Popular PUHCA Exemption Narrowed
By Lynn N. Hargis
Enron lost the first round in a case that could have broad implications for power companies that operate in more than one state in the United States.
The chief administrative law judge at the US Securities and Exchange Commission said in a decision in early February that Enron subjected itself to potentially onerous financial and corporate regulation under a sweeping 1935 statute called the “Public Utility Holding Company Act,” or “PUHCA,” because of its ownership of Portland General Electric, an electric public utility in Oregon.
Enron had gone to great lengths — even changing its place of incorporation to Oregon — in order to avoid regulation under the 1935 statute. This reincorporation was supposed to exempt it from the statute under a “single-state exemption” that exempts the owner of a power company that operates only in a single state.
However, the judge said that, even though the service territory of Portland General is confined to Oregon, the utility operates outside the state because of the wholesale electric sales that Portland General makes at interstate “hubs” that are across the Oregon border. Since the single-state exemption requires that a “material” utility and its parent must be “predominantly intrastate in character” and carry on their business substantially in a single state in which both are organized, the judge found that Enron’s public utility, Portland General, does not qualify for the single-state exemption because too great a share of its revenue comes from out-of-state sales.
The judge’s finding was made despite the fact that the Public Utility Commission of Oregon — which intervened in the case — insisted that it “effectively regulates” the effect of Portland General’s out-of-state wholesale sales on retail rates and urged the judge to grant the single-state exemption. PUHCA was supposed to help the states by having the federal government step in to regulate electric and gas utilities that have expanded too much into interstate commerce for a state to regulate effectively. The judge found the Oregon commission’s position to be “significant, but not controlling.”
The single-state exemption has been used by many owners of power companies to avoid regulation under PUHCA. Anyone who did not get a formal order from the Securities and Exchange Commission confirming that the exemption applies, rather than simply relying on a filing with the SEC, and whose utility engages in lots of wholesale interstate sales should probably be nervous after the judge’s ruling.
The ruling can still be appealed to the full Securities and Exchange Commission.
The ruling may complicate plans by private equity funds and Asian and European companies to buy US utilities.
Other Possible Exemptions
The judge also rejected Enron’s claim that it qualified for two other exemptions from PUHCA. One of the exemptions — what the regulatory lawyers call a section 3(a)(3) exemption — would have been available if Enron could have proven it was only “incidentally” a utility holding company. The SEC staff took the position before the judge that Enron could not claim this exemption unless it could show that Portland General provided no material part of Enron’s revenue and is “functionally related” to one or more businesses in which Enron is primarily engaged.
The other exemption — called a section 3(a)(5) exemption — would have worked if Enron could have shown that the revenues it received from Portland General were not “material” to Enron when compared to the revenue from Enron’s other subsidiaries owning “utility assets” either in foreign countries or that had been specifically exempted from PUHCA by Congress, such as power plants to which one of three labels attaches for regulatory purposes: QF, EWG or FUCO. The judge found that Enron did not qualify for the section 3(a)(5) exemption on either substantive or materiality grounds.
Enron had essentially conceded that it could no longer meet the materiality requirements for these two exemptions, given the loss of its energy trading businesses and its bankruptcy, but asked the judge for a temporary exemption of two years or so until it could sell off Portland General and portions of Enron’s other power plants that are known as “qualifying facilities,” or “QFs,” and which cannot be owned by Enron under federal regulations unless it has one of the latter two exemptions.
Effects and Outlook
The decision could mean loss of QF status for some power plants in which Enron invested.
Numerous parties attempted to intervene in the proceeding because of the potential impacts on the other owners of the Enron qualifying facilities or on other utility parent companies that have a single-state exemption. Most attempting intervention were only allowed limited participation status, and the judge noted at the outset of her decision that “[t]he facts presented herein have not been tested by cross-examination.”
The proceedings were on a fast track. They were initially held before an SEC commissioner, pursuant to an SEC order that immediately followed a Senate committee report criticizing the SEC’s failure to exercise adequate oversight over Enron’s filings under PUHCA. Enron argued to the judge that a finding that Portland General is not predominantly intrastate in character and does not carry on business substantially in a single state will make the single-state exemption irrelevant in the context of today’s electricity industry. Enron also questioned whether the SEC intended to examine other utilities that have disposed of generation assets and increased their trading in electricity markets. The judge said that these were policy issues that deserved consideration in another forum, but were not relevant to a determination of whether Enron’s exemption applications meet the statutory requirements and SEC precedent.
The initial decision will become a final SEC decision unless Enron or another party appeals the decision within 21 days, or unless the SEC itself decides to review the decision on its own initiative. The deadline to appeal should expire around March 1. If the judge’s decision becomes final as issued, Enron will have to register with the SEC under PUHCA and submit to comprehensive financial and other regulation to which some 28 registered holding companies currently submit, until it is able to sell Portland General, although Enron’s bankruptcy proceedings may affect what happened. Since the new owner of Portland General would also presumably have to register with the SEC, the ruling could limit the number of bidders for the utility. Indeed, the City of Portland found the decision encouraging, since it can bid for Portland General and not be subject to PUHCA as an agency of the state.
There will also presumably be issues raised as to whether Enron’s QFs can maintain their QF status with Enron as an owner. This question is before the Federal Energy Regulatory Commission. A related settlement with Enron-owned QFs selling to Southern California Edison is pending.
Finally, there may be questions raised regarding other utility holding companies that are currently enjoying exemption from PUHCA pursuant to filings under SEC rules or as to the “good faith” of other pending PUHCA exemption applications that rely on arguments similar to those made by Enron and rejected by the judge, if the SEC affirms the initial decision or leaves it standing. A parent company is ordinarily allowed to rely on a pending application for exemption from PUHCA as long as the application was made in “good faith.”
The SEC order originally called for a second phase of the hearing as to whether, even if Enron met the qualifications for an exemption, such exemption should nonetheless be denied under the “unless and except” clause of PUHCA. This clause allows the SEC to deny or limit an exemption if it finds it would be detrimental to the public interest or to the interest of investors or consumers. Since the judge found that Enron does not meet the statutory criteria, the second hearing phase does not appear to be required by the terms of the original SEC order.