lot of the discussion here--
and by the way, Mr. Buffett is invested in a regulated utility 
today but limited to PUHCA to 9.9 percent of the voting rights.
    The States are aware of consumer protections that exist 
today. There are effectively well in excess of 5,000 State 
professional regulators in the United States. There are 22 
members of the SEC PUHCA staff. This notion that that 22-member 
staff can do a better job than the State regulatory bodies I 
think is wholly unreasonable. By moving to FERC and giving the 
States those additional rights, the States can protect the 
consumers. They will have access to both affiliate and books 
and records information, which they must have, and then FERC 
can have a much greater oversight on the wholesale activities 
that also play very, very significantly in the States' proper 
regulation.
    I think those are where they need to be. The notion of 
arbitrarily, as Mr. Hempling would argue that it is a bad thing 
for a AAA-rated company like Berkshire Hathaway to own Portland 
General, if it is properly regulated and there is properly 
access to books and records--that somehow that is a bad thing I 
would just submit is comical.
    Northwest Natural Gas is a fine small company, but by them 
being, if you will, forced to buy Portland General because 
Enron could not find anyone else, now Portland General is going 
to be forced to take on a very substantial debt load. We would 
buy them with cash. The regulator would have a much simpler 
time dealing with that situation. I am not trying to criticize 
Northwest Natural Gas.
    The Chairman. Let me ask Mr. Hempling to comment, but let 
me just first clarify the question. Enron's ownership of the 
utility in Oregon has resulted in higher rates, as I understand 
it.
    Mr. Sokol. I do not think that is correct. I think the 
higher rates in Oregon--and the commissioner is here--that had 
to be raised the last couple of years were caused by the 
California problem and the west coast escalation of wholesale 
rates, not by Enron.
    The Chairman. So, the higher rates are not a result of 
Enron's involvement, but looking forward, the complaint now, as 
I understand it, from some is that once this utility in Oregon 
is acquired by Northwest Natural Gas, the consumers, the 
customers of that utility, are going to be paying higher rates 
because they will, as you say, have to be paying to cover this 
debt load.
    Mr. Sokol. I think there is the fear of that. I do not 
believe the regulatory body will allow that to happen. There 
are consumers who are postulating that that is the case. The 
risk that comes, though, is that by a company becoming highly 
leveraged to own a regulated utility like Portland General--if 
they get into financial trouble, will there be an attempt to 
try and convince the regulator that they should raise the 
rates? I do not believe the transfer of Portland General to 
Northwest Natural Gas should cause any change in rates. 
Regulators are fully capable of imputing the proper cost of 
capital and not charging consumers----
    The Chairman. Let me ask Mr. Hempling. Is it your view that 
Berkshire Hathaway or any other company should be prohibited 
from coming in and purchasing a utility in Oregon as they 
currently are under PUHCA, even though, as you point out, that 
does not add to the competition? It is essentially purchasing 
an existing monopoly. But the argument being made by Mr. Sokol 
is they will run the existing monopoly very well and it will be 
a benefit to the consumers for them to be the owner of it, 
rather than having someone else the owner. What is your 
response to that?
    Mr. Hempling. My view, as stated expressly in the 
testimony, apparently disregarded by Mr. Sokol, is as follows. 
I would be delighted to have Mr. Buffett or anybody else in 
this industry acquiring any number of retail monopolies. I 
would be delighted for that to happen.
    He needs to make a showing. He needs to make a showing that 
this acquisition is going to improve service for the customers 
of the acquiree. He needs to make a showing that his 
acquisition will not harm the customers of the utilities he 
presently owns. He needs to make a showing that his global 
investments in other businesses are sufficiently fenced off 
from the acquired company that there will be no risk.
    He needs to do this in a context where there is a 
competition for the right to acquire this new utility because, 
sir, presently in the utility industry mergers are not subject 
to a competitive process. Mergers are back room deals brought 
to the commissions for approval. There is not, like there is in 
the competitive market, fights among companies for the right to 
acquire someone with the person who offers the most to the 
customer getting the arrangement. That is not how mergers work.
    So, to say that because of the conditions I wish to place 
on the acquisition, conditions which mimic faithfully the 
competitive market, that I somehow think it would be bad for 
Mr. Buffett to enter this industry is intentionally to miss the 
point. Mr. Buffett happens to be exactly what we need in this 
industry if we can show that his entry is good for all 
involved.
    The Chairman. You are saying there are certain conditions 
that ought to be required to be met by FERC, once they are 
given this new authority, if they are. If Congress shifts this 
authority over to FERC, we should insist that when they approve 
acquisitions, such as the one we are discussing here, they 
require certain conditions to be met.
    Mr. Hempling. That is correct, sir.
    The Chairman. My time is up. Senator Smith, let me call on 
you, since we are going back and forth here, and then I will 
call on Senator Wyden.
    Senator Smith. Thank you, Mr. Chairman. I thank all of our 
witnesses for being here, Roy, particularly you from Oregon. It 
is good to see you. I am very curious about your perspective on 
how this Enron debacle is affecting us in Oregon.
    My own evaluation I think can best be summed up by an 
unnamed Enron executive, as quoted in the New York Times on 
November 10, 2001. He said Enron's achievement in creating a 
regulatory black whole fit nicely with what he called the 
company's core management philosophy, which was to be the first 
mover into a market and make money in the initial chaos and 
lack of transparency. Do you see that as an accurate 
description of what Enron was doing?
    Mr. Hemmingway. Senator Smith, I think with respect to 
Enron's wholesale trading activities, that in many cases that 
was the case.
    Senator Smith. You think they were doing that in Oregon?
    Mr. Hemmingway. No. With respect to their ownership of 
Portland General Electric, there was an entirely separate 
enterprise there, and Enron acted as an absentee owner and had 
relatively little activity on a day-to-day basis with respect 
to that company.
    Senator Smith. Do you have reason to believe, though, that 
they bought PGE to pick off the transmission rights into 
California?
    Mr. Hemmingway. Senator, there is no evidence that we have 
seen that they have abused those transmission rights into 
California.
    Senator Smith. And you would know that.
    Mr. Hemmingway. Not everything is transparent with respect 
to that. That is something that I think is subject to 
continuing investigation. Certainly transmission rights have an 
influence on their ability to exercise market power, and you 
had some evidence recently in front of this committee about 
their ability to exercise market power in the Western market. 
But I doubt that it is possible to use the transmission rights 
to exercise considerable market power alone.
    Senator Smith. I am glad to hear that.
    You remember when Enron bought PGE in 1997. A condition of 
the merger was that Enron agreed that there would be $141 
million in merger-related benefits to customers. Have those 
benefits been realized in Oregon?
    Mr. Hemmingway. Senator, by and large they have. There are 
some continuing obligations of that merger which are still 
owing because the time has not expired. Our last rate case that 
we concluded in August we think dealt with those final 
benefits, and they will be paid to customers.
    Senator Smith. So, you are satisfied we will get the full 
benefit of that.
    Mr. Hemmingway. Yes.
    Senator Smith. Are you concerned about the report in the 
Oregonian last Sunday that PGE collected more than $357 million 
from ratepayers, most of which are Oregonians, since it was 
acquired from Enron, in order to cover its Federal income 
taxes? And apparently it did not pay any income taxes in those 
years. Were you aware of that?
    Mr. Hemmingway. We were not aware of what Enron's tax 
situation was, Senator, until it was reported in the press.
    Senator Smith. You do not have access to those records.
    Mr. Hemmingway. We do not get their tax return.
    But what we do as regulators--and I think this is true 
across the country with all utility subsidiaries--is we look at 
the companies that we regulate as if they were stand-alone 
businesses. And we erected a firewall in 1997 between Enron and 
Portland General Electric to ensure that Enron could not raid 
PGE's assets and vice versa, that Portland General customers 
would not be subject to any problems that Enron might run into. 
Part of that firewall is us looking at PGE as if it were a 
stand-alone company when we regulate it. So, we look at the 
income taxes that Portland General would have paid if they were 
a stand-alone company, and that is what is included in rates.
    Now, if we were to do the opposite and tear down that 
firewall, the situation might occur that Portland General might 
be in a situation where one year they do not owe any income 
taxes, but Enron or its parent might owe income taxes. Then 
what do we do in that circumstance? Are we to charge ratepayers 
for taxes that they would not otherwise owe in a stand-alone 
company?
    So, we have chosen to regulate it as if it were a stand-
alone company. It is certainly something we will be looking at 
in the future as we deal with more complex ownership structures 
of utilities. But I think the decision in the past was 
completely defensible.
    Senator Smith. Very good. I want to say publicly that the 
Oregon Public Utilities Commission is very important, and we 
need you to succeed.
    My next question is do you have the resources to succeed at 
the mission that we need you to do?
    Mr. Hemmingway. Senator Smith, thank you. I believe we do. 
We have been an independent regulatory agency. We are funded by 
utility fees, so we are not subject to the problems in the 
budget which are currently going on in the State of Oregon. We 
have generally good cooperation with the entities that we 
regulate. We do have concern, as I indicated in my testimony, 
that industry consolidation will make our job more complex, but 
with access to books and records and with cooperation of the 
entities that we regulate, we believe we can continue to 
regulate effectively.
    Senator Smith. Very good.
    One final question, Mr. Chairman. Did PGE buy high-cost 
power from Enron last year?
    Mr. Hemmingway. Mr. Chairman, I do not know the details, 
but I imagine they did. The question is, was that high-cost 
power priced above market, and I do not believe it was. PGE 
bought power from literally dozens and dozens of different 
sources, and that power was priced at a very high price due to 
the market conditions largely due to the California problem. 
And those costs have been passed on to ratepayers such that PGE 
industrial customers are now paying 50 percent more for power 
than they were a year ago. That is not a fortunate situation. 
But if there was market manipulation, it occurred throughout 
the wholesale market and it was not something that PGE had any 
control over. So, we were forced to pass those costs along.
    Senator Smith. Can you just state, is there any instance in 
which this Enron debacle has unfolded in which Oregonians have 
been particularly victimized? From your regulatory standpoint, 
where have Oregonians suffered from this?
    Mr. Hemmingway. Well, certainly the employees, Senator, of 
Portland General Electric have suffered terribly in their loss 
of their 401(k) pension funds.
    Senator Smith. But as to ratepayers.
    Mr. Hemmingway. As to ratepayers, I do not believe so. 
Portland General Electric still has access to the capital 
markets. There is a question as to whether they are paying more 
as a result of Enron or whether they are paying more as a 
result of the problems in the industry as a whole. But overall, 
this utility is able to function just as well as it did before.
    Senator Smith. Thank you very much.
    The Chairman. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman. Thank you for 
holding this hearing. I want to explore with our witnesses the 
process and the decision that seems to have allowed Enron to 
self-certify as qualified for a PUHCA exemption.
    I want to begin, Mr. Hempling, if I could, with you because 
in reviewing your written testimony last night, at page 29 of 
the testimony you make a number of important points.
    First, you point out that Enron was a global company and 
therefore it should not have been eligible for an exemption 
from PUHCA for holding companies that are predominantly 
intrastate in character and carry on their business 
substantially in a single State.
    Second, you make the point that a proper application of 
PUHCA would have prevented the activities that led to Enron's 
collapse.
    On your first point, could you briefly tell us why Enron 
should not have qualified for an exemption from PUHCA?
    Mr. Hempling. Yes, sir, Senator Wyden. The exemption under 
which Enron operated after its acquisition of Portland General 
Electric is the exemption set forth in section 3(a)(1) of the 
act. It is commonly known as the intrastate exemption.
    The language of the statute literally requires that the 
holding company and each of the utility subsidiaries from which 
it gains a material amount of income must be predominantly 
intrastate in character and must do business substantially in a 
single State. These requirements apply distinctly to the 
holding company, as well as to the utility subsidiary.
    So, the analysis is whether Enron Corp., the holding 
company, which owns pipelines, gas companies throughout the 
United States, which has holdings throughout the world, is 
predominantly intrastate in character and whether Enron Corp., 
the holding company, does business substantially in a single 
State. Common sense would tell you that it does not.
    Senator Wyden. Now, you also say in your written testimony 
that the SEC could have found that Enron should not have been 
an exempt holding company. Is it your view that the SEC abused 
its discretion in not challenging Enron's claim that it was 
exempt from PUHCA?
    Mr. Hempling. As a lawyer, I probably would not use the 
term ``abuse of discretion'' because I do not think the SEC had 
any discretion in this area. The statutory language is plain 
that the ``predominantly intrastate in character'' requirement 
and the ``doing business substantially in a single State'' 
requirement applies to the holding company as well as to the 
utility. There is no discretion. So, what we have is not an 
abuse of discretion. We have simply a disregard for the 
statutory language.
    Senator Wyden. The law does seem clear on its face to me, 
and you have now said that the SEC disregarded the plain 
language of the law. How in your view was it that Enron was 
able to get this exemption from PUHCA despite the clear 
language of the law? What was the process that caused this to 
happen?
    Mr. Hempling. The process under the SEC regulations 
provides an applicant for exemption with two options. One is to 
ask the commission for an order, and the other is to certify on 
its own that it meets the exemption. It is my understanding 
that the self-certification approach that is made available 
under rule 2 of the SEC's regulations under the act was the 
path selected.
    Senator Wyden. So, there was no notice to the public here, 
no hearing. Basically the public just learns about the self-
certification, as you call it, after the fact.
    Mr. Hempling. I believe that is correct. Commonly, in 
contrast, under the Federal Power Act, when a utility wants 
something, it makes application. The application is noticed by 
the FERC in the Federal Register. Those who make a habit of 
reading the Federal Register daily find out about it, have an 
opportunity to intervene, protest, ask for a hearing, and upon 
being aggrieved by a commission decision, take the matter to 
court. That process does not exist under rule 2 under the 
Holding Company Act.
    Senator Wyden. Did this self-certification occur in 1997 
when Enron acquired PGE?
    Mr. Hempling. I think the form that was filed by Enron to 
gain the exemption was a 1997 filing, yes, sir.
    Senator Wyden. Now, has anyone tried to challenge these 
self-certification processes that Enron won? Or is it just sort 
of stacked against public scrutiny of these exemptions?
    Mr. Hempling. Well, the scrutiny is possible because you 
can find out about it afterwards, Senator, but the process by 
which the exemption is granted is not readily accessible. I 
have a batting average in appealing SEC orders that is somewhat 
to the south of Sammy Sosa's, and one of the reasons why it is 
so low is because the appealability of an intrastate exemption 
does not exist. It is viewed by the courts as not an agency 
action and therefore one cannot--at the least the Ninth Circuit 
said one cannot--challenge an exemption that is obtained this 
way.
    Senator Wyden. Now, on your second point, you say--I'll 
quote you. ``Had Enron been treated as a registered holding 
company, those activities leading to its present state would 
have been curbed or prohibited, assuming the act were applied 
conscientiously.'' Are you saying that SEC enforcement of PUHCA 
could have avoided or at least minimized the collapse of Enron?
    Mr. Hempling. I think that is correct, Senator. Now, I do 
not want to pose as an expert on the Enron debacle. There are 
several million other people who are doing that right now. But 
I will say that as a registered holding company, Enron would 
have been subject to three types of provisions under the act.
    The first provision, section 11(b)(1) would require Enron 
to have limited its activities to those that are incidental to 
or reasonably necessary or appropriate to the operation of an 
integrated public utility system. That means that any of the 
diversified activities, the ones that do not involve the core 
business of running an electric system, would have had to have 
been discarded. To the extent the Enron problems flowed from 
those types of businesses, the Enron problems would not have 
arisen had the required divestiture taken place.
    The second type of provision relates to inter-affiliate 
transactions. Registered holding companies are subject to 
sections 12 and 13. Section 12, in particular, deals with 
financial transactions between affiliates. Issuances of 
securities, guarantees of debt, injection of equity, and those 
types of arrangements would have had to have been approved, as 
consistent with the public interest, by the SEC if Enron were a 
registered holding company. As an exempt holding company, there 
is no SEC jurisdiction over them.
    And the third area would be sections 6 and 7 of the act 
which relate to the issuances of securities generally, which 
are reviewed not merely for accuracy but for prudence and 
reasonableness. A subsidiary or a holding company issuing debt, 
which is a registered holding company, would have had to 
satisfy the SEC's public interest criteria.
    So, my position was that were registered status to have 
applied, which it would have applied had there not been the 
intrastate exemption, there would have been those three 
junctures at which review of the Enron situation would take 
place.
    Senator Wyden. I thank you and thank you, Mr. Chairman, 
because I want to follow up now with Mr. Hunt briefly with 
respect to what Mr. Hempling has said because this raises in my 
mind some serious questions about commission policy.
    As you just heard, Commissioner Hunt, Mr. Hempling's 
answers raised some very serious questions that in 1997 the 
Securities and Exchange Commission allowed Enron to self-
certify it was eligible for an exemption when it was not, and 
had the law been properly applied, Enron's collapse in his 
judgment could have been avoided. You all were at the 
commission at that point. The statute seems clear on its face 
that both the utility and the holding company have to be 
primarily in one State to qualify for the exemption.
    Did the commission's review of Enron's certification that 
it was exempt from PUHCA as a predominantly intrastate company 
find that it was not a global concern?
    Mr. Hunt. Well, sir, we do not think that Enron could have 
engaged in its core business of energy marketing if it had been 
registered as a registered holding company for some of the 
reasons that Mr. Hempling cited: the geographic area 
restrictions in the statute, the uniform, efficient operation 
of a company. We just do not think that if Enron had been 
registered as a registered holding company, they would ever 
have gone into the business that got them into trouble. They 
just, in our view, could not have done it as a registered 
public utility holding company.
    In 1994, as I mentioned in my testimony, the staff did 
grant a no-action letter in which the staff agreed not to 
recommend enforcement action if they operated as a power 
marketing company because we and the staff, at that time, 
thought that the power marketing business was not a business 
that made them a public utility, generating and transmitting 
energy. So, in 1994, the staff issued a no-action letter.
    And then in 1998, I think, not in 1997, when they acquired 
the Portland General Electric Company, they did claim the 
exemption under rule 2, and we did think at that time that, 
because of the incorporation of the holding company, the 
operation of the utility in the same State of incorporation, 
that it was entitled to the intrastate exemption insofar as it 
was a utility holding company, as opposed to its other 
operations. The core of its problems, the power marketing--
again in 1994, we took the position that that did not make the 
company a registered utility holding company.
    Senator Wyden. The only thing that troubles me about that 
answer, Mr. Hunt, is energy marketing is a separate issue from 
the company that owned PGE. And what Mr. Hempling said is this 
does not come close. Does not come close. I asked him about 
whether the commission possibly abused its discretion in 
granting the exemption. He says it is not even a close call. He 
said the law is very clear. He said this is a global concern. 
It is not an intrastate concern. And you are talking about 
apples when the law specifically mentions oranges.
    I would like to have a second round on this, Mr. Chairman. 
I know Senator Cantwell has questions she wants to raise.
    Mr. Hunt. Mr. Chairman, could I respond to that?
    Senator Wyden. Yes, I would like that. I would like to know 
about what the process was for considering this.
    The Chairman. Why don't you go ahead, Mr. Hunt, and 
respond, and then we will call on Senator Cantwell for a round 
of questions.
    Mr. Hunt. Senator Wyden, in looking at the status of 
utility holding companies as to whether they are entitled to 
the intrastate exemption or any other exemption, we do not look 
at what we consider non-utility activities, and we did not 
think that the so-called global activities of Enron were 
activities we should look at in terms of determining its right 
to or non-right to the intrastate exemption. And since we did 
not consider its power marketing global activities utility 
activities, we did not look at those activities in coming to 
the conclusion that it was entitled to the intrastate exemption 
under rule 2. That is a longstanding position of the 
Commission.
    Senator Wyden. Well, Mr. Hunt, let me read the language Mr. 
Hempling is referring to. It says holding companies and all the 
subsidiaries have to be intrastate. I am looking right at the 
statute.
    Mr. Sokol. Senator, as a 3(a)(1) exempt company, can I try 
to respond to that? We have exactly the same exemption and we 
are a global company as well.
    The language--and let me read it slowly--says, ``such 
holding company, and every subsidiary company thereof which is 
a public-utility company''--that is a defined term under the 
act--``from which such holding company derives, directly or 
indirectly, any material part of its income are predominantly 
intrastate in character and carry on their business 
substantially in that single State in which such holding 
company and every subsidiary company thereof are organized.''
    I am not defending Enron, but Enron Corporation is 
incorporated in Oregon and its public utility, only public 
utility it owns, which is Portland General, is only in the 
State of Oregon. And by the way, we are the same. We have a 
utility that is predominantly in the State of Iowa, and we have 
global operations. I do not think there is any lack of 
discretion or appropriateness in the 3(a)(1) exemption for 
Enron.
    Senator Wyden. Can we just hear from Mr. Hempling on that? 
I just think the statute is very clear.
    Mr. Hempling. I do not think there is any confusion here. I 
think that Commissioner Hunt described the policy of the SEC, 
as I have understood it, accurately. It is the policy of the 
SEC that, when looking at the holding company, as distinct from 
the public utility, when it looks at the holding company, it 
only looks at the holding company in its capacity as an owner 
of a public utility company, and if the holding company in its 
capacity as an owner of a public utility company is intrastate, 
then it will grant the exemption. As I have suggested, I see no 
discretion upon which one can give that answer because it 
simply says ``such holding company.''
    Now, Justice Scalia once said when the legislative history 
is ambiguous, there is no prohibition in looking at the words 
of the statute.
    [Laughter.]
    Mr. Hempling. But even if one does look to the legislative 
history, one finds that the abuses which led to the enactment 
of the act had to do with the holding company and not merely 
the holding company in its capacity as the owner of a public 
utility company but the holding company as a form of doing 
business which controlled vast types of businesses and assets 
which had little or nothing to do with the public utility 
business. That is why the distinct phrase holding company, 
unlimited by the interpretation that the commission has been 
giving it, is in the statute.
    Senator Wyden. Thank you, Mr. Chairman.
    The Chairman. Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman, for holding this 
important hearing today on the Public Utility Holding Company 
Act and its effect on the energy markets and consumers.
    I have a question for Ms. Marlette about some of your 
testimony as it relates to, obviously, the changes that you are 
recommending and oversight, but particularly as it related to 
your comments on FERC's authority to prescribe RTO's.
    Let me first say I understand conceptually how RTO's 
provide benefits to consumers in some regions of the country. 
However, as you are probably aware, the Northwest situation is 
unique in the amount of power generated by Bonneville, which 
does not fall under the commission's jurisdiction. It already 
has a centralized grid and in some sense it owns 75 percent of 
the region's transmission system.
    So, the question on the minds of many of our constituents 
is what kinds of benefits can an RTO provide to us in that 
Northwest parties are already engaged in the vigorous 
discussion of RTO's. So, I want to caution FERC in thinking 
that a one-size-fits-all RTO system would be a reasonable 
approach to this and get your comments on specifically the 
interrelation to this and PUHCA reform and to the Northwest.
    Ms. Marlette. We are certainly well aware of the concerns 
of the Northwest with respect to RTO's, and as you probably 
already know, we are undertaking a cost-benefit analysis, which 
we hope to get back soon, to look at the benefits to the 
specific regions. Generally, the major benefits of an RTO--to 
me, the biggest benefit is eliminating undue discrimination in 
the access to and pricing of transmission, including 
eliminating pancaking of transmission rates, and also providing 
a forum for regional transmission planning so that States 
within a region can come together and the RTO can be a focal 
point for that planning.
    But, as I said, we are looking at the specific cost 
benefits. It is a pending issue at the commission. When we 
issued Order 2000, we did a cost-benefit analysis, and that is 
being updated.
    Senator Cantwell. I think you can understand that given the 
Northwest's unique nature and then what has transpired, how 
crazy people would think that a west-wide RTO, given all the 
problems that have thus occurred, would be for the Northwest to 
participate in.
    Ms. Marlette. The Commissioners are well aware of that and 
the concerns about not imposing a one-size-fits-all and 
particularly the concerns in the Western part of the country, 
in light of California.
    Senator Cantwell. I wanted to follow up too. This is 
somewhat of a follow-on to last week's hearing about the 
unregulated nature of energy markets and the link to get long-
term power pricing. You may or may not know, but I am assuming 
you know since you are of counsel there, that I asked Chairman 
Wood about a 206 investigation. In fact, I think he said we 
will get an answer one way or another and we will commit to 
doing that for you. So, have you, in fact, opened up a 206 
investigation?
    Ms. Marlette. I have the letters on my desk, as do others, 
both yours and Senator Wyden's. To formally, officially open a 
206 investigation, a majority of the Commission would need to 
vote to do that under the Federal Power Act. So, we have not 
issued any orders as yet.
    The Commission is looking at trying to do some fact finding 
as we speak, to gather some information.
    One point I should try to make clear is that under 206, the 
Commission's authority is to open investigations as to public 
utility contracts, the entities that we regulate. We do not 
directly regulate EnronOnLine. We have not asserted 
jurisdiction over it itself as a public utility. So, any 206's 
would be into the rates under the seller's long-term contracts. 
That would be where a 206 would come in.
    However, having said that, the Commission can certainly, in 
fact-finding, gather information and we are going to do that 
with respect to the EnronOnLine activities.
    Senator Cantwell. Well, I just want to point out that we 
have been consistent about the investigation of long-term 
contracts, given that that was the price manipulation that the 
Northwest felt was going on last spring. So, we have been 
consistent in asking for an investigation and, when the price 
cap or price mitigation plan was put into place, that long-term 
contracts be looked at. So, I really believe that any 
hesitation by FERC will be viewed very negatively in not being 
cooperative in getting to what really has resulted in some 
parts of our State in 50 percent rate increases that now 
consumers will have to live up to for the next 3 or 4 years.
    In fact, I am sure that probably what is happening is Enron 
is buying cheap power at $30 a megawatt from some source in my 
State, selling it to another utility for their long-term 
contract, which was probably like $130 a megawatt. And that is 
still going on today and consumers are going to have to 
continue to pay that 50 percent rate increase, and I believe 
that FERC needs to do its job to get that investigation 
underway immediately.
    Ms. Marlette. Yes, Senator. I do not want to be perceived 
at all as the Commission hesitating, but what we are trying to 
do right now at the staff level is fact gathering so that we 
have enough to know how to go forward and whom to investigate 
and how to frame an investigation. So, we are seriously 
undertaking some fact-finding investigation.
    Senator Cantwell. We look forward to your update as soon as 
possible.
    Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Mr. Hempling, let me ask a couple of things. You have 
several suggestions for strengthening the language in S. 1766 
as regards FERC's responsibilities. I think the way you put it, 
you believe that FERC needs more substantial affirmative 
authority. I think that was the phrase that I heard you use.
    One of the suggestions there was that FERC should be 
obligated to assess the effect of the merger on retail 
competition, not just authorized to do so. Is that accurate?
    Mr. Hempling. Yes, sir, that is correct. If I understand 
the present FERC policy today, it is set forth in what is 
called the FERC merger policy issued several years ago. It 
includes a recognition that the retail customer is a concern of 
FERC's even though retail ratemaking is not and the policy is 
that upon the request of a State commission, I believe in the 
context where a State commission has no jurisdiction over a 
merger, the FERC will look into it.
    I find that approach to be spotty because we have a 
national infrastructure. Ultimately it is the retail customer 
who pays the bill, who finances the industry, and we have 
utilities whose very purposes for merging are to gain influence 
and dominance in retail markets. So, because of the national 
importance of the industry, I think relying on the episodic 
request from a State commission, the public admission by a 
State commission that it lacks jurisdiction, is a policy that 
is not sufficiently comprehensive to protect the consumer 
especially during a period where consolidation is occurring so 
rapidly.
    The Chairman. Mr. Hemmingway, do you have a problem with 
that suggestion if we were to specify in Federal law that FERC 
is obligated, in looking at these mergers, to look at the 
effect the merger would have on retail competition?
    Mr. Hemmingway. I have no problem with that. Senator, that 
is exactly what we do in reviewing mergers under our statutes 
in Oregon.
    The Chairman. There is also a suggestion in your testimony, 
Mr. Hempling, that the bill should codify FERC's recent policy 
of establishing that the right to charge market rates lasts 
only as long as the rates are just and reasonable. You think 
that needs to be specified.
    Mr. Hempling. Yes, sir. Ms. Marlette can speak to this more 
authoritatively. It is my understanding that in the past, 
before approximately December, if FERC had authorized a company 
to charge what the market will bear and someone found out that 
the market is no longer competitive so that rates are now just 
and reasonable, that person or FERC could institute a complaint 
proceeding and refunds would be available prospectively. But a 
long period of time can go on between the time that the markets 
turn noncompetitive and that complaint gets filed.
    And I believe FERC in December recognized this notion and 
intends to assign to all future authorizations of market-based 
rates the statement that at any point in time that this becomes 
unjust and unreasonable, even if we do not find out about it 
afterwards, we will grant refunds back to that date. And I 
think codifying that would remove the possibility that future 
commissions, like past commissions other than this commission, 
would miss the boat on protecting the consumer.
    The Chairman. Ms. Marlette, do you have a problem with that 
suggestion?
    Ms. Marlette. Well, just a couple of clarifications. What 
the Commission proposed to do--and we instituted a 206 
investigation into all public utility tariffs, proposing to 
place into all existing tariffs and future tariffs a condition 
which says that if the seller is found to have engaged in anti-
competitive conduct, then it will be subject to refunds. We 
could go back in time--those provisions have not taken effect 
yet. We have asked for comment on it. Actually I think the 
comments may be in by now. We do have a pending proceeding on 
that issue, so I do not feel it appropriate to discuss whether 
it ought to be legislated since I have not personally 
considered all the views on the issue.
    The Chairman. Mr. Hemmingway, in your testimony I believe 
you have a statement that the books and records provisions that 
are in S. 1766 should be strengthened, but you do not specify 
in what way. Could you elaborate on that or tell us more 
specifically how you would like to see those strengthened?
    Mr. Hemmingway. Yes, Mr. Chairman. With respect to State 
commissions, it requires that there be an open proceeding 
before there can be a request for books and records. Many 
utility commissions do ongoing audit efforts with utilities 
without opening up a specific docket. We in Oregon tend to open 
dockets on everything, but many commissions do not. It would be 
fruitful, Mr. Chairman, if that provision could be broadened so 
that State utility commissions did not need to open a 
proceeding before requesting books and records.
    The Chairman. One of the prohibitions that is in the Public 
Utility Holding Company Act is this prohibition against 
acquiring anything that is not part of an integrated public 
utility system, as I understand it. As I understand everyone's 
testimony, including yours, Mr. Hempling, everyone has agreed 
that that does not make sense in the current economic 
circumstance that we live in, that that prohibition that says 
you can only acquire an asset or a business that is part of an 
integrated public utility system--that that requirement is 
obsolete at this point. Let me ask Mr. Hempling if you agree 
with that.
    Mr. Hempling. Making the concern a requirement is the 
error. The concern itself is not. The distant collection of 
monopoly assets based on inquisitiveness or market dominance is 
still a concern. It is because of the possibilities brought by 
an investor like Mr. Buffett, who seems to run a good business, 
that I have suggested that that concern should not be 
translated anymore into a prohibition. So, I think there is 
complete agreement, as you pointed out, on that. The 
fundamental difference has to do with whether the acquisition 
is going to be reviewed sufficiently.
    The Chairman. Let me go ahead and defer to Senator Wyden 
for another round.
    Senator Wyden. Thank you, Mr. Chairman. I just want to note 
for the record that no one could ever question your commitment 
to energy conservation because it is so cold on this side of 
the dais.
    [Laughter.]
    Senator Wyden. You are doing more than your share.
    I appreciate having another round.
    The Chairman. We appreciate that rousing endorsement.
    [Laughter.]
    Senator Wyden. Commissioner Hunt, let me go back to 
something you said in response to my earlier question. You said 
in response to my earlier question that the SEC's decision to 
issue the no-action letter in 1994 allowing Enron to engage in 
energy trading without having to register under PUHCA, your 
view was that Enron would not have been able to get into the 
business of energy trading had it not been a registered holding 
company.
    Mr. Hunt. I think my statement, Senator, was I do not think 
they would have been able to get into the business of energy 
trading if they were a registered public utility holding 
company because it is global in nature and their business would 
have violated many of the restrictive aspects of the 1935 act.
    Senator Wyden. Is it the principal job of the SEC to help 
companies like Enron get into the energy trading business?
    Mr. Hunt. No, sir. I think our principal job is to regulate 
the securities markets of the United States and to provide for 
the easy raising of capital for American industry and to 
protect investors.
    Senator Wyden. Well, my read is it is SEC's job to enforce 
the letter and the spirit of the law rather than help folks get 
into the energy trading business.
    Mr. Hunt. Senator, we gave this kind of relief to 20 
companies after we gave the relief to Enron. We also 
incorporated it into our rule 58, defining energy marketing as 
a permitted non-utility business in 1997 after notice to the 
general public. And of course, the rulemaking was a public 
proceeding. In our rule 58, we said that the brokering and 
marketing of energy commodities, including but not limited to 
electricity, natural or manufactured gas and other combustible 
fuels, was a permitted non-utility activity of utility holding 
companies.
    Now, people would have had a right to object to that rule 
when we proposed it, but we defined energy marketing as a non-
utility activity for purposes of the 1935 act in 1997.
    Senator Wyden. Well, again, what you are saying sure seems 
to be different than what we have heard from Mr. Hempling. Mr. 
Hempling described something that the public got no notice 
about.
    Mr. Hempling. Sir, if I may clarify.
    Senator Wyden. Why do you not?
    Mr. Hempling. Yes, sir, because I think there is nothing 
about which Commissioner Hunt is saying that is not 100 percent 
accurate. I want to make sure the record is clear.
    When I talked about the absence of advanced public notice, 
I was referring to the process by which the intrastate 
exemption under section 3(a)(1) is granted. Commissioner Hunt 
is, of course, correct that with respect to the declaration 
that marketing, brokering, and other activities are determined 
to be permitted for registered holding companies, that was 
certainly done pursuant to the traditional notice and comment 
rulemaking that the SEC and all agencies engage in. There were 
no procedural defects associated with the rule 58.
    Senator Wyden. Nobody is saying that.
    I just want to go back to the issue that I have been 
concerned about, that my constituents are concerned about: 
there was not any public process with respect to this self-
certification.
    Now, Mr. Hunt, during the time you served on the SEC, were 
there ever any questions about the self-certification process?
    Mr. Hunt. Certainly none that came to my attention, 
Senator. I do not think so.
    Senator Wyden. Now, in 1997, around the same time--this 
would be a question again for you, Mr. Hunt--that Enron was 
self-certifying it was exempt from PUHCA, Enron also sought 
another exemption from the SEC. This was under the Investment 
Company Act. Now, in seeking that exemption, Enron certainly 
did not hide the fact that it wanted to expand its overseas 
operation. Enron specifically requested an exemption from the 
investment company statute to engage in foreign infrastructure 
projects, and the SEC granted that exemption.
    Mr. Hunt. Yes, sir.
    Senator Wyden. Given that the SEC was on notice that Enron 
was going to engage in overseas operations, that it was going 
to be a global company, did anyone at the SEC compare that 
filing with Enron's self-certification that it was exempt from 
PUHCA because it was saying the company was primarily in 
business in one State?
    My reason for asking this I think is obvious. How can you 
be a global company in one respect under one act the SEC 
enforces, the Investment Company Act, and then be classified as 
operating primarily in one State under another act the SEC 
enforces which is PUHCA?
    Mr. Hunt. Easy, sir. The Investment Company Act is designed 
to get at companies that essentially hold investment securities 
in other companies. What Enron was doing was engaging in 
infrastructure, bridge, railroad, dam, projects around the 
world. In many countries, the legal regimes of those countries 
prohibit a foreign corporation from holding a majority interest 
in any kind of corporation whether it is constructing 
infrastructure items or other things. Therefore, Enron found 
itself holding minority interests in companies around the world 
in infrastructure engagements. But for an exemption from the 
Investment Company Act of 1940, Enron would have, therefore, 
been deemed to be an investment company because it may have had 
over 45 percent of its assets invested in this way and perhaps 
would have had more than 45 percent of its income derived from 
these infrastructure engagements.
    It was the Division of Investment Management's view that 
this was not the sort of activity that the Investment Company 
Act was meant to regulate, that the Investment Company Act was 
meant to regulate such investments as are engaged in by mutual 
funds or other investment companies, and that, under these 
circumstances, given the business in which Enron was engaged 
and going to be engaged, its security holders did not need the 
protection under the Investment Company Act of 1940.
    Senator Wyden. Mr. Chairman, I know my time is expired. I 
want to wrap up by asking that an article from the Wall Street 
Journal be entered into the record. It is entitled ``Enron's 
Rise and Fall Mirrors Collapse of Middle West Utilities 70 
Years Ago.'' Just in wrapping up, I quote from the article. It 
says, ``In rapid order in 1934 and 1935, Congress passed the 
Securities and Exchange Act, the Public Utility Holding Company 
Act, and the Federal Power Act. These laws sought to break up 
the power trusts and guarantee investors the information they 
need to make informed decisions. More than a half century 
later, Enron would figure out ways around part of those same 
laws.''
    I think what we have heard today--and again, these are very 
complicated issues and you have been very gracious in terms of 
letting us look at these issues--raises some very troubling 
questions. I am not reaching any judgments at this point, but 
certainly what we have heard--and particularly when Mr. 
Hempling says it is not a close call here, there was not any 
abuse of discretion, that the SEC in his judgment did not 
follow the law on this issue, I think we ought to be digging 
further. I am anxious to work cooperatively with you in this 
regard.
    The Chairman. Thank you.
    Senator Carper, I had another few questions. Would you like 
to go ahead first with your questions?
    Senator Carper. I would like to hear your questions.
    The Chairman. Well, I am glad to ask them and you can then 
ask yours.
    Senator Carper. Thank you.
    The Chairman. Let me ask a general question. One of the 
things the Public Utility Holding Company Act was intended to 
accomplish was to prevent this cross-subsidization that we 
worry about so that you do not wind up with ratepayers having 
to subsidize other businesses that they have had no involvement 
in. Mr. Hemmingway, you testified that you try to regulate 
there in Oregon each company, each utility, as a stand-alone 
business so that you work hard to be sure that there is no 
cross-subsidization.
    PUHCA, as I understand it, has a prohibition against it in 
the sense that it says if you get into a business that is an 
affiliated business, you have got to do business with that 
business on a cost basis. So, one example would be if you buy a 
lumber company to make electric poles, you cannot enrich your 
lumber company by charging an unduly high price for those 
electric poles and making the utility customer pay that price. 
You have got to sell them at cost. Now, that is my 
understanding of one thing PUHCA is trying to do.
    Does the language we have in this S. 1766 adequately ensure 
that that cross-subsidization will not be there once this 
responsibility is transferred, if it is, if this legislation 
goes through and the responsibility is going to be with the 
State commissions and is going to be with FERC--does the 
language we have here ensure against that cross-subsidization 
as effectively as PUHCA has?
    Mr. Hemmingway.
    Mr. Hemmingway. Mr. Chairman, cross-subsidization is an 
issue for any utility regulator because utilities often have 
enterprises which are not regulated. They may do everything 
from--we have had airplane leasing to real estate development 
to coal development. And whether they are registered or come 
under any purview of the Holding Company Act whatsoever. So, 
any regulator is accustomed to having to separate out these 
enterprises and to ensure that there is not any cross-
subsidization from regulated enterprises to non-regulated 
enterprises. And the key there is being able to have access to 
the books and records of the company to be able to audit them 
and to make sure that that is not happening.
    Now, when PUHCA is repealed, as is contemplated in S. 1766, 
there is a provision with respect to the way that registered 
holding companies are regulated that requires the allocation of 
costs from an affiliated company to be done at cost, and it may 
happen that it may suit regulators to look at market prices in 
a situation where market prices, for instance, are well below 
cost. It may well happen, for instance, that a utility has 
developed real estate and the real estate market has dropped 
and the question then comes before the regulator, must you 
allow the cost of that real estate in the rates or can you look 
at market. With the repeal of PUHCA, we would not be facing 
that situation of having the SEC do that allocation of cost, 
but we could actually look at market alone.
    To sum up, the key to us is being able to have access to 
the books and records of whatever corporate structure results, 
whether it is a holding company or not, and if we have access, 
we think we can effectively regulate.
    The Chairman. Good.
    Mr. Hempling.
    Mr. Hempling. Yes, sir. It certainly is correct to outlaw 
the types of transactions that lead to cross-subsidies, and the 
bill does that appropriately. But the history of regulation and 
the present of regulation is that there is a distinction 
between transaction and structure. If one has the type of 
corporate structure and market structure where there is an 
incentive and opportunity to cross-subsidize, then all one is 
doing is making far more work for the regulator at the other 
end and creating far more uncertainty.
    When I looked at the form filed by the Enron Corp. asking 
for its intrastate exemption, I looked for the list of 
subsidiaries that it had around the world, and it said, see 
appendix 1. And when I went to appendix 1, it said, not filed 
pursuant to regulation 202 of the SEC's S-T. And I asked a 
colleague of mine who is in corporate law, what does that mean, 
and he said, it is so voluminous that they asked for an 
exemption from having to do it electronically because they 
would have had to put too many things through a scanner.
    The point is that one can have staff, one can be committed 
to the policing of cross-subsidies. But I make most of my money 
working within State commissions, and I am not aware of any 
State commissions where there is surplus staff to review for 
the cross-subsidies based on the increasing complexity 
transactionally that will arise once the Holding Company Act is 
repealed.
    The Chairman. But now, what is your solution? Is your 
solution that we say, if a company does have extensive other 
holdings, like Berkshire Hathaway does, that we should not let 
them in the utility business? Is that your solution?
    Mr. Hempling. No, sir, not at all. My solution is simply 
what the act does now, with the exception of the prohibition. 
What the act does now is create an advance review. So, let the 
Federal regulators, as well as the State regulators, look at 
the corporate structure that is being proposed before the 
acquisition and ask the simple question, are we going to have 
the authority, the resources, the technical ability to trace 
the cross-subsidies, at what cost? Is our legislative body 
going to continue to fund us at the level necessary to incur 
those costs? And if so, have at it.
    The Chairman. So, you are saying if FERC has the ability to 
do a prior review before Berkshire Hathaway could come in and 
buy a utility or anybody else could come in and buy a utility, 
and if the State commission involved has the ability to do a 
prior review and say, okay, you can do it, then that satisfies 
your concern.
    Mr. Hempling. Yes, sir, if the reviewing agencies are 
required to conduct a review and that they are required to 
conduct it pursuant to the traditional public interest 
criteria.
    Now, I want to be clear. I am not talking about the 12-
month delay. I understand what competitive entry is. I run a 
law practice where I compete. I do not want to get 6 months of 
delay before I decide whether to bid on a job. But these are 
the types of structural reviews that can be done concisely in 
advance upon the proper filings of things, and then someone who 
passes----
    The Chairman. So, someone could come in and make a bid to 
purchase a utility, and it would be conditioned upon approval 
by the appropriate commissions, and that would be the end.
    Mr. Hempling. Yes, sir. Again, what we would be doing is 
retaining what is good about the act and eliminating the 
obstructions that are in the act.
    The Chairman. Mr. Sokol.
    Mr. Sokol. Senator, I would just make two comments. First 
of all, that is exactly what happens today and your bill will 
only enhance that. I would ask the chairman of the Oregon 
Commission whether he would allow--the thing I would disagree 
with, Mr. Hempling, is it is not enough to just review it up 
front because corporations change. The State regulators have 
got to have the right to review it every time they want to 
review it and have the access to information.
    The Chairman. Do you agree with his point that both the 
State regulators and FERC should have ongoing access to books 
and records?
    Mr. Sokol. As they require it, yes.
    Mr. Hunt. Senator, if I may. We would not dictate the 
rules, but FERC should have rulemaking authority to prohibit 
those kinds of affiliated transactions that they find to 
inherently have a conflict of interest.
    The Chairman. Senator Carper, I have asked my questions.
    Senator Carper. Well, good. Thank you, sir, for allowing me 
to ask a few myself.
    I apologize for being late. I serve on three committees 
that are meeting this morning and I am trying to go from one to 
the other and cover them all. The Senate is in session, and I 
have been presiding for a while and speaking on the Senate 
floor. So, I am just glad to be here. I am glad that you all 
are still here.
    I will be real honest with you. I have not had a chance to 
read your testimony. I understand the basic reason we are 
having this hearing is to try to get your input as to whether 
or not some of the events that are involved around the Enron 
bankruptcy raise concerns among some people that the regulation 
of energy companies might be insufficient if we repeal PUHCA.
    What I really would most appreciate is just for each of you 
to take a minute and answer that question for me, and if there 
is anything else that you want me to take out of this hearing 
that you think, by golly, you have missed most of this, pal, 
but there are one or two things you ought to know and here they 
are. Just take a minute apiece and answer the basic question 
for me.
    Mr. Hunt. Senator, my name is Isaac Hunt. I am with the 
Securities and Exchange Commission. We, fortunately or 
unfortunately, administer PUHCA now.
    [Laughter.]
    Mr. Hunt. It is our position and has been for 20 years that 
PUHCA is outdated, that most of the evils that PUHCA was meant 
to remedy have been remedied, that more authority should be 
given to FERC, the principal utility regulator, and to the 
States to have complete access to the books and records of 
utility companies so that they can guard against these cross-
affiliate transactions that we were just talking about with the 
chairman.
    We think that the State regulation has improved. We think 
that FERC is clearly the agency that the Congress intends to be 
principal utility regulator at the Federal level, and we think 
we should be out of this business.
    Senator Carper. Thank you for that direct response.
    Others, please.
    Mr. Hemmingway. I am Roy Hemmingway, the chairman of the 
Oregon Public Utility Commission.
    Senator Carper. Welcome.
    Mr. Hemmingway. Thank you.
    The Public Utility Holding Company Act is basically the 
constitution by which the electric and natural gas retail 
utility industry is structured today. We have hundreds of 
relatively small enterprises serving retail consumers around 
the country.
    If PUHCA is repealed, we expect that there will be 
considerably greater acceleration of consolidation in this 
industry, and you can have your own opinion whether that is a 
good thing or a bad thing. I think in many respects it would be 
a good thing.
    The concern, though, that we have as State regulators is 
that that consolidation makes regulation more difficult and 
more complicated and shifts some of that jurisdiction to the 
Federal Government. We think that we can accommodate that 
change if we have ability to investigate books and records and 
if FERC has additional authority to approve mergers. But we 
think that the Congress and the Federal agencies will need to 
maintain vigilance because it is somewhat unpredictable as to 
what kind of industry structure will result from repeal of 
PUHCA and there may be abuses in the future that we cannot 
anticipate at this time.
    Senator Carper. Thank you.
    Ms. Marlette. I am here as a staff witness.
    Senator Carper. Are you with FERC?
    Ms. Marlette. I am the General Counsel of the FERC.
    Our Commission witnesses have consistently for the last, I 
think, 5 to 6 years testified that PUHCA does need to be 
repealed or reformed. We think it is inconsistent with 
competitive markets right now. It encourages geographic 
concentrations of generation, which actually can increase 
market power, and it can serve as a disincentive to investments 
in RTO's, regional transmission organizations.
    There are certain areas of PUHCA which have actually 
impeded our Commission's ability to protect the ratepayers 
served by registered holding companies from affiliate cross-
subsidization, the issue that Senator Bingaman was talking 
about a few minutes ago. I think that Senator Bingaman's bill, 
the repeal, that would add access to books and records by both 
State and Federal regulators of all members of the holding 
company system would significantly enhance our ability to 
monitor against market power and cross-subsidization, and it 
would cure the problem that is in the act right now in that 
regard.
    Senator Carper. Thanks very much.
    Mr. Sokol. Senator, David Sokol, CEO of MidAmerican Energy. 
Our largest shareholder is Berkshire Hathaway.
    I think we need to separate the issues. S. 1766 is a very 
good bill, particularly the portions about PUHCA reform. We 
must protect the access to books and records, affiliate 
transactions, et cetera, and we must give the State and FERC 
more authority there. We also have to get rid of those parts of 
PUHCA that stop companies like Berkshire Hathaway from 
investing in this sector so that we have high quality investors 
moving industry forward.
    Enron is a red herring in this sense. Enron had two PUHCA 
exemptions: the 3(a)(1) which was appropriate, and the market 
trading which was appropriate as well. Enron did not go 
bankrupt because it bought Portland General Electric. In fact, 
as the commissioner has stated, Portland General's consumers 
were not harmed by Enron's bankruptcy. PUHCA is actually 
inhibiting their ability to sell it to a credit worthy company.
    Enron was not harmed because it was in the marketing 
business of energy. Enron went bankrupt because of arrogance, 
accounting fraud, and mismanagement. Those are the issues of 
Enron. PUHCA did not stop it. In some ways, PUHCA may have 
helped Enron do what they were doing, but again it was an 
illegal activity based operation and it went bankrupt, as it 
should, as other companies have in the past.
    We cannot not move forward with energy modernization over 
the excitement of Enron. We need to put executives in jail when 
they break the law, and we need to hold auditors accountable. 
But PUHCA has to be reformed if, in fact, we want to move 
forward with the energy sector because right now we are on the 
50-yard line. The Congress deregulated wholesale electricity in 
1992, but we still do not have rule clarification throughout 
the sector, and that is a serious mistake and frankly a recipe 
for serious problems in the future if we do not fix it.
    Senator Carper. So, we are on the 50-yard line. Who has the 
ball?
    Mr. Sokol. You all do.
    [Laughter.]
    Senator Carper. Is it a first down?
    Mr. Sokol. First down.
    Senator Carper. Before we turn to Mr. Hempling for a 
closing word, you said there are three reasons why Enron went 
down. Just say those again. I thought that was nicely put.
    Mr. Sokol. Arrogance, accounting fraud, and mismanagement.
    Senator Carper. Mr. Hempling.
    Mr. Hempling. Thank you, Senator. The Holding Company Act 
uses structural limits to protect consumers in an industry 
where competition is ineffective and regulators are outmatched. 
Those are the preconditions for repealing the Holding Company 
Act. If wholesale competition works, if retail regulation 
works, then the limitations imposed on entry by the Holding 
Company Act are appropriate, but the record is that wholesale 
competition is a work in progress. Many tasks lie ahead from 
understanding regional transmission policy to learning how to 
measure the competitiveness of wholesale markets. We have about 
the best FERC we have had in years. It is struggling 
determinedly with these issues, but it would be the last to say 
that it could predict when these matters will be resolved.
    We should adjust the Holding Company Act so that new 
companies who can bring real benefits, real savings, real 
competition to the market enter, but we have to make sure those 
entries are pro-competitive. We have to do that by assuring 
that the Federal Energy Regulatory Commission has the 
appropriate tools to do so. The position that says repeal the 
Holding Company Act and we will see how things work does not 
take into account the realities of wholesale competition today.
    Senator Carper. Well, my thanks to each of you. That was 
very helpful for me. I am sure, Mr. Chairman, this is 
repetition for you, and I apologize for that. But this has been 
a good, helpful exchange. And we thank each of you for your 
contributions and your presence.
    The Chairman. I think that is a very good summary of the 
testimony we heard. Thank you all very much. I think this is 
very useful testimony.
    [Whereupon, at 11:50 p.m., the hearing was adjourned.]

                               APPENDIXES

                              ----------                              


                               Appendix I

                   Responses to Additional Questions

                              ----------                              

                      Federal Energy Regulatory Commission,
                                 Washington, DC, February 15, 2002.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate, 
        Washington, DC.
    Dear Chairman Bingaman: Thank you for your letter of February 8 
enclosing questions from Senator Richard C. Shelby and Senator Maria 
Cantwell for the record of your Committee's February 6 hearing.
    I have enclosed my responses to Senator Shelby's and Senator 
Cantwell's questions. If you need additional information, please do not 
hesitate to let me know.
            Sincerely,
                                       Cynthia A. Marlette,
                                                   General Counsel.
[Enclosures]

               Responses to Questions From Senator Shelby
    Question 1. Mr. Hempling has stated that the SEC did not apply 
PUHCA in an appropriate manner when considering Enron's request for a 
no-action letter with respect to engaging in power marketing 
activities. In his statement, Commissioner Hunt said that if Congress 
chooses to not repeal PUHCA it should be given to the FERC. If this 
were to happen, could you please describe for us how FERC would apply 
PUHCA to energy marketing activities like those engaged in by Enron?
    Answer. My understanding is that Enron sought a no-action letter 
for its power marketing activities on the basis that these activities 
did not entail ownership or operation of generation, transmission or 
distribution ``facilities'' under the definition of an electric utility 
company under PUHCA. The SEC staff issued a no-action letter. It is not 
clear whether FERC could interpret ``facilities'' in PUHCA differently 
than the SEC Staff. However, the FERC has held that ``facilities'' 
under the Federal Power Act includes books, records and contracts, and 
it has exercised jurisdiction over power marketers on this basis. If 
the FERC were given authority to administer PUHCA, I do not know 
whether a court would affirm an interpretation of PUHCA consistent with 
the FERC's interpretation of the same term under the Federal Power Act.
    Question 2. Commissioner Hunt stated that the SEC took into 
consideration Enron's ability to get ``into the business'' of power 
marketing without a no-action letter. Would the FERC disagree with the 
SEC's consideration of the importance of power marketing to competitive 
electricity markets?
    Answer. I agree that power marketing is important to competitive 
electricity markets. Power marketing allows market participants a 
greater array of possible transactions, in which the marketer takes 
electrical supply from a number of generators and repackages it in the 
quantities and with the terms desired by buyers. In short, power 
marketing can produce greater efficiencies in the markets.
                                 ______
                                 
              Responses to Questions From Senator Cantwell
    Question 1. While I understand, conceptually, how RTOs may provide 
benefits to consumers in some regions of the country, you are probably 
aware that the Pacific Northwest's situation is quite unique in this 
regard, because of the presence of the Bonneville Power Administration 
(BPA). BPA is already a centralized grid operator in the sense its owns 
about 75 percent of our region's high-voltage transmission system. 
Nevertheless, Northwest parties are engaged in vigorous discussion and 
working on an RTO proposal that would meet the needs of our region's 
consumers. However, I just want to caution FERC that it cannot 
prescribe a one-size-fits-all approach to RTOs, and that we need to see 
measurable benefits in the Northwest. I believe the Northwest must be 
given time to craft an RTO that meets our singular needs--in contrast 
to the timeline and concepts outlined in various FERC orders and staff 
papers. Do you agree, however, that FERC lacks the authority to direct 
a Power Marketing Administration such as BPA to participate in an RTO?
    Answer. Yes, I agree that the FERC has no direct authority to 
require a PMA such as BPA to participate in an RTO. With respect to BPA 
specifically, BPA is overseen by the Department of Energy, and is not 
within the Commission's direct jurisdiction under sections 205-206 of 
the FPA.
    Question 2. With regard to the unregulated nature of forward energy 
markets discussed at the Jan. 30 Energy Committee hearing, there are 
some of us who are taking a close look at legislative proposals to 
close this loophole, which some believe may have allowed Enron--through 
its Internet-based trading platform, EnronOnline--to manipulate prices 
in the West. What type of jurisdiction and resources do you believe 
FERC would need to patrol these markets and apply the same just and 
reasonable standard it is currently charged with upholding in other 
wholesale market transactions?
    Answer. If the Congress finds it appropriate to expand the FERC's 
jurisdiction in the way you describe, the legislative language should 
give FERC explicit jurisdiction over: (1) derivatives transactions 
based on, or reflecting, the prices of or for natural gas or electric 
energy; (2) persons making such transactions; and (3) any entity that 
operates an electronic facility in which persons make such 
transactions. Exceptions from this jurisdiction should apply for any 
transactions within the exclusive jurisdiction of the CFTC or the 
exclusive jurisdiction of a State over retail sales of natural gas or 
electricity. If FERC's responsibilities were expanded in this way, FERC 
would likely need significant additional resources.
    Question 3. In the wake of Enron's collapse, many merchant 
generating companies seem to be in shaky financial condition and, 
therefore, are potential buy-out targets. In fact, at least three 
proposed power plants in Washington--needed to meet the West's growing 
energy demand--have already been put on hold because of this 
uncertainty. The weak financial condition of some of these companies 
raises concerns. Given that consolidation within the generation sector 
is at odds with increased competition, how high should we set the bar 
for utility mergers and acquisitions, in order to prevent undue market 
power? Shouldn't mergers be deemed ``in the public interest'' before 
they are allowed to proceed?
    Answer. Mergers involving merchant generation companies generally 
require FERC approval under FPA Section 203. (The exception would be a 
merger involving only generation facilities and not transmission 
facilities or wholesale contracts, a circumstance that occurs 
infrequently, if ever.) Under Section 203, proposed mergers must be 
``consistent with the public interest'' in order to be approved. Under 
existing court precedent, ``consistent with the public interest'' does 
not require a showing of positive benefit to the public, but rather a 
showing of no detriment to the status quo. The Commission considers the 
effect on competition of proposed mergers involving jurisdictional 
facilities under the FPA. If the Commission finds that a merger is 
likely to harm competition, the Commission may impose conditions on the 
merger to prevent such harm. The Commission has used this authority in 
past cases to require such procompetitive measures as the filing of an 
open access tariff. The Commission also considers the effect of the 
merger on rates and on regulation and may impose conditions in these 
areas as well. If the Congress were to change the standard under FPA 
section 203 to require mergers to be ``in the public interest,'' this 
arguably would give the Commission the discretion to require merger 
applicants to demonstrate that the merger would increase competition or 
result in other positive benefits.
    Question 4. S. 1766, the Senate energy bill, relies on FERC access 
to books and records to prevent abusive transactions among a utility 
holding company's affiliates. Enron reportedly had 5,800 affiliates--
including 281 located off-shore. Given these potentially complex 
corporate structures, is access to books and records sufficient to 
prevent abusive transactions? Does FERC have the resources to comb 
through this massive amount of information?
    Answer. Under section 301 of the FPA, the Commission currently has 
extensive access to books and records of public utilities and their 
affiliates. Increased access to books and records of all members of a 
holding company system would provide additional regulatory protection 
and sufficient authority to prevent inappropriate affiliate cross-
subsidization. However, FERC may need additional resources to properly 
audit books and records. Currently, few FERC personnel have the 
experience and training needed to examine and fully analyze the 
extremely complex corporate structures and affiliate transactions used 
by companies such as Enron. The amount of any additional resources 
needed might vary based on any guidance or instructions Congress gives 
the Commission along with such new authority. For example, if Congress 
requires annual comprehensive reviews of the books and records of all 
large utilities, the additional resources needed would be quite 
extensive.
                                 ______
                                 
                   U.S. Securities and Exchange Commission,
                                 Washington, DC, February 20, 2002.
Hon. Jeff Bingaman,
Committee on Energy and Natural Resources, U.S. Senate, Dirksen Senate 
        Office Building, Washington, DC.
    Dear Chairman Bingaman: Thank you for your letter of February 6th 
regarding my testimony before the Committee on Energy and Natural 
Resources and transmitting follow-up questions from members of the 
Committee. I appreciate the opportunity to respond to the concerns of 
Committee members. I ask that you include my responses to these 
questions, which follow on the attached pages, in the hearing record.
    Please do not hesitate to let me know if I can be of further 
assistance.
            Sincerely yours,
                                        Isaac C. Hunt, Jr.,
                                                      Commissioner.
               Responses to Questions From Senator Shelby
    Question. Commissioner Hunt, could you please detail for us again, 
why the SEC issued a no-action letter with respect to Enron's power 
marketing activities? What factors were taken into consideration and 
why?
    Answer. The no-action letter that Enron Power Marketing, Inc. 
(``EPMI'') received stated that the staff would not recommend 
enforcement action against the company if it engaged in certain types 
of power marketing activities. As a general matter, in a no-enforcement 
no-action letter, the staff--not the Commission--agrees not to 
recommend enforcement action to the Commission. Typically, as occurred 
in this case, the party seeking the letter makes detailed 
representations to the staff about the proposed transaction or activity 
in question. While the staff usually will not agree or disagree with 
the legal analysis set forth by the party, the staff, in issuing the 
no-action letter, will base its determinations on those 
representations.
    In a 1994 no-action letter to EPMI, the SEC staff stated that it 
would not recommend an enforcement action under section 2(a)(3) of the 
Public Utility Holding Company Act of 1935 (``PUHCA'') in the event 
that EPMI, an indirect subsidiary of Enron Corp., entered into 
contracts for the purchase and resale of electric power or for 
transmission capacity in connection with its power marketing 
activities. EPMI did not own any generating plants, transmission lines 
or electric distribution systems. EPMI argued in its incoming request 
that under PUHCA, the contracts and books and records underlying its 
power marketing activities were not ``facilities'' used for the 
``generation, transmission or distribution of electric energy for 
sale'' and that its power marketing subsidiary therefore was not, for 
purposes of PUHCA, an electric utility company subject to the Act. EPMI 
also indicated that other companies were engaging in similar power 
marketing activities without registering under the Act.
    Based on these representations, the staff gave EPMI the requested 
no-action assurance.\1\ Although the staff's letter clearly stated that 
the staff did not necessarily agree or disagree with EPMI's legal 
analysis, the staff would have considered whether, in its view, EPMI 
was engaging in activities that were subject to the PUHCA. In deciding 
to issue the letter, the staff likely concluded that power marketing 
was not a utility activity. Since issuing the no-action letter to EPMI, 
the staff has issued approximately 20 analogous letters to other power 
marketers. The Commission itself has issued several orders and 
promulgated a rule (Rule 58) allowing registered holding companies to 
engage in power marketing as a non-utility activity, evidencing its 
agreement that power marketing is not a utility activity.\2\
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    \1\ In the past, the staff has noted the potential breadth of the 
term ``facility.'' Specifically, in a 1974 no-action letter issued to 
Unilease No. 10, Inc., the staff noted that the term could ``include[] 
anything which aids or makes easier the performance of the business in 
which the company is engaged.'' In that letter, however, the staff also 
noted that ``the Act generally distinguishes between the business of a 
public utility company and businesses which are nonutilities in 
function and character.'' On this basis, the staff concluded that the 
``business of fuel procurement, storage and delivery'' was non-utility 
in character, and that a company engaged in those activities was not 
necessarily a utility company. Therefore, even though the 1974 letter 
notes the potential breadth of the term ``facility,'' the result the 
staff reached in the EPMI letter is not inconsistent with the result it 
reached over 20 years earlier.
    \2\ Rule 58, 17 C.F.R. Sec. 250.58, permits a registered holding 
company system to engage in various non-utility activities, including 
``[t]he brokering and marketing of energy commodities, including but 
not limited to electricity, natural or manufactured gas and other 
combustible fuels.'' Rule 58(b)(1)(v), 17 C.F.R. Sec. 250.58(b)(1)(v).
---------------------------------------------------------------------------
    Question. Could the SEC explain in a more fulsome manner the 
import, rationale, and precedent for the order issued in 1997 (Release 
No. IC-22560; March 13, 1997) that exempted Enron Corp. from regulation 
under the Investment Company Act of 1940? Does this rationale conflict 
with that utilized in the 1994 and 1997 no-action letters issued to 
Enron under PUHCA? If not, then why not? A brief description of similar 
40 Act orders to other energy-related companies would be helpful also.
    Answer. As outlined below, the issues underlying the 1997 exemptive 
order and the 1994 and 1997 no-action letters were different, and thus 
there was no conflict between them. The 1997 exemptive order addressed 
whether Enron's participation in foreign infrastructure projects could 
lead to it falling within the definition of ``investment company'' in 
the Investment Company Act. In contrast, the two no-action letters 
dealt with whether a subsidiary engaged in power marketing fell within 
the definition of ``utility'' for purposes of PUHCA.
    The 1997 exemptive order dealt with Enron's interests in foreign 
infrastructure projects in which it believed that it could not acquire 
a majority interest for reasons such as restrictions imposed by local 
law. The Investment Company Act defines an investment company, among 
other things, as any issuer that holds ``investment securities'' in 
excess of 40% of its total assets on an unconsolidated basis (exclusive 
of cash and U.S. government securities). To the extent Enron's minority 
interests in foreign infrastructure projects were ``investment 
securities,'' they limited the extent to which Enron could participate 
in foreign infrastructure projects without coming within the definition 
of ``investment company.''
    According to Enron's application for the 1997 SEC exemption 
(``Application''), Enron viewed many of its interests in foreign 
infrastructure projects as outside the definition of ``investment 
security,'' but wanted the SEC exemption to eliminate any uncertainty. 
Enron further noted that the Investment Company Act was not intended to 
regulate industrial foreign infrastructure activity.\3\
---------------------------------------------------------------------------
    \3\ In its June 17, 1996 report on the Securities Amendments of 
1996 (the National Securities Markets Improvement Act of 1996), the 
House Committee on Commerce stated that it ``expects the Commission to 
take administrative action expeditiously, either on a case-by-case 
basis through exemptive orders or through rulemaking, to exempt from 
regulation as investment companies U.S. companies that own substantial 
interests in foreign infrastructure companies and that are directly or 
through affiliates actively involved in foreign infrastructure 
projects.''
---------------------------------------------------------------------------
    Prior to issuing the Enron order, the Commission had granted orders 
under section 3(b)(2) of the Act to other companies engaged in foreign 
infrastructure projects.\4\ The Enron order extended those orders 
somewhat by including within the scope of the exemption smaller, non-
controlling equity stakes in foreign infrastructure projects. 
Nonetheless, given the unique limitations sometimes imposed on the 
ability of U.S. companies to own large equity stakes in foreign 
infrastructure projects, the relief granted Enron was consistent in 
principle with the prior orders. In addition, the 1997 order was 
consistent with the legislative history of the National Securities 
Markets Improvement Act of 1996.\5\ Since that time, the Commission has 
issued analogous orders under section 6(c) to four companies, each of 
which is involved in foreign infrastructure projects in the 
telecommunications area.\6\ Although no other company engaged in 
energy-related foreign infrastructure projects has applied for this 
type of order, there does not seem to be any reason to distinguish 
between energy-related and telecommunications-related infrastructure 
projects for purposes of the Investment Company Act.
---------------------------------------------------------------------------
    \4\ See CITIC Pacific Limited, Investment Company Act Release Nos. 
21282 (Aug. 15, 1995) (notice) and 21375 (Sept. 12, 1995) (order); 
Consolidated TVX Mining Corporation, Investment Company Act Release 
Nos. 17853 (Nov. 13, 1990) (notice) and 17902 (Dec. 11, 1990) (order).
    \5\ See supra note 3.
    \6\ See e.g., Propel, Inc., Investment Company Act Release Nos. 
24633 (Sep. 6, 2000) (notice) and 24673 (Oct. 3, 2000) (order); 
Telesystem International Wireless Inc., Investment Company Act Release 
Nos. 23618 (Dec. 22, 1998) (notice) and 23658 (Jan. 20, 1999) (order); 
Formus Communications, Investment Company Act Release Nos. 23486 (Oct. 
14, 1998) (notice) and 23530 (Nov. 10, 1998) (order); Tele-
Communications International, Inc., Investment Company Act Release Nos. 
22797 (Aug. 22, 1997) (notice) and 22825 (Sep. 17, 1997) (order).
---------------------------------------------------------------------------
    Based on the representations in Enron's application, it does not 
appear that Enron would have registered under the Investment Company 
Act even absent the 1997 SEC exemption. According to the Application, 
if the SEC did not grant the requested exemption, Enron would have 
structured or limited its participation in foreign infrastructure 
projects so as not to come under the definition of investment company 
in the Investment Company Act. An operating company typically finds the 
requirements of the Investment Company Act incompatible with its 
business needs. It is therefore not uncommon for an operating company 
to structure its operations and holdings to avoid falling within the 
scope of the Investment Company Act.
    Finally, the relief granted Enron under the Investment Company Act 
does not conflict with any relief Enron received under PUHCA. First, 
there is no relationship between the Investment Company Act relief and 
the no-action relief that Enron received from the staff with respect to 
its power marketing activities. Second, as I discussed in my testimony, 
Enron's global business as portrayed in its exemptive application does 
not conflict with Enron's claim of the intrastate exemption under 
PUHCA. In administering the intrastate exemption, the Commission has 
always looked to the place of incorporation of the holding company, the 
place of incorporation of the holding company's utility subsidiaries, 
and the states in which those subsidiaries conducted their utility 
business. As long as the holding company and material utility 
subsidiaries are all incorporated in the same state and the utility 
activities are conducted in that state, the holding company is entitled 
to the intrastate exemption. The Commission has traditionally held that 
the scope and geographic extent of the holding company's non-utility 
activities (such as Enron's foreign infrastructure projects) are not to 
be considered as part of this analysis. In order to aid the Committee's 
understanding of this issue, I have attached to this response a 
memorandum prepared by the Division of Investment Management addressing 
how the Commission has administered the intrastate exemption since the 
enactment of PUHCA.

                               MEMORANDUM

To: Commissioner Isaac C. Hunt, Jr.

From: Paul F. Roye, Director, Division of Investment Management

Re: The Commission's Historic Approach to the Section 3(a)(1) 
``Intrastate'' Exemption

    During your February 6, 2002 testimony before the Senate Committee 
on Energy and Natural Resources, you were asked a number of questions 
about the Commission's approach to the ``intrastate'' exemption 
provided by section 3(a)(1) of the Public Utility Holding Company Act 
of 1935 (``PUHCA''). These questions may have been related to the 
claims of Scott Hempling, another witness, who testified that because 
Enron was a global company,, it ``clearly did not meet the requirements 
of Section 3(a)(1).'' \1\ Senator Wyden, in particular, expressed 
interest in this issue. We have prepared this memorandum to clarify the 
Commission's historic approach of under which a holding company's non-
utility activities are not considered in analyzing whether it qualifies 
for the intrastate exemption.
---------------------------------------------------------------------------
    \1\ Written Testimony of Scott Hempling before the Senate Committee 
on Energy and Natural Resources on ``The Public Utility Holding Company 
Act of 1935 and S. 1766'' (Feb. 6, 2002) at 31.
---------------------------------------------------------------------------
    Enron has been an exempt holding company since it acquired Portland 
General Electric in 1997. Immediately following its acquisition of 
Portland General, Enron was incorporated in Oregon, as was Portland 
General, Enron's only ``public utility'' subsidiary. Portland General's 
utility operations were conducted almost exclusively within Oregon. 
Although Enron engaged in substantial non-utility activities through 
other subsidiaries across the United States and internationally, it 
claimed exemption under PUHCA rule 2 as an intrastate holding company.
    Section 3(a)(1) requires the Commission, ``unless and except 
insofar as it finds the exemption detrimental to the public interest or 
the interest of investors or consumers'' to exempt any holding company 
if:

          Such holding company, and every subsidiary company thereof 
        which is a public-utility company from which such holding 
        company derives, directly or indirectly, any material part of 
        its income, are predominantly intrastate in character and carry 
        on their business substantially in a single State in which such 
        holding company and every such subsidiary company are 
        organized.\2\
---------------------------------------------------------------------------
    \2\ PUHCA Sec. 3(a)(1), 15 U.S.C. Sec. 79c(a)(1).

    Under longstanding Commission precedent, holding companies exempt 
under section 3(a)(1) have a virtually unlimited ability to diversify 
into non-utility activities without any limitation on the geographical 
scope of those activities. The leading treatise on the regulation of 
utility holding companies states that ``nonutility subsidiaries may be 
organized anywhere and . . . the holding company may itself engage in 
nonutility activities anywhere.'' \3\
---------------------------------------------------------------------------
    \3\ Douglas W. Hawes, Utility Holding Companies at 3-12 (1984 and 
Supp. 1987).
---------------------------------------------------------------------------
    This precedent goes back to the earliest days of the Commission's 
administration of the Act. Some of these early cases address whether a 
holding company's sale of a manufactured product in interstate commerce 
puts its exemption at risk. For example, in 1936, the Commission 
concluded that a company incorporated in South Carolina with a single 
utility subsidiary incorporated and operating in South Carolina did not 
lose its entitlement to the exemption because it engaged in interstate 
sales of textiles it manufactured through another subsidiary.\4\ The 
Commission reached virtually identical conclusions in granting 
exemptions to the International Pulp Company \5\ and the Copper Range 
Company.\6\
---------------------------------------------------------------------------
    \4\ In the Matter of Monarch Mills, 1 S.E.C. 822 (1936). The 
Commission noted that ``[t]he only interstate activities of the 
applicant are in connection with the sale of the textile products of 
its South Carolina plants. These sales are effected through New York 
commission merchants.'' Id. at 823. The Commission then rejected the 
notion that this ``should prevent it from obtaining the exemption under 
Section 3(a)(1) to which it would otherwise be entitled.'' Id.
    \5\ In the Matter of International Pulp Co., 1 S.E.C. 906 (1936).
    \6\ In the Matter of Copper Range Co., 2 S.E.C. 61 (1937). In 
Copper Range, the Commission definitively stated that ``this Commission 
has indicated in numerous cases that it does not deem that interstate 
activities in such non-public utility phases of its business should 
prevent the applicant from obtaining the exemption under Section 
3(a)(1) to which it otherwise would be entitled.'' Id. at 62.
---------------------------------------------------------------------------
    The early cases extend beyond the interstate sales of non-utility 
subsidiaries incorporated in the same state as the holding company and 
make clear that a holding company that owns non-utility subsidiaries 
that are incorporated in and operate in different states than the 
holding company may also claim an exemption under section 3(a)(1). Most 
notably, in 1937, the Commission granted an exemption to the 
Southeastern Indiana Corporation.\7\ The company, which was 
incorporated in Indiana, owned a single public utility subsidiary, 
which was also incorporated in and operating exclusively in Indiana. 
The company also owned a number of non-utility subsidiaries 
incorporated in Indiana and Ohio that variously provided bus and 
telephone service in Indiana, Ohio and Kentucky. In granting the 
company's request for an intrastate exemption, the Commission stated 
that:
---------------------------------------------------------------------------
    \7\ In the Matter of Southeastern Indiana Corp., 2 S.E.C. 156 
(1937).

          [S]uch non-public utility (as defined in Section 2(a)(5)) 
        activities of the applicant do not deprive it of its intrastate 
        character so far as the public utility aspect of its business 
        is concerned, and that so long as all of its public utility 
        subsidiaries are organized under the laws of Indiana and 
        confine their public utility business to that State, it will be 
        entitled to the exemption provided by Section 3(a)(1).\8\
---------------------------------------------------------------------------
    \8\ Id. at 157.

    The Southeastern Indiana decision thus made it clear that utility 
holding companies could engage in non-utility activities through 
subsidiaries incorporated in any state without losing their intrastate 
exemption. During the 1940s and 1950s, the Commission granted 
intrastate exemptions to companies that engaged in substantial 
nonutility activities in other states. For example, in 1945, the 
Commission granted an intrastate exemption to a Kansas corporation that 
owned two public utility subsidiaries that operated in Kansas and non-
utility subsidiaries that, among other things, were incorporated in and 
provided telephone service in Arkansas, Kansas, Indiana, Missouri, New 
Jersey, Ohio and Pennsylvania.\9\ The non-utility subsidiaries 
represented most of the company's business. The Commission apparently 
found it clear ``that such non-utility activities do not deprive [the 
applicant] of its intrastate character so far as the public utility 
aspects of its business are concerned.'' \10\ Likewise, in 1955, the 
Commission granted an intrastate exemption to a Massachusetts 
corporation that owned a single public utility subsidiary in 
Massachusetts but also owned subsidiaries, some incorporated in other 
states, that engaged in substantial coal mining operations (including 
activities related to the transportation and distribution of coal, and 
the conversion of the coal into gas and other products) throughout the 
eastern United States.\11\ Neither the notice nor the order contain any 
substantial legal analysis of the claim for exemption, suggesting that 
both the Commission and the applicant thought granting the exemption to 
be noncontroversial in spite of the applicant's substantial interstate, 
non-utility activities.
---------------------------------------------------------------------------
    \9\ See In the Matter of United Utilities, Inc., Holding Co. Act 
Release No. 6045 (Sept. 14, 1945) (order approving the sale of certain 
utility assets in Colorado that might have caused the company to lose 
its entitlement to the intrastate exemption) (``Sale Order'') and In 
the Matter of United Utilities, Inc., Holding Co. Act Release No. 6162 
(Oct. 25, 1945) (order granting exemption under section 3(a)(1)). The 
Sale Order makes clear that United Utilities' telephone operations 
produced over 75% of the holding company's gross revenues.
    \10\ Sale Order, supra (citing Southeastern Indiana Corp.).
    \11\ See In the Matter of Eastern Gas & Fuel Associates, Holding 
Co. Act Release No. 12786 (Jan. 25, 1955) (notice of application for an 
exemption under section 3(a)(1)) and Holding Co. Act Release No. 12807 
(Feb. 28, 1955) (order granting exemption under section 3(a)(1)). 
According to the notice, the company owned subsidiaries in 
Massachusetts, Delaware, Virginia, Connecticut, Pennsylvania, West 
Virginia, New Jersey and, perhaps surprisingly, a collier incorporated 
in Liberia.
---------------------------------------------------------------------------
    Given the language of section 3(a)(1), it might well have been 
within the Commission's discretion to decide these cases in a way other 
than it did, and confine the non-utility activities of exempt 
intrastate holding companies to the same state in which the holding 
company and its utility subsidiaries were incorporated. Indeed, there 
are a few aberrational decisions in which the Commission relected 
exemptions that seem to fall within this line of precedent.\12\ 
However, the policy of not looking at the non-utility activities of a 
holding company when analyzing its claim to the intrastate exemption 
clearly goes back to the earliest days of the Commission's 
administration of PUHCA--a time when the individual commissioners who 
considered and decided these matters likely were familiar with the 
specific details surrounding the enactment of PUHCA and the goals that 
Congress was seeking to achieve through the Act.\13\ In this context, 
to argue that the Commission is not just abusing its discretion, but is 
acting far outside the discretion permitted it, in allowing companies 
with substantial interstate non-utility activities to claim exemption 
under section 3(a)(1) fails to take into consideration the fact that 
the Commission has interpreted the intrastate exemption this way for 
over 65 years in a manner consistent with the underlying policy goals 
of PUHCA.
---------------------------------------------------------------------------
    \12\ See Houston Natural Gas Corp., 3 S.E.C. 664 (1938). In Houston 
Gas, the Commission appropriately denied the applicant an exemption 
under section 3(a)(1) because, although all the applicant holding 
company's subsidiaries were incorporated in and operated exclusively in 
Texas, the holding company itself was incorporated in Delaware. Id. at 
667. However, the decision includes a lengthy discussion in which the 
Commission opined that because the company sold its securities in 
numerous states and sent interstate mail and made interstate telephone 
calls, it was not entitled to the intrastate exemption. Id. at 667-68. 
Literally applied, this analysis would deny the section 3(a)(1) 
exemption to virtually all companies--it is hard to comprehend how any 
company could conduct its business, whether today or in 1938, without 
engaging in some interstate administrative activities. The discussion 
in Houston Natural Gas is therefore better understood either as 
unpersuasive dicta or as an attempt by the Commission to explain why it 
mattered, for purposes of the statute, that the holding company and its 
utility subsidiaries were incorporated in different states.
    \13\ Commissioners during this period included William O. Douglas, 
George Matthews, and Robert Healy. James Landis was Chairman of the 
Commission from September 1935 through September 1937, the period 
during which the earliest of the cases establishing this precedent 
under section 3(a)(1) were decided.
---------------------------------------------------------------------------
    One of the overriding concerns of PUHCA is to give federal 
regulators jurisdiction over multistate holding companies that no 
single state can effectively regulate. In particular, PUHCA is meant to 
ensure that if a state does not have jurisdiction over both the holding 
company and the utility that does business in its state--a situation 
that will occur if the holding company is incorporated in a state 
different than that in which the utility subsidiary is incorporated--a 
federal regulator with access to all the holding company's books and 
records can step in to monitor and police affiliate transactions.\14\ 
In general, the Commission has concluded that where the holding company 
and all its utility subsidiaries are incorporated in the same state, 
this concern does not arise, and an exemption from PUHCA is 
warranted.\15\
---------------------------------------------------------------------------
    \14\ ``It is plain, therefore, that Congress directed the exemption 
under Section 3(a)(1) solely to holding companies organized in the same 
state as its subsidiaries; it purposely withheld that exemption from 
holding companies which control operating utilities in states other 
than its domicile . .  . in order to assure necessary regulation not 
otherwise forthcoming.'' In the Matter of Houston Natural Gas Corp., 3 
S.E.C. 664, 667 (1938).
    \15\ The Commission retains the authority under section 3 and rules 
2 and 6 to revoke an otherwise-warranted intrastate exemption if doing 
so is necessary to protect the public interest or the interests of 
investors or consumers.
---------------------------------------------------------------------------
                                 ______
                                 
                Response to Question From Senator Wyden
    Question. I am requesting all records of communications between 
Enron Corp. or its subsidiaries or affiliates (``collectively referred 
to as ``Enron'') or any representative of Enron and the U.S. Securities 
and Exchange Commission (SEC) concerning the Public Utility Holding 
Company Act of 1935 or the Investment Company Act of 1940, including 
any written, oral, electronic or telephone communication.
    Answer. Included with this response are documents responsive to 
this request. These documents include applications filed by Enron under 
both acts, other materials supplied by Enron to the Commission and its 
staff, orders and notices that the Commission has issued with respect 
to Enron, Enron's no-action requests and the staff's responses, comment 
letters from SEC staff to counsel for Enron, and correspondence from 
counsel for Enron to SEC staff. Consistent with our usual practice, we 
are not including internal memoranda, handwritten notes, and other non-
public materials that reflect the SEC's deliberations. We also have not 
included certain routine filings made by Enron related to its claim of 
exemption under rule 2 and notifying the Commission of the status of 
certain of its subsidiaries as foreign utility companies or exempt 
wholesale generators under sections 32 and 33 of PUHCA. As always, we 
would be pleased to answer any further questions Senator Wyden or other 
members of the Committee may have with respect to these materials. I 
also note that Enron requested confidential treatment under the Freedom 
of Information Act for some of the documents that I am including with 
my response under separate cover.
                                 ______
                                 
              Responses to Questions From Senator Cantwell
    Question. PUHCA Sec. 12(h) prohibits certain political and campaign 
contributions by registered holding companies. Has the SEC reviewed the 
campaign contributions of registered holding companies and ensured that 
no improper contributions are being made? If so, please provide me with 
that information. If not, please explain why the SEC has not adhered to 
this statutory requirement.
    Answer. As you point out, section 12(h) of PUHCA prohibits a 
registered holding company from ``mak[ing] any contribution whatsoever 
in connection with candidacy, nomination, election or appointment of 
any person for or to any office or position'' in federal or state 
government. It also prohibits a registered holding company from 
mak[ing] any contribution to or in support of any political party or 
any committee or agency thereof.''
    This provision applies only to registered holding companies. Exempt 
holding companies such as Enron are not subject to this prohibition.\7\ 
With respect to registered holding companies, the Federal Election 
Campaign Act clarified section 12(h) to permit the ``establishment, 
administration and solicitation of contributions to a separate 
segregated fund to be utilized by the corporation for political 
purposes.'' \8\ Based upon this amendment, many registered holding 
companies have set up PACs to which their employees contribute so that 
the corporation can advance its political goals.
---------------------------------------------------------------------------
    \7\ Exempt holding companies, like all corporations, appear to be 
prohibited by the Federal Election Campaign Act from ``mak[ing] a 
contribution or expenditure in connection with any election at which 
presidential and vice presidential electors or a Senator or 
Representative . . . are to be voted for, or in connection with any 
primary election or political convention or caucus held to select 
candidates for any of the foregoing offices . . . .'' 2 U.S.C. 
Sec. 441b(a). The SEC, however, does not administer this statute.
    \8\ 2 U.S.C. Sec. 441 b(b)(2) (``For purposes of this section and 
section 12(h) of the Public Utility Holding Company Act . . . the term 
`contribution or expenditure' . . . shall not include . . . (C) the 
establishment, administration, and solicitation of contributions to a 
separate segregated fund to be utilized for political purposes by a 
corporation, labor organization, membership organization, cooperative, 
or corporation without capital stock.'')
---------------------------------------------------------------------------
    Commission staff regularly examine registered holding companies to 
monitor their overall compliance with the Act. Our examinations are 
primarily directed at the core abuses that led to passage of the Act, 
particularly the provisions governing allocation of costs among system 
companies and affiliate transactions between system companies. While 
examining for compliance with section 12(h) is not one of our primary 
areas of focus, no violations of the section have come to our attention 
in recent years. However, as part of the examination program, we do 
analyze how the costs of administering PACs are allocated among 
companies in the holding company system. This tends to ensure that the 
costs of administering PACs are not unfairly allocated to the holding 
company's utility subsidiaries. We would obviously take seriously any 
allegation that a registered holding company is violating section 
12(h).
                              Appendix II

              Additional Material Submitted for the Record

                              ----------                              

          Statement of the American Forest & Paper Association
    The American Forest & Paper Association (AF&PA) appreciates the 
opportunity to submit testimony for the hearing record related to the 
repeal of the Public Utility Holding Company Act. AF&PA is the national 
trade association representing more than 240 member companies and 
related associations that engage in or represent the manufacturers of 
pulp, paper, paperboard and wood products. America's forest and paper 
industry ranges from state-of-the-art paper mills to small, family-
owned sawmills and some nine million individual woodlot owners.
    The forest products industry is a major energy producer and 
consumer, producing nearly 60 percent of its own power, largely though 
the use of biomass. At some paper and wood manufacturing facilities, 
self-generated electricity goes beyond serving onsite production needs 
by providing supplemental electricity to the surrounding electric power 
grid.
    We support comprehensive electricity legislation that promotes 
competition in the energy markets. However, until there is a truly 
competitive marketplace, we have concerns about the vacuum that may 
exist if PUHCA is repealed without adequate safeguards put in its 
place. Therefore, we offer the following suggestions as possible ways 
to ensure that a competitive market can take hold in the context of 
efforts such as S. 1766 to promote competition in the electricity 
marketplace.
                 puhca and related market power issues
    PUHCA was originally designed to break up ``the unconstrained and 
excessively large trusts that then controlled the Nation's electric and 
gas distribution networks.'' It was intended to be an effective 
safeguard against market power abuses by utilities and their affiliates 
that evaded regulatory oversight through complex holding company 
arrangements.
    The current enforcement under PUHCA is not effective. The 
Securities and Exchange Commission has openly admitted that it has done 
a poor job at enforcing provisions of PUHCA. But market power issues 
are still extremely important, particularly in states that have no 
retail competition. The development of a fully functioning competitive 
electricity market (wholesale and retail) cannot take place if 
utilities, whether they be investor-owned, federal, municipal or 
cooperative, are allowed significant government-sanctioned advantages 
over their competitors.
    PUHCA should not be repealed before the establishment of a fully 
functioning competitive market (wholesale and retail) for electricity 
throughout the nation. However, should the Congress decide to proceed 
with PUHCA repeal legislation, then steps need to be taken to ensure 
that implementation of such legislation coincides with the effective 
operation of truly competitive electricity markets. At a bare minimum, 
the repeal date of PUHCA for a utility should be linked to the date 
that the FERC certifies that markets served by that utility are open 
and competitive. The relevant market should be defined as a large area, 
such as that covered by an RTO.
    AF&PA would support the repeal of PUHCA under the following 
conditions that would apply to both public and private power:

   Legislation is enacted requiring participation in Regional 
        Transmission Organizations (RTOs) by all transmission entities. 
        This legislation must set a firm deadline for RTO 
        participation, give the FERC adequate authority to implement 
        RTOs, and be effective only upon the full and efficient 
        functioning of the RTOs.
   Markets administered by RTOs are fully functional and 
        workably competitive.
   Legislation is enacted that (i) requires FERC to act on a 
        complaint regarding the abuse of market power within 90 days of 
        the filing of the complaint, (ii) failing timely action by 
        FERC, allows the complainant to seek redress from the Federal 
        Trade Commission, and (iii) allows such complaints to be 
        initiated by consumers and other market participants.
   Legislation is enacted that provides explicit criteria 
        (e.g., market concentration, scale, etc.) for the merger or 
        acquisition of regulated entities, and requires clear and 
        significant economic benefits to ratepayers as a condition of 
        approval.
   Legislation is enacted that (1) provides access to the books 
        and records of holding companies by state commissions and (ii) 
        limits the pass-through to captive retail ratepayers by 
        regulated utilities of costs incurred by their marketing 
        affiliates only to those costs that serve the ratepayers and 
        that are either cost-based or shown to be competitive in a 
        fully functioning competitive market.
   Absent a nationwide, fully functioning competitive retail 
        electricity market, implementation of PUHCA repeal only upon 
        certification by the FERC that the markets served by the 
        utility are fully functioning and competitive.

    We appreciate the opportunity to submit these suggestions related 
to PUHCA repeal and look forward to working with the Committee and the 
full Senate as this issue moves through the legislative process.
                                 ______
                                 
             Statement of the Executive Intelligence Review
 enron: the convergence of energy and financial deregulation, and the 
                    end of the off-balance-sheet era
    With every day that passes, it becomes more obvious that Enron was 
a thoroughly corrupt corporation, which cooked its books through a 
variety of schemes, including the use of special purpose entities and 
off-balance-sheet partnerships. As a result of these machinations, 
Enron presented a completely false face to the public--it was a 
financial scam, masquerading as an energy company.
    At this point, few would argue that Enron was out of control, 
operating well outside the bounds of ethics and apparently outside the 
law, and few would argue that those officers and directors of Enron, as 
well as its accountants and lawyers, should be held accountable for 
their actions, or the lack thereof.
    There is another group which should be held accountable, and that 
group includes the policymakers who have systematically stripped away 
the body of protections which had been written into State and Federal 
laws and regulations, in order to keep the Enrons of the world in 
check.
    Lyndon LaRouche, the founding editor of EIR News Service, has both 
through this news service and through his role as a pre-candidate for 
the 2004 Presidential election, led the mobilization against energy 
deregulation, focusing the attention of California, the nation and the 
international community on the destructive nature of deregulation, and 
the key role Enron has played in that process. LaRouche has also led 
the fight against the out-of-control speculation in the derivatives 
markets, where Enron also played.
    The Enron debacle now gives Congress, and this Committee, the 
opportunity to re-visit the nation's approach to deregulation, to 
confront and correct the errors which are destroying out nation's 
economy. It is an opportunity which should not be wasted.
Beyond the Culture of Corruption
    The ``culture of corruption'' which thrived at Enron is nothing 
new; history is replete with similar examples of untrammeled greed, and 
of the need to protect populations from that greed. The strength of our 
nation is based in part on the creativity of our people, and for that 
creativity to flourish, the public must be protected from exploitation. 
Creativity is the rising tide which lifts all boats, but those boats 
must also be protected from pirates.
    In its investigation of the Enron affair, the Congress must look 
not just at the company, but at the environment in which the company 
operated. In this case, that means looking at how deregulation created 
the conditions under which Enron's activities became possible.
    One of the founding principles of the United States, is that the 
Government has not just the right, but the duty, to advance and protect 
the General Welfare of the People. In the wake of the Great Depression, 
a number of laws were passed to protect the People from abuses; 
prominent among them the Glass-Steagall Act, which was designed to 
prevent financial insiders from profiting at the expense of the general 
public, and the Public Utilities Holding Company Act, which was 
designed to protect the People from the machinations of the giant 
Morgan and Insull electricity cartels, whose holding company structures 
were in many respects the equivalents of today's off-balance-sheet 
structures. Congress passed these laws because events proved them 
necessary--they were necessary then, and they are necessary today.
    Over the years, most of the protections implemented during the 
Roosevelt era have been stripped away. Glass-Steagall was gutted, then 
repealed, and an already weakened PUHCA is facing a similar fate unless 
wiser minds prevail. The combination of energy deregulation and the 
surge in mergers among regulated utility holding companies has created 
an environment in which the electricity market is increasingly coming 
to resemble the casino mondiale financial markets.
    Enron, in many respects, reflects the deadly convergence of 
financial and energy deregulation. In its S.E.C. filings, Enron 
described itself as an investment bank, and testimony before this 
Congress has detailed the extent to which Enron was a derivatives 
trading firm rather than an energy company. What Enron was doing was 
applying to the deregulated energy markets, the same kinds of 
speculative derivatives trading that the big investment and commercial 
banks--a distinction which is fast disappearing--have long applied to 
the deregulated financial markets.
    In its off-balance-sheet activities, Enron was following a trend 
which began in the banking world. Until recently, every issue of the 
Federal Deposit Insurance Corporation's Quarterly Banking Profile 
contained a line item for ``off-balance-sheet derivatives,'' The 
F.D.I.C. has discretely dropped the ``off-balance-sheet'' portion of 
the designation, but the derivatives remain, $51.7 trillion of them, 
backed by $6.6 trillion in assets and $586 billion in equity capital. A 
loss equivalent to just 1.1% of the total derivatives portfolio would 
be sufficient to wipe out the entire equity capital of the U.S. banking 
system.
    The most egregious example of derivatives speculation is J.P. 
Morgan Chase & Co., which by itself has a $24 trillion derivatives 
portfolio, roughly half of the total derivatives held by all U.S. bank 
holding companies. That figure is as of the third quarter, at which 
point Morgan Chase reported assets of $799 billion and equity capital 
of $42.7 billion. meaning that a loss equivalent to less than 0.2% of 
is derivatives portfolio would wipe out its equity base. At Citigroup 
and Bank of America, which between them have another $18 trillion in 
derivatives, it would take only 0.5%.
    These aren't banks any more than Enron was an energy company. 
Enron's reported $200 billion derivatives portfolio pales by comparison 
to the holdings of the big banks, but Enron was just getting started. 
The big banks were already involved in energy trading, and with Enron's 
demise have strengthened their position in the market.
    The extraordinary danger presented by such derivatives speculation 
is clear in the Enron case, where derivatives were used to hide the 
company's condition, but again, this is just a case of Enron following 
the example of its banking peers, as investigations by the Japanese 
Government have brought to light numerous examples where Wall Street 
firms employed derivatives to help Japanese companies hide losses. 
Derivatives were also at the root of the 1998 failure of Long-Term 
Capital Management, and the wave of derivatives losses which swept the 
country in the early 1990s. The shocking $105 billion drop in assets at 
Morgan Chase during the fourth quarter suggests that the derivatives 
losses have not gone away, but are just better hidden in a complex of 
off-balance-sheet structures of the type we see in the Enron case.
    Had Congress and the States not dismantled the nations regulatory 
protections, there would be no need for these hearings. This hearing 
provides the Senate with the opportunity to return to a policy of sound 
regulation in the public interest. PUHCA must be strengthened, not 
weakened, as the first step in rolling back deregulation. Congress must 
choose between servicing the casino at the expense of the population, 
and protecting the General Welfare by rebuilding the protections which 
have been stripped away.
    The Energy Committee, in particular, has the responsibility of 
``picking up the pieces'' from the ``Enronomics'' era so that the 
nation may begin to reverse the damage done by deregulation. As 
LaRouche outlines in his forthcoming special report ``At the End of a 
Delusion,'' we can build our way out of this deepening global 
depression, if we chose to do so, but it requires the courage to admit 
that we must abandon the policies which have created this disaster.
    LaRouche outlined the measures which are required in the energy 
realm in an international Webcast on Jan. 24, 2002, in an exchange with 
State Sen. Joe Neal (D-Las Vegas), a senior Nevada lawmaker, who 
successfully led the fight against deregulation, and against Enron, in 
his state, and also in other states and in Mexico.
    In response to Neal's question about the reasons for the collapse 
of Enron and what it means for the country, LaRouche responded:

          I would go backwards, and go from the end-result of the crash 
        of Enron, rather than trying to, say, re-write the history of 
        what Enron's history should have been.
          First of all, we face a major energy crisis in the United 
        States. The severity of this crisis is hidden by the fact of 
        the collapse of our industries. If we were to rev up the 
        economy overnight, we couldn't support it.
          People don't realize that we have been exporting our 
        industries, in shutting down whole sections of the functions of 
        our economy, we have lowered the requirement of energy! If we 
        were to try to restore the economy, to what it was at, say, 
        1980 or earlier, we would have to have a large amount of new 
        energy.
          So, therefore, we have the need for a national energy 
        recovery program, which would cover, inclusively, the problems 
        which are illustrated by and posed by Enron, and similar 
        institutions. That means that we have to repeal deregulation; 
        go back to the system of regulation, we used to have: I think 
        we'd just go back to that; that's adequate, because it would 
        work: There're are precedents; the machinery is all 
        understood--it would work; just do it.
          But, set, also, into motion--See President Bush is trying to 
        find out ways of stimulating the economy, and he doesn't know 
        how to do it. Well, this is one of the ways of doing it. If you 
        take Federal money, and use it, not just as Federal printed 
        money, but Federal credit; and you put it into a national 
        energy program, which is going to fix the national energy grid 
        system, to make it more usable and to improve its performance: 
        That, in itself, is a good way to make the economy grow. And, 
        it's typical of the various measures, which government can 
        take, which are largely in the area of infrastructure and 
        special projects; not in the private sector, as such, but in 
        those areas alone, which will cause the economy to grow.