SEC Signals Tougher Stance On PUHCA Exemptions
By Robert F. Shapiro
Enron lost a fight with the US government in late December over whether it was exempted from burdensome regulatory requirements under the Public Utility Holding Company Act, or “PUHCA.”
The US Securities and Exchange Commission rejected Enron’s appeal of an administrative law judge’s decision that denied Enron’s claims that it qualified for various exemptions under PUHCA. The decision could have ramifications for other power companies.
The Public Utility Holding Company Act is a law enacted in the 1930’s that makes it difficult for power companies to operate in more than one state. Companies that own power plants in more than one state go to great lengths to qualify for exemptions from the statute. Any company that is not exempted must register with the US Securities and Exchange Commission as a “registered holding company.” Most companies want to avoid PUHCA registration because it would subject them to pervasive financial and corporate regulation and could restrict the type and scope of investments that the companies can make.
Single State Exemption
Enron claimed that it was entitled to exemption under the so-called “single state” exemption found in section 3(a)(1) of PUHCA. The “single state” exemption requires a holding company to be incorporated and to operate primarily as a utility holding company in the same state in which the utility is incorporated and operates. It is the exemption that is utilized most frequently by parent companies of utilities in the United States. When Enron acquired Portland General Electric Company in 1997, it reorganized to become an Oregon corporation in order to avail itself of the “single state” exemption and avoid having to become a registered holding company under PUHCA.
The SEC denied Enron’s claim that it was entitled to the exemption.
Enron argued that since it reincorporated in Oregon and since the Portland General service territory was limited to the state of Oregon, it should qualify. But the SEC disagreed, finding that Portland General earned an average of 34% of its gross utility operating revenues from interstate sales and owned significant out-of-state generating and transmission assets that represented 13% of its total book value and 14% of its generating capacity.
The SEC also rejected the Oregon Public Utilities Commission’s argument that section 3(a)(1) should apply because Portland General is effectively regulated by the Oregon PUC, making SEC regulation unnecessary. The SEC reasoned that substantial out-of-state activity created the potential for the utility to escape effective state regulation.
The SEC was careful to distinguish between a utility’s interstate sales, which could be problematic for section 3(a)(1) exemptions, and a utility’s interstate purchases, which would not have an impact on the exemption. The SEC also suggested that if Enron had restructured the wholesale trading operations of Portland General into a separate subsidiary, Enron might have avoided the adverse outcome.
There are numerous public utility companies with single state exemptions that make interstate sales and that own out-of-state generating and transmission assets. If they haven’t done so already, these companies should review their sales and holdings to determine if they need to restructure in order to avoid a fate similar to Enron’s.
Enron also made filings for exemption under PUHCA sections 3(a)(3) and 3(a)(5) in order to get around the utility ownership restrictions for “qualifying facilities,” or “QFs.” A QF is a power plant that produces two useful forms of energy from a single fuel — for example, steam and electricity — or that generates electricity using waste or other renewable fuels. A utility cannot own more than 50% of the total equity in a QF. A utility holding company that is exempted under the single state rule is still considered a utility for purposes of the QF ownership limit. However, the Federal Energy Regulatory Commission has held that a holding company that receives a section 3(a)(3) or section 3(a)(5) exemption under PUHCA would not be deemed to be a utility for purposes of the utility ownership limit. FERC reasoned that these exemptions are based on a finding that the company is only “incidentally” a utility holding company or derives no material part of its income from a public utility company in the United States, and thus there is no reason to consider this interest as owned by a utility. Because Enron wholly owned certain QFs or owned QFs in tandem with utility partners, Enron made section 3(a)(3) and 3(a)(5) filings with the SEC to avoid having to sell off its QF interests.
When Enron made its section 3(a)(3) and 3(a)(5) filings, it claimed that it met the statutory requirements for exemption on grounds that the revenue and income of Portland General paled beside its worldwide revenue and income. Regardless of the validity of the claims when originally made, by the time Enron filed for bankruptcy at the end of December 2001 or within months thereafter, Enron’s revenues and profitability plummeted to the point that Enron no longer could argue that it met the section 3(a)(3) or 3(a)(5) standards. The SEC had little difficulty in concluding that Enron was not entitled to an exemption under either section. Since there have been very few applications for section 3(a)(3) or 3(a)(5) exemptions, the SEC’s determinations as to these exemptions appear to be less significant for other companies than its ruling with respect to the section 3(a)(1) exemption.
The only lingering issue with respect to its section 3(a)(3) and 3(a)(5) exemptions is whether Enron made a “good faith filing” for these exemptions in 2000, since a good faith filing for an exemption allows the applicant to maintain the exemption until the SEC acts on the filing. If the filings were not made in good faith, the exemptions would be removed retroactively. Neither the SEC nor the administrative law judge whose order was essentially affirmed by the SEC made a finding on the “good faith” issue.
Enron additionally asked the SEC for a temporary exemption from PUHCA registration based on the fact that it had filed for bankruptcy, filed a reorganization plan, and signed an agreement to sell Portland General. But the SEC determined that the outcomes of the bankruptcy process and the sale were uncertain and that, in any event, Enron had not sought a temporary holding company exemption under section 3(a)(4) of PUHCA. This type of exemption has traditionally been used by banks who foreclose on utility assets and own such assets only long enough to dispose of them to a third party.
A few days after the SEC decision denying all PUHCA exemptions to Enron, Enron made another filing with the SEC seeking exemption from registration under section 3(a)(4) of PUHCA. The commission, on January 14, 2004, ordered that a hearing be conducted on the filing. As with the other PUHCA exemptions, a “good faith” filing for exemption automatically exempts the applicant from PUHCA until the SEC acts. However, in this case, the SEC hearing order expressly noted that the SEC is taking no position as to whether the Enron application met the “good faith” filing requirement. Presumably that will be determined at the hearing, along with the exemption request.