Investment Adviser Must Get Prior Approval to Manage Utility Shares

Investment Adviser Must Get Prior Approval to Manage Utility Shares

January 01, 2009

The Federal Energy Regulatory Commission ruled in late November that an investment adviser should have gotten government approval before acquiring and managing more than $10 million in voting shares of several public utilities in customer accounts.

The ruling reflects a broad view of FERC authority over utility acquisitions.

FERC for the first time made clear that an investment firm that manages investments in utilities for third parties and retains the right to vote shares in those utilities can be considered to be a “holding company.” Under a relatively new provision of the Federal Power Act, added by the Energy Policy Act of 2005, a “holding company” is required to get FERC approval to acquire more than $10 million in utility securities.

The ruling involved Horizon Asset Management. FERC refused to give Horizon retroactive approval for its purchases of voting shares in several public utilities after concluding the company is technically a utility “holding company.” However, because this was a new interpretation of a new law, FERC did not impose any sanctions on Horizon.

FERC made it clear that there may be other investment firms that are similarly situated to Horizon, that FERC may not be so lenient next time, and that these firms have 90 days from the date that the order is published in the Federal Register to seek authorization from FERC for their previous acquisitions. That deadline is February 23, 2009.

What Horizon Was Doing

Horizon manages a number of separate investment accounts for unaffiliated entities. Horizon earns management fees, but the entities, called “account holders” for purposes of the FERC order, own the stock. However, Horizon has the exclusive authority to manage the accounts and is delegated by the account holders the right to vote the shares in the accounts, as well as to purchase and sell the securities in the accounts. Horizon told FERC that it generally defers to an entity known as Institutional Shareholder Services, or “ISS,” in exercising its voting rights, but Horizon does retain the right to override the decisions of ISS.

A “holding company” is defined in the Public Utility Holding Company Act of 2005 as a company that “directly or indirectly owns, controls or holds, with the power to vote” 10% or more of the voting securities of a public utility company or a holding company.

Horizon argued that it was not a holding company because the account holders, not Horizon, actually purchased the stock and that Horizon generally deferred on the voting to ISS.

FERC found that the account holders delegated their voting authority to Horizon, and that Horizon retained the authority to vote the shares. Further, Horizon conceded that the account holders own more than 10% of the outstanding voting securities of Aquila, Inc., a public utility company, and Horizon manages those accounts. Therefore, FERC found that Horizon was a holding company, even though it did not acquire utility securities, because it acquired rights to vote those utility securities over the 10% ownership threshold.

Blanket Authorizations

Horizon also sought blanket authorizations or, that is, it wanted FERC to pre-approve, the acquisition of securities of utilities or holding companies for its account holders in the future, subject to a list of conditions. One of the principal conditions was a commitment by Horizon to hold less than 10% of the voting securities of a public utility or holding company in any individual Horizon account, and less than 19.99% of the voting securities of a public utility or holding company collectively by Horizon and any affiliated entity having voting power. FERC granted the blanket authorization for a three-year period, and permitted Horizon to apply for an extension of the blanket authorization at the end of that period, based on the foregoing ceilings on the purchase of utility securities as well as other commitments by Horizon and FERC requirements, which included the following.

First, Horizon must file with FERC, at the same time it files with the US Securities and Exchange Commission, any Schedule 13G filings relevant to the blanket authorizations, and any changes from the Schedule 13G information must be provided to FERC within 45 days after the end of each calendar year. Horizon must also copy FERC with any comments or deficiency letters received from the SEC. A Schedule 13G filing is made with the SEC when a filer acquires 5% or more of a class of securities in the ordinary course of business and not with the intention to effect a change or influence over the control of the issuer.

Second, Horizon agreed not to take action that would require it to make a Schedule 13D filing with the SEC with respect to the securities of a public utility or holding company. A Schedule 13D filing is required when a person acquires 5% or more of a class of securities “with the purpose or effect of changing or influencing the control of the issuer” or if the ownership would be equal to or more than 20% of the class of equity securities.

Third, Horizon is required to retain the records of its transactions relating to public utility securities as required under the Investment Advisors Act.

Fourth, Horizon agreed to include language in its policies and procedures manual, account holder agreements and in its Form ADV, relating to registration of investment advisors under the Investment Advisors Act, that it will not exercise control over any public utility or holding company nor will it withdraw this language without providing FERC with at least 90 days’ prior notice.

Fifth, Horizon agreed generally to defer to ISS voting recommendations, to exercise its vote in a manner that is consistent with its fiduciary duties to its shareholders, and to maintain readily auditable records of its voting of shares of public utilities and holding companies.

Sixth, Horizon agreed to file at FERC, for informational purposes, a quarterly report 45 days after the end of each calendar quarter detailing public utility and holding company securities held as of the end of that quarter.

Finally, Horizon must inform the Federal Energy Regulatory Commission within 30 days of any material change in circumstances that would change the facts, policies and procedures relied upon by FERC in granting the blanket authorization.

FERC also dismissed Horizon’s request for blanket authorization under another section of the Federal Power Act to undertake the same activities with the same restrictions. Under that section, FERC would have required pre-approval if the activities resulted in a change of control of the public utility or holding company. Since FERC determined that the activities requested would not result in a change of control, blanket authorization under that section was unnecessary.

PUHCA Exemption Filings

FERC issued an order at the same time as the Horizon order to clarify filing requirements for holding companies under Public Utility Holding Company Act of 2005, also known as PUHCA 2005.

Certain holding companies are automatically exempted from PUHCA 2005 because they own only cogeneration facilities and other power plants no more than 80 megawatts in size that use waste and other renewable fuels — called “qualifying facilities” under the Public Utility Regulatory Policies Act — exempt wholesale generators (generating facilities selling exclusively at wholesale) or foreign utility companies or “FUCOs” (entities that reside and sell power only overseas).

However, there are other categories of holding companies that are eligible for exemption or waivers only by filing an exemption notification at FERC. These include entities that would be considered utility holding companies but for the fact that they are purely passive investors, investors in public utilities that have no captive customers and are not affiliated with a utility that has captive customers, electric cooperatives, single state holding company systems, investors in transmission-only companies, and holding companies that own generation facilities of 100 megawatts or less and use the power fundamentally for their own loads or for end uses by affiliates. There are also holding companies that can obtain a waiver or exemption by seeking and obtaining a declaratory order from FERC if they are not otherwise eligible to file an exemption notification.

For those companies that filed for exemption or waivers from the PUHCA 2005 requirements or received a declaratory order, FERC determined that these entities not only have to notify FERC of any material changes in fact that may affect their exemptions or waivers, but also have to notify FERC if the company becomes a holding company with respect to an additional public utility or holding company.

This means that if a company acquires 10% or more of the voting securities of an additional public utility or holding company, that information must be reported, whether or not there has been any change to the facts on which the original exemption or waiver was granted. For those companies that should have provided this information because they have become holding companies for an additional public utility or holding company following the granting of an earlier exemption or waiver, FERC has given them until January 9, 2009 — 45 days from the date the new order was published in the Federal Register — to provide the information.