Like a zombie, the undead, or other movie monster who is impervious to all attempts to kill it, the Public Utility Holding Company Act of 1935 ("PUHCA") refuses to go quietly. In fact, recent events are breathing new life in the old law. Many electric utilities may be surprised to learn that their long-standing exemption from PUHCA regulation may be in jeopardy.
This New Deal legislation reformed the electric and gas distribution industries during the 1930s, ‘40s and ‘50s, largely eliminating the utility "holding company." By the late 1970s, there were only 11 "registered" holding companies – those holding companies controlling multiple utility operating companies serving more than one state. By contrast, the SEC’s October 2003 Financial and Corporate Report lists 28 top-level registered holding companies serving more than 70 million customers. The dramatic increase in the number of utility companies subject to full regulation under PUHCA is a result of a number of utility mergers resulting in multistate systems. However, since that 2003 report, several dramatic events have taken place that show that PUHCA is likely to have an even greater impact on the U.S. electric industry in the near future.
In very general terms, a utility system can be "exempt" from PUHCA constraints only if its operations are confined to a single state, or in some cases contiguous states. If a company wants to control utilities in multiple states, the price is "registration" under PUHCA – with its attendant regulation and restrictions. Since the 1980s, Congress has been attempting to repeal PUHCA. All attempts to date have failed, although repeal provisions are included in the stalled energy legislation under consideration in this Congress. Notwithstanding significant support for repeal of this 70-year-old law, its influence on the U.S. utility industry is growing, and prospects for repeal this election year seem dim. Furthermore, the SEC administration of PUHCA has recently taken a significant turn toward more vigorous enforcement after many years of trying to streamline the constraints of the law.
The dramatic increase in the importance of PUHCA is traceable in large part to fallout from the Enron collapse. Enron owns Portland General Electric and therefore is a "holding company." Enron claimed exemption from PUHCA because Portland serves utility customers only in Oregon. However, in December 2003, the SEC found that Enron was not qualified for this exemption because, among other things, of the volume of wholesale electric business Portland conducted where purchases or sales occurred outside Oregon. Many observers felt this was a significant departure from traditional SEC interpretation of the applicable PUHCA provisions. They predicted that many other companies – heretofore thought to be exempt – would find themselves having to register under PUHCA as "multistate" utilities even if their retail customers were solely in a single state.
This prediction seems to be coming to pass. On July 16, 2004, Black Hills Corporation announced that it believed it was no longer qualified to be an exempt company "due to the extent of the Company's participation in interstate electric power sales." Black Hills filed with the SEC for approval to take certain steps necessary to transform into a registered holding company. Black Hills has a single public utility subsidiary – Black Hills Power – providing electric service in western South Dakota, northeastern Wyoming, and southeastern Montana.
Black Hills Power serves about 61,000 customers and generated about $171 million in revenues from regulated electric sales in 2003. Of this amount, 18 percent of electric revenues consisted of off-system and short-term contract wholesale sales. Black Hills Corporation and its subsidiaries operate in two other primary operating groups: nonregulated wholesale energy and communications. The wholesale energy businesses include coal mining, oil and natural gas production, fuel marketing of natural gas and oil and oil transportation, and independent power activities, all aggregated for reporting purposes as Black Hills Energy. The wholesale energy segment contributed revenues of just over $1 billion in 2003, of which $675 million was attributable to energy marketing.
Similarly to Enron and Portland General, Black Hills has incentives for its regulated utility to increase its purchases and sales of wholesale energy. Black Hills notes that its utility is operating under a retail rate freeze until January 1, 2005. This rate freeze allows the utility to retain the benefits from cost savings and wholesale "off-system" sales and provides it with flexibility in allocating the utility’s generating capacity to maximize returns. Without the rate freeze, the utility would likely have to pass on to retail customers the net benefits of wholesale trading. Portland General engaged in wholesale trading principally for the benefit of its retail customers.
The benefits provided by Black Hills’ situation would be reduced if the utility had to limit its wholesale sales to South Dakota alone and forego purchases and sales deemed to occur in other states. The company emphasizes that it sits at a strategic location on the border of the Eastern and Western Interconnections in the U.S. and thus is able to participate in markets in both areas and take advantage of price differences between the two markets. A constraint on its ability to buy and sell wholesale power to diverse customers located throughout the country would adversely impact on its ability to exploit this natural advantage.
It is not possible to determine from the publicly available information the current volume of wholesale electric purchases and sales made by the utility, Black Hills Power, that occur in South Dakota or elsewhere. It also appears from Black Hills’ public filings that its unregulated power generation business engages in significant wholesale sales. This latter category of sale would not normally affect the holding company’s status under PUHCA; it is only the sales or purchases made by the "utility company" itself that are relevant to a PUHCA analysis. Nevertheless, it seems that the volume of transactions by the utility must be significant.
The steps taken by Black Hills may serve as a forerunner of things to come. Many regulated utilities engage in wholesale energy trading directly, not through unregulated affiliates. As shown by the contrast between Black Hills and Portland General, there are incentives to engage in trading whether or not the utility is in a state with traditional regulation, like Oregon, or whether the utility is subject to alternative situations – such as the rate freeze of Black Hills or it is located in a state that has undergone retail restructuring. Those utilities that have separated all of their generation into separate affiliates, or have sold to unrelated parties, probably can avoid the pitfalls under PUHCA of wholesale trading. Yet any company’s situation should be reviewed carefully by management to determine if the company faces unsuspected PUHCA problems.
The filing made by Black Hills to facilitate its transformation into a registered holding company does not discuss the reasons why it no longer qualifies to be exempt. Thus, it obviously is not trying to contest the SEC’s current view on the impact of wholesale electricity purchases and sales on the PUHCA status of a utility. Those companies that are concerned about the impact of these developments on their status should do the following:
First, the company should analyze its electricity sales and purchases and compare the volume (by kilowatt-hours and revenues) of its activity within its principal state versus those transactions occurring outside that state. In the Enron situation, a significant amount of the transactions of Portland General were deemed to have taken place at trading hubs located outside Oregon. Also relevant in Enron was ownership by Portland General of utility assets outside Oregon and its ownership of interstate transmission facilities.
Second, if this analysis indicates that a significant percentage of the transactions are "out-of-state," then the company must determine how to address the issue. What is significant? Portland earned an average of 34 percent of its gross utility operating revenue from interstate sales over the three years prior to the SEC decision. Interstate transactions at or above 10 percent would be cause for careful additional scrutiny.
Black Hills appears to have several strategic reasons to convert voluntarily to registered holding company status. Other companies may not see any advantage to becoming registered and therefore may seek to continue to avoid the restrictions that registration would bring. A holding company can enjoy the PUHCA Section 3(a)(1) intrastate exemption by one of two means: either it has received an express order of the SEC finding that the exemption applies, or it makes an annual filing with the SEC on Form U-3A-2 claiming the exemption and asserting that the facts supporting the exemption are in place. In either case, a holding company could do nothing and wait for the SEC to challenge its exemption. Alternatively, a company could seek a determination that it is still eligible for the exemption.
The SEC has the authority to revoke an existing exemption, whether the exemption relies on a specific order or is based on the annual filing. For an existing order, if the SEC finds that the circumstances that gave rise to the issuance of the order no longer exist, it must, by order after notice and opportunity for hearing, revoke the exemption. For those companies that only make the annual filing, the SEC can revoke the exemption on 30 days’ notice. The company would be entitled to make a filing seeking an order of exemption and, if that filing is made in good faith, will continue to enjoy the exemption pending resolution of the matter.
A holding company that is concerned about the status of its exemption could file an application with the SEC seeking an order of exemption, if it currently was exempt by virtue of the annual filing, or an order confirming its prior order of exemption. Either procedure would provide a forum to determine definitively the company’s position. A company with serious questions regarding its status may feel compelled to take such steps to avoid uncertainties regarding its regulatory status in connection with public or private financings, merger and acquisition activity, including acquisitions of businesses that a registered holding company would not be allowed to own. Uncertainty could give rise to concerns regarding liquidity, for example if revolving credit agreements require "down-dated" representations regarding status under PUHCA at the time any drawing is made under those agreements. The company’s inability to confirm its exempt status could suspend its ability to borrow under those agreements. Any number of other actions, which an exempt company could take unimpeded, could be called into question by uncertainty over the company’s exemption.
The SEC has been under political pressure to step up its enforcement of PUHCA. Given the attention that has been focused on the relevance under PUHCA of the amount of out-of-state electricity transactions, exempt utility holding companies should be prepared to respond to inquiries about their status from investors, state regulators, and other interested parties and, ultimately, from the SEC itself.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
