Utility Oversight: Recent Changes in Law Call for Improved	 
Vigilance by FERC (25-FEB-08, GAO-08-289).			 
                                                                 
Under the Public Utility Holding Company Act of 1935 (PUHCA 1935)
and other laws, federal agencies and state commissions have	 
traditionally regulated utilities to protect consumers from	 
supply disruptions and unfair pricing. The Energy Policy Act of  
2005 (EPAct) repealed PUHCA 1935, removing some limitations on	 
the companies that could merge with or invest in utilities,	 
leaving the Federal Energy Regulatory Commission (FERC), which	 
already regulated utilities, with primary federal responsibility 
for regulating them. Because of the potential for new mergers or 
acquisitions between utilities and companies previously 	 
restricted from investing in utilities, there has been		 
considerable interest in whether cross-subsidization--unfairly	 
passing on to consumers the cost of transactions between utility 
companies and their "affiliates"--could occur. GAO was asked to  
(1) examine the extent to which FERC changed its merger and	 
acquisition and post merger review and oversight processes since 
EPAct to protect against cross-subsidization and (2) survey state
utility commissions about their oversight.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-289 					        
    ACCNO:   A80995						        
  TITLE:     Utility Oversight: Recent Changes in Law Call for	      
Improved Vigilance by FERC					 
     DATE:   02/25/2008 
  SUBJECT:   Audit oversight					 
	     Auditing standards 				 
	     Corporate audits					 
	     Corporate mergers					 
	     Electric energy					 
	     Electric utilities 				 
	     Federal law					 
	     Federal regulations				 
	     Independent regulatory commissions 		 
	     Internal controls					 
	     Natural gas					 
	     Public utilities					 
	     Reporting requirements				 
	     Utility rates					 

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GAO-08-289

   

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material separately. 

Report to Congressional Requesters: 

United States Government Accountability Office: 

GAO: 

February 2008: 

Utility Oversight: 

Recent Changes in Law Call for Improved Vigilance by FERC: 

GAO-08-289: 

GAO Highlights: 

Highlights of GAO-08-289, a report to congressional requesters. 

Why GAO Did This Study: 

Under the Public Utility Holding Company Act of 1935 (PUHCA 1935) and 
other laws, federal agencies and state commissions have traditionally 
regulated utilities to protect consumers from supply disruptions and 
unfair pricing. The Energy Policy Act of 2005 (EPAct) repealed PUHCA 
1935, removing some limitations on the companies that could merge with 
or invest in utilities, leaving the Federal Energy Regulatory 
Commission (FERC), which already regulated utilities, with primary 
federal responsibility for regulating them. Because of the potential 
for new mergers or acquisitions between utilities and companies 
previously restricted from investing in utilities, there has been 
considerable interest in whether cross-subsidizationï¿½unfairly passing 
on to consumers the cost of transactions between utility companies and 
their ï¿½affiliatesï¿½ï¿½ï¿½could occur. GAO was asked to (1) examine the 
extent to which FERC changed its merger and acquisition and post merger 
review and oversight processes since EPAct to protect against cross-
subsidization and (2) survey state utility commissions about their 
oversight. 

What GAO Found: 

FERC has made few substantive changes to either its merger review 
process or its postmerger oversight since EPAct and, as a result, does 
not have a strong basis for ensuring that harmful cross-subsidization 
does not occur. FERC officials told us that they plan to require 
merging companies to disclose existing or planned cross-subsidization 
and to certify in writing that they will not engage in cross-
subsidization, but do not plan to independently verify such 
information. Once mergers have taken place, FERC intends to rely on its 
existing enforcement mechanismsï¿½primarily companiesï¿½ self-reporting 
noncompliance and a limited number of compliance auditsï¿½to detect 
potential cross-subsidization. FERC officials told us that they believe 
the threat of large fines, as allowed by EPAct, will encourage 
companies to investigate and self-report any non-compliance. In 
addition, FERC officials told us that, for 2008, FERC developed its 
plans to conduct compliance audits of 3 of the 36 holding companies it 
regulates based on informal discussions between senior agency officials 
and staffs in key offices. However, FERC does not formally use a risk 
based approach that considers factors, such as companiesï¿½ financial 
condition or history of compliance. A risk-based audit approach is an 
important consideration in efficiently allocating its limited resources 
to detect non-compliance. In addition, we found that FERCï¿½s public 
audit reports often lacked a clear description of the audit objectives, 
scope, methodology, and findingsï¿½inhibiting their use in improving 
transparency with stakeholders or helping FERC staff improve their 
audit practices. 

State utility commissionsï¿½ views of their oversight capacity varied, 
but many reported a need for additional resources, such as staff and 
funding, to respond to changes in their oversight after the repeal of 
PUHCA 1935. State regulators in all but a few states reported that 
utilities must seek state approval for proposed mergers. State 
regulators reported being mostly concerned about the impact of mergers 
on customer rates, but 25 of 45 reporting states also noted concerns 
that the resulting, potentially more complex company could be more 
difficult to regulate. Most states reported having some type of audit 
authority over the transactions between utilities and their affiliated 
companies, but many states currently review or audit only a small 
percentage of these transactions, with 28 of the 49 reporting states 
auditing 1 percent or less over the last five years. On the other hand, 
some states reported that they require periodic, specialized audits of 
affiliate transactions. In addition, although almost all states require 
financial reports from utilities and report they have access to utility 
companiesï¿½ financial books and records, many states reported they do 
not have such direct access to the books and records of affiliated 
companies. While EPAct provides state regulators the ability to obtain 
such information, some states expressed concern that this access is 
narrow and could require them to be extremely specific in identifying 
needed information, thus potentially limiting their audit access. From 
a resources perspective, 22 of the 50 states reporting said that they 
needed additional staffing and funding to a carry out their oversight 
responsibilities. 

What GAO Recommends: 

GAO recommends that FERC use a risk-based approach to detect cross-
subsidization, enhance audit reporting, and reassess resources to 
demonstrate oversight vigilance. While FERCï¿½s Chairman disagreed with 
GAOï¿½s findings and recommendations, GAO maintains they are sound. 

For the full product, including scope and methodology, click on GAO-08-
289. For the survey results, click on [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-
290SP]. For more information, contact Mark Gaffigan at (202) 512-3841 
or [email protected]. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

FERC'S Merger Review and Postmerger Oversight to Prevent Cross- 
Subsidization in Utility Holding Company Systems Are Limited: 

States Vary in Their Capacities to Oversee Utilities: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Scope and Methodology: 

Appendix II:Agency Comments and Our Response: 

GAO Comments: 

Appendix III: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Merger Proposals Reviewed by FERC since EPAct: 

Table 2: FERC's Audit Universe by Category of Company: 

Table 3: Key Factors in Commission Evaluations of Mergers and 
Acquisitions: 

Table 4: State Reviews and Audits of Affiliate Transactions: 

Table 5: State Commissions' Access to Books and Records: 

Table 6: Some States Foresee Needing Additional Resources Due to EPAct: 

Abbreviations: 

EPAct: Energy Policy Act of 2005: 

FERC: Federal Energy Regulatory Commission: 

GAGAS: Generally Accepted Government Auditing Standards: 

NARUC: National Association of Regulatory Utility Commissioners: 

PUHCA 1935: Public Utility Holding Company Act of 1935: 

PUHCA 2005: Public Utility Holding Company Act of 2005: 

SEC: Securities and Exchange Commission: 

United States Government Accountability Office: 

Washington, DC 20548: 

February 25, 2008: 

The Honorable Jeff Bingaman: 
Chairman: 
Committee on Energy and Natural Resources: 
United States Senate: 

The Honorable Sam Brownback: 
United States Senate: 

The Honorable Russell Feingold: 
United States Senate: 

Public electric and natural gas utilities sell about $325 billion worth 
of electricity and natural gas to more than 140 million customers in 
U.S. homes and businesses each year. These customers depend on reliable 
and reasonably priced electricity and natural gas for everything from 
lighting homes to large-scale manufacturing. Federal and state 
regulators seek to balance efforts to ensure that these utilities are 
profitable enough to attract private investment to pay for things such 
as construction of new power plants with efforts to protect consumers 
from potential supply disruptions and unfair pricing practices. With 
the utility industry facing the need to invest potentially hundreds of 
billions of dollars to expand and upgrade the utility infrastructure 
over the next 10 years, recent changes in federal laws and regulations 
have eliminated some limitations on the types of companies that can own 
and invest in utilities--thereby opening the sector to new investment. 
These changes, however, have raised considerable interest about whether 
the remaining laws and regulations strike an appropriate balance 
between encouraging investment in the utility sector and protecting 
consumers. 

Public electric and natural gas utilities historically operated as 
state-regulated monopolies, providing electricity and natural gas 
services to all consumers within a geographic region. For many years, 
utilities were primarily regulated by the states through state utility 
commissions, which approved plans for new plants and other 
infrastructure, examined operating costs such as labor and purchases of 
fuel, and approved prices--also referred to as "rates"--to allow 
utility companies the opportunity to recover these costs and make 
reasonable profits. As regulators, state commissions reviewed proposed 
mergers or acquisitions involving state-regulated utilities, audited 
some individual purchases of goods and services for compliance with 
relevant pricing and other regulatory requirements, and often examined 
financial records of utilities. In exchange for this regulation, 
utilities were typically allowed an opportunity to recover costs 
prudently incurred to provide electricity or natural gas to customers 
and an opportunity to earn a specified rate of return on their 
investments. This opportunity to recover costs and a rate of return 
often meant that utilities were perceived as low-risk investments and 
were able to obtain money from stock and bond markets at low costs 
relative to companies in more risky businesses such as energy 
exploration and development. 

Over time, changes occurred in the utility industry that made it more 
difficult for individual states to regulate utilities. First, the 
utility industry grew very rapidly during the early part of the 20th 
century, and utilities that spanned multiple states began to emerge. 
These multistate utilities shared use of plants and equipment located 
in different states that often had different rules and jurisdictional 
authority, making it more difficult for individual state utility 
commissions to effectively regulate them. Second, by the 1920s, as a 
result of mergers and acquisitions, utilities were largely controlled 
by a handful of complex corporations--called holding companies--many of 
which owned several utilities as well as other companies. In many 
cases, the companies within these holding companies--called affiliates-
-sold a wide range of goods and services to utilities, such as fuel for 
power plants. These transactions between affiliates are generally 
referred to as affiliate transactions. Some affiliate transactions 
could benefit utility customers, such as when utilities effectively 
shared the cost of legal and other administrative services with 
affiliates instead of each company maintaining staff and other 
resources to provide these services separately. However, since the 
rates utility customers pay generally include all of the costs of goods 
and services bought to serve them, affiliate transactions that were 
priced unfairly could result in utility customers subsidizing 
operations outside the utility--called cross-subsidies. When this 
harmful cross-subsidization occurs, utility rates to electricity and 
natural gas consumers are inflated, causing them to pay too much and 
allowing the utility to unfairly compete in other industries. Third, 
poor disclosure of financial information and limited access to 
financial records often made it difficult to accurately assess the 
utilities' financial health. Compounding this, many of these holding 
companies were involved in risky business ventures outside the utility 
industry and had pledged utility assets to support those investments. 
Partly as a result of the poor financial disclosure and the complex web 
of corporate ownership and affiliate transactions, many utilities went 
into bankruptcy during the financial collapse followed by the Great 
Depression of the 1930s, placing at risk the electricity and natural 
gas services that consumers and businesses relied upon. 

To restore public confidence after the Depression, the federal 
government undertook three efforts to improve the regulation of 
utilities. First, to protect investors, the federal government created 
the Securities and Exchange Commission (SEC) to establish rules for the 
financial markets and publicly traded companies participating in those 
markets as well as a means to regulate them. Among these were rules 
focused on improving reporting of financial information to the public. 
This improved oversight and access to financial information fostered 
development of publicly held companies and financial markets for timely 
financial information. For example, credit rating agencies and other 
financial firms began to track company financial conditions on a 
regular basis to determine if any changes could pose risks to the 
company's investors. Second, to protect utility customers, the federal 
government enacted the Federal Power Act of 1935 which served, and 
continues to serve today, as the foundation of federal regulatory 
authority related to regulation of public utilities. Among other 
things, this law empowered the Federal Energy Regulatory 
Commission[Footnote 1] (FERC) to serve as the primary federal regulator 
of utilities and made it responsible for overseeing interstate 
transmission of electricity, wholesale sales of electricity to 
resellers (e.g., sales by utilities to other utilities), and reviewing 
proposed mergers or acquisitions involving companies it 
regulates.[Footnote 2] In its role of regulating interstate 
transmission and wholesale sales, FERC has been responsible for 
approving prices (i.e., rates) for the use of transmission lines and 
the sales of electricity in wholesale markets--also commonly called 
"rate setting." In recent years, FERC has granted "market-based rates" 
for wholesale sales to many companies. For the rates that FERC still 
approves, generally interstate transmission rates, utilities generally 
initiate these rate-setting procedures--often in order to increase 
rates to recover rising costs. During such procedures FERC may examine 
individual costs incurred by utilities to determine whether to allow 
utilities to recover them in regulated rates. In this way, FERC may 
determine which costs may lawfully be included in rates charged to 
customers. However, such reviews may not be done for several years, 
under some circumstances. To perform its role as federal regulator, 
FERC has annually collected certain financial and operational data on 
utilities and more frequently collected other data, such as prices and 
quantities of sales of electricity to others. While this law created a 
new layer of federal regulation over certain aspects of the utility 
industry, state commissions maintain their traditional role as the 
primary regulator of retail sales--approving many aspects of utility 
operations, such as the siting and construction of new power plants and 
approving the rates consumers pay. Third, the federal government 
enacted the Public Utility Holding Company Act of 1935 (PUHCA 1935) to 
regulate investment in the utility industry to protect investors and 
consumers from potential abuses by holding companies and empowered SEC 
to administer this law. PUHCA 1935 sought to simplify and reorganize 
existing holding companies' structures, limit the formation of new 
holding companies that were not physically connected by electric power 
lines, and prohibited existing holding companies from acquiring more 
than one utility, unless the utilities were physically connected by 
power lines. In addition, PUHCA 1935 restricted the ability of 
companies outside the utility industry to own or control public 
utilities. In order to maintain control over holding companies, SEC was 
given responsibility for reviewing mergers or acquisitions involving 
holding companies, or which could result in the formation of a holding 
company. 

PUHCA 1935 also empowered the SEC to examine utility operations. As 
such, PUHCA 1935 gave the SEC authority to require more extensive 
financial reporting than what was previously required and to examine 
and limit affiliate transactions to ensure that utilities do not 
purchase goods and services at inflated prices from companies within 
the same corporation then pass those inflated costs on to utility 
consumers. In overseeing affiliate transactions in recent years, SEC 
audited each holding company about every 6 years. 

Over time, other statutory and regulatory changes reduced some of the 
strict limitations PUHCA 1935 initially imposed. For example, PUHCA 
1935 was amended in 1978 and 1992 to exempt certain companies that 
generated electricity but did not sell it directly to consumers. This 
change allowed companies outside the utility sector to build and 
operate power plants and sell electricity to utilities and others, but 
remain outside of the jurisdiction of the SEC. Further, in 1995, to 
facilitate investment and respond to changes in the utility industry, 
SEC determined it should interpret PUHCA 1935 more broadly to allow 
certain mergers and acquisitions by nonutilities. The SEC also allowed 
some mergers and acquisitions to proceed without becoming subject to 
SEC oversight if they met certain financial requirements designed to 
limit control over the utilities.[Footnote 3] These interpretations 
allowed some mergers by utilities and nonutilities, holding companies, 
and other diversified corporations. While allowing these specific 
transactions to proceed, SEC still placed restrictions on transactions 
that would result in these new owners owning multiple U.S. utilities. 

Over the past two decades, interested parties have advocated repeal or 
further amendment of PUHCA 1935. The utility industry sought PUHCA 
1935's repeal to improve investment in the utility sector, and some 
believed that this investment could help utilities make needed 
improvements at a lower cost than on their own. Some advocates also 
believed that this oversight was no longer needed because several other 
federal laws had been passed, including antitrust laws requiring the 
Department of Justice and the Federal Trade Commission to examine large 
mergers and laws requiring extensive financial disclosure to provide 
for improved financial oversight of utilities. Furthermore, advocates 
of repeal argued that federal regulation of utilities by FERC includes 
extensive oversight of power sales and mergers. Finally, industry has 
held that state commissions have extensive authority to oversee 
utilities and limit abusive practices that could affect the rates paid 
by consumers. On the other hand, opponents of PUHCA 1935's repeal, 
including some business and consumer representatives, expressed concern 
that utilities would become too complex to effectively regulate, 
potentially resulting in higher prices for consumers. Business groups 
outside the utility industry were also concerned that utilities could 
use their monopolies in providing electricity and natural gas services 
to unfairly compete in other businesses--in other words, they could use 
utility revenues to cross-subsidize investments into other businesses 
and harm competition and competitors in those other industries. 
Consumer representatives also expressed concern that, unbound by PUHCA 
1935's limitations on the types of companies that could own utilities, 
utilities could become part of more risky financial structures, as had 
been the case in the 1930s, compared to the traditional low-risk 
utility structure. 

Through the Energy Policy Act of 2005 (EPAct), the federal government, 
among other things, repealed PUHCA 1935, thus eliminating the 
restrictions on the types of companies that can own utilities, and 
replaced it with the Public Utility Holding Company Act of 2005 (PUHCA 
2005). EPAct also granted FERC enhanced civil penalty authorities. The 
act did not change the states' overall responsibilities for regulating 
retail markets, but with the repeal of PUHCA 1935, SEC no longer had an 
oversight role in regulating utility holding companies or for 
preventing cross-subsidies.[Footnote 4] FERC's new authorities under 
EPAct, to regulate corporate structures and transactions, fell into two 
broad areas and required FERC to issue regulations that implement these 
authorities, which it has done. 

Merger review. EPAct expanded FERC's merger review to require FERC to 
ensure that a proposed merger will not result in harmful cross- 
subsidization. Traditionally, under the authority of the Federal Power 
Act, FERC determined whether a proposed merger was consistent with the 
public interest. FERC's 1996 merger review policy statement outlines 
three primary factors for analysis before approving a merger--the 
merger's effect on: competition, rates, and regulation. According to 
FERC officials, although preventing cross-subsidization has been a long-
standing responsibility of FERC under its rate-setting authority, 
preventing it at the point of the merger review is new for 
FERC.[Footnote 5] 

Postmerger oversight. With the repeal of PUHCA 1935, FERC became the 
principal federal agency responsible for determining how costs for 
affiliate transactions should be allocated for all utility holding 
companies irrespective of when they were formed (i.e., new companies 
formed through mergers or acquisitions or already existing companies). 
Traditionally, as part of its review and approval of prices public 
utilities charge for use of transmission lines and wholesale sales of 
electricity, for companies not overseen by SEC, FERC had the authority 
to determine whether costs from affiliate transactions between 
companies in the same holding company were allowed.[Footnote 6] To help 
FERC better oversee these transactions, EPAct provided FERC specific 
postmerger access to the books, accounts, memos, and financial records 
of utility owners and their affiliates and subsidiaries. The act also 
granted state utility commissions access to such information subject to 
some conditions. Furthermore, EPAct gave FERC enhanced civil penalty 
authority to help it enforce it new requirements, providing the 
commission the ability to levy penalties of up to $1 million per day 
per violation. 

Business and consumer groups, as well as some state regulators, 
disagree as to whether the current federal and state legal and 
regulatory structure imposed by EPAct is sufficient to protect 
consumers. In the context of this disagreement, we agreed to examine: 
(1) the extent to which FERC, since EPAct's enactment, has changed its 
merger or acquisition review process and postmerger or acquisition 
oversight to ensure that potential harmful cross-subsidization by 
utilities does not occur; and (2) the views of state utility 
commissions regarding their current capacity, in terms of regulations 
and resources, to oversee utilities. 

To answer these questions, we reviewed relevant reports, examined 
existing data, interviewed key officials, and conducted site visits in 
four states that had strong protections in place for overseeing holding 
and related affiliate companies or where additional consumer 
protections were being considered as a direct result of the repeal of 
PUHCA 1935. In addition, we conducted a detailed survey of state 
regulators in all 50 states and the District of Columbia. We have 
provided a copy of our survey and detailed tables showing the staff of 
the public utility commissions' responses to the questions in a 
separate report, Utility Oversight: Survey of State Public Utility 
Commissions Regarding Utility Commission Authorities and Reporting 
Responsibilities for Overseeing Utilities Since the Passage of EPAct 
2005 (GAO-08-290SP), available on the Internet [hyperlink, 
http://www.gao.gov/special.pubs/gao-08-290sp]. We did not attempt to 
develop a cost-benefit analysis of the repeal of PUHCA 1935. A detailed 
description of our methodology is included in appendix I. We performed 
our review from May 2006 through February 2008 in accordance with 
generally accepted government auditing standards. Those standards 
require that we plan and perform the audit to obtain sufficient, 
appropriate evidence to provide a reasonable basis for our findings and 
conclusions based on our audit objectives. We believe that the evidence 
obtained provides a reasonable basis for our findings and conclusions 
based on our audit objectives. 

Results in Brief: 

FERC has made few substantive changes to either its merger review 
process or its postmerger oversight since EPAct and, as a result, does 
not have a strong basis for ensuring that harmful cross-subsidization 
does not occur. With regard to its review of mergers and acquisitions, 
FERC officials told us that they do not intend to make changes to their 
process other than to require companies to disclose any existing or 
planned cross-subsidization and explain why it is in the public 
interest, and to certify in writing that they will not engage in 
harmful cross-subsidization. With this disclosure and company 
attestation, FERC officials review organizational and financial 
information provided by the companies at the time of the proposed 
merger and do not take further steps to independently verify such 
information. With regard to postmerger oversight, including its 
oversight of already existing companies previously regulated by SEC or 
FERC, FERC intends to continue to rely on its existing enforcement 
mechanisms to detect potential cross-subsidies--primarily companies 
self-reporting noncompliance and a limited number of compliance audits. 
FERC officials told us that they believe the threat of large fines, as 
allowed by EPAct, will encourage companies to investigate and self- 
report noncompliance that they discover. To augment self-reporting, 
FERC officials told us that they are using an informal plan to 
reallocate their limited audit staff to conduct affiliate transaction 
audits of 3 companies in 2008 (of the 36 holding companies it 
regulates). FERC officials told us that it relies on informal 
discussions between senior FERC managers and staffs to plan its audits 
each year, but does not formally consider the risks posed by various 
companies. A risk assessment, for example, could include developing a 
risk profile for companies by using data on a company's financial 
condition and by collaborating with states to consider a company's 
history of compliance. In contrast to FERC's approach for selecting 
companies for compliance audits, financial auditors and other experts 
told us that such a risk-based audit approach is an important 
consideration in allocating resources to detect noncompliance. Finally, 
we found that where affiliate transactions were audited, the resulting 
audit reports often lacked a clear description of the audit objectives, 
scope, methodology, and findings--thus preventing them from being 
useful to FERC staff to build better audit practices or to improve 
transparency to states and companies policing these transactions or the 
public more generally. 

Although states' views varied on their current regulatory capacities to 
review utility mergers and acquisitions and oversee affiliate 
transactions, many states reported the need for additional resources, 
such as staff and funding, to respond to changes in oversight after the 
repeal of PUHCA 1935. With regard to the review of mergers, state 
regulators in all but a few states reported utilities must seek state 
approval for these proposals. State regulators reported being mostly 
concerned about the impact of mergers on customer rates, but 25 of 45 
reporting states also noted concerns that the resulting potentially 
more complex company could be more difficult to regulate. In recent 
years, two state commissions denied mergers, in part, because of these 
concerns. With regard to affiliate transactions and the potential for 
cross-subsidies, most states have some type of authority to approve, 
review, and audit affiliate transactions, but many states currently 
review or audit only a small percentage of the transactions. For 
example, over the last 5 years, the majority of states (28 of 49 states 
reporting) audited 1 percent or less of affiliate transactions. On the 
other hand, some states reported that they require periodic, 
specialized audits of affiliate transactions to ensure transactions are 
consistent with applicable rules. Although almost all states require 
financial reports from utilities and report they have access to 
financial books and records from utilities in order to review affiliate 
transactions, many states reported they do not have such direct access 
to the books and records of holding or affiliated companies. Some 
utility experts believe that this lack of authority could prevent some 
states from linking the financial risks associated with affiliate 
companies to their regulated utility customers. While EPAct provides 
state regulators the ability to obtain such information, some states 
expressed concern that this access is narrow and could require them to 
be extremely specific in identifying needed information, thus 
potentially limiting their audit access. From a resources perspective, 
almost one-half (22 of 50 states reporting) said that with the changes 
in EPAct they needed additional staffing and funding to a carry out 
their oversight responsibilities. A commission official told us that 
examining affiliate transactions can be resource intensive since 
determining whether a transaction is unfair may require detailed 
analysis of the transaction and the market for the good or service that 
was the subject of the transaction. 

GAO recommends that the Chairman of FERC develop a risk-based audit 
approach to detect cross-subsidization, enhance its public audit 
reporting, and reassess its resources in light of a risk-based audit 
approach in order to demonstrate that its oversight is sufficiently 
vigilant. The FERC Chairman disagreed with our report findings and 
recommendations. We maintain that fully implementing our 
recommendations would enhance the effectiveness of FERC's oversight. 

FERC'S Merger Review and Postmerger Oversight to Prevent Cross- 
Subsidization in Utility Holding Company Systems Are Limited: 

FERC has made few substantive changes to either its merger review 
process or its postmerger oversight as a consequence of its new 
responsibilities and, as a result, does not have a strong basis for 
ensuring that harmful cross-subsidization does not occur. To review 
mergers and acquisitions, FERC officials told us that they do not 
intend to make changes to their process other than to require companies 
to disclose any existing or planned cross-subsidization and explain why 
it is in the public interest, and to certify in writing that they will 
not engage in harmful cross-subsidization. For postmerger oversight, 
FERC intends to continue to rely on its existing enforcement 
mechanisms, as expanded by EPAct, to detect potential cross-subsidies-
-primarily companies' self-reporting of noncompliance and a limited 
number of compliance audits. However, FERC does not formally consider 
the risks posed by various companies in determining which companies to 
audit--a consideration that financial auditors and other experts told 
us is important when auditing with limited resources. We also found 
that where affiliate transactions were audited, the resulting audit 
reports sometimes lacked clear and useful information. 

FERC's Merger and Acquisition Review Relies Primarily on Company 
Disclosures and Commitments Not to Cross-Subsidize: 

FERC's merger review process requires companies to submit evidence that 
a merger or acquisition will not result in unapproved cross- 
subsidization, and its ability to prevent cross-subsidization depends 
largely on commitments by the merging parties rather than independent 
analysis. FERC-regulated companies that are proposing to merge with or 
acquire a regulated company must submit a public application for FERC 
to review and approve. As part of its review of these applications, 
FERC is now responsible for ensuring that mergers do not result in 
harmful cross-subsidies. To do this, FERC attempts to ensure that 
mergers will not result in: 

* any transfer of facilities between or issuance of securities by a 
traditionally regulated public utility to an affiliate;[Footnote 7] 

* any new financial obligation by a traditionally regulated public 
utility for the benefit of an affiliate;[Footnote 8] or: 

* any new affiliate contract between a nonutility affiliate company and 
a traditionally regulated public utility company, other than agreements 
subject to review by FERC under the Federal Power Act. 

To fulfill this new responsibility, FERC established an additional 
requirement that the merging companies submit new information as part 
of their application for merger or acquisition approval, referred to as 
"Exhibit M." Exhibit M requires companies to describe organizational 
and financial information, such as affiliate relationships and any 
existing or planned cross-subsidies. If cross-subsidies already exist 
or are planned, companies are required to describe how these are in the 
public interest by, for example identifying how the planned cross- 
subsidy benefits utility ratepayers and does not harm others. Further, 
in FERC's recent supplemental merger policy statement, issued July 20, 
2007, FERC provided additional guidance on certain types of 
transactions that are not likely to raise concerns about cross- 
subsidization--termed "safe harbors."[Footnote 9] FERC also requires 
company officials to attest that they will not engage in unapproved 
cross-subsidies in the future and specifically requires the merger 
application, including Exhibit M, to be signed by a person or persons 
having appropriate knowledge and authority. 

FERC's merger or acquisition decision is based on a public record that 
starts with an initial application. This record includes the filing of 
the initial application. FERC's review process also allows stakeholders 
or other interested parties, such as state regulators, consumer 
advocates, or others to submit information and arguments to this public 
record for FERC to consider. FERC officials told us that they evaluate 
the information in the public record for the application and do not 
separately develop or collect evidence or conduct separate analyses of 
a proposed merger beyond what is submitted as part of the record. FERC 
officials told us that they can, and sometimes do, request that 
applicants provide additional information or conduct additional 
analysis. In addition, FERC may require a public hearing before making 
a decision. Whether or not a hearing is held, officials noted that they 
are required to make their decision based on the evidence that is in 
the public record. On the basis of this information, FERC officials 
told us that they will determine which, if any, existing or planned 
cross-subsidies may be allowed, which is then detailed in the final 
merger or acquisition order. 

According to experts, FERC is generally supportive of mergers. FERC 
officials largely acknowledged this perspective, telling us that under 
law and regulation, FERC must approve mergers that are consistent with 
the public interest. These officials also said that FERC believes it 
has broad flexibility in determining what is consistent with the public 
interest, particularly in light of changing conditions in the industry 
and, as such, it does not read the statute as creating a presumption 
against mergers.[Footnote 10] On the other hand, FERC officials said 
that FERC was not prepared to presume that all mergers were beneficial 
but that it was the merger applicant's responsibility to demonstrate 
that the merger was consistent with the public interest by, for 
example, demonstrating how it improves efficiency or lowers costs while 
not harming competition. 

Between the time EPAct was enacted in 2005 and July 10, 2007, FERC has 
reviewed or was in the process of reviewing 15 mergers or potential 
mergers (see table 1).[Footnote 11] FERC has not rejected any merger 
applications. In nine cases, FERC approved the merger without 
condition. In three cases, FERC approved the merger with conditions, 
for example, requiring the merging parties to provide further evidence 
of ratepayer protection consistent with FERC-approved "hold harmless" 
provisions. One merger was withdrawn by the merging parties prior to 
FERC's decision. The two other applications are still pending. 

Table 1: Merger Proposals Reviewed by FERC since EPAct: 

Merging parties: Duke Energy Corp. and Cinergy Corp; 
Decision date: 12/20/2005; 
FERC order: Approved without conditions. 

Merging parties: MidAmerican Energy Holding Co., Scottish Power plc, 
and PacifiCorp Holdings, Inc; 
Decision date: 12/20/2005; 
FERC order: Approved without conditions. 

Merging parties: Florida Power & Light and Constellation Energy; 
Decision date: Not applicable; 
FERC order: Merger was withdrawn prior to FERC decision. 

Merging parties: Georgia Power Company and Savannah Electric Power 
Company; 
Decision date: 3/30/2006; 
FERC order: Approved without conditions. 

Merging parties: ITC Holdings Corp., International Transmission Co., 
Michigan Transco Holding Limited Partnership, Michigan Electric 
Transmission Co. LLC and Trans-Elect NTD Path 15, LLC; 
Decision date: 9/21/2006; 
FERC order: Approved subject to conditions. 

Merging parties: National Grid plc and KeySpan Corp; 
Decision date: 10/20/2006; 
FERC order: Approved subject to conditions. 

Merging parties: Boston Edison Co., Cambridge Electric Light Company, 
Commonwealth Electric Co., and Canal Electric Co; 
Decision date: 10/ 20/2006; 
FERC order: Approved subject to conditions. 

Merging parties: Northwestern Corp. and Babcock & Brown Infrastructure 
Limited; 
Decision date: 10/25/2006; 
FERC order: Approved without conditions. 

Merging parties: Green Mountain Power Corp, Northern New England 
Electric Corp. and Northstars Merger Subsidiary Corp; 
Decision date: 12/4/2006; 
FERC order: Approved without conditions. 

Merging parties: WPS Resources Corp. and Peoples Energy Corp; 
Decision date: 12/26/2006; 
FERC order: Approved without conditions. 

Merging parties: Duquesne Light Holdings, Inc., DQE Merger Sub, Inc., 
and DQE Holdings; 
Decision date: 12/22/2006; 
FERC order: Approved without conditions. 

Merging parties: Dynegy Inc., and LS Power Development, LLC; 
Decision date: 12/21/2006; 
FERC order: Approved without conditions. 

Merging parties: EBG Holdings LLC, Boston Generating LLC, and Astoria 
Generating Company Holdings LLC; 
Decision date: 5/30/2007; 
FERC order: Approved without conditions. 

Merging parties: Oncor Electric Delivery Co., TXU Portfolio Management 
Co. LP, and Texas Energy Future Holdings Limited Partnership; 
Decision date: Not applicable; 
FERC order: Not yet decided. 

Merging parties: ITC Holdings Corp. and Interstate Power and Light Co; 
Decision date: Not applicable; 
FERC order: Not yet decided. 

Source: FERC. 

[End of table] 

FERC'S Postmerger Oversight Relies on Its Existing Enforcement 
Mechanisms and Lacks a Risk-Based Approach: 

FERC officials in the Office of Enforcement intend to use the same 
tools to enforce prohibitions on cross-subsidization that they 
currently use for other enforcement actions. In general, the Office of 
Enforcement relies on two primary tools--self-reporting and a limited 
number of compliance audits.[Footnote 12] However, we found that FERC 
does not use a formal risk-based approach to guide its audit planning-
-the active portion of its oversight efforts to detect cross- 
subsidization--or deploy its limited audit resources. As such, FERC's 
actions do not provide a strong basis for ensuring the detection of 
potentially harmful cross-subsidization. 

The first detection tool that FERC emphasizes is that companies self- 
police their own affiliate transactions and intercompany relationships 
and voluntarily self-report instances of harmful cross-subsidization to 
FERC. FERC's policy statement on enforcement emphasizes such voluntary 
internal compliance and reporting as well as cooperation with FERC in 
order to detect and correct violations. A company's actions in 
following this policy, along with the seriousness of a potential 
violation, help inform FERC's decision on the appropriate level of 
potential penalty to impose on violating companies.[Footnote 13] FERC 
indicates that it places great importance on company's proactive self- 
reporting because it believes that companies are in the best position 
to detect and correct both inadvertent and intentional violations of 
FERC orders, rules, and regulation. According to FERC officials, 
companies can actively police their own behavior through a formal 
program for internal compliance, internal audits, and through annual 
external financial audits. 

Since the enactment of EPAct,[Footnote 14] when Congress formally 
highlighted its concern about cross-subsidization, no companies have 
self-reported any of these types of violations. FERC officials said 
that FERC had approved 12 settlements with natural gas and electric 
entities, none of which involved violations of the PUHCA 2005 
provisions in EPAct. In these cases, FERC has assessed civil penalties 
totaling $39.8 million on the companies.[Footnote 15] FERC officials 
told us that because it can now levy much larger fines--up to $1 
million per violation per day--they expect companies to become more 
vigilant in monitoring their behavior. 

Regarding FERC's reliance on self-reporting, key stakeholders have 
raised several concerns about this approach. First, because FERC's 
rules related to affiliate transactions are broad, company managers may 
not always be fully aware of how these rules apply to specific 
affiliate transactions. According to market experts, including a 
November 2007 report issued by a former FERC Commissioner on behalf of 
a broad consortium of energy companies, FERC's rules are often written 
broadly and it is unclear what standards of conduct FERC uses to 
oversee transactions between companies. This can result in utility 
managers being unaware that specific transactions may violate current 
FERC policies. One controller we met with told us that these broad 
rules can be counterproductive in encouraging company compliance and 
self-reporting because it is difficult to determine if the rules are 
actually being violated. Second, internal company audits tend to focus 
on areas of highest perceived risk and, as a result, may not focus 
specifically on affiliate transactions. Internal auditors with whom we 
spoke told us that they have relatively small staffs and are 
responsible for auditing a wide range of matters within a corporation 
and, as such, they focus their efforts on areas they believe pose the 
highest risk to the company. They said this approach means that they 
rarely focus on affiliate transactions, unless those transactions 
represent a large financial exposure to the company's potential 
profitability. Finally, financial audit firms we spoke with told us 
their work primarily focuses on auditing financial statement balances 
and related disclosures. These audits focus on providing an opinion 
about whether the financial statements present fairly, in all material 
respects, the financial position and operations of the company. As 
such, they said that their work with regard to affiliate transactions 
is limited to the related disclosures rather than determining if 
harmful cross-subsidization was occurring. Only in cases where 
transactions could have a material effect on the overall financial 
statements of a company would they conduct detailed testing and review 
pricing arrangements. Compounding these concerns, and FERC's belief 
that the threat of large fines will encourage companies to self-report, 
companies expressed uneasiness over FERC's use of its new penalty 
authority on self-reporting companies. One company official noted that 
some of the recent penalties for companies that self-reported 
violations were large and would "chill" companies' willingness to self- 
report violations. In addition, state commissions expressed concerns 
about a reliance on self-reporting of cross-subsidies and reported that 
effective oversight would require regular and rigorous audits of 
affiliate transactions. 

As a second way to detect potential harmful cross-subsidization, FERC 
plans to conduct a limited number of compliance audits of holding 
companies each year. Since enactment of PUHCA 2005 provisions in EPAct, 
FERC has not completed any audits to detect whether cross-subsidization 
is occurring. In our review of FERC processes for planning these 
audits, however, officials with the Division of Audits in the Office of 
Enforcement told us that FERC conducts audit planning for 1 fiscal year 
at a time. On the basis of this approach, FERC's current audit plan for 
these matters in 2008 will audit three companies--Exelon Corporation, 
Allegheny, Inc., and the Southern Company. The overall objective of 
these audits will be to determine whether these companies are 
inappropriately cross-subsidizing or granting special preference to 
affiliates or burdening utility assets for the benefit of nonutility 
affiliated companies. Such compliance audits, officials told us, will 
determine whether companies are complying with FERC rules for the 
pricing of affiliate transactions, among other things. FERC's audit 
plan is not designed to address the number of audits FERC will conduct 
beyond 2008, or at what companies it will conduct them since the 
planning for 2009, for example, will not be done until sometime later 
in 2008. In addition, based on discussions with FERC officials, the 
development of its audit plan is informal and developed in an ad hoc 
manner to address the specific audits for a given year. Specifically, 
these officials said that the plan is developed through informal 
discussions between FERC's Office of Enforcement, including its 
Division of Audits, and relevant FERC offices with related expertise, 
including the Office of General Counsel, the Office of Energy Markets 
Regulation, and the new Office of Electric Reliability. FERC officials 
also told us that the plan is reviewed by top agency officials and 
approved by the Chairman. 

While FERC's audit plan for 2008 reflects insights of key FERC staff, 
it does not formally consider the risks posed by individual companies, 
or the overall universe of companies, in determining which companies to 
audit or how many audit resources to deploy. FERC officials told us 
that while they do not specifically consider the individual or 
collective risks posed by companies in a formal manner, they believe 
that their discussions with knowledgeable staff provide a reasonable 
picture of risk. However, on the basis of our discussions with FERC 
staff, this picture of risk may be somewhat limited in that it is 
informed only by the views of a few key staff and does not seek input 
from stakeholders, such as the financial community or state 
commissions, or reflect analysis of key data on risk. 

To obtain a more complete picture of risk, FERC could more actively 
monitor company-specific data to develop a picture of the risks posed 
by the companies it regulates--something it currently does not do. To 
partly address this, FERC recently required certain affiliates to begin 
gathering comprehensive financial information in 2008 and filing the 
first of what will be annual financial reports by May 2009.[Footnote 
16] According to a FERC audit official, after a year or 2 of data 
collection, analysis, and conducting audits, it will be in a much 
better position to plan, conduct, and report the results of its audits 
of affiliate relationships and potential cross-subsidization.[Footnote 
17] In addition, this official said that FERC does not typically review 
certain publicly available financial information, such as bond ratings 
and stock prices for companies that FERC regulates or their affiliates. 
According to bond rating companies, they actively monitor companies' 
operating and financial condition to identify the key risks faced by 
companies and reflect these risks in the ratings they assign to the 
company's debt. Further, state officials agreed that such information 
may help provide a view of the financial condition of specific 
companies, or the overall industry, and how they may be changing. In 
support of the use of this information, some state regulators told us 
that such information has been helpful to them in identifying when 
companies may engage in unlawful cross-subsidies. Finally, some state 
officials said that because they regulate companies on a day-to-day 
basis, they have considerable expertise and knowledge that may prove 
useful to FERC. Thus, unless FERC changes its view about the usefulness 
of such data, it will continue to lack available information that may 
be potentially useful in assessing risk. 

The importance of formally considering risk when carrying out 
compliance oversight is highlighted by prior GAO reports.[Footnote 18] 
In these reports GAO identified instances where other agencies, such as 
SEC, the Department of Homeland Security, and the Environmental 
Protection Agency could use and have used risk-based approaches to 
inspect for compliance with regulations. In some cases, agencies have 
developed and used statistical models to estimate an entity's (e.g., a 
company's) risk of a violation and as a means to target limited audit 
resources. In other cases, we have recommended that agencies continue 
to devote some resources to auditing entities on a random basis but use 
the data collected from these random audits to update statistical 
models so that the agency can continue to identify high-risk entities. 
Furthermore, according to financial auditors and other experts we spoke 
with, risk assessments are an important consideration in targeting 
audits and allocating resources to detect noncompliance. Without a 
sufficient assessment of risk, it may be difficult for FERC to convince 
companies, states, and other market stakeholders that it can adequately 
and consistently detect cross-subsidization. 

At present, without a risk-based approach to guide its audit planning 
and deploy its limited audit resources, FERC may not be effectively 
allocating its staff to audit the companies it regulates. FERC's 
Division of Audits currently has a total of 34 full-time staff, 
including 21 accountants/ auditors, 6 energy industry analysts, 3 
economists, 2 engineers, 1 attorney, and 1 support staff. FERC has 
determined that of the 149 companies that have been identified as 
holding companies, 36 of them are currently subject to its PUHCA 2005 
authority and it plans to allocate 9 of its available staff to these 
audits in 2008.[Footnote 19] Officials in the Division of Audits told 
us that they believe a typical audit would involve three to four audit 
staff--an auditor-in-charge and one or two auditors. Other companies 
and state auditors involved in auditing affiliate transactions told us 
that these audits can be difficult and require significant use of 
auditors with specialized skills and experience. These auditors also 
told us that examining affiliate transactions can be resource intensive 
since determining whether a transaction is unfair may require detailed 
analysis of the transaction and the market for the good or service that 
was the subject of the transaction. At its planned 2008 audit rate of 3 
companies, it would take FERC 12 years to audit each of these companies 
once. In commenting on the report, FERC noted that the number of audits 
in future years may change. Nevertheless, FERC may face additional 
companies, some of which may require more complex audits. According to 
financial and industry experts we spoke with, the elimination of PUHCA 
1935 is likely to attract companies previously restricted from owning 
utilities to consider mergers or acquisitions. For example, some 
experts told us that foreign companies, corporate conglomerates, and 
private equity companies are considering mergers or acquisitions of 
U.S. utilities. In addition to companies subject to FERC's oversight 
under the PUHCA 2005 provisions of EPAct, FERC also has audit 
responsibilities for the electric reliability organization, the North 
American Electricity Reliability Corporation, which oversees issuing 
and enforcing rules, such as compliance with reliability standards, 
focused on ensuring reliable electricity supplies. At present, there 
are about 4,700 companies that could potentially be audited for 
compliance with FERC's rules, regulations, and orders regarding 
reliability, transmission, and electricity pricing rules. FERC 
officials said some overlap exist between categories, such as investor- 
owned utilities and electric suppliers with market-based rate 
authority. In addition, according to FERC, Federal Power Act section 
215 companies would initially be audited and overseen by the new 
Regional Reliability Organization and the related regional entities. 
FERC officials also said that they intend to audit about 100 of these 
companies during 2008. The universe of companies that FERC is 
responsible for auditing is identified in 10 categories in table 2. 
Because of the magnitude of companies it oversees and the range of 
rules it enforces, FERC enforcement and audit officials described their 
offices as resource constrained and acknowledged that the Office of 
Enforcement has not yet adopted a formal, risk-based approach to target 
these resources. 

Table 2: FERC's Audit Universe by Category of Company: 

Category of jurisdictional company: Investor-owned utilities; 
Number of companies: 211. 

Category of jurisdictional company: Electric suppliers with market- 
based rate authority; 
Number of companies: 1,304. 

Category of jurisdictional company: FPA section 215 (reliability); 
Number of companies: 1,510. 

Category of jurisdictional company: Power marketing agencies; 
Number of companies: 5. 

Category of jurisdictional company: Hydroelectric projects; 
Number of companies: 1,022. 

Category of jurisdictional company: Liquid natural gas terminals; 
Number of companies: 17. 

Category of jurisdictional company: Oil pipelines; 
Number of companies: 199. 

Category of jurisdictional company: Interstate natural gas pipelines; 
Number of companies: 159. 

Category of jurisdictional company: Natural gas storage facilities; 
Number of companies: 201. 

Category of jurisdictional company: Intrastate pipelines (Natural Gas 
Policy Act, section 311); 
Number of companies: 68. 

Category of jurisdictional company: Total; 
Number of companies: 4,696. 

Source: FERC. 

Note: Some overlap exists between categories, such as investor-owned 
utilities and electric suppliers with market-based rate authority. In 
addition, according to FERC, Federal Power Act section 215 companies 
would initially be audited and overseen by its new Regional Reliability 
Organization and the related regional entities. 

[End of table] 

FERC's Postmerger Audit Reports on Affiliate Transactions Often Lack 
Clear Information: 

FERC's publicly available audit reports pertaining to affiliate 
transactions are not clear and, thus, their usefulness in terms of 
public transparency and disclosure is limited. Although FERC has not 
yet completed any affiliate transaction audits or yet issued any 
reports under EPAct, officials with the Division of Audits told us that 
they intend to rely on their existing "exception-based" audit reporting 
policy. A FERC official told us their "exception-based" audit reporting 
policy means audit reports would only reflect the audit findings and 
recommendations associated with the audit issues on which FERC found 
the company to be out of compliance. In contrast, if an audit does not 
result in FERC taking an enforcement action due to noncompliance, the 
audit report does not provide information on the methodology the 
auditors used nor their findings. Thus, FERC's public audit reports may 
not always fully reflect key elements such as objectives, scope, 
methodology, and the specific audit findings. Federal government 
auditing standards, developed by GAO and referred to as Generally 
Accepted Government Auditing Standards (GAGAS), stipulate that audit 
reports contain this basic information, and other information as well, 
in order to comply with GAGAS. According to FERC officials, they are 
not required to comply with GAGAS, but "follow the spirit" of these 
standards because they provide a good framework for performing high- 
quality audits.[Footnote 20] In our review of 18 recent FERC audit 
reports pertaining to affiliate transactions, we found that they did 
not always identify any findings on affiliate transactions or have any 
recommendations. Further, the audit reports sometimes lacked key 
information, such as the type, number, and value of affiliate 
transactions at the company involved and the percentage of all 
affiliate transactions tested, or the test results. A FERC official 
conceded that FERC past audit reports on affiliate transactions do not 
always meet GAGAS standards because they are not required to do so. 
However, without this information, it may be difficult for regulated 
companies to understand the nature of FERC's oversight concerns and to 
conduct internal audits to identify potential violations that are 
consistent with those conducted by FERC--key elements in improving 
companies' self-reporting. Further, financial audit firms, internal 
auditors, and auditors at state commissions told us that they typically 
review prior related audits, including those done by FERC, as part of 
their preparation for a new audit. To the extent that FERC audit 
reports lack information on the work they performed, they limit the 
usefulness of these audits for future auditors as well as miss an 
opportunity to improve FERC's audit practices and transparency to state 
regulators and other companies and stakeholders. Furthermore, without 
such information in the audit report, we and other stakeholders, such 
as state commissions, cannot confidently and credibly determine that 
the auditor's efforts to detect abusive affiliate transactions and 
cross-subsidization were sufficient. A recent report prepared by a 
former FERC Commissioner on behalf of a wide range of industry 
stakeholders expressed concern that FERC increase the transparency of 
its audits and investigations in order to, among other things, help 
individual market participants to improve their internal compliance 
programs and correct deficiencies before they cause harm to consumers. 

States Vary in Their Capacities to Oversee Utilities: 

States utility commissions' views of their oversight capacities vary, 
but many states foresee a need for additional resources to respond to 
changes from EPAct. Almost all states have specific authority to review 
and either approve or disapprove mergers and acquisitions. Despite this 
authority, many states' commission staff expressed concern over their 
ability to regulate the resulting companies. Almost all states report 
they have some type of authority over affiliate transactions, although 
many states report reviewing or auditing few of these transactions. 
Further, although almost all states can access the books and records of 
the utility to substantiate costs and other relevant data, many states 
report they cannot obtain such access to these books and records at the 
holding company or other affiliated nonutility companies. Almost half 
of the states report they need additional staff and funding to respond 
to changes stemming from EPAct. 

Almost All States Have Merger Approval Authority but Many States 
Express Concern about Future Regulation of the Resulting Companies 
after Merger Approval: 

On the basis of our survey of state commission staff,[Footnote 21] all 
but 3 states (out of 50 responses) have authority to review and either 
approve or disapprove mergers. The types of authority states have vary, 
however. For example, one state noted that, technically, it could only 
disapprove a merger and, as such, the state allows a merger by taking 
no action to disapprove it. Three states noted their state legislatures 
had not provided them direct merger review authority,[Footnote 22] but 
they were able to use other commission authority to conduct such 
reviews. 

State commissions responding to our survey noted that the most 
important factors they consider in evaluating mergers or acquisitions 
are the effects on regulated rates and the quality of retail service 
(e.g., no significant problems with service interruptions for 
consumers). The next most important factors were the commission's 
ability to regulate the resulting company and the effect on the 
financial complexity of the company that would result from the merger. 
Staff from one state told us in additional narrative comments that they 
were concerned that with the passage of EPAct utilities will become 
larger, more complex, and located in geographically diverse areas. They 
specifically expressed concerns over the challenges of allocating costs 
between various entities due to the potential for centralization of 
services in these types of resulting companies. 

Table 3 below lists the 4 top factors rated as either of very great 
importance or great importance out of 15 factors we asked states to 
rate in their evaluation of proposed mergers and acquisitions.[Footnote 
23] 

Table 3: Key Factors in Commission Evaluations of Mergers and 
Acquisitions: 

Key factors in commission evaluations: Impact of combination on 
regulated retail rates; 
Number of states noting these factors as having great or very great 
importance: 44; 
Total states responding: 47. 

Key factors in commission evaluations: Impact on retail service 
quality; 
Number of states noting these factors as having great or very great 
importance: 43; 
Total states responding: 46. 

Key factors in commission evaluations: Impact on ease or difficulty of 
regulation of resulting company by commission; 
Number of states noting these factors as having great or very great 
importance: 25; 
Total states responding: 44. 

Key factors in commission evaluations: Impact on financial complexity 
of resulting company; 
Number of states noting these factors as having great or very great 
importance: 23; 
Total states responding: 44. 

Source: GAO analysis of state survey of utility commission authorities 
and reporting responsibilities. 

Note: GAO asked commission staff to evaluate the importance of 15 
different factors they might consider in evaluating mergers and 
acquisitions. They were asked to rank these factors on a 5-point scale 
with the 2 highest points on the scale being very great importance and 
great importance. The factors listed in the table are the four factors 
most commonly listed as being of either very great or great importance. 
Some states did not comment on all factors. 

[End of table] 

In recent years, the difficulty and increased complexity of regulating 
merged companies has been cited by two state commissions denying 
proposed mergers in their states. For example, a state commission 
official in Montana told us the commission denied a merger in July 
2007, between Northwestern Company and Babcock and Brown 
Infrastructure, an Australian company, even though it had been approved 
by FERC. This merger involved a Montana regulated utility, whose 
headquarters was located in South Dakota and was being bought by a 
foreign-owned holding company. According to this official, the 
commission denied the merger partly due to concerns about regulating 
the utility under such a corporate combination. He noted concerns that 
no top corporate officials would be located in Montana and that the 
time zone differences with the Australian company made contact with 
those officials more difficult in dealing with regulatory issues. As a 
result of the denial by the state commission, the merger was not 
allowed to proceed. In a different proposed merger in Oregon, state 
utility commission officials told us they denied the proposed merger in 
March 2005 between Portland General Electric, one of their regulated 
utilities and the Texas Pacific Group, a private equity fund company. 
They noted under their implementation of Oregon's statutes, mergers 
must meet two standards: (1) they must provide net benefits to 
consumers and (2) they cannot harm consumers. Officials in Oregon noted 
that the state commission was concerned that consumers could be harmed 
because regulating the resulting company would be more difficult due to 
the financial complexity of the new ownership arrangement. In addition, 
the commission was concerned that consumers faced potential harm due to 
risks posed by high levels of debt and the private equity firm's short- 
term business plan. Although an application had been made for a review 
at FERC it was withdrawn in April 2005 prior to FERC review. 

State commission views regarding potential mergers and acquisitions are 
of increasing importance in the financial community, as well. Officials 
from the financial community noted they believe state commissions may 
be highly suspicious of some of the new corporate structures being 
proposed, especially the role of private equity firms. They also noted 
that some commissions have expressed significant concerns over the 
formation of vast utility companies operating in multiple states. As a 
result of these and other concerns, these officials reported that some 
companies potentially interested in merging with or acquiring utilities 
have been reluctant to propose transactions so far. 

Most States Have Authorities over Affiliate Transactions, but Many 
States Report Auditing Few Transactions: 

Almost all states report having authorities over affiliate transactions 
or regular reporting of such transactions, or both. Nationally, 49 
states noted they have some type of affiliate transaction authority. 
These authorities, however, vary from prohibitions against certain 
types of transactions, or prior approval by the commission for 
transactions over a certain dollar amount, to less restrictive 
requirements such as allowance of the transaction without prior review. 
In some cases state commission authorities permit them to disallow 
these transactions at a later time if they were inappropriate. In fact 
more than half the states (27) reported that under their authority, 
affiliate transactions did not require prior commission approval, but 
could be reviewed and disallowed later. Such a disallowance would 
result in the cost of the transaction not being passed on to consumers 
or being recovered from the company. Only 3 states reported that 
affiliate transactions always needed prior commission approval. 

Nearly all states (41) require utilities to report affiliate 
transactions at least annually, or more frequently. These reports 
varied, however, in frequency of reporting, types of transactions 
requiring reporting, and the detail of reporting. For example, some 
states required reporting all transactions at least annually, while 
others required reporting of only certain types of transactions or just 
reporting the total dollars spent by each affiliate. Several of the 
state commissions we interviewed noted the importance of strong state 
authority over affiliate transactions. Staff in one state noted their 
commission must preapprove any affiliate transactions over $25,000 and 
conditions for approval were stringent. In some instances the state's 
attorney general stepped in to stop companies from going ahead with 
affiliate transactions that had not been preapproved. 

Some states are concerned that they may not have sufficient authorities 
to oversee affiliate transactions, after the repeal of PUHCA 1935. In 
our survey, some state commissions expressed a need to increase their 
authority over affiliate transactions. During the course of our work 
one state took action to increase its authority. In 2006, the 
California commission strengthened existing affiliate transactions 
authorities, partly due to concerns related to the repeal of PUHCA 
1935. The new rules clarified the scope of allowable utility affiliate 
transactions and tightened the rules on when and how specific services, 
such as, legal services could be shared between affiliates and the 
regulated utility. 

Despite various authority governing the prior authorization and 
disclosure of affiliate transactions, many states responding to our 
survey reported they audit few if any affiliate transactions or 
dedicate much staff time to reviewing these transactions. The majority 
of states reported they have audited 1 percent or less of these 
transactions over the last 5 years and dedicated no staff time to 
reviews or audits over the last year. Table 4 shows that many states 
are not performing reviews or audits of affiliate transactions. 

Table 4: State Reviews and Audits of Affiliate Transactions: 

Limited state reviews or audits conducted: Number of states with no 
staff time dedicated to auditing holding companies and affiliates over 
last 12 months; 
Number of states: 24; 
Total states responding: 41. 

Limited state reviews or audits conducted: Number of states performing 
no reviews of affiliate transactions within the last 5 years; 
Number of states: 18; 
Total states responding: 45. 

Limited state reviews or audits conducted: Number of states auditing 1 
percent or less of affiliate transactions over the last 5 years; 
Number of states: 28; 
Total states responding: 49. 

Limited state reviews or audits conducted: Number of states that 
dedicated 1 staff year or less to affiliate transactions over the last 
5 years; 
Number of states: 27; 
Total states responding: 44. 

Source: GAO analysis of state survey of utility commission authorities 
and reporting responsibilities. 

[End of table] 

Since the passage of EPAct several aspects of monitoring of affiliate 
transactions were raised as key challenges by several state commissions 
responding to our survey and during our interviews. For example, an 
attorney from one state utility commission expressed concerns about 
having enough resources and expertise to enforce existing authorities. 
He noted that holding company and affiliate transactions can be very 
complex and time-consuming to review. He noted these reviews are 
resource intensive, since determining whether a transaction is unfair 
may require detailed analysis of the transaction and the market for the 
good or service that was subject of the transaction. Another expert, 
with extensive experience with FERC and several state public utility 
commissions noted that on the basis of his experience, states do not 
generally have the resources to effectively review affiliate 
transactions, particularly when they are multistate in nature. 
Similarly, a consultant whose firm does numerous affiliate transaction 
audits in many states, noted in a March 2007 FERC technical conference 
on related issues that many states, even when they have significant 
authority, lack staff to review transactions. Further, he noted that 
state commissions often lack the staff expertise to adequately address 
the accounting and financial operations aspects of these affiliate 
relationships as well as the risks inherent to audits of affiliate 
transactions: 

Some states, however, do put special emphasis on auditing affiliate 
transactions. All four states we visited routinely audit affiliate 
transactions. Commission officials in one of these states told us they 
commit the equivalent of 2.5 full time employees to auditing affiliate 
transactions for reasonableness (e.g., prices appear to be correct). If 
they find unreasonable transactions the commission can adjust future 
electricity rates to correct for the problem (e.g., they disallow some 
or all of the value of the transaction and remove that amount from 
prices that consumers pay). Their goal is to audit each utility every 2 
years and they estimate that over the last 5 years they have audited 
100 percent of all utility affiliate transactions. As part of their 
audits the staff requests SEC filings, monitors credit reports, and 
reviews other related financial data. However despite this effort, 
representatives from two consumer groups in this state expressed 
concerns that affiliate transactions are so complex that the state 
commission just does not have enough resources to fully audit these 
transactions. Two additional states commissions we interviewed contract 
with outside auditors to do specific audits of the affiliate 
transactions of the state's regulated utilities biennially. State 
commission staff in one of these states noted their audits review 
company affiliate transactions for appropriateness and proper pricing. 
The purpose of the audits is to show the transactions were made fairly 
to the utility and that ratepayers are not paying more than they 
should. One auditor who had done affiliate transaction audit work for 
another state we visited described that state's approach to auditing 
affiliate transactions as being very aggressive in that their audits 
involved significant data analysis and the reports contained 
considerable detail about the findings. 

Some States Report Not Having Access to Holding Company Books and 
Records: 

All states regularly require financial reports from utilities and are 
able to obtain access to the financial books and records of these 
utilities that document costs, but access beyond the utility varies. 
All 49 states that responded to this survey question, noted that they 
require utilities to at least provide financial reports. Most states 
(41) only require such reporting by the utility but 8 states require 
reports that also include the holding company or both the holding 
company and the affiliated companies. Of the 48 states that responded 
to our questions about the frequency of required reporting, 35 require 
annual reports; 6, quarterly reports; and 7, monthly reports. 

Although all states but 1 report having access to the books and records 
of the utilities in their states, some report they do not have such 
access to other companies within the holding company.[Footnote 24] 
Nearly one-third of the states reporting said they do not have access 
to the books and records of the utility holding company. Similarly, 
over 40 percent of the states reporting said they do not have such 
access to affiliated nonutility companies. Table 5 shows state 
commission access to different parts of holding companies. 

Table 5: State Commissions' Access to Books and Records: 

Organization: Regulated utility; 
Yes, commission has access: 49; 
No commission access: 1; 
Total states responding: 50. 

Organization: Utility holding company; 
Yes, commission has access: 32; 
No commission access: 14; 
Total states responding: 46. 

Organization: Affiliated nonutility company; 
Yes, commission has access: 28; 
No commission access: 20; 
Total states responding: 48. 

Source: GAO analysis of state survey of utility commission authorities 
and reporting responsibilities. 

Note: Question asked "Excluding the information, if any is provided to 
the commission through financial reporting by the utilities, does your 
commission have access to any books and records that document costs and 
other relevant information for each of the following?" 

[End of table] 

Utility experts also expressed concerns over state commissions' access 
to the books and records of holding companies or other affiliate 
companies either through state authority or through assistance by FERC. 
Lack of such access, these experts noted, may limit the effectiveness 
of state commission oversight and result in harmful cross-subsidization 
because the states cannot link financial risks associated with 
affiliated companies to their regulated utility customers. Experts 
expressed concern over state commission authority. For example, the 
president of an audit company, who currently works with two-thirds of 
the utility commissions across the country and completed many affiliate 
audits, noted that there is a lack of clear authority in some states to 
gain access to the key records in other states, even though the utility 
shares common services across the states that bear upon the utilities 
transactions. Similarly, one commission official told us that it is 
difficult to get access using state authority alone. He noted that 
holding companies can set up numerous roadblocks for staff to access 
the records. Consistent with this view, in comments to our survey 
concerning key challenges since the passage of EPAct one state noted a 
concern about the responsiveness of a parent holding company based out 
of state to specific in-state inquiries. 

While the PUHCA 2005 provisions of EPAct provide states with additional 
access to books and records, some states expressed reservations 
relating to the level of protection this offered their states. In 
response to our survey, 8 states noted that access to books and 
records, if they had to gain assistance through FERC, offered little or 
no protection to their states, while another 14 states noted this 
offered only some protection. In contrast, only 3 states noted that 
FERC assistance in gaining access offered great protection. Commission 
staff in one state told us that obtaining such information requires 
state commissions to be very specific in identifying the necessary 
information. However, this commission staff noted that it may be 
difficult to develop such detailed knowledge. According to this state 
commission staff, such a detailed requirement to access information may 
limit their ability to conduct adequate and timely affiliate 
transaction audits. A utility expert who has experience with both FERC 
and state commissions also noted that states often follow leads and do 
not always know the specific information to support a detailed request. 
As a result of the potential need to develop a series of detailed 
requests, it may take longer to complete an audit. He stated this 
creates significant risks for states and their ratepayers as the full 
scope of utility transactions cannot be understood without seeing the 
entire trail of these transactions through the holding company and 
affiliate books and records. 

States Foresee Needing Additional Resources: 

States and other officials expressed concerns that the state 
commissions do not currently have sufficient resources and may need 
additional resources to respond to the changes from EPAct. Since states 
have gained over 2 years of experience since EPAct was passed, many 
believe they now need additional resources to carry out their 
responsibilities. Specifically, as seen in table 6, 44 percent of the 
states responded to our survey that they need additional staffing or 
funding, or both, to deal with the changes from EPAct. Further, 6 out 
of 30 states raised staffing as a key challenge in overseeing utilities 
since the passage of EPAct. One state, for example, noted monitoring of 
affiliate relationships as a key challenge, particularly in light of 
its current staff and resources. Since the passage of EPAct, 8 states 
have proposed or actually increased staffing. 

Table 6: Some States Foresee Needing Additional Resources Due to EPAct: 

Type of resource: Additional staffing; Yes: 22; No: 28; Total states 
responding: 50. 

Type of resource: Additional funding; Yes: 22; No: 28; Total states 
responding: 50. 

[End of table] 

Source : GAO analysis of state survey of utility commission authorities 
and reporting responsibilities. 

Note: Survey question asked "Does your commission foresee needing any 
of the following to deal with the changes from EPAct 2005 concerning 
holding companies, mergers and various activities previously covered by 
the Public Utility Holding Company Act of 1935?" 

Staffing concerns were also mentioned as problems by officials at the 
commissions or by representatives of consumer groups in 3 of the 4 
states we visited as well others. For example, an official from the one 
of these state's commissions noted that the state, in response to 
tighter budgets, had reduced staffing levels across-the-board including 
the utility commission and that the median age of the commission staff 
was now 56 and could soon face a wave of retirements. In addition, 
representatives of two consumer groups in another state expressed 
concerns that the commission does not have enough resources to oversee 
or audit affiliate transactions. In addition an official from a 
national credit-rating agency expressed concern that some state 
commissions may not fully appreciate the degree of difficulty they 
could face with existing staffs in the years ahead. 

Conclusions: 

The repeal of PUHCA 1935 further opened the door for new and different 
corporate combinations, including the ownership of utilities by complex 
international companies or equity firms, potentially providing needed 
investment to the utility industry. However, this potential to increase 
investment comes at the potential cost of making regulation more 
difficult. Further, the introduction of new types of investors, with 
incentives that may be at odds with traditional utility company 
services, could change the utility industry into something quite 
different than the industry that FERC and the states have overseen for 
decades. Despite these evolving changes, FERC continues to rely to a 
considerable degree on companies to self-certify that they will not 
cross-subsidize and self-report when they do. On the basis of our 
discussions with industry, state regulators, and audit experts, this 
reliance on self-enforcement--backed up by a few audits--does little to 
convince consumers and other market stakeholders that FERC's oversight 
is sufficiently vigilant. 

As FERC and states approve mergers, the responsibility for ensuring 
that cross-subsidization will not occur shifts to FERC's Office of 
Enforcement and state commission staffs. However, in the case of FERC 
this presents a challenge because FERC lacks a formal way of allocating 
resources to the areas of highest potential risk--leaving audit 
resources deployed in an ad hoc manner. Without a risk-based audit 
approach, FERC may not allocate its scarce audit resources to the right 
areas, potentially allowing cross-subsidization to go undetected. In 
addition, since states generally review only a very small percent of 
affiliate transaction to identify potential cross-subsidization and 
many reported resource constraints, some states' detection of cross- 
subsidization may be limited. 

By reassessing its audit approach, how it shares the results of its 
audits, and its resources, FERC could take important steps to 
demonstrate its commitment to ensure that companies are not engaged in 
cross-subsidization at the expense of consumers. Absent such a 
reassessment, the potential exists for FERC to approve the formation of 
companies that are difficult and costly for it and states to oversee 
and potentially risky for consumers and the broader market. 

Recommendations for Executive Action: 

We recommend that the Chairman of the Federal Energy Regulatory 
Commission (FERC) take the following actions: 

1. Develop a comprehensive, risk-based approach to planning audits of 
affiliate transactions in holding companies and other corporations that 
it oversees to more efficiently target its resources to highest 
priority needs and to address the risk that affiliate transactions pose 
for utility customers, shareholders, bondholders, and other 
stakeholders. 

2. As an aid to developing this risk-based approach, FERC should 
develop a better understanding of the risks posed by each company by 
doing the following: 

a. Monitoring the financial condition of utilities to detect 
significant changes in the financial health of the utility sector, as 
some state regulators have found it useful to do. To do this, FERC 
could leverage analyses done by the financial market and develop a 
standard set of performance indicators. 

b. Developing a better means of collaborating with state regulators to 
leverage resources already applied to enforcement efforts and to 
capitalize on state regulators' unique knowledge. As part of this 
effort, FERC may want to consider identifying a liaison, or liaisons, 
for state regulators to contact and to serve as a focal point(s). 

3. Develop an audit reporting approach to clearly identify the 
objectives, scope and methodology, and the specific findings of the 
audit, irrespective of whether FERC takes an enforcement action, in 
order to improve public confidence in FERC's enforcement functions and 
the usefulness of audit reports on affiliate transactions for FERC, 
state regulators, affected utilities, and others. 

4. After developing a more formal risk-based approach, reassess whether 
it has sufficient audit resources to perform these audits. If FERC 
believes that it does not have sufficient resources to conduct adequate 
auditing of the companies that it oversees within its existing staff 
and budget, FERC should provide this information to Congress and 
request additional resources. 

Agency Comments and Our Evaluation: 

We provided a draft of our report to FERC for review and comment. We 
received written comments from FERC's Chairman and that letter and our 
detailed response is presented in appendix II. In his comments, the 
Chairman strongly disagreed with the report finding that FERC does not 
have a strong basis for ensuring that utilities do not engage in 
harmful cross-subsidization and noted that he believed the report 
contained inaccuracies and misunderstandings. We disagree with the 
Chairman's characterization of our report and note that the letter's 
assertions about some aspects of FERC's operations are, in fact, quite 
different than the views of numerous commission staff and experts with 
whom we met over the course of the past year as well as FERC's own 
Policy Statement on Enforcement. In addition, we believe that the 
repeal of PUHCA 1935 represents an important change in the context of 
FERC's regulation of the industry and, in light of this change, FERC 
should err on the side of a "vigilance first" approach to preventing 
potential cross-subsidization by enhancing its current approach to 
audit planning and reevaluating audit resources. Overall, we believe 
our report presents a fair and balanced presentation of the facts and 
issues associated with FERC's oversight and, as a result, encourage the 
Chairman to fully consider our recommendations. FERC also provided 
technical comments, which we incorporated, as appropriate. 

As agreed with your offices, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 14 days 
from the report date. At that time, we will send copies to the Chairman 
of the Federal Energy Regulatory Commission (FERC) and other interested 
parties. We will also make copies available to others upon request. In 
addition, the report will be available at no charge on the GAO Web site 
at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-3841, or [email protected]. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. GAO staff who made major contributions 
to this report are listed in appendix III. 

Signed by: 

Mark Gaffigan: 

Acting Director, Natural Resources and Environment: 

[End of section] 

Appendix I: Scope and Methodology: 

In this report, we agreed to determine: (1) the extent to which FERC 
changed its merger or acquisition review process and postmerger or 
acquisition oversight to ensure that potential harmful cross- 
subsidization by utilities does not occur, and (2) the views of state 
utility commissions regarding their current capacity, in terms of 
regulations and resources, to oversee utilities. 

Overall, to address the objectives we reviewed relevant reports, 
examined existing data, interviewed key officials and collected new 
data and information from 49 states and the District of Columbia. We 
interviewed and obtained documentation, when applicable, from a wide 
range of stakeholders including federal and state officials, industry 
officials, and various other special groups and organizations. We 
interviewed federal agency officials at FERC, the Department of 
Justice, the Federal Trade Commission, and the Securities and Exchange 
Commission (SEC). We obtained views from organizations including the 
National Association of Regulatory Utility Commissioners (NARUC), 
American Antitrust Institute, National Regulatory Research Institute, 
American Public Power Association, Electricity Consumers Resource 
Council, Edison Electric Institute, and Public Citizen. In addition, we 
obtained information and views on the effects of the Energy Policy Act 
of 2005 (EPAct) on investment in the utility industry from two national 
credit reporting agencies, Standard and Poor's and Fitch Ratings, and 
the investment advisor Goldman Sachs Company. 

To specifically determine how FERC has changed its merger review 
processes and postmerger oversight to prevent cross-subsidization 
affecting utilities, we reviewed the Energy Policy Act of 2005 and the 
Public Utility Holding Company Act of 2005 (PUHCA 2005) provisions in 
EPAct related to FERC's review of mergers and acquisitions, access to 
the books and records of companies in holding company systems, and 
assessment of civil penalties on companies that violate its rules. We 
reviewed information on the number, identity, and outcome of mergers 
that FERC has reviewed, audits of affiliate transactions that FERC has 
conducted, and civil penalties that FERC has assessed since passage of 
the 2005 legislation. We interviewed officials in FERC's Office of 
Enforcement, Office of Energy Markets and Reliability, and Office of 
General Counsel concerning their plans to implement the statutory 
provisions of EPAct, including the PUHCA 2005 provisions and their 
development or update of new and existing rules, policies, and 
procedures regarding merger review, law enforcement, and audits. We 
performed a limited review of selected FERC merger orders and audit 
reports, including 18 completed audit reports the commission identified 
as pertaining to affiliate transactions, to assess FERC's practices for 
reviewing mergers and conducting audits to prevent cross-subsidization. 

To address the second objective and gain insight into states' views on 
their current capacities to oversee utilities, we visited four states, 
California, New Jersey, Oregon, and Wisconsin and conducted an Internet-
based survey with staff from the public utility commissions in the 50 
states and District of Columbia. In our site visits we met with 
officials from the public utility commissions, representatives of two 
utilities in each state, in some cases the utilities' internal and 
external audit firms, and we also obtained views from representatives 
of consumer protection groups. We obtained information on the state's 
authorities, actions, and resources relating to mergers, affiliate 
transactions, financial reporting, and access to company records. We 
gathered opinions relating to the federal regulatory changes and 
current or planned enforcement by FERC. We selected these states 
through a literature search, discussions with representatives of NARUC, 
a national organization representing state utility commissions, and 
from some initial discussions with selected states. We chose several 
states to visit that had strong protections related to holding 
companies/affiliates and utilities prior to the repeal of PUHCA 1935. 
We also selected two states of the four that were considering 
additional consumer protections directly due to the repeal of PUHCA 
1935. We also discussed key issues with commission officials from 
Kansas and Montana. 

Since little detailed information existed that summarized the 
authorities, actions, and resources of all the states' regulatory 
oversight related to utilities and holding companies, we supplemented 
our audit work with a survey of the staff of the 50 states' and 
District of Columbia's public utility commissions. The survey was 
developed between September and December 2006. Because we administered 
the survey to all of the state public utility commissions, our results 
are not subject to sampling error. However, the practical difficulties 
of conducting any survey may introduce other types of errors, commonly 
referred to as nonsampling errors. For example, differences in how a 
particular question is interpreted, the sources of information 
available to respondents in answering a question, or the types of 
people who do not respond can introduce unwanted variability into the 
survey results We included steps in the development of the survey to 
minimize such nonsampling error. 

To reduce nonsampling error, we had cognizant officials at NARUC review 
the survey to make sure they could clearly comprehend the questions. We 
also pretested the survey with two states to ensure that (1) the 
questions were clear and unambiguous, (2) terminology was used 
correctly, (3) the survey did not place an undue burden on commission 
officials, and (4) the survey was comprehensive and unbiased. In 
selecting the pretest sites, we sought the advice of NARUC and selected 
states that had different types of regulatory requirements. We made 
changes to the content and format of the final survey based on the 
pretests. 

We conducted the survey using a self-administered electronic 
questionnaire posted to GAO's Web site on the Internet. To ensure that 
we would obtain information from commission staff most knowledgeable, 
we first obtained a list of key contacts from NARUC. We sent e-mail 
notifications to the Chairmen of the public utility commissions 
informing them of the purpose of our survey and requesting that they 
make any changes on the contact list provided to us by NARUC that would 
be most appropriate. After we made changes to our contact list, we sent 
e-mail notifications to alert the appropriate officials of the 
forthcoming survey. These were followed by another e-mail containing 
unique passwords and usernames that enabled officials to access and 
complete the survey and notifying officials that the survey was 
activated. Although the survey was available on the Web until June 30, 
2007, we followed up with officials first through e-mail reminders and 
then by telephone to encourage them to respond. We received survey 
responses from 49 states plus the District of Columbia (each state 
could only provide one response). One state did not respond due to 
other high priorities at the time of our survey. We edited all 
completed surveys for consistency, but it was agreed we would not 
follow up with states relating to specific responses, but only to 
encourage them to send us their survey. 

Detailed survey results are available at: [hyperlink, 
http://www.gao.gov/special.pubs/gao-08-290sp]. 

[End of section] 

Appendix II: Agency Comments and Our Response: 

Note: GAO comments supplementing those in the report text appear at the 
end of this appendix. 

Federal Energy Regulatory Commission: 
Washington, DC 20426: 

January 22, 2008: 

Office Of The Chairman: 

Mr. Mark Gaffigan: 
Acting Director, Natural Resources and Environment: 
United States Government Accountability Office: 
Room 2T47
441 G Street, NW
Washington, DC 20548 

Dear Mr. Gaffigan: 

Thank you for the opportunity to comment on the U.S. Government 
Accountability Office's Draft Report to Congressional Requestors 
entitled "Utility Oversight: Recent Changes in Law Call for Improved 
Vigilance by FERC", GAO- 08- 289 (Draft GAO Report). My staff received 
the draft report on December 20, 2007, with a requested response from 
me as Chairman of the Federal Energy Regulatory Commission (FERC or 
Commission) by January 22, 2008. This letter contains both general 
overview comments on the report as well as detailed comments on errors 
or omissions in the report. 

I strongly disagree with the Draft GAO Report's statements and 
implications that the Commission "does not have a strong basis for 
ensuring that utilities do not engage in harmful cross-subsidization" 
and that the Commission has not taken sufficient steps in this- area 
following the passage of the Energy Policy Act of 2005 (EPAct 2005). 
Further, the Draft GAO Report contains numerous inaccuracies and 
apparent misunderstandings regarding cross-subsidization, the 
Commission's historical regulation of jurisdictional utilities with 
respect to cross-subsidization and the Commission's current regulatory 
structure, and the Commission's current audit and enforcement process 
with respect to this discrete area of its enforcement responsibilities. 
All of these matters are set forth in detail below. 

Initially, the introduction of the Draft GAO Report errs in stating 
that EPAct 2005's repeal of the Public Utility Holding Company Act of 
1935 (PUHCA 1935). which removed limitations on the types of companies 
that could merge with or invest in utilities. "shifted sole 
responsibility for regulating public utilities from the Securities and 
Exchange Commission [SEC] to the Federal Energy Regulatory 
Commission...." The SEC has never had sole responsibility for 
regulating public utilities. In fact, prior to EPAct 2005, the SEC had 
very little responsibility for regulating public utilities. While it 
regulated certain activities of holding companies, with minor 
exceptions the SEC did not regulate public utilities. Regulation of 
public utilities (both public utility subsidiaries of holding companies 
and public utilities that were not part of holding companies) has long 
been the province of this Commission and the states. 

(See comment 1.): 

Since 1935, this Commission, and not. the SEC, has had exclusive 
responsibility for regulating transmission and wholesale sales of 
electric energy by public utilities and has had shared responsibility 
with the SEC with respect to certain other activities (e.g., mergers 
involving both a public utility and a holding company). With respect to 
cross- subsidization, in particular, the Draft GAO Report ignores the 
Commission's extensive ratemaking authority that has been in place 
since 1935 (Federal Power Act (FPA)) and 1938 (Natural Gas Act) to 
prevent cross-subsidization, and the Commission's expertise and 
practices developed over the last 70 years in its exercise of that 
authority. The importance of the powerful ratemaking tool of 
disallowing flow-through in rates of costs deemed to represent cross-
subsidies, a tool which the SEC never had, cannot be overstated. The 
draft report also does not reflect an accurate understanding of the 
Commission's historical and existing review and analysis of proposed 
mergers. Although our merger review historically overlapped, in part, 
with merger review by the SEC, the SEC did not undertake the extensive 
analysis and customer protection oversight performed by the 
Commission.[Footnote 25] Similarly, the Draft GAO Report is incorrect 
in its stated and implied conclusions that the Commission has failed to 
significantly change its processes since the passage of EPAct 2005 to 
address the issue of inappropriate cross- subsidization. 

(See response 4.): 

(See response 1.): 

(See response 3.): 

(See response 2.): 

Broadly, the Draft GAO Report seems to urge the Commission to resurrect 
the regulation of holding companies that occurred under PUHCA 1935 on 
the thin bones of the Public Utility Holding Company Act of 2005 (PUHCA 
2005). This would clearly not be appropriate. Notwithstanding its 
similar title, PUHCA 2005 is primarily an access to book and records 
statute. It gives the Commission no substantive authority to regulate 
public utilities, it merely supplements the Commission's pre-existing 
authority to access the books and records of holding companies, public 
utilities, and other holding company affiliates, and it gives states 
separate, independent authority to access that information. We have not 
sought to resurrect PUHCA 1935 for the simple reason that the statute 
was repealed by Congress after great deliberation and PUHCA 2005 has 
none of the substantive authority of PUHCA 1935. The heart of the 
Commission's authority to regulate public utilities remains FPA 
provisions enacted more than 70 years ago. This authority was expanded 
by EPAct 2005, primarily through the amendment to FPA section 203 to 
give the Commission jurisdiction over certain holding company mergers 
and acquisitions, and we have appropriately exercised this expanded 
authority over the past two years. 

The Draft GAO Report asserts that "FERC has made few substantive 
changes to ... its merger review process ... since EPAct [2005]." As 
discussed below, that is simply incorrect. The Commission has taken a 
number of significant steps to implement the provisions of revised FPA 
section 203. We have focused much of our attention on the cross-
subsidization provisions because in other respects EPAct 2005 largely 
codified the merger test used by the Commission for years. 

(See response 3.): 

In response to EPAct 2005, which repealed PUHCA 1935, enacted PUHCA 
2005 and amended section 203 of the FPA to require explicit 
consideration of cross- subsidization at the time mergers are reviewed 
and to give the Commission authority over certain holding company 
mergers and acquisitions of securities, the Commission responded 
promptly with a series of actions all within the short time frames 
required by the new laws: 

- adopted regulations to implement PUHCA 2005, codified at 18 C.F.R. 
Part 366;[Footnote 27] 

- adopted detailed accounting, reporting, and record retention 
requirements for utility holding companies and their service 
companies;[Footnote 28] 

- adopted regulations to implement PUHCA 2005, codified at 18 C.F.R. 
Part 366;[Footnote 27] 

- adopted detailed accounting, reporting, and record retention 
requirements for utility holding companies and their service companies; 
[Footnote 28] 

- required FPA section 203 applicants to demonstrate that proposed 
mergers would not result in cross-subsidization or the pledge or 
encumbrance of utility assets, or explain how the cross- subsidization 
or pledge or encumbrance would be in the public interests;[Footnote 
29]  

Similarly, in the context of a specific merger proposal filed after 
EPAct 2005 was enacted[Footnote 30] and later in the Notice of Proposed 
Rulemaking in Cross-Subsidization Restrictions on Affiliate 
Transactions,[Footnote 31] the Commission stated that all merger 
approvals would be conditioned on a "code of conduct" that would govern 
dealings between franchised public utilities and both market-based rate 
power sales affiliates and non- utility affiliates, in order to address 
cross-subsidization concerns involving power and non-power goods and 
services transactions. The Commission found that, despite the passage 
of EPAct 2005, imposing such conditions was in the public 
interests[Footnote 32] 

As a foundation for a second round of initiatives following EPAct 2005, 
on December 7, 2006 and March 8, 2007, the Commission held public 
conferences regarding section 203 and the newly enacted PUHCA 2005 in 
which industry participants and state commissioners provided input on 
key issues including the protection of utility customers from 
inappropriate cross-subsidization. In particular, the Commission sought 
input regarding overlaps in state-federal jurisdiction with respect to 
mergers and various cross-subsidization protections such as "ring-
fencing" and other techniques to protect the assets of regulated 
utilities. One important purpose of these technical conferences was to 
solicit the views of state regulators on the best way to prevent cross-
subsidization, and how to coordinate federal and state merger review to 
that end. The Commission also sought comment on whether additional 
measures under the Commission's FPA and NGA authorities were needed to 
supplement existing protections against cross-subsidization. In 
response to the input received in those conferences and written 
comments following the conferences, in July 2007, the Commission took 
the following actions: 

- The Commission approved a Supplemental Merger Policy Statement, in 
which it provided additional clarification and guidance on, among other 
things, information that must be provided as part of an application 
when proposed transactions do not raise cross-subsidization concerns, 
and as relevant here, the types of commitments applicants could make 
and the ring-fencing measures applicants could offer to address cross-
subsidization concerns when proposed transactions raise cross-
subsidization concerns. In response to recommendations by the states, 
the Policy Statement also stated that the Commission would defer to 
state ring-fencing measures absent evidence that additional measures 
were needed to protect wholesale customers. Further, where states have 
no authority to impose cross-subsidization protections, transactions 
would not qualify for "safe harbor" protection. FPA Section 203 
Supplemental Policy Statement, 72 Fed. Reg. 42,277 (Aug. 2, 2007), FERC 
Stats. & Regs. ï¿½  31,253 (2007). 

- The Commission issued a Notice of Proposed Rulemaking, proposing to 
codify restrictions on the pricing of power and non- power goods and 
services in affiliate transactions between franchised public utilities 
with captive customers, on the one hand. and their market-regulated 
power sales affiliates and their non- utility affiliates, on the other 
hand. These restrictions would apply to all public utilities, not just 
those proposing a merger. Cross-Subsidization Restrictions on Affiliate 
Transactions, 72 Fed. Reg. 41,644 (July 31, 2007), FERC Stats. & Regs. 
ï¿½ 32,618 (2007). 

- The Commission issued a second Notice of Proposed Rulemaking, 
proposing to grant limited blanket authorizations for certain 
jurisdictional corporate transactions that would not be expected to 
harm either competition or captive customers. Blanket Authorization 
under FPA Section 203, 72 Fed. Reg. 41,640 (July 31, 2007), FERC Stats. 
& Regs. 9[ 32,619 (2007). 

The Commission is currently working on finalizing these important 
initiatives, which will provide additional cross-subsidization 
protections and guidance. As this brief discussion demonstrates, the 
Draft GAO Report's suggestion that the Commission has done little in 
response to EPAct 2005 and PUHCA 2005 is simply incorrect. 

It is important to understand that inappropriate cross-subsidization is 
a constant concern, which does not arise only in the context of, and 
following, a merger or other jurisdictional corporate transaction. 
Cross-subsidies can occur at any time and the Commission has 
appropriately focused on up-front conditions and mandatory prophylactic 
rules ï¿½ like those highlighted above ï¿½ that, for example, identify 
pricing standards that must be applied to affiliate transactions should 
they occur. 

Cross-subsidization is primarily a ratemaking concept, one that is very 
familiar to the Commission. The Commission has developed policies under 
its rate-setting authority to prevent harmful cross-subsidization over 
the past 70 years. Not only does the Commission analyze cross-
subsidization in the context of a specific rate-setting proceeding and 
disallow flow-through of inappropriate costs, but it also has generic 
cross-subsidy restrictions in its regulations. 

For instance, the Commission's regulations include a provision 
expressly prohibiting power sales between a franchised public utility 
with captive customers and any market-regulated power sales affiliates 
without first receiving Commission authorization for the transaction 
under FPA section 205. The Commission reviews such filings to protect 
against inappropriate cross-subsidization. Similarly, the Commission's 
regulations require that sales of any non-power goods or services by a 
market-regulated power sales affiliate to an affiliated franchised 
public utility with captive customers will not be at a price above 
market, and any such sales from a franchised utility with captive 
customers to the market-regulated power sales affiliate must be at the 
higher of cost or market, unless otherwise authorized by the 
Commission. 

With respect to the Commission's ratemaking responsibilities, the 
Commission promulgated rules to take advantage of the new access to 
books and records provisions of PUHCA 2005. The information obtained 
from holding companies under its new regulations enhances the 
Commission's ability to determine audit candidates and also arms the 
public with financial information to assist with the filing of formal 
and informal complaints. In this regard, as noted above, the Commission 
adopted new standardized accounting regulations in October 2006, and to 
allow for greater transparency to protect ratepayers from paying 
improper service company costs, the Commission added a new Uniform 
System of Accounts for centralized service companies. In addition, the 
Commission implemented record retention requirements to require holding 
companies and service companies to retain records consistent with the 
retention periods for public utilities and natural gas companies, and 
required centralized service companies to file financial information 
and information related to providing non-power goods and services to 
affiliates.[Footnote 33] Information collected in that form is 
available electronically to market participants and the public for use 
in detecting cross-subsidization, affiliate abuse, or other violations 
of the Commission regulations. 

As a further protection, the Commission staff conducts targeted audits 
as proactive measures to detect and protect against cross-
subsidization. Even before PUHCA 1935 was repealed, the Commission had 
a long-standing practice dating back at least to the 1970s of auditing 
affiliated transactions as part of its financial audit program. More 
recently, in November 2003, the Commission began auditing affiliated 
transactions as part of its multi-scope audits covering its market-
based rate program.[Footnote 34] Specifically, in anticipation of the 
repeal of PUHCA 1935, the Commission developed and implemented a 
comprehensive audit program to conduct audits of affiliated 
transactions to ensure that cross-subsidization does not occur. The 
audit program reflects the detailed auditing procedures and techniques 
used to guide the audit team in accomplishing the audit work. 

The Draft GAO Report incorrectly concludes in several places that the 
Commission intends to rely on self-reports as the primary enforcement 
mechanism to prevent cross-subsidization. The Commission has never 
relied on self-reports as its primary enforcement mechanism to prevent 
inappropriate cross-subsidization or assure compliance with other 
regulatory requirements. Because cross-subsidization is an aspect of 
ratemaking, by its very nature, it does not lend itself to being self-
reported as a violation of the Commission's rules. Ratemaking is a 
complicated process which relics on the development of an extensive 
record on costs and revenues, and determination of the proper 
allocation of costs between jurisdictional and non-jurisdictional 
operations, the appropriate distribution of costs between and among the 
various jurisdictional services, and the selection of an appropriate 
rate of return. Under these circumstances, self-reports would not be an 
effective method to monitor cross-subsidization. It is possible that 
the Draft GAO Report may be confusing self-reports regarding standards 
of conduct violations (pertaining to communications between the 
transmission and generation functions of a utility) with self-reports 
regarding cross-subsidization. Moreover, the Draft GAO Report seems 
unaware that, prior to passing through costs in rates, a public utility 
must request authority to do so and therefore the Commission, at the 
time of such a request, can determine whether the proposed rate or rate 
formula permits inappropriate cross-subsidization to occur and, if so, 
to disallow rate recovery. 

(See response 4.): 

Similarly, the Draft GAO Report makes incorrect assertions concerning 
the universe of companies subject to the Commission's jurisdiction, the 
number of PUHCA audits the Commission will conduct in the future, and 
the process used to select the PUHCA audit candidates. With respect to 
the universe of companies subject to the Commission's jurisdiction, the 
Draft GAO Report implies that the Commission will audit only 100 
companies out of a universe of 4,700 potential audit candidates. The 
Draft GAO Report fails to take into account the Commission's 
comprehensive compliance program in its Office of Energy Projects (OEP) 
for overseeing the jurisdictional operation of 17 LNG terminals and 
1,022 hydroelectric projects. In addition, the Draft GAO Report also 
fails to indicate that the primary audit responsibility for the 1,510 
FPA section 215 reliability standards compliance audits falls on the 
Electric Reliability Organization and the Regional Entities. Aside from 
these 2,539 audit candidates, there is also significant overlap between 
the other categories of jurisdictional companies. Thus, the universe of 
potential audit candidates is significantly below the 4,700 figure 
cited in the Draft GAO Report. 

(See response 5.): 

The Draft GAO Report also is incorrect when it suggests that the 
Commission will audit holding companies only once every 12 years. The 
Commission considers a number of factors including the size and 
complexity of holding companies in determining how many holding company 
audits the Commission will conduct in a given year. Until the 
Commission obtains sufficient experience conducting holding company 
audits pursuant to PUHCA 2005, the Commission cannot correctly estimate 
how many of these audits will be necessary in the future. The three 
PUHCA 2005 audits scheduled for FY08 are the initial audits focused on 
compliance with these requirements, and concentrate on some of the 
largest utility holding companies. It is inappropriate to assume these 
PUHCA audits are indicative of the number of audits that the Commission 
will perform in subsequent years. 

The Draft GAO Report incorrectly portrays the Commission's method of 
selecting audit candidates as informal. The Commission consistently 
uses a variety of methods to assess risk in order to facilitate the 
selection of audit candidates. These methods include internally 
developed screens and models, past compliance history, information 
gleaned from on-going and completed audits, investigations, and 
complaints, Commission financial forms, SEC filings, websites, rate 
information gathered from Commission and state rate filings and 
discussions with the Commission's legal and technical experts. 

(See response 6.): 

The Draft GAO Report gives short shrift to a public utility's 
commitments that are made with respect to cross-subsidization in the 
context of a merger proceeding and appears to ignore the fact that such 
commitments are incorporated in the Commission's order as conditions of 
allowing a merger or other corporate transaction. If those commitments 
are not adhered to, the public utility will be in violation of a 
Commission order and subject to sanctions including possible civil 
penalties. Further, the Commission retains authority under FPA section 
203(b) to issue supplemental merger orders as it finds may be necessary 
or appropriate. The Draft GAO Report also ignores generic rules 
delineating and proscribing cross-subsidization in power sales and non-
power goods and services transactions between affiliates, which are 
both auditable and enforceable. Continuing rate review by the 
Commission, and rate complaints by customers, as well as audits provide 
regulatory tools to identify and disallow inappropriate cost-
subsidization and inappropriate cost recovery. Inappropriate costs may 
be disallowed in rates and/or penalties may be assessed for not 
complying with such commitments and restrictions. The Commission's 
audit process and further clarification of apparent misunderstandings 
regarding the Commission's audit process with respect to cross-
subsidies are discussed below. 

(See response 7.): 

In the draft report, the GAO makes four recommendations that 
purportedly would enhance the Commission's ability to detect and 
prevent harmful cross-subsidization involving public utilities. These 
recommendations focus primarily on post-merger oversight, in particular 
with respect to the audit process. In brief, the GAO recommends that 
the Commission use a risk-based approach to detect cross-subsidization, 
enhance the agency's audit reporting, and reassess resources to 
demonstrate that its oversight is sufficiently vigilant. 

The Draft GAO Report's first recommendation is that the Commission 
"[d]evelop a comprehensive, risk-based approach to auditing affiliate 
transactions in holding companies and other corporations that it 
oversees to more efficiently target its resources to highest priority 
needs and to address the risk that affiliate transactions pose for 
utility customers, shareholders, bondholders, and other stakeholders." 
Contrary to the premise of this recommendation, the Commission followed 
a risk-based approach in selecting the FY08 PUHCA audit candidates and 
will continue to follow a similar approach in the future. The risk-
based approach entailed a comprehensive review of audit materials 
obtained from the SEC; discussions with the SEC; examination of 
financial information contained in FERC Form No. 60, FERC Form No. 1, 
and SEC filings; rate information gathered from Commission filings; and 
discussions with the Commission's legal and technical experts. In 
addition to the above methods, the Commission audit staff searched 
through 155 boxes of audit materials received from the SEC covering 28 
holding companies, participated in several conference calls with the 
SEC staff responsible for the implementation of PUHCA 1935 and 
discussed audit practices, processes and procedures, as well as 
outstanding issues for certain holding companies. Finally, shortly 
after the audits started, the Commission held discussions with state 
commission officials in the states of Georgia, Alabama, Mississippi, 
Florida, Maryland, Virginia, West Virginia, and Pennsylvania. 

(See response 6.): 

The second recommendation suggests that the Commission should develop a 
better understanding of the risks posed by each company.[Footnote 35] 
Briefly, the Draft GAO Report suggests monitoring the financial 
condition of utilities and collaborating with state regulators. 
Contrary to the Draft GAO Report's assumptions, the Commission audit 
staff frequently interacts with state regulators during an audit. For 
example, the Commission's audit staff recently either met or had 
telephone conversations with eight state regulators regarding the three 
current FY08 PUHCA 2005 audits. These actions demonstrate that I 
recognize maintaining contact with state regulators is mutually 
beneficial to the states and the Commission. 

(See response 8.): 

However, the suggestion that the Commission should monitor the 
financial condition of public utilities fails to appreciate that a 
company's stock price and bond ratings are typically driven by the 
company's overall business risks and prospects. Thus, the fact that a 
company's stocks or bonds are doing well or poorly says little or 
nothing, standing alone, about whether cross-subsidization is 
occurring. That is why the Commission's existing method of assessing 
risk is comprehensive and takes into account both financial and non-
financial information rather than solely relying on a public utility's 
stock prices and bond ratings as indicators of potential cross-
subsidization. 

The third recommendation is that the Commission "[d]evelop an audit 
reporting approach to clearly identify the objectives, scope and 
methodology, and the specific findings of the audit, irrespective of 
whether FERC takes an enforcement action in order to improve public 
confidence in FERC's enforcement functions and the usefulness of audit 
reports on affiliate transactions for FERC, state regulators, affected 
utilities, and others." The Commission has always strived to clearly 
identify its objectives and methodologies for all areas of its 
jurisdictional responsibilities. The Commission is currently 
implementing this recommendation in the audit context. For example, in 
November 2007, the Commission's audit staff began the process of 
including an enhanced audit methodology section in all of its public 
audit reports.[36] Also, the Commission's public audit reports have 
always included audit objectives and scope, as well as audit findings, 
where applicable. In contrast, the SEC previously issued non- public 
audit reports at the completion of its holding company audits. Thus, 
the Commission's enhanced audit methodology and practice of publicly 
publishing audit reports provide the public and the regulated community 
with greater transparency than previously provided by the SEC. 

Finally, the Draft GAO Report recommends that the Commission, "[a]fter 
developing a more factual risk-based approach, reassess whether it has 
sufficient audit resources to perform these audits" and request 
additional funds, if necessary. Currently, the Commission continuously 
reassesses its audit and other resources to achieve its strategic 
goals. To that end, for each audit cycle, the Commission prepares an 
annual audit plan that is vetted with senior Commission officials, 
reviewed and approved by me as Chairman, and shared with all of my 
fellow Commissioners for their information and input. Needless to say, 
the Commission will continue to seek additional funds from Congress if 
it believes it needs more resources to carry out its auditing 
responsibilities, including PUHCA 2005 audits, just as the Commission 
recently did when requesting

(See response 10.): 

To summarize, the Commission's auditors already follow a risk-based 
approach for selecting holding company audit candidates for examination 
of their affiliated transactions, and the Commission constantly 
assesses and reassesses its audit resources to carry out the audit 
priorities in the annual audit plan. Similarly, the Commission 
continues to collaborate with state regulators to capitalize on their 
unique knowledge. Interacting with state regulators during the course 
of an audit is a practice the Commission auditors have followed for a 
long time. Finally, the Commission continually strives to maintain and 
improve existing staff practices to ensure that the audit reports 
include clear audit objectives, scope, and methodologies. 

(See response 11.): 

Finally, before turning from these more general comments to more 
specific comments, I should note that the Draft GAO Report contains 
considerable discussion regarding states' abilities to protect against 
cross-subsidization at the retail level. 1 and my fellow Commissioners 
have recognized this very important issue in our post-EPAct 2005 
actions and it was a topic of lengthy discussion at one of our 
technical conferences and in our consideration of the Supplemental 
Policy Statement issued in July 2007 and referenced above. In fact, we 
heard feedback from our state colleagues that the Commission should 
defer to state commissions and state regulatory tools with respect to 
protecting retail customers. The Draft GAO Report also refers to 
concerns that state commissions may not be able to obtain books and 
records of utility holding companies and utility associates and 
affiliates necessary to assist them in detecting potential cross- 
subsidization by retail customers and that, under PUHCA 2005's access 
to books and records provisions, state commissions have to go through 
this Commission to obtain information. These statements, particularly 
the statement at page 30 of the Draft GAO Report that refers to 
developing "a series of detailed requests to FERC," are incorrect. 
PUHCA section 1265, 42 U.S.C. ï¿½ 16453, gives state commissions explicit 
authority to obtain information ï¿½ including "books, accounts, memoranda 
and other records" ï¿½ from utility holding companies and utility 
associate and affiliate companies "wherever located;" there is no 
requirement in PUHCA 2005 that state commissions need this Commission's 
authorization to obtain such information or that they otherwise must go 
through this Commission. 

The Draft GAO Report is also inaccurate in its criticism of mergers 
approved by the Commission since enactment of EPAct 2005. The report 
argues these mergers were made possible by repeal of PUHCA 1935. The 
fact, however, is that the two largest mergers during GAO's study 
period ï¿½ Cinergy/Duke and Mid-American/PacifiCorp ï¿½ were all announced 
prior to the repeal of PUHCA 1935. The Draft GAO Report asserts that 
repeal of PUHCA 1935 "opened the door" for ownership of utilities by 
international companies and "new types of investors." That statement 
fails to recognize that there were a number of acquisitions of U.S. 
utilities by international companies before repeal of PUHCA 
1935.[Footnote 37 In addition, there were proposed acquisitions of 
utilities by equity firms before repeal of PUHCA 1935, some of which 
were successful.[Footnote 38] 

(See response 12.): 

The Draft GAO Report asserts "FERC is generally supportive of mergers," 
but cites unnamed "experts" without attribution. The Draft GAO Report 
implies criticism that the Commission has not conditioned more of the 
mergers approved since enactment of EPAct 2005. Yet, it makes no effort 
to analyze any of the approved mergers that were not conditioned. For 
example, GAO fails to mention that two of these mergers were 
cross-country mergers involving utilities in different regions of the 
country, and that other mergers involved acquisition of a utility by a 
new entrant. The Commission conditions mergers as necessary to mitigate 
merger-related increases in market power, and as a general matter 
neither of these types of mergers raise market power issues. In my 
view, it is unfair to criticize the Commission for not conditioning 
mergers that presented no market power or other issues. 

I also take great exception to the Draft GAO Report's characterization 
of the capacity of state commissions to oversee utilities. The report 
specifically criticizes state commissions for not auditing more 
affiliate transactions. I believe this criticism is unfair ï¿½ my state 
colleagues are dedicated to protecting retail consumers, and are as 
committed to preventing cross-subsidization as this Commission. 
Recognizing the expertise of states in this area, we consulted closely 
with our state colleagues as we implemented our expanded merger 
authority. 

(See response 13.): 

Turning from my more general concerns with the Draft GAO Report to more 
specific concerns, let me proceed page-by-page and identify errors or 
misstatements that I believe need to be corrected:[Footnote 39] 

(1) Introductory Page: As an initial matter, as I noted at the outset, 
the discussion of "Why GAO Did This Study" errs in stating that EPAct 
2005's repeal of PUHCA 1935, which removed limitations on the types of 
companies that could merge with or invest in utilities, "shifted sole 
responsibility for regulating public utilities from the Securities and 
Exchange Commission to the Federal Energy Regulatory Commission... . 
The SEC never had sole responsibility for regulating public utilities. 
I discuss this error earlier in this letter, so I will not repeat that 
discussion here. 

(See response 1.): 

(2) Introductory Page: The Draft GAO Report leads with a claim that for 
2008 the Commission plans to conduct audits of only 3 of the 149 
companies that it regulates. That claim misrepresents the percentage of 
companies presently planned to be audited. As recognized later in the 
Draft GAO Report, on page 29, while there are 149 holding companies, 
only 36 of these holding companies are subject to Commission authority 
under PUHCA 2005; the other holding companies have received either an 
exemption or a waiver of all or most of the requirements of PUHCA 2005 
and the Commission's implementing regulations. I also note that certain 
exemptions given under PUHCA 2005 are required by statute. 

(3) Page 3, Footnote 2: The Draft GAO Report incorrectly characterizes 
the Commission's limited authority with respect to Texas. Much of Texas 
is the responsibility of the Electric Reliability Council of Texas 
(ERCOT) and is electrically isolated from the rest of the United States 
(with the exception of certain direct current ties that are subject to 
only limited Commission authority); power flowing within ERCOT is not 
considered to be power flowing in interstate commerce and hence the 
utilities that transmit and/or sell such power are not considered to be 
"public utilities" that are subject to Commission rate regulation under 
Part II of the FPA. 

(See response 15.): 

(4) Page 6: The Draft GAO Report suggests that, before the passage of 
EPAct 2005, the Commission was not concerned with cross- subsidization; 
the Draft GAO Report states that preventing inappropriate cross-
subsidization is a "new" responsibility. As described above, that is 
incorrect. The Commission has long been concerned with identifying and 
addressing inappropriate cross-subsidization; all that is new is the 
explicit statutory directive to consider cross-subsidization at the 
time a merger's approved.

(See response 16.): 

(5) Page 8: The Draft GAO Report indicates that the Commission has done 
little in response to the passage of EPAct 2005. As described above, 
that is incorrect. In the comparatively short time since the passage of 
EPAct 2005, the Commission has instituted a number of rulemaking 
proceedings, and issued a number of Final Rules and other documents. 

(See response 3.): 

(6) Page 3, 8, 10: The Draft GAO Report implies that the Commission 
relies largely on self-reporting and a limited number of audits (again 
citing the incorrect 3 of 149 comparison discussed above). The detailed 
discussion provided above demonstrates that with respect to cross- 
subsidization this implication is incorrect. While self-reports are 
important, they are neither the beginning nor the end of the 
Commission's efforts. The Draft GAO Report does not, for example, 
recognize the Commission's ongoing ratemaking authority to ensure 
inappropriate cost-subsidies are not charged to ratepayers, and does 
not recognize such customer protections as the restrictions on 
affiliate transactions that are discussed above. 

See response 4.): 

(7) Pages 10-11: The Draft GAO Report chastises the Commission for not 
doing an "independent" analysis of proposed mergers. This discussion 
largely ignores that the Commission makes its decision in each case 
based on the record developed in that case ï¿½ a record created not only 
by the applicants but by the filings of customers, competitors, state
commissions and attorneys general, and others that may oppose the 
merger. if the record as developed by the parties through their various 
filings is not adequate. the Commission can find, for example, that an 
applicant's filing is "deficient" and direct the applicant to submit 
additional record evidence; such evidence would, like the original 
application, be reviewed by and subject to challenge by customers, 
competitors, state commissions and attorneys general, and others that 
may oppose the merger. If the record is still inadequate, the 
Commission can institute so-called paper hearing procedures or even 
trial-type evidentiary hearing procedures. Once there is sufficient 
record evidence, the Commission is required to act based on this record 
evidence. The Commission, like most regulatory agencies, is not 
permitted to act based on non-record evidence; indeed, its decision 
will be overturned by a reviewing court if it decides based on non-
record evidence. That being said, the Commission is free to 
independently analyze that record evidence, and does so. The Commission 
is not bound to follow the analysis of the applicants, and it often 
does not. Rather, the Commission analyzes the entire record and 
determines what result is appropriate based on the entire record, and 
the Commission provides its analysis of the record in the public order 
that it issues. The Draft GAO Report confuses the record evidence that 
must form the basis of the Commission's actions with the analysis of 
that evidence by the Commission, and incorrectly assumes that because 
the Commission cannot rely on non-record evidence the Commission cannot 
develop or rely on its own analysis. Finally, I note that EPAct 2005 
amended FPA section 203 to require that the Commission expedite review 
for corporate transactions and to provide that if the Commission does 
not act within 180 days the application "shall be deemed granted" 
(unless the Commission for good cause extends the time for not more 
than an additional 180 days). Thus, the Commission's process as a 
matter of statute must be streamlined. 

(See response 17.): 

(8) Page 11: The Draft GAO Report again suggests that, before the 
passage of EPAct 2005, the Commission was not concerned with cross- 
subsidization; the Draft GAO Report states that preventing 
inappropriate cross-subsidization is a responsibility that the 
Commission "now" has. As described above, that is incorrect. The 
Commission has long been concerned with identifying and addressing 
inappropriate cross- subsidization; what is new is the explicit 
statutory directive, to address cross-subsidization at the time the 
merger application is approved. 

(See response 16.): 

(9) Page 12: While acknowledging the need for a public record, the 
Draft GAO Report chastises the Commission for failing to develop its 
own evidence. Again, as described above, the Draft GAO Report fails to 
recognize that the Commission is barred from using non-public, extra-
record evidence; rather, the Commission must decide based on record 
evidence. 

(See response 17.): 

(10) Page 14: The Draft GAO Report chastises the Commission for not 
"formally" considering risk, but fails to recognize that the Commission 
does take risk into account. The Draft GAO Report also ignores the 
Commission's ongoing ratemaking authority and the ability of customers 
and competitors, among others, to challenge through formally docketed 
complaints rates that they believe reflect inappropriate cross-
subsidization. 

(See responses 6&4.): 

(11) Page 15: The Draft GAO Report takes a November 2007 report 
submitted "on behalf of a broad consortium of energy companies" and 
does not consider that the report may not be objective, but rather may 
reflect the commercial interests of the energy companies that sponsored 
it. Further, this report did not even directly address the issue of 
cross- subsidization. 

(See response 18.): 

(12) Page 16: The Draft GAO Report references an unidentified "company 
official" without addressing whether that particular official is 
objective but whose views instead may reflect the commercial interests 

of that company. In addition, that official's comments appear to be 
based on a very limited public data set which, given the newness of the 
Commission's expanded penalty authority, is necessarily more likely to 
reflect self-reports. Further, it is not clear that that company 
official was even addressing the issue of cross-subsidization.

(13) Page 16: The Draft GAO Report refers to the Commission's plan to 
conduct a "limited number of compliance audits." The Draft GAO Report, 
however, does not acknowledge that the Commission's PUHCA 2005 books 
and records authority with respect to holding companies is new, and 
that the implementing regulations are likewise new. In fact, these are 
the initial PUHCA 2005 audits. In this same vein, the Draft GAO Report 
also refers to "compliance with the PUHCA 2005 provisions contained in 
EPAct [2005J." This implies that PUHCA 2005 has significant substantive 
requirements; however, it does not. The statute merely supplements our 
pre-existing authority to access the books and records of public 
utilities and holding companies.

(See response 19.): 

(14) Page 17: The Draft GAO Report suggests the Commission's audit plan 
should be developed after "seek[ing] l input from stakeholders." This 
is a course I do not plan to pursue, since I believe it would be 
inappropriate to consult with non-federal persons, such as regulated 
companies, on the allocation and deployment of the Commission's 
enforcement resources. 

(See response 20.): 

(15) Page 18: The Draft GAO Report suggests that the Commission should 
consider looking to bond ratings and other public financial data in 
determining what companies to audit, and that the Commission should 
look to statistical models in identifying what companies to audit. As 
to the latter point, in particular, these statistical models are 
unidentified, and it is unclear whether and to what degree those models 
may be of value in identifying the companies that should be audited. 
Similarly, it is unclear whether bond ratings and other similar data 
are a sound method of identifying, for example, what companies may be 
engaged in inappropriate cross-subsidization and therefore should be 
audited. 

(See response 8.): 

(16) Page 19: The Draft GAO Report shows no appreciation for the limits 
on Commission enforcement resources, and that a greater commitment to 
conducting PUHCA 2005 audits would require a reallocation of 
enforcement staff from auditing compliance with other regulatory 
requirements, such as reliability standards, or investigating possible 
manipulation of power and gas markets. 

(See response 21.): 

(17) Page 19: While the Draft GAO Report notes the number of staff 
members that are at present expected to be assigned to audit holding 
companies, the Draft GAO Report does not acknowledge that that number 
represents a quarter of the audit staff and thus, as a percentage, 
represents a substantial commitment of resources. 

(18) Page 19: The Draft GAO Report refers to "companies subject to 
FERC's oversight under the PUHCA [2005] provisions of EPAct [2005]," 
which carries with it an implication that PUHCA 2005 contains 
significant substantive requirements that companies must comply with. 
That implication is not accurate, as PUHCA 2005 is limited to accessing 
books and records.

(See response 19.): 

(19) Page 19, Footnote 18: The Draft GAO Report notes that it did not 
assess whether the exemptions or waivers from PUHCA 2005 and the 
Commission's implementing regulations "were reasonable." The Draft GAO 
Report fails to recognize that certain of the exemptions are 
statutorily mandated by section 1266(a) of PUHCA 2005, 42 U.S.C. ï¿½ 
16454(a), and that the Commission "shall", i.e., must, grant other 
exemptions if the Commission makes certain findings pursuant to section 
I266(b) of PUHCA 2005, 42 U.S.C. ï¿½ 16454(b).

(See response 14.): 

(20) Pages 20-21: The Draft GAO Report states, on the one hand,
that the Commission has not yet conducted any affiliate transaction 
audits, but then objects to how the Commission has conducted affiliate 
transaction audits to date. 

(See response 22.): 

(21) Page 22: The Draft GAO Report references a report (presumably the 
same report referenced on page 15), sponsored by companies benignly 
described as "a wide range of industry stakeholders." These 
stakeholders actually represent Commission-regulated companies. More to 
the point, the Draft GAO Report again takes that report at face value 
and does not take into account that that report may not be objective, 
but rather is equally likely to be an advocacy document reflecting the 
commercial interests of the energy companies that sponsored it. Also, 
the report does not even directly address the issue of cross-
subsidization. 

(See response 18.): 

(22) Page 32: In its conclusions, the Draft GAO Report suggests that 
all that the Commission does is to "rely" on commitments by merger 
applicants. That is decidedly not the case. While applicant commitments 
are certainly important tools in the Commission's toolbox, they are far 
from the only tools and indeed are not necessarily the best, most 
useful tools. The Commission has many means by which it can enforce 
prohibitions on cross-subsidization. As the Draft GAO Report notes on 
page 6, PUHCA 2005 provided the Commission specific post-merger access 
to the books, accounts, memos, and financial records of utility owners 
and their affiliates and subsidiaries to enhance the Commission's 
traditional review of affiliate transactions in the context of the 
Commission's review and approval of prices public utilities charge for 
the use of transmission lines and for wholesale sales of electricity. 
The Commission will continue to evaluate whether utilities may pass 
through costs of affiliated transactions in the context of rate reviews 
prior to accepting the rates utilities charge their customers. That 
aside, it is unclear why these commitments should be disregarded. These 
commitments may reflect a careful review of Commission policy, and 
anticipate merger conditions that would otherwise be imposed by the 
Commission to prevent cross-subsidization. Further, adherence to those 
commitments is a condition of the Commission's approval and if public 
utilities do not adhere to the commitments they are subject to 
sanctions, including possible civil penalties. 

(See responses 7&4.): 

(23) Page 32: In its conclusions, the Draft GAO Report suggests that 
the Commission should focus on "areas of highest potential risk." This 
recommendation is reasonable but the Draft GAO Report is vague on how 
the Commission should do that, beyond general references to 
unidentified statistical models and to bond ratings and other public 
financial information. It is uncertain what specific actions the report 
recommends.

(See response 6.): 

In conclusion, let me emphasize that, just as the Commission has done 
since 1935, it will continue to be vigilant to protect customers from 
inappropriate cross-subsidization through its ratemaking and other 
regulatory authorities. 

I believe the rules and policies the Commission has adopted since EPAct 
2005 was enacted, and the strengthening of its enforcement function 
following EPAct 2005, have given the Commission an even stronger 
foundation to do this. Our existing cross-office approach to regulating 
utilities allows us to bring to bear all agency expertise necessary to 
detect potential problems and protect customers. In this regard, I have 
asked Commission staff to explore what further adjustments might 
improve our processes based on the Draft GAO Report recommendations. I 
encourage you to ask your staff to once again meet with my staff to 
obtain a better understanding of the Commission's implementation of 
EPAct 2005, PUHCA 2005 and the Commission's post-merger oversight. 

I believe the Draft GAO Report suffers from a fundamental 
misunderstanding of important issues, is based on incomplete 
information, contains many errors, and demonstrates flawed analysis. 
Unfortunately, that greatly diminishes the value of the report. 
Nonetheless, 1 have directed Commission staff to carefully consider the 
recommendations in the report. 

I regret that it was necessary to submit such a lengthy response. Much 
of this information has been submitted to your staff previously, in 
some cases more than once. It is not apparent why this information was 
not considered. Unfortunately, the Draft GAO Report does not reflect an 
awareness and an appreciation of essential facts. 1 thought it 
necessary to provide a complete response in the hopes your analysis of 
these important issues would be properly grounded. 

Thank you again for the opportunity to comment on the Draft GAO 
Report.  

Sincerely, 

Signed by: 

Joseph T. Kelliher: 

Chairman: 

[End of section] 

Appendix A: Historical Merger Authority: 

Section 203 of the Federal Power Act (FPA) long provided (and, even 
after EPAct 2005, still provides) that proposed mergers and other 
jurisdictional corporate transactions require Commission authorization, 
and that such authorization must be granted if the Commission finds 
that the merger or transaction is "consistent with the public 
interest." Since 1996, in evaluating proposed mergers and other 
jurisdictional corporate transactions, the Commission has employed a 
three-part analysis[Footnote 40]ï¿½ looking at the effect of the merger 
or transaction on rates, competition, and regulation. 

Though not expressly stated as a part of the Commission's merger 
analysis, consideration of cross-subsidization by the Commission is not 
new. In practice, it has long been an integral part of the Commission's 
analysis of mergers and other jurisdictional corporate transactions. 
For example, in January 1996, in considering a proposed merger of 
Wisconsin Electric Power Company, Northern States Power Company 
(Minnesota), Northern States Power Company (Wisconsin), and Cenergy, 
Inc., the Commission noted that "[c]ross-subsidization through inter- 
affiliate transactions is a major concern of the Commission,"[Footnote 
41] and the Commission further noted that, while the applicants had 
pledged not to claim that SEC oversight of inter-affiliate transactions 
was a bar to state utility commission review of the utilities' costs 
and rates, the applicants had made no similar pledge not to claim that 
SEC oversight of inter-affiliate transactions was a bar to this 
Commission's review of the utilities' costs and rates; the Commission 
set the proposed merger for hearing. Wisconsin Electric Power Co., 74 
FERC 161,069 at 61,191, 61,193 & n.23 (1996), reh'g denied, 79 FERC  ï¿½ 
61,158 (1997). 

In 1997, in addressing a Boston Edison Company corporate 
reorganization, the Commission again noted its concern with possible 
inappropriate cross- subsidization, explaining that the reorganization 
at issue would, in fact, separate non-utility operations and costs from 
utility operations and costs which, in turn, "should facilitate 
regulatory monitoring of possible cross-subsidization between the two 
lines of business." Boston Edison Co., 80 FERC ï¿½ 61,274 at 61,992 
(1997). The Commission also expressly noted the cross-protections that 
would be in place ï¿½ state-established standards of conduct and 
contractual agreements between the relevant affiliated companies ï¿½ , 
and found that these protections would "both act to help protect 
against cross-subsidization between the utility and non-utility 
affiliates and ensure comparable treatment between affiliates and non- 
affiliates as well as arm's-length relationships among affiliates." The 
Commission thus concluded that the reorganization would "not increase 
the potential for affiliate abuse or preferential dealings." Id. at 
61,993-94. 

Similarly, in 2000, in the context of a proposed merger between CP&L 
Holdings, Inc. and Florida Progress Corporation, the Commission found 
that, while the applicants had included "certain protections against 
cross-subsidization," the applicants proposed price cap was 
inadequate[Footnote 42] explaining that "[w]ithout an adequate 
protection method, the danger exists that a negotiated rate that is too 
high might shift transaction benefits from the ratepayers of one 
company to the ratepayers of the other" and that "a negotiated rate 
that is too low might shift transaction benefits as well." Accordingly, 
the Commission directed the applicants to "incorporate an appropriate 
pricing safeguard." CP&L Holdings, Inc., 92 FERC 161,023 at 61,060 
(2000), reh'g denied, 94 FERC ï¿½ 61,096 (2001). 

As a further illustration of the Commission's longstanding concern with 
inappropriate cross-subsidization, in 2004, the Commission adopted new 
guidelines for transactions between affiliates. The Commission 
explained that acquisitions involving affiliates presented "an inherent 
potential for discriminatory treatment in favor of the affiliate" and 
that the Commission, to ensure that proposed transactions are 
consistent with the public interest, as required by section 203 of the 
FPA, "must assure that a public utility's acquisition of a plant from 
an affiliate is free from preferential treatment" and does not harm to 
competition and the development of vibrant, fully-competitive 
generation markets. Accordingly, the Commission found that a proposed 
transaction "is not consistent with the public interest unless shown 
not to be the result of affiliate abuse," and required an analysis that 
would demonstrate a lack of affiliate abuse (based on the so-called 
Edgar standard, referring to Boston Edison Co. Re: Edgar Electric 
Energy Co., 55 FERC 9( 61,382 at 62,167-70 (1991)). The Commission also 
adopted solicitation guidelines intended to demonstrate that affiliates 
had no undue advantage over non-affiliates, with a showing that (1) the 
solicitation process was open and fair, (2) the products sought through 
the solicitation were precisely defined, (3) the evaluation criteria 
used to evaluate the competing bids were standardized and applied 
equally to all bids and to all bidders, and (4) the solicitation was 
overseen by an independent third-party (who designed the solicitation, 
administered the bidding, and evaluated the bids). Ameren Energy 
Generating Co., 108 FERC 9[ 61,081 at P 59-84 (2004). 

[End of section] 

GAO Comments: 

The following are GAO's responses to the Federal Energy Regulatory 
Commission's comments on our draft report as outlined in its January 
22, 2008, letter. 

1. Our statement in the summary Highlights of the draft report 
referring to Energy Policy Act (EPAct) shifting sole responsibility 
from the Securities and Exchange Commission (SEC) to Federal Energy 
Regulatory Commission (FERC) was not intended to imply that, prior to 
the passage of EPAct, FERC had no role in regulating public utilities. 
We simply wanted to point out that, after EPAct, sole responsibility 
for oversight of potential cross-subsidies rested with FERC. We revised 
the Highlights text to clarify the historical roles of FERC and SEC. 
Other information in the draft report accurately reflected each 
agency's role. 

2. As a point of clarification, we make no explicit or implicit 
recommendation regarding "resurrecting" the Public Utility Holding 
Company Act of 1935 (PUHCA 1935). We share FERC's apparent view that 
this was not the intent of Congress and the President in repealing 
PUHCA 1935. Our report focused on FERC's new role as the sole federal 
agency responsible for enforcing prohibitions against cross- 
subsidization. 

3. We acknowledge that FERC has executed the administrative steps to 
begin implementing EPAct, made changes such as adding a "code of 
conduct" for utilities and their affiliates as well as other changes 
discussed in the letter within the short time frames provided under 
law--and recognized this in our draft report. However, as we noted in 
our draft report, our view and the view expressed by FERC staff we met 
with during our investigation is that FERC's overall merger review 
process remains largely unchanged except that FERC now requires 
companies to attest in writing that they will not engage in 
unauthorized cross- subsidization. We commend FERC for its ongoing 
outreach efforts, such as conferences to solicit stakeholders' views, 
but we maintain that those efforts have, so far, resulted in few 
changes to FERC's merger review process. Accordingly, we made no change 
to our draft report in response to this comment. 

4. The Chairman of FERC said that we incorrectly conclude that the 
commission intends to rely on self-reporting as the primary enforcement 
mechanism to prevent cross-subsidization but did not explain what 
mechanism(s) FERC will use to detect potential cross-subsidization. To 
be clear, our draft report stated that once a merger has taken place, 
FERC intends to rely on its existing enforcement mechanisms--primarily 
(1) companies' self-reporting and (2) compliance audits--to detect 
potential cross-subsidization. In addition, the draft report stated 
that FERC officials also said they used their "hotline" reporting 
system to identify potential violation of FERC rules. Throughout the 
course of our audit work, key FERC staff, including those involved in 
enforcement, noted that self-reporting was a central element in 
enforcing FERC's overall enforcement approach, including all of the 
statutes, orders, rules, and regulations the commission enforces. FERC 
officials also provided a copy of FERC's October 25, 2005, Policy 
Statement on Enforcement--which prominently features self-reporting-- 
in the context of our discussion of how FERC planned to enforce the 
prohibitions on cross-subsidization. We share the views of the Chairman 
that self-reporting is not an effective method to reliably detect cross-
subsidization. The Chairman also said that we may be confusing self-
reports regarding standards of conduct violations with self- reports 
regarding cross-subsidization. We have not confused these two distinct 
reporting mechanisms as our report focuses on concerns related to 
potential cross-subsidization. As the draft report also discusses, the 
second key mechanism that FERC intends to use to detect potential cross-
subsidization, and its only proactive enforcement component, is a 
limited number of compliance audits. We believe that audits provide 
tremendous potential value in enforcing the prohibitions against 
unauthorized cross-subsidization (delineated in detail by FERC on pages 
3 through 7 of the Chairman's letter and addressed in our comment 3), 
especially in light of FERC's new role as the federal agency primarily 
responsible for the oversight of public utilities. We believe that 
audits of companies and transactions should play a key role in the 
FERC's overall enforcement strategy, particularly in the area of cross- 
subsidization. With regard to preventing potential cross-subsidization 
through rate reviews, we are aware of this process and recognized in 
our draft report that FERC retains a limited ratemaking role and, as 
such, may have opportunities to establish cost recovery rules 
prospectively in these proceedings. We added additional language to our 
draft report to indicate that FERC may examine costs incurred by 
utilities for rates it still sets and, in so doing, decide which costs 
may be lawfully included in rates charged to customers. We also 
recognize that FERC allows third parties to report potential violations 
using its hotline or by filing a complaint that the terms of the 
approved rates are being violated. We revised our draft report to 
better reflect that such reports and complaints may lead to a FERC 
investigation. However, because we have no way of knowing (1) whether 
third parties will be a reliable enforcement tool, (2) how likely FERC 
is to conduct rate setting procedures, and (3) FERC's plans currently 
reflect only 3 audits, we remain concerned that FERC is overly reliant 
on self-reporting. 

5. We relied on FERC officials to identify the universe of companies it 
could audit and how many it planned to audit for the information 
contained in our draft report. In addition, we included suggestions 
from FERC staff regarding caveats to its audit responsibilities and 
overlaps raised in the Chairman's letter. For example, the draft report 
noted that there was overlap between the various categories and that 
the Regional Reliability Organization, according to FERC, would be 
responsible for the initial audits of these 1,510 companies. 
Nonetheless, we moved our table note to the body of the report to 
emphasize these overlaps and the fact that the number of potential 
audit candidates could be lower than the universe of 4,700 companies 
identified by FERC. It is important to note, however, that some of the 
audits may be quite different and require different resources than 
audits of affiliate transactions. For example, audits of compliance 
with reliability rules may focus on whether companies have conducted 
sufficient training of staff, not addressing the unique accounting 
issues associated with affiliate transactions. While this change in the 
text of the report may help the reader better understand overlaps in 
the universe of companies, it is still not clear from the Chairman's 
comments how many audits will ultimately be required of these 
companies, the nature of the audits or the resources needed, and how 
they would affect the resources available for audits of affiliate 
transactions. Regarding the frequency of audits, our draft report 
states, "At its planned 2008 audit rate of 3 companies, it would take 
FERC 12 years to audit each of these companies once." We recognize that 
the current audit rate may change since such determinations are made 
annually, but we use these data--as provided by FERC--as the best 
available at the time of our review. We added an explicit notation that 
the number of audits may change to further clarify the statement 
already in the report. 

6. The Chairman stated that the draft report incorrectly portrays 
FERC's method of selecting audit candidates as informal and that FERC 
actually uses a variety of methods to assess the individual and 
collective risks posed by companies it oversees. However, during the 
course of our year- long engagement, including discussions with key 
FERC officials, the process was described as informal and did not 
mention the other mechanisms described in the Chairman's letter. In 
addition, FERC staff, when we asked for a record of a risk-based 
analysis or the criteria FERC would have used to conduct such an 
analysis, were unable to provide them and told us audit selections were 
based on informal discussions with knowledgeable senior FERC staff. 
Although FERC officials may individually consider risk as they 
discussed audit planning in these informal discussions--and we noted in 
the draft report these officials believe their judgments provide a 
reasonable picture of risk--such considerations are not sufficiently 
formal or systematic and could change as staff in key positions change. 
In our view, a risk-based audit planning approach should be 
sufficiently rigorous and systematic to ensure that it reliably and 
consistently guides FERC in assessing individual company risks and the 
overall risks posed by the companies collectively and making audit 
selections accordingly. Furthermore such an approach should be flexible 
enough to meet FERC's current and expected future auditing demands now 
that it is solely responsible for detecting potential cross-
subsidization. We noted in our draft report that some federal agencies 
develop their own statistical measures of risk, derived in some cases 
from models although there are other methods. It may or may not be 
appropriate for FERC to use this type of tool but we want FERC to be 
aware that there are other ways of more formally considering risk in 
agency decision making. In any case, designing a formal risk-based 
approach will take time and effort and FERC may want to consider 
consulting with outside experts. It was our intent, by excluding these 
statistical methods from our recommendation, to provide the Chairman 
with flexibility on how best to implement a more formal, risk-based 
approach. With regard to FERC's comment about its outreach to states 
during audits, we commend FERC for these efforts when conducting 
compliance audits, but also believe FERC could benefit from the states' 
expertise and knowledge earlier in the process when determining which 
companies to audit. We continue to believe that our recommendation, if 
implemented, would improve the likelihood that the audits will be most 
effective. As such, we made no change to our draft report in response 
to these comments. 

7. We are aware that FERC has established many expectations and rules-- 
through both the company attestation process and its generic 
prohibitions on cross-subsidization--but we have concerns as to whether 
FERC has devoted enough attention to the formidable task of enforcing 
those rules by detecting violations. We recognize the importance of 
company attestations that they will not engage in cross-subsidization 
for use in developing a formal record from which FERC can potentially 
take enforcement actions. We share FERC's view that companies should 
honor their commitments to the federal government, but know that staff 
turnover at these companies can be high, and that financial and other 
circumstances of companies can, and do, change. Because of this, and 
other factors, we believe that it is important to recognize the value 
of these company attestations in creating a record, but also believe 
that it is important to be vigilant and proactive in looking for 
potential violations. As a result, we made no change to the draft 
report in response to this comment. With regard to the Chairman's 
related comment about FERC's generic rules, we agree that these rules 
delineate FERC's expectations for compliance; however, while these 
rules define potential violations, they do not detect them. Therefore, 
they must be coupled with vigilant enforcement mechanisms, such as 
audits to detect potential cross-subsidization. It is these mechanisms 
that the draft report concludes are inadequate in FERC's approach. We 
made no change to our draft report for this comment. With regard to the 
Chairman's comment about rate review, we discuss this point in our 
response to comment 4. 

8. As noted above in comment 6, we are pleased that FERC includes 
discussions with state regulators when it conducts audits, however we 
believe FERC could further benefit from their expertise when selecting 
which companies to audit. With regard to financial indicators, as noted 
in the draft report, we believe that the deterioration of a company's 
financial condition may raise the potential for financial abuses. In 
that regard, how the financial community values a company's stocks or 
bonds is used as a high-level example of financial indicators that 
could be helpful to FERC. We do not suggest in our report that FERC 
should examine only stock and bond values; rather, we suggest that FERC 
should be gauging risk by, among other things "monitoring the financial 
condition of utilities." Companies' financial data is a window into 
their risks and an opportunity to leverage the financial community's 
research. Such research is not strictly limited to stock and bond 
prices; it could include other appropriate metrics, such as financial 
ratios. In implementing our recommendation, FERC may wish to consult 
with financial experts to develop a set of useful metrics to monitor. 
We believe, as do others we spoke with in states and the financial 
community, that such indicators could provide additional insights into 
the risk posed by individual companies and the financial health of the 
overall industry. We made no change to our draft report in response to 
these comments. 

9. As the Chairman indicates, FERC is in the process of implementing 
our recommendation to improve the usefulness of its audit reports. We 
discussed the need to improve the transparency of its audit 
requirements and actions during our discussions with FERC audit 
officials and encourage FERC to fully implement this recommendation. 

10. As noted in the draft report, we believe that FERC should develop a 
formal risk-based audit planning approach to help inform its decisions 
about which companies to audit but also to assist it in better 
leveraging its resources. The development of such an approach could 
also help FERC determine whether it needs additional audit staff 
resources to fulfill its oversight responsibilities, particularly given 
that SEC no longer conducts such audits. We continue to encourage FERC 
to assess its resources for auditing and enforcement efforts and did 
not change our recommendation. 

11. We agree that the Public Utility Holding Company Act of 2005 (PUHCA 
2005) provisions in EPAct grant states the authority to obtain this 
information directly. Our statements related to state commissions' 
access to books and records of utilities, holding companies, and 
affiliate companies was not intended to imply that states must go 
through FERC for access to this information. However, the draft report 
points out that this is the perception or experience in some states. 
For example, in response to our state survey, 14 states reported their 
state commission did not have access to these records at the holding 
company and 20 states reported this problem for affiliated nonutility 
companies. Further, as we reported, officials from companies that 
conduct audits for the states noted difficulties in obtaining access to 
out-of-state companies' books and records. We did not evaluate states' 
reasons for these views. Since there seem to be misunderstandings or 
misinformation about the access granted under the PUHCA 2005 provisions 
in EPAct, FERC could play an important role in clarifying these 
authorities or providing assistance in response to states' concerns, or 
both. In response to this comment, we clarified the language related to 
states' access to companies' books and records. 

12. The intent of our discussion of mergers in the draft report is not 
to criticize FERC's merger review decisions or the conditions FERC 
placed on mergers. Rather, our intent is to provide some perspective on 
the number and status of FERC's merger reviews and their disposition. 
Nonetheless, we note that FERC has been supportive of mergers--a point 
repeated by numerous FERC staff--and that FERC believes that it has 
certain obligations to approve mergers. Regarding FERC's concern that 
the draft report does not recognize that "new types of investors" have 
acquired U.S. utilities before the repeal of PUHCA 1935, the draft 
report described such transactions in its discussion of changes to the 
strict limitations in this act. As such, we recognize that while PUHCA 
1935 placed limitations on what types of companies could control 
utilities, some investors were allowed to invest into the utility 
industry if they met certain financial requirements (see GAO-05-617). 
Because these financial requirements placed limits on the companies 
outside the utility sector, the number of these types of investments 
was limited. In our discussions with financial experts, we found that, 
with the repeal of PUHCA 1935, more companies from outside the utility 
sector are considering utility mergers or acquisitions, or both, which 
could broaden the pool of potential investors. We revised the text of 
the report to better reflect these considerations. 

13. As a point of clarification, our report conveys the views of state 
commission staff; we did not analyze state commissions' auditing 
efforts or other state regulations or responsibilities. As such, we 
make no criticism of state commissions with regard to auditing, or any 
other areas of state regulation or responsibility. With this in mind, 
FERC should be aware that it is the view of state regulators--not based 
on evaluation by GAO--that state commissions are generally not 
conducting extensive compliance audits because of limited staff and 
other factors. On numerous occasions, FERC officials noted that state 
regulators, outside audit firms, and others are conducting audits of 
affiliate transactions; however, based on our discussions with each of 
these groups, we did not find this to be the case. We believe FERC 
should consider this information as it develops a formal risk-based 
audit planning approach, therefore we did not change the draft report 
in response to this comment. 

14. With regard to accurately representing the percentage of companies 
that FERC plans to audit in 2008, FERC determined that 36 of 149 
holding companies are subject to its authority under the PUHCA 2005 
provisions in EPAct and told us it planned to audit 3. Although we 
agree that certain exemptions are required by statute, we did not 
conduct a legal analysis of these exceptions and waivers required by 
law nor did we review FERC's evaluation of these applications to 
determine if the 36 holding companies (of the 149) accurately reflect 
the potential universe of companies to be audited. Because we did not 
make these evaluations, we revised the Highlights page of the draft 
report to reflect that FERC said it would audit 3 of the 36 companies 
it regulates, as we more fully described in the body of the report. 

15. We revised footnote number 2 in the draft report to further clarify 
what authority FERC has with respect to Texas. 

16. We disagree that the draft report suggests that, before the passage 
of EPAct 2005, the commission was not concerned with cross-
subsidization. The draft explicitly stated that preventing cross-
subsidization has been a long-standing responsibility of FERC and that 
preventing it at the point of merger review is new. As such, we made no 
change to the report in response to this comment. 

17. We note that our draft report did not have an objective to 
determine the adequacy of FERC's merger review and, as such, makes no 
finding regarding the quality of the FERC's review. The draft report 
describes the record-based analysis noted in the Chairman's comment, 
and participants' possible roles, and states that FERC does not 
independently develop such information--a point that was repeatedly 
noted by FERC officials; rather, its review is limited to reviewing the 
record. We agree that FERC must make its decisions based on this 
record, and that it can take additional steps to make sure the evidence 
provided is sufficient. We clarified the language in the report to note 
that FERC can request that applicants provide additional information 
and perform its own independent analysis of record evidence. 

18. During our review, we sought input from many stakeholders and 
involved parties. The report referenced by the Chairman's comments 
provides one insight as to how industry perceives FERC's actions but 
does not provide the sole insight, and we disclosed the report's author 
and interest group affiliation so that the readers are aware of their 
interests. Similarly, the company official cited in the Chairman's next 
comment reflects one example of concerns expressed by companies. In 
either case, we recognize--as should any reader of this report--that 
stakeholders have specific interests in FERC's decisions and 
operations. However, it is important to note that some of the 
industries FERC regulates are expressing opinions similar to views we 
have developed independently during the course of our work in this 
area--namely that FERC needs to provide greater transparency of its 
enforcement functions. Furthermore, it is also worth noting that the 
need for greater transparency has been a theme over the last several 
years for GAO's work regarding FERC, which has previously recognized 
this and made strides toward improving transparency. It is encouraging 
to point out that the Chairman recently acknowledged a similar view and 
committed FERC to improving the transparency of its enforcement 
functions. We made no change to our draft report in response to these 
comments. 

19. The draft report contained language stating that EPAct provided 
FERC specific postmerger access to books, accounts, memos, and 
financial records of utility owners and their affiliates and 
subsidiaries, therefore we made no change to our draft report in 
response to this comment. Regarding the comment about "compliance with 
PUHCA 2005", we deleted the language in the draft report related to 
company compliance. 

20. We are not advocating that FERC allow nonfederal parties, such as 
FERC- regulated companies, to determine auditing priorities and agree 
that this would pose significant risks. We believe our recommendation 
that FERC seek input from stakeholders, such as the financial community 
and state commissions--many of whom have more frequent or more recent 
dealings with the utilities, or may have more recent audit experience 
with these companies, or both--may be an opportunity for FERC to better 
leverage these resources. Such input, along with the other information 
sources already at FERC's disposal, could help inform FERC's decisions 
but should not substitute for the risk-based decision-making criteria 
that we recommend FERC develop as part of a risk-based audit planning 
approach. We made no change to our draft report in response to these 
comments. 

21. We recognize that the current FERC staffing choices, as they relate 
to auditing, leave few resources available to cover a broad range of 
potentially auditable entities. It is clear that the context within 
which the FERC audit staff are operating has changed in important ways 
and may require a reassessment of FERC resources, therefore we 
recommended that FERC seek additional resources, if needed. It is in 
this vein that we have outlined a path for FERC to make such a 
reassessment and to report its results to Congress so that it could 
potentially consider such a request. In addition, as noted in earlier 
comments, the development of a risk-based audit planning approach could 
also help FERC allocate its existing resources most efficiently and 
effectively. We made no change to our draft report in response to these 
comments. 

22. Our draft report states that FERC has not yet completed any 
affiliate transaction audits under the PUHCA 2005 provisions of EPAct, 
but notes that FERC intends to rely on its existing, "exception-based," 
reporting that it used for other types of audits. As noted in the draft 
report, our examination of FERC reports issued under this exception-
based reporting policy raised concerns. As a point of clarification, 
our concern about this policy is meant to provide constructive 
criticism so that future reports on affiliate transactions could be 
more transparent and useful to FERC staff, states, and market 
participants. We made no change to our draft report in response to 
these comments. 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Mark Gaffigan, (202) 512-3841, [email protected]: 

Staff Acknowledgments: 

In addition to the contact named above, key contributors to this report 
included Dan Haas, Jon Ludwigson, Randy Jones, and Tony Padilla. 
Important assistance was also provided by Lee Carroll, Brad Dobbins, 
Kevin Dooley, Dan Egan, Gloria Hernandez-Saunders, Allison O'Neill, 
Glenn Slocum, Jay Smale, and Barbara Timmerman. 

[End of section] 

Footnotes:  

[1] The Federal Power Act of 1935 empowered the Federal Power 
Commission, the predecessor to FERC. 

[2] Subsequent to the enactment of the Federal Power Act, FERC was 
empowered by the Natural Gas Act as the primary federal regulator of 
natural gas transportation and sales, and was granted similar but not 
identical authorities. Most of the geographic area of Texas is 
electrically isolated from the rest of the United States. Electricity 
flowing within this electrically isolated area is not considered to be 
interstate in nature and, hence, the utilities that transmit or sell, 
or both, such electricity are not considered to be subject to FERC rate 
regulation. FERC does have limited jurisdiction over the facilities 
that connect the electrically isolated portion of Texas to the rest of 
the United States. 

[3] For a more complete discussion of these financial restrictions, see 
GAO, Public Utility Holding Company Act: Opportunities Exist to 
Strengthen SEC's Administration of the Act, GAO-05-617 (Washington, 
D.C.: July 8, 2005). 

[4] The SEC will continue enforcing laws and regulations governing the 
issuance of securities and regular financial reporting by public 
companies. 

[5] Related to mergers, the Department of Justice and the Federal Trade 
Commission will continue their long-standing enforcement of antitrust 
laws. These include the premerger provisions of the Hart-Scott-Rodino 
Antitrust Improvements Act of 1976 and Section 7 of the Clayton Act. 

[6] According to FERC, its rules governing market-based rates contain 
specific restrictions on affiliate transactions. 

[7] This specifically applies to any "public utility associate company 
that has captive customers or that owns or provides transmission 
service over jurisdictional transmission facilities, and an associate 
company." 

[8] FERC specifically prohibits any new pledge or encumbrance of assets 
of a traditional public utility associate company that has captive 
customers or that owns or provides transmission service over 
jurisdictional transmission facilities, for the benefit of an associate 
company. 

[9] FERC recognizes three types of transactions that are unlikely to 
raise cross-subsidization concerns, including (1) transactions where 
the applicant shows that a traditionally regulated utility is not 
involved so there is no potential harm to utility customers, (2) 
transactions that are subject to review by a state commission because 
it has the authority to impose cross-subsidization protections, and (3) 
transactions that involve only nonaffiliates so that the potential for 
inappropriate cross-subsidization generally is not present. 

[10] To the contrary, FERC officials noted that if FERC does not act on 
an application within 180 days, EPAct states that the application 
"shall be deemed granted" unless FERC grants itself one 180-day 
extension. 

[11] These data include mergers, acquisitions, or the sales of assets. 

[12] FERC officials also told us that in addition to self-reporting and 
audits of some companies, they also may initiate investigations based 
on internal and external reports of potential violations. Officials 
told us that they are able to initiate internal investigations based on 
referrals from FERC staff such as those monitoring natural gas and 
electricity trading and markets in the market monitoring center. In 
addition, FERC officials noted that companies and individuals may 
report potential violators. Such reports may be made, they said, 
through their "hotline" reporting system, which allows individuals to 
anonymously report suspected violations of FERC rules. In addition, 
individuals knowledgeable of FERC's processes and rules may also report 
violations as formal or informal complaints that companies are 
violating the terms and conditions of the detailed FERC-approved 
tariffs or rates. FERC officials did not tell us how many such reports 
have been made related to cross-subsidies or how many of such reports 
resulted in cross-subsidy violations. However, officials noted that all 
complaints are investigated to determine whether they have merit. 

[13] FERC generally plans to retain its flexibility and discretion to 
decide remedies on a case-by-case basis rather than to prescribe 
penalties or develop formulas for different violations. 

[14] Subtitle F of EPAct replaced PUHCA 1935 with the "Public Utility 
Holding Company Act of 2005." 

[15] In January 2007, FERC first used the expanded civil penalty 
authority provided by Congress in the EPAct by assessing total 
penalties of $22.5 million on SCANA Corp., PacifiCorp, Energy Corp., 
Northwestern Energy Corp., and NRG Energy Inc. 

[16] This requirement affects traditional, centralized service 
companies (i.e., a company providing services such as administrative, 
financial, or accounting services, which are provided to other 
companies in the same holding company system). 

[17] FERC officials told us that in addition to these new data, FERC 
adopted new accounting rules to implement the PUHCA provisions in EPAct 
and that these rules make certain financial information available to 
the public, thus improving public transparency of financial accounting 
for holding and service companies. 

[18] GAO, Mutual Fund Industry: SEC's Revised Examination Approach 
Offers Potential Benefits, but Significant Oversight Challenges Remain, 
GAO-05-415 (Washington, D.C.: Aug. 17, 2005); GAO, Pension Plans: 
Stronger Labor ERISA Enforcement Should Better Protect Plan 
Participants , GAO/HEHS-94-157 (Washington, D.C.: Aug. 8, 1994). 

[19] Initially, FERC officials identified 149 companies that had filed 
a FERC form 65 (notification of holding company status) with it. Of 
that total, 113 companies requested and received from FERC an exemption 
(FERC form 65A exemption notification) or waiver (FERC form 65B waiver 
notification) from the PUHCA 2005 provisions in EPAct. FERC grants an 
exemption, for example, if the holding company and its subsidiaries are 
nontraditional utilities without captive customers. FERC could also 
grant a waiver, for example, if the company is a holding company in a 
single state. We did not assess whether these exemptions or waivers 
were reasonable. 

[20] FERC is not specifically required to comply with GAGAS. In 
general, cabinet-level agencies--such as the Department of Energy--and 
selected other federal agencies and commissions--such as the Nuclear 
Regulatory Commission--are required to follow GAGAS. The following are 
among the laws, regulations, and guidelines that require use of GAGAS: 
(1) The Inspector General Act of 1978, as amended, 5 U.S.C. App. 
(2000), requires that the statutorily appointed federal inspectors 
general comply with GAGAS for audits of federal establishments, 
organizations, programs, activities, and functions. The act further 
states that the inspectors general shall take appropriate steps to 
assure that any work performed by nonfederal auditors complies with 
GAGAS; (2) The Chief Financial Officers Act of 1990 (Pub. L. No. 101-
576), as expanded by the Government Management Reform Act of 1994 (Pub. 
L. No. 103-356), requires that GAGAS be followed in audits of executive 
branch departments' and agencies' financial statements; (3) The Single 
Audit Act Amendments of 1996 (Pub. L. No. 104-156) require that GAGAS 
be followed in audits of state and local governments and nonprofit 
entities that receive federal awards; and (4) The Office of Management 
and Budget (OMB) Circular A-133, Audits of States, Local Governments, 
and Non-Profit Organizations, which provides the governmentwide 
guidelines and policies on performing audits to comply with the Single 
Audit Act, also requires the use of GAGAS. Even if not required to do 
so, auditors may find it useful to follow GAGAS. Many audit 
organizations not formally required to do so, both in the United States 
and in other countries, voluntarily follow GAGAS. 

[21] Responses to our survey came from 49 states and the District of 
Columbia. For all references to this survey, we do not distinguish 
responses for the District of Columbia separately from those of the 
states. 

[22] After completion of our survey, one state subsequently obtained 
approval from its legislature to review and approve future electric 
utility mergers. 

[23] The entire table of all factors can be reviewed in question 6 of 
our survey at [hyperlink, http://www.gao.gov/special.pubs/gao-08-
290sp]. 

[24] PUHCA 2005 provisions in EPAct (section 1265) give state 
commissions explicit authority to obtain information--including "books, 
accounts, memoranda and other records"--from utility holding companies 
and utility associates and affiliated companies "wherever located." 

[25] A detailed discussion of the Commission's pre-EPAct 2005 merger 
reviews is provided in Appendix A. As discussed below, following the 
passage of EPAct 2005, the Commission strengthened its merger oversight 
review. 

[26] PUHCA 2005 did not transfer the SEC's PUHCA 1935 functions to the 
Commission. Instead, as an "access to books and records" statute, it 
provides the Commission and states with access to the books and records 
of holding companies and their members if relevant to jurisdictional 
rates. 

The only provision of PUHCA 2005 that touches on the Commission's 
substantive authority is a procedural provision that allows multi-state 
holding companies and state commissions to obtain a determination 
regarding centralized service company cost allocations for such multi-
state holding companies, although the Commission already has 
substantive authority to do this under the FPA. 

[27] See Repeal of the Public Utility Holding Company Act of 1935 and 
Enactment of the Public Utility Holding Company Act of 2005, Order No. 
667, 70 Fed. Reg. 75,592 (Dec. 20, 2005), FERC Stats. & Regs. ï¿½ 31,197 
(2005), order on reh'g, Order No. 667-A, 71 Fed. Reg. 28,446 (May 16, 
2006), FERC Stats & Regs. 9[ 31,213 (2006), order on reh'g, Order No. 
667-B, 71 Fed. Reg. 42,750 (July 28, 2006), FERC Stats. & Regs. 31,224 
(2006), order on reh'g, Order No. 667-C, 72 Fed. Reg. 8277 (Feb. 26, 
2007), 118 FERC $ 61,133 (2007). 

[28] Financial Accounting, Reporting and Record Retention Requirements 
Under the Public Utility Holding Company Act of 2005, Order No. 684, 71 
Fed. Reg. 65,200 (Nov. 7, 2006), FERC Stats. & Regs. 9[ 31.229 (2006). 

[29] 18 C.F.R. ï¿½ 33.2(j), adopted in Transactions Subject to FPA 
Section 203, Order No. 669, 71 Fed. Reg. 1348 (Jan. 6, 2006), FERC 
Stats & Regs. 91 31,200 (2005), order on reh'g, Order No. 669-A, 71 
Fed. Reg. 28422 (May 16, 2006), FERC Stats & Regs. 9[ 31,214 (2006), 
order on reh'g, Order No. 669-B, 71 fed. Reg. 42579 (July 27, 2006), 
FERC Stats. & Regs. ï¿½31,225 (2006). Accord, Cross-Subsidization 
Restrictions on Affiliate Transactions, 72 Fed. Reg. 41,644 (July 31, 
2007), FERC Stats. & Regs. 9[ 32,618 at P 11-13 (2007). 

[30] National Grid plc, 117 FERC ï¿½ 61,080 (2006) 

[31] 72 Fed. Reg. 41,644 (July 31, 2007), FERC Stats. & Regs. ï¿½ 32,618 
(2007). 

[32] See National Grid, 117 FERC 9[ 61.080 at P 66 & n.78; Cross-
Subsidization Restrictions on Affiliate Transactions', FERC Stats. & 
Regs. ï¿½ 32,618 at P 11-13. 

[33]  Financial Accounting, Reporting and Records Retention 
Requirements Under the Public Utility Holding Company Act of 2005, 
Order No. 684, 71 Fed. Reg. 65,200 (Nov. 7, 2006). 

[34] See, e.g., Progress Energy, 111 FERC 161,243 (2005); Public 
Service Company of Colorado, Docket No. PA05-1-000 (November 28, 2005) 
(unpublished letter order); Florida Power & Light, Docket No. PA05-7-
000 (May 12, 2006) (unpublished letter order). 

[35] The Draft GAO Report suggests: (a) monitoring the financial 
condition of utilities to detect significant changes in the financial 
health of the utility sector, as some state regulators have found it 
useful to do. To do this the Commission could leverage analyses done by 
the financial market and develop a standard set of performance 
indicators; and (b) developing a better means of collaborating with 
state regulators to leverage resources already applied to enforcement 
efforts and to capitalize on state regulators unique knowledge. As part 
of this effort, the Commission could consider identifying a liaison, or 
liaisons, for state regulators to contact and to serve as a focal point 
or points. 

[36] See, e.g., Kansas City Power & Light Co., Docket No. PA06-6-000 
(Nov. 27, 2007) (unpublished letter order). 

[37] See, e.g., Niagara Mohawk Holdings., Inc., 95 FERC 1 61,381 
(2001); Bangor Hydro-Electric Company, 94 FERC ï¿½ 61,049 (2001); 
Louisville Gas & Electric Company, 91 FERC ï¿½ 61,321 (2000); PacifiCorp, 
87 FERC ï¿½ 61,288 (1999); New England Power Company, 87 FERC ï¿½ 61,287 
(1999). 

[38] See, e.g., Tucson Electric Power Co., 80 FERC ï¿½ 62,275 (1997); 
Portland General Electric Company, Docket No. EC04-90 (withdrawn April 
8, 2005); Mid- American Energy Company, 89 FERC ï¿½ 62,225 (2000). 

[39]  Appendix B contains staff's detailed rebuttal to the incorrect 
and misleading audit-related statements contained in the Draft GAO 
Report. 

[40] See 18 C.F.R. ï¿½ 2.26. 

[41] In a similar vein, in 2000, in considering a proposed transaction 
involving Consolidated Water Power Company, the Commission noted that 
`[w]hen a public utility is acquired by another company,...the 
Commission's ability to adequately protect public utility ratepayers 
against inappropriate cross-subsidization may be impaired absent access 
to the parent companies' books and records," but the Commission also 
noted that section 301 of the FPA "gives the Commission authority to 
examine the books and records of any person who controls, directly or 
indirectly, a jurisdictional public utility insofar as the books and 
records relate to transactions with or the business of such public 
utility." Consolidated Water Power Co., 91 FERC 9[ 61,275 at 61,931-32 
(2000); accord E.ON AG, 97 FERC 9[ 61,049 at 61,284 (2001). 

[42] The Commission had previously noted that the effect of 
inappropriate cross-subsidization is felt through a utility's rates. 
Boston Edison Co., 80 FERC ï¿½ 61,273 at 61,986 (1997). Thus, it can be 
addressed at the wholesale level through the Commission's review of the 
proposed transaction at the outset and through the Commission's 
continuing review of the utility's wholesale rates, and at the retail 
level through state regulatory commission review of the utility's 
retail rates. Id. 

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