[BETA] Fortnightly

Merger Menace: Holding Companies and Overcapitalization

States remain as powerless to control holding companies as they were

in 1935, when PUHCA was passed.

During the 1970s and 1980s, diversification swept the gas and electric utility industries. One byproduct of this craze was the formation of a large number of new public utility holding companies, exempt not only from regulation by the Securities and Exchange Commission (SEC), but from state regulation over security issues. The new generation of unregulated public utility holding companies has created a constituency for complete deregulation of the public utility holding company.

Since 1982, in every session of Congress, legislators have introduced bills seeking repeal of the Public Utility Holding Company Act of 1935 (PUHCA). Even the SEC has joined the chorus in favor of repeal. So far, Congress has only loosened some restrictions under the Energy Policy Act of 1992. In October 1995, Sen. Alfonse M. D'Amato (R-NY) sponsored a bill that would effectively repeal PUHCA one year after passage.1 Even if the bill does not become law in this session of Congress, the pressure will remain for full repeal or, as one author recently suggested, a "re-deal."2

The primary argument for repeal or re-deal is that PUHCA is an anachronism that only serves as a "second belt over two sets of suspenders" to existing state and federal regulation.3 This argument completely disregards the problem of overcapitalization. While proponents of repeal dismiss the threat of overcapitalization as unreal, the experience of a merger approved by the Minnesota Public Utilities Commission (MPUC) suggests otherwise. In fact, the MPUC's experience reveals that state commissions remain as powerless to deal with the problem of holding companies engaged in interstate commerce as they were in 1935, when PUHCA was passed.

The Problem of Overcapitalization

Overcapitalization is a menace because it creates an irresistible pressure for rate increases to fulfill the expectations of increased revenues. PUHCA expressly recognizes the relationship between the abuse of overcapitalization by holding companies and public utility subsidiaries:

"when such securities are issued [by a public utility holding company or its utility subsidiary] on the basis of fictitious or unsound asset values having no fair relation to the sums invested in or the earning capacity of the properties and upon the basis of paper profits from intercompany transactions, or in anticipation of excessive revenues from subsidiary public utility companies."4

State regulators claim that state regulation of utility securities is adequate to prevent overcapitalization. They only demand access to affiliate books and records to ensure the continued protection of the public interest. D'Amato's bill to repeal PUHCA pays lip service to this concern by guaranteeing "access to affiliate books and records" to both states and the Federal Energy Regulatory Commission (FERC). Congress was presented with these same arguments in 1935 and rejected them on the advice of disinterested observers such as the National Power Policy Committee, which concluded that, "[e]ven if such [holding company] books and records are obtainable, however, such books and records will be comparatively unintelligible and even misleading until uniform accounting methods are made compulsory." That Committee