Utility Regulation: Opportunities Exist to Improve Oversight	 
(01-MAY-08, GAO-08-752T).					 
                                                                 
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2005 (EPAct) repealed PUHCA 1935, removing some limitations on	 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, and  
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  
testify on its February 2008 report, Utility Oversight: Recent	 
Changes in Law Call for Improved Vigilance by FERC (GAO-08-289), 
which (1) examined the extent to which FERC changed its merger	 
review and post merger oversight since EPAct to protect against  
cross-subsidization and (2) surveyed state utility commissions	 
about their oversight. In this report, GAO recommended that FERC 
adopt a risk-based approach to auditing and improve its audit	 
reports, among other things. The FERC Chairman disagreed with the
need for our recommendations, but GAO maintains that implementing
them would improve oversight.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-752T					        
    ACCNO:   A81944						        
  TITLE:     Utility Regulation: Opportunities Exist to Improve       
Oversight							 
     DATE:   05/01/2008 
  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-08-752T

   

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Testimony: 

Before the Committee on Energy and Natural Resources, U.S. Senate: 

United States Government Accountability Office: 
GAO: 

For Release on Delivery: 
Expected at 9:30 a.m. EDT: 
Thursday, May 1, 2008: 

Utility Regulation: 

Opportunities Exist to Improve Oversight: 

Statement of Mark Gaffigan, Director:
Natural Resources and Environment: 

GAO-08-752T: 

GAO Highlights: 

Highlights of GAO-08-752T, a testimony before the Committee on Energy 
and Natural Resources, U.S. Senate. 

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, and 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 testify on its February 2008 report, Utility 
Oversight: Recent Changes in Law Call for Improved Vigilance by FERC 
(GAO-08-289), which (1) examined the extent to which FERC changed its 
merger review and post merger oversight since EPAct to protect against 
cross-subsidization and (2) surveyed state utility commissions about 
their oversight. In this report, GAO recommended that FERC adopt a risk-
based approach to auditing and improve its audit reports, among other 
things. The FERC Chairman disagreed with the need for our 
recommendations, but GAO maintains that implementing them would improve 
oversight. 

What GAO Found: 

In its February 2008 report, GAO reported that FERC had made few 
substantive changes to either its merger review process or its post 
merger 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 GAO that they plan to require merging companies to 
disclose any cross-subsidization and to certify in writing that they 
will not engage in unapproved cross-subsidization. After 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 
the large fines allowed under EPAct will encourage companies to 
investigate and self-report noncompliance. To augment self-reporting, 
FERC officials told us that, in 2008, they are using an informal plan 
to reallocate their limited audit staff to audit the affiliate 
transactions of 3 of the 36 holding companies it regulates. In planning 
these compliance audits, FERC officials told us that they do not 
formally consider companiesï¿½ risk for noncompliance ï¿½ï¿½a factor that 
financial auditors and other experts told us is an important 
consideration in allocating audit resources. Rather, they rely on 
informal discussions between senior FERC managers and staff. Moreover, 
we found that FERCï¿½s audit reporting approach results in audit reports 
that often lack a clear description of the audit objectives, scope, 
methodology, and findingsï¿½inhibiting their use to stakeholders. 

GAOï¿½s survey of state utility commissions found that statesï¿½ views 
varied on their current regulatory capacities to review utility mergers 
and acquisitions and oversee affiliate transactions; however many 
states reported a need for additional resources, such as staff and 
funding, to respond to changes in oversight after the repeal of PUHCA 
1935. All but a few states have the authority to approve mergers, but 
many states expressed concern about their ability to regulate the 
resulting companies. In recent years, two state commissions denied 
mergers, in part because of these concerns. Most states also have some 
type of authority to approve, review, and audit affiliate transactions, 
but many states review or audit only a small percentage of the 
transactions; 28 of the 49 states that responded to our survey question 
about auditing said they audited 1 percent or fewer transactions over 
the last five years. In addition, although almost all states reported 
that they had access to financial books and records from utilities to 
review affiliate transactions, many states reported they do not have 
such direct access to the books and records of holding companies or 
their affiliated companies. While EPAct provides state regulators the 
ability to obtain such information, some states expressed concern that 
this access could require them to be extremely specific in identifying 
needed information, thus potentially limiting their audit access. 
Finally, 22 of the 50 states that responded to our survey question 
about resources said that they need additional staffing or funding, or 
both, to respond to changes that resulted from EPAct, and 8 states have 
proposed or actually increased staffing since EPAct was enacted. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-752T]. For more 
information, contact Mark Gaffigan at (202) 512-3841 or 
[email protected]. 

[End of section] 

Mr. Chairman and Members of the Committee: 

Thank you for the opportunity to discuss our work on federal and state 
efforts to protect against potential cross-subsidization in the utility 
industry after the repeal of the Public Utility Holding Company Act of 
1935 (PUHCA 1935). Public 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 utilities may face the need to 
invest potentially hundreds of billions of dollars to expand and 
upgrade the utility infrastructure over the next 10 years. Oversight of 
utilities is carried out by the federal government and state 
commissions--with the federal role focused on regulation of interstate 
transmission and wholesale markets and the states' role focused on 
regulating retail markets. These federal and state regulators seek to 
balance efforts to protect utility consumers from potential supply 
disruptions and unfair pricing practices while ensuring that utilities 
are profitable enough to attract private investment. Traditionally, 
this regulation took place within the framework of PUHCA 1935 and other 
federal laws. In 2005, the Energy Policy Act (EPAct) repealed PUHCA 
1935, removing some limitations on the companies that could merge with 
or invest in utilities and opening the sector to new investment. The 
repeal of PUHCA 1935 has raised concerns about whether the remaining 
laws and regulations strike an appropriate balance between encouraging 
investment in the utility sector and protecting consumers. 

PUHCA 1935 was a response to the rapid expansion, consolidation, and 
subsequent bankruptcies in the utility sector during the early part of 
the 20th century. Prior to its enactment, utilities were regulated by 
state commissions. As utilities grew, they began to span across 
multiple states that often had different rules and jurisdictional 
authority, making it difficult for state utility commissions to 
effectively regulate them. 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. Since 
the rates utility customers pay generally include the cost of all the 
goods and services bought to serve them, some transactions between 
these affiliates allowed the utilities to take advantage of economies 
of scale to the benefit of 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, affiliate 
transactions that were priced unfairly could inflate customers' rates 
to subsidize operations outside the utility--called cross- 
subsidization. Compounding this complex web of corporate ownership and 
affiliate transactions, poor disclosure of financial information and 
limited access to financial records made it difficult for investors to 
accurately assess the utilities' financial health. 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: 

To restore public confidence after the Depression, the federal 
government undertook three efforts that influenced the regulation of 
utilities. First, to protect investors, including utility investors, 
the federal government created the Securities and Exchange Commission 
(SEC) in 1934. SEC established rules--including improved financial 
reporting--for the financial markets and publicly traded companies 
participating in those markets, as well as a means to regulate them. 
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, and empowered the Federal Energy 
Regulatory Commission (FERC) to serve as the primary federal regulator 
of utilities.[Footnote 1] As such, FERC became 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. 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." As part of 
that process, FERC has determined which costs, including affiliate 
transaction costs, may be lawfully included in rates. Third, the 
federal government enacted PUHCA 1935 to regulate investment in the 
utility industry and protect investors and consumers from potential 
abuses such as cross-subsidization by holding companies. SEC was 
responsible for administering PUHCA, including reviewing mergers or 
acquisitions involving holding companies. To that end, SEC was given 
primary responsibility for examining and determining how to allocate 
affiliate transaction costs for holding companies it regulates. Among 
other things, PUHCA limited 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. Over time, 
other statutory and regulatory changes reduced some of the strict 
limitations PUHCA 1935 initially imposed. 

Over the past two decades, some interested parties in the utility 
industry sought repeal of PUHCA 1935, arguing that it was a roadblock 
to the private investment that could reduce the cost of improvements to 
the utility infrastructure, and noting that several federal antitrust 
laws that apply to utility companies have been passed since PUHCA was 
enacted. Opponents of PUHCA 1935's repeal, including some business and 
consumer representatives, expressed concern that its repeal would 
encourage utilities to return to the kinds of risky business ventures 
that spawned it, and that utilities would again become too complex to 
effectively regulate, potentially raising prices for consumers. 
Business groups outside the utility industry were also concerned that 
utilities could use their monopolies to cross-subsidize investments 
into other kinds of businesses and harm competition in those 
industries. 

In 2005, EPAct repealed PUHCA 1935--thereby opening the sector to new 
investment--and replaced it with PUHCA 2005. The repeal of EPAct 1935 
eliminated SEC's oversight role in regulating utility holding companies 
or preventing cross-subsidies, giving FERC new authorities to regulate 
corporate structures and transactions.[Footnote 2] FERC's expanded 
authorities fall into two broad areas: 1) FERC was required to ensure 
at the point of the merger review that the proposed merger would not 
result in harmful cross-subsidization, and 2) FERC became the principal 
federal agency responsible for determining how costs for affiliate 
transactions should be allocated for all utility holding companies. 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, and 
granted state utility commissions similar access. Furthermore, EPAct 
expanded FERC's civil penalty authority to help it enforce its new 
requirements, providing the commission the ability to levy penalties of 
up to $1 million per day per violation. After EPAct, states continue to 
play key roles overseeing utilities and reviewing mergers, including 
conducting some audits of affiliate transactions. 

My testimony today will focus on our February 2008 report, Utility 
Oversight: Recent Changes in Law Call for Improved Vigilance by FERC 
(GAO-08-289), which examined: (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. For that 
report, we reviewed relevant reports and data, interviewed key 
officials, visited four states--California, New Jersey, Oregon, and 
Wisconsin--that had or were considering implementing strong protections 
for overseeing holding and related affiliate companies, and surveyed 
state utility regulators in all 50 states and the District of Columbia. 
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. 

In summary, we 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 unapproved cross-
subsidization. Once mergers have taken place, FERC intends to rely on 
its existing enforcement mechanisms--primarily companies' self- 
reporting noncompliance and a limited number of compliance audits--to 
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 noncompliance. 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 of the 36 holding companies it regulates in 
2008. In planning these compliance audits, FERC officials told us that 
they do not formally consider companies' risk for noncompliance--a 
factor that financial auditors and other experts told us is an 
important consideration in allocating audit resources--relying instead 
on informal discussions between senior FERC managers and staff. 
Moreover, we found that FERC's audit reporting approach results in 
audit reports that often lack a clear description of the audit 
objectives, scope, methodology, and findings--inhibiting their use to 
stakeholders. 

* Although states' views varied on their current regulatory capacities 
to review utility mergers and acquisitions and oversee affiliate 
transactions, many states reported a need for additional resources, 
such as staff and funding, to respond to changes in oversight after the 
repeal of PUHCA 1935. All but a few states have merger approval 
authority, but many states expressed concern about their ability to 
regulate the resulting companies after merger approval. In recent 
years, two state commissions denied mergers, in part because of these 
concerns. Most states also have some type of authority to approve, 
review, and audit affiliate transactions, but many states review or 
audit only a small percentage of the transactions, with 28 of the 49 
reporting states auditing 1 percent or less over the last five years. 
In addition, although almost all states reported that they had access 
to financial books and records from utilities to review affiliate 
transactions, many states reported they do not have such direct access 
to the books and records of holding companies or their affiliated 
companies. While EPAct provides state regulators the ability to obtain 
such information, some states expressed concern that this access could 
require them to be extremely specific in identifying needed 
information, thus potentially limiting their audit access. Finally, 22 
of the 50 states that responded to our survey question about resources 
said that they need additional staffing or funding, or both, to respond 
to changes that resulted from EPAct, and 8 states have proposed or 
actually increased staffing since EPAct was enacted. 

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

In February 2008, we reported that FERC had made few substantive 
changes to either its merger and acquisition 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. Specifically: 

Reviewing mergers and acquisitions. FERC's merger and acquisition 
review relies primarily on company disclosures and commitments not to 
cross-subsidize. 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. 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. FERC also 
requires company officials to attest that they will not engage in 
unapproved cross-subsidies in the future. This information becomes part 
of a public record that stakeholders or other interested parties, such 
as state regulators, consumer advocates, or others may review and 
comment on, and FERC may hold a public hearing on the merger. FERC 
officials told us that they evaluate the information in the public 
record for the application and do not collect evidence or conduct 
separate analyses of a proposed merger. On the basis of this 
information, FERC officials told us that they determine which, if any, 
existing or planned cross-subsidies to allow, then include this 
information in detail in the final merger or acquisition order. Between 
the time EPAct was enacted in 2005 and July 10, 2007--when FERC 
provided detailed information to us--FERC had reviewed or was in the 
process of reviewing 15 mergers, acquisitions, or sales of assets. FERC 
had approved 12 mergers, although it approved three of these with 
conditions--for example, requiring the merging parties to provide 
further evidence of provisions to protect customers. Of the remaining 
three applications, one application was withdrawn by the merging 
parties prior to FERC's decision and the other two were still pending. 

Postmerger oversight. FERC's postmerger oversight relies on its 
existing enforcement mechanisms--primarily self-reporting and a limited 
number of compliance audits.[Footnote 3] FERC indicates that it places 
great importance on self-reporting because it believes companies can 
actively police their own behavior through internal and external 
audits, and that the companies are in the best position to detect and 
correct both inadvertent and intentional noncompliance. FERC officials 
told us that they expect companies to become more vigilant in 
monitoring their behavior because FERC can now levy much larger fines-
-up to $1 million per day per violation--and that a violating company's 
actions in following this self-reporting policy, along with the 
seriousness of a potential violation, help inform FERC's decision on 
the appropriate penalty.[Footnote 4] Key stakeholders have raised 
concerns that internal company audits tend to focus on areas of highest 
risk to the company profits and, as a result, may not focus 
specifically on affiliate transactions. One company official noted that 
the threat of large fines may "chill" companies' willingness to self- 
report violations. Between the enactment of EPAct--when Congress 
formally highlighted its concern about cross-subsidization--and our 
February 2008 report, no companies had self-reported any of these types 
of violations. To augment self-reporting, FERC plans to conduct a 
limited number of compliance audits of holding companies each year, 
although at the time of our February 2008 report, it had not completed 
any audits to detect whether cross-subsidization is occurring. In 2008, 
FERC's plans to audit 3 of the 36 companies it regulates--Exelon 
Corporation, Allegheny, Inc., and the Southern Company. If this rate 
continues, it would take FERC 12 years to audit each of these companies 
once, although FERC officials noted that they plan audits one year at a 
time and that the number of audits may change in future years. 

We found that FERC does not use a formal risk-based approach to plan 
its compliance audits--a factor that financial auditors and other 
experts told us is an important consideration in allocating audit 
resources. Instead, FERC officials plan audits based on informal 
discussions between FERC's Office of Enforcement, including its 
Division of Audits, and relevant FERC offices with related expertise. 
To obtain a more complete picture of risk, FERC could more actively 
monitor company-specific data--something it currently does not do. In 
addition, we found that FERC's postmerger audit reports on affiliate 
transactions often lack clear information--that they may not always 
fully reflect key elements such as objectives, scope, methodology, and 
the specific audit findings, and sometimes lacked key information, such 
as the type, number, and value of affiliate transactions at the company 
involved, the percentage of all affiliate transactions tested, and the 
test results. Without this information, these audit reports are of 
limited use in assessing the risk that affiliate transactions pose for 
utility customers, shareholders, bondholders, and other stakeholders. 

In our February 2008 report, we recommended that the Chairman of the 
Federal Energy Regulatory Commission (FERC) develop a comprehensive, 
risk-based approach to planning audits of affiliate transactions to 
better target FERC's audit resources to highest priority needs. 
Specifically, we recommended that FERC monitor the financial condition 
of utilities, as some state regulators have found useful, by leveraging 
analyses done by the financial market and developing a standard set of 
performance indicators. In addition, we recommended that FERC develop a 
better means of collaborating with state regulators to leverage audit 
resources states have already applied to enforcement efforts and to 
capitalize on state regulators' unique knowledge. We also recommended 
that FERC develop an audit reporting approach to clearly identify the 
objectives, scope and methodology, and the specific findings of the 
audit to improve public confidence in FERC's enforcement functions and 
the usefulness of its audit reports. The Chairman strongly disagreed 
with our overall findings and the need for our recommendations; 
nonetheless, we maintain that implementing our recommendations would 
enhance the effectiveness of FERC's oversight. 

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. The survey we conducted for our February 2008 
report highlighted the following concerns: 

* Almost all states have merger approval authority, but many states 
expressed concern about their ability to regulate the resulting 
companies. All but 3 states[Footnote 5] (out of 50 responses) have 
authority to review and either approve or disapprove mergers, but their 
authorities varied. For example, one state could only disapprove a 
merger and, as such, allows a merger by taking no action to disapprove 
it. 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, the difficulty of 
regulating merged companies has been cited by two state commissions-- 
one in Montana and one in Oregon--that denied proposed mergers in their 
states. For example, a state commission official in Montana told us the 
commission denied a FERC-approved merger in July 2007 that involved a 
Montana regulated utility, whose headquarters was in South Dakota, 
which would have been bought by an Australian holding company. 

* Most states have authorities over affiliate transactions, but many 
states report auditing few transactions. Nationally, 49 states noted 
they have some type of affiliate transaction authority, and while some 
states reported that they require periodic, specialized audits of 
affiliate transactions, 28 of the 49 reporting states reported auditing 
1 percent or fewer over the last five years. Audit authorities vary 
from prohibitions against certain types of transactions to less 
restrictive requirements such as allowance of a transaction without 
prior review, but authority to disallow the transaction at a later time 
if it was deemed inappropriate. Only 3 states reported that affiliate 
transactions always needed prior commission approval. One attorney in a 
state utility commission noted that holding company and affiliate 
transactions can be very complex and time-consuming to review, and had 
concerns about having enough resources to do this. 

* Some states report not having access to holding company books and 
records. Although almost all states report they have access to 
financial books and records from utilities to review affiliate 
transactions, many states reported they do not have such direct access 
to the books and records of holding companies or their affiliated 
companies. While EPAct provides state regulators the ability to obtain 
such information, some states expressed concern that this access could 
require them to be extremely specific in identifying needed 
information, which may be difficult. Lack of direct access, 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. All of the 49 states that responded to this survey 
question noted that they require utilities to provide financial 
reports, and 8 of these states require reports that also include the 
holding company or both the holding company and the affiliated 
companies. 

* States foresee needing additional resources to respond to the changes 
from EPAct. Specifically, 22 of the 50 states that responded to our 
survey said that they need additional staffing or funding, or both, to 
respond to the changes that resulted from EPAct. Further, 6 out of 30 
states raised staffing as a key challenge in overseeing utilities since 
the passage of EPAct, and 8 states have proposed or actually increased 
staffing. 

In conclusion, the repeal of PUHCA 1935 opened the door for needed 
investment in the utility industry; however, it comes at the potential 
cost of complicating regulation of the industry. Further, the 
introduction of new types of investors and different corporate 
combinations--including the ownership of utilities by complex 
international companies, equity firms, or other investors with 
different incentives than providing 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. In light of these changes, we believe FERC should err on the 
side of a "vigilance first" approach to preventing potential cross- 
subsidization. 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. Without a risk-based 
approach to guide its audit planning--the active portion of its 
postmerger oversight--FERC may be missing opportunities to demonstrate 
its commitment to ensuring that companies are not engaged in cross- 
subsidization at the expense of consumers and may not be using its 
audit resources in the most efficient and effective manner. Without 
reassessing its merger review and postmerger oversight, FERC may 
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. In addition, the lack of clear information in audit 
reports not only limits their value to stakeholders, but may undermine 
regulated companies' efforts 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 their self-reporting. We continue to encourage 
the FERC Chairman to consider our recommendations. 

Mr. Chairman, this completes my prepared statement. I would be happy to 
respond to any questions you or other Members of the Committee may have 
at this time. 

GAO Contact and Acknowledgments: 

Contact points for our Offices of Congressional Relations and Public 
Affairs may be found on the last page of this testimony. For further 
information about this testimony, please contact Mark Gaffigan at (202) 
512-3841 or at [email protected]. Individuals who contributed to this 
statement include Dan Haas, Randy Jones, Jon Ludwigson, Alison O'Neill, 
Anthony Padilla, and Barbara Timmerman. 

[End of testimony] 

Footnotes: 

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

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

[3] 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. 

[4] 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. 

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

[End of section] 

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