Merger Menace: Holding Companies and Overcapitalization
"The only practical control over public utility holding companies will be one [that] can directly reach the holding company itself and supervise its security structure and its use of capital and make possible over a period of time the elimination of the holding company where it serves no demonstrably useful purpose."5
The Arkla-DEI-Minnegasco Merger
The MPUC's handling of a merger between a Minnesota gas utility, its holding company, and an interstate gas utility and pipeline demonstrates how state regulation alone is inadequate to deal with the problem of overcapitalization effected by manipulation of utility securities. Minnegasco was a gas distribution company serving Minneapolis, one of the country's largest natural gas distribution markets. Its holding company, Diversified Energies, Inc. (DEI) was one of the new generation of exempt holding companies, formed in 1982 to enable Minnegasco executives to explore diversification opportunities. The only condition the MPUC imposed upon the creation of the DEI holding company was approval of a contract between the two affiliates, DEI and Minnegasco.
In 1990, DEI entered into an agreement with Arkla (em a natural gas pipeline, distribution, and production company (em to sell Minnegasco. The merger agreement presented DEI shareholders with a pure "stock-for stock" conversion: DEI stock for Arkla stock. Although the merger was presented for stockholder and regulatory purposes as an integrated transaction, the merger agreement described the transaction in several steps: 1) DEI stock would be transferred to Arkla, 2) DEI would be dissolved, 3) Minnegasco would be formally merged into Arkla, and 4) dissenters or nonvoting shares would be "converted" into Arkla shares "by operation of law" after shareholder approval. The exchange valuation announced by the companies promised that DEI shareholders would receive Arkla shares valued at over twice their value prior to closing before the merger was announced. In other words, regardless of how a person might vote on the merger, a DEI shareholder with stock valued at $29.60 would receive 1.752 shares of Arkla stock if a majority of his or her fellow shareholders approved.6 There was no guarantee that the shareholder could actually receive cash for the post-merger value of Arkla stock in the amount of $36.354.
The merger proxy statement (which complied with the Securities and Exchange Act of 1934) indicated that Arkla's balance sheet would be "written up" by approximately $397 million to reflect goodwill and an "acquisition adjustment" gained by the merger with DEI.7 A "writeup" is an inflation of the balance sheet by an arbitrary amount that is unrelated to the earning capacity of the issuers. The proxy did not specifically state so, but since the purpose of the merger was to capture the strong Minneapolis retail natural gas market, the average shareholder would assume that the DEI/Minnegasco stock was undervalued and that the value would improve once future rate increases were obtained.
The MPUC asserted jurisdiction over the merger under Minnesota law.8 The Minnesota commissioners learned that under the "consistent with the public interest" standard of Minnesota law, they could only disapprove a merger or acquisition if they found such a transaction contrary to the