For the partners in a utility merger, the celebration must wait. After opening the most delicate of dialogues, and then negotiating the price and closing the deal, the merger partners must yet gain the approval of regulators. The application may lie sealed in its FedEx pouch, safely on its way to Washington. But long before that, corporate counsel will have reminded the weary negotiators of three daunting facts:

1) The Federal Energy Regulatory Commission (FERC) will review the merger to determine if it is consistent with the "public interest."

2) The FERC's merger policies have kept the industry jumping for nearly a decade.

3) Some Commissioners now believe that the FERC's merger policies may need a tuneup to face the post-EPAct (Energy Policy Act of 1992) world.

Experienced utility executives will remember the 80's, when the FERC aggressively and successfully used its merger approval authority to force merging utilities to file "open-access" transmission tariffs.1 The story was simple: The FERC resorted to merger conditions in the 1980s as a crude tool when it found it had no other means of forcing generic transmission tariffs on a reluctant industry.

Today's executives, driven by business realities that the FERC itself has accelerated, are again opting for the benefits and efficiencies of merger. And, after passage of EPAct and the advent of the FERC Mega-NOPR,2 some might think that the FERC would close the book on using its "conditioning authority" to reshape the industry. Think again.

A FAMILIAR RACE

It may be too soon to view aggressive use of merger policy as a relic of FERC history. In fact, Chair Moler has promised two restless Commissioners (em Hoecker and Massey (em that after finalizing the transmission Mega-NOPR, the FERC will turn its attention to merger standards. From the perspective of Massey and Hoecker, attention to merger policy is overdue. As early as last summer, in the Midwest Power Systems and Iowa-Illinois Gas Co. merger proceeding, the Commissioners offered a concurring opinion that the FERC's merger policy was out of date and should be reexamined "in parallel with our open-access rulemaking."3

While careful to point out that they do not have a "distaste for mergers," Hoecker and Massey clearly are worried that the size and market power of merged companies will lead to unacceptable concentrations "in the number of generation and transmission alternatives that remain in the wake of [a] merger." Massey, for example, contends that the public-interest standard currently applied by the FERC is "frankly, not a very high standard," and that the FERC's existing analysis is not "particularly rigorous." Accordingly, he suggests a "generic reevaluation of [FERC's] merger policy," with the goal of enhancing competition.4

Notwithstanding Massey's critique, it must be noted that the FERC's current public-interest

calculus does consider whether the merger would "harm competition." Although not strictly bound by antitrust principles, the FERC currently applies to its merger reviews the standards traditionally invoked under section 7 of the Clayton Act, "to give understandable content to the broad statutory concept of the public interest."5 In general terms, these traditional antitrust principles require a close assessment of whether the merger may substantially lessen competition or create a monopoly in the relevant market.

RAISING THE HURDLES

So what is Massey's basis for saying that the current public-interest standard is not very high nor the FERC analysis particularly rigorous? After all, the current standard is as high as that applied in other industries under the antitrust laws. Nor can the increasingly competitive nature of utility markets justify abandonment or reengineering of the traditional antitrust principles that historically have been used in precisely such competitive markets. Moreover, the FERC's standard, as noted, was rigorous enough to begin the movement toward generic transmission tariff filings during the late 1980s. If the traditional Clayton Act merger analysis standard isn't rigorous enough, companies proposing mergers may shudder to consider the scope of a potential new FERC merger analysis.

Indeed, suggesting a need for heightened merger scrutiny by federal regulators is ironic. As

the FERC itself observes in the

Mega-NOPR:

"The electric power industry is today an industry in transition. In response to changes in the law, technology and markets, competitive pressures are steadily building .... Development of [competitive] markets is certain."6

Advocacy of a new and more intrusive merger policy implies that a regulator rather than market forces should preside over the realignment of economic interests that results from this increased competition in bulk-power markets.

Understandably, the FERC should permit only those mergers that pass muster under traditional Clayton Act principles. A sound merger policy, however, requires the FERC to allow mergers that fulfill a procompetitive role in the marketplace. For this reason, the Supreme Court's seminal merger decision in Brown Shoe specifically credited the Clayton Act with having "recognized the stimulation to competition that might flow from particular mergers," and credited Congress with desiring "to restrain mergers only to the extent that such combinations may tend to lessen competition."7

The Department of Justice has also recognized the importance of balance in merger enforcement policy:

"Although they sometimes harm competition, mergers generally play an important role in a free-enterprise economy. They can penalize ineffective management and facilitate the efficient flow of investment capital and the redeployment of existing productive assets. While challenging competitively harmful mergers, the Department seeks to avoid unnecessary interference with that larger universe of mergers that are either competitively beneficial or neutral."8

A much less balanced perspective is being urged upon the Commission: "[T]he FERC

arguably should avoid any diminishment of competition. One could argue that every merger diminishes competition by eliminating competition between two independent companies."9 A FERC merger policy that seeks to inject what it considers "procompetitive policies," rather than merely weeding out competitively harmful mergers, would compromise the Congressional aims as embodied in Brown Shoe.

Competition provides a strong profit incentive for efficiency and progress, and is thus widely viewed as superior to economic regulation in workably competitive markets.10 If the FERC were to create a standard of heightened scrutiny for electric utility mergers that goes beyond the requirements of traditional Clayton Act principles, its actions would suggest that electric markets not be allowed to react on their own to increased competition. Rather, federal regulators must actively manage the reconfiguration of markets. This suggestion would run counter to the basis for the nearly universal consensus, already adopted by the FERC, that "more competition will mean lower rates for wholesale customers and, ultimately, for consumers."11 Company management, rather than regulators, should bear the responsibility and authority for determining how best to achieve efficiencies and realign a company's economic interests in response to competition.

Under the guise of harmonizing its merger approach with that of the Department of Justice, the FERC should not selectively borrow principles it finds attractive. The unifying theme of the Merger Guidelines holds that "mergers should not be permitted to create or enhance market power or to facilitate its exercise." That premise underlies section 7 of the Clayton Act and traditional FERC merger analysis. The analysis focuses on harm to competition or anticompetitive results of the merger; it is not driven by a grand design to instill or inject more competition to further putatively procompetitive regulatory policies.12 The approach suggested in the Midwest Power Systems concurrence cannot be reconciled with the Merger Guidelines, which were never intended to introduce "managed competition" or make the marketplace more competitive in the eyes of the government than it would have been without the merger.

CHANGING THE RULES

In crafting its Guidelines, the Department of Justice recognized the importance of certainty and predictability: "By stating its policy as simply and clearly as possible, the [Department] hopes to reduce the uncertainty associated with enforcement of the antitrust laws in this area."13 Without question, the Guidelines are intended to be reasonably and flexibly applied in light of facts and circumstances surrounding each proposed merger. Yet, the Guidelines recognize the importance of providing business decisionmakers with basic direction and guidance so that they may fairly evaluate and predict whether a particular merger would be approved. To the extent that a new FERC merger policy would be designed not to preclude competitively injurious transactions but instead to bring about "regulator-enhanced" competition, it might significantly hinder managements' ability to react to changing market conditions by restructuring their businesses. Once again, market forces that would otherwise work to realign economic interests could be chilled, and regulatory oversight rather than competition would remain the "driving force" in the restructuring of the industry.

Also disturbing is the possibility that a new FERC merger policy might overemphasize one particular principle from the Guidelines that suits a new regulatory objective: i.e., whether the efficiency claims attributable to a merger reasonably can be achieved by the parties through other means. The concurring opinion in Midwest Power Systems specifically suggests that the FERC should examine whether "in an increasingly competitive market, the merger applicant should be held responsible for achieving efficiency and cost reductions in the ordinary course of business, outside the merger option."14 It is certainly possible that through devices such as contractual arrangements, strategic alliances, and joint ventures, investor-owned utilities might obtain some of these efficiencies. The incorporation, however, of a "can you work together without a merger" test as a prominent component of the FERC's merger analysis poses significant problems for potential merger partners.

Once a merger is consummated, the merged firms are viewed as a single firm under antitrust law. That single firm is, of course, legally incapable of conspiring with itself. In the absence of a merger, however, companies that pursue efficiencies and coordinated cost reductions in the

ordinary course of business must bear the full brunt of scrutiny under section 1 of the Sherman Act, which prohibits anticompetitive joint action or collusion. If, as a condition to merger approval, the FERC requires companies to demonstrate that they tried to achieve efficiencies through creative new forms of joint action, it may blur the line between efficiency-enhancing joint action and impermissible collusion. Section 1 often chills the very exchange of competitively sensitive information that is necessary to identify and capture the efficiencies associated with joint action between competitors.

The dilemma facing utility executives is illustrated by a recent example from the defense industry. In 1992, the Federal Trade Commission (FTC) opposed Alliant Techsystems' proposed merger with its principal competitor in the ammunition supply market, at least in part because the FTC concluded that the merger efficiencies could largely be achieved through contractual arrangements in the competitive bidding context. In 1994, Alliant Techsystems was on the receiving end of a complaint filed by the government, alleging that Alliant had entered into an anticompetitive joint venture or teaming arrangement in response to a federal request for proposals in a particular market for cluster bombs. As part of a consent decree entered into in 1994, Alliant and its partners in the teaming arrangement each agreed to pay civil penalties exceeding 2 million dollars.15

In a variety of contexts, federal antitrust regulators have warned against possible collusion resulting from strategic alliances, joint ventures, joint contractual relationships, and other activities that the FERC might be tempted to explore as a precondition to merger approval.16

Apart from encouraging unprotected joint action between competitors, the approach of the Midwest Power Systems concurrence is unlikely to serve the end of distinguishing good mergers from bad ones. It is probably safe to say that utilities would not lightly pursue drastic restructuring in the form of a merger (particularly a merger of equals) if lawful, less drastic alternatives could achieve the same efficiencies. Moreover, the proposed comparative analysis of alternatives would likely necessitate an unwieldy, speculative, and difficult factual inquiry that would tax the capabilities of traditional antitrust enforcement authorities. Even if federal electricity regulators were equipped to perform such a complex analysis, the best that can be said is that such analysis flies in the face of allowing competition rather than regulation to drive the market's restructuring process.

MAKING THE RACE LONGER

The call for a new merger standard apparently assumes that harmful increased concentration in the generation sector will occur as a result of all utility mergers. The logical path to this conclusion is a curious one: "In other words, should the merged company be given credit for achieving the competitive benefits of open access if all public utilities have open access?"17 The argument seems to be that having achieved throughout the industry what merger policy of the 1980s sought to achieve only on a case-by-case basis, the FERC must now raise its competitive sights to a higher level.

The reasoning runs backwards: If transaction-specific open access adequately offset any generation concentration associated with past mergers, the problem should be further diminished once open access becomes the industry norm.

The message appears to be that some within the FERC are simply not finished doing all that they believe must be done to improve the industry; the ante for playing in the merger game must go up again. Viewed this way, a more intrusive FERC merger policy could offer an easy means of fine-tuning regulation in favor of new market entrants.

For potential merger partners, this approach also evidences a potentially harmful tendency to generalize about market definition and market analysis, and to use those generalizations to expand the reach, if not the rigor, of FERC merger analysis. Even the Department of Justice comments on the FERC Mega-NOPR recognize that open access is likely to broaden the relevant geographic market for generation by alleviating some of the impediments to wholesale wheeling.18 As a result, open access is likely to lower concentration in generation markets and, thus, reduce the risk that market power will be exploited.

Regulators should avoid a static view of competition in the industry, particularly in an industry involving approximately 715 generator owners, including 234 exempt wholesale generators.19 The case certainly has not been made for a new merger standard around the untested (and probably incorrect) presumption that competitively harmful generation concentration will be the order of the day if utility mergers are allowed. Without seriously and carefully factoring in the broadening of the geographic market for generation that is taking place on the heels of the FERC's own unprecedented requirements for generic transmission tariffs, regulators will be required to manage the structure of the industry forever (em searching for a structure that promotes "robust wholesale competition" that is in the "public interest."

The prescription for precise doses of managed competition may be very simple, and not at all surprising. Without waiting for the therapeutic results of transmission comparability, some would bring the industry back to the operating table for the type of surgery applied by the FERC's merger conditions in the 80's. About this treatment regime, Commissioner Massey has mused over the idea of forcing merger partners to turn their transmission systems over to an independent system operator (ISO) to mitigate market power.

Industry executives and counsel have heard the message. And, perhaps with an eye toward the conditioning authority developed in the Utah Power and Light Co. case, utilities have included the ISO concept in merger applications as well as their own public pronouncements about the future of the industry.20 Thus, once again, change in FERC merger policies could prove both a catalyst to action and a prelude to more restructuring.

THE SAVVY RUNNER

As an informed student of the industry, Massey is correct in observing: "The smart savvy utility executives who are looking to merge will form an alliance that can build on strengths, reduce weaknesses, provide substantial customer benefits, and otherwise make the right strategic fit."21 The FERC should allow executives to make these adjustments, thereby allowing market forces to operate in response to the rapid changes brought about by increased competition. For the FERC to reengineer its merger standard to inject more of its brand of competition into the mix would upset the proper balance that must govern sound merger policy. As the

Department of Justice has recognized, good mergers can stimulate competition. The balanced approach traditionally applied to other competitive markets should continue to guide the FERC's review of utility mergers. t

John Mandt is a partner with the Balch & Bingham law firm in Birmingham, AL. He advises public utility and other clients concerning antitrust matters, mergers and acquisitions, and corporate finance. Karl Moor is a partner with the firm's Washington, DC, office, specializing in regulatory matters affecting investor-owned electric utilities, with particular emphasis on matters of competition policy and the antitrust implications of regulatory change.

1 Section 203 of the Federal Power Act vests regulatory authority over public utility mergers with the FERC, 15 U.S.C. (sc 824a (1988).

2 Federal Energy Regulatory Commission's Notice of Proposed Rulemaking, "Promoting Wholesale Competition Through Open Access Nondiscriminatory Trans. Servs. By Pub. Utils.," Dkt. No. RM95-8-000, Suppl. Notice of Proposed Rulemaking, "Recovery of Stranded Costs by Pub. Utils. and Transmitting Utils.," Dkt. No. RM94-7-001, ("FERC Mega-NOPR"), 70 F.E.R.C. (pp 61,357, 60 Fed.Reg. 17,662 (April 7, 1995).

3 Midwest Power Sys., Inc. Dkt. No. EC95-4-000, 71 F.E.R.C. (pp 61,386 at 62,513 (1995).

4 See, "FERC's Evolving Merger Policy," Address by William L. Massey, Commissioner Federal Energy Regulatory Commission, Edison Electric Institute, Fall Legal Conference, Palm Beach, FL, October 12, 1995, p. 3 ("Massey speech to EEI").

5 See, Utah Power & Light Co., 45 F.E.R.C. (pp 61,095 at 61,283 (1988).

6 Mega-NOPR, mimeo at 4.

7 See, Brown Shoe Co. v. U.S., 370 U.S. 294, 319-20 (1962).

8 See, 1984 Merger Guidelines at Section 1; 1992 Merger Guidelines at 0.1.

9 See, Massey Speech to EEI at 6.

10 See, W. Hughes & G. Hall, "Substituting Competition for Regulation," 11 Energy Law Journal 243, 245 (1990).

11 Mega-NOPR, mimeo at 3.

12 See, Midwest Power Sys., Inc., 71 F.E.R.C. (pp 61,386 at 62,512 (June 22, 1995).

13 See, 1992 Merger Guidelines at Section 0.

14 Midwest Power Sys., Inc., 71 F.E.R.C. (pp 61,386 at 62,513.

15 See, FTC v. Alliant Techsystems, Inc., [1992-3] Trade Cas. (CCH) (pp 70,047 (D.D.C.1992); U.S. v. Alliant Techsystems, Inc., 1994 WL 362247 (C.D.Ill.1994).

16 See, generally, Kwoka & Warren Boulton, "Efficiencies, Falling Firms, and Alternatives to Merger; A Policy Synthesis," Antitrust Bulletin, 431, 439 (Summer 1986) (noting that merger alternatives such as joint ventures, plant swaps, or interfirm contracting may pose competitive risks of increased collusion).

17 See, Massey speech to EEI, mimeo at 7 (emphasis added).

18 Comments of the Department of Justice in response to the Federal Energy Regulatory Commission's Mega-NOPR, filed August 7, 1995.

19 1993 Electric Power Annual at III.

20 Utah Power & Light Co., 45 F.E.R.C. (pp 61,095.

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