Traps for the unwary: PUHCA
The Public Utility Holding Company Act — called PUHCA — is the “sleeper cell” of US energy regulations.
It was largely extinguished by Congress in 2005, but lingering provisions infiltrate deals and can tag unwary investors with unintentional regulatory status.
Anyone doing deals in the US gas and power sector should understand that a single improperly-structured investment can subject an entire corporate family to regulation by the Federal Energy Regulatory Commission as a utility holding company.
Four primary consequences flow from such regulation.
FERC may require prior authorization of transactions, leading to inopportune closing delays. Implicated entities must comply with onerous book and recordkeeping requirements. There can be sanctions and negative public relations fallout associated with PUHCA violations. FERC can also restrict corporate activities and impose compliance obligations.
Various tactics exist to deactivate PUHCA’s power.
It Only Takes One
An investor may become subject to FERC regulation as a utility holding company if it takes ownership or control of 10% or more of the voting securities of an “electric utility company,” a “gas utility company,” or another utility holding company.
All it takes is one such investment to subject an entire group of affiliated companies to regulation.
Terminology is key under PUHCA.
An “electric utility company” includes any entity that owns or operates facilities for the generation or transmission of electricity for wholesale or retail sale.
A “gas utility company” includes entities that own or operate facilities used for retail distribution of gas for heat, light or power.
Any upstream entity that directly or indirectly holds the threshold interests in an electric or gas utility company is a “holding company.”
Thereafter, as long as the relevant asset is on the books, the holding company and all of its subsidiaries will be labelled a “holding company system.”
To put PUHCA into context, it is a Depression-era remnant that was initially enacted in 1935 in an age of powerful multi-state utility conglomerates and corruption. Congress wanted to prevent unregulated upstream owners of regulated utilities from using their market power to engage in price gouging of utility ratepayers, debt shielding and general money laundering. Times changed, and Congress repealed the original version of PUHCA in 2005, and replaced it with an abridged version that significantly limited the reach of the statute and reduced the burden on holding companies caught in its net.
Busy executives often first learn of PUHCA when the commercial value of a transaction is threatened by delay.
FERC must review and approve or deny certain acquisitions in which a utility holding company plans directly or indirectly to acquire or merge with an electric utility company, an entity that transmits electricity, or another utility holding company.
If prior approval is required, then applicants should conservatively allow at least 180 days for FERC review before closing. Realistically, the average review period only lasts about 60 days for uncontested applications. FERC may grant a request for a condensed review period for good cause, but in recent years its staff has indicated that “good cause” must involve more than routine commercial interests. FERC also has the power to extend the review period, which it typically reserves for controversial transactions.
If a deal closes without obtaining required approval, then from a regulatory perspective it is effectively void. Imagine the consequent chaos. Participants may also be subject to sanctions.
Prior approval by FERC is also required for certain “dispositions” of FERC-regulated public utilities, including transfers of utility assets and changes of control over the seller. A FERC-regulated public utility is any company that owns or operates facilities used to make wholesale sales of power or to transmit power in interstate commerce.
Thus, review could be required even if a corporate family is seeking to sell, rather than acquire, utility interests. It can also apply to a seller in a transaction even if it does not apply to the buyer. There are several exemptions and blanket authorizations that might eliminate this burden.
In sum, whether FERC prior approval will actually be required for a transaction can be nuanced, and any transaction involving the transfer of interests in energy entities or assets should be evaluated with PUHCA in mind.
Books and Records
Any utility holding company subject to FERC regulation must record, maintain, retain and grant FERC access to any books, accounting statements, and other records that FERC deems relevant to the jurisdictional price of gas or energy sold by public utilities and natural gas companies or otherwise pertaining to the protection of the customers of such entities.
This requirement extends not only to the holding company, but also its affiliates.
FERC’s reach transcends US boundaries to foreign affiliates.
The books and records subject to review must be maintained and retained pursuant to a detailed uniform system of accounts in some circumstances.
State regulators also have review authority over the books and records of utility holding companies and their affiliates under PUHCA. A state may pry to the extent it considers the records relevant to the rates a utility doing business in the state charges for electricity or gas or for any other reason considered necessary to discharge its regulatory duties effectively.
Anyone violating PUHCA can be subject to penalties of up to $1 million per violation per day, plus be required to disgorge any improper profit.
Executives involved in such violations may also be referred to the Department of Justice for criminal prosecution and can be sent to prison.
Candidly, neither criminal nor significant civil penalties are likely. Perhaps of greater concern is the potential for damage to corporate reputation. Although average consumers are unlikely to know about PUHCA, they understand when a company is alleged to have violated a federal law designed to protect consumers. The scandal is extra spicy when it involves energy interests and consolidated wealth, regardless of how mundane the actual violation or regulation at issue.
In egregious circumstances, there is a risk that FERC may limit a company’s ability to engage in regulated activities. This could significantly affect a corporate revenue stream and lead to devaluation of expensive assets. Rarely will a PUHCA-related violation be a company’s only regulatory violation, particularly if the entity became regulated unwittingly. The discovery of regulatory violations is routinely followed by an obligation to adopt expensive corporate compliance programs and submit to periodic regulatory audits or reporting requirements. The variety and unpredictability of possible repercussions for PUHCA-related violations underscores the importance of prevention.
The most common strategy to avoid running afoul of PUHCA is to restrict the type of energy assets within a corporate portfolio.
Broad PUHCA exemptions can automatically spare investors if they invest in a company or project considered a qualifying facility (QF), exempt wholesale generator (EWG), or foreign utility company (FUCO).
A QF is a small power project that uses renewable energy or waste as fuel or a cogeneration facility that produces two useful forms of energy from a single fuel and satisfies certain other FERC requirements.
An EWG is a company that is engaged directly or indirectly and exclusively in the business of owning or operating eligible generating facilities and selling the electricity at wholesale.
A FUCO is either an electric or gas utility company located outside the US, that does not derive income from utility activities within the US, and does not have any subsidiary public utility companies within the US.
A holding company that only owns QFs, EWGs and FUCOs is usually excused from having to obtain prior authorization from FERC to acquire interests in other QFs, EWGs and FUCOs.
Other holding companies and transactions frequently qualify for PUHCA exemptions or waivers if FERC finds that the books and records of such entity or class of transactions poses little or no risk to jurisdictional rates or utility consumers. Common examples include purely passive investments by investors like mutual funds in utility companies, single-state holding companies that derive no more than 13% of their revenues from utility activities outside a single state, and holding companies of electric utility companies no greater than 100 MW in aggregate size used primarily to self-serve its own or affiliates’ loads. An important — and frequently misunderstood — caveat to these routine waivers and exemptions is that they only apply if the holding company makes certain FERC filings.