**Testimony of Suedeen G. Kelly**

**Commissioner, Federal Energy Regulatory Commission**

**Before the Committee on Energy and Natural Resources**

**United States Senate**

**May 1, 2008**

[Introduction]{.underline}

Thank you, Chairman Bingaman, Ranking Member Domenici, and members of
the Committee for your leadership and for the opportunity to update you
on the status of the Energy Policy Act of 2005 (EPAct 2005) and the
Public Utility Holding Company Act of 2005 (PUHCA 2005) and their
implementation.

I also want to extend my gratitude to Senators Feingold and Brownback
who, along with Chairman Bingaman, asked the Government Accountability
Office (GAO) to look into the progress made on the implementation of
EPAct 2005. More specifically, I applaud them all for demanding a close
look at what the Commission is doing to prevent cross-subsidization.
Cross-subsidization was central to this legislation's enactment, and we
-- as a Commission -- can and must go farther than we have on this most
serious issue. As Federal Energy Regulatory Commission (FERC) Chairman
Kelliher noted in his testimony, "At heart, the Commission is a consumer
protection agency," and the Commission must continue to work closely
with this Committee and, more broadly, the Senate and the House to make
sure that FERC is protecting the American consumer.

This has never been more the case than today. With the repeal of PUHCA
1935, EPAct 2005 has correctly taken the Securities and Exchange
Commission (SEC) out of the enforcement-picture and has expanded FERC's
role considerably. I am proud of the work that the Commission and --
notably -- our tremendous staff have done to breathe life into this new
and evolving role.

Congress was correct to repeal PUHCA 1935, entrusting the regulatory and
enforcement roles to the states and to FERC, when it comes to the
holding companies that have acquired or seek to acquire public
utilities. FERC is equipped to regulate and take enforcement action to
enforce that regulation. Under PUHCA 2005, FERC and the states have
access to the holding companies' books and records, so that regulators
can make fully informed decisions. Congress has also correctly given the
Commission the authority it needs to "blow the whistle", as necessary,
and assess appropriate penalties.

Permit me to discuss four issues: first, the impact of this new
legislation on investment in the energy market; second, the need to
build more process into FERC's enforcement authority; third,
cross-subsidization; and fourth, the case for compliance.

[Impact of EPAct 2005 on the Energy Market -- New Investors]{.underline}

To understand the states' and the Commission's regulatory and
enforcement roles under this relatively new legislation, it is essential
to discuss the very positive impact EPAct 2005 has on the energy market
itself.

Born in this Committee, EPAct 2005 has helped the American consumer and
the economy by broadening the field of investors in the energy market,
which is one of the best ways to spur the improvements and innovations
in the market that we are all so eager to see. The proponents of this
legislation saw *new* opportunities for *new* investors with *new* money
and *new* ideas to enter the energy market, giving the impetus to push
ahead through the beginning of the 21^st^ century. As noted in the GAO
report, this objective has been met: new investors have entered the
energy marketplace since EPAct 2005 was enacted and specifically
*because* it was enacted. That is good news for the American consumer.

[Building a Better Enforcement Process]{.underline}

What this also means is that the energy market has welcomed a host of
new members and investors who may be, and -- in some cases -- are,
unfamiliar with regulation. It would be irresponsible for all of us to
purposefully attract new investors to the energy market and not educate
them about the rules that govern it. Therefore, the Commission must --
at a *minimum* -- develop an enforcement strategy and be transparent in
communicating that strategy to market participants. There is a distinct
difference between including objectives and scope in an individual audit
and setting forth the Commission's objectives, scope, vision, and
strategy for enforcement more broadly.

The GAO's thoughtful paper raises issues that this Committee and my
fellow Commissioners have and must take seriously. Whether we build
strategy risk-based assessments into the Commission's enforcement
mandate, as the GAO recommends, or some other methodology that is clear,
predictable, fair, and sufficiently straightforward such that market
participants can understand it and know what rules they must follow, it
is imperative that the Commission adopt and communicate a clear vision
for its enforcement strategy.

A risk-based assessment has considerable merit on the micro-level for
individual companies. First, risk is a metric readily identifiable in
the business community; market participants and holding companies make
decisions each day on the basis of their own risk calculations in a
variety of circumstances. Second, risk assessments can lay down clear
metrics that will give market participants sufficient predictability
concerning what is expected of them. Third, risk also provides the
flexibility to not be so prescriptive that the metrics rule out
unforeseen or variable circumstances. One size does not fit all, and
risk assessments take that reality into account.

For nearly all of the same reasons, a risk-based approach to enforcement
also has merit, on the macro-level, of assessing which companies,
regions, or problems should cause the Commission the greatest concern,
as it develops its enforcement strategy.

The key in all of this is to continue to foster Congress' successful
intent behind EPAct 2005 and PUHCA 2005: bringing new investment and new
investors into the marketplace, while avoiding another Enron from
occurring. With a clearly thought out and communicated enforcement
strategy, that marketplace predictability and enhanced certainty will
attract even greater investment and further protect the American
consumer from exploitation.

[Cross-Subsidization]{.underline}

It is no mystery that the provisions on cross-subsidization were central
to the passage and enactment of EPAct 2005. Nor was it a mystery in
2005. Cross-subsidization is to be avoided at all costs. Through
cross-subsidization, a utility could increase rates to the American
consumer not to benefit the consumer but to benefit some business entity
held by the utility or its holding company. Or, through
cross-subsidization, a utility could allow some unregulated entity held
by it or its holding company to use the utility's assets to provide it
an unfair competitive advantage and, possibly, harm the utility's
financial integrity. That is why the Commission took the steps it did,
as laid out in testimony by Chairman Kelliher. However, we can and must
do more.

Chairman Kelliher cautions against adopting a uniform and preemptive
federal rule on cross-subsidization in the absence of widespread
evidence of state regulatory failure. I agree with him that many state
regulatory commissions have succeeded, but they have not succeeded
across the board. I also agree that there is no one silver bullet for
preventing cross-subsidization, and that -- to use the example Chairman
Kelliher invoked -- some states have found ring-fencing to be very
successful, even though it can cause problems for other states which
have chosen not to accept it. That does not mean the federal government
cannot insist that at least one of a suite of mechanisms to prevent
cross-subsidization be adopted. Not every one of the 50 states needs to
adopt ring-fencing specifically, but they should all adopt some proven
mechanism to help them better regulate these holding companies and guard
the American consumer from cross-subsidization.

As a practical matter, the Commission currently relies primarily on
self-reported assurances from the market participants it regulates to
learn about their cross-subsidization practices and the likelihood of
those practices occurring. No amount of conferences, rules, or policy
statements will help the Commission obtain better information about
cross-subsidization until the Commission's auditing and enforcement arms
are given more resources and a clearer mandate to obtain the same
information on their own \-- *independent* of the information provided
directly by the market participants. Enhanced resources would also
permit the Commission to obtain better information from state regulators
and to meet more frequently with them. Finally, enhanced audit and
enforcement resources would build the Commission's capacity to analyze
this information so that it can better fulfill its mission to protect
the public interest.

Now is not the time to rule out options, but to explore them and adopt
one or more of them soon, whether it is through independent risk-based
assessments, as GAO recommends; ring-fencing; or some other method. We
must make sure we are doing all we can to guard the American consumer
from cross-subsidization and other forms of exploitation.

[The Case for Compliance]{.underline}

As the enforcement role of the Commission and the states continues to
evolve, regulators must work with market participants to ensure that
they understand how to comply with the rules -- especially insofar as
new investors who are unfamiliar with FERC, state regulators, and the
regulated energy marketplace generally are concerned. The Commission has
not used its authority to play "gotcha" with holding companies and other
market participants. That was not the intent of Congress and this
Committee. Still, we must make that abundantly clear to all market
participants and, in particular, to the new investors that EPAct 2005
was intended to attract.

With the 2005 enactment, the Commission has entered the enforcement
business and has room to grow in this endeavor. The Commission may want
to examine the enforcement practices of other government agencies
entrusted with similar authority, such as the Federal Trade Commission.
There are always ways to improve, and so why not look down the street to
agencies that have experience in this business? What are their
practices? What are their strategies? How are they staffed? What do
their budgets look like?

We may learn from these other agencies that it would be prudent for the
Commission to enter the "compliance" business as well. By assisting
regulated companies with their compliance on a more consistent basis,
they will gain a much better sense of what the rules are, how to comply
with them, and what the Commission values. The Commission, in turn, will
learn from its regulated companies which rules are clear and effective
and which are not. A strong compliance program presumably would provide
market participants with greater assurance that the Commission is not
out to play "gotcha." To the contrary, a more productive relationship
should emerge. At the end of the day, the American consumer would
benefit from a Commission working regularly with market participants to
make sure they understand the rules and are playing by them.

[Conclusion]{.underline}

This Committee's efforts, under the leadership of Chairman Bingaman and
Ranking Member Domenici, cannot go for naught. These new laws can be a
boon not only to the energy market and the American economy, but also to
the American consumer. This legislation has sent FERC into a new world
of enforcement with the authority to impose million dollar per day
penalties. With that great power comes great responsibility. We not only
need to know where to look, but also what we are looking for. To that
end, we must develop a comprehensive enforcement strategy and be clear
about it. We must also enlist market participants and the states as
allies to protect the American consumer from exploitation. The heavy
stick of enforcement cannot -- by itself -- get the job done. We must
require that public utilities have the necessary structures in place to
prevent cross-subsidization, and we must work together to make sure
everyone plays by the rules. Thank you.