Perspective

Fortnightly Magazine - June 15 1997

Corporations will need FERC approval for a merger simply because they own paper assets that qualify as utility property.

In three companion orders issued April 30, 1997, the Federal Energy Regulatory Commission tried to stake out new jurisdictional turf. It attempted to expand its jurisdiction under section 203 of the Federal Power Act to cover "convergent" mergers and reorganizations involving electric utility holding companies and power marketers. Examination of the orders reveals a mighty effort by FERC to come to grips with the protean nature of what we mean by the term "public utility."

We used to know what a "public utility" was: a vertically integrated business, serving as the producer, transmitter and distributor of electricity within a defined geographic territory. This definition is not universally true any more. Now we have "quasi-utilities" that provide only one or two of these services. The open-access world also has produced "virtual utilities," marketers who trade in electricity without owning or controlling any of the physical facilities needed for production, transmission or distribution.

The three new rulings FERC issued were: Enova Corp. and Pacific Enterprises %n1%n; Morgan Stanley Capital Group Inc. %n2%n; and NorAm Energy Services Inc. %n3%n The cases are especially significant for some corporations that do not resemble traditional utilities. Such firms will find that the new rulings require them to obtain approval from the FERC for a merger, restructuring or any other reorganization if they own any "public utility" assets. This category of assets may include the contracts, books and records owned by a power marketer. It won't matter that a utility itself is not being merged or reorganized. Nor that the deal involves only a power marketer's "paper assets."

What is the FERC's purpose? As we shall see, the FERC fears that mergers will impede competition. However, the same transactions already have satisfied antitrust scrutiny under the Hart-Scott-Rodino Act. The Department of Justice and the Federal Trade Commission, the government's presumed experts in antitrust law, have given these companies the green light. Why should section 203 require yet another round of bureaucratic oversight?

This section of the Federal Power Act was enacted to curb the so-called "Power Trusts" (em pyramidal holding company structures. Perfected by Samuel Insull (once the private secretary of Thomas Edison), the holding companies were thought to be devices for diverting utility earnings to Wall Street bankers. To rein in these "Malefactors of Great Wealth," Congress gave wide authority to the Federal Power Commission (now the FERC) to approve or disapprove a public utility's sale, lease or other disposition of jurisdictional assets (i.e., anything except generating facilities) worth more than $50,000, as well as any merger or consolidation of jurisdictional assets with those of another public utility.

Given the nexus between section 203 and the perceived abuses of holding companies during the 1920s and 1930s, it is ironic that, during the past decade or so, FERC has labored mightily to decide whether to apply section 203 to deals involving holding companies. The climax of these efforts came in the April 30 orders.

Prelude

Before 1987, the formation of a holding company to own the stock of a public utility was not regarded as a jurisdictional activity requiring FERC approval. After all, common stock is not a jurisdictional asset per se. Then, the FERC issued a series of three key rulings under section 203.

First, in 1987, it ruled that the transfer of a utility's stock (as when a utility creates a holding company) represents a transfer of ownership and control of its wires and other assets, necessitating approval under section 203. %n4%n Three years later, it carved out an exemption: The merger of two public utility holding companies would not invoke jurisdiction under section 203. %n5%n That exemption proved short-lived, however. In 1994, the FERC found a reason to review mergers between holding companies. It adopted a rebuttable presumption that "when public utility holding companies merge, their public utility subsidiaries likely retain no real corporate independence." Consequently, the FERC declared, "mergers between public utility holding companies also accomplish an indirect merger of their public utility subsidiaries," which requires approval under section 203. %n6%n

These cases all involved "traditional" public utility restructurings. However, as the industry entered the open-access and post-Order No. 888 worlds, non-traditional utility mergers became more prevalent. This trend prompted the Commission's decision to revisit section 203.

Enova's Novel Deal

As noted, a utility can trigger section 203 review when it transfers its own stock to a new holding company. A merger of two public utility holding companies can do the same. What happens, then, when two holding companies transfer their stock to a new common parent? The FERC answered that question in its lead case of April 30 in its Enova ruling.

The case involved Enova Corp. and Pacific Enterprises, both holding companies. They had filed a joint application seeking a disclaimer of jurisdiction over their merger. Enova is the parent of traditional electric utility, San Diego Gas & Electric Co. and a power marketer, Enova Energy. The latter has received authority to sell power wholesale at market-based rates. On the other side, Pacific Enterprises owned no public utility assets at all. It is the parent of Southern California Gas Co., an intrastate natural gas pipeline. As planned, the merger would not include any disposition of the stock of either San Diego Gas & Electric Co., the traditional utility, nor Enova Energy, the power marketer. The reorganization was to take place solely at the holding company level, two tiers above the operating energy companies.

Nevertheless, the Commission required approval of the deal under section 203. According to FERC, the transaction involved the transfer of control of utility assets. "The merger of the Enova and Pacific holding companies," the FERC explained, "will result in a disposition (a transfer of control) of the jurisdictional facilities of SDG&E and Enova Energy, and that, for purposes of section 203, the public utilities SDG&E and Enova Energy will have effectively disposed of their jurisdictional facilities."

As the Commission observed, section 203 was broad in scope, speaking to dispositions "by any means whatsoever." Reviewing section 203's legislative history, FERC concluded that it focused on disposition of control, "however such disposition might be effected."

It made no difference, the FERC said, that the subject of the change of control was "paper assets," such as contracts for the sale of electricity, rather than wires and transformers and other traditional public utility facilities (em both were jurisdictional assets. For future guidance, the Commission indicated that it would expedite its review of deals that would not pose major concerns, such as the merger of a marketer into a nonutility. It promised to modify its procedures, reduce the length of the comment period and expedite its decision in those cases. However, it warned that it would pay closer attention to transactions that could foster abuses of market power. Examples are horizontal mergers between vertically integrated utilities and mergers between two marketers or between a power marketers and an entity having control over fuel, transportation or other inputs to electric generation.

Do Marketers Matter?

The FERC had a chance to show off its new procedural determination in the second of the April 30 trilogy, the Morgan Stanley case. In dealing with the merger between Morgan Stanley, a great Wall Street investment banking firm, and financial services conglomerate Dean Witter, Discover & Co., the FERC ruled that section 203 applied to the merger but then proceeded to grant approval without much ceremony. Neither firm even resembled a public utility. They had sought a disclaimer of jurisdiction or, in the alternative, approval of the merger under section 203. The FERC refused to issue the disclaimer but approved the merger.

It did so in record time. The Commission took little more than a month from the filing to final action (em virtually instantaneous service in the FERC world. Because neither of the merging companies (nor their affiliates) owned transmission facilities nor a territorial franchise, the proposed "disposition of jurisdictional facilities" raised no concern over market power in generation or transmission. As a power marketer, Morgan Stanley Capital Group Inc. had neither captive customers nor market power (both prerequisites to the right to sell electricity at unregulated rates). The merger would produce no invidious rate effects, the FERC held.

But the FERC did not linger long over the real question: Should a merger be subject to FERC's section 203 scrutiny simply because the paper assets of a power marketer were involved? The FERC claimed jurisdiction because Morgan Stanley Capital Group, some two tiers down in the corporate hierarchy below the level at which the merger was taking place, had received authority in 1995 to do business as a power marketer charging market-based rates. This factor was the only link to a public utility in the entire case. Nevertheless, said the Commission, section 203 approval was required.

Was the transfer of control over mere paper assets what Congress had in mind in 1935 when it enacted section 203? The Commission would give its answer to that question in NorAm, the last of the April 30 trilogy.

The NorAm case began when NorAm Energy Services, a power marketer, filed a routine notice of change in its status. %n7%n It advised the Commission that its corporate parent planned a merger/restructuring with Houston Lighting and Power Co. Although HL&P is an electric utility, it operates only in the ERCOT region of Texas. %n8%n It is not interconnected with an interstate grid, so it does not qualify as a "public utility" under the Federal Power Act. The only "public utility" in the case was NorAm Energy Services, which would emerge from the deal as a second-tier subsidiary of a new holding company, a first-tier

subsidiary of the same corporation that had owned it at the outset.

NorAm argued that its status as a power marketer warranted a different treatment than that accorded a traditional utility merger. The Commission demurred, however. "[T]he statute makes no such distinction," it replied. The wholesale power sales contracts and books and records that a power marketer owns, the FERC said, are jurisdictional facilities under section 203. Thus, the planned merger between NorAm's parent and Houston Industries would amount to a transfer of control over "section 203 assets."

In addition, said FERC (quoting from its Enova-Pacific order), "[T]he Commission may disregard corporate form and regard a parent and its subsidiaries as a unit in order to determine whether statutory mandates would be frustrated by the proposed transaction."

Having concluded it had jurisdiction, the FERC withheld any ruling on the merits of the NorAm merger. That ruling, it said, would have to abide a formal review of the transaction. The decision to treat the merger this way leaves unanswered the question of what, if any, public policy was served by the exercise of the FERC's jurisdiction.

Conclusion: Reductio ad Absurdum

From a technical standpoint, the Commission's analysis of the issues in these three orders seems unobjectionable. FERC's discussion of the legislative history of section 203 did not distort it. Power marketers have indeed been considered "public utilities." The Commission's treatment of marketers' contracts as jurisdictional assets has never been seriously questioned. One can hardly quarrel with the FERC's notion that a sound national energy policy warrants review of "convergence" mergers between traditional, vertically integrated public utilities and other major energy concerns, such as natural gas pipelines and distribution companies. %n9%n

Less convincing, however, is the Commission's reason for asserting its jurisdiction over less traditional alliances. Why should a merger be subject to detailed FERC review when the deal has no real connection to the energy industry except for a power marketer lodged in the lower tiers of the corporate structure? Even in the absence of section 203 review, the FERC enjoys ample control over power marketers by virtue of its right to revoke their authority to do business at market-based rates, without which they cannot exist. The FERC has indicated it will exercise this authority if a marketer acquires an interest in power production inputs or engages in unauthorized dealings with affiliated electric utilities, among other reasons. Why is it necessary to take the additional step of subjecting power marketers to section 203 review when their corporate families align with a nonutility?

The Commission's attempt to answer these questions in NorAm offered two somewhat dubious arguments:

s First, special exemptions for marketers might undermine the entire regulatory program.

s Second, marketer status is unrelated to the exercise of jurisdiction under section 203.

As the Commission explained, all jurisdictional public utilities, not merely power marketers, remain subject to a myriad of regulatory controls. Carried to its logical conclusion, said the FERC, any argument that such controls make section 203 review unnecessary "would mean the Commission could not assert jurisdiction over dispositions of most public utility facilities, since we have oversight of, and place conditions on, virtually all utilities that engage in jurisdictional sales (em traditional and non-traditional utilities (such as power marketers) alike."

In any event, the Commission added airily, the question is irrelevant. "The fact that we have oversight of, and may impose conditions on the sale of, power marketers such as NorAm is unrelated to the issue of the Commission's jurisdiction over the disposition of NorAm's jurisdictional facilities."

Neither of these justifications seems satisfactory nor convincing. The first point suffers from the fallacy of reductio ad absurdum. In essence, the Commission argued that if it distinguished between "virtual

utilities," such as power marketers, and full-blown, vertically integrated utilities, its entire regulatory scheme could collapse. That reasoning is nonsense. Power marketers already enjoy many administrative exemptions from the FERC's regulations. No one has noticed a crumbling away of the Commission's regulatory program for traditional public utilities as a result. What the FERC's reasoning misses, of course, is that waivers exist to be granted. The exercise of discretion marks the essence of government.

The FERC's final point, that the unique status of power marketers is "unrelated to the issue" of an exemption from review under section 203, is simply an ipse dixit. It is "unrelated" only because the FERC chooses to ignore the relationship.

The NorAm order is plainly too broad. Perhaps its overbreadth was due to the Commission's effort to break new ground in dealing with the implications of quasi-utilities and virtual utilities. Given the pace of new developments in the electric industry and the size of its docket, the FERC certainly enjoys little time for patient reflection.

Nevertheless, the Commission should revisit the issue of requiring section 203 review of mergers involving corporate families that include no utilities except power marketers. It should examine whether an additional round of government review really serves the public interest simply because an enterprise trades in electric energy as a commodity. If FERC does so, it may well conclude that this is an instance in which "light-handed" regulation can serve the public interest. t

Isaac D. Benkin is a partner in the Washington, D.C. office of Winthrop, Stimson, Putnam & Roberts. He is a former administrative law judge at the Federal Energy Regulatory Commission.

1Docket No. EL97-15-000, 79 FERC ¶61,107.

2Docket No. EC97-23-000, 79 FERC ¶61,109 (consolidated with CHI Power Marketing, Inc., Docket No. EC97-26-000).

3Docket No. EL97-25-000, 79 FERC ¶61,108.

4Cent. Vermont Pub. Serv. Corp., 39 FERC ¶61,295 (1987).

5Missouri Basin Mun. Pwr. Agency, 53 FERC ¶61,368 (1990), reh. den., 55 FERC ¶61,464 (1991).

6Illinois Pwr. Co., 67 FERC ¶61,136 (1994).

7"Change-in-status" filings notify FERC of some change in the information upon which the Commission based its approval of power marketer status. They are usually pro forma in nature, though this one struck the FERC as significant.

8ERCOT, the Electric Reliability Council of Texas, is one of the regional reliability councils set up by the North American Electric Reliability Council.

9Indeed, at least one major merger between a public utility and a large natural gas pipeline had been submitted to FERC for approval under section 203 on a voluntary basis. See Enron Corp. and Portland General Corp., 78 FERC ¶61,179 (1997).


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