Introduction

As mentioned in Chapter 1, the Public Utility Holding Company Act of 1935 (PUHCA) is being targeted for immediate repeal by some groups because of its restrictions regarding utility mergers and acquisitions which might save money for customers and enhance profits for shareholders. Other groups firmly believe that, while its provisions are becoming obsolete, PUHCA cannot be repealed until comprehensive electric utility industry restructuring legislation is instituted. Mergers would grow if the law was repealed outright and, since mergers reduce the number of competitors, competition could be meaningless. This appendix explains the effect the law is having today on corporate combinations in the Nation's electric power industry and takes a look at the advantages and disadvantages of the law's regulations in light of the current move towards competition. A background section which explains the basics about why PUHCA was promulgated 65 years ago is provided in order to help the reader fully understand the current controversy surrounding the law.⁽³³⁾

Background

The Public Utility Holding Company Act (PUHCA), enacted in 1935, was aimed at breaking up the unconstrained and excessively large trusts that then controlled the Nation's electric and gas distribution networks. They were accused of many abuses, including "control of an entire system by means of a small investment at the top of a pyramid of companies, sale of services to subsidiaries at excessive prices, buying and selling properties within the system at unreasonable prices, intra-system loans at unfair terms, and the wild bidding war to buy operating companies." ⁽³⁴⁾ The Act was passed at a time when financial pyramid schemes were extensive. These schemes allowed operating utilities in many areas of the country to come under the control of a small number of holding companies, which were in turn owned by other holding companies. These pyramids were sometimes 10 layers thick (see box).

"Some holding companies were solid operations run for no other purpose than to coordinate and make efficient the operation of the subsidiary companies. But the holding company movement became a craze because of the promotional profits to be made. The holding companies were condemned and fell because of the excesses committed. The present structure of the electric utility industry is the direct result of legislation designed to destroy the holding company that did not have an operating rationale for its existence. As promoters saw the huge profits to be gained from the holding company business, they began to bid against each other to buy operating properties to put into the holding companies. Sometimes the promoters had to resort to odd measures to make things look good. One could, for instance, combine electric and ice properties, hiding the fact that most of the earnings were coming from the competitive, unsafe, and dwindling ice business. A good promoter could put together a combination of companies, sell preferred stock and bonds to the public to pay for the properties, take 10 percent or more as a commission, and keep the bulk (or all) of the voting common stock of the holding company, thereby remaining in control without having paid a cent into the business."⁽³⁵⁾

Before PUHCA, almost half of all electricity generated in the United States was controlled by three huge holding companies, and more than 100 other holding companies existed.⁽³⁶⁾ The size and complexity of these huge trusts made industry regulation and oversight control by the States impossible. After the collapse of several large holding companies, the Federal Trade Commission (FTC) conducted an investigation after which it criticized the many abuses that tended to raise the cost of electricity to consumers. The Securities and Exchange Commission (SEC) also investigated and "publicly charged that the holding companies had been guilty of stock watering and capital inflation, manipulation of subsidies, and improper accounting practices. The general counsel of the FTC went further, claiming that [w]ords such as fraud, deceit, misrepresentation, dishonesty, breach of trust, and oppression are the only suitable terms to apply."⁽³⁷⁾

Under PUHCA, the SEC was charged with the administration of the Act and the regulation of the holding companies. One of the most important features of the Act was that the SEC was given the power to break up the massive interstate holding companies by requiring them to divest their holdings until each became a single consolidated system serving a circumscribed geographic area. Another feature of the law permitted holding companies to engage only in business that was essential and appropriate for the operation of a single integrated utility. The law contained a provision that all holding companies had to register with the SEC, which was authorized to supervise and regulate the holding company system. Through the registration process, the SEC decided whether the holding company would need to be regulated under or exempted from the requirements of the Act. The SEC also was charged with regulating the issuance and acquisition of securities by holding companies. Strict limitations on intrasystem transactions and political activities were also imposed.⁽³⁸⁾

The holding companies at first resisted compliance, and some challenged the constitutionality of the Act, but the Supreme Court upheld PUHCA's legality. By 1947, virtually all holding companies had undergone some type of simplification or integration, and by 1950 the utility reorganizations were virtually complete.⁽³⁹⁾

PUHCA in the 1990s

In essence, the restrictions facing today's utility holding companies regarding acquisitions fall into two categories-geographic and functional. Geographic restrictions require a holding company which seeks to acquire utilities that operate in non-contiguous States to "register " with the SEC. Functional restrictions do not allow a registered holding company to engage in businesses that are not functionally related to their core utility business. "Thus, while an 'exempt' holding company (e.g., one whose utility operations are predominantly in a single State) can diversify into virtually any business line (within bounds established by State law),⁽⁴⁰⁾ a registered holding company must only engage in utility-related businesses that perform functions primarily for the benefit of affiliated utility companies." ⁽⁴¹⁾

A holding company is a company that confines its activities to owning stock in, and supervising management of, other companies. The SEC, as administrator of PUHCA, defines a utility holding company as a company which directly or indirectly owns, controls, or holds 10 percent or more of the outstanding voting securities of a public utility company. "Where merging utilities decide to retain their existing operating company structure, the resulting combination must meet the requirements of PUHCA. An investor is generally allowed to take 'one free bite' at the electric utility industry by acquiring less than 10 percent of the voting securities of a single public utility company. However, under the so-called 'two bite' restriction imposed under Section 9(a)(2) of the Act, an investor generally cannot acquire more than a 5 percent voting interest (i.e., become an 'affiliate') in two or more different electric utility companies without obtaining the prior approval of the SEC. The SEC has taken the position that the acquisition of 5 percent or more of the voting securities of a public utility holding company with two or more utility subsidiaries also requires SEC approval under Section 9(a)(2), since this involves the indirect acquisition of 5 percent or more of the securities of two utilities. Even holding companies that are exempt from registration and the other operative provisions of the Act are subject to the 'two bite' restriction."⁽⁴²⁾

"It is important to remember that the restrictions contained in PUHCA apply to only those companies that seek to organize themselves using the holding company structure. If a company organizes its individual State operations as divisions, then the restrictions of PUHCA do not apply. Thus Utilicorp United, Inc. (Kansas City, MO) has utility operations in nine States--States that are geographically diverse and non-contiguous. To the extent PUHCA restricts additional utility acquisitions, these are restrictions that the company itself assumed through its choice of corporate form."⁽⁴³⁾

Figure A1. States Where Registered Holding Companies are Headquartered, as of June 1, 1998

The utility merger trend has greatly accelerated over the past few years. Several of these mergers have occurred between exempt holding companies, several have resulted in the formation of new registered holding companies, and one even involved an acquisition by an already registered holding company. As of June 1, 1998, there were 19 registered holding companies, all headquartered in the eastern half of the United States, 10 of which were electric and three of which were gas. Six companies were a combination of the two (Figure A1 and Table A1).

There were 112 holding companies exempt from SEC regulation under the umbrella of PUHCA Section 3 (a) (1) which states that a holding company is exempt if "such holding company, and every subsidiary company thereof … are predominantly intrastate in character and carry on their business substantially in a single State in which such holding company and any such subsidiary company thereof are organized." ⁽⁴⁴⁾ Additionally, 39 holding companies were exempt under Section 3 (a) (2) which states that a holding company is exempt if "such holding company is predominantly a public utility company whose operations … do not extend beyond the State in which it is organized and States contiguous thereto." ⁽⁴⁵⁾

The Call for Immediate PUHCA Reform⁽⁴⁶⁾

It is argued that electric utility registered holding companies are not playing on a level field with other electricity industry entities, such as qualifying facilities (QFs) and exempt wholesale generators (EWGs). QFs were mandated under the Public Utility Regulatory Policies Act of 1978 (PURPA) which eliminated PUHCA constraints on certain QFs.⁽⁴⁷⁾ EWGs were mandated under the Energy Policy Act of 1992, which significantly modified PUHCA by allowing both utilities and nonutilities qualifying as EWGs to build, own, and operate power plants for wholesaling electricity in more than one geographic area. This is a condition not available to holding companies which, under PUHCA, must restrict their operations to a single contiguous electricity system.⁽⁴⁸⁾ It is this unlevel field which is behind the push from certain groups to eliminate PUHCA's restrictions on holding companies. These groups believe that, in an atmosphere of open competition, everyone must be able to compete under the same rules and regulations.

Those groups who support immediate repeal of the law say that PUHCA impedes domestic investments, diverts capital overseas, and unnecessarily restricts certain multistate utilities from competing in businesses crucial to delivering energy-related services. In addition, the law imposes many unneeded restrictions and significant costs upon utilities, placing them at a competitive disadvantage. These restrictions can eliminate attractive business opportunities that might save money for customers and enhance profits for shareholders. Since PUHCA requires prior approval from the SEC before company affiliates or subsidiaries can enter into contracts with each other, opportunities to reduce costs or operate with efficiencies cannot always be realized. (See the inset box for information regarding two bills which propose immediate repeal of PUHCA that have been introduced into the current Congress.)

PUHCA Reform Must Wait

Those who are against PUHCA reform are mainly concerned about the timing. Repealing the law prior to the promulgation of comprehensive electricity reform legislation, which would contain necessary safeguards to protect consumers and the environment, would enable today's monopoly utilities to garner even more market power. Mergers reduce the number of competitors and mergers would grow if the law were repealed; therefore, competition might be meaningless. Right now, it is believed by some groups to be the only Federal law that protects consumers and the environment from market power abuses by the utility sector.

In light of the recent wave of mergers, it is feared that there could be a handful of competitors with substantial market power. Repealing PUHCA without replacing it with a modernized version with strong market power protections could result in the acceleration of mergers, acquisitions, and consolidation. A likely result, according to some groups, would be higher electricity bills for consumers and more layoffs for workers. Those factions who promote immediate PUHCA repeal say that today there are measures that give the States the power to regulate holding companies, but anti-repeal supporters say the States may have the authority but they do not have the resources.

The following bills (most of which include provisions for PUHCA reform) take a comprehensive approach to electricity industry restructuring and are pending before the current Congress:

Endnotes

33. For a very detailed look at PUHCA, refer to The Public Utility Holding Company Act of 1935: 1935-1992 (DOE/EIA-0563). To receive a hard copy, contact EIA's National Energy Information Center by phone at (202) 586-8800 or by E:mail at infoctr@eia.doe.gov. It can also be viewed and downloaded from EIA's World Wide Web Site at: http://www.eia.doe.gov.

34. L. S. Hyman, America's Electric Utilities: Past, Present and Future, Fifth Edition (Arlington, VA: Public Utilities Reports, Inc., 1994), p. 111.

35. Ibid., p. 101.

36. The Securities and Exchange Commission actually noted 142 registered holding companies in 1939. Securities and Exchange Commission, Fifth Annual Report of the Securities and Exchange Commission, Fiscal Year Ended June 30, 1939 (Washington, DC, 1940), pp. 1 and 43.

37. T. J. Brennan et al., A Shock to the System: Restructuring America's Electricity Industry (Resources for the Future: Washington, DC, July 1996), p. 160.

38. For a more extensive and detailed discussion of PUHCA, see Energy Information Administration, The Public Utility Holding Company Act of 1935: 1935-1992, DOE/EIA-0563 (Washington, DC, January 1993), pp. 39-53.

39. J. Seligman, The Transformation of Wall Street and The History of the Securities and Exchange Commission in Modern Corporate Finance (Boston, MA: Houghton, Mifflin Company, 1982), p. 134.

40. In the past, exempt holding companies have invested in security businesses, real estate, savings and loans, equipment supply, and even used car lots.

41. M. Kanner, PUHCA: Impact on Investments by Utilities, http://www.citizen.org/cmep/restructuring/puhca/kanner.htm.

42. N. J. Klauder, F. L. Norton, and M. K. Huntington, Utility Mergers & Acquisitions , A Competitive Utility Special Report (Infocast, Inc., May, 1999).

43. Ibid.

44. Public Utility Holding Company Act of 1935 (Public Law 74-333), Section 3.

45. Ibid.

46. Although PUHCA reform or outright repeal is being considered today because of the move to deregulate, the same plea for change has been made several times over the past 20 years. In the 1970s, utilities sought relief from PUHCA constraints in order to diversify into nonutility lines of business as a means to improve their declining profits. In the 1980s, they sought to diversify in order to exploit the positive experience of independent power producers under the Public Utility Regulatory Policies Act of 1978 (PURPA). In fact, the SEC has conducted studies on the validity of PUHCA in today's electric utility industry and, on several occasions, has recommended that the law be amended.

47. For an explanation of  "qualifying facilities" and the Public Utility Regulatory Policies Act of 1978, refer to Energy Information Administration, The Changing Structure of the Electric Power Industry, An Update, DOE/EIA-0562(96) (Washington, DC, December 1996), pp. 27-28.

48. For an explanation of "exempt wholesale generators" and the Energy Policy Act of 1992, refer to Energy Information Administration, The Changing Structure of the Electric Power Industry, An Update, DOE/EIA-0562(96) (Washington, DC, December 1996), pp. 28-29.

• Proceed to Appendix B
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