The story of how regulators allowed once-safe utilities to become high-risk investments could soon be told in Washington.
By the end of this week, the
Securities and Exchange Commission
is expected to respond to more than 50 pointed questions from federal lawmakers about its enforcement of the Public Utility Holding Company Act of 1935. The agency has come under fire for liberally exempting companies from a regulation that industry insiders -- and even the SEC itself -- have long pushed to abolish altogether.
The law restricts geographic expansion and risky outside investments by public utility companies. But industry leaders have spent the past two decades portraying the measure as a throwback that has long outlived its usefulness, one that hinders capital investment in the utility sector.
Indeed, some experts believe that up to $1 trillion could pour into the industry if PUHCA, originally designed to bust up abusive monopolies, were repealed.
, led by legendary value investor Warren Buffett, has, by itself, pledged to invest $10 billion in the sector if the PUHCA restrictions are lifted.
Last year, PUHCA opponents nearly eliminated the law in a sweeping energy bill that failed to pass in the end. Even so, many companies -- including
-- have simply found their way around the PUHCA restrictions with the blessing of the SEC.
In a scathing report last year, the American Public Power Association blamed the SEC for enabling the utility industry downturn. Specifically, the association says that SEC regulators have exercised "nonexistent" enforcement of PUHCA since a 1992 partial repeal of the law began allowing utilities to expand into riskier deregulated businesses. As a result, the group claims, the SEC has failed in its duty to protect the public.
"The Enron story is an excellent illustration, as its dramatic rise has been revealed as a fraud ... and its collapse wiped out the retirement savings of utility employees and other investors," the group stated in a detailed argument aimed at strengthening, rather than eliminating, PUHCA enforcement. "However, Enron is not a unique, or even unusual, case -- just the first and most spectacular example."
Standard & Poor's
has since taken a similar stand by saying that lax enforcement of PUHCA has hurt the credit quality of many utilities and that its repeal could cause even further damage to the already battered sector. In the meantime, the House Committee on Energy and Commerce -- led by ranking Democrat John Dingell of Michigan -- is harshly questioning the SEC about its PUHCA policies.
"We fear that a continuation of current commission practices will allow Enron-like accounting and corporate structures to circumvent the investor and consumer protections of PUHCA," Dingell and fellow committee member Edward Markey wrote in a lengthy April 21 letter to the SEC. "In the wake of the Enron debacle, and in the face of possible repeal of PUHCA, we cannot overstate the importance to investors and consumers of resolving these issues sooner rather than too late to forestall disaster."
The committee is asking the SEC to explain its policies regarding PUHCA exemptions for public utilities and, more recently, nonutilities -- including investor favorite Berkshire -- that have started rushing into the industry. It has also requested a full investigation by the U.S. General Accounting Office into the SEC's administration of the law, "especially the exemption provisions that have been abused by Enron and others to the detriment of investors, ratepayers and the public interest."
A committee spokesman told
on Monday that it has yet to receive responses to its requests. As a matter of policy, the SEC declines to comment on congressional inquiries.
To be fair, the SEC did withdraw Enron's PUHCA exemption -- but only after the company had already gone bankrupt.
Last year, the SEC determined that Enron, as the parent of Portland Gas & Electric, was subject to federal oversight because it generated substantial revenue from electricity sales outside of PGE's home state. Congressmen Dingell and Markey quickly pounced. They questioned the SEC's past decisions and even suggested that 14 other companies -- including leveraged buyout target
-- may have been improperly exempted from PUHCA as well. They pointed out that these companies, too, "appear to engage in interstate wholesale electricity sales."
The congressmen also challenged the SEC's decision to issue "no-action" letters to nonutility companies, most notably Berkshire Hathaway, seeking exclusion from PUHCA rules. The questions, at times, were pointed:
- On how many occasions over the last 10 years has a request for a no-action letter under PUHCA been filed and granted on the same day?
Do companies ever negotiate the terms of a no-action letter in private with SEC staff prior to the issuance (of) a no-action letter?
Did this occur with respect to the Berkshire Hathaway no-action letter or the other no-action letters?
Berkshire Hathaway sparked broad interest in the sector with its 1999 acquisition of MidAmerican Energy. Since then, two prominent private equity players --
Texas Pacific Group
and Kohlberg Kravis & Roberts -- have plunged into the utility sector as well.
But a state commission has raised concerns about KKR at least. Late last month, the Arizona Corporation Commission staff warned that KKR's planned buyout of UniSource -- parent of the state's second-largest utility -- "is not in the public interest."
KKR plans to finance the $3 billion acquisition with some new debt that will make UniSource even more leveraged than it already is. Critics fear that KKR -- perhaps best known for its takeover of RJR Nabisco during the LBO frenzy of the 1980s -- will then begin cutting corners to maximize profits before selling UniSource in pieces.
"Leveraged buyouts ... typically result in major pressure to cut costs," the commission staff wrote on April 30. "The transaction contains no enforceable protections against reductions that would be inappropriate to maintaining safe, reliable and adequate electric service. Absent specific commitments to protect utility customers in the future, staff does not believe the deal should be consummated."
For its part, KKR has portrayed UniSource as another long-term investment for a firm that, on average, now keeps its ownership stake in companies for seven or eight years. And UniSource investors -- welcoming a 30% premium over their predeal share price -- have clearly embraced the transaction. During an election on the merger in late March, roughly 97% of the votes fell in favor of the deal.
UniSource CEO James Pignatelli, who will continue to lead the company, celebrated the arrangement as a good one for everybody involved. But the utility commission staff disagreed.
"Although the transaction provides immediate benefit to the new investors, existing shareholders and senior management of UniSource, the transaction introduces a new level of risk to the regulated utilities," the staff determined. "Staff concludes that the buyout, as proposed, could impair the financial status of the regulated utility."
UniSource expects to satisfy the commission's concerns and secure approval for the transaction in the end. The company faces a commission hearing on the matter June 21. It must also seek permission for the transaction from, among others, the SEC.
In the meantime, congressmen Dingell and Markey are already questioning the SEC's oversight of KKR following two earlier utility buyouts. They wonder whether the SEC has improperly excluded KKR's utilities from regulation in the past and whether -- even after further review -- it will continue to do so.
"Does the SEC believe utility assets located in Ohio, Michigan and Arizona would actually meet PUHCA's 'integrated public utility system' test?" the lawmakers question. "Is the SEC intending to rely on the reasoning it used to approve the merger of
American Electric Power
and Central & Southwest -- the same reasoning struck down by the Court of Appeals?"
Two years ago, an appeals court ordered the SEC to reconsider an AEP merger that didn't appear to comply with PUHCA rules. But the SEC has so far taken no major action on the matter.
Dingell and Markey expressed frustration.
"Why has it taken two years for the SEC to respond to an order by the court in this matter -- a major judicial reversal of what is perhaps the largest PUHCA transaction in decades -- while it expedites no-action letters?" they asked. "It has been suggested to us that the SEC and its staff simply chose to ignore the court's remand of the AEP-CSW merger in the hope that Congress would simply repeal PUHCA and thereby render the entire case mute. Is this true?"
Earlier, the SEC had tried -- but failed -- to reassure the lawmakers that it had the public's best interests at heart. Instead, the agency managed to stir up "a number of additional questions and concerns, some of them quite troubling" in the eyes of the two congressmen.
"We are especially pleased to receive the assurances in
SEC Chairman William Donaldson's letter that 'the commission shares your goal of effectively administering the act, particularly in light of the crucial importance of our nation's utility industry to our economy and to national security,'" the pair wrote. "Unfortunately, in recent history, actual practice has rarely met that standard."
The American Public Power Association clearly agrees.
"The financial problems of many electric utilities and utility holding companies today can be traced directly to
the partial repeal of PUHCA in 1992," the association stated. "What remained of PUHCA was bent, twisted or simply ignored by the SEC."