```

[Senate Hearing 110-509]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 110-509
 
                      REGULATION OF THE ELECTRIC 
                            UTILITY INDUSTRY

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   TO

  EXAMINE THE ADEQUACY OF STATE AND FEDERAL REGULATORY STRUCTURES FOR 
GOVERNING ELECTRIC UTILITY HOLDING COMPANIES IN LIGHT OF THE REPEAL OF 
  THE PUBLIC UTILITY HOLDING COMPANY ACT IN THE ENERGY POLICY ACT OF 
2005, WITH PARTICULAR ATTENTION TO THE REPORT ISSUED BY THE GOVERNMENT 
ACCOUNTABILITY OFFICE--GAO-08-289, UTILITY OVERSIGHT: RECENT CHANGES IN 
                LAW CALL FOR IMPROVED VIGILANCE BY FERC

                               __________

                              MAY 1, 2008

                       Printed for the use of the
               Committee on Energy and Natural Resources

                     U.S. GOVERNMENT PRINTING OFFICE
44-545 PDF                 WASHINGTON DC:  2008
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               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman

DANIEL K. AKAKA, Hawaii              PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota        LARRY E. CRAIG, Idaho
RON WYDEN, Oregon                    LISA MURKOWSKI, Alaska
TIM JOHNSON, South Dakota            RICHARD BURR, North Carolina
MARY L. LANDRIEU, Louisiana          JIM DeMINT, South Carolina
MARIA CANTWELL, Washington           BOB CORKER, Tennessee
KEN SALAZAR, Colorado                JOHN BARRASSO, Wyoming
ROBERT MENENDEZ, New Jersey          JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas         GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont             JIM BUNNING, Kentucky
JON TESTER, Montana                  MEL MARTINEZ, Florida

                    Robert M. Simon, Staff Director
                      Sam E. Fowler, Chief Counsel
              Frank Macchiarola, Republican Staff Director
             Judith K. Pensabene, Republican Chief Counsel

                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Bingaman, Hon. Jeff, U.S. Senator From New Mexico................
Boyd, Michael E., President, CARE, Sunnyvale, CA.................
Domenici, Hon. Pete V., U.S. Senator From New Mexico.............
Feingold, Hon. Russell D., U.S. Senator From Wisconsin...........
Gaffigan, Mark, Director, Natural Resources and Environment, 
  Government Accountability Office...............................
Hempling, Scott, Executive Director, National Regulatory Research 
  Institute......................................................
Kelliher, Joseph T., Chairman, Federal Energy Regulatory 
  Commission.....................................................
Kelly, Suedeen G., Commissioner, Federal Energy Regulatory 
  Commission.....................................................
Kerr II, James Y., Commissioner, North Carolina Utilities 
  Commission Representing National Association of Regulatory 
  Utility Commissioners..........................................
Moeller, Philip D., Commissioner, Federal Energy Regulatory 
  Commission.....................................................
Owens, David K., Executive Vice President, Business Operations, 
  Edison Electric Institute......................................
Spitzer, Marc, Commissioner, Federal Energy Regulatory Commission
Wellinghoff, Jon, Commissioner, Federal Energy Regulatory 
  Commission.....................................................

                                APPENDIX

Responses to additional questions................................

                      REGULATION OF THE ELECTRIC 
                            UTILITY INDUSTRY

                              ----------                              

                         THURSDAY, MAY 1, 2008

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:30 a.m. in room 
SD-366, Dirksen Senate Office Building, Hon. Jeff Bingaman, 
chairman, presiding.

OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW 
                             MEXICO

    The Chairman. Alright. Good morning. Thanks to all of you 
for coming. I have a short statement to give. I know Senator 
Domenici does as well.
    But, Senator Feingold is our first witness today and is a 
Senator who is largely responsible for us having this hearing. 
He was very focused on this issue back when we were enacting 
the 2005 Energy bill. We appreciate him being here.
    So why don't we just go right to him and hear his testimony 
at this point. After that, I'll give my statement and Senator 
Domenici will give his.
    Senator Domenici. Welcome.

   STATEMENT OF HON. RUSSELL D. FEINGOLD, U.S. SENATOR FROM 
                           WISCONSIN

    Senator Feingold. Thank you so much, Mr. Chairman. I thank 
Senator Domenici, the Ranking Member. It's tremendously 
courteous of you to allow me to go at all and certainly to go 
at the beginning.
    Thank you very, very much. Thank you for holding this 
hearing. I'm here today to express my strong concerns about the 
lack of consumer and small business protections against harmful 
transactions or cross subsidization between companies and their 
affiliate companies.
    The Energy Policy Act of 2005 significantly altered the 
Federal regulation of utilities by repealing the Public Utility 
Holding Company Act or PUHCA of 1935. In response Chairman 
Bingaman, Senator Brownback and I requested a report from the 
General Accounting Office to examine the effect of PUHCA's 
repeal on the oversight of electric utility holding companies 
and the ability to prevent harmful cross subsidization. I'm 
pleased that the committee is examining the GAO's recent 
findings and recommendations that are identified in the report 
entitled, Utility Oversight: Recent Changes in Law Call for 
Improved Vigilance by FERC.*
---------------------------------------------------------------------------
    * Report has been retained in committee files
---------------------------------------------------------------------------
    The report is disturbing. It reveals that ``the Federal 
Energy Regulatory Commission has made few substantive changes 
to either its merger review process or its post merger 
oversight since the EPA Act and as a result does not have a 
strong basis for ensuring the harmful cross subsidization does 
not occur.'' Chairman, harmful cross subsidization results in 
very real and serious impacts on consumers, small businesses 
and our economy as a whole.
    Unfair practices between utility companies and their 
affiliates force electricity and natural gas consumers to foot 
the bill for another company's expenses and allows the 
utilities to unfairly compete against small businesses. Now 
previously, PUHCA, as you well know, had stood as a barrier to 
harmful cross subsidization and other abusive affiliate 
transactions for decades. Given its repeal it is essential that 
Congress ensure their effective authorities for oversight and 
regulation of electric utility holding companies.
    Under the current law established in 2005 to encourage 
investment in the utility sector there is little doubt that 
utilities will become larger, more complex and located in 
geographically diverse areas. The size and complexity of these 
companies also will make it more difficult to identify abuses. 
Unfortunately all too often utilities have succumb to 
temptation and have relied on the more stable regulated 
utilities within the company to shore up balance sheets and 
offset risky non-utility investments while customers, 
ratepayers and investors pay the bill.
    To ensure adequate protections, Senator Brownback and I 
have championed efforts to require FERC to establish ring 
fencing rules to help ensure that the financial integrity of 
public utilities is not harmed by the repeal of PUHCA. Ring 
fencing is the legal walling off or encircling of a regulated 
utility from its unregulated affiliates. Insulating utilities 
in this way is intended to protect regulating the utility 
itself and its investors, the electricity and natural gas 
consumers as well as to prevent unfair, illegally subsidized 
competition with small businesses.
    Our legislative proposal has the support of trade 
associations, unions, small business representatives, public 
interest groups and utility associations, such as the American 
Public Power Association, the American Sub Contractors 
Association, Associated Builders and Contractors, Association 
of Financial Guarantee Insurers, International Brotherhood of 
Electrical Workers, National Electrical Contractors 
Association, Plumbing, Heating, Cooling Contractors, public 
citizens, public interest research groups, Small Business 
Legislative Council and the Sheet Metal and Air Conditioning 
Contractors National Association.
    So, Mr. Chairman, I look forward to continue to work with 
you, this committee, Senator Brownback and our colleagues to 
ensure that there are strong safeguards against harmful cross 
subsidization. Thanks so much to both of you.
    The Chairman. Thank you very much for your testimony and 
your interest in this issue and continued focus on it. I think 
it's useful to us. We are going to try at today's hearing to 
get good testimony about what, if any, additional action we 
should consider here in the Congress. But thank you very much.
    Senator Domenici. Thank you, Senator.
    The Chairman. Let me go ahead and make a statement, and 
then Senator Domenici. Then we'll call the first panel forward. 
I believe this is an important hearing. I look forward to 
hearing from the witnesses, and appreciate the thoughtful 
testimony we've already received in written form.
    In 2005 when we passed the Energy Policy Act, we did a 
number of things related to the electric utility industry. 
Among the most important, Senator Feingold mentioned was the 
repeal of PUHCA. PUHCA had stood as an important consumer 
protection statutes since 1935. In the 1930s when PUHCA was 
passed, the country had just been through a great deal of 
turmoil in the electric utility industry.
    In the 1920s the industry had expanded rapidly. The 
financing of that expansion was through some highly 
questionable corporate practices. Large complicated holding 
company structures were developed and sprawled across the 
country.
    Regulation by the States was almost impossible, and there 
was no Federal regulation at that point. Many observers credit 
the Pondsey schemes developed to finance electricity expansion 
with being one of the main causes of the stock market crash in 
1929.
    Congress and the Roosevelt Administration passed PUHCA to 
get control of the corporate structure of the electricity 
industry. It did that in two ways. First, ownership of 
utilities by other kinds of businesses or ownership of other 
businesses by utilities was discouraged or outright banned.
    Second, large multi-State holding companies were required 
to file all affiliate transactions. All transactions with 
utility affiliates had to be at cost. The intent was to keep 
our corporate structure simple enough that State regulators 
could keep track of it or to subject multi-State systems to 
stringent regulation of inter-affiliate relationships at the 
Federal level.
    So as we began to move toward a more competitive industry 
many viewed PUHCA as being outmoded. Its strict ownership 
requirements discourage potential investors. Its geographic and 
structural requirements discourage new interest into markets.
    I agreed with that point of view. I still do. However, I 
also felt that the consumer protections of the Holding Company 
Act should not be entirely lost. We insisted that part of the 
legislation we would enact would strengthen FERC's merger 
authority to require clearer protection against cross 
subsidization and pledges of debt by a utility for the benefit 
of its affiliate companies.
    Many in Congress believe that this was not enough. The 
consumers would not be protected without broader consumer 
safeguards. We had just been through another era when utilities 
were getting into financial trouble because of their 
relationships with corporate affiliates and Members of Congress 
were concerned.
    Some of these protections were accepted, such as the merger 
authority language. Senator Cantwell proposed market 
manipulation provisions that were included. Other proposals 
were not accepted. Specifically, Senator Feingold and Senator 
Brownback's proposal for affiliate transactions was not 
accepted.
    At that time, they asked for a report to be done by the GAO 
and that we have a hearing. I supported that request and this 
hearing is the result of that request.
    GAO has issued its report. GAO is here today to testify on 
its conclusions. They were highly critical, as Senator Feingold 
pointed out, of FERC's application of its new authority, its 
new merger authority and of its cross subsidization regime in 
general. FERC is here, primarily to argue that the rules they 
have put in place are sufficiently protective in their view.
    If GAO is correct and FERC's rules are insufficient, that's 
a serious issue that we need to try to correct. If Chairman 
Kelliher is correct and FERC is adequately protecting consumers 
than obviously we have nothing to worry about. So we're here 
today to look at that exact question. I very much appreciate 
all the witnesses being here.
    Senator Domenici.

   STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM NEW 
                             MEXICO

    Senator Domenici. Thank you very much, Mr. Chairman. Thanks 
to all of the Commissioners for joining us here today. I was 
one of those who for years thought PUHCA, years before its 
repeal, thought that it should be repealed. I remember that 
you, Mr. Chairman, went along with that as you've indicated in 
your statement. We did provide some safeguards that you wanted 
in the energy legislation that included that PUHCA repeal.
    I want to, here and now, complement the Commission under 
the leadership of its chairman. I believe from everything I 
have ascertained that the disagreement of Chairman Kelliher 
with the GAO findings is quite appropriate. I believe the 
chairman is correct. I believe GAO is not correct. Maybe they 
can convince me today.
    But from what I see all the ominous predictions, when we 
passed the repeal about merger mania would occur. We would see 
all kinds of the things happening that were protected against. 
None of those have happened.
    There's been no merger mania. Just been about average 
merger effectiveness as the years prior to the repeal. I want 
to, by day's end, hope that I can say to the Commission that 
they should continue with what they're doing and do it in a 
very strong and forceful way.
    I'm willing to listen to what those who are here to say 
that you ought to do more. But I frankly do not believe any 
harm to anyone has occurred during the time that we've had the 
repeal, during which the Commission has exercised its authority 
and has brought in the States where they can be helpers and 
make the thing work better. All in all, I think, in a very 
admirable job. Thank you very much, Mr. Chairman. I look 
forward to the witnesses.
    [The prepared statement of Senator Domenici follows:]

    Prepared Statement of Hon. Pete V. Domenici, U.S. Senator From 
                               New Mexico

    Welcome. Thank you all for being here this morning. I very much 
appreciate the witnesses taking time out of their busy schedules--
particularly all five FERC Commissioners--to appear before us today as 
we examine the repeal of ``PUHCA,'' the Public Utility Holding Company 
Act of 1935.
    After years of debate, Congress repealed this 70-year-old law in 
the Energy Policy Act of 2005. The rigid geographic and ownership 
limitations--while important protections in the wake of the 1929 stock 
market crash--became outdated. PUHCA's restrictions served as a barrier 
to much needed investment in the utility industry and denied customers 
potential merger-related benefits.
    Those opposed to PUHCA repeal argued that consumers would not be 
protected because affordable and reliable utility services could not be 
ensured. But everyone shared the common goal of consumer protection.
    In order to close any regulatory gaps left from PUHCA's repeal, 
Congress moved to protect consumers from affiliate abuse by:

   strengthening the merger review authority of both FERC and 
        the state commissions;
   enacting ``PUHCA 2005''--a provision granting federal and 
        state regulators access to holding company books and records 
        for audit and oversight purposes; and
   amending the Federal Power Act to require FERC, in its 
        merger review process, to protect consumers from improper 
        cross-subsidizations.

    Additionally, to address any remaining concerns of our colleagues 
who supported federal ``ring-fencing'' measures, the Energy Committee 
agreed to ask GAO to study the implications of PUHCA repeal and 
committed to conduct a hearing on the results. Of course that completed 
GAO report is now before this Committee--it's why we're all here today.
    Despite some of the doomsday predictions we heard during the energy 
debate, there has not been an explosion of merger proposals in the 
industry. FERC has reviewed only 17 merger proposals since passage of 
EPAct. Importantly, GAO has not found any instances of cross-
subsidization since PUHCA repeal.
    However, GAO does find fault with the oversight provided by both 
FERC and the states and concludes that the Commission lacks a strong 
basis for ensuring that harmful cross-subsidization does not occur.
    Mr. Chairman, I appreciate you holding this hearing today. I know 
FERC has worked very hard to implement its new Energy Policy Act 
responsibilities and that Chairman Kelliher disagrees strongly with the 
GAO's findings. While PUHCA may no longer be the front-burner issue it 
was back during the energy bill debate in 2005, it is important that we 
understand the implications of that repeal and its impact on consumers. 
I also want to thank GAO for undertaking this review and thank the 
other witnesses before us--representing state, consumer, and utility 
interests--in assessing today's post-PUHCA regulatory scheme.

    The Chairman. Thank you very much. Why don't we go ahead 
and call the first panel forward. Chairman Kelliher, 
Commissioner Moeller, Commissioner Wellinghoff, Commissioner 
Kelly and Commissioner Spitzer, please. Thank you all for being 
here. We very much appreciate it.
    Why don't we start with you, Chairman Kelliher? Why don't 
you go ahead with your statement? We'll include all the 
statements, of course, in the record as if read. But any points 
you would like to make to us orally, we're glad to hear those 
as well. So, go right ahead.

   STATEMENT OF JOSEPH T. KELLIHER, CHAIRMAN, FEDERAL ENERGY 
                     REGULATORY COMMISSION

    Mr. Kelliher. Thank you, Mr. Chairman. Let me begin first 
of all by thanking you for your efforts on the Farm bill. There 
were provisions in the Farm bill that could have fractured FERC 
jurisdiction over wholesale power markets, could have impaired 
our ability to assure just and reasonable wholesale power 
prices and actually invited manipulation. I want to thank you 
for your leadership in working on those provisions and the hard 
work of your staff. So I'm grateful for that.
    My written statement does emphasize what FERC has done 
since Congress expanded our merger authority in 2005. But what 
I'd like to do in my oral remarks is really answer, emphasize, 
a slightly different point. Why we have taken the course that 
we have and why we have not pursued certain alternatives. So 
really answer the why question rather than the what question.
    Now let me begin first of all by thanking Chairman 
Bingaman, Senator Domenici and other members of the committee 
for the strong merger provisions of the Energy Policy Act of 
2005. The expanded scope of that provision included generation 
facilities and holding company review and those changes I 
personally believe were necessary. I personally advocated in 
favor of those for close to 10 years.
    But Congress, in the expanded merger provisions, the 
expanded 203 provisions of the Energy Policy Act did largely 
ratify the merger test that FERC had used for a number of 
years. FERC--the Congress also added the cross subsidization 
provisions in section 203. I really think that's the core of 
the question here today is have we properly exercised, have we 
properly utilized the provisions regarding cross subsidies the 
Congress added to our merger and corporate review authority.
    I want to emphasize though that cross subsidization, by no 
means, is a new duty for the Commission. It's something that 
we've been doing since the 1930s. It's really at the heart of 
ratemaking, preventing improper cross subsidization.
    So addressing it in the context of merger review is not 
new. It's different. We have normally policed cross subsidies 
when we set rates rather than review a merger. But it's not 
altogether a new proposition for us.
    Now the Commission has been very active in implementing the 
expanded section 203 provisions. As detailed in my written 
testimony, we began within weeks of enactment of the new law. 
We continued through February of this year, so altogether the 
Commission has spent about two and a half years on the expanded 
section 203 provisions. But I welcome the interest of the 
committee in this area. I think we have acted in a manner 
consistent with the statutory language and congressional 
intent.
    But really to understand how the Commission has preceded, 
it's important to understand the nature of section 203. This is 
a very highly complex area. It is frequently short handed as 
our merger provision. But it actually goes far beyond mergers. 
It also applies to more than traditional utilities.
    I think there might be a perception that section 203 is a 
merger provision, only affects utilities. It does not. The 
range of entities that are subject to 203 is very broad.
    It includes independent power producers who have no cost 
based rates. It includes marketers and traders who own no 
generation, but own contracts. It includes utilities that truly 
are not vertically integrated. They don't own generation. They 
don't make wholesale power sales.
    It also applies to a very wide range of transactions. 
Securities transactions, utility purchases of power plants, 
internal transfers where there actually is no sale, merger or 
acquisition, the sale of power plants between two unaffiliated 
power producers. So it applies to a very wide range of 
transactions. Some of which actually do not entail a risk of 
cross subsidization.
    Now another factor that governed our review is what should 
the proper relationship of FERC be to State regulators as we 
address cross subsidization. To me that's governed our 
decisions. Given there's a broad range of transactions.
    Another complexity is that there's more than one way to 
guard against cross subsidization. Even ring fencing, which is 
a popular and a proven means. It is a category. There's 
actually a variety of ring fencing measures. So some 
transactions raise risk of cross subsidization, some do not. 
There are a range of equally effective ways to guard against 
cross subsidization.
    So then that led us to a threshold question of how should 
we use this in a new authority given our relationship with the 
States. The way electricity is governed in this country, we 
have a very Federalist scheme. FERC has strong authority. 
States have strong authorities.
    The kinds of transactions that do entail some risk of cross 
subsidization typically involve a vertically integrated 
utility. Vertically integrated utilities are typically governed 
by both FERC and State regulation. The kind of transactions 
that arguably raise the greatest risk of cross subsidization 
are typically subject to both FERC and State merger review.
    Now we had two paths that we could go down as we use our 
new 203 authority. One is a preemptive approach where we would 
establish a single Federal rule to guard against cross 
subsidization at the point of a merger or we could take a 
cooperative approach. To me the rationale for the preemption 
approach would be a view, a prediction or actually almost an 
assumption of comprehensive failure by the part of State 
regulators to guard against cross subsidies. I'm not prepared 
to make that assumption. I don't think the Commission is 
either.
    The rationale for cooperation is a view that Federal and 
State regulators actually have a concert of interest. We both 
want to avoid cross subsidies. We both have a duty to prevent 
cross subsidies. We're charged with protecting different 
consumers, retail consumers or wholesale consumers.
    But we actually have a concert of interest. We believe that 
we recognize there's more than one equally effective way to 
guard against cross subsidies. There's actually no need to 
preempt the States. To me, need alone should dictate whether we 
preempt the States. I think it's actually unnecessary to 
preempt the States in this area.
    So FERC has taken a cooperative approach with the States. 
The approach that we've taken, we will review. We allow States 
to address cross subsidies. We will review the conditions they 
establish. If we find them inadequate we will add to them. But 
we will have a cooperative approach.
    That is reflected in the recent order the Commission 
approved with regard to Puget Sound in Washington State. 
Washington State has very strong ring fencing protections. We 
will look to the provisions, the protections that the State 
ultimately decides on. If necessary, we'll add to them.
    With that I just wanted to emphasize the kind of approach 
that we took and the considerations that we bore in mind as we 
developed our policy toward implementing section 203. I thank 
you for inviting the Commission today.
    [The prepared statement of Mr. Kelliher follows:]

  Prepared Statement of Joseph T. Kelliher, Chairman, Federal Energy 
                         Regulatory Commission

                        INTRODUCTION AND SUMMARY

    Mr. Chairman and members of the Committee, thank you for the 
opportunity to speak here today. My testimony addresses the efforts of 
the Federal Energy Regulatory Commission (FERC or the Commission) to 
implement the aspects of the Energy Policy Act of 2005 (EPAct 2005) 
concerning electric utility holding companies in the context of mergers 
and elsewhere. Supplies and prices of energy play a critical role in 
our economy and in the welfare of our Nation's citizens. EPAct 2005 
sought, in various ways, to allow and encourage greater investment in 
the energy industry while at the same time protecting customers from 
cross-subsidization and other improper activities. I welcome the 
Committee's review of these important issues.
    At heart, the Commission is a consumer protection agency. Our 
primary task since the 1930s has been to guard the consumer from 
exploitation. The Commission has extensive ratemaking authority under 
the Federal Power Act (1935) and the Natural Gas Act (1938), and the 
Commission has used that authority vigorously to prevent cross-
subsidization. Our most powerful tool for preventing cross-
subsidization is the disallowance of recovery in rates of costs found 
unjust and unreasonable as improper cross-subsidies. The states have 
similar tools to prevent rate recovery of unjust and unreasonable 
costs. And, these tools apply to all utilities, not just the few 
involved in a merger at any given time.
    EPAct 2005 expanded FERC's merger and corporate review authority 
under section 203 of the Federal Power Act (FPA). Specifically, EPAct 
2005 clarified our jurisdiction over public utility holding company 
mergers, and granted FERC authority over acquisitions of generation 
facilities used for wholesale sales and certain holding company 
securities acquisitions. With respect to these changes, I thank 
Chairman Bingaman in particular for his leadership in filling statutory 
gaps regarding holding company mergers and generation facility 
acquisitions. EPAct 2005 also largely codified the merger test used by 
FERC for some years but, significantly, added to the public interest 
determination a required finding that a transaction will not result in 
cross subsidization of a non-utility associate company or the pledge or 
encumbrance of utility assets for the benefit of an associate company, 
unless such cross-subsidization, pledge or encumbrance is in the public 
interest. Finally, EPAct 2005 amended FPA section 203 to hold that a 
merger or other corporate transaction requiring section 203 approval 
will be deemed granted if the Commission does not act within 180 days 
of filing, with the opportunity for the Commission to grant itself one 
180-day extension for good cause. This time limitation signaled 
Congressional intent that the Commission act expeditiously in making 
its public interest determinations for corporate transactions.
    EPAct 2005 also repealed the Public Utility Holding Company Act of 
1935 (PUHCA 1935) and enacted PUHCA 2005. Under PUHCA 1935, the 
Securities and Exchange Commission (SEC) regulated certain utility 
holding companies extensively. In the decades after PUHCA 1935's 
enactment, federal and state regulation of utilities increased 
significantly enough that PUHCA 1935 was thought to be an unnecessary 
impediment to investment in the energy industry. Therefore, PUHCA 2005 
does not require or allow the Commission to regulate holding companies 
in the same way as the SEC did under PUHCA 1935. This is because the 
Commission and states have very powerful regulatory tools to protect 
customers against holding company abuses, particularly their corporate 
and ratemaking authorities. To assist them in using their ratemaking 
tools, PUHCA 2005 authorizes the Commission and state regulators to 
obtain the books and records of holding companies and their members if 
relevant to jurisdictional rates. State regulators have independent 
authority under PUHCA 2005, and do not need FERC's approval to obtain 
information. The only provision of PUHCA 2005 that touches on the 
Commission's substantive authority is a procedural provision that 
allows multi-state holding companies and state commissions to obtain a 
determination regarding centralized service company cost allocations 
for such multi-state holding companies, although the Commission already 
has substantive authority to do this under the FPA now that PUHCA 1935 
has been repealed.
    The Commission implemented its responsibilities under EPAct 2005 
within the tight deadlines set by Congress, and has subsequently issued 
additional rules to improve its implementation of PUHCA 2005, its new 
corporate authorities under FPA section 203 and its rate oversight with 
respect to potential cross-subsidies. The Commission's new rules 
address, e.g., accounting for centralized service companies in holding 
companies, pricing for affiliate trades of non-power goods and 
services, and cross-subsidy filing requirements for applicants in FPA 
section 203 cases. On the latter issue, our policy is to accept state 
cross-subsidization protections absent evidence that additional 
measures are needed to protect wholesale customers or where states lack 
authority in this area.
    In addition, the Commission staff conducts targeted audits to 
detect and protect against cross-subsidization. The Commission 
considers a range of factors in selecting companies for audits, 
including a variety of methods for assessing risk. The Commission has 
never relied on self-reports as its primary enforcement mechanism to 
prevent inappropriate cross-subsidization. While the Government 
Accountability Office (GAO) has criticized our efforts, I do not 
believe its report reflects a full understanding of the factors 
considered by the Commission in selecting companies for audits or in 
conducting the audits, as discussed in more detail below.

       IMPLEMENTATION OF EPACT 2005'S MERGER AND PUHCA PROVISIONS

    Upon enactment of EPAct 2005, the Commission took a series of 
actions addressing FPA section 203 and PUHCA 2005, all within the 
statutory deadlines:

          (1) adopted regulations to implement PUHCA 2005, including 
        detailed reporting and record retention requirements for 
        utility holding companies and their service companies, and 
        accounting requirements for centralized service companies, 
        codified at 18 C.F.R. Part 366 (December 2005);
          (2) revised the accounting requirements for centralized 
        service companies, to provide greater accounting transparency 
        (proposed rule, April 2006; final rule, October 2006);
          (3) amended the Commission's regulations for FPA section 203 
        to require explicit consideration of whether a proposed merger 
        or other corporate transaction ``will result in cross-
        subsidization''; required applicants to provide the Commission 
        with a record that would allow it to address cross-
        subsidization; and required applicants to demonstrate that 
        proposed mergers would not result in cross-subsidization or the 
        pledge or encumbrance of utility assets, or explain how the 
        cross-subsidization or pledge or encumbrance would be in the 
        public interest (December 2005); and
          (4) amended the Commission's regulations under FPA section 
        203 to grant ``blanket authorizations'' (a regulatory pre-
        approval) for certain transactions that would accommodate 
        greater investment in utilities, including certain holding 
        company acquisitions of utility securities under new FPA 
        section 203(a)(2), where there was no adverse impact on 
        competition or harm to captive customers (December 2005).

    As a foundation for a second round of initiatives, the Commission 
held public conferences on December 7, 2006, and March 8, 2007. 
Industry participants and state commissioners provided input on key 
issues including the protection of utility customers from cross-
subsidization. In particular, the Commission sought input on overlaps 
in state-federal jurisdiction with respect to mergers and various 
cross-subsidization protections such as ``ring-fencing'' and other 
techniques to protect the assets of regulated utilities. One important 
purpose of these conferences was to solicit the views of state 
regulators on the best way to prevent cross-subsidization, and how to 
coordinate federal and state merger review to that end.
    In response to the input received in those conferences and written 
comments following the conferences, the Commission took the following 
actions in July 2007:

          (1) The Commission issued a Supplemental Merger Policy 
        Statement, which provided clarification and guidance on the 
        types of commitments applicants could make and the ring-fencing 
        measures applicants could offer to address cross-subsidization 
        concerns. In response to recommendations by the states, the 
        Commission said that it would accept state ring-fencing 
        measures absent evidence that additional measures were needed 
        to protect wholesale customers or where there was a regulatory 
        gap because states lacked such authority. The Commission also 
        adopted certain ``safe harbors,'' for example, for transactions 
        not involving a franchised public utility with captive 
        customers, since these are unlikely to present cross-
        subsidization concerns.
          (2) The Commission proposed rules to codify restrictions on 
        the pricing of power and non-power goods and services in 
        affiliate transactions between franchised public utilities with 
        captive customers, on the one hand, and their market-regulated 
        power sales affiliates and their non-utility affiliates, on the 
        other hand.
          (3) The Commission proposed rules to grant additional limited 
        ``blanket authorizations'' for certain jurisdictional corporate 
        transactions that would not harm either competition or captive 
        customers.

    In February of this year, the Commission adopted final rules on the 
pricing of non-power goods and services. The rules require that any 
such sales to a franchised public utility with captive customers by a 
market-regulated power sales affiliate or non-utility affiliate will 
not be at a price above market price, and any such sales by a 
franchised utility with captive customers to a market-regulated power 
sales affiliate or non-utility affiliate will be at the higher of cost 
or market price, unless otherwise authorized by the Commission. The 
Commission also codified a requirement it had previously imposed case-
by-case, requiring its prior approval under FPA section 205 of any 
power sales between a franchised public utility with captive customers 
and any market-regulated power sales affiliates. These restrictions 
apply to all public utilities, not just those proposing a merger. These 
rules strengthen FERC's ability to protect customers against affiliate 
abuse.
    Also in February, the Commission adopted final rules allowing 
additional limited blanket authorizations to facilitate investment in 
the electric utility industry and, at the same time, ensure that public 
utility customers are adequately protected from any adverse effects of 
such transactions.
    All of the above rules and the Commission's Supplemental Merger 
Policy Statement have focused first and foremost on ensuring customer 
protection (including protection against inappropriate cross-
subsidization) and precluding harm to competition, but also on removing 
unnecessary transaction burdens and limitations on much-needed 
investment in the utility industry. Also, consistent with Congress' 
specific directive in the section 203 amendments, the Commission in its 
rules has identified classes of transactions that meet the statutory 
standards for approval and thus can be expeditiously considered for 
approval.

            CROSS-SUBSIDIZATION ISSUES UNDER FPA SECTION 203

    In exercising our new responsibility to police cross subsidies in 
evaluating merger applications, we could have imposed a uniform and 
preemptive federal rule on ring-fencing provisions. That approach, 
however, could have preempted state merger conditions even if those 
conditions guarded against improper cross subsidization just as 
effectively as the federal rule. Given the common interest of FERC and 
state regulators in policing improper cross subsidization, that 
approach would have produced unnecessary conflict between federal and 
state regulators.
    Under FERC's more flexible approach, we will review merger 
conditions imposed by a state commission to protect consumers from 
improper cross subsidization or encumbrance, such as ring fencing or 
other measures. If these conditions are sufficient to guard against 
improper cross subsidization, FERC will not impose additional 
conditions. If we determine state safeguards are inadequate, we will 
impose additional conditions. If states have no authority to act, we 
likewise will step in to ensure that adequate protections are in place.
    Our approach reflects the reality that a wide variety of 
transactions are subject to FPA section 203, many of which are not 
mergers of regulated utilities. Some of these transactions entail some 
risk of improper cross-subsidization, but others do not. Our approach 
also reflects the reality that there is more than one mechanism to 
effectively guard against improper cross-subsidization. Ring fencing is 
only one such means.
    In most cases, a transaction subject to section 203 that entails 
some risk of cross-subsidization would also be subject to review by 
state commissions. A preemptive federal approach would limit the 
ability of state commissions to craft cross-subsidization safeguards, 
and force state commissions to accept the federal rule. A preemptive 
approach could be warranted in circumstances such as when uniform 
regulation would provide a particular benefit or when widespread 
evidence suggests a regulatory failure on the part of state 
commissions. I do not believe that protecting against improper cross-
subsidization presents such a situation. I believe my state colleagues 
have been vigilant in guarding against cross-subsidization in the 
course of state merger review. Under our approach, FERC properly 
exercises its new duty to guard against improper cross-subsidization, 
and we can and will take action where state protections are inadequate. 
But we view preemption as a last resort, not a first resort.
    Earlier this month, the Commission applied this approach in 
conditionally approving the merger of Puget Energy, the holding company 
that owns Puget Sound Energy and other public utilities, and a number 
of investor firms, led by Macquarie Group. We found the transaction 
will not harm competition or rates, adversely affect regulation or 
result in improper cross subsidization. The Washington Utilities and 
Transportation Commission has strong ring fencing requirements, and the 
applicants' filing with the state commission proposed ring fencing 
commitments and other measures to insulate Puget Sound from any risk 
related to the financial activities of its affiliates as a result of 
the transaction. Consistent with our Supplemental Merger Policy 
Statement, we stated that we would accept the cross-subsidization 
conditions ultimately adopted by the Washington commission unless they 
are inadequate to police improper cross subsidization. We reserved our 
authority to issue supplemental orders as appropriate after the ring 
fencing provisions adopted by the Washington commission are filed with 
the Commission.
    In every case under FPA section 203, the Commission bases its 
decision on the record developed in that case--a record created not 
only by the applicant but also by others, including customers and state 
consumer advocates, competitors, state commissions and attorneys 
general. If this record is not adequate, the Commission can find that 
the applicant's filing is ``deficient'' and direct the applicant to 
submit additional record evidence. Other parties can review and 
challenge any of the evidence. The Commission also can institute so-
called ``paper hearing'' procedures or even trial-type evidentiary 
hearing procedures. Once there is sufficient record evidence, the 
Commission's decision must be based on this record evidence. A 
Commission decision based on non-record evidence will be overturned by 
a reviewing court.
    The Commission carefully analyzes the record evidence submitted by 
a section 203 applicant. However, the Commission is not bound to follow 
the analysis of the applicants, and it often does not. Rather, the 
Commission analyzes the entire record, determines the appropriate 
result based on the entire record, and provides its analysis of the 
record in its public order.
    While the Commission in some cases relies on commitments by merger 
applicants, and these commitments are important tools, they are far 
from the only tools used by the Commission. The Commission has many 
means by which it can prevent cross-subsidization, including its 
traditional ratemaking authority. However, applicant commitments 
usually reflect a careful review of Commission policy by the 
applicants, and applicants often anticipate merger conditions that 
would otherwise be imposed by the Commission to prevent cross-
subsidization. Further, adherence to those commitments is a condition 
of the Commission's approval and if public utilities do not adhere to 
the commitments they are subject to sanctions, including possible civil 
penalties. For every transaction approved under section 203, the 
Commission also retains authority under section 203(b) to issue such 
supplemental orders as it may find necessary or appropriate with 
respect to the transaction.

              CROSS-SUBSIDIZATION ISSUES IN OTHER CONTEXTS

    The Commission's rules implementing PUHCA 2005 will enhance the 
ability of the Commission and others to police cross-subsidization. As 
noted above, the Commission adopted new accounting regulations in 
October 2006, adding a new Uniform System of Accounts for centralized 
service companies, in order to provide greater transparency to protect 
ratepayers from paying improper service company costs. In addition, the 
Commission's December 2005 rules required holding companies and service 
companies to retain records consistent with the retention periods for 
public utilities and natural gas companies, and required centralized 
service companies to file on an annual basis financial information and 
information related to non-power goods and services provided to 
affiliates. Information collected in that form is available 
electronically to market participants and the public for use in 
detecting cross-subsidization, affiliate abuse, or other improper 
activities.
    As further protection, the Commission staff conducts targeted 
audits as proactive measures to detect and protect against cross-
subsidization. Even before PUHCA 1935 was repealed, the Commission had 
a longstanding practice dating back at least to the 1970s of auditing 
affiliated transactions as part of its financial audit program. More 
recently, in November 2003, the Commission began auditing affiliated 
transactions as part of its multi-scope audits covering its market-
based rate program. See, e.g., Progress Energy, 111 FERC  61,243 
(2005); Public Service Company of Colorado, Docket No. PA05-1-000 
(November 28, 2005).
    In anticipation of the repeal of PUHCA 1935, the Commission 
developed and implemented a comprehensive audit program to conduct 
audits of affiliated transactions to detect and deter cross-
subsidization. The audit program reflects the detailed auditing 
procedures and techniques used to guide the audit team in conducting 
the audits.
    The Commission considers a number of factors including the size and 
complexity of holding companies in determining how many holding company 
audits the Commission will conduct in a given year. PUHCA 2005 did not 
go in effect until February 2006. Until the Commission obtains 
sufficient experience conducting holding company audits pursuant to 
PUHCA 2005, the Commission cannot estimate precisely how many of these 
audits will be needed in the future. Three PUHCA 2005 audits are 
scheduled for FY08 and these are the initial audits focused on 
compliance with these requirements. These three audits include some of 
the largest utility holding companies. These audits are not definitive 
indicators of the number of audits that the Commission will perform in 
subsequent years.
    The Commission uses a variety of methods to assess risk in 
selecting audit candidates. These methods include internally developed 
screens and models, past compliance history, information gleaned from 
on-going and completed audits, investigations, complaints, Commission 
financial forms, SEC filings, websites, and rate information gathered 
from Commission and state rate filings. Further, unlike other agencies 
that do not have ratemaking responsibilities, the Commission has 
available a variety of legal and technical experts very familiar with 
the details of public utilities and the holding companies of which they 
are a part, and the particular regulatory and other issues facing those 
public utilities. We therefore bring all our expertise to bear in 
determining which companies should be audited.
    Contrary to the implications in the recent GAO Report,\1\ the 
Commission has never relied on self-reports as its primary enforcement 
mechanism to prevent inappropriate cross-subsidization. Cross-
subsidization, by its very nature, does not lend itself to being self-
reported. Ratemaking is a complicated process which relies on the 
development of an extensive record on costs and revenues, and 
determination of the proper allocation of costs between jurisdictional 
and non-jurisdictional operations, the appropriate distribution of 
costs between and among the various jurisdictional services, and the 
selection of an appropriate rate of return. Under these circumstances, 
self-reports would not be an effective method to monitor cross-
subsidization. In any event, prior to passing through costs in cost-
based rates, a public utility must request authority to do so and 
therefore the Commission, at the time of such a request, can determine 
whether the proposed rate or rate formula permits inappropriate cross-
subsidization to occur and, if so, to disallow rate recovery. Further, 
as described above, the Commission has adopted specific, prophylactic 
restrictions regarding the pricing standard that will be applied in 
determining whether transactions will be considered to have resulted in 
inappropriate cross-subsidization (in shorthand, whether an ``at cost'' 
or a ``market'' standard will be applied).
---------------------------------------------------------------------------
    \1\ GAO Report, Recent Changes in Law Call for Improved Vigilance 
by FERC, GAO-08-289(February 2008) at 8,10 and 14-15.
---------------------------------------------------------------------------
    In its report, the GAO makes four recommendations that purportedly 
would enhance the Commission's ability to detect and prevent harmful 
cross-subsidization involving public utilities. These recommendations 
focus primarily on post-merger oversight, in particular with respect to 
the audit process. While I appreciate the GAO's concern that audit 
candidates be chosen appropriately and that the Commission should take 
into account the financial risks facing a company, and I have asked 
Commission staff to look into the recommendations made by GAO, I do not 
believe the report reflects a full understanding of the factors 
considered by the Commission in selecting companies to be audited, or 
all of the factors in addition to risk that should be considered in 
selecting such companies.
    The GAO Report's first recommendation is that the Commission 
``[d]evelop a comprehensive, risk-based approach to planning audits of 
affiliate transactions in holding companies and other corporations that 
it oversees to more efficiently target its resources to highest 
priority needs and to address the risk that affiliate transactions pose 
for utility customers, shareholders, bondholders, and other 
stakeholders.'' Contrary to the premise of this recommendation, the 
Commission followed a risk-based approach in selecting the FY08 PUHCA 
audit candidates and will continue to follow a similar approach in the 
future. The risk-based approach entailed a comprehensive review of 
audit materials obtained from the SEC; discussions with the SEC; 
examination of financial information contained in FERC Form No. 60, 
FERC Form No. 1, and SEC filings; rate information gathered from 
Commission filings; and discussions with the Commission's legal and 
technical experts. In addition to the above methods, the Commission 
audit staff searched through 155 boxes of audit materials received from 
the SEC covering 28 holding companies, participated in several 
conference calls with the SEC staff responsible for the implementation 
of PUHCA 1935 and discussed audit practices, processes and procedures, 
as well as outstanding issues for certain holding companies. Finally, 
shortly after the audits started, the Commission held discussions with 
state commission officials in the states of Georgia, Alabama, 
Mississippi, Florida, Maryland, Virginia, West Virginia, and 
Pennsylvania.
    The second recommendation suggests that the Commission should 
develop a better understanding of the risks posed by each company, by 
monitoring the financial condition of utilities and developing a better 
means of collaborating with state regulators. Contrary to the GAO 
Report's assumptions, the Commission audit staff frequently interacts 
with state regulators during an audit. For example, the Commission's 
audit staff recently either met or had telephone conversations with 
eight state regulators regarding the three current FY08 PUHCA 2005 
audits. These actions demonstrate the Commission's recognition that 
maintaining contact with state regulators is mutually beneficial to the 
states and the Commission.
    However, the suggestion that the Commission should monitor the 
financial condition of utilities fails to appreciate that a company's 
stock price and bond ratings are typically driven by the company's 
overall business risks and prospects. Thus, the fact that a company's 
stocks or bonds are doing well or poorly says little or nothing, 
standing alone, about whether cross-subsidization is occurring. That is 
why the Commission's existing method of assessing risk is comprehensive 
and takes into account both financial and non-financial information 
rather than solely relying on a utility's stock prices and bond ratings 
as indicators of potential cross-subsidization.
    The third recommendation is that the Commission ``[d]evelop an 
audit reporting approach to clearly identify the objectives, scope and 
methodology, and the specific findings of the audit, irrespective of 
whether FERC takes an enforcement action, in order to improve public 
confidence in FERC's enforcement functions and the usefulness of audit 
reports on affiliate transactions for FERC, state regulators, affected 
utilities, and others.'' The Commission has always strived to clearly 
identify its objectives and methodologies for all areas of its 
jurisdictional responsibilities. The Commission is currently 
implementing this recommendation in the audit context. For example, in 
November 2007, the Commission's audit staff began the process of 
including an enhanced audit methodology section in all of its public 
audit reports. See, e.g., Kansas City Power & Light Co., Docket No. 
PA06-6-000 (Nov. 27, 2007). Also, the Commission's public audit reports 
have always included audit objectives and scope, as well as audit 
findings, where applicable. In contrast, the SEC previously issued non-
public audit reports at the completion of its holding company audits. 
Thus, the Commission's enhanced audit methodology and practice of 
publicly publishing audit reports have increased the transparency of 
the process.
    Finally, the GAO Report recommends that the Commission, ``[a]fter 
developing a more formal risk-based approach, reassess whether it has 
sufficient audit resources to perform these audits'' and request 
additional funds, if necessary. The Commission continuously reassesses 
its audit and other resources to achieve its strategic goals. To that 
end, for each audit cycle, the Commission prepares an annual audit plan 
that is vetted with senior Commission officials, and reviewed and 
approved by me as Chairman. Needless to say, the Commission will 
continue to seek additional funds from Congress if it believes it needs 
more resources to carry out its auditing responsibilities, including 
PUHCA 2005 and cross-subsidization audits, just as the Commission 
recently did when requesting additional funds for transmission system 
reliability audits. To summarize, the Commission's auditors already 
follow a risk-based approach for selecting holding company audit 
candidates for examination of their affiliated transactions, and the 
Commission constantly assesses and reassesses its audit resources to 
carry out the audit priorities in the annual audit plan. Similarly, the 
Commission continues to collaborate with state regulators to capitalize 
on their unique knowledge. Interacting with state regulators during the 
course of an audit is a practice the Commission auditors have followed 
for a long time. Finally, the Commission continually strives to 
maintain and improve existing staff practices to ensure that the audit 
reports include clear audit objectives, scope, and methodologies.

                               CONCLUSION

    In conclusion, let me emphasize that, just as the Commission has 
done since 1935, it will continue to be vigilant to protect customers 
from inappropriate cross-subsidization through its ratemaking and other 
authorities, and to also protect them against mergers or other 
jurisdictional corporate transactions that are not consistent with the 
public interest. The rules and policies the Commission has adopted 
since enactment of EPAct 2005, and the strengthening of its enforcement 
function, have given the Commission an even stronger foundation to 
protect against inappropriate cross-subsidization on an ongoing basis 
irrespective of whether a merger is involved. Our existing cross-office 
approach to regulating utilities allows us to bring to bear all agency 
expertise necessary to detect potential problems and protect customers. 
Further, with respect to protecting customers against inappropriate 
cross-subsidization or realignment at the time of a request for merger 
or other corporate approval under section 203 of the FPA, the 
Commission has in place a sound program for ensuring such protection--
an approach that provides appropriate deference to state regulatory 
protections and that fills any regulatory gaps.
    I note that it has now been two years since the repeal of PUHCA 
1935, the enactment of the PUHCA 2005 books and records provisions, and 
the amendments to our FPA section 203 corporate authority took effect 
(February 2006). Since that time, the predicted ``rush'' of major 
utility mergers and realignments has not occurred, and in fact the 
annual number of merger applications filed with the Commission has not 
increased compared to the prior period. Whatever the future may hold 
with respect to increased utility merger or investment activity, I 
believe the Commission has laid a solid foundation to adequately 
protect customers and we will continue to adapt our policies and our 
auditing approach as necessary to meet our core customer protection 
mission.
    I would be happy to answer any questions the Committee members may 
have, after my colleagues have had an opportunity to express their 
views.

    The Chairman. Thank you very much for your testimony. 
Commissioner Kelly, go right ahead.

  STATEMENT OF SUEDEEN G. KELLY, COMMISSIONER, FEDERAL ENERGY 
                     REGULATORY COMMISSION

    Ms. Kelly. Thank you, Mr. Chairman. Thank you, Chairman 
Bingaman, Ranking Member Domenici and members of the committee 
for your leadership and for the opportunity today to update you 
on the status of the Energy Policy Act of 2005 and PUHCA of 
2005 and their implementation.
    As Chairman Kelliher noted in his written testimony, at 
heart, the Commission is a consumer protection agency. The 
Commission must continue to work closely with this committee, 
and more broadly, the Senate and the House to make certain that 
FERC is protecting the American consumer. This has never been 
more the case than today.
    With the repeal of PUHCA 1935, EPACT has correctly taken 
the SEC out of the enforcement business and given the role to 
FERC. That has expanded FERC's role considerably. I'm very 
proud of the work that this Commission has done and notably our 
tremendous staff to breathe life into our new and evolving 
role.
    Today I'd like to discuss four issues:
    First, the impact of this legislation on investment in the 
energy market.
    Second the need to build more process into FERC's 
enforcement authority.
    Third, the issues of cross subsidization and encumbrances 
of utility assets.
    Fourth, the case for compliance.
    To understand the States and the Commission's regulatory 
and enforcement roles under this relatively new legislation, 
it's essential to discuss the very positive impact that EPACT 
has had on the energy market itself. EPACT has helped the 
American consumer and the economy by broadening the field of 
investors in the energy market, which of course, is one of the 
best ways to spur the improvements and innovations in the 
market that we are 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 into the 21st century.
    As noted in the GAO report, this objective has been met. 
New investors have entered the energy marketplace since EPACT 
was enacted and specifically because it was enacted. This is 
good news for the American consumer.
    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's a distinct difference between including objectives 
and scope in an individual audit and setting forth the 
Commission's objective, scope, vision and strategy for 
enforcement more broadly. The GAO's paper raises issues that 
this committee and my fellow Commissioners have taken seriously 
and must take seriously. Whether we build risk based 
assessments into the Commission's enforcement mandate as the 
GAO recommends or some other methodology that is clear, 
predictable, fair and sufficiently straight forward that market 
participants can understand it and know what rules to follow. 
It's 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 everyday 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. Risk assessments take 
that reality into account.
    The key in all of this is to continue to foster Congress' 
successful intent behind EPACT and the repeal of PUHCA 1935, 
bringing new investment and new investors into the marketplace 
while avoiding another ENRON from occurring. With the 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 any exploitation.
    It's no mystery that the provisions on cross subsidization 
were central to the passage and enactment of EPACT 2005 and the 
repeal of PUHCA of 1935. 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 
consumer 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 utilities assets to provide it an 
unfair competitive advantage. Or it could also be used to harm 
the financial integrity of the utility itself.
    That is why the Commission took the steps that it has as 
laid out in the chairman's written testimony. However, we can 
and we must do more. The chairman 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. 
Not all States have comprehensive corporate structuring 
statutes in place.
    PUHCA provided that protection for the American consumer. 
PUHCA did it in a very blunt and, as we came to see, a very 
inefficient way. So, Congress has rightfully repealed that Act. 
But in its absence it requires us to be vigilant that corporate 
structures not be adopted which provide the possibility of 
harmful cross subsidization or inappropriate encumbrances of 
utility investment of utility assets to the detriment of 
utility investors and consumers.
    I agree that there is no one silver bullet for preventing 
cross subsidization. Some States have found ring fencing to be 
very successful. Other States find that it presents problems 
and have chosen not to accept it. That does not mean the 
Federal Government cannot provide more leadership in the area 
of cross subsidization.
    We could, for example, insist that at least one of the 
suite of mechanisms to prevent cross subsidization be adopted. 
Not every one of the 50 States needs to adopt ring fencing. But 
they should all be looking at some proven mechanism to ensure 
that where cross subsidization is a possibility the corporate 
structure will be done in such a way as to prevent that from 
occurring. FERC could and should help States pilot a course for 
the adoption of productive corporate structure policies.
    I would also like to talk about the future--what I hope to 
see the role----
    The Chairman. Could you sort of summarize because we're 
going to run out of time?
    Ms. Kelly. Thank you, Mr. Chairman.
    The Chairman. Thanks.
    Ms. Kelly. I just wanted to say briefly that as the 
enforcement role of the Commission and the States continue to 
evolve, regulators should be working with market participants 
to ensure that they understand how to comply with the rules. I 
would like to see the Commission embark on a serious program of 
compliance and not just enforcement. Thank you.
    [The prepared statement of Ms. Kelly follows:]

 Prepared Statement of Suedeen G. Kelly, Commissioner, Federal Energy 
                         Regulatory Commission

                              INTRODUCTION

    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

    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 21st 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

    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

    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

    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

    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.

    The Chairman. Thank you very much.
    Commissioner Moeller.

 STATEMENT OF PHILIP D. MOELLER, COMMISSIONER, FEDERAL ENERGY 
                     REGULATORY COMMISSION

    Mr. Moeller. Thank you, Mr. Chairman, Senator Domenici, 
Senator Craig, Senator Cantwell. It's my pleasure to be here 
before you today. My statement largely supports the written 
testimony submitted by Chairman Kelliher concerning our ability 
to detect and prevent any improper cross subsidization between 
regulated utilities and their affiliates.
    The Commission has had a long standing responsibility to 
prevent utility consumers from paying rates that reflect 
inappropriate cross subsidies. In my opinion the best 
opportunity for the Commission to discover cross subsidization 
is in the rate making process. That is before any cost can be 
recovered from wholesale customers served under cost based 
rates.
    The Commission reviews those costs to determine if their 
recovery would be just and reasonable. Costs that result from 
inappropriate cross subsidies are not recoverable in rates. 
While our auditing enforcement and merger authority is 
significant these measures complement rather than substitute 
for the rate review that FERC conducts. In addition the States 
have responsibility over retail rates providing them with 
authority to deny the recovery of amounts representing 
inappropriate cost for subsidies and other unjust and 
unreasonable costs.
    As far as I have seen the repeal of PUHCA 1935 has not led 
to an increase in cross subsidization. Not withstanding, our 
Commission must exercise and is exercising vigilance in our 
rate making, our merger review, our enforcement processes and 
our auditing functions. I also believe that as competitive 
energy markets mature, cross subsidization will become less of 
an issue.
    In purely competitive markets where there are no captive 
customers and energy is sold at market based rates, utilities 
will not have an incentive to add costs that result in non-
competitive prices. However the markets regulated by the 
Commission are not purely competitive at this time and thus, 
not immune from inappropriate cross subsidization between 
affiliates. As such the Commission is and must exercise its 
authority to guard against inappropriate cross subsidization.
    With regard to the report issued by the Government 
Accountability Office, I appreciate their efforts to examine 
this issue. As explained in the chairman's statement, to some 
extent we are considering or have already implemented or 
adopted their recommendations. But in our efforts to 
continually improve our oversight responsibilities and to 
provide a more transparent enforcement process, I encourage any 
comments, suggestions or criticisms as full compliance with our 
rules and regulations is my policy goal.
    Our job is to protect the consumers. One of the major 
enforcement powers we have are the new authorities that you 
gave us as a Commission in the 2005 Act. I've, at times over 
the last year felt like a little bit of a lone voice asking 
that our enforcement process be more open and transparent and 
give more context to those who regulate so that it is fair.
    Again, ultimately, consumers are protected through that. So 
I'm quite heartened by the fact that I think that our 
Commission has a growing recognition that that process needs to 
be more open, particularly heartened by Commissioner Kelly's 
comments to that effect. At the appropriate time I'd be happy 
to answer any questions.
    [The prepared statement of Mr. Moeller follows:]

 Prepared Statement of Philip D. Moeller, Commissioner, Federal Energy 
                         Regulatory Commission

    Mr. Chairman and members of the Committee, I appreciate the 
opportunity to appear before you today. My statement largely supports 
the written testimony submitted by Chairman Kelliher concerning our 
ability to detect and prevent any improper cross-subsidization between 
regulated utilities and their affiliates.
    The Commission has had a long-standing responsibility to prevent 
utility consumers from paying rates that reflect inappropriate cross-
subsidies. In my opinion, the best opportunity for the Commission to 
discover cross-subsidization is in the ratemaking process. That is, 
before any costs can be recovered from wholesale customers served under 
cost-based rates, the Commission reviews those costs to determine if 
their recovery would be just and reasonable. Costs that result from 
inappropriate cross-subsidies are not recoverable in rates. While our 
auditing, enforcement, and merger authority is significant, these 
measures complement rather than substitute for the rate review that 
FERC conducts. In addition, the states have responsibility over retail 
rates, providing them with authority to deny the recovery of amounts 
representing inappropriate cross-subsidies and other unjust and 
unreasonable costs.
    As far as I have seen, the repeal of PUHCA 1935 has not led to an 
increase in cross-subsidization. Notwithstanding, our Commission must 
exercise and is exercising vigilance in our ratemaking, our merger 
review, our enforcement processes, and our auditing functions. I also 
believe that as competitive energy markets mature, cross-subsidization 
will become less of an issue. In purely competitive markets where there 
are no captive customers and energy is sold at market-based rates, 
utilities will not have an incentive to add costs that result in non-
competitive prices. However, the markets regulated by the Commission 
are not purely competitive at this time and thus, not immune from 
inappropriate cross-subsidization between affiliates. As such, the 
Commission is, and must, exercise its authority to guard against 
inappropriate cross-subsidization.
    Finally, with regard to the report issued by the Government 
Accountability Office, I appreciate their efforts to examine this 
issue. As explained in the Chairman's statement, to some extent we are 
considering or have already adopted their recommendations. However, in 
our efforts to continually improve our oversight responsibilities and 
to provide a more transparent enforcement process, I encourage any 
comments, suggestions, or criticisms as full compliance with our rules 
and regulations is my policy goal.
    I would be happy to respond to any questions.

    The Chairman. Thank you very much.
    Commissioner Spitzer.

    STATEMENT OF MARC SPITZER, COMMISSIONER, FEDERAL ENERGY 
                     REGULATORY COMMISSION

    Mr. Spitzer. Thank you, Mr. Chairman, members. We've got 
very learned colleagues here and sort of feel an old statement 
by an Arizona hero, Morris Udall, is relevant. Everything's 
been said, but not by everybody.
    So I'll try to expedite my comments and particularly refer 
to my having spent about 9 months of my life on a ring fencing 
case in Arizona involving an acquisition in 2004 that informs 
me as to the----
    The Chairman. Which side of the case were you on?
    [Laughter.]
    Mr. Spitzer. I was representing the State of Arizona as the 
commissioner at the time.
    The Chairman. Ok.
    Mr. Spitzer. Mr. Chairman, and I believe the FERC policies 
that have arisen from the regulatory environment from EPACT 
2005 correctly balance the competing considerations, 
specifically fulfilling the congressional mandate to protect 
rate payers with respectful consideration of State commissions 
and their orders. Ensuring that an applicant demonstrate a 
proposed transaction will not result in inappropriate cross 
subsidization. FERC has deferred and I believe should defer to 
State Utility Commission's findings regarding ring fencing.
    FERC will impose protections regarding cross subsidization 
or asset impairment if prophylactic authority does not exist 
under State law or if specific State Regulatory protections are 
insufficient to protect customers. FERC's imposition of 
additional ring fencing measures is best exercised as a 
backstop authority rather than a mechanism to preempt State 
action. State Utility Commissions have long employed tools to 
protect their retail customers from asset impairment and cross 
subsidization in various contexts, including proceedings 
regarding mergers and acquisitions. Thus, where States are 
willing and able to address cross subsidization, FERC should 
generally defer to lawful and effective State Utility 
Commission orders.
    As chair of the Arizona Corporation Commission I presided 
over an application to acquire Unisource Energy Corporation, 
the parent corporation of Tucson Electric Power Company. In 
that case the Arizona Commission borrowed liberally from the 
1997 decision of the Public Utility Commission of Oregon 
approving the acquisition of Portland General Electric Company 
by ENRON Corporation. In approving the 1997 acquisition the 
Oregon Commission adopted several ring fencing provisions that 
have been described as the gold standard for the protection of 
retail ratepayers from asset impairment and cross subsidization 
in the context of utility merger.
    The proof in the pudding, so to speak is that due to ten 
ring fencing conditions that the Oregon Commission imposed on 
that merger transaction, the bankruptcy of ENRON Corporation 
resulted in no negative impacts upon the regulated Oregon 
utility. I cite to you the testimony in our technical 
conference on this matter of Commissioner Ray Baum from the 
Public Utility Commission of Oregon. The Arizona case also 
raised potential asset impairment and cross subsidization 
concerns.
    Consequently the Arizona Commission examined at great 
length all of the potential adverse ratepayer impacts of the 
acquisition of an Arizona utility by out of State interests. 
This review resulted in the parties to the proceeding, 
including the Arizona Commission staff, to stipulate to the 
Oregon Commission's ring fencing language with modest revisions 
arising from and consistent with Arizona law. FERC should not 
presume States are unwilling to protect their retail ratepayers 
from asset impairment or from cross subsidization.
    The cases decided by State Utility Commissions, including 
my own experience on the Arizona Commission, suggest the 
contrary is true. Therefore, FERC has properly adopted a 
backstop for those circumstances where the States are without 
statutory authority, unwilling or unable to impose cross 
subsidization protections. In fact, since the passage of EPACT 
2005, FERC has not preempted a State Utility Commission's ring 
fencing determination, nor has it imposed views potentially 
inconsistent with State rules.
    It is incorrect, however, to contend that FERC has failed 
to fulfill its statutory obligations. For example, in the Puget 
Energy case, FERC recently approved a Federal Power Act, 
section 203 acquisition conditioned on the Washington Utilities 
and Transportation Commission's approval of proposed ring 
fencing provisions. If the Washington Commission's cross 
subsidization requirements are not adequate to protect 
customers, the Commission will consider requiring additional 
ring fencing provisions. But I must note, being familiar with 
the Washington Commission, I think it would be incorrect for 
FERC to presume that the Washington Commission's protections 
will be inadequate.
    State Utility Commissions are generally best suited to 
craft effective ring fencing conditions to protect utility 
assets and more importantly, their own ratepayers. Therefore, 
where State Utility Commissions are willing and able to impose 
adequate ring fencing rules that protect customers, the FERC 
should not preempt or require additional and potentially 
conflicting measures. Mr. Chairman, thank you very much.
    [The prepared statement of Mr. Spitzer follows:]

   Prepared Statement of Marc Spitzer, Commissioner, Federal Energy 
                         Regulatory Commission

    The first and noblest mission of utility regulation is the 
protection of the ratepaying public. The Federal Energy Regulatory 
Commission (FERC) and state utility commissions share this important 
mission through a matrix of federal and state rules. The primary 
obligation of FERC is to ensure reliable wholesale energy supplies at 
just and reasonable rates. As described in Chairman Kelliher's 
testimony, FERC has adopted a number of mechanisms to fulfill its 
statutory obligations.
    In the Energy Policy Act of 2005 (EPAct 2005), Congress expanded 
those obligations by amending Section 203 of the Federal Power Act 
(FPA) to require FERC to consider, among other things, whether a 
proposed merger or other corporate transaction will result in the 
improper impairment of utility assets or subsidization of non-utility 
affiliates. EPAct 2005, section 1289.
    In response to EPAct 2005, FERC undertook several rulemaking 
proceedings to establish regulations and policies governing cross-
subsidization and asset impairment attendant to review of transactions 
under FPA Section 203. A primary objective of these proceedings, 
particularly in light of the repeal of the Public Utility Holding 
Company Act of 1935 (PUHCA 1935), was to address potential harm to 
captive ratepayers.
    Among the interests balanced in the FERC rulemakings were how to 
faithfully discharge the Congressionally-mandated obligation without 
unnecessarily or counter-productively interfering in the long-standing 
tradition of ``ring-fencing'' decisions by state utility commissions. I 
believe the FERC's policies achieve the correct balance. In ensuring 
compliance with the requirement that an applicant demonstrate that a 
proposed transaction will not result in inappropriate cross-
subsidization, FERC has deferred, and I believe should defer, to state 
utility commissions' findings regarding ring-fencing. FERC will impose 
protections regarding cross-subsidization or asset impairment only if 
prophylactic authority does not exist under state law or if specific 
state regulatory protections are insufficient to protect captive 
customers.
    FERC's imposition of additional ring-fencing measures is best 
exercised as a ``backstop'' authority rather than as a mechanism to 
preempt state action. State utility commissions have long employed 
tools to protect their retail customers from asset impairment and 
cross-subsidization in various contexts, including proceedings 
regarding mergers and acquisitions. Thus, where states are willing and 
able to address crosssubsidization, FERC generally should defer to 
lawful and effective state utility commission orders.
    As Chair of the Arizona Corporation Commission (Arizona 
Commission), I presided over an application to acquire UniSource Energy 
Corporation, the parent corporation of Tucson Electric Power Company. 
In the Matter of the Reorganization of UniSource Energy Corporation, 
Decision No. 67454, ACC Docket No. E-04230A-03-0933 (Jan. 4, 2005). In 
that case, the Arizona Commission borrowed liberally from the 1997 
decision of the Public Utility Commission of Oregon (Oregon Commission) 
approving the acquisition of Portland General Electric Company by Enron 
Corp. In approving the 1997 acquisition, the Oregon Commission adopted 
several ring-fencing provisions that have been described as the ``gold 
standard'' for the protection of retail ratepayers from asset 
impairment and cross-subsidization in the context of a utility merger. 
The ``proof in the pudding,'' so to speak, is that, due to the ten 
ring-fencing conditions that the Oregon Commission imposed on that 
merger transaction, the bankruptcy of Enron Corp. resulted in no 
negative impacts upon the regulated Oregon utility. Testimony of 
Commissioner Ray Baum of the Public Utility Commission of Oregon, 
Technical Conference on Public Utility Holding Company Act of 2005 and 
Federal Power Act Section 203 Issues, FERC Docket No. AD07-2-000, at 24 
(Dec. 7, 2006).
    The Arizona case raised potential asset impairment and cross-
subsidization concerns. Consequently, the Arizona Commission examined, 
at great length, all of the potential adverse ratepayer impacts of the 
acquisition of an Arizona utility by out-of-state interests. This 
review resulted in the parties to the proceeding, including the Arizona 
Commission staff, stipulating to the Oregon Commission's ring-fencing 
language with modest revisions arising from and consistent with Arizona 
law.
    FERC should not presume states are unwilling to protect their 
retail ratepayers from asset impairment or cross-subsidization. The 
cases decided by state utility commissions, including my own experience 
on the Arizona Commission, suggest the contrary is true. Therefore, 
FERC properly has adopted a ``backstop'' for those circumstances where 
the states are without statutory authority, or are unwilling, to impose 
cross-subsidization protections.
    In fact, since the passage of EPAct 2005, FERC has not preempted a 
state utility commission's ring-fencing determination nor has it 
imposed views potentially inconsistent with state rules. It is 
incorrect, however, to contend FERC has failed to fulfill its statutory 
obligations. For example, in Puget Energy, Inc., 123 FERC  61,050 
(2008), FERC recently approved an FPA Section 203 acquisition 
conditioned on the Washington Utilities and Transportation Commission 
(Washington Commission) approval of proposed ring-fencing provisions. 
If, however, the Washington Commission's cross-subsidization 
requirements are not adequate to protect customers, the Commission will 
consider requiring additional ring-fencing protections.
    State utility commissions are generally best situated to craft 
effective ring-fencing conditions to protect utility assets, and most 
importantly, their own ratepayers. Therefore, where state utility 
commissions are willing and able to impose adequate ringfencing rules 
that protect consumers, the FERC should not preempt or require 
additional, potentially conflicting, measures.

    The Chairman. Thank you very much.
    Commissioner Wellinghoff.

  STATEMENT OF JON WELLINGHOFF, COMMISSIONER, FEDERAL ENERGY 
                     REGULATORY COMMISSION

    Mr. Wellinghoff. Thank you, Chairman Bingaman, Ranking 
Member Domenici and members of the committee. Thank you for the 
opportunity to appear here today to discuss these issues with 
you. I endorse Chairman Kelliher's testimony concerning the 
role of the Federal Energy Regulatory Commission in protecting 
consumers against improper cross subsidization from mergers 
that involve an electric utility holding company.
    I would like to highlight three related issues though. 
First, I strongly support Chairman Kelliher's statement that 
FERC is a consumer protection agency. I also agree that FERC 
and State regulators have a common interest in policing cross 
subsidization.
    I believe that FERC's approach to that issue appropriately 
reflects both these important principles. Specifically, FERC's 
approach recognizes that States have an important role to play 
in protecting consumers against improper cross subsidization in 
the context of corporate transactions. As Chairman Kelliher 
described in evaluating merger applications pursuant to section 
203, the Federal Power Act, as amended, FERC reviews ring 
fencing measures and other merger conditions that a State 
commission imposes to safe guard customers against cross 
subsidization. If that examination convinces FERC that such 
state imposed conditions are sufficient we will not impose 
additional conditions.
    However, our approach also recognizes that Congress 
assigned new authority to FERC in EPACT 2005. Where we 
determined that state imposed conditions are inadequate or that 
relevant State commissions lack authority to act, FERC can and 
will use our new authority under the 2005 EPACT to protect 
consumers against improper cross subsidization. I believe that 
such initial deference to State regulatory review where 
appropriate both promotes an efficient use of resources and 
fosters greater State/Federal coordination.
    By contrast, I am concerned that a less flexible preemptive 
approach would unnecessarily undermine such coordination and 
would limit the ability of State commissions to craft cross 
subsidization safeguards. In this regard I agree with the 
comments made at FERC's December 2006 Technical Conference on 
these issues by Oregon Commissioner Ray Baum and former 
Wisconsin Commissioner Robert Garvin, who observed that many 
State commissions are effectively and independently carrying 
out the statutory responsibilities to protect retail customers 
from adverse effects of subsidization by public utility 
affiliates within a holding company organization.
    Second, it's worth emphasizing that in every case under 
section 203 of the FPA the Commission bases its decision on the 
record developed in that case by the applicant and other 
parties. In addition to submissions from customers, 
competitors, State Commissioners and Attorney Generals, I'd 
like to highlight the contribution that FERC receives from 
State consumer advocates. I was honored to serve as Nevada's 
first State Consumer Advocate for customers of public utilities 
and I believe that State Consumer Advocates can and do play an 
important role of building the case records that supports 
FERC's actions to protect customers against improper cross 
subsidization.
    Finally while it is essential to have well designed rules 
in place at the Federal and State levels to protect against 
improper cross subsidization, it is equally important to ensure 
that those rules are being followed. This is a place for 
auditing. Because FERC has great resources for auditing than 
the States in many instances this is an area in which Federal/
State collaboration can be particularly instructive.
    As Chairman Kelliher stated in his testimony FERC's audit 
staff interacts frequently with State regulators during an 
audit reflecting our recognition that maintaining contact with 
State regulators is mutually beneficial to FERC and the States. 
I would like to reiterate Chairman Kelliher's comments that 
FERC will continue to seek additional funds from Congress if we 
believe that more resources are necessary to carry out 
essential auditing responsibilities including cross 
subsidization audits just as FERC currently did when requesting 
additional funds for transmission system reliability audits.
    Thank you very much again, Mr. Chairman for inviting me.
    [The prepared statement of Mr. Wellinghoff follows:]

  Prepared Statement of Jon Wellinghoff, Commissioner, Federal Energy 
                         Regulatory Commission

    Chairman Bingaman, Ranking Member Domenici, and members of the 
Committee, thank you for the opportunity to appear before you today.
    I endorse Chairman Kelliher's testimony concerning the role of the 
Federal Energy Regulatory Commission (FERC) in protecting consumers 
against improper cross-subsidization from mergers that involve an 
electric utility holding company. I would like to highlight three 
related issues.
    First, I strongly support Chairman Kelliher's statement that FERC 
is a consumer protection agency. I also agree that FERC and state 
regulators have a common interest in policing cross-subsidization. I 
believe that FERC's approach to this issue appropriately reflects both 
of those important principles.
    Specifically, FERC's approach recognizes that states have an 
important role to play in protecting customers against improper cross-
subsidization in the context of corporate transactions. As Chairman 
Kelliher described, in evaluating a merger application pursuant to 
section 203 of the Federal Power Act (FPA) as amended by the Energy 
Policy Act of 2005 (EPAct 2005), FERC reviews ring fencing measures and 
other merger conditions that a state commission imposes to safeguard 
customers against cross-subsidization. If that examination convinces us 
that such state-imposed conditions are sufficient, then we will not 
impose additional conditions.
    However, our approach also recognizes that the Congress assigned 
new authority to FERC in EPAct 2005. Where we determine that state-
imposed conditions are inadequate, or that a relevant state commission 
lacks the authority to act, FERC can and will use our new authority 
under EPAct 2005 to protect customers and ultimate consumers against 
improper cross-subsidization.
    I believe that such initial deference to state regulatory review, 
where appropriate, both promotes an efficient use of resources and 
fosters greater federal-state coordination. By contrast, I am concerned 
that a less flexible, pre-emptive approach would unnecessarily 
undermine such coordination and would limit the ability of state 
commissions to craft cross-subsidization safeguards. In this regard, I 
agree with comments made at FERC's December 2006 technical conference 
on these issues by Oregon Commissioner Ray Baum and former Wisconsin 
Commissioner Robert Garvin, who observed that many state commissions 
are effectively and independently carrying out their statutory 
responsibilities to protect retail customers from the adverse effects 
of subsidization by public utility affiliates within a holding company 
organization.
    Second, it is worth emphasizing that in every case under section 
203 of the FPA, the Commission bases its decision on the record 
developed in that case by the applicant and other parties. In addition 
to submissions from customers, competitors, state commissioners, and 
attorneys general, I would like to highlight the contributions that 
FERC receives from state consumer advocates. I was honored to serve as 
Nevada's first consumer advocate for customers of public utilities, and 
I believe that state consumer advocates can and do play an important 
role in building the case records that support FERC's actions to 
protect customers against improper cross-subsidization.
    Finally, while it is essential to have well-designed rules in place 
at the federal and state levels to protect against improper cross-
subsidization, it is equally important to ensure that those rules are 
being followed. This is the place for auditing. Because FERC has 
greater resources for auditing than the states in many instances, this 
is an area in which federal-state collaboration can be particularly 
constructive. As Chairman Kelliher stated in his testimony, FERC's 
audit staff interacts frequently with state regulators during an audit, 
reflecting our recognition that maintaining contact with state 
regulators is mutually beneficial to FERC and the states. I would like 
to reiterate Chairman Kelliher's commitment that FERC will continue to 
seek additional funds from the Congress if we believe that more 
resources are needed to carry out our essential auditing 
responsibilities, including cross-subsidization audits, just as FERC 
recently did when requesting additional funds for transmission system 
reliability audits.
    Thank you again for inviting me to speak here today.

    The Chairman. Thank you very much. Thank you all for your 
excellent testimony. Let me ask a few questions and then defer 
to Senator Domenici for his questions.
    It seems like just hearing your various statements, I 
think, at least from my perspective, we're all in agreement on 
some basic things. FERC should not be preempting the States. I 
agree with that. I think everybody has said that.
    It's best for FERC to exercise backstop authority. That's 
what I think we intended with the law. I guess my concern is 
that I don't know that there, I believe Commissioner Kelly, you 
said that I think the words you used were that FERC needs to 
have a clearly thought out and communicated enforcement 
strategy. I'm not sure that that is currently in place.
    I guess I'm not sure that State regulators or corporations 
that may consider mergers have a clear idea of when FERC will 
step in and exercise backstop authority. That's a concern that 
occurs to me. Let me also just refer, I believe your testimony, 
Commissioner Spitzer, of where you talk about here at the end 
of your statement, where State Utility Commissions are willing 
and able to impose adequate ring fencing rules that protect 
consumers, FERC should not preempt or require additional, 
potentially conflicting measures. I agree with that.
    The obvious question though is what are adequate ring 
fencing rules at the State level? What has FERC told States and 
told potential companies, with the idea of entering into 
mergers, about what adequate ring fencing rules are. I guess 
that's my concern.
    Chairman Kelliher, do you have some reaction to that?
    Mr. Kelliher. Yes, sir. First of all, I agree that section 
203, a point I tried to make in my oral testimony, that section 
203 the Federal Power Act is highly complex and the 
transactions are complex. I would not be surprised if there's 
some level of uncertainty in the regulated community as well as 
in the public as to how does FERC go about these reviews.
    But also the reviews are very fact intensive because look 
at two different scenarios. Look at two companies, utilities, 
that are distribution only companies. They own no generation. 
They own no transmission. They engage in no sales at market 
based rates. All they do is provide distribution service at a 
rate set by State regulators. Let's say they merge.
    Then look at another scenario of two independent power 
producers merge. They make no cost based sales. Everything is a 
market based rate sale. Let's say they're arguably in two 
totally different regions of the country.
    The kind of conditions that FERC might impose, I would 
expect would vary in those two circumstances. In the second 
there might be an argument that there's actually no risk of 
cross subsidization. If there's no rate set by government. 
There's no cost base rate. There's no regulated rate. You can 
argue there's actually no risk of cross subsidization. So we 
don't impose any protections on cross subsidization. In the 
first, you might also argue there's not a risk of cross 
subsidization because there's no non-regulated--there's no sale 
of a service or a product that's not regulated.
    But the third scenario would be a complicated merger, a 
holding company, two holding companies that engage in market 
based rate sales, cost based rate sales. Let's argue they're 
even adjacent. In that case we might see a significant risk of 
cross subsidization, the need to guard against it. We would 
look at how the State, in this case, there might be multiple 
States. What conditions are imposed by the States in their 
review of those mergers and then what conditions do we need to 
perhaps add to that.
    That's part of the difficulty is that some mergers involve 
multiple States. Some involve one State. The recent action we 
took on Puget. It involved an acquisition of a utility in a 
single State. Washington State has very strong ring fencing 
provisions. They have some of the best regulators in the State 
including North Carolina.
    North Carolina and Washington have excellent regulators.
    [Laughter.]
    Mr. Kelliher. We are not going to blindly trust them. But 
we're going to rely on the commitments the applicant made and 
the State regulators. Then we'll look at those commitments. We 
might add to them.
    The Chairman. Ok. Let me just ask Commissioner Kelly if you 
have a thought about this. I gather, as I understand the 
chairman's position is that there are so many varieties of 
mergers involved here, so many circumstances, it's really not 
possible to give more specific direction as to what the 
Commission would expect States to do by way of dealing with 
this problem.
    Do you have a point of view?
    Ms. Kelly. Mr. Chairman, I believe that we can exercise 
more leadership in this area of ensuring sensible and 
appropriate corporate structures. Many of the States are 
sophisticated in this area, but others are not. We have mostly 
deferred to the States.
    We could do more without preempting the States than we have 
done. For example, we could take a more active role in 
explaining for the States, where the problems lie in explaining 
the importance of preventing the possibility of cross 
subsidization instead of just taking care of it through the 
rate making process after it has occurred. Considering the 
productive verses the non-productive or any productive 
corporate structures that are possible and keeping an eye out 
for interstate conflicts because when you defer to States that 
have different rules, there is the potential of interstate 
conflicts and of putting undue burdens on entities that do 
business in multiple States.
    It's possible that we could come up with principles to 
guide States without preempting. I think we should also 
consider the possibility of adopting the State's structural 
requirements as our own because currently if we defer to the 
States, it's just a State requirement. If we adopted them as 
our own, it would give us the ability to use our enforcement 
assets and resources in the event that the States don't have 
adequate ones, should some transgression occur.
    The Chairman. Thank you very much.
    Senator Domenici.
    Senator Domenici. Thank you, Mr. Chairman. Commissioner 
Kelly, let me ask this--first make an observation. It seems to 
me that I was listening to each Commissioner and it seems like 
that they all agree that basically with Chairman Kelliher's 
statement, with the exception of you, Commissioner Kelly. I'm 
not sure how much you're differing.
    First I would like to ask, so that I would understand that, 
have you raised with the Commission or the chairman the facts 
that you are raising here today? Ask that the Commission do 
something that's preparatory that they aren't currently doing?
    Ms. Kelly. Senator Domenici, our role in implementing this 
provision of EPACT has evolved. It's evolved since the law was 
passed in 2005. When we initially----
    Senator Domenici. That has nothing to do with my question. 
My question is have you recommended to the Commission that they 
do something they're not doing with reference to implementation 
of the provisions that we've put in the law?
    Ms. Kelly. As we have gone along, I have worked with the 
chairman and the other Commissioners to evolve our thinking on 
this issue.
    Senator Domenici. Right.
    Ms. Kelly. Initially we didn't, when we implemented rules, 
when we proposed rules and adopted rules to implement PUHCA 
2005, we did not deal with the issue of looking in advance at 
corporate structures and that was acceptable to me because we 
didn't have the knowledge. However, the chairman agreed to have 
a technical conference on the subject, which we did in 2006.
    A result of that technical conference we accumulated more 
knowledge on the issue. Then at the end of 2006, we issued a 
policy statement which evolved our thinking on this issue and 
showed that we did have a concern about pre-merger review of 
corporate statements. In that policy statement we have we 
talked about ring fencing and other structures. We announced 
our policy of looking at the States. Then in subsequent 
decisions we have continued to evolve our thinking.
    So I feel that the relationship that I've had with the 
chairman and the other Commissioners has been very productive 
and has resulted in an evolution of thinking about the 
importance of this. I anticipate that it will continue.
    Senator Domenici. That was a very long answer to a very 
easy question. It's not difficult. I mean I really think I was 
asking you whether you shared these views with the Commission 
or did you come share them with us today for the first time?
    Ms. Kelly. Oh, thank you, Senator.
    Senator Domenici. I asked the question like that. You 
didn't answer it. But that's alright. I guess you don't want 
to.
    Chairman Kelliher, would you tell me with reference to the 
GAO report, they find that FERC does not have a strong basis 
for ensuring that cross subsidization does not occur. Do you 
agree with the report? How is the Commission protecting 
consumers in that regard?
    Mr. Kelliher. I would have to say I strongly disagree with 
the report and continue to disagree respectfully. But I think 
our primary means--I think in part it's just a disagreement on 
how--what is the best means for FERC to guard against improper 
cross subsidization? FERC, we have done that historically 
through rate making.
    When we set a rate, we prevent cross subsidy from being 
recovered when we set a rate, when we set a regulated rate. We 
did that in the 1930s. We do that today.
    To me, rate making is the principal means at FERC to guard 
against improper cross subsidization. Our rate making authority 
was not affected by any extent by the 2005 Act. It wasn't 
decreased and i.e., rate making is our principal means of 
guarding against cross subsidies.
    The 203 merger provisions are a supplement to that because 
in part they only apply under certain kinds of transactions and 
by certain kinds of entities. Whereas rate making has a broader 
reach and a continuous reach. A merger view is a single point 
in time. Whereas rate making is, well, I don't want to say that 
rate making is forever. It sounds obnoxious. It's suggests that 
there will always be a FERC. But rate making is more permanent, 
let's say.
    Senator Domenici. Ok. I just want to know, I'm sure that 
all the Commissioners are aware of the GAO study and the GAO 
report. First let me start with you, Commissioner Moeller, do 
you agree or disagree with the GAO report? Are you all doing 
your job right or do they make suggestions that indicate you 
should change your ways?
    Mr. Moeller. Senator Domenici, I think what the GAO report 
respectfully may have missed is the point that the chairman 
made and I tried to make in my testimony, the role of rate 
making in protecting consumers from inappropriate cross 
subsidies. That said, I thought the recommendations were, 
really several of them, reasonable. I think we've actually 
worked at implementing some of them, particularly being a 
little more open in terms of how our auditing process goes.
    So in that sense, I think maybe they missed the larger 
point. But I appreciated their recommendations.
    Senator Domenici. What about you, Mr. Spitzer?
    Mr. Spitzer. Thank you, Mr. Chairman, Senator. Certainly 
the FERC and all of us are wiling to consider anything to 
further protect the interest of the ratepayers of this country. 
With regard to the specifics, I think I'd associate my views 
with those of Commissioner Moeller.
    In terms of information sharing, I think we maybe could do 
a better job and that could be very valuable to State 
regulators, particularly with new types of corporate 
structures. Just as an example, in Arizona we had to modify the 
Oregon ring fencing provisions because Oregon involved an 
acquisition by a SEC corporation of the operating utility. In 
Arizona you had a leveraged buy out transaction which was 
structured as a general partnership.
    So the ring fencing rules had to be different to 
accommodate different structures. Now we have infrastructure 
funds that are structured even differently than leveraged 
partnerships. They're not based on debt. They're based on 
equity. To the degree to which FERC will share information and 
share audit reports with our State colleagues, I think would be 
very valuable.
    That being said, my experience in transactions prior to 
PUHCA and then since I came to FERC in 2006, I don't see any 
harm that's occurred by virtue of the FERC rulemaking. So I 
don't believe our rulemaking is inadequate. But certainly 
anything we can do in terms of further sharing information and 
audits might be very beneficial.
    Senator Domenici. Commissioner.
    Mr. Wellinghoff. Mr. Chairman, Senator Domenici, I disagree 
with the fundamental premise of the GAO report. That is, that 
it indicates that we're not protecting the interests of 
consumers. However I think I certainly would agree with 
Commissioner Moeller and I think some of the points that 
Commissioner Kelly made that there's always room for 
improvement.
    I think there are suggestions in the GAO report that 
certainly are worth considering and worth incorporating into 
our practices. I would have no problem with considering that.
    Senator Domenici. Thank you very much. Ms. Kelly?
    Ms. Kelly. Senator Domenici, I agree that the GAO provides 
us with some good ideas for improving our enforcement process.
    Senator Domenici. I thank you all very much. Thank you, Mr. 
Chairman.
    The Chairman. Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman. Commissioner 
Kelliher, when you have cross subsidization it results in 
utilities paying either inflated or above cost for goods and 
services provided by that non-utility, right?
    Mr. Kelliher. It could work two ways. A utility could sell 
something below cost to an affiliate that makes sales or a 
utility could buy something from an affiliate at above cost. So 
it could work both. The utility customer loses either way, I 
think.
    Senator Cantwell. Right.
    Mr. Kelliher. Yes.
    Senator Cantwell. Exactly. To know if a utility paid above 
market prices for an affiliate you would have to look and 
review the cost and do a comparative, right, to really 
understand that?
    Mr. Kelliher. Yes, when there's an attempt to recover those 
costs through a rate because if a utility seeks to change a 
rate or set a rate, they would need FERC approval for 
jurisdictional transactions. They would need State approval for 
other transactions.
    Senator Cantwell. But I mean, you would have to review all 
those costs to really understand that. FERC, you know, under 
their market based rates, doesn't look at individual cost 
components.
    Mr. Kelliher. We're----
    Senator Cantwell. For a utility rate. You don't look at 
that.
    Mr. Kelliher. Typically cross subsidy can occur when you 
have a vertically integrated utility. This is a general rule. 
Vertically integrated utility engages in both cost based 
transactions as well as market based transactions.
    Some company, corporate systems have affiliates and you 
have the mix of both cost based and market based transactions.
    Senator Cantwell. But I'm saying under FERC what you look 
at. You look at market based rates and so the Commission 
doesn't review those individual component costs in looking at 
the utility rate.
    Mr. Kelliher. We set both market based rates and cost based 
rates. We set cost based rates for transmission. For wholesale 
power sales we set cost based rates as well as market based 
rates.
    Market based rates are a privilege, not a right. To get 
market based rates the company has to demonstrate the absence 
of market power or mitigate any market power. We have been 
revoking market based rates where we find that a company cannot 
demonstrate the absence of market power.
    Senator Cantwell. I feel like we're tiptoeing around this 
issue as it relates to ring fencing and that is that somehow 
it's this State should have the first attempt. I mean I look at 
the GAO report and it says that FERC has made few substantive 
changes to either its merger review process or its post merger 
review oversight since EPACT. As a result does not have a 
strong basis for ensuring that harmful cross subsidization does 
not occur.
    Maybe Commissioner Kelly is in a different position than 
the rest of you on the panel. But it seems to me that FERC 
should implement a ring fencing provision to have more 
effective tools in looking at these mergers. It should be part 
of the process. Because I think where you are with your market 
based rate authority it creates an enormous opportunity for 
utilities and these decisions to move away, basically, from 
protecting the consumers.
    You're the cop on the beat. You can't leave it up to the 
great State of Washington, ok. Yes, they have a great utility. 
That utility commission did its job, but what about the other 
States? What about these issues that are across States?
    So you're basically saying, yes, it really worked 
effectively in Washington State because they did their job. But 
the bottom line is you don't have effective tools unless you 
adopt something, like ring fencing, to really say that 
consumers are going to be protected. I think the bottom line 
here is that the public needs to understand because I don't 
know of anybody out there who really is following the cross 
subsidization, ring fencing, all of that dialog.
    I mean the bottom line here is on mergers. Is the cop on 
the beat going to do their job and protect consumers when a 
merger happens from allowing a partnership, profit margin 
sharing to basically drive up the rates, eventually, from 
consumers? Because if you would have had a savings and instead 
they are used. If you would have had profits and they were used 
instead to subsidize this other company instead of helping to 
protect the consumers on their rates. Eventually the consumer's 
rates are going to go up.
    So, I'm, Mr. Chairman, a fan of having a stronger statute 
at the Federal level. We can't just leave it up to whether some 
States want to do this job in policing the markets. That's what 
FERC's job is, policing the markets.
    I thank the Chair.
    Mr. Kelliher. Could I respond, Mr. Chairman or I'm sorry.
    The Chairman. If you'd like to respond, go ahead. If not, 
we'll go to the next questioner. Go ahead.
    Mr. Kelliher. At your discretion, sir.
    The Chairman. You go ahead.
    Mr. Kelliher. Ok, thank you. I would like to say, emphasize 
that we do not blindly trust the States. Look at the 
hypothetical--look at Washington State. Washington State has 
strong ring fencing provisions. We approved the Puget Sound 
acquisition, but we retained the authority to impose--issue 
additional orders, impose additional conditions.
    Look at a hypothetical. Let's assume failure by the 
Washington State regulators, I don't think it's likely, but I 
suppose it's not a zero percent scenario. Let's assume they 
just set aside the requirements and say, we're not going to 
ring fence. We're not going to do anything. We'll impose no 
cross subsidization provisions.
    In that scenario I think there's a good chance the 
Commission would issue a future order imposing its own cross 
subsidization provisions. It might be ring fencing. It might be 
something else. But there is a possibility of preemption as we 
use of cross subsidization authority in section 203. But it is 
a last resort, not a first resort. I think that's the 
distinction.
    Should it be a first resort? Should it be reflexive? Should 
we have something on the shelf that we impose in every 203 
transaction? I don't think that would be wise given the nature 
of the transactions.
    The Commission recently had to approve the acquisition of 
Bear Sterns by J.P. Morgan. Ring fencing frequently improves 
cash management. If we had a uniform Federal approach on cross 
subsidization I suppose we would have taken it and imposed it 
in the J.P. Morgan acquisition of Bear Sterns. FERC would be 
policing the cash activities of that entity. That doesn't seem 
to be--we decided that really wasn't the right approach.
    So there is a scenario of preemption if we're convinced 
there's failure by the States. So that seemed to be your 
concern. I just wanted to reassure you that we will act in the 
event that a State fails, does not have to prevent cross 
subsidies. We will attach our own provisions.
    Senator Cantwell. If I could, Mr. Chairman, for 15 seconds.
    The Chairman. Sure.
    Senator Cantwell. I would just say with all that's happened 
in the marketplace, having a very bright line on something like 
ring fencing. That it's in your tool box would help in stopping 
these problems. I certainly, you know, Bear Sterns owning, you 
know, 10 percent of a utility.
    I would hate to see what would happen to Bear Stern to own 
10 percent of all utilities. We'd all be in a lot of trouble. 
So, thank you.
    The Chairman. Senator Craig.
    Senator Craig. Thank you very much, Mr. Chairman. I say to 
all of you I helped lead the repeal of PUHCA. I'm glad it's 
gone. So, I'm always curious when those who opposed it ask the 
GAO to examine because in repealing it we saw multiple roles.
    We saw the role of the State as it related to cross 
subsidization. I think you've all spoken to that. It sounds 
like whether some agree or disagree that there's a variance of 
ability or desire out there. But where it appears to be 
necessary there seems to be action. It also appears to me that 
at least, Mr. Chairman, you're telling us that where there is 
inaction, the FERC is very willing to take action.
    I've always felt in the marketplace in your role of 
protecting consumers that rates went a lot further in 
protecting the consumer than bureaucracies, often times or 
systems. Now systems can lead to rates. I understand that.
    But at the same time I'm glad you see a State role. I think 
that's extremely important in all of this. As our markets 
change, obviously the oversight and the responsibility of FERC 
is critically important. I would much prefer that this 
committee and the GAO focus on other things that I think are 
tremendously more important today to consumers than this 
business.
    How about market manipulation, reliability, competitive 
markets, I mean, to me, today, in the changing face of where we 
are, those become extremely more valuable as roles for FERC to 
play. I would hope that the business that you're in as it 
relates to this particular activity and transitioning out of 
PUHCA is not overpowering your ability to do all of these other 
things. Because I think there are considerably more important 
to the consumer in the marketplace.
    I also want to thank you for, you know, implementing hydro 
re-licensing. Those are the kinds of things that we have to get 
done out there in the market that is important. You deserve 
kudos for that. I'm willing to offer those up because I think 
it's important.
    So I guess if there is a question in my comment it would be 
are you spending the right amount of time and the right amount 
of energy and the right amount of resource in reliability, 
market manipulation, competitive markets? Mr. Chairman?
    Mr. Kelliher. I think those are exactly the top priorities 
in the areas of enforcement. These are new responsibilities 
Congress gave us just two and a half years ago and to me the 
top priorities in the area of enforcement are preventing market 
manipulation, preventing market power exercise and upholding 
reliability standards. That's where we have to dedicate our 
resources.
    If they're top priorities they should get top priority of 
our resources. So we are conducting audits. We are conduction 
PUHCA audits. We conduct other financial audits. But I think we 
have to focus on the high priorities.
    Senator Craig. Anyone else wish to respond?
    Ms. Kelly. Senator, I would just like to take this 
opportunity to say how much I've appreciated Chairman 
Kelliher's leadership in the implementation of EPACT 2005. As 
this committee well knows, we were given many new tasks and 
many new responsibilities. I believe that, if I recall 
correctly, the initial list was 35 new efforts we were to 
undertake within a year and a half and we did all of those.
    I think that with our newest responsibilities the way we 
are approaching them is continuing to evolve and continuing to 
improve which is not surprising that it works that way as we 
get more familiar with our responsibilities. If I could make 
one more pitch that I put in my written testimony for more 
resources for enforcement. Thank you.
    Senator Craig. Thank you, Commissioner Kelly. It's 
certainly in those priorities that we've laid out in EPACT 
2005, we want to make sure you have the resources to do that. I 
think the American consumer, more today than ever before, is 
focused on the price of their energy. They want to know that 
it's being reasonably priced in relation to its costs of 
production. Thank you. Thank you all.
    The Chairman. Senator Salazar.
    Senator Salazar. Thank you.
    Senator Domenici. Senator Salazar, would you yield for one, 
30 seconds?
    Senator Salazar. Absolutely, Senator.
    Senator Domenici. I wanted to make an observation, Senator 
Bingaman. I have to leave for a while. I just wanted to 
congratulate the Commission. I think that you have properly, 
Commissioner Kelly, summarized the great task that we gave you. 
I don't think there's a better Commission than this one, nor do 
I think looking at the law which had abundant new provisions 
for a lot of agencies. A great law, I think.
    You all were given about as many changes to administer as 
any and you did it admirably. So I commend you. I hope that we 
can get you the right resources. You're not the only one that 
tells us they need them, but I'm glad you reminded us. As you 
should be adequately--you should have adequate resources for 
powerful people that are smart, that know their business, 
helping you. So thank you very much. Thank you, Mr. Chairman.
    The Chairman. Thank you. Senator Salazar.
    Senator Salazar. Thank you, Chairman Bingaman. Thank you 
for the Commissioners and your testimony here this morning. You 
know, I looked at the GAO report last night and as I was 
reading it, it seems to be simply in many ways a suggestion for 
how we improve regulation.
    I mean, if you look at the title of the report itself. It 
says Utility Regulation opportunities exist to improve 
oversight. Looking at the summary of what the GAO has found 
here. It says that all the comprehensive risk based approach to 
planning audits. It says monitor financial conditions of 
utilities and has other recommendations there.
    Yet I sense from the testimony presented both in written 
form as well as here this morning that the Commission is being 
very defensive of these GAO findings. If you recall in the 2005 
bill which we were all involved in getting through. The 
legislation that was proposed or the amendment I think on the 
floor by Senator Brownback and Senator Feingold resulted in our 
agreeing that what we would do is to have GAO conduct a review 
after we had the chance to implement the law for a couple of 
years.
    So my question to each of you starting with you, Chairman 
Kelliher, is whether there are things in this GAO report that 
you find useful in terms of the ultimate objective here which 
is making sure that we are protecting consumers in this new day 
of post PUHCA which had been in place for what, 70 years before 
we got to the 2005 EPACT Act. Are there things within the 
recommendations that the GAO has provided to this committee 
that you would find helpful. What would be the top two or three 
if, or maybe you don't find any helpful? Give me a response to 
that.
    Mr. Kelliher. I would say that I would disagree with some 
of the assertions and conclusions in the report. I just think 
they're simply incorrect. But I don't reject the 
recommendations out of hand. I think it is something we should 
bear in mind whether we should conduct more audits. I think 
that's, you know, in a perfect world we would do more across 
the board in the area of enforcement. Perhaps we would do more 
audits.
    I think in some cases it's just a difference in 
interpretation. I think we actually do risk based audits 
currently. But we just view risk in a different manner than 
GAO. But I think, as my colleagues have said, we are taking 
therecommendations in the spirit in which they are offered.
    I would have preferred that the report say that FERC is 
doing a good job and it could do an even better job if it 
considered these recommendations. But we're considering the 
recommendations nonetheless.
    Senator Salazar. Is the ability to do a better job 
dependent on the resources currently that FERC has? For 
example, doing additional audits or what are the barriers for 
the Commission of being able to implement an improvement 
strategy along the lines that GAO has indicated?
    Mr. Kelliher. Resources are certainly an issue because we 
have asked Congress for additional enforcement resources and 
Congress has been supportive. But whatever we have is finite. 
Then we have to allocate it.
    To me the highest priority areas are preventing market 
manipulation, preventing market power exercise, upholding 
reliability standards. Then the other enforcement priorities 
have to, to some extent, fight for the remainder of our 
enforcement budget. This, I don't think, I think the financial 
audits, the PUHCA audits simply aren't the same priority as 
preventing market manipulation.
    So if we do get more enforcement resources we might be able 
to conduct more audits.
    Senator Salazar. Let me ask the other Commissioners if 
you'd comment quickly on this.
    Commissioner Kelly.
    Ms. Kelly. Senator Salazar, I agree with the GAO's 
recommendation that we engage in some sort of open, 
transparent, comprehensive risk based or some other similar 
approach to undertake our enforcement activities. I think that 
would be helpful to us. I think it would be helpful to the 
regulated community.
    So I think they have a lot to offer there. I do believe 
that we need more resources in our enforcement area.
    Senator Salazar. Commissioner Moeller.
    Mr. Moeller. Senator Salazar, a little context, having been 
a Senate staffer for several years when PUHCA repeal was being 
considered, I think there was a big concern that there would be 
merger mania after it was repealed. I think the perspective is 
that there hasn't been, that we have been vigilant, but we need 
to continue to be vigilant in examining inappropriate cross 
subsidization in the case of a merger.
    In talking to our audit folks, I think they feel that they 
could be a little more open. But they also focus on things 
where they see improvements. They don't go through the litany 
of where they think a company is doing something well.
    So that could be just a basic disagreement as to an 
approach as to how we do audits. But again, I'm amenable to any 
recommendations on how we can be more open and more transparent 
in every part of our enforcement program.
    Senator Salazar. Commissioner Spitzer.
    Mr. Spitzer. Thank you, Senator. There were a number of 
mergers arising prior to 2005 repeal of 1935 PUHCA. A number of 
them turned out very badly including the Kansas transaction 
that I know concerned Senator Brownback and 1935 PUHCA did not 
serve ratepayers well. My judgment is that, due to the efforts 
of this Congress, in 2005 ratepayer protections were actually 
enhanced over the status quo ante.
    The second observation would be that had FERC promulgated a 
rule of a one size fits all preemptive ring fencing, for 
example, Oregon, that would not have worked in the Arizona 
transaction and might not have worked in other transactions 
involving different types of investment vehicles.
    That would segue into my third observation which would be 
perhaps more outreach by FERC to State commissions. Making the 
States aware, which have limited resources, that FERC has 
perhaps certain observations or views regarding some of the new 
investment vehicles in the utility space might assist the 
States. That is the information and collaborative outreach that 
I look forward to working with my State colleagues in the 
future.
    Senator Salazar. If I could ask one more question of you? 
Is there a great variance in terms of the State capacity from 
PUC to PUC? I would imagine that you have some States that have 
significant resources and can provide the oversight function 
that allows for them to play the backstop function. But do you 
have? I would imagine the Commission has a good sense that some 
States are, you might give them a ten in an eight plus rating 
in terms of their oversight. Other States probably don't have 
the resources really to provide that kind of oversight.
    Mr. Spitzer. Senator in the second panel you're going to 
hear from NARUC and Mr. Kerr, Commission Kerr, could certainly 
discuss some of the efforts that the States have done in 
collaborating amongst themselves. I would agree absolutely that 
the States have different levels of resources and both within 
the NARUC as well with FERC, there is collaboration with the 
States. One of our missions should be to assist those States 
where resource constraints cause them to ask for additional 
advice.
    Senator Salazar. Thank you.
    Commissioner Wellinghoff.
    Mr. Wellinghoff. Thank you, Mr. Chairman, Senator Salazar. 
I believe that there are a number of things in the GAO report 
that we do need to consider. We look at the issue of risk 
ranking of audits, for example.
    I would agree with the chairman that I think in some degree 
we do that already. Certainly with risk ranking, looking at 
market manipulation is the highest risk. The highest potential 
harm to consumers I think we have to really put our audit 
enforcement forces in that area first.
    However, with respect to within analysis of potential cross 
subsidization, perhaps there is some room for more structured 
ranking of those audits as GAO suggests. But perhaps GAO also 
needs to investigate more detail exactly how we are currently 
structuring those audits. As the chairman indicates we do have 
some measure of a risk ranking that we already use, although it 
may not be something that's published and transparently 
available.
    If we did provide that information I think it could help 
clarify that. In addition to the chairman's point on making it 
more transparent as to what our backstop really is. Let's make 
it clear. There certainly is a backstop to the extent that the 
States are not providing for a vigorous and effective ring 
fencing.
    It certainly would be my policy and my position that FERC 
would and should step in. But there is an issue of what is 
actually that line. I think Senator Cantwell was concerned 
about what is that line as well. Perhaps we could have a 
workshop with the States and with the industry to explore that 
line a little more.
    I think we're defining the line as we get more cases. 
Certainly I think the Puget case gives us one point on that 
line. But perhaps we need to get more points on that line. 
Thank you.
    Senator Salazar. Thank you, Commissioner. Thank you, Mr. 
Chairman.
    The Chairman. Thank you very much. Let me thank all the 
Commissioners. You've been very generous with your time and 
very excellent testimony. We appreciate it.
    Why don't we go ahead with the second panel? We have four 
additional witnesses on the second panel.
    Mark Gaffigan, who's the Director with the Energy Project 
Division of Natural Resources and Environment with the GAO.
    David Owens, Executive Vice President with Edison Electric 
Institute.
    The Honorable James Kerr who is the Commissioner with the 
North Carolina Utilities Commission and representing NARUC here 
today.
    Scott Hempling is Executive Director with the National 
Regulatory Research Institute.
    Thank you all for being here.
    Commissioner Kerr, I mispronounced your name. I apologize.
    Let me just alert folks that about 11 o'clock, I'm going to 
have to go to a meeting that Senator Reid has called. Senator 
Salazar has agreed to remain and preside at that point. So, why 
don't we go ahead with testimony? Then after each of you has 
summarized your testimony I'm sure there will be questions.
    Mr. Gaffigan, why don't you go right ahead?

  STATEMENT OF MARK GAFFIGAN, DIRECTOR, NATURAL RESOURCES AND 
         ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Gaffigan. Thank you, Mr. Chairman. Mr. Chairman, 
Senator Salazar, members of the committee, Good morning. I'm 
pleased to be here to discuss Federal and State oversight of 
electric utility holding companies in light of the 2005 repeal 
of PUHCA.
    Since the repeal of PUHCA there has been considerable 
interest about harmful cross subsidization--that is the passing 
of inappropriate costs to utility consumers from transactions 
between utilities and affiliated companies that are part of 
larger utility holding companies. Regarding Federal oversight 
of cross subsidization PUHCA's repeal impacted the Federal 
Energy Regulatory Commission in two ways.
    First, FERC's merger review responsibilities were expanded 
to ensure at the time of merger that mergers between companies 
would not result in cross subsidization.
    Second, it made FERC the principle Federal agency 
responsible for post merger oversight of utility holding 
companies, eliminating the role of the Securities and Exchange 
Commission.
    States continue to share in utility oversight and are very 
much interested in and impacted by Federal efforts. My 
testimony today will be based on GAO's February 2008 report 
that addressed the extent to which FERC has changed its merger 
and post merger oversight processes to protect against cross 
subsidization and second, the views of States about their 
oversight capacity.
    Regarding FERC, as has been stated, we found that FERC had 
made few substantive changes to either its merger review 
process or its post merger oversight and thus did not have a 
strong basis for ensuring that harmful cross subsidization does 
not occur. In the merger review process, FERC will rely on its 
existing policy that requires merging companies to disclose 
existing or planned cross subsidization. To certify in writing 
that they will not engage in cross subsidization.
    After mergers take place, FERC will rely on its existing 
enforcement mechanisms, which include company self reporting of 
violations. Two, a limited number of compliance audits. Our 
primary concern and the focus of our report recommendations is 
our view that FERC is over reliant on self reporting and under 
reliant on cost and compliance audits.
    Specifically FERC believes that the threat of large fines 
will encourage companies to investigate and self report any 
cross subsidization. However, to date, no companies have self 
reported any such violations. Some key stakeholders who we 
spoke to have raised concerns about this approach.
    For example, could large fines chill a company's 
willingness to self report? Others were concerned that 
companies may not be fully aware of the broad cross 
subsidization rules. Given the concerns about self reporting 
and its inherent limitations, FERC's other primary enforcement 
mechanism, compliance audits, is an important tool.
    However, since the repeal of PUHCA, FERC has not completed 
any holding company audits for cross subsidization. In 2008, 
FERC plans to audit three of the 36 holding companies it has 
determined are subject to its oversight. While this rate of 
review and the number of holding companies may change, at this 
pace, it would take 12 years for FERC to review each company.
    Most important, while FERC's audit plans for 2008 reflects 
insights of key staff. We did not find that FERC had a risk 
based approach that formally considers the risk posed by 
individual companies in determining where to focus its audit 
resources. For example, the use of company financial 
information and input from knowledgeable people in the 
financial community and States could be used to help plan 
FERC's audits.
    Without a risk based approach, FERC may not be effectively 
allocating its limited audit resources. Currently FERC's 
division of audits has 34 full time staff. With a magnitude of 
companies it oversees and a range of rules it enforces that go 
well beyond holding company cross subsidization.
    Making the most of limited resources is a theme that is not 
exclusive to the Federal role. It is an excellent segue to the 
State's views on their oversight capacity. While State views 
vary, a common theme that we identified in our survey of the 
States was the need for additional resources to respond to 
changes in oversight after repeal of PUHCA.
    For example, the majority of States reported auditing 1 
percent or less of transactions between affiliated companies 
over the last 5 years. States expressed their concerns about 
Federal over reliance on self reporting and the need for 
regular audits in light of their limited resources. Since 
oversight is a shared mission, and there is a common resource 
limitation, it makes even more sense for FERC to consider our 
recommendations to develop a risk based audit approach that 
includes collaboration with the States, consideration of 
company's financial status and clear audit reporting. After 
development of such an approach, FERC would also be in the best 
position to assess the need for its resources to perform its 
audits.
    This concludes my opening statement. I have submitted a 
written statement for the record. I welcome any questions you 
might have. Thank you.
    [The prepared statement of Mr. Gaffigan follows:]

 Prepared Statement of Mark Gaffigan, Director, Natural Resources and 
             Environment, Government Accountability Office
      Utility Regulation: Opportunities Exist to Improve Oversight

                         WHY GAO DID THIS STUDY

    Under the Public Utility Holding Company Act of 1935 (PUHCA 1935) 
and other laws, federal agencies and state commissions have 
traditionally regulated utilities to protect consumers from supply 
disruptions and unfair pricing. The Energy Policy Act of 2005 (EPAct) 
repealed PUHCA 1935, removing some limitations on the companies that 
could merge with or invest in utilities, and leaving the Federal Energy 
Regulatory Commission (FERC), which already regulated utilities, with 
primary federal responsibility for regulating them. Because of the 
potential for new mergers or acquisitions between utilities and 
companies previously restricted from investing in utilities, there has 
been considerable interest in whether cross-subsidization--unfairly 
passing on to consumers the cost of transactions between utility 
companies and their ``affiliates''--could occur.
    GAO was asked to testify on its February 2008 report, Utility 
Oversight: Recent Changes in Law Call for Improved Vigilance by FERC 
(GAO-08-289), which (1) examined the extent to which FERC changed its 
merger review and post merger oversight since EPAct to protect against 
cross-subsidization and (2) surveyed state utility commissions about 
their oversight. In this report, GAO recommended that FERC adopt a 
risk-based approach to auditing and improve its audit reports, among 
other things. The FERC Chairman disagreed with the need for our 
recommendations, but GAO maintains that implementing them would improve 
oversight.

                             WHAT GAO FOUND

    In its February 2008 report, GAO reported that FERC had made few 
substantive changes to either its merger review process or its post 
merger oversight since EPAct and, as a result, does not have a strong 
basis for ensuring that harmful cross-subsidization does not occur. 
FERC officials told GAO that they plan to require merging companies to 
disclose any cross-subsidization and to certify in writing that they 
will not engage in unapproved cross-subsidization. After mergers have 
taken place, FERC intends to rely on its existing enforcement 
mechanisms--primarily companies' self-reporting noncompliance and a 
limited number of compliance audits--to detect potential cross-
subsidization. FERC officials told us that they believe the threat of 
the large fines allowed under EPAct will encourage companies to 
investigate and self-report noncompliance. To augment self-reporting, 
FERC officials told us that, in 2008, they are using an informal plan 
to reallocate their limited audit staff to audit the affiliate 
transactions of 3 of the 36 holding companies it regulates. In planning 
these compliance audits, FERC officials told us that they do not 
formally consider companies' risk for noncompliance --a factor that 
financial auditors and other experts told us is an important 
consideration in allocating audit resources. Rather, they rely on 
informal discussions between senior FERC managers and staff. Moreover, 
we found that FERC's audit reporting approach results in audit reports 
that often lack a clear description of the audit objectives, scope, 
methodology, and findings--inhibiting their use to stakeholders.
    GAO's survey of state utility commissions found that states' views 
varied on their current regulatory capacities to review utility mergers 
and acquisitions and oversee affiliate transactions; however many 
states reported a need for additional resources, such as staff and 
funding, to respond to changes in oversight after the repeal of PUHCA 
1935. All but a few states have the authority to approve mergers, but 
many states expressed concern about their ability to regulate the 
resulting companies. In recent years, two state commissions denied 
mergers, in part because of these concerns. Most states also have some 
type of authority to approve, review, and audit affiliate transactions, 
but many states review or audit only a small percentage of the 
transactions; 28 of the 49 states that responded to our survey question 
about auditing said they audited 1 percent or fewer transactions over 
the last five years. In addition, although almost all states reported 
that they had access to financial books and records from utilities to 
review affiliate transactions, many states reported they do not have 
such direct access to the books and records of holding companies or 
their affiliated companies. While EPAct provides state regulators the 
ability to obtain such information, some states expressed concern that 
this access could require them to be extremely specific in identifying 
needed information, thus potentially limiting their audit access. 
Finally, 22 of the 50 states that responded to our survey question 
about resources said that they need additional staffing or funding, or 
both, to respond to changes that resulted from EPAct, and 8 states have 
proposed or actually increased staffing since EPAct was enacted.
    Mr. Chairman and Members of the Committee: Thank you for the 
opportunity to discuss our work on federal and state efforts to protect 
against potential cross-subsidization in the utility industry after the 
repeal of the Public Utility Holding Company Act of 1935 (PUHCA 1935). 
Public utilities sell about $325 billion worth of electricity and 
natural gas to more than 140 million customers in U.S. homes and 
businesses each year. These utilities may face the need to invest 
potentially hundreds of billions of dollars to expand and upgrade the 
utility infrastructure over the next 10 years. Oversight of utilities 
is carried out by the federal government and state commissions--with 
the federal role focused on regulation of interstate transmission and 
wholesale markets and the states' role focused on regulating retail 
markets. These federal and state regulators seek to balance efforts to 
protect utility consumers from potential supply disruptions and unfair 
pricing practices while ensuring that utilities are profitable enough 
to attract private investment. Traditionally, this regulation took 
place within the framework of PUHCA 1935 and other federal laws. In 
2005, the Energy Policy Act (EPAct) repealed PUHCA 1935, removing some 
limitations on the companies that could merge with or invest in 
utilities and opening the sector to new investment. The repeal of PUHCA 
1935 has raised concerns about whether the remaining laws and 
regulations strike an appropriate balance between encouraging 
investment in the utility sector and protecting consumers.
    PUHCA 1935 was a response to the rapid expansion, consolidation, 
and subsequent bankruptcies in the utility sector during the early part 
of the 20th century. Prior to its enactment, utilities were regulated 
by state commissions. As utilities grew, they began to span across 
multiple states that often had different rules and jurisdictional 
authority, making it difficult for state utility commissions to 
effectively regulate them. By the 1920s, as a result of mergers and 
acquisitions, utilities were largely controlled by a handful of complex 
corporations--called holding companies--many of which owned several 
utilities as well as other companies. In many cases, the companies 
within these holding companies--called affiliates--sold a wide range of 
goods and services to utilities, such as fuel for power plants. Since 
the rates utility customers pay generally include the cost of all the 
goods and services bought to serve them, some transactions between 
these affiliates allowed the utilities to take advantage of economies 
of scale to the benefit of utility customers, such as when utilities 
effectively shared the cost of legal and other administrative services 
with affiliates instead of each company maintaining staff and other 
resources to provide these services separately.
    However, affiliate transactions that were priced unfairly could 
inflate customers' rates to subsidize operations outside the utility--
called cross-subsidization. Compounding this complex web of corporate 
ownership and affiliate transactions, poor disclosure of financial 
information and limited access to financial records made it difficult 
for investors to accurately assess the utilities' financial health. 
Many of these holding companies were involved in risky business 
ventures outside the utility industry and had pledged utility assets to 
support those investments. Partly as a result of the poor financial 
disclosure and the complex web of corporate ownership and affiliate 
transactions, many utilities went into bankruptcy during the financial 
collapse followed by the Great Depression.
    To restore public confidence after the Depression, the federal 
government undertook three efforts that influenced the regulation of 
utilities. First, to protect investors, including utility investors, 
the federal government created the Securities and Exchange Commission 
(SEC) in 1934. SEC established rules--including improved financial 
reporting--for the financial markets and publicly traded companies 
participating in those markets, as well as a means to regulate them. 
Second, to protect utility customers, the federal government enacted 
the Federal Power Act of 1935 which served, and continues to serve 
today, as the foundation of federal regulatory authority related to 
regulation of public utilities, and empowered the Federal Energy 
Regulatory Commission (FERC) to serve as the primary federal regulator 
of utilities.\1\ As such, FERC became responsible for overseeing 
interstate transmission of electricity, wholesale sales of electricity 
to resellers (e.g., sales by utilities to other utilities), and 
reviewing proposed mergers or acquisitions involving companies it 
regulates. In its role of regulating interstate transmission and 
wholesale sales, FERC has been responsible for approving prices (i.e., 
rates) for the use of transmission lines and the sales of electricity 
in wholesale markets--also commonly called ``rate setting.'' As part of 
that process, FERC has determined which costs, including affiliate 
transaction costs, may be lawfully included in rates. Third, the 
federal government enacted PUHCA 1935 to regulate investment in the 
utility industry and protect investors and consumers from potential 
abuses such as cross-subsidization by holding companies. SEC was 
responsible for administering PUHCA, including reviewing mergers or 
acquisitions involving holding companies. To that end, SEC was given 
primary responsibility for examining and determining how to allocate 
affiliate transaction costs for holding companies it regulates. Among 
other things, PUHCA limited the formation of new holding companies that 
were not physically connected by electric power lines, and prohibited 
existing holding companies from acquiring more than one utility, unless 
the utilities were physically connected by power lines. Over time, 
other statutory and regulatory changes reduced some of the strict 
limitations PUHCA 1935 initially imposed.
---------------------------------------------------------------------------
    \1\ The Federal Power Act of 1935 empowered the Federal Power 
Commission, the predecessor to FERC.
---------------------------------------------------------------------------
    Over the past two decades, some interested parties in the utility 
industry sought repeal of PUHCA 1935, arguing that it was a roadblock 
to the private investment that could reduce the cost of improvements to 
the utility infrastructure, and noting that several federal antitrust 
laws that apply to utility companies have been passed since PUHCA was 
enacted. Opponents of PUHCA 1935's repeal, including some business and 
consumer representatives, expressed concern that its repeal would 
encourage utilities to return to the kinds of risky business ventures 
that spawned it, and that utilities would again become too complex to 
effectively regulate, potentially raising prices for consumers. 
Business groups outside the utility industry were also concerned that 
utilities could use their monopolies to cross-subsidize investments 
into other kinds of businesses and harm competition in those 
industries.
    In 2005, EPAct repealed PUHCA 1935--thereby opening the sector to 
new investment--and replaced it with PUHCA 2005. The repeal of EPAct 
1935 eliminated SEC's oversight role in regulating utility holding 
companies or preventing cross-subsidies, giving FERC new authorities to 
regulate corporate structures and transactions.\2\ FERC's expanded 
authorities fall into two broad areas: 1) FERC was required to ensure 
at the point of the merger review that the proposed merger would not 
result in harmful cross-subsidization, and 2) FERC became the principal 
federal agency responsible for determining how costs for affiliate 
transactions should be allocated for all utility holding companies. To 
help FERC better oversee these transactions, EPAct provided FERC 
specific postmerger access to the books, accounts, memos, and financial 
records of utility owners and their affiliates and subsidiaries, and 
granted state utility commissions similar access. Furthermore, EPAct 
expanded FERC's civil penalty authority to help it enforce its new 
requirements, providing the commission the ability to levy penalties of 
up to $1 million per day per violation. After EPAct, states continue to 
play key roles overseeing utilities and reviewing mergers, including 
conducting some audits of affiliate transactions.
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    \2\ The SEC will continue enforcing laws and regulations governing 
the issuance of securities and regular financial reporting by public 
companies. The Department of Justice and the Federal Trade Commission 
will continue their long-standing enforcement of antitrust laws. These 
include the premerger provisions of the Hart-Scott-Rodino Antitrust 
Improvements Act of 1976 and Section 7 of the Clayton Act.
---------------------------------------------------------------------------
    My testimony today will focus on our February 2008 report, Utility 
Oversight: Recent Changes in Law Call for Improved Vigilance by FERC 
(GAO-08-289), which examined: (1) the extent to which FERC, since 
EPAct's enactment, has changed its merger or acquisition review process 
and postmerger or acquisition oversight to ensure that potential 
harmful cross-subsidization by utilities does not occur; and (2) the 
views of state utility commissions regarding their current capacity, in 
terms of regulations and resources, to oversee utilities. For that 
report, we reviewed relevant reports and data, interviewed key 
officials, visited four states--California, New Jersey, Oregon, and 
Wisconsin--that had or were considering implementing strong protections 
for overseeing holding and related affiliate companies, and surveyed 
state utility regulators in all 50 states and the District of Columbia. 
We performed our review from May 2006 through February 2008 in 
accordance with generally accepted government auditing standards. Those 
standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives.
    In summary, we found:

   FERC has made few substantive changes to either its merger 
        review process or its postmerger oversight since EPAct and, as 
        a result, does not have a strong basis for ensuring that 
        harmful cross-subsidization does not occur. FERC officials told 
        us that they plan to require merging companies to disclose 
        existing or planned cross-subsidization and to certify in 
        writing that they will not engage in unapproved cross-
        subsidization. Once mergers have taken place, FERC intends to 
        rely on its existing enforcement mechanisms--primarily 
        companies' self-reporting noncompliance and a limited number of 
        compliance audits--to detect potential cross-subsidization. 
        FERC officials told us that they believe the threat of large 
        fines, as allowed by EPAct, will encourage companies to 
        investigate and self-report noncompliance. To augment self-
        reporting, FERC officials told us that they are using an 
        informal plan to reallocate their limited audit staff to 
        conduct affiliate transaction audits of 3 of the 36 holding 
        companies it regulates in 2008. In planning these compliance 
        audits, FERC officials told us that they do not formally 
        consider companies' risk for noncompliance--a factor that 
        financial auditors and other experts told us is an important 
        consideration in allocating audit resources--relying instead on 
        informal discussions between senior FERC managers and staff. 
        Moreover, we found that FERC's audit reporting approach results 
        in audit reports that often lack a clear description of the 
        audit objectives, scope, methodology, and findings--inhibiting 
        their use to stakeholders.
   Although states' views varied on their current regulatory 
        capacities to review utility mergers and acquisitions and 
        oversee affiliate transactions, many states reported a need for 
        additional resources, such as staff and funding, to respond to 
        changes in oversight after the repeal of PUHCA 1935. All but a 
        few states have merger approval authority, but many states 
        expressed concern about their ability to regulate the resulting 
        companies after merger approval. In recent years, two state 
        commissions denied mergers, in part because of these concerns. 
        Most states also have some type of authority to approve, 
        review, and audit affiliate transactions, but many states 
        review or audit only a small percentage of the transactions, 
        with 28 of the 49 reporting states auditing 1 percent or less 
        over the last five years. In addition, although almost all 
        states reported that they had access to financial books and 
        records from utilities to review affiliate transactions, many 
        states reported they do not have such direct access to the 
        books and records of holding companies or their affiliated 
        companies. While EPAct provides state regulators the ability to 
        obtain such information, some states expressed concern that 
        this access could require them to be extremely specific in 
        identifying needed information, thus potentially limiting their 
        audit access. Finally, 22 of the 50 states that responded to 
        our survey question about resources said that they need 
        additional staffing or funding, or both, to respond to changes 
        that resulted from EPAct, and 8 states have proposed or 
        actually increased staffing since EPAct was enacted.

   FERC'S MERGER AND ACQUISITION REVIEW AND POSTMERGER OVERSIGHT TO 
  PREVENT CROSS-SUBSIDIZATION IN UTILITY HOLDING COMPANY SYSTEMS ARE 
                                LIMITED

    In February 2008, we reported that FERC had made few substantive 
changes to either its merger and acquisition review process or its 
postmerger oversight as a consequence of its new responsibilities and, 
as a result, does not have a strong basis for ensuring that harmful 
cross-subsidization does not occur. Specifically:

    Reviewing mergers and acquisitions.--FERC's merger and acquisition 
review relies primarily on company disclosures and commitments not to 
cross-subsidize. FERC-regulated companies that are proposing to merge 
with or acquire a regulated company must submit a public application 
for FERC to review and approve. If cross-subsidies already exist or are 
planned, companies are required to describe how these are in the public 
interest by, for example identifying how the planned cross-subsidy 
benefits utility ratepayers and does not harm others. FERC also 
requires company officials to attest that they will not engage in 
unapproved cross-subsidies in the future. This information becomes part 
of a public record that stakeholders or other interested parties, such 
as state regulators, consumer advocates, or others may review and 
comment on, and FERC may hold a public hearing on the merger. FERC 
officials told us that they evaluate the information in the public 
record for the application and do not collect evidence or conduct 
separate analyses of a proposed merger. On the basis of this 
information, FERC officials told us that they determine which, if any, 
existing or planned cross-subsidies to allow, then include this 
information in detail in the final merger or acquisition order. Between 
the time EPAct was enacted in 2005 and July 10, 2007--when FERC 
provided detailed information to us--FERC had reviewed or was in the 
process of reviewing 15 mergers, acquisitions, or sales of assets. FERC 
had approved 12 mergers, although it approved three of these with 
conditions--for example, requiring the merging parties to provide 
further evidence of provisions to protect customers. Of the remaining 
three applications, one application was withdrawn by the merging 
parties prior to FERC's decision and the other two were still pending.
    Postmerger oversight.--FERC's postmerger oversight relies on its 
existing enforcement mechanisms--primarily self-reporting and a limited 
number of compliance audits.\3\ FERC indicates that it places great 
importance on self-reporting because it believes companies can actively 
police their own behavior through internal and external audits, and 
that the companies are in the best position to detect and correct both 
inadvertent and intentional noncompliance. FERC officials told us that 
they expect companies to become more vigilant in monitoring their 
behavior because FERC can now levy much larger fines--up to $1 million 
per day per violation--and that a violating company's actions in 
following this self-reporting policy, along with the seriousness of a 
potential violation, help inform FERC's decision on the appropriate 
penalty.\4\ Key stakeholders have raised concerns that internal company 
audits tend to focus on areas of highest risk to the company profits 
and, as a result, may not focus specifically on affiliate transactions. 
One company official noted that the threat of large fines may ``chill'' 
companies' willingness to self-report violations. Between the enactment 
of EPAct--when Congress formally highlighted its concern about cross-
subsidization--and our February 2008 report, no companies had self-
reported any of these types of violations. To augment self-reporting, 
FERC plans to conduct a limited number of compliance audits of holding 
companies each year, although at the time of our February 2008 report, 
it had not completed any audits to detect whether cross-subsidization 
is occurring. In 2008, FERC's plans to audit 3 of the 36 companies it 
regulates--Exelon Corporation, Allegheny, Inc., and the Southern 
Company. If this rate continues, it would take FERC 12 years to audit 
each of these companies once, although FERC officials noted that they 
plan audits one year at a time and that the number of audits may change 
in future years.
---------------------------------------------------------------------------
    \3\ FERC officials also told us that in addition to self-reporting 
and audits of some companies, they also may initiate investigations 
based on internal and external reports of potential violations. 
Officials told us that they are able to initiate internal 
investigations based on referrals from FERC staff such as those 
monitoring natural gas and electricity trading and markets in the 
market monitoring center. In addition, FERC officials noted that 
companies and individuals may report potential violators. Such reports 
may be made, they said, through their ``hotline'' reporting system, 
which allows individuals to anonymously report suspected violations of 
FERC rules. In addition, individuals knowledgeable of FERC's processes 
and rules may also report violations as formal or informal complaints 
that companies are violating the terms and conditions of the detailed 
FERC-approved tariffs or rates. FERC officials did not tell us how many 
such reports have been made related to cross-subsidies or how many of 
such reports resulted in cross-subsidy violations. However, officials 
noted that all complaints are investigated to determine whether they 
have merit.
    \4\ FERC generally plans to retain its flexibility and discretion 
to decide remedies on a caseby-case basis rather than to prescribe 
penalties or develop formulas for different violations.
---------------------------------------------------------------------------
    We found that FERC does not use a formal risk-based approach to 
plan its compliance audits--a factor that financial auditors and other 
experts told us is an important consideration in allocating audit 
resources. Instead, FERC officials plan audits based on informal 
discussions between FERC's Office of Enforcement, including its 
Division of Audits, and relevant FERC offices with related expertise. 
To obtain a more complete picture of risk, FERC could more actively 
monitor company-specific data--something it currently does not do. In 
addition, we found that FERC's postmerger audit reports on affiliate 
transactions often lack clear information--that they may not always 
fully reflect key elements such as objectives, scope, methodology, and 
the specific audit findings, and sometimes lacked key information, such 
as the type, number, and value of affiliate transactions at the company 
involved, the percentage of all affiliate transactions tested, and the 
test results. Without this information, these audit reports are of 
limited use in assessing the risk that affiliate transactions pose for 
utility customers, shareholders, bondholders, and other stakeholders.
    In our February 2008 report, we recommended that the Chairman of 
the Federal Energy Regulatory Commission (FERC) develop a 
comprehensive, risk-based approach to planning audits of affiliate 
transactions to better target FERC's audit resources to highest 
priority needs. Specifically, we recommended that FERC monitor the 
financial condition of utilities, as some state regulators have found 
useful, by leveraging analyses done by the financial market and 
developing a standard set of performance indicators. In addition, we 
recommended that FERC develop a better means of collaborating with 
state regulators to leverage audit resources states have already 
applied to enforcement efforts and to capitalize on state regulators' 
unique knowledge. We also recommended that FERC develop an audit 
reporting approach to clearly identify the objectives, scope and 
methodology, and the specific findings of the audit to improve public 
confidence in FERC's enforcement functions and the usefulness of its 
audit reports. The Chairman strongly disagreed with our overall 
findings and the need for our recommendations; nonetheless, we maintain 
that implementing our recommendations would enhance the effectiveness 
of FERC's oversight.

          STATES VARY IN THEIR CAPACITIES TO OVERSEE UTILITIES

    States utility commissions' views of their oversight capacities 
vary, but many states foresee a need for additional resources to 
respond to changes from EPAct. The survey we conducted for our February 
2008 report highlighted the following concerns:

   Almost all states have merger approval authority, but many 
        states expressed concern about their ability to regulate the 
        resulting companies. All but 3 states\5\ (out of 50 responses) 
        have authority to review and either approve or disapprove 
        mergers, but their authorities varied. For example, one state 
        could only disapprove a merger and, as such, allows a merger by 
        taking no action to disapprove it. State regulators reported 
        being mostly concerned about the impact of mergers on customer 
        rates, but 25 of 45 reporting states also noted concerns that 
        the resulting, potentially more complex company could be more 
        difficult to regulate. In recent years, the difficulty of 
        regulating merged companies has been cited by two state 
        commissions--one in Montana and one in Oregon--that denied 
        proposed mergers in their states. For example, a state 
        commission official in Montana told us the commission denied a 
        FERC-approved merger in July 2007 that involved a Montana 
        regulated utility, whose headquarters was in South Dakota, 
        which would have been bought by an Australian holding company.
---------------------------------------------------------------------------
    \5\ After completion of our survey, one state subsequently obtained 
approval from its legislature to review and approve future electric 
utility mergers.
---------------------------------------------------------------------------
   Most states have authorities over affiliate transactions, 
        but many states report auditing few transactions. Nationally, 
        49 states noted they have some type of affiliate transaction 
        authority, and while some states reported that they require 
        periodic, specialized audits of affiliate transactions, 28 of 
        the 49 reporting states reported auditing 1 percent or fewer 
        over the last five years. Audit authorities vary from 
        prohibitions against certain types of transactions to less 
        restrictive requirements such as allowance of a transaction 
        without prior review, but authority to disallow the transaction 
        at a later time if it was deemed inappropriate. Only 3 states 
        reported that affiliate transactions always needed prior 
        commission approval. One attorney in a state utility commission 
        noted that holding company and affiliate transactions can be 
        very complex and time-consuming to review, and had concerns 
        about having enough resources to do this.
   Some states report not having access to holding company 
        books and records. Although almost all states report they have 
        access to financial books and records from utilities to review 
        affiliate transactions, many states reported they do not have 
        such direct access to the books and records of holding 
        companies or their affiliated companies. While EPAct provides 
        state regulators the ability to obtain such information, some 
        states expressed concern that this access could require them to 
        be extremely specific in identifying needed information, which 
        may be difficult. Lack of direct access, experts noted, may 
        limit the effectiveness of state commission oversight and 
        result in harmful cross-subsidization because the states cannot 
        link financial risks associated with affiliated companies to 
        their regulated utility customers. All of the 49 states that 
        responded to this survey question noted that they require 
        utilities to provide financial reports, and 8 of these states 
        require reports that also include the holding company or both 
        the holding company and the affiliated companies.
   States foresee needing additional resources to respond to 
        the changes from EPAct. Specifically, 22 of the 50 states that 
        responded to our survey said that they need additional staffing 
        or funding, or both, to respond to the changes that resulted 
        from EPAct. Further, 6 out of 30 states raised staffing as a 
        key challenge in overseeing utilities since the passage of 
        EPAct, and 8 states have proposed or actually increased 
        staffing.

    In conclusion, the repeal of PUHCA 1935 opened the door for needed 
investment in the utility industry; however, it comes at the potential 
cost of complicating regulation of the industry. Further, the 
introduction of new types of investors and different corporate 
combinations--including the ownership of utilities by complex 
international companies, equity firms, or other investors with 
different incentives than providing traditional utility company 
services--could change the utility industry into something quite 
different than the industry that FERC and the states have overseen for 
decades. In light of these changes, we believe FERC should err on the 
side of a ``vigilance first'' approach to preventing potential cross-
subsidization. As FERC and states approve mergers, the responsibility 
for ensuring that cross-subsidization will not occur shifts to FERC's 
Office of Enforcement and state commission staffs. Without a risk-based 
approach to guide its audit planning--the active portion of its 
postmerger oversight--FERC may be missing opportunities to demonstrate 
its commitment to ensuring that companies are not engaged in cross-
subsidization at the expense of consumers and may not be using its 
audit resources in the most efficient and effective manner. Without 
reassessing its merger review and postmerger oversight, FERC may 
approve the formation of companies that are difficult and costly for it 
and states to oversee and potentially risky for consumers and the 
broader market. In addition, the lack of clear information in audit 
reports not only limits their value to stakeholders, but may undermine 
regulated companies' efforts to understand the nature of FERC's 
oversight concerns and to conduct internal audits to identify potential 
violations that are consistent with those conducted by FERC--key 
elements in improving their self-reporting. We continue to encourage 
the FERC Chairman to consider our recommendations.
    Mr. Chairman, this completes my prepared statement. I would be 
happy to respond to any questions you or other Members of the Committee 
may have at this time.

    The Chairman. Thank you very much.
    Commissioner Kerr.

  STATEMENT OF JAMES Y. KERR II, COMMISSIONER, NORTH CAROLINA 
   UTILITIES COMMISSION REPRESENTING NATIONAL ASSOCIATION OF 
                REGULATORY UTILITY COMMISSIONERS

    Mr. Kerr. Thank you, Mr. Chairman. On behalf of my 
colleagues at NARUC I appreciate the opportunity to be here 
today and thank you and the members of this committee. I 
suspect I ought to also thank Chairman Kelliher for his 
insightful assessment of the relative regulatory bodies across 
the country. My colleagues in Washington State and I believe 
he's absolutely correct in that regard.
    I want to thank you, Mr. Chairman, Senator Brownback and 
Senator Feingold for requesting this report and especially 
thank GAO for the quality work product. NARUC had the 
opportunity to work closely with GAO in conducting the survey 
and producing the report. Since the report was issued GAO has 
presented on the report to our staffs of committee on 
accounting.
    We believe the report provides both States and our Federal 
colleagues at FERC a valuable tool to continue to do what 
you've asked us to do with the adoption of EPACT 2005 which is 
to work together to ensure that we effectively carry out our 
shared responsibility to consumers. I believe that the report 
reveals no actual regulatory failures. It reveals no actual 
regulatory gaps.
    It does however identify areas for potential improvements 
for regulation at both the State and Federal level. Given the 
awesome responsibility we share with our Federal colleagues to 
protect consumers, I believe that the GAO report is both timely 
and helpful.
    I want to briefly summarize four points from the 
perspective of State regulators.
    First of all and this cannot be underestimated is the 
capital needs facing these vital industries are tremendous and 
they are growing everyday. The growing concern about various 
environmental issues, interest in efficiency, demand response, 
alternative generation as well as advanced technologies for 
more traditional forms of generation are causing significant 
increases in the capital demands in these industries and that 
is coupled unfortunately at a time when both commodity and 
construction costs are escalating.
    We cannot perceptively and prescriptively determine how or 
where the capital will or should come from to meet these needs. 
We can and do care greatly about who owns and operates these 
vital businesses. How they are owned and operated. But we 
cannot afford to discriminate or foreclose the various 
approaches the needs are simply too great.
    These, as Chairman Kelliher said, and I agree are very fact 
specific inquiries. To meet the challenges we will need the 
opportunity to consider a variety of approaches, transactions 
and sources of capital both internal and external. We need to 
be able to benefit from the creativity and variety that the--
with the adoption of EPACT 2005 and the repeal of PUHCA 1935, 
we now have a greater opportunity to take advantage of.
    But you, as you are doing today, should ask yourselves do 
we have an adequate and effective regulatory structure to 
perform this inquiry and to protect consumers. You've heard a 
lot from the first panel about the Federal approach. I won't 
cover that again.
    I will say that I think when you read the record in this 
case including the GAO report the answer is yes, we do have an 
effective regulatory structure. From the State level and I'll 
anticipate the question of do we disagree with the GAO report 
in any regard. I don't think this is a disagreement. But I 
would say that I think the GAO report probably underestimates 
the pervasive, positive role that rate making authority plays.
    I don't mean to be trite. But I do believe that the old 
expression that if you have them by the rates, their hearts and 
minds will follow is in fact, an accurate assessment of the 
importance of rate making authority as it affects the totality 
of the relationship. We have the power, as demonstrated by the 
record to approve mergers and acquisitions and other transfers.
    But also importantly and I think this was slightly 
underemphasized is the ability to condition merger approvals, 
rate making orders to address areas where actual statutory 
authority may not exist. I have attached to my testimony an 
extensive appendix from our Duke Synergy merger review that I 
think makes that point almost too clear with its length and the 
detail. Then once you've done that. You have the ability to 
regulate, verify and enforce the various relationships that 
exist. I think that from a State perspective we believe that we 
do.
    So what are we doing since the repeal of PUHCA and where do 
we find ourselves? My last point would be that we are working 
cooperatively with our Federal colleagues. We are, as the GAO 
suggests, we might want to, willing to do more in this regard.
    Some States are expanding the regulatory tools where they 
determine necessary. They are either getting statutory 
authority or relying more on orders and conditions. We are 
working through to leverage resources. To Senator Salazar, to 
your earlier question, we are trying to leverage resources 
across States and commissions through NARUC, through the 
National Regulatory Research Institute, through our extensive 
interaction with the financial community and if resources are a 
problem we can work with our State legislatures on funding for 
resources if additional resources are necessary.
    I'd be happy to answer questions at the appropriate time. 
Thank you.
    [The prepared statement of Mr. Kerr follows:]

 Prepared Statement of James Y. Kerr II, Commissioner, North Carolina 
 Utilities Commission Representing National Association of Regulatory 
                         Utility Commissioners

    Good morning Chairman Bingaman, Ranking Member Domenici, Members of 
this Committee, and distinguished panelists.
    My name is Jim Kerr. I am a member of the North Carolina Utilities 
Commission (``NCUC''). I am also the immediate past President of the 
National Association of Regulatory Utility Commissioners (``NARUC''), 
and I am testifying today on behalf of that organization. In addition, 
my testimony reflects the views of the NCUC and provides some detailed 
information concerning our approach to issues raised in this hearing 
and the GAO Report. On behalf of NARUC and the NCUC, I very much 
appreciate the opportunity to appear before you this morning.
    I ask that my testimony be made a part of the record and I will 
summarize our views.
    NARUC is a quasi-governmental, non-profit organization founded in 
1889. Our membership includes the State public utility commissions 
serving all States and territories. NARUC's mission is to serve the 
public interest by improving the quality and effectiveness of public 
utility regulation. Our members regulate the retail rates and services 
of electric, gas, water, and telephone utilities. We are obligated 
under the laws of our respective States to ensure the establishment and 
maintenance of such utility services as may be required by the public 
convenience and necessity and to ensure that such services are provided 
under rates and subject to terms and conditions of service that are 
just, reasonable, and non-discriminatory.

                              INTRODUCTION

    The Energy Policy Act of 2005 (``EPAct 2005'') repealed the Public 
Utility Holding Company Act of 1935 (``PUHCA 1935'') and enacted the 
Public Utility Holding Company Act of 2005 (``PUHCA 2005''). EPAct 2005 
also expanded the Federal Energy Regulatory Commission's (``FERC' or 
the ``Commission'') merger and corporate review authority under Federal 
Power Act (``FPA'') Section 203.
    PUHCA 1935 repeal opened the door for new and different corporate 
combinations, including the ownership of utilities by complex 
international holding companies or private equity firms. At the same 
time, the repeal did not fundamentally alter the manner in which State 
commissions regulate.
    State regulatory commissions have traditionally had jurisdiction 
over the regulation of utilities in various areas, including mergers 
and acquisitions, affiliate transactions, audits, and financial 
reporting. The repeal of PUHCA 1935 did not change the States' 
authority in these areas. In fact, EPAct 2005 explicitly gave State 
Commissions authority to obtain the books and records of a public 
utility in a holding company system, the holding company or any 
associate company or affiliate.
    State commissions have the obligation under State law to ensure the 
establishment and maintenance of such energy utility services as may be 
required by the public convenience and necessity. We have to ensure 
that such services are provided at rates and conditions that are just, 
reasonable and nondiscriminatory for all consumers.
    State commissions have powerful regulatory tools to protect 
customers. Each State has extensive ratemaking authority, and in the 
exercise of the same, has the right to disallow recovery in rates of 
inappropriate or improper costs, including those deemed to represent 
cross-subsidies. The exercise of State merger review authority provides 
a means to protect consumer interests by imposing conditions on any 
proposed transaction. In fact, the broad statutory mandates to uphold 
the public interest and ensure reliable service at just and reasonable 
rates have allowed State commissions to establish specific consumer 
protections not directly spelled out under their broad statutory 
authority.

                         COORDINATION WITH FERC

    The Report by the Government Accountability Office (``GAO''), 
Recent Changes In Law Call for Improved Vigilance by FERC, GAO-08-289 
(February 2008)(``GAO Report'' or Report'') concluded with a number of 
recommendations to the FERC Chairman.\1\ One of the recommendations 
stated that the Chairman should develop ``a better means of 
collaborating with [S]tate regulators to leverage resources already 
applied to enforcement efforts and to capitalize on [S]tate regulators' 
unique knowledge. As part of this effort, FERC may want to consider 
identifying a liaison, or liaisons, for [S]tate regulators to contact 
and to serve as a focal point(s).''\2\
---------------------------------------------------------------------------
    \1\ GAO Report, Recent Changes In Law Call for Improved Vigilance 
by FERC, GAO-08-289 (February 2008) at 31-32.
    \2\ Id.
---------------------------------------------------------------------------
    NARUC has had an extensive and constructive working relationship 
with FERC, and welcomes the recommendation of the GAO Report in this 
regard. Currently, we have three State/FERC Collaboratives that cover 
cross jurisdictional areas: demand response, competitive procurement 
and smart grid. These initiatives have involved all members of the FERC 
and Senior Staff and a broad cross-section of State Commissioners and 
Staff. These efforts have been collegial, informative and productive. 
In short, the relationship and precedent exists to explore to continue 
working together in this particular case.
    FERC's implementing regulations under EPAct 2005 have been 
respectful of State authority. FERC has said that where there is State 
authority in the area of merger review and cross-subsidization 
protections, that authority should be recognized. For example, as to 
reviews under FPA Section 203, the FERC policy is to accept State 
cross-subsidization protections unless there is evidence that 
additional measures are needed to protect wholesale customers or if 
there is a regulatory gap because the State lacks authority in the 
area. This approach properly coordinates federal and State merger 
review to avoid unnecessary conflict and potential claim of federal 
preemption.

                      RESPONSES TO THE GAO REPORT

    The following sections will focus on responding to the issues 
covered in the GAO Report's survey of State commissions. The issues 
covered in the State survey are (1) State Review of Mergers, (2) State 
Regulation of Affiliate Transactions and Cross-Subsidies, (3) Financial 
Protections or Ring-Fencing (4) Audits, Access to Books and Records, 
and Financial Reporting; and (5) Status of State Resources. The GAO 
recognized that most of the State commissions have authority which they 
exercise in these areas.
    We note that the detail of the State responses to specific 
questions depended on the respondent. Further research into State 
Commission practices were conducted with GAO Staff's visits to four 
States only.\3\ In addition, responses and observations were provided 
from non-State commission entities, such as officials from the 
financial community,\4\ an ``expert'' with ``extensive experience with 
FERC and several [S]tate public utility commissions'',\5\ a 
``consultant whose firm does numerous affiliate transaction audits in 
many [S]tates'',\6\ ``utility experts'';\7\ a ``president of an audit 
company'';\8\ and ``representatives from two consumer groups''.\9\ 
These points were not made to be critical of the GAO Report, but to 
recognize the difficulty in responding with precision to the Survey 
responses.
---------------------------------------------------------------------------
    \3\ Id. at 26.
    \4\ Id. at 24.
    \5\ Id. at 26.
    \6\ Id.
    \7\ Id. at 28.
    \8\ Id.
    \9\ Id. at 27.
---------------------------------------------------------------------------
(1) State Review of Mergers
    Almost all States have specific authority to review mergers and 
similar corporate transactions. The GAO Report recognized that even for 
the two States that do not have direct merger review authority, these 
States were able to use other State Commission authority to conduct 
such reviews.\10\ Each State will apply its merger authority to the 
facts and circumstances of the merger transaction at hand.
---------------------------------------------------------------------------
    \10\ The GAO Report survey concluded that only 3 States (Florida, 
Indiana, Texas) out of the responding 50 States lack authority to 
review mergers. GAO Report, Recent Changes In Law Call for Improved 
Vigilance by FERC, GAO-08-289 (February 2008) at 22. The Report notes 
that after completion of the survey, one State (Texas) subsequently 
obtained approval from its legislature to review and approve future 
electric utility mergers.
---------------------------------------------------------------------------
    The merger statute in my home State of North Carolina is fairly 
typical: It prohibits any transfer affecting a public utility without 
approval from the NCUC.\11\ Such approval will be given ``if justified 
by the public convenience and necessity''. The ``public convenience and 
necessity'' standard has been described by the North Carolina courts as 
``a relative or elastic theory rather than an abstract or absolute 
rule''.\12\
---------------------------------------------------------------------------
    \11\ N.C. Gen. Stat. 62-111.
    \12\ State ex. rel. North Carolina Utilities Commission v. Casey, 
245 N.C. 297, 96 S.E.2d 8 (N.C. 1957).
---------------------------------------------------------------------------
    According to the leading North Carolina case construing our 
transfer statute, the NCUC is required to ``inquire into all aspects of 
anticipated service and rates occasioned and engendered by the proposed 
transfer'' in deciding the issues raised by a merger application.\13\ 
The ultimate decision must be made by analyzing ``the facts of each 
case''. This amounts to a requirement that we utilize a ``totality of 
the circumstances'' or an ad hoc balancing test in review merger 
applications.
---------------------------------------------------------------------------
    \13\ State ex. rel. Utilities Commission v. Village of Pinehurst, 
115 P.U.R.4th 558, 393 S.E.2d 111 (N.C.App. 1996).
---------------------------------------------------------------------------
    While the repeal of PUHCA 1935 has not fundamentally altered our 
authority or ability to review merger applications, our merger analysis 
has been affected in a limited number of ways:

          (1) We have not had to impose conditions that attempted to 
        preclude PUHCA 1935-related preemption under the Ohio Power 
        decision;
          (2) We have had to beef up our accounting-related conditions 
        to account for the absence of certain accounting practices that 
        would have otherwise been required by PUHCA 1935; and
          (3) We have had to impose financial protection conditions to 
        account for the absence of various limitations and protections 
        that had been provided for by PUHCA 1935.

    Other than the above and a widening scope of the types of 
transactions that can be presented to the NCUC for review and approval, 
PUHCA 1935 repeal has had little impact on the manner to which we 
handle merger-related proceedings.
    To be sure, the NCUC tries to provide applicants with some idea of 
the nature of our concerns in preparation for filing an application for 
a merger or similar business combination transaction. As a matter of 
decisional law, we have attempted to put some further meat on the 
statutory test in our decisions. Several of our prior orders provide 
that a merger should be approved, whether as proposed or as 
conditioned, as long as:

          (1) The proposed transfer has no known adverse impact on the 
        rates and service of the utility;
          (2) Customers are protected from potential harm as much as 
        possible; and
          (3) Customers are provided with sufficient benefits as a 
        result of the transfer to offset any potential costs, risks and 
        harms.

    We have required applicants to file cost/benefit and market power 
studies. The obvious purpose of this request is to ensure that a 
particular proposal will not have a harmful anticompetitive effect on 
North Carolina retail ratepayers and to provide us some idea of the 
extent of any cost savings from a particular merger.
    As a general proposition, we have tended to ascertain if a proposed 
transaction makes broad business sense. If it does, we determine what, 
if anything, needs to be done through the adoption of conditions to 
ensure that customers are not harmed and that the benefits are 
commensurate with the potential costs, risks, and harms. Because of the 
fact that the broad business justification for most of the transactions 
before us is relatively apparent, most of our Orders tend to focus on 
the development of appropriate conditions.
    For your review and information I have attached an Appendix* which 
illustrates in greater detail how the NCUC reviewed the Duke Energy 
Corporation/Cinergy Corporation merger (``Duke/Cinergy merger'') after 
the repeal of PUHCA 1935. For example, the NCUC adopted: (1) certain 
conditions relating to accounting rules and affiliate transactions; (2) 
conditions intended to preserve the utility's access to capital and to 
ensure that the utility is not utilized solely as a source of funding 
for unrelated holding company activities; and (3) certain rate-related 
transactions intended to require the utility to share the cost savings 
predicted to result from the transaction. All these conditions had the 
simple purpose of preserving the ability of the NCUC to regulate the 
utility in the same way that it always had.
---------------------------------------------------------------------------
    * Document has been retained in committee files.
---------------------------------------------------------------------------
(2) State Regulation of Affiliate Transactions and Cross-Subsidies
    With regard to affiliate transactions and authority to prevent 
potential cross-subsidies, the GAO reported that almost all the State 
commissions regulate affiliate transactions or regular reporting of 
such transactions, or both.\14\ In fact, the Report said that 49 of the 
reporting 50 States have some type of authority to approve, review and 
audit transactions between utilities and their affiliated 
companies.\15\
---------------------------------------------------------------------------
    \14\ GAO Report, Recent Changes In Law Call for Improved Vigilance 
by FERC, GAO-08-289 (February 2008) at 25.
    \15\ Id. at 9, 25. The Report noted that 27 States reported that 
under their authority, affiliate transactions did not require prior 
State commission approval, but could be reviewed and disallowed later. 
Id. at 25. The findings were that 41 States require utilities to report 
affiliate transactions at least annually, or more frequently. Id.
---------------------------------------------------------------------------
    In North Carolina, we have specific statutory authority to review 
affiliate transactions. The majority of potential affiliate contracts 
are subject to being reviewed and declared void if found to be unjust 
or unreasonable and made for the purpose or with the effect of 
concealing, transferring or dissipating the earnings of the utility. In 
addition, prior to paying any kind of compensation to the listed types 
of affiliated companies for services, the utility must obtain the 
Commission's approval to pay the compensation. All affiliated costs and 
expenses are subject to being audited and disallowed within the context 
of a general rate case.
    In our most recent merger proceeding we required that an 
independent audit be conducted no less than every two years of the 
affiliate transactions undertaken pursuant to the affiliate agreements 
associated with the merger. The audit includes both the holding 
company's and the utility's compliance with all conditions imposed by 
the Commission concerning affiliate company transactions, including the 
propriety of the transfer pricing of goods and services between and/or 
among the utility and its affiliates.
    In addition, a number of State Commissions--Arkansas, 
California,\16\ Kansas,\17\ Maryland\18\ and New Jersey--have opened 
proceedings to address measures for ratepayer protection post-PUHCA 
1935 repeal.
---------------------------------------------------------------------------
    \16\ Order Instituting Rulemaking Concerning Relationship Between 
California Energy Utilities and Their Holding Companies and Non-
Regulated Affiliates, Docket No. R. 05-10-030, October 27, 2005. The 
GAO Report cited to California's work to increase its authority to 
oversee affiliate transactions. GAO Report, Recent Changes In Law Call 
for Improved Vigilance by FERC, GAO-08-289 (February 2008) at 25.
    \17\ In the Matter of the Investigation of Affiliate and Ring-
Fencing Rules Applicable to all Kansas Electric and Gas Public 
Utilities, Docket No. 06-GMIX-181 -GIV, May 14, 2007.
    \18\ Commission Staff Analysis of Ringfencing Measures for 
Investor-Owned Electric and Gas Utilities, Maryland Public Service 
Commission, February 18, 2005.
---------------------------------------------------------------------------
    For example, the New Jersey Board of Public Utilities (``BPU'') 
approved new regulations with the goal of providing additional 
protection for the State's electric and natural gas customers.\19\ The 
New Jersey BPU developed the regulations after analyzing what changes 
should be made to offset the protections lost at the federal level with 
the repeal of PUHCA 1935.\20\
---------------------------------------------------------------------------
    \19\ Affiliate Relations, Fair Competition and Accounting 
Standards, Public Utility Holding Company Standards and Related 
Reporting Requirements, Docket Number AX05070641 (September 18, 2006).
    \20\ Id.
---------------------------------------------------------------------------
    As these examples show, each State commission must address for 
itself how it wishes to balance allowing additional investment while 
also ensuring consumer protections. Each State must be allowed to 
structure the scope of ratepayer protections that will fulfill its 
statutory duty and public interest charge.
(3) Financial Protections or Ring-Fencing
    PUHCA 1935 provided protection to ratepayers against a variety of 
financial risks caused by the creation of a holding company, such as 
draining the utility of cash and using it for collateral and 
diversification into non-core, risky businesses. With the repeal of 
PUHCA 1935, none of these federal limitations and protections remains 
in effect.
    Even before the repeal of PUHCA 1935, many States sought to protect 
ratepayers from risks associated with utilities being acquired by 
holding companies, including diversification into non-utility 
businesses. Although it has become common practice for electric 
utilities to diversify into non-utility and foreign businesses, this 
diversification carries an increased risk. NARUC believes that this 
risk should not be borne or shifted to the customers of the regulated 
utility, since the beneficiaries of these investments are the 
shareholders.
    States use a variety of mechanisms to effectively guard against 
improper cross-subsidization. One approach is to craft ``ring-fencing'' 
protections. The goal of ring-fencing is to build structural and 
financial protections around utility subsidiaries within a holding 
company system in order to insulate these subsidiaries from potential 
risks and negative impacts created by affiliates.\21\ Rating agencies 
have looked favorably on ring-fencing provisions established through 
State regulatory policies.
---------------------------------------------------------------------------
    \21\ Some examples of ring-fencing provisions are: (1) requirement 
that regulated utilities maintain a separate corporate entity; (2) 
utility to have its own Board of Directors and management; (3) 
utility's accounts and records kept separately from those of 
affiliates; (4) independent cash management and debt for utilities; (5) 
State commission approval before securities can be issued; (6) limits 
on dividends (7) minimum equity requirements; (8) periodic ring-fencing 
reports.
---------------------------------------------------------------------------
    Perhaps the most well-known instance of a State using ring-fencing 
to protect a utility from potential holding company risks occurred when 
the Public Utility Commission of Oregon saved Portland General Electric 
Company (``PGE'') from the adverse effects of the Enron bankruptcy. 
Despite Enron's historic collapse, PGE was able to maintain its 
financial integrity because of the actions taken by the State to 
``ring-fence'' or protect the utility from Enron's other business 
ventures.
    Another State approach is a ``mini-PUHCA''--a tool that attempts to 
recreate PUHCA 1935 at the State level. The Wisconsin Utilities Holding 
Company Act (``WUHCA'')\22\ is a well-known example of statutory ring-
fencing. In implementing the State law, the Wisconsin Public Service 
Commission (``PSCW'') has adopted a three-pronged approach to address 
cross-subsidization: (1) imposing restrictions, (2) implementing 
reporting requirements, and (3) conducting compliance audits of holding 
company transactions and operations.
---------------------------------------------------------------------------
    \22\ Wis. Stat. Sec.  196.795.
---------------------------------------------------------------------------
(4) Audits, Access to Books and Records, and Financial Reporting
    As the GAO Report notes, each State Commission's audit process is 
unique.\23\ The Report recognized that for the 4 States GAO Staff 
visited, those States put ``special emphasis on auditing affiliate 
transactions''.\24\
---------------------------------------------------------------------------
    \23\ GAO Report, Recent Changes In Law Call for Improved Vigilance 
by FERC, GAO-08-289 (February 2008) at 9, 25-26.
    \24\ Id. at 27.
---------------------------------------------------------------------------
    FERC and State regulators already collaborate on audit review. We 
will continue to work with our federal colleagues on improving audits 
of affiliated transactions and cross-subsidies.
    The GAO concluded that all States regularly require financial 
reports from utilities and are able to obtain access to the financial 
books and records of these utilities.\25\ The Report said that all 49 
responding States require utilities to at least provide financial 
reports.\26\ GAO added that States have access to utility companies' 
financial books and records in order to review affiliate 
transactions.\27\
---------------------------------------------------------------------------
    \25\ Id. 27
    \26\ Id. at 9, 27.
    \27\ Id. at 9.
---------------------------------------------------------------------------
    NARUC advocated the explicit EPAct 2005 authority for State access 
to needed books and records. Access to the books and records to verify 
transactions directly affecting a company's regulated utility 
operations is of vital importance to State commissions. Requests for 
such access by a State commission, its staff, or its authorized agents 
are presumably valid, material, and relevant, with the burden falling 
to the company to prove otherwise.
    The GAO concludes, however, that some States do not have such 
direct access to books and records of holding companies or affiliated 
nonutility companies.\28\ The reasons vary.\29\ State Commissions will 
continue to work on ways to improve their access to this information. 
FERC's detailed accounting and increased transparency in its record 
retention policies for holding companies and centralized service 
companies assists in improving States access to needed information from 
utility companies and their affiliates.
---------------------------------------------------------------------------
    \28\ Id. at 9, 27-28.
    \29\ Id.
---------------------------------------------------------------------------
(5) Status of State Resources
    GAO reported that some States reported that they needed additional 
staffing and funding to respond to changes in their oversight 
responsibility.\30\ At the same time, the Report recognized that States 
have gained over 2 years of experience since EPAct 2005 was passed.\31\
---------------------------------------------------------------------------
    \30\ Id. at 9, 29-30.
    \31\ Id. at 29.
---------------------------------------------------------------------------
    States have been and will continue to collaborate and expand on 
their knowledge base. NARUC's Meetings, which occur three times a year, 
have featured various PUHCA and utility merger panels. NARUC's Staff 
Subcommittee on Accounting and Finance has also produced 
publications\32\ and sponsored meeting panels on these topics. This 
Staff Subcommittee collaborated with GAO Staff on the State survey. The 
National Regulatory Research Institute (``NRRI'') has published various 
briefing documents to educate State Commissioners on key issues arising 
from PUHCA 1935 repeal and the changing utility merger landscape.\33\
---------------------------------------------------------------------------
    \32\ See, e.g, Ring Fencing Mechanisms for Insulating a Utility in 
a Holding Company System, NARUC Staff Subcommittee on Accounting and 
Finance, July 27, 2003.
    \33\ See e.g., Implications of EPAct 2005 for State Commissions, 
The National Regulatory Research Institute, October 2005; Repeal of the 
Public Utility Holding Company Act of 1935: Implications and Options 
for State Commissions, The National Regulatory Research Institute, 
August 2006; Private Equity Buyouts of Public Utilities: Preparation 
for Regulators, The National Regulatory Research Institute, December 
2007.
---------------------------------------------------------------------------
    States can better coordinate with their State colleagues on a 
regional basis, as well as with FERC, in regulating these increasingly 
complex multi-State utility companies. State commissions can work with 
their respective legislatures to improve the status of State resources.

                               CONCLUSION

    In our view, NARUC's members have performed admirably in their 
oversight responsibilities in the short time since passage of EPAct 
2005. In light of the challenges identified by GAO, there will be more 
work ahead to insure continued oversight of mergers in the utility 
sector, particularly given the vastly different resources available to 
the various States. We are confident that with FERC's continued 
cooperation and collaboration, as well as the academic resources 
NARUC's members have with NRRI the States will be ready for the 
challenge.

    Senator Salazar [presiding]. Thank you, Mr. Kerr.
    Mr. Owens.

STATEMENT OF DAVID K. OWENS, EXECUTIVE VICE PRESIDENT, BUSINESS 
             OPERATIONS, EDISON ELECTRIC INSTITUTE

    Mr. Owens. Thank you, Senator. I certainly do appreciate 
this opportunity.
    My name is David K. Owens. I'm the Executive Vice President 
of the Business Operations at the Edison Electric Institute. As 
you well know EEI is a trade association of U.S. shareholder 
owned electric companies and has international affiliates and 
associate members worldwide.
    I certainly do appreciate the leadership that this 
committee has provided with the implementation of EPACT 2005 to 
encourage investment in electric utility infrastructure. We 
believe that EPACT has been successful in encouraging 
significant new investments. We applaud the leadership of this 
committee.
    We also believe that FERC has done a really good job of 
implementing its new responsibilities under EPACT 2005. FERC 
has undertaken a completed series of major rulemaking, as the 
Chair mentioned earlier. Those have lead as an example to the 
adoption of new requirements for holding companies and their 
service companies. FERC has adopted new accounting standards as 
an example for centralized service companies. They've developed 
clear rules for pricing affiliate transactions. They've 
developed new auditing and enforcement initiatives. So they've 
done a whole set of major new initiatives in order to deal with 
this evolving area.
    They've done all of this while working very closely with 
the States. As you all know our country needs significant new 
investment in electric infrastructure in the coming years. To 
provide the enormous investment which we estimate to be over a 
trillion dollars by 2030, it requires us to employ a 
flexibility and a variety of organizational structures and 
organizational arrangements. This is in order to finance, 
construct, to operate and maintain facilities needed to provide 
our country with the electricity it demands. In addition some 
of our companies need the option to merge in some instances or 
consolidate with other companies with the appropriate 
regulatory reviews in order to achieve additional efficiency 
benefits which benefit our customers.
    Now under existing Federal laws we believe that FERC is 
well equipped to ensure that mergers and acquisitions are in 
the public interest and that consumers are well protected. We 
think that FERC has done a fairly adequate job in that area. 
EPACT 2005, as we all know, Congress replaced a 70-year-old 
PUHCA 1935 with updated PUHCA 2005. It also updated and 
expanded section 203 of the Federal Power Act to give FERC new 
authorities regarding mergers.
    As a result FERC has strengthened its regulation of utility 
mergers and acquisitions and has incorporated new oversight of 
affiliate transactions in particular to prevent cross 
subsidization, an encumbrance of utility assets except when in 
the public interest. Contrary to projections or predictions by 
many that EPACT would lead to this vast array of mergers, that 
really has not happened. We've had a modest increase in 
mergers.
    In my written testimony I've outlined the many steps FERC 
has taken to put in place advanced merger, acquisition, 
accounting, financial and reporting regulations policies and 
practices. The significant actions have involved a tremendous 
commitment by FERC with substantial input from State regulators 
and other key stakeholders. We believe the States play an 
important role in regulating utilities, in approving mergers, 
in protecting retail consumers and Federal laws should continue 
to accommodate this role without duplicative or conflicting 
requirements.
    States clearly play a very active role as Commissioner Kerr 
has just indicated. They oversee utility mergers. They oversee 
retail rates. They look at the just and reasonable 
transactions. They oversee a whole range of activities relating 
to affiliate transactions. Most State commissions have 
considerable authority to ensure the financial integrity of 
utilities they regulate and to insulate and protect consumers 
of public utilities from potential adverse consequences of non-
utility related investment or activities.
    Congress and FERC have recognized that States play such a 
vital role in regulating electric utility mergers and 
activities and have sought to accommodate the State role in 
Federal statutes and regulations. Thus the Federal Power Act 
provides a clear sharing of responsibilities between States and 
FERC and oversee utility activities and similarly FERC 
regulation reflect the complementary Federal and State roles.
    Now I realize I'm running out of time. Let me make a point. 
That point is that I disagree substantially with some of the 
recommendations of the GAO report. Specifically with regard 
with whether FERC is doing a good job and whether there are 
regulatory gaps.
    We disagree, as I indicated, FERC has issued a broad range 
of rulemakings. They have comprehensive authority over all 
aspects of rate making. They've adopted new accounting rules. 
They've adopted pricing rules for affiliates. So they've done 
an awful lot. They have very broad based auditing 
responsibility. So I don't believe that the comments or the 
suggestions by GAO are well founded.
    I do believe that there are some recommendations that the 
Commission should look at carefully and that relates to 
transparency and working more closely with the States. Thank 
you.
    [The prepared statement of Mr. Owens follows:]

    Prepared Statement of David K. Owens, Executive Vice President, 
             Business Operations, Edison Electric Institute

    My name is David K. Owens, and I am Executive Vice President in 
charge of the Business Operations Group at the Edison Electric 
Institute (EEI). EEI is the trade association of U.S. shareholder-owned 
electric companies and has international affiliate and industry 
associate members worldwide. Our U.S. members serve 95% of the ultimate 
customers in the shareholder-owned segment of the industry and 
represent about 70% of the U.S. electric power industry.
    EEI appreciates the steps forward that Congress took in the Energy 
Policy Act of 2005 (EPAct 2005) to encourage new investment in and by 
the electric utility industry. Our country needs new investment in 
electric infrastructure to ensure continued availability of reliable, 
affordable electricity. The steps Congress took in EPAct 2005 to 
modernize regulation of the industry, while ensuring that ample 
consumer protections remain in place, were appropriate and are 
producing positive results. Contrary to predictions that were made 
before EPAct 2005 was enacted, merger activity since enactment has 
actually been relatively modest. At the same time, the provisions of 
EPAct 2005 have encouraged significant new investment in energy 
infrastructure.
    Moreover, the Federal Energy Regulatory Commission (FERC) has done 
an exemplary job in implementing its new responsibilities under EPAct 
2005. FERC has undertaken and completed a series of major rulemakings 
and new auditing and enforcement initiatives in a very short time, 
meeting tight deadlines set in EPAct 2005. In the process, FERC has 
strengthened its regulation of utility mergers and acquisitions, 
managed the complicated transition from the Public Utility Holding 
Company Act of 1935 (PUHCA 1935) to its successor the Public Utility 
Holding Company Act of 2005 (PUHCA 2005), and incorporated new 
oversight of affiliate transactions, in particular to prevent cross-
subsidization and encumbrance of utility assets except when in the 
public interest. And FERC has done all this while working closely with 
and respecting the authority of the states that also regulate utilities 
in these areas.

      OUR COUNTRY NEEDS SIGNIFICANT NEW INVESTMENT IN ELECTRICITY 
INFRASTRUCTURE IN COMING YEARS TO MEET INCREASING DEMAND AND TO ENSURE 
                         CONTINUED RELIABILITY

    As this Committee knows well, electricity is a vital service to our 
nation. EEI and its member companies take pride in providing reliable, 
affordable supplies of electricity, even as our country's population 
and demand for electricity have grown dramatically in recent years and 
continue to grow. Electricity is essential to powering our homes, 
businesses, and industries with cooling, refrigeration, heating, 
lighting, computers, telecommunications equipment, medical equipment, 
and the host of other day-to-day necessities on which we all rely. 
Because electricity is provided and used on an instantaneous basis and 
cannot practicably be stored, the provision of affordable, reliable 
electricity requires a careful balancing of generation, transmission, 
and distribution facilities. In turn, constructing, operating, and 
maintaining these facilities require an enormous investment.
    In coming years, the United States will need significant additional 
electricity generation and delivery resources. The Energy Information 
Administration (EIA) is projecting that electricity demand will 
increase by 30% by 2030. Already, as the North American Electric 
Reliability Corporation (NERC) has indicated in its most recent 10-year 
assessment of the nation's electricity system, many areas of the 
country are operating on thin demand-supply and delivery-capacity 
margins.\1\ This need for new facilities will only increase in future 
years, as a result of continued population growth, increasing 
electrification of our nation's homes and businesses, increasing demand 
for renewable energy resources, and compliance with enhanced 
environmental standards--even with a major commitment to energy 
efficiency.
---------------------------------------------------------------------------
    \1\ NERC 2007 Long-Term Reliability Assessment 2007-2016 (October 
2007), www.nerc.com.
---------------------------------------------------------------------------
    To put these issues in perspective, I would like to provide some 
numbers:
Overall Capital Expenditures (Capex)
   Capex for U.S. shareholder-owned electric utilities rose by 
        15.5% in 2007, from $59.9 billion in 2006 to $69.1 billion in 
        2007, and is projected to reach approximately $75 billion in 
        2008 and $75.5 billion in 2009.\2\
---------------------------------------------------------------------------
    \2\ The 2008 and 2009 projections and the 2007 category allocation 
are based on EEI's spring 2007 study of industry capital spending based 
on SEC Form 10-K data, company presentations, and discussions with 
companies.
---------------------------------------------------------------------------
   Total capital spending in 2007 was projected to be allocated 
        as follows: Generation 31%; Distribution 30%; Environmental 
        14%; Transmission 12%; Natural Gas-related 6%; and General/ 
        Other 7%.\3\
---------------------------------------------------------------------------
    \3\ Id. The ``General/ Other'' category includes investments that 
do not fit into the other categories listed, such as construction, 
materials, fuel processing, and mining activities.
---------------------------------------------------------------------------
   Companies are boosting spending on environmental compliance 
        and transmission and distribution upgrades, and are beginning 
        to announce new generation projects in many power markets to 
        ensure adequate reserve margins over the long term. Already, 
        657 projects that would provide more than 130,000 MW of 
        capacity either have applications pending, have been approved, 
        or already are under construction.\4\
---------------------------------------------------------------------------
    \4\ These numbers are based on recent analyses byVentex, Inc., an 
EEI consultant.
---------------------------------------------------------------------------
   According to a recent study conducted by the Brattle Group, 
        dramatically increased raw materials prices (e.g., steel, 
        cement) have increased construction costs directly and 
        indirectly through the higher cost of manufactured components 
        common in utility infrastructure projects. These cost increases 
        have primarily been due to high global demand for commodities 
        and manufactured goods, higher production and transportation 
        costs (in part owing to high fuel prices), and a weakening U.S. 
        dollar.
   Preliminary findings released by the Brattle Group estimate 
        that, without taking into account utility energy efficiency 
        programs, close to $1.5 trillion in investment in new 
        generation ($559 billion) and transmission and distribution 
        ($900 billion) will be required by 2030 to meet electricity 
        demand. Brattle further estimates that required generation 
        investment can be reduced from $559 billion to $457 billion if 
        more aggressive utility energy efficiency programs are 
        implemented.
Transmission Capital Expenditures\5\
---------------------------------------------------------------------------
    \5\ These transmission and distribution investment data are 
provided in real terms (2006$) and have been adjusted for inflation 
using the Handy-Whitman Index. Planned transmission investment was 
adjusted for inflation using the GDP Deflator.
---------------------------------------------------------------------------
   In 2006, both shareholder-owned electric utilities and 
        stand-alone transmission companies invested an historic $6.9 
        billion in the nation's transmission grid. This represents a 
        51% increase over 2000 levels.
   Since the beginning of 2000, the industry has invested more 
        than $37.8 billion in the nation's transmission system.
   Over the 2007-2010 time period, the industry is planning to 
        invest $37 billion in the transmission system.
   This amount represents a 55% increase over the amount 
        invested from the 2003-2006 period.
Distribution Capital Expenditures
   In 2006, shareholder-owned electric utility investment in 
        the distribution system surpassed $17 billion for the first 
        time. This level of investment ($17.3 billion) represents a 
        6.5% increase over the inflation-adjusted $16.2 billion ($14.5 
        billion prior to inflation adjustment) invested in 2005.
   2006 industry distribution investment represents an 18% 
        increase over 2000 levels.
   Since the beginning of 2000, the industry has invested 
        almost $109 billion in the nation's distribution system.
  to provide the investment resources for electricity infrastructure, 
       electric utilities need to be able to employ a variety of 
 organizational structures, merge, consolidate, form partnerships, and 
                             acquire assets
    EEI members include vertically integrated electric utilities that 
provide electricity generation, transmission, distribution, and related 
services to families and businesses throughout the country. Our members 
also include generation-only and transmission-only ``stand alone'' 
companies. Many of these utilities and companies are owned by parent 
companies that may also own other electric utilities, energy, and non-
energy businesses. Many of the energy companies are affiliated with 
others, either through parent-subsidiary or partnership models.
    Thus, there are a variety of organizational structures and 
affiliations within the electric utility industry. This variety of 
structures and affiliations has enabled the electricity industry to 
finance, construct, operate, and maintain facilities needed to provide 
our country with the electricity it needs. Indeed, the sheer cost of 
electricity facilities, and the risks involved in siting, financing, 
and earning a reasonable rate of return on them--especially in times of 
increasing wholesale competition and fuel and materials charges--often 
require the ability to use a variety of organizational structures and 
affiliations to share costs and risks.
    In addition, utilities need the option to merge or consolidate with 
other companies. For electric utilities and their customers, mergers 
and acquisitions offer many potential benefits including:

   Potential cost efficiencies
   Increased economies of scale
   Greater optimization of generation, transmission, and 
        distribution assets
   The ability of a larger utility to offer new and innovative 
        products and services to consumers
   Acquisition of superior technology capability
   Scale necessary for significant capex, to maintain credit 
        quality, to lower cost of capital, and to enhance access to 
        capital markets and new investors.

    Indeed, severely limiting utilities' ability to take advantage of 
economies of scale and experience in competitive markets could deny 
electric customers the benefits of such economic efficiencies. These 
efficiencies enable companies to supply products and services at lower 
costs to consumers.
    This said, the pace of mergers and acquisitions in recent years has 
been relatively modest. In 2007, there were four announced deals, six 
completed transactions, and one withdrawn deal. In 2006, there were 
seven announced deals. This represents a small step up in overall 
activity from the quiet three-year period from 2003 through 2005, when 
most companies were implementing back-to-basics strategies by exiting 
non-core businesses, investing in core utility and competitive 
generation operations, and strengthening their balance sheets. 
Nevertheless, the number of whole company merger and acquisition deals 
in 2006 and in 2007 remained well below the higher pace that marked the 
late 1990s, when 10 to 20 announcements per year were the norm. An 
emerging trend of recent utility merger and acquisition activity has 
been the increasing participation of private equity investors and 
international buyers, including infrastructure funds and international 
utilities.

   UNDER EXISTING FEDERAL LAWS, FERC IS WELL EQUIPPED TO ENSURE THAT 
MERGERS AND ACQUISITIONS ARE IN THE PUBLIC INTEREST, AND THAT CONSUMERS 
            ARE WELL PROTECTED--AND FERC IS FULLY ON THE JOB

    Recognizing the need for new infrastructure, and the need to 
accommodate new investment in and by the electricity industry, in the 
past two decades, Congress has taken steps to update and modernize the 
laws governing the structure and operation of the industry. These steps 
have helped to ensure that companies have sufficient flexibility to 
provide the resources needed to get the job done, while also ensuring 
that consumers and markets are well protected. In particular, Congress, 
states, and the FERC have taken steps to encourage competition in fuel 
supply and electricity generation, while also ensuring open access to 
electric and natural gas transmission facilities. In addition, 
organized markets for electricity sales and delivery have evolved, 
including regional transmission organizations (RTOs) and independent 
system operators (ISOs), providing the ability to call on a wide array 
of generation and transmission resources to serve load centers within 
different regions of the country.
    Recognizing that these legal and policy changes have spurred 
changes in the electric utility industry, in EPAct 2005, Congress 
replaced the 70-year old PUHCA 1935 with an updated PUHCA 2005. In 
addition, Congress updated section 203 of the Federal Power Act (FPA) 
to require FERC, in reviewing proposed mergers and financial 
transactions, to ensure that these activities will not result in cross-
subsidization of non-utilities by utilities or encumbrance of utility 
assets, unless in the public interest.
    In making these changes, Congress recognized that the FPA and other 
laws governing the electric utility industry have evolved substantially 
since 1935. Furthermore, FERC, states, and Wall Street have developed 
increasingly sophisticated regulations and other measures to ensure 
that companies that provide electricity services make ample information 
about their finances and activities available to regulators and the 
public, and the companies do not engage in inappropriate behavior that 
can harm customers.
    In particular, FERC has put in place advanced merger, acquisition, 
accounting, financial, and reporting regulations, policies, and 
practices. Under its merger provisions, FERC examines a wide array of 
factors, such as: the ability of companies in a proposed merger to 
exercise market power; the relative concentration that would result 
from the merger; benefits of the merger to wholesale and retail 
consumers; and measures necessary to protect consumers. FERC also has 
detailed accounting and financial disclosure requirements to ensure 
that public utility, wholesale, and transmission activities are open to 
regulators and the public. FERC actively oversees utility financial 
transactions under section 203 of the Federal Power Act, and FERC 
oversees rates to ensure that they remain just and reasonable under 
sections 205 and 206 of the Act.
    In addition, FERC has moved aggressively under its existing 
authority to prevent abuse of financial relationships between regulated 
utilities and their unregulated affiliates, issuing strict new rules 
that prohibit utilities from using debt linked to utility assets for 
non-utility businesses. FERC has imposed rules to regulate cash 
management practices, including limits on the amount of funds that can 
be transferred from a regulated subsidiary to a non-regulated parent 
company. FERC also has adopted detailed standards of conduct to ensure 
that transmission providers do not use their unique access to 
information to provide unfair advantages to their wholesale merchant 
functions and their marketing affiliates. FERC vigorously audits and 
enforces compliance with these standards. FERC closely scrutinizes all 
transactions where a utility seeks to purchase power from an affiliate 
by contract or purchase a power plant owned by an affiliate, to ensure 
that the price does not exceed the market price and the utility does 
not unduly favor its affiliate over other competitors in the wholesale 
market.
    Since passage of EPAct 2005 alone, FERC has issued a number of 
complex, stringent regulations aimed at implementing PUHCA 2005 and 
revised FPA section 203. These regulations ensure that companies will 
keep detailed records and make them available as needed to FERC and to 
state regulators. They ensure that FERC approval is required for 
mergers, acquisitions, and major financial transactions, subject to 
strict guidelines and certain blanket authorizations to help streamline 
the review process. They also protect against inappropriate cross-
subsidization of non-utilities by utilities, in particular when captive 
customers could be harmed. To list just a few of the more significant 
FERC developments in these areas since EPAct 2005:

   PUHCA 2005 regulations
    --December 8, 2005--Final rule and report to Congress
    --April 24, 2006--Rehearing order
    --July 20, 2006--Rehearing order
    --December 7, 2006--Technical conference
    --February 26, 2007--Rehearing order

   PUHCA 2005 accounting and reporting regulations
    --January 11, 2006--Guidelines for notification of holding company 
            status
    --January 13, 2006--New dockets prefix notice
    --February 9, 2006--Additional guidelines for filings under PUHCA 
            2005
    --March 6, 2006--Filing guidelines for self certification notices
    --April 7, 2006--Electronic filing guidelines
    --July 18, 2006--Technical conference
    --October 19, 2006--Final rule
    --October 19, 2006--Form 60 electronic filing final rule
    --December 14, 2006--Form 60 software notice

   FPA section 203, merger, and cross-subsidy regulations
    --December 23, 2005--Final rule
    --January 10, 2006--Errata to the rule
    --April 24, 2006--Rehearing order
    --July 20, 2006--Rehearing order
    --August 1, 2006--Errata to the rehearing order
    --December 7, 2006--Technical conference
    --March 8, 2007--Technical conference
    --July 20, 2007--Policy statement
    --February 21, 2008--Final rules and supplemental policy statement

    These activities have involved thousands of hours of work by FERC, 
with input by the public, to ensure that the Commission has developed 
careful, protective measures. In each of the technical conferences, 
FERC Commissioners and staff heard in person from representatives of 
all stakeholders, particularly representatives of state commissions and 
consumers addressing the respective role of FERC and the states. The 
Commission has had to take a large array of factors into account, 
balancing the need for information and to impose appropriate 
constraints, against the cost and impacts on companies and markets. We 
believe, on balance, the Commission has sought to implement its 
statutory responsibilities fairly and effectively, in the public 
interest.

   STATES PLAY AN IMPORTANT ROLE IN REGULATING UTILITIES, APPROVING 
 UTILITY MERGERS, AND PROTECTING RETAIL CUSTOMERS. FEDERAL LAW SHOULD 
 CONTINUE TO ACCOMMODATE THIS ROLE WITHOUT DUPLICATIVE OR CONFLICTING 
                              REQUIREMENTS

    As the General Accounting Office (GAO) has recognized at page 9 of 
its report to Congress on ``Utility Oversight'' in the wake of EPAct 
2005, ``state regulators in all but a few states reported [that] 
utilities must seek state approval'' for mergers, and ``most states 
have some type of authority to approve, review, and audit affiliate 
transactions.'' In fact, as the record before FERC and in its technical 
conferences demonstrates, states play a prominent role in these areas.
    States clearly play a very active role in reviewing proposed 
mergers. State utility commissions look closely to ensure that mergers 
will be in the public interest and will fully protect retail customers. 
Often governors and even legislatures weigh in as well. States also are 
not shy about denying approval of a proposed merger if they believe 
that the proposal does not meet these tests or provide adequate 
benefits to utility customers. In addition, states actively oversee 
utility activities, including affiliate transactions, with a 
substantial focus on protecting retail customers. States oversee retail 
rates to ensure that the rates are reasonable given the costs needed to 
provide electricity. States also ensure that rate-regulated utility 
resources are not inappropriately used for non-utility activities, and 
states ensure that utility affiliates fairly reimburse regulated 
utilities for any shared resources. States ensure compliance with these 
rules through their careful scrutiny of company books and records, to 
which PUHCA 2005 assures access. A February 2004 Fitch Ratings report 
highlights the ``increasingly proactive'' efforts of state commissions 
in these areas, especially through their authority to approve rates:

          [State regulatory commissions] generally have broad statutory 
        mandates to do whatever is necessary to uphold the public 
        interest and ensure that reliable service is provided at just 
        and reasonable rates. This broad authority can be used to 
        disallow from customer rates any financing, affiliate 
        transaction or other operating costs viewed as inconsistent 
        with the public interest.\6\
---------------------------------------------------------------------------
    \6\ ``Utility Regulatory Survey of State Public Service 
Commissions,'' Fitch Ratings Ltd., February 25, 2004, p. 2.

    Last year, EEI conducted a survey of existing state laws and 
voluntary utility practices. We found that under their original 
enabling state legislation, most state commissions have considerable 
authority to assure the financial integrity of the utilities they 
regulate and to insulate and protect customers of public utilities from 
potential adverse consequences of non-utility related investments or 
activities. These authorities allow state commissions to address 
transactions involving affiliates of a public utility and to insulate 
the jurisdictional utility and its consumers from the actions of other 
affiliates when appropriate. While each state commission may implement 
its authority in its own manner, most state commissions have the 
---------------------------------------------------------------------------
authority:

   To approve the issuance of securities by the jurisdictional 
        utility (or utility subsidiaries), including common stock, 
        preferred stock, long-term debt, short-term debt above a 
        certain ``materiality'' threshold, and guarantees of 
        obligations of others.
   To regulate the capital structure of the jurisdictional 
        utility (e.g. debt to equity ratios).
   To assure that payment of dividends by a jurisdictional 
        utility is derived from retained earnings or does not lead to a 
        deviation from the utility's approved capital structure range.
   To regulate or review intercompany loans involving a holding 
        company or utility affiliates.
   To establish appropriate pricing for the sale of goods and 
        services between a jurisdictional utility and affiliated 
        companies.
   To regulate services, transactions or contracts between a 
        jurisdictional utility and its holding company or other 
        affiliates companies above a material amount. Some states 
        exercise this oversight though an audit or prudence-review 
        process; others through a prior contract review.
   To approve the sale or pledge of jurisdictional assets of 
        the public utility.
   To approve the acquisition of utility assets (above a 
        material amount) by a public utility that would be put into 
        rate base within the commission's jurisdiction.
   To approve a sale or merger of a jurisdictional utility, 
        including approval of the transfer of equity rights which 
        provide a controlling interest in a jurisdictional utility.
   To obtain needed information from the jurisdictional utility 
        to ensure compliance with these other authorities through 
        annual or periodic reporting, certification of status, an audit 
        process, rate case filing or other methods.

    Furthermore, states are continually refining and expanding the 
authority of state public utility commissions over utility activities.
    Congress and FERC have recognized that states play an important 
role in regulating electric utility mergers and activities, and have 
sought to accommodate the state role carefully in federal statutes and 
regulations. Thus, the FPA provides a clear sharing of responsibilities 
between states and FERC in overseeing utility activities. And 
similarly, FERC regulations reflect the complementary federal and state 
roles.
    For example, in adopting new regulations for implementing FPA 
section 203, FERC has been appropriately careful not to preempt 
effective state regulations, but instead to review state-imposed 
requirements to see if additional requirements are warranted under 
federal law. Applying these regulations, FERC recently approved a 
proposed merger involving Puget Energy, conditioned in part on the 
Washington Utilities and Transportation Commission adopting conditions 
that the merging companies proposed to have the state commission adopt 
to protect against inappropriate cross-subsidization. FERC concluded 
that, if adopted, those measures would fully protect against cross-
subsidization without the need for additional federal constraints. FERC 
therefore approved the merger contingent on those conditions being 
adopted at the state level. This is cooperative federalism in the 
public interest in action.

  FERC IS ACTIVELY AND APPROPRIATELY IMPLEMENTING ITS PUHCA 2005, FPA 
 SECTION 203, MERGER, AND CROSS SUBSIDY RESPONSIBILITIES, AND DOES NOT 
  NEED ADDITIONAL AUTHORITY THAT COULD CREATE UNNECESSARY BURDENS AND 
               UNCERTAINTY, THUS DISCOURAGING INVESTMENT

    Taking all the developments just discussed into account, EEI 
fundamentally disagrees with the GAO report's conclusion that FERC is 
not doing an active enough job at overseeing utility mergers, 
acquisitions, affiliate transaction, and cross-subsidy issues. FERC 
actively oversees utility mergers and acquisitions, and the Commission 
has instituted a very aggressive array of regulations, accounting and 
reporting requirements, and auditing and enforcement measures to 
protect captive customers, promote effective markets, ensure fair 
competition, prevent inappropriate cross subsidies and encumbrance of 
utility assets, and provide open access to transmission. Congress has 
put an array of such statutory requirements in place, and we believe 
these requirements are more than sufficient and are being effectively 
implemented by FERC.
    In addition, the Securities and Exchange Commission (SEC) oversees 
company accounting, auditing, finances, and participation in financial 
markets, including through implementation of the Sarbanes-Oxley Act of 
2002. States oversee utility retail rates and activities, as discussed 
above. And companies have voluntarily and as part of binding 
commitments adopted an array of positive measures to protect customers. 
Taken together, these measures provide robust assurances that the 
electric utility industry operates for the public benefit, and these 
measures amply protect consumers.
    Requiring FERC to take additional steps toward rigid rules for 
corporate and financial separation of shareholder-owned electric 
utilities and their non-utility affiliate companies is unnecessary in 
light of the fact that FERC and the states already have the authority 
to protect, and do protect, regulated utilities and their customers 
from any potential risks of affiliate businesses.
    Increased federal oversight over non-utility corporate activities 
and structure could create substantial barriers to investment and 
competition in electricity markets, and could create unreasonable 
restrictions and delays on the day-to-day business operations of 
companies, contrary to what Congress intended when it modernized 
utility regulation in EPAct 2005. It also could encroach upon authority 
currently exercised by state utility commissions, and it would 
unnecessarily duplicate, and possibly contradict, consumer protections 
and corporate governance standards already in place at the federal and 
state levels, including tough SEC corporate governance and accounting 
standards imposed on all publicly-traded companies, not just utilities, 
by the Sarbanes-Oxley Act. Furthermore, issues of affiliate 
transactions and corporate financing are already addressed by state and 
federal regulators, who have the flexibility to consider individual 
circumstances and transactions.
    Given the array of federal and state laws now in place, there is 
abundant federal statutory and regulatory oversight of mergers and 
acquisitions and protections against inappropriate cross subsidization 
and encumbrance of utility assets. Congress does not need to add any 
additional new requirements and constraints at this time.

    Senator Salazar. Thank you, Mr. Owens.
    Mr. Hempling.

   STATEMENT OF SCOTT HEMPLING, EXECUTIVE DIRECTOR, NATIONAL 
                 REGULATORY RESEARCH INSTITUTE

    Mr. Hempling. Thank you, Senators for the opportunity to 
appear. I'm Scott Hempling, Executive Director of the National 
Regulatory Research Institute. I'm here as an expert, not as a 
representative of any entity. My expertise derives from years 
in private practice where I've been on the inside of dozens of 
State commissions and know the facts associated with their 
efforts.
    Senators, over the past century our citizens have paid 
trillions to support the infrastructure of our Nation's 
electric utilities. We must ensure that the recipients of those 
trillions remain accountable to the public. For 70 years the 
Public Utility Holding Company Act of 1935 provided that 
accountability.
    Its central technique was corporate simplification. Each 
utility holding company had to limit its assets and activities 
to those necessary to vital electric service. The Act thus 
aligned corporate form with public interest obligation.
    The GAO/FERC dialog focuses on cross subsidies. 
Specifically, to FERC's practices and policies protect 
ratepayers from bearing the cost of business activities 
unrelated to the provision of essential electric service. But 
that question is only a subset of the much larger questions 
forced upon regulators by Congress' repeal of the 1935 Act.
    The larger question is what is our vision for corporate 
structure? Is that vision consistent across States and between 
States and FERC? If there is no such vision do we have a 
process for creating one?
    When it repealed the 1935 Act, Congress left these 
questions unanswered. At the same time, repeal increased the 
likelihood of structural complexity. Gone are the geographic 
limits. Gone are the type of business limits on utility mergers 
and acquisitions. Gone are the prohibitions on leverage 
financing. Gone is the at cost requirement for all inter-
affiliate transactions. The corporate structure options are now 
nearly unlimited.
    State commissions and FERC thus face questions they have 
not had to address, systematically at least, for 70 years. 
Should they limit the types of companies and corporate 
structures that furnish essential service? Should they welcome 
new structural options without limit? Should they proceed ad 
hoc? Are leveraged private equity firms when owned by investors 
with short term interests an appropriate substitute for 
traditional conservative buy and hold investors?
    On these questions, Senators, there is no expert consensus, 
no political consensus and no systematic process for arriving 
at either. Some argue that protection against cross subsidies 
and other structural risks lies in rate making. This view is 
not fact based.
    Ratemaking depends on auditing. Auditing is not like a trip 
to the dentist who checks every tooth. Auditing is sampling. It 
cannot promise 100 percent coverage, especially with limited or 
what FERC calls, targeted regulatory resources allowing 
structures that invite cross subsidies or complicate auditing 
increases the probability of problems.
    Ratemaking is also after the fact. But after the fact 
regulation invites too big to fail results. In the business 
world poor decisionmakers fail, but not always.
    We all are familiar with situations, some very recent, in 
which a company size or significance pressures regulators to 
prop them up. State commissions dependent on the incumbent 
utility will tend to save the company rather than revoke its 
right to serve. Given the inherent uncertainty of back end rate 
review, front end structure review makes more sense. The 
regulatory community needs to address this reality.
    The GAO study cited State commission concerns about 
availability of resources to deal with cross subsidies. Those 
concerns are the real, empirical world that I know about, that 
I practiced law in, that I presently serve. In fact the 
resource problem is larger. After several dozen mergers and 
acquisitions in the electric and gas industries since 1985, no 
one has systematically studied the economic, engineering, 
finance and managerial implications of these transactions.
    In conclusion my testimony today urges alertness and 
anticipation. We need to identify the types of utility 
corporate transactions that trigger regulatory concern and we 
need to create policies to address them. Some say that to 
articulate a vision for accountable corporate structures is to 
``reconstruct'' the 1935 Act in violation of Congress' 2005 
intent.
    This argument is deficient in logic and law. Section 203, 
the Power Act, requires the Commission to judge mergers by a 
public interest standard. The public interest requires 
accountability. The 2005 Congress did not dilute this language. 
It subjected more transactions to it.
    It remains regulators continuous obligation to align 
corporate structures with the public interest. With the repeal 
of the 1935 Act that obligation becomes more difficult to 
fulfill. The acquisition of remote utility properties, the 
mixing of utility and non-utility businesses, the use of 
unconventional ownership structures and financing structures, 
these all call for new resources and new expertise. The dialog 
created here by GAO and FERC is a worthy beginning, but it is 
only beginning.
    Mr. Chairman, I hope during the questions we can address 
the issue of preemption because I believe there's some 
significant misunderstandings about the nature of that term and 
how it should apply in this context. In the meantime, let me 
thank you and the members of the committee for this opportunity 
to testify. I look forward to your questions.
    [The prepared statement of Mr. Hempling follows:]

  Prepared Statement of Scott Hempling, Executive Director, National 
                     Regulatory Research Institute

    Mr. Chairman and Members of the Committee: My name is Scott 
Hempling. I am the Executive Director of the National Regulatory 
Research Institute (NRRI). NRRI is an independent, Section 501(c)(3) 
corporation, funded largely by voluntary state commission payments. Its 
mission is to carry out the research activities that enable utility 
regulators to make public interest decisions of the highest possible 
quality. My testimony today reflects my own views, and not those of 
NRRI, any state commission or any past client of mine or of NRRI.
    As an attorney in private practice, I advised public and private 
sector clients involved in regulated industries, particularly state 
regulatory commissions and organizations of consumers or consumer 
representatives. I have represented clients in many cases under the 
Public Utility Holding Company Act of 1935 (PUHCA), before the 
Securities and Exchange Commission (SEC) and the U. S. Court of 
Appeals. I have testified before this and other Congressional 
committees many times on PUHCA and other electric industry matters.
    The stated purpose of this hearing is to ``examine the adequacy of 
state and federal regulatory structures for governing electric utility 
holding company structures in light of the repeal of the Public Utility 
Holding Company Act'' of 1935, and in particular to discuss the 
concerns raised by the report of the United States Government 
Accountability Office (GAO), Recent Changes in the Law Call for 
Improved Vigilance by FERC, GAO 08-289 (February 2008). These ``recent 
changes'' are the 2005 repeal of the Public Utility Holding Company Act 
of 1935, and the new FERC authorities established by the Public Utility 
Holding Company Act of 2005. The GAO report has produced some useful 
dialogue between FERC and the GAO on FERC's regulatory policies. My 
testimony seeks to extend this dialogue so that we address the gamut of 
regulatory issues raised by the Committee and by the 2005 amendments.
    My testimony has five parts.
    Part I places the current debate between FERC and GAO in the larger 
context of corporate structure regulation. Effective corporate 
structure regulation should encourage transactions that serve the 
public interest and discourage ones that do not.
    Part II explains that the 2005 repeal of the Public Utility Holding 
Company Act of 1935 created gaps in corporate structure regulation.
    Part III argues that to restore public accountability in corporate 
structure transactions we must (a) identify and promote sensible 
corporate structures and (b) apply cost-benefit standards.
    Part IV explains that regulatory preparedness for the new 
structural transactions made possible by the repeal of PUHCA 1935 
requires multidisciplinary expertise and a shared multijurisdictional 
purpose.
    Part V, the conclusion, argues for alertness on the part of all 
regulators.

I. CROSS SUBSIDIES IN CONTEXT: EFFECTIVE CORPORATE STRUCTURE REGULATION 
   SHOULD ENCOURAGE TRANSACTIONS THAT SERVE THE PUBLIC INTEREST AND 
                DISCOURAGE INEFFICIENT ONES THAT DO NOT

    Over a century, our citizens have paid trillions of dollars to 
support the infrastructure of our nation's electric and gas industries. 
Corporate structure regulation seeks to make the recipients of those 
trillions--owners, financiers and operators of that infrastructure--
accountable to the public. To that end, legislators and regulators have 
asked five questions:

          1. Who can acquire and own electric and gas utilities?
          2. What business activities may exist within the utility's 
        corporate family?
          3. What corporate structures may these corporate families 
        have?
          4. What financial structures may these corporate families 
        have?
          5. What interactions may occur among the members of the 
        corporate family?

    These five questions share a common purpose: to encourage 
transactions in the public interest, and discourage transactions that 
are not.
    The detailed dialogue between the General Accounting Office and the 
Federal Energy Regulatory Commission on cross subsidies addresses one 
subset of these questions: Do FERC's practices and policies prevent 
infrastructure owners from forcing ratepayers to bear, through 
excessive electricity and gas rates, the cost of business activities 
unrelated to the provision of essential electric and gas service?
    The five major questions make clear that cross subsidy regulation 
is only one part of a corporate structure accountability mechanism. The 
GAO-FERC debate is part of a larger conversation: What is our vision 
for corporate structure? Does anyone have one? If so, is that vision 
consistent across states, and between states and FERC? If there is such 
a vision, do the regulators work consistently toward that goal? If 
there is no such vision, is there a process for creating one?
    When Congress in 2005 repealed the Public Utility Holding Company 
Act of 1935, it left these questions unanswered. The result is multiple 
gaps in corporate structure regulation, in our ability to screen 
inefficient from efficient transactions, and in the accountability of 
infrastructure owners to consumers, investors and the public. Ensuring 
accountability requires that regulators identify and promote sensible 
corporate structures that satisfy rigorous cost-benefit standards. To 
prepare for this task--to put standards in place before receiving 
proposals for the many structural transactions made possible by the 
2005 repeal--requires new multidisciplinary expertise and a common 
purpose shared by the multiple regulatory jurisdictions.

   II. THE REPEAL OF PUHCA 1935 CREATED GAPS IN CORPORATE STRUCTURE 
                               REGULATION

A. PUHCA 1935 created accountability to investors, consumers and the 
        public through four types of regulation
    For 70 years, the federal Public Utility Holding Company Act of 
1935 (``PUHCA 1935'') defined and limited the structural options for 
electric utilities.\1\ PUHCA 1935's central policy goal was utility 
accountability--to customers, investors, regulators and legislators. 
Its central technique was corporate simplification--the alignment of 
corporate form with public service obligation.
---------------------------------------------------------------------------
    \1\ I use the term ``PUHCA 1935'' to distinguish that statute from 
the Public Utility Holding Company Act of 2005, which includes the 
language repealing the PUHCA 1935, plus some provisions relating to 
regulators' access to books and records, and procedures for allocating 
certain costs among holding company affiliates. PUHCA 1935 was codified 
at 15 U.S.C. sec. 79 et seq. Practitioners customarily referred to 
PUHCA 1935 provisions by section number rather than by U.S. Code cite; 
therefore Section 1 of PUHCA is 15 U.S.C. sec. 79a, Section 2 is 15 
U.S.C. sec. 79b, etc.
---------------------------------------------------------------------------
    The alignment mechanism was the ``integrated public-utility 
system''. each utility holding company had to limit its assets and 
activities to those necessary to provide electric or gas service to the 
public. PUHCA 1935 applied this principle by running corporate 
structure proposals through a series of tests, restrictions and reviews 
in four major areas: mergers and acquisitions, mixing of utility and 
non-utility businesses, issuances of debt or equity, and interaffiliate 
transactions. An understanding of these tests assists the analysis of 
how deeply the regulatory infrastructure has changed.
            1. Mergers and acquisitions
    Under Section 10 of PUHCA 1935, the acquisition of a public 
utility, through the holding company form, had to satisfy six tests. 
Specifically, the acquisition:

          1. Must not ``tend towards interlocking relations or the 
        concentration of control of public-utility companies, of a kind 
        or to an extent detrimental to the public interest or the 
        interest of investors, or consumers,'' Section 10(b)(1);
          2. Must bear a ``fair relation to the sums invested in or the 
        earning capacity of'' the property acquired, Section 10(b)(2);
          3. Must not ``unduly complicate the capital structure of the 
        holding company system,'' Section 10(b)(3);
          4. Must not be ``detrimental to the public interest or the 
        interest of investors or consumers or the proper functioning 
        of'' the holding company system, Section 10(b)(3);
          5. Must not be ``detrimental to the carrying out of the 
        provisions of'' Section 11 (relating to simplification of 
        holding company systems, Section 10(c)(1); and
          6. Must ``serve the public interest by tending towards the 
        economical and efficient development of an integrated public-
        utility system,'' Section 10(c)(2).
            2. Mixing of utility and non-utility businesses
    For ``registered'' holding companies (usually the multi-state 
systems), the Act limited operations to ``a single integrated public-
utility system.'' The only exception was for ``such other businesses 
[i.e., other than the business of a public-utility company] as are 
reasonably incidental, or economically necessary or appropriate to the 
operations of such integrated public-utility system....'' Section 1 
1(b)(1). Example: If a utility owned coal burning plants, its holding 
company could own a coal mine to service those plants; but it could not 
own hotels and restaurants to house and feed coal miners.
    For all ``exempt'' holding companies (usually the intrastate 
systems), the Act allowed ownership of nonutility businesses, but only 
to the extent not ``detrimental to the public interest, or the interest 
of investors or consumers.'' Section 3(a).
            3. Issuances of debt or equity
    For the registered holding companies, Section 7(d)(1) prohibited an 
issuance of securities if the issuance triggered one or more of six 
negative findings:

          1.``The security is not reasonably adapted to the security 
        structure of the declarant and other companies in the same 
        holding-company system''.
          2.``The security is not reasonably adapted to the earning 
        power of the declarant''.
          3.``Financing by the issue and sale of the particular 
        security is not necessary or appropriate to the economical and 
        efficient operation of a business in which the applicant 
        lawfully is engaged or has an interest''.
          4.``The fees, commissions, or other remuneration, to 
        whomsoever paid, directly or indirectly, in connection with the 
        issue, sale, or distribution of the security are not 
        reasonable''.
          5.``In the case of a security that is a guaranty of, or 
        assumption of liability on, a security of another company, the 
        circumstances are such as to constitute the 6 making of such 
        guaranty or the assumption of such liability an improper risk 
        for the declarant''; or
          6.``The terms and conditions of the issue or sale of the 
        security are detrimental to the public interest or the interest 
        of investors or consumers.''
            4. Interaffiliate transactions
    Sections 12 and 13 of PUHCA 1935 applied to registered holding 
companies a set of prohibitions and conditions relating to 
interaffiliate transactions in two major categories: financial 
transactions (e.g., loans, guarantees of indebtedness, extension of 
collateral), and sales of goods and services (other than electricity or 
gas).
    Prohibited transactions included any loaning of money, or 
guaranteeing of indebtedness, by a utility subsidiary in favor of its 
holding company or any affiliate. See Section 12(a). Other 
interaffiliate transactions had to heed SEC rules, which generally 
required interaffiliate pricing to be ``at cost,'' to prevent utility 
subsidiaries from being forced to subsidize nonutility businesses. See, 
e.g., Section 13(d).
B. The repeal of PUHCA 1935 eliminated key accountability measures, 
        increasing the likelihood of corporate complexity and abuse of 
        interaffiliate relations
    By eliminating the 1935 Act's restrictions and reviews, the 2005 
statute increased the likelihood of structural complexity, including 
self-dealing between regulated and unregulated holding company 
affiliates. Gone are the geographic and type-of-business limits on 
utility mergers and acquisitions, along with reviews of and limits on 
leveraged financing and interaffiliate transactions.
    These changes make utility regulation more challenging. Because 
PUHCA 1935 induced conservatism in corporate restructuring, states and 
FERC had less need to create their own policies. Of the dozens of 
mergers between 1985 and 2005, most involved the joining of adjacent 
utilities. In these cases, the main challenges were to test the claims 
of cost savings from the combination (claims based on the assumption 
that the combination would produce greater economies of scale and 
scope); then allocate the risks, costs and benefits associated with 
those claims among customer groups and investors. Additional challenges 
included identifying and protecting against horizontal and vertical 
market power; and ensuring that the larger, post-merger entity devoted 
sufficient attention to local quality of service. These mergers, for 
the most part, did not involve the joining of remote electric 
facilities, or the mixing of utility and nonutility businesses, or 
leveraged private equity financing that increased debt while decreasing 
public information.
    By removing limits on geographical, type-of business or financial 
arrangements, the repeal of PUHCA 1935 changed the market for corporate 
restructuring. Regulators at state commissions and at FERC thus face 
questions they had not had to address, systematically at least, for 70 
years: Should they impose limits on the types of companies and 
corporate structures that provide retail monopoly service to 
electricity and gas customers? Or should they welcome new structural 
options without limit? With respect to these questions, there is no 
expert consensus, no political consensus, and no systematic process for 
arriving at one.

      III. TO ENSURE PUBLIC ACCOUNTABILITY IN CORPORATE STRUCTURE 
   TRANSACTIONS, WE MUST (A) IDENTIFY AND PROMOTE SENSIBLE CORPORATE 
            STRUCTURES AND (B) APPLY COST-BENEFIT STANDARDS

A. What types of corporate structures promote the public interest?
    In repealing PUHCA 1935, the 2005 Congress expressed no particular 
vision for corporate structures. There are no federal statutory limits 
on geographic remoteness, the mixing of utility and nonutility 
business, leveraging, private buyouts, interaffiliate transactions. 
Anyone can try anything.
    Regulators thus face corporate structure transactions not 
permitted, or not permitted without review, for 70 years. This 
circumstance requires us to revisit regulatory policy on corporate 
structures. The purpose of such revisiting is not to replicate every 
aspect of the prior federal regime, but to inquire systematically into 
the nature of the new transactions and to determine the appropriate 
regulatory response, if any.
    The table on the following page, ``Corporate Restructuring by 
Public Utilities: How Should Regulators Prepare and Respond?,'' 
displays the necessary analysis. Listed on the left are corporate 
structure events which attempt to describe all major types of 
transactions: 7 categories and 21 subcategories. Listed across the top 
are the 3 categories of regulatory options--prohibition; permission 
without review; and permission subject to reviews, limits and 
conditions. By completing this table, the regulator determines, 
systematically, the types of companies and corporate structures 
permitted to provide utility service. For each of these 63 cells, PUHCA 
1935 gave an answer. With PUHCA 1935's detail eliminated, the answers 
now must come from state law, and state and federal regulatory 
discretion.
    This Part III of my testimony introduces the type of analysis 
applicable to four of these subjects: expansion of utility business, 
mixing of utility and nonutility businesses, interaffiliate 
transactions and issuance of debt or equity. First, the regulator must 
define the types of transactions that trigger regulatory concern. Then 
the regulator must determine the response: prohibition, permission 
without review, or permission subject to standards and review. The 
concepts below are examples for consideration. Some overlap. There is 
no intent that all should be promulgated. Rather, regulators and 
legislators should consider the full array and select those that suit 
their preferences.
    Caution: Advocates of regulatory forbearance may misinterpret this 
table as a recommendation for regulatory conditions in every cell. The 
table does not prescribe a result; rather, it ensures alertness--to 
those corporate structure actions that warrant regulatory attention, 
and to the types of regulatory intervention (including no 
intervention). The purpose is to alert regulators to a statutory fact: 
the 1935 Act addressed every cell, in some way; the 2005 Act addresses 
only some.
            1. Utility acquisitions of more utility businesses
    The regulatory concern here relates to diseconomies of scale, 
management distraction and business risk: Will a utility become part of 
a system so large that quality and efficiency of local service will 
suffer, or local concerns be ignored, in setting terms and conditions 
of service? These transactions warrant attention whether structured as 
an acquisition, pooling of interests, transfer of assets or other form 
of restructuring; or whether the certificate to serve is transferred or 
remains in the original hands.
    As with all the subject areas discussed here, the options for 
regulatory action on utility requests for permission to acquire other 
utility businesses include prohibitions, permission without review, and 
permissions subject to conditions and reviews. In cases where the 
statute or regulator does not prohibit the acquisition, regulators 
should submit it to economic tests, such as requirements of new 
efficiencies, non-recovery of any acquisition premium except to the 
extent the premium is matched by demonstrated cost reductions, and 
limits on the utility debt used for the acquisition. There also are 
structural conditions, such as placing the in-state utility business in 
a corporation separate from nonutility business, requiring that the 
utility maintain its own bond ratings, and requiring that the in-state 
utility obtain, file, maintain and update annually a third party's 
nonconsolidation opinion, i.e., an opinion that regulatory provisions 
are sufficient to prevent utility from being forced into bankruptcy 
should the holding company or other affiliate fail. Operational 
conditions include requirements that the merged entities be 
operationally integrated, commit to specified operational cost 
reductions (otherwise, there would not be cost justification for the 
merger), use best practices in all areas, satisfy quality of service 
standards, and bring no new cost or risk unless exceeded by measurable 
benefits.
    A risk associated with any of these conditions is that they may not 
provide a level of protections comparable to what existed before the 
transaction.
            2. Mixing of utility and nonutility businesses
    The mixing of utility and nonutility business, including the 
control of a utility business by a nonutility owner, was long 
prohibited or discouraged by PUHCA 1935. The concerns here are 
management distractions, use of utility ratepayers to finance or 
guarantee debt associated with the nonutility business, and unearned 
competitive advantages for utilities entering nonutility markets.
    Regulatory options, along with prohibition, and permission without 
review, include: (a) limits on the percentage of total holding company 
assets, revenues or net income that can be attributable to nonutility 
businesses; (b) limits on holding company or utility financing of any 
acquisition of nonutility businesses; (c) limits on the utility's 
ability to file for bankruptcy based on affiliate difficulties; and (d) 
forms of separation between utility and nonutility businesses, such as 
separate affiliates, accounting, financing and financial statements.
            3. Interaffiliate transactions
    Affiliate transactions fall into four major categories: sales of 
utility services, sales of nonutility goods and services, sales of 
utility assets, and financial transactions (e.g., loans and guarantees 
of indebtedness). Affiliate transactions move in both directions: to 
and from the utility, from and to the holding company or other 
affiliates. There are multiple risks. ``Cross subsidy'' is a term 
frequently used in this context but infrequently defined. Where the 
corporate family has both utility and nonutility businesses, a cross 
subsidy occurs when a utility ratepayer bears costs caused by 
nonutility activities; i.e., when the ratepayer pays a price for 
utility service higher than she would have paid in the absence of the 
nonutility activities. When a utility holding company buys a hotel and 
shifts acquisition costs to the ratepayers, a cross subsidy occurs. 
When a utility enters a risky nonutility business, and the utility 
covers the higher cost of capital through utility rates, a cross 
subsidy occurs.
    Cross subsidies are only part of the adverse effects of 
inappropriate interaffiliate relations. When utility customers have 
historically borne the economic cost of an asset, they should receive 
the full market value associated with that asset's use by others. But a 
common practice is for the nonutility affiliate to obtain rights to the 
asset at cost rather than at market value. The result is not a cross 
subsidy, technically, because the ratepayers' rates do not rise as a 
result of nonutility affiliate's use. But there is a mismatch of risk 
and reward. The utility ratepayers bear all the costs but receive only 
part of the benefits.
    The regulatory options for addressing these challenges again range 
from prohibition to conditional permissions to unconditional 
permissions. Examples: (a) prohibition on a public utility providing to 
an affiliate any financial loan, guarantee or other benefit other than 
the normal payment of dividends; (b) requirement that any goods or 
services sold by a utility to an affiliate be priced at the higher of 
book or market; (c) requirement that any goods or services sold to a 
utility by an affiliate be priced at the lower of book or market; (d) 
advance review of dividend payments to protect financial integrity of 
the holding company system and the working capital of in-state utility 
affiliate; and (e) advance approval for interaffiliate cost allocation 
practices and contracts above a minimum dollar level.
            4. Issuance of debt or equity
    With the electric and gas industries now free of any federal 
prohibitions on the types of corporate acquisition, utilities, their 
holding companies or their affiliates may attempt securities 
transactions that could trigger regulatory concern over leveraging, and 
over acquisition prices in excess of underlying value (with the 
expectation that captive ratepayers will fund the excess). The types of 
transactions warranting attention include issuance of debt or equity, 
and guarantees or assumptions of liabilities, (a) at the holding 
company level, for utility or nonutility purposes; (b) at the utility 
level, for utility purposes or nonutility purposes; and (c) at the 
nonutility level, for utility purposes or nonutility purposes.
    The regulatory options include, besides prohibiting, or permitting 
without review, these transactions, the following: (a) the terms and 
conditions of the security issuance must be consistent with the sound 
and economical financing of the public utility businesses, i.e., that 
there is neither excess nor insufficient debt, and that the debt be 
reasonably adapted to the security structure of the utility and all 
companies in the holding company system; (b) the fees associated with 
the securities issuance must be reasonable and there may be no 
conflicts of interest among the transacting parties and their advisers, 
and (c) debt incurred by or guaranteed by a public utility must be used 
for public utility purposes only.
B. In assessing corporate couplings, how do we ensure that benefits 
        justify the costs?
    After dozens of utility mergers, the fundamental economic analysis 
of whether a merger is, from the consumers' perspective ``worth it,'' 
remains unsettled. This ``merger equation'' involves four main 
questions:

          1. What should be the relationship of costs to benefits?
          2. How should we measure costs?
          3. How should we measure benefits?
          4. If actual costs and benefits deviate from projections, who 
        is accountable?

    There is no commonly held answer to these questions. In many 
mergers, the questions never arise, let alone receive answers.
    What should be the relationship of costs to benefits? The most 
frequent answer is either (a) ``benefits must not be less than costs'' 
(sometimes called the ``no harm'' test), or (b) benefits must exceed 
cost, but not necessarily by much (sometimes called the ``positive 
benefits'' test). Another test, applied uniformly in prudence review, 
and in standard financial analysis, but rarely in merger review, is 
``Does the cost produce benefits at least equal to alternative, 
feasible uses of the money?'' The roots of this third test are in the 
common sense view of economic efficiency, that the ``public interest'' 
is harmed when a merger consumes resources that would allow a lower-
cost means of achieving benefits. In the regulatory community there has 
been no systematic examination of these alternative equations, or of 
the implications of allowing dozens of mergers to proceed without such 
examination.
    How should we measure costs and benefits? Savings asserted by 
merger applicants have included: administrative/general savings, labor 
savings, fuel savings, O&M savings, savings from coordination 
efficiencies, savings from construction deferral and savings from bulk 
purchases and other economies of scale.
    As with the benefit-cost relationship, there is no common 
regulatory treatment of costs. Some states require merger applicants to 
quantify savings with the degree of specificity required in a rate 
proceeding, or to accept rate reductions based on their assertions of 
savings. Sometimes, however, applicants' assertions of savings are so 
general that there is insufficient information on which to base a 
credible cost-benefit judgment. Regulators also differ over the period 
of time over which they must quantify savings. Nancy Brockway, NRRI's 
Director of Multi-Utility Research and Policy, points out that there is 
no industry standard for estimating likely merger synergies, and 
typically no track record of proven synergies from other mergers by 
which to assess forecast results from the proposal under review.
    If actual costs and benefits deviate from projections, who is 
accountable? A continuing difficulty is determining whether an asserted 
merger benefit would have occurred without the merger. Otherwise merger 
cost recovery from ratepayers would negate cost reductions that would 
have occurred without the merger.
    After-the-fact rate review is not enough. Some argue that 
protection against cross subsidies and other risks lies in ratemaking. 
The implication is that structural complexity poses no risk because 
ratemaking will catch problems. This view is not fact-based. Ratemaking 
depends on auditing. Auditing is not like a trip to the dentist, who 
checks every tooth. Auditing is sampling. It cannot promise 100% 
coverage--especially with limited regulatory resources. Allowing 
structures that invite cross subsidies or complicate auditing increases 
the probability of problems.
    Reliance on after-the-fact disallowance also invites too-big-to-
fail situations. In the competitive world, poor decisionmakers fail. 
But not always. We all are familiar with situations in which a 
company's size or national importance pressures regulators to prop them 
up. State commissions whose residents depend on the incumbent will tend 
to save the company rather than exact the ultimate penalty--especially 
since bankruptcy law addresses creditor rights, not consumer 
protection. Given the inherent uncertainty of ``back-end'' 
accountability in the form of rate review, ``front-end'' accountability 
in the form of advance review of financial risks becomes even more 
critical.

 IV. REGULATORY PREPAREDNESS FOR NEW STRUCTURAL TRANSACTIONS REQUIRES 
  MULTIDISCIPLINARY EXPERTISE AND A SHARED MULTIJURISDICTIONAL PURPOSE

A. Multidisciplinary analysis calls for a new array of regulatory 
        resources and skills
    The GAO study cited state commission concerns about availability of 
resources to deal with cross subsidies. That concern applies as well to 
the larger set of questions throughout this testimony. Analysis of 
corporate structure events requires expertise and resources in the area 
of economics, engineering, finance and accounting, and business 
management. In this subpart I give examples of the types of question 
demanding new skills and resources.
    1. Economics: What are the economies and diseconomies of scale for 
the various components of utility service--production, transmission, 
distribution, customer relations? What are the economies and 
diseconomies of scope among various utility and nonutility activities 
potentially coexisting within the same corporate family? How can 
regulators gather this information in the context of reviewing merger 
and acquisition proposals?
    2. Engineering: For each of the major physical functions involved 
in utility service, what are the geographic and size limits beyond 
which reliability, quality and responsiveness of service are affected?
    3. Finance and accounting: What are appropriate financial 
structures for the various businesses within a utility holding company 
structure? Do some structures pose the risk of corporate managers 
channeling utility cash flow to nonutility businesses, in amounts 
detrimental to the utility's optimal functioning? For example, can 
there be ``safe harbors'' for various types of nonutility investments 
by utility holding companies, such that should business failures occur, 
no damage to the utility will result? Are there true benefits to 
utility shareholders to having a utility holding company diversified 
into other business, as compared to the shareholders diversifying their 
portfolios individually?
    In corporate acquisitions occurring within noncompetitive markets, 
there is a risk of financial circularity: the acquiring company pays a 
premium for a utility knowing that the premium can be recovered from 
monopoly ratepayers. (Competitive markets, in contrast, cap premium 
payments because the acquired entity cannot raise product prices above 
market prices.) Given the circularity risk, what methods exist for 
determining the appropriate size of acquisition premia? What regulatory 
policies best line up the acquirer's desire to pay a premium, the 
acquiree's insistence on a premium, and the ratepayer's legal right to 
protection from rate increases associated with the premium? (Such 
policies should encourage efficient mergers--meaning mergers that lower 
costs--and discourage inefficient mergers.)
    4. Business management: What are implications for efficient and 
effective management when utility operations are geographically 
dispersed, i.e., not operationally integrated? How do managers, and 
regulators, determine these limits? What are the incentives, for 
various management positions, which result from a mix of utility and 
nonutility businesses in the same corporate family? Are these 
incentives aligned with the public interest? What are the skill sets 
necessary to manage, simultaneously and successfully, monopoly and 
competitive businesses within the same corporate family? After several 
dozen mergers and acquisitions in the electric and gas industries since 
1985, what data are available to study these questions?
B. Multiple regulators of the corporate structure market need a shared 
        purpose
    While eliminating federal statutory restrictions, Congress left 
pre-existing state and FERC roles undiminished. The responsibility for 
making those judgments necessary to prevent adverse effects on 
consumers, markets (for power, gas and finance) and the general public 
thus shifts to the regulators, federal and state, who must try to use 
their existing jurisdictional tools to address the new challenges. This 
situation creates opportunities for regulatory experimentation and 
creativity, but it raises a fair question: Will the separate actions, 
or inactions, of multiple jurisdictions produce a rational regulatory 
policy on corporate restructuring in multistate markets?
    I suggest that the current conversation on cross subsidies grow 
into a discussion of this larger question: Do we need consistent 
regulatory policies across jurisdictional lines to encourage utility 
corporate structures that serve the public interest, and discourage 
ones that do not? Can we achieve that consistency while still leaving 
flexibility for individual jurisdictions?
    This question need not trigger a federal-state dispute over a 
jurisdictional zero-sum equation. There is opportunity for a 
jurisdictional policy that allows for federal and state roles, and for 
variation among the states on a number of issues. A rational policy 
would distinguish between (a) the need for an efficient multistate 
market for utility asset acquisitions, and (b) the need for responsible 
state-level regulation to ensure efficient and reliable local service. 
Without a concerted effort on the part of federal and state policy 
makers to address the whole set of issues raised by utility mergers and 
acquisitions, from cross-subsidies to federal/state jurisdiction, 
however, we will dilute out ability to address the gaps left by the 
repeal of PUHCA 1935. I hope this Commission, and the participants in 
today's testimonial panels, can address this question.

V. CONCLUSION: THE REPEAL OF PUHCA 1935 DOES NOT RELIEVE REGULATORS OF 
 THEIR DUTY TO ADVANCE THE PUBLIC INTEREST THROUGH CORPORATE STRUCTURE 
                               REGULATION

    This testimony has focused on alertness, in the form of four types 
of anticipatory actions: (a) identifying the types of utility corporate 
structure transactions that trigger regulatory concern; (b) 
establishing principles to guide market participants who fashion such 
transactions; (c) recognizing the multidisciplinary ingredients to 
effective regulatory review; and (d) revisiting the federal-state 
relationship to ensure consistency in vision and implementation. The 
present focus on cross subsidies is too narrow to accommodate these 
larger, more far reaching questions.
    Some have argued that to articulate and encourage a vision for 
accountable corporate structures is to ``reconstruct'' PUHCA 1935, in 
violation of Congress's 2005 intent. This argument is deficient in 
logic, law and thoughtfulness. Section 203 of the Federal Power Act 
requires the Commission to judge mergers by a ``public interest 
standards. The 2005 Congress did not dilute this language, but rather 
subjected more transactions to it. State merger statutes create similar 
duties.
    It remains regulators' continuous obligation to align corporate 
structures with the public interest. With the repeal of PUHCA 1935, 
that obligation becomes more difficult to fulfill. The acquisition of 
remote utility properties, the mixing of utility and nonutility 
businesses, and the use of unconventional ownership structures and 
financing structures, all call for new resources and new expertise. The 
dialogue created here by GAO and FERC is a worthy beginning, but it is 
only a beginning.
    Thank you for the opportunity to present this testimony. I look 
forward to any questions from the Committee.

    Senator Salazar. Thank you, Mr. Hempling. Let me start out 
with you, Mr. Gaffigan. You, in your testimony talked about the 
few substantive changes in FERC after the 2005 Act. You talk 
about how we essentially have a system in place that's self 
certification system. I think your conclusion is that FERC is 
too over reliant on self reporting. That they don't have a risk 
based approach to targeted auditing that the resources that 
FERC has with only 34 auditors isn't sufficient for them to do 
the job that we assigned to them under the 2005 EPACT.
    Would the remedy there essentially be to give more 
resources to FERC so that they could actually do the job that 
was assigned to them by the Congress back in 2005? How big is 
that deficiency?
    Mr. Gaffigan. Right. I think the first step is to have them 
sit down and do a real risk based approach, in other words, 
understanding what's the portfolio of companies that they're 
going to look at.
    For example, if it is the 36 utility holding companies, 
which ones are the highest risk? How involved are they? If we 
have more mergers become involved what's the make up of the 
companies? I mean, really complex types of issues.
    That's going to really dictate and put them in a position 
to say, alright, here's how many resources we need to cover 
this. We're short. So I wouldn't go off and just say, look, 
just throw a bunch of auditors at it. I would have them do the 
risk based approach as our recommendation outlines. Then I 
think, then they'll be in a position to give a good assessment 
of what their resource needs might be.
    Senator Salazar. Based on what you know, based on having 
done the GAO report, how short do you think they are on 
resources? Or do you think you can't answer that until you go 
through the risk based analysis.
    Mr. Gaffigan. I think to give you a good answer, you can't 
answer that. I expect it to change over time. You know, we 
could have more mergers than is expected and that would dictate 
how much staff they're going to have.
    I think they're in a position where, you know, when the SEC 
went away, they used to do these audits. They were a group of 
about 25 auditors. So they have gone away. The Division of 
Audits has pretty much stayed the same within FERC.
    Senator Salazar. Commissioner Kerr, on behalf of the 
States. The concept here is that the States through their PUCs 
do a lot of this work and so FERC essentially acts as a 
backstop. Do the States have, I mean, your testimony is the 
States don't have the resources. You're resource deficient.
    What I'd like you to do is to talk about that a little bit 
and also talk about the variance between the States because 
knowing the reality of States some legislatures and Governors 
will put more money into their commissions than others. And so 
do we have a patchwork of regulation here for when deferring to 
the State levels that is not workable.
    Mr. Kerr. Senator, I would be fired I think if I said we 
have all the resources at the State level we need and by my 
colleagues. They wouldn't like that. I mean, obviously 
resources are always scarce.
    I think certainly the question is yes, that there is 
variety from State to State or commission to commission when 
you think about financial or human resources. I would say the 
good human resources aren't always in the bigger States. I 
mean, we're just variable, like any group of 50.
    But I don't think, and I think that GAO's report bore this 
out, I don't think there is tremendous variation in terms of 
legal authority. I mean the report is pretty clear. There is 
consistent authority found in statute or rules to look at 
mergers, to audit, to have access to books and records.
    Certainly in EPACT 2005 Congress expanded for all States 
access to books and records of holding companies and 
affiliates. So I think that the legal. There's not as much 
legal variety or variation across the States. I think that the 
report bears that out.
    Now I will say that they did identify some discrepancies or 
some variety, fairly minimal. I think that's why we're glad 
that they've come and reported to us. It gives us a tool to 
fill in some of those gaps. Certainly since the repeal of PUHCA 
some States have gone in and asked for certain authorities from 
their legislatures that they felt like they needed.
    So, yes, as to financial and human. I don't think so from a 
legal standpoint. In other words we have the authority to do 
the job.
    I think the answer for how do we handle that variability 
from a resource standpoint is largely found in organizations 
like NARUC, like the National Regulatory Research Institute, 
which Mr. Hempling heads up for us. In fact we went looking at 
the future and our responsibilities. We went out and found 
someone like Mr. Hempling to come in and assist us.
    At footnote 32 and 33 of my testimony I've listed some of 
the work that we've done with the prospect and the reality of 
PUHCA repeal to help prepare States. Academic reports, 
substantive work to try to make sure that that variability we 
can leverage the resources of the national organization and the 
various States to try to even out and fill in and provide for 
that variability.
    Senator Salazar. Thank you.
    Mr. Kerr. I would make one other just quick point too and 
that is the level at which we are doing a better job in the 
last two or 3 years of working with the financial community. I 
think they know where we are now and we know where they are. So 
I think the way, the manner and the level at which we 
understand the private equity community, the fixed income side 
of these issues.
    We're much more sophisticated. I think we needed to be. I 
think that is helpful. I do think that's across the board. I 
mean that's at the national level and at the regional level and 
we're doing a better job there.
    Senator Salazar. Thank you, Commissioner Kerr.
    Senator Murkowski.
    Senator Murkowski. Thank you, Mr. Chairman. I apologize 
that I was not here for the first half of this hearing. 
Obviously a very important issue and one that I'm pleased that 
has been brought before the committee.
    I was over in the Indian Affairs Committee where we were 
talking about the Indian Energy Act and the fact that we may 
have put in place some good provisions, but we have lacked in 
certain areas when it comes to providing things like loan 
guarantees and the financial assistance. So it was an important 
hearing over there too this morning. Busy morning.
    Let me ask you, Mr. Gaffigan, well I wasn't here for Mr. 
Kelliher's testimony. I did have an opportunity to review it. 
You're arguing that the principle means for identifying the 
cross subsidies is through the financial audits, the periodic 
financial audits.
    But the Commission highlights its rate making authority as 
the most powerful and perhaps the most effective tool for to 
prevent the cross subsidies. Do you agree that this rate making 
authority can be an effective tool both at the State and 
Federal level or is that a basic area of disagreement here?
    Mr. Gaffigan. You know, rate making is part of it. I mean 
our focus was on the compliance audit which formerly SEC did. 
What I would say about rate making, you know, it occurs 
infrequently. They could be many years apart. The audits can be 
many years apart and in sort of a prospective look.
    So what I would say it's a different tool. I think what the 
compliance audits we're talking about offer a retrospective 
look and a particular look at affiliate transactions and the 
whole range of cost. FERC is looking at, you know, transmission 
costs and the wholesale sale of electricity. So it doesn't 
cover necessarily all the costs that ultimately a consumer can 
pay.
    So I would say they are complementary and what I would say 
is that the compliance audits we're talking about are just as 
important. That was the focus of our concern.
    Senator Murkowski. I see. So it's not an either/or. You're 
saying that it's a complementary process then.
    Mr. Gaffigan. Absolutely.
    Senator Murkowski. Mr. Owens, you've testified that this 
increased Federal oversight over non-utility corporate 
activities could actually create barriers to investment and 
competition in the electricity markets. Which is exactly what 
we were intending to do, to eliminate when we repealed PUHCA. 
Can you elaborate a little bit more on this line?
    Mr. Owens. If the rules aren't clear. If the rules appear 
to be preemptive of activities that the States have underway 
where they also review a range of activities that companies are 
engaged in, it could create tremendous confusion and delay in 
getting a range of financing approvals. It could also 
potentially could create tension between the State commissions 
as well as the Federal Energy Regulatory Commission if the 
rules are not clear and the rules are not collaborative.
    Ratemaking is a very comprehensive responsibility that both 
the States and FERC have. I do agree with the earlier comments 
that it's just not an audit. It's the looking of all aspects of 
a company's operations.
    But the rules have to be clear. The rules have to be 
understandable. The rules have to be implemented in a way that 
it does not create confusion and uncertainty.
    Senator Murkowski. Mr. Hempling, you have left the door 
open. You invited the question from Senator Salazar and myself 
on the issue of preemption. Your testimony provides for 
revisiting the Federal/State relationship to achieve consistent 
regulatory policies across jurisdiction lines with respect to 
cross subsidies.
    Are these the code words for Federal preemption? Talk a 
little bit about where you were going when you kind of left 
that question hanging there.
    Mr. Hempling. Thank you very much, Senator. I in fact meant 
the opposite. But first let me address the issue of preemption, 
deference and backstop, three words that have been used 
frequently this morning.
    There is absolutely no, in my opinion, congressional intent 
in the 2005 statute to authorize FERC to make decisions that 
are preemptive of States. I'm concerned that that word has 
departed from the way I learned it in law school. I went to law 
school a long time ago. But I think somewhat more recently than 
some of the other panelists.
    Preemption, technically, simply means that the State law 
becomes invalid and inoperative under State law. I don't think 
anything in the 2005 statute could have that effect. There is 
the possibility that the FERC could find that the range of 
conditions imposed at the State level are insufficient as a 
matter of Federal law. Therefore the Federal Energy Regulatory 
Commission could add to them.
    But there is no authority in FERC to declare that somehow 
the State law conditions are inoperative or unlawful. To the 
extent the prior panelists meant preemption in that way, 
there's no legal basis for it. I think perhaps they were using 
it in a non-legal way.
    But I think it has caused confusion because the issue here 
is not a matter of deference to States. The FERC has 
independent legal authority. By the way in the context of 
section 203, that authority is not confined to the protection 
of wholesale customers. I'm sure the chairman and his lawyers 
know that.
    The only wholesale notion in the Federal Power Act has to 
do with rates. But in the context of mergers and acquisitions 
and restructurings under section 203, the public interest 
includes all customers both wholesale and retail. There is no 
legal authority in FERC to create in some party a burden to 
prove to FERC that somehow State conditions are inadequate.
    The FERC has an independent obligation to ensure that all 
customers are protected. The fact that FERC might come in to 
say we like the Washington State conditions, but we think more 
are necessary. That's not called preemption the way I learned 
it in law school. That's called exercising independent 
authority to strengthen.
    I know of many States who would be very pleased to have 
FERC play that role because the States either lack the 
resources or the political support to impose as many conditions 
as they would like. So when we talk about cooperation and 
complementing each other. It is in the exercise of independent 
authority at the State and the Federal level.
    My concern about consistency actually is consistent with 
what Mr. Owens and others have said is that I want to see clear 
signals sent to the marketplace. Some mergers and acquisitions 
are going to be good. We've got corporate boundaries that were 
drawn almost 100 years ago.
    Some of them are old and need to be replaced with larger 
companies that have better economies of scale. Other mergers 
are going to be inefficient because they are motivated by the 
wrong desires. We need this concept of consistent rules that 
are clear so that the marketplace knows how to react.
    That's where I think collaboration can occur. Thank you for 
the opportunity.
    Senator Murkowski. I appreciate your statement there. Thank 
you, Mr. Chairman. I've gone over my time.
    Senator Salazar. Thank you very much, Senator Murkowski. 
Let me ask a question of you, Mr. Owens for EEI. One of the 
things that was predicted back in 2005 when we working on EPACT 
and the repeal of PUHCA was that we were going to see merger 
mania, 70 years of regulation under PUHCA ended in 2005 and 
everybody said we were going to see major merger mania. It 
hasn't happened.
    Looking ahead, what do you see? Do you see the possibility 
of merger mania in the utility world?
    Mr. Owens. If I knew that answer I wouldn't be here. I'd be 
a rich man. Let me stop being a--I would say it really depends 
on market conditions and whether companies can see benefits 
that will accrue to customers as well as benefits that would 
accrue from technology improvements.
    You can't predict whether a merger is going to occur or 
not. As all the panelists have indicated there are a range of 
issues that are presented when a company considers merging with 
another company or acquire another company. The bottom line of 
all those considerations are savings to consumers, 
technological advancements, economies of scale, economies of 
scope.
    Senator Salazar. Let me try to pinpoint my question a 
little bit more.
    Mr. Owens. Yes.
    Senator Salazar. We see what's happening in the airline 
industry today where there are a number of conversations about 
mergers and the airline industry. We have seen it over the last 
ten, fifteen years with respect to what happens in the 
financial industry and the banking industry with respect to 
mergers.
    Mr. Owens. Yes.
    Senator Salazar. We have not seen a merger mania.
    Mr. Owens. That's right.
    Senator Salazar. A significant movement in that way in last 
several years with respect to regulated utilities. Do you, in 
terms of the way that EEI sees the world, is that something 
that you are thinking might happen? Do you think it's not going 
to happen? I mean what are your economists----
    Mr. Owens. Wall Street would love to see it happen. They 
indicate that there are too many companies. I mentioned earlier 
that many of our companies are undergoing tremendous investment 
in infrastructure. Based upon the major investment in 
infrastructure it is likely that some companies will not be 
able to have the finance ability to build a major new facility. 
They may find that they have a stronger balance sheet if they 
combine with other companies. So that's one condition that 
could lead to greater mergers.
    There's uncertainty with respect to what happens under the 
concerns about climate change. Companies have different levels 
of resources. Companies that are not heavily coal based may see 
an opportunity or an advantage in combining with a company that 
has a broader array of resources.
    Again all of these are pretty speculative. They really 
depend upon changing conditions. But I don't think they're so 
far fetched.
    There are international companies that are looking at the 
U.S. market and the dropping of the value of the dollar and the 
strong balance sheets that some of the international companies 
have. They may view that they can see opportunities in 
acquiring a U.S. company and providing economies to that U.S. 
company. I think we're in an environment where that can occur.
    We look at all of that and say we don't see a tremendous 
rise in mergers potentially occurring. But we think the factors 
that could lead to mergers, many of those factors are presented 
today.
    Senator Salazar. So it could, in fact, happen, which in the 
sense makes the importance of this hearing and having a FERC 
that has the adequate oversight work well.
    Mr. Hempling, I'll come back to you, Mr. Gaffigan. On this 
question of preemption, I think I understand what you were 
saying that this is not really a preemption in the legal sense. 
You have independent authority at FERC. You have independent 
authority with the State Regulatory Commissions. So those 
independent authorities need to be exercised in the public 
interest.
    The question I would have for you then is how do we make 
sure that these independent authorities get exercise in a way 
where they're essentially part of the same team of protecting 
the public interest as opposed to having, you know, one big cop 
at the Federal level and another cop at the State level. How do 
you create that kind of collaboration so there is consistency 
with respect to the regulation?
    Mr. Hempling. I was afraid somebody would ask such a 
thoughtful question and not that the other questions haven't 
been thoughtful. It's a difficult way to answer it without 
getting stuck in the canard that I'm proposing a ``one size 
fits all'' which is a phrase people often use to describe a 
solution they don't like.
    I want to first emphasize that I'm not talking about the 
need to have a single approach to every transaction. I think 
the prior panel made clear that depending on whether it's a 
partnership, a SCEcorp or other sorts of arrangements, there 
need to be different types of tools. I think what has to happen 
is much more difficult than what we're addressing. That is 
there has to be some consensus about the nature of the 
corporations that we want serving the company.
    There's something episodic and opportunistic about the way 
it's working right now. I was never among the ones who 
predicted merger mania. I don't think the concern is the speed 
at which these transactions or the rate at which they occur.
    I think the question is what is the nature of the 
companies. Are we indifferent when a Warren Buffet acquires a 
Washington or an Oregon utility? Are we indifferent when a 
private equity firm acquires a utility? Do we care whether the 
long term shareholders have been replaced by short term 
shareholders?
    My concern is that there is lacking a dialog among 
regulators at the State and Federal level and together as to 
what it is we're trying to achieve here. Because if one were to 
infer from the present regulatory stance the inference would be 
that whatever the ``market'' produces in terms of couplings is 
what is right. I'm concerned that the market is not 
sufficiently competitive or disciplined or overseen for us to 
have that type of trust in it.
    So I'll simply concede that I have no direct answer to your 
question, yet. But I believe it's the main one we have to 
address, sir.
    Senator Salazar. Ok. Why don't we keep--my time is up. So, 
Commissioner Kerr and Mr. Gaffigan, if you'll quickly respond 
and then we'll turn it over to Senator Murkowski.
    Mr. Kerr. I think I agree with Mr. Hempling. I think the 
trouble is it is so difficult. Things are moving so fast. It's 
hard to make that distinction. You know, Mr. Buffet's 
involvement in the utility industry has been, I think, 
successful and welcome. Certainly if you look at the disaster 
that became ENRON, you know, that basically evolved off a 
utility platform. It began as a typical utility platform that 
evolved.
    I think my basic point is we can't know prescriptively, 
prospectively what we are going to need or where these 
investments are going to come from. I absolutely agree with Mr. 
Hempling that we know the type of investor, the longer term 
horizon, the folks who understand the unique public service 
obligation of these entities. It's more difficult to sort 
through and figure out who is Warren Buffet and who is Gordon 
Gecko. I can see that. I don't see how you're going to do that 
in advance.
    Senator Salazar. Do you think, Commissioner Kerr, that Mr. 
Hempling suggestion on the need for the dialog between FERC and 
the States is adequate?
    Mr. Kerr. I think absolutely. I think we have that. I mean, 
I think one of the points that I want to make clear that might 
have slipped by during the first panel is the policy statement 
that FERC has adopted was based on a technical conference that 
had representatives of two State commissions including Oregon 
which is really the preeminent case of ring fencing and the 
effectiveness of protecting the underlying utility from the 
ENRON debacle.
    So I think that dialog is ongoing. I mean, can we do more 
as the GAO suggests? Yes, certainly, we might be able to. I 
think both FERC and the State and NARUC have indicated, an 
absolutely, a willingness to do more if that's what we need to 
do.
    Senator Salazar. If you take about 20 seconds, Mr. 
Gaffigan.
    Mr. Gaffigan. I can. I just want to add to Mr. Hempling, 
the merger mania concerns we heard were not the numbers and the 
rate. It was: what are things going to look like? That's the 
concern we had. We don't have a concern about regulatory gaps, 
as Mr. Owens implies.
    We have a concern about how are these States going to deal 
with this issue of more complex companies coming in and 
potentially putting themselves in the situation of having to 
approve a merger. They could face things that are more daunting 
than what was faced in the 1930s and the whole reason for PUHCA 
in the first place.
    Senator Salazar. Senator Murkowski.
    Senator Murkowski. Just very quickly to finish up my 
questions. This should be a, you know, 30-second answer from 
each of you. With FERC do we have in place sufficient customer 
protections in light of PUHCA repeal? Now Mr. Gaffigan you 
mentioned you're not concerned that there have been any 
regulatory gaps that have resulted as a consequence of the 
repeal.
    But do we have sufficient customer protections, consumer 
protections in place?
    Mr. Gaffigan. Our concern was not with the rules. It's with 
enforcement of the rules. That's our main concern. I think 
that, you know, FERC has an opportunity to do some things in 
the recommendations that I think will provide that assurance.
    That's all our recommendations were saying. I think we 
heard even from all the Commissioners, some element of, yes, 
there might be some value there. Some stronger than others, but 
even Commissioner Kelliher, Chairman Kelliher was talking about 
it. In his comments he says well, I'm going to have the staff 
consider the GAO recommendations, carefully consider.
    That's all we're saying, that the rules are there. It's the 
enforcement of the rules that we're concerned about.
    Senator Murkowski. Commissioner Kerr.
    Mr. Kerr. I think the rules and the authorities are there, 
but at the State and Federal level I think there's an awareness 
of the issues and the potential concerns with respect to 
consumer protection at both the State and Federal level. I 
think there's a working relationship that gives us the 
opportunity to make sure that consumers are protected. I think 
with the GAO report we've got a critique from an independent 
agency that's made some suggestions that will further benefit 
the points we already have.
    So I don't think I could ever answer you absolutely, are we 
perfect. But I think we are where you should expect us to be 
when you adopted EPACT 2005.
    Senator Murkowski. Good.
    Mr. Owens.
    Mr. Owens. I also think the rules are there. I think the 
elements to make sure that the rules are carried out are there. 
I do believe that I will agree here with the GAO that there 
could be continuing collaboration with the States.
    FERC has and the States have several collaboratives that 
undertaking today. I would encourage that they seek to fill any 
resource gaps by working more closely together. More clearly 
identifying, as Mr. Hempling said, if there are concerns about 
the evolution of different organizational structures then I 
think the States and the FERC need to collaborate.
    I think it is appropriate if they believe that those 
structures are structures that are creating adversity with 
respect to looking at affiliated arrangements. There should be 
a dialog about that rather than adopting rules that would lead 
to uncertainty and raise the overall cost of capital and 
frustrate utility investment infrastructure.
    So I would be in support of greater collaboration, greater 
clarity and having FERC and the States work together.
    Senator Murkowski. Mr. Hempling, you get the final word.
    Mr. Hempling. Thank you, Senator. A comment on substance 
and then a comment on attitude. Concerning substance, I think 
FERC has to be more hip to the possibility that the motivations 
behind certain transactions are not long term and may deviate 
from the public interest. There needs to be more skepticism 
there.
    They need to start subjecting the mergers and acquisitions 
to attest showings of economies and efficiencies restrictions 
of leveraging. They need to examine empirically the sufficiency 
of resources at the Federal and the State level.
    A word on attitude. The Federal Power Act is not a 
backstop. The Federal Power Act is not a statute that defers. 
The Federal Power Act is a command to the Federal Energy 
Regulatory Commission to protect the consumer. It takes nothing 
away from Federal/State relations for the Federal Energy 
Regulatory Commission to say we must play a lead role here with 
the resources that we have.
    So I'm looking for a modification of their attitude in that 
respect. Thank you very much.
    Senator Murkowski. Thank you.
    Thank you, Mr. Chairman.
    Senator Salazar. Thank you very much, Senator Murkowski. 
Mr. Gaffigan, Chairman Kelliher argued in his testimony that 
the financial health of the holding company is not evidence as 
to whether cross subsidization is occurring. From your point of 
view in your review, are there other threats to the well being 
of a utility and its rate payers, of the financial health of 
the parent company might be a good indicator of?
    Mr. Gaffigan. I think our point in our report was there are 
a lot of financial indicators that FERC could look at to assess 
its risk, not just financial statements. There's a whole range 
of things. We, in our recommendation, indicated that they look 
at that portfolio and come up with some good measures of 
financial risk. So we think there's a lot of opportunities for 
them to look at the risk of financial companies by looking at a 
lot of different types of financial information.
    Senator Salazar. Mr. Hempling, in EPACT 2005 we gave FERC 
new authorities and obligations to review mergers. Specifically 
we required the middle law to find that there would be no cross 
subsidization or encumbrance of assets for the benefit of the 
affiliate as a result of the merger. In your view have FERC's 
modification of their merger rules adequately implemented this 
requirement?
    Mr. Hempling. There's one difference I would have with FERC 
is to their rules and that concerns the measurement for the 
appropriateness of inter-affiliate relations. If I'm not 
mistaken the rule is that there is a sale by an affiliate to 
the utility the price cannot exceed market.
    That's a deviation from the Holding Company Act rule which 
is an at cost rule. The notion had always been that the sale 
from an affiliate to the utility should be at the lower of cost 
or market. The reason for that is to avoid a situation that has 
occurred in a number of States where an asset like generation, 
which had been charged for to ratepayers at an embedded cost, 
depreciated over time, that that generation migrates to an 
affiliate and then the output is sold back to the utility at a 
higher market price thereby depriving the utilities ratepayers 
of the bargain for which they many years before had paid.
    So I would recommend that FERC, if I'm not mistaken on that 
rule, modify it so that the sale from the affiliate to the 
utility is the lower cost or market. Other than that, sir, I 
would say that the rules themselves given their purpose are 
reasonable in light of the congressional intent. I did make the 
statement earlier that I think there's more here than just 
those issues.
    Senator Salazar. So your view is then that there ought to 
be a modification of that rule on the part of FERC. Are there 
statutory changes that you would make a recommendation to this 
committee that we ought to look at?
    Mr. Hempling. That's a good question. It deserves a long 
answer, but I'll give you a short one. I would like to see FERC 
apply to mergers and acquisitions a better defined test than 
the test that presently exists which is merely, ``consistent 
with the public interest.'' That's a generic phrase seen often 
in regulatory statutes.
    I like the notion of the FERC requiring that mergers 
demonstrate that life will be better off in the industry with 
the merger than without. That the purpose of the merger is to 
create economies and efficiencies associated with the coupling 
which could not be achieved by lower cost means. That's not the 
standard that exists in the new statute. It was the standard 
that exists in the old statute.
    Let me warn people who are about to run to their cell 
phones. I'm not suggesting that we bring back the Holding 
Company Act with all its prohibitions. I am suggesting there's 
a middle ground where we screen mergers and insist that the 
ones that occur are the ones that do serve the public interest 
by adding efficiencies.
    Senator Salazar. Now is that something to be accomplished 
by change in the law or is it something that can be 
accomplished through modifications of the rules by FERC?
    Mr. Hempling. FERC could do it under its present authority. 
It could define the phrase consistent with the public interest 
to require the creation of efficiencies and economies. They 
could do it under present authority. If they do not then 
there's reason to talk about modifying the statute in that 
regard.
    Mr. Kerr. You've succeeded in getting a Commissioner to 
argue with the head of our research institute. I'm sure that 
wasn't your intent. But just let me say this I think I agree 
with Mr. Hempling as we sit here today.
    I do think though when we start thinking about our future, 
our sense of the public interest in this arena is evolving. 
We're probably moving away from the concept of pure economic 
efficiency or lowest cost. We are confronting environmental 
challenges that are going to have us view the role of the 
utilities, perhaps, somewhat differently.
    We may want the lower cost of capital that is available to 
the typical utility applied to, for instance, renewable 
generation opportunities. They are not the most economically, 
efficiently currently as you all know wrestling with the tax 
credit issues. So what we're going to want tomorrow in the 
public interest may not be what we have traditionally viewed as 
purely economically efficient investments or structures.
    That was the key point that I wanted to make is we know 
it's changing rapidly. We're not sure where we're going to be 
with respect to how we serve the public interest in this vital 
segment of our economy and so my personal view is that more 
flexibility at the current time. As long as you all are 
comfortable that we and our Federal colleagues know what we're 
doing, I think more flexibility at the current time is what we 
need to meet the challenges we confront because our concept of 
how this segment of our society is going to be dealt with is 
evolving rapidly. It's not purely a matter of economic 
efficiency anymore.
    Mr. Hempling. I consider Commissioner Kerr's statement as 
an enhancement to my suggestion. I fully agree with it.
    Senator Salazar. Thank you very much.
    There are a number of other questions which I know Chairman 
Bingaman and other Senators on the committee have and so those 
will be sent to you. We would ask that you respond to those 
questions.
    We thank you for your testimony here this morning. We have 
learned a lot. It will guide us as we will move forward. Thank 
you very much. The meeting is adjourned.
    [Whereupon, at 11:44 a.m. the hearing was adjourned.]

    [The following statement was received for the record.]

      Statement of Michael E. Boyd, President, CARE, Sunnyvale, CA

    I watched the May 1st Committee Hearing on the adequacy of FERC's 
consumer protection with much dismay. After waiting seven years for 
refunds for California's energy consumers for the seventy one billion 
dollars of energy overcharges imposed on California's consumers during 
the 2000--2001 energy crisis I am frankly not surprised that FERC 
Chairman Kelliher hears and sees no evil in the energy markets. This is 
because Chairman Kelliher is part of the problem. The Senate need look 
no farther than to where Mr. Kelliher came from before he became 
Chairman, working heading up VP Dick Cheney's 2001 Energy Task Force to 
know why FERC's consumer protection program is an oxymoron. Mr. 
Cheney's Energy Task Force likely was the architect of the program set 
up to transfer a huge amount money from energy consumers in the West to 
the very power generators and energy marketers FERC is supposed to 
regulate. This plan to privatize the profit for a few energy insiders, 
has resulted in a huge socialization of the costs of deregulation on 
the backs of energy consumers nationwide. Our group CAlifornians for 
Renewable Energy, Inc. (CARE) has brought a law suit before the US 9th 
Circuit Court of Appeals challenging the FERC's Decisions regarding the 
crisis (attached).*
---------------------------------------------------------------------------
    * Document has been retained in committee files.
---------------------------------------------------------------------------
    The FERC decisions addressing the 2000-1 western energy crisis did 
not hold hearings or other proceedings including the affected 
ratepayers. CARE's efforts were the only direct ratepayer 
participation. All the other parties to the proceedings were regulated 
utility companies, energy commodity traders, governmental ``non-public 
utilities'' and state and federal government agencies that implemented 
the policies and practices leading to the energy crisis. Those harmed 
include CARE members, specifically those members who are low-income and 
people of color, who had their utility service turned-off because of 
the exorbitant rates charged. By denying the affected plaintiffs the 
opportunity for a fair hearing before the FERC it has deprived 
plaintiffs of their constitutional rights. Yet CARE's concerns and 
injuries were not considered during the proceedings in question. This 
is a violation CARE's due process rights.
    I would like an opportunity for energy consumers to be given the 
opportunity that FERC was unwilling to provide us to be heard by the 
U.S. Senate Committee on Energy and Natural Resources on the adequacy 
of FERC's consumer protection or the lack thereof.

                                APPENDIX

                   Responses to Additional Questions

                              ----------                              

     Responses of Mark Gaffigan to Questions From Senator Bingaman
    Question 1. Your report recommends that FERC adopt a risk-based 
analysis in selecting candidates for audits of affiliate transactions. 
Chairman Kelliher indicates that FERC already this [sic]. Is there a 
difference between what you are suggesting and what the Commission 
already does?
    Answer. We believe there is a difference between what GAO suggests 
and the Commission's current practice. During the course of our year-
long engagement, key senior FERC officials described the process for 
selecting companies to audit as informal; they did not mention the 
mechanisms the Chairman described in his testimony as a risk-based 
approach. When we asked FERC staff for a record of a risk-based 
analysis, or the criteria FERC would have used to conduct such an 
analysis, they were unable to provide them and consistently told us 
audit selections were based on informal discussions with knowledgeable 
senior FERC staff.
    While FERC officials may consider risk in these discussions and, as 
we noted in our February 2008 report, may believe their judgments 
provide a reasonable picture of risk, we believe a risk-based audit 
planning approach should be more systematic. A more systematic approach 
would more reliably guide FERC in assessing individual company risks 
and the overall risks posed by the companies collectively, and would 
ensure that its audit selection process remained consistent when staff 
in key positions change.
    As we noted in our report, some federal agencies develop their own 
statistical measures of risk using quantitative models. This method may 
be appropriate for FERC, but there are others. FERC's approach will 
need to flexible enough to meet its current and expected future 
auditing demands now that it is solely responsible for detecting 
potential cross-subsidization. In our recommendations, we did not 
prescribe a method for developing and implementing a more formal, risk-
based approach; our intent was to give the Chairman flexibility to 
identify the most appropriate method. In any case, designing a formal 
risk-based approach will take time and effort, and FERC may want to 
consider consulting with outside experts.
    Question 2. Chairman Kelliher argues that the financial health of a 
holding company is not evidence as to whether cross-subsidization is 
occurring. Are there other threats to the well-being of a utility and 
its ratepayers that the financial health of the parent company might be 
a good indicator of?
    Answer. It is not our view that the health of the parent company is 
an indicator of cross-subsidization, but rather that FERC should 
develop appropriate financial metrics to identify companies' risks and 
the potential pressures that could lead to unauthorized cross-
subsidization. FERC could incorporate these metrics into its audit 
selection process.
     Responses of Mark Gaffigan to Questions From Senator Domenici
    Question 1. Does FERC have in place sufficient customer protections 
in light of PUHCA repeal? Has the repeal of the Holding Company Act 
resulted in any regulatory gaps?
    Answer. We did not analyze all federal and state regulations to 
determine whether the repeal of PUHCA 1935 resulted in any regulatory 
gaps; however, as we noted in our report, we are concerned that while 
FERC has taken significant steps to enact its new authorities, it has 
not yet made sufficient changes to its processes to protect consumers 
from harmful cross-subsidies. As we note in our report, while FERC has 
many rules prohibiting cross-subsidies, it has taken few formal steps 
to detect violations of these rules. We believe that implementing our 
recommendations would improve FERC's oversight and help it better 
protect consumers.
    Question 2. You argue that the principal means of identifying 
cross-subsidies is through periodic financial audits. However, the 
Commission has highlighted its ratemaking authority as a powerful tool 
to prevent cross-subsidies.
    Do you agree that ratemaking can be an effective tool at both the 
state and federal level? If not, why don't you believe that improper 
cross-subsidies can be prevented through ratemaking?
    Answer. In our report, we recognized that FERC retains a limited 
ratemaking role and, as such, may have opportunities to examine costs 
incurred by utilities and decide which costs may be lawfully included 
in rates charged to customers. However, we also noted that rate reviews 
are infrequent and are generally prospective--they do not always 
include the retrospective analysis of costs incurred and compliance 
with FERC's ratemaking rules that would be necessary to detect cross-
subsidies.
    Question 3. GAO notes that since PUCHA's repeal, through last July, 
FERC reviewed 15 proposed mergers--about the same number as the same 
period prior to the Act's repeal. Do you believe any of these mergers 
hurt consumers and resulted in accumulation of market power?
    Answer. We did not examine the positive or negative implications 
for consumers of the mergers that have occurred since EPAct 2005 was 
enacted, nor the market power implications of these mergers.
    Question 4. You advocate for the Commission to adopt a more risk-
based audit approach. Isn't FERC already doing a risk-based audit 
approach? Doesn't the Commission need the flexibility to address their 
high-priority areas of policing market manipulation, market power 
exercise, and reliability?
    Answer. We believe there is a difference between what GAO suggests 
and the Commission's current practice. During the course of our year-
long engagement, key senior FERC officials described the process for 
selecting companies to audit as informal; they did not mention the 
mechanisms the Chairman described in his testimony as a risk-based 
approach. When we asked FERC staff for a record of a risk-based 
analysis, or the criteria FERC would have used to conduct such an 
analysis, they were unable to provide them and consistently told us 
audit selections were based on informal discussions with knowledgeable 
senior FERC staff.
    While FERC officials may consider risk in these discussions and, as 
we noted in our February 2008 report, may believe their judgments 
provide a reasonable picture of risk, we believe a risk-based audit 
planning approach should be more systematic. A more systematic approach 
would more reliably guide FERC in assessing individual company risks 
and the overall risks posed by the companies collectively, and would 
ensure that its audit selection process remained consistent when staff 
in key positions change. Furthermore, such and approach should be 
flexible enough to meet FERC's current and expanded future auditing 
demands now that it is solely responsible for detecting potential 
cross-subsidization.
    It is clear that, as a result of statutory and regulatory changes, 
FERC has many additional and important responsibilities beyond those 
related to cross-subsidization and FERC needs flexibility to determine 
how best to address its high priority areas. However, it is equally 
clear that FERC is the sole federal agency responsible for ensuring 
that harmful cross-subsidization does not occur and may be the only 
regulatory agency with sufficient scope and access to effectively 
detect cross-subsidies. Given that Congress has entrusted FERC to 
``ensure'' that unauthorized cross-subsidies do not occur, we are 
encouraging FERC to develop a formal, comprehensive, risk-based, audit 
approach to detect when such subsidies may be occurring and to seek 
additional resources, if needed.
                                 ______
                                 
    Responses of Suedeen G. Kelly to Questions From Senator Bingaman
    Question 1. Do you believe that FERC has acted to fulfill 
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a 
merger?
    Answer. I believe FERC can, and should, exercise more leadership to 
ensure that no cross-subsidization or encumbrance of assets will occur 
as a result of a merger. To date, we have deferred to the states to 
require sensible and appropriate corporate structures to protect 
against cross-subsidization or encumbrance of assets. We should do more 
than we have done--without preempting the states. For example, we could 
take a more active role in explaining, for the states, (1) where the 
problems lie with corporate structures; (2) the importance of 
preventing the possibility of cross-subsidization instead of merely 
taking care of it through the ratemaking process after it has occurred; 
and (3) potential corporate structures that are productive, versus non-
productive. We need to be vigilant regarding the possibility of 
interstate conflicts because, when we defer to states that have 
different rules, there is the potential for interstate conflicts and 
for the imposition of undue burdens on entities that do business in 
multiple states.
    We should also establish principles related to how corporations 
should be structured that could guide the states without preempting 
them.
    We should also consider the possibility of adopting states' 
corporate structure requirements as our own. When we merely defer to 
the states, their structural requirements remain theirs alone. If we 
adopted these requirements as ours, it would give FERC the ability to 
use our audit and enforcement assets to ensure compliance in the event 
the states do not have adequate audit and enforcement resources.
    Question 2. Do you believe that FERC's cross-subsidization 
protection is adequate to protect ratepayers?
    Answer. I believe FERC's reliance on the ratemaking process is not 
adequate to protect ratepayers from cross-subsidization. Ratepayers are 
better protected when appropriate requirements for how corporations 
should be structured are in place to prevent cross-subsidization or 
encumbrances of assets from occurring. As I explained in my answer to 
Question 1, above, FERC could do more, without preempting the states, 
to ensure appropriate corporate structure requirements are in place and 
are complied with.
    Question 3. Is there anything that we need to change in the law to 
give you sufficient authority to protect consumers adequately or to be 
sure that you do so?
    Answer. I believe EPAct 2005 gives the Commission sufficient 
authority to protect consumers adequately. I believe the Commission 
could use enhanced auditing and enforcement resources to better ensure 
compliance with the law.
    Responses of Suedeen G. Kelly to Questions From Senator Domenici
    Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct? 
If not, what does FERC rely on to police cross-subsidization?
    Answer. If inappropriate cross-subsidization were to occur, FERC 
would rely on its usual enforcement tools to detect it. These are self-
reports, hotline calls and audits.
    Question 2. Is the Commission doing enough follow-up to ensure that 
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based 
audit approach as GAO suggests? GAO also notes that FERC has only 3 
ongoing audits on cross-subsidization. Why isn't FERC taking a more 
proactive approach to auditing?
    Answer. FERC does not use a formal, risk-based approach like that 
described in the GAO Report to plan its audits. Instead, FERC uses, and 
has always used, an informal, but reasoned, approach in allocating 
audit resources. The GAO's Report makes suggestions that FERC should 
consider to improve its approach to audit planning. Whether FERC builds 
risk-based assessments into its 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 its objectives, scope and 
vision for its enforcement strategy. Enhanced audit and enforcement 
resources would enable the Commission to take a more proactive approach 
to auditing for inappropriate cross-subsidization.
    Question 3. Do you all agree with Chairman Kelliher that ratemaking 
is a powerful enforcement tool for detecting cross-subsidization? 
Please elaborate on how the Commission uses its ratemaking authority to 
protect consumers.
    Answer. The Commission's ratemaking tool with respect to cross-
subsidization prevents the flow-through into rates of costs deemed to 
represent cross-subsidies. Thus, the ability of this tool to detect a 
cross-subsidy is limited to the following situation: (1) the utility 
applies to FERC for a rate increase; (2) the utility seeks a rate 
increase based on an historic test year; (3) the chosen historic test 
year includes a cross-subsidization event and resulting cost; and (4) 
the utility seeks to recover that cross-subsidization cost in its new 
rates.
    Question 4. Your colleagues appear to be in agreement that FERC 
should take a flexible approach in order to collaborate with state 
regulators and not preempt state authority. Do you disagree with the 
Commission's policy to accept state cross-subsidization protections 
absent evidence that additional measures are needed to protect 
wholesale customers or where states lack authority in this area?
    Answer. I agree with my colleagues that FERC should not preempt 
state cross-subsidization protections. However, I believe FERC should 
exercise more leadership in determining whether additional measures are 
needed to protect wholesale customers. Instead of relying on some third 
party to alert us to the need for additional measures, we could, for 
example, expand our merger policy to establish principles regarding 
corporate structure requirements that we believe would be appropriate 
and productive. This would likely also be helpful to merger applicants 
who would have more certainty around the issue of appropriate 
structural requirements. We should also consider the possibility of 
adopting the corporate structure requirements imposed by a state in a 
particular merger as our own.
    Question 5. You conclude your testimony by stating that we must 
``make sure we are doing all we can to guard the American consumer from 
cross-subsidization and other forms of exploitation.'' Are you 
proposing a legislative fix? If so, what and at what level? The federal 
or the state?
    Answer. I believe EPAct 2005 gives the Commission sufficient 
authority to protect consumers adequately from cross-subsidization and 
encumbrances of assets. I believe the Commission could use enhanced 
auditing and enforcement resources to better ensure compliance with the 
law.
                                 ______
                                 
     Responses of David K. Owens to Questions From Senator Bingaman
    Question 1. Do you believe that FERC's merger review adequately 
implements the new authority given them in EPAct?
    Answer. The Edison Electric Institute (EEI) believes that the 
Federal Energy Regulatory Commission's (FERC's or the Commission's) 
merger regulations and merger review process fully implement the 
Commission's new authority under the Energy Policy Act of 2005 (EPAct 
2005). These regulations and review process also maintain the 
Commission's tradition of ensuring that mergers are in the public 
interest, will not adversely affect markets, and will protect and 
benefit consumers as a condition of approving the mergers.
    As I noted in my prepared testimony, the Commission has put in 
place a number of new regulations specifically aimed at implementing 
the new authority relating to mergers and acquisitions that FERC 
received in EPAct 2005, both under the Public Utility Holding Act of 
2005 (PUHCA 2005) and revised section 203 of the Federal Power Act 
(FPA). Those new regulations track the provisions of EPAct 2005 very 
carefully in order to implement Congress's intent.
    FERC's section 203 regulations specifically incorporate provisions 
aimed at preventing inappropriate cross-subsidization by utilities of 
their affiliates and inappropriate encumbrance of utility assets for 
non-utility purposes. Companies proposing mergers or acquisitions 
subject to section 203 must ensure that such cross-subsidies will not 
occur, in accordance with the provisions of the statute and 
regulations. Moreover, the Commission has gone further and imposed 
similar constraints under FPA sections 205 and 206, requiring that all 
companies subject to FERC's rate jurisdiction ensure that utility-
affiliate transactions are priced according to strict rules aimed at 
protecting utility customers.
    Under FERC's PUHCA 2005 regulations, if a utility is part of a 
holding company that has a centralized service company (which typically 
consolidates services such as accounting, construction, legal, 
operations, maintenance, real estate, and risk management services as a 
means to reduce costs to consumers), the Commission has required 
service companies to keep detailed records in a new section of the 
Uniform System of Accounts, and to file detailed information with the 
Commission in a lengthy new FERC Form 60 that will ensure transparency. 
These recordkeeping and reporting requirements complement the detailed 
requirements that already apply to utilities themselves under the FPA 
and FERC regulations. The PUHCA 2005 regulations also mandate FERC and 
state commission access to holding company records, in keeping with the 
new statute.
    These new regulations complement the Commission's existing merger 
policy and regulations at 18 C.F.R. Part 33. Under that existing policy 
and regulations, the Commission also examines the market effects of a 
proposed merger including the degree of concentration of companies in 
the affected markets, the anticipated benefits to consumers, and 
measures to prevent market power or other potential negative 
consequences of a merger.
    In addition, the Commission requires public utilities that 
participate in holding company cash management programs to file 
participation agreements explaining how the programs manage utility and 
affiliate cash and borrowing. The companies also must maintain detailed 
records of utility participation in the programs, and must notify the 
Commission if proprietary capital ratios fall below 30 percent within 
any given quarter year. The Commission has recognized that cash 
management programs help to reduce the cost of borrowing and increase 
liquidity within holding companies, while thus ensuring that the 
programs are subject to Commission review.
    In sum, EEI believes that the Commission is taking its merger 
responsibility and authority very seriously, including the new merger 
and cross subsidy provisions of EPAct 2005. FERC is carefully 
implementing its responsibility and authority to ensure that mergers 
and other transactions subject to FPA section 203 are fully in the 
public interest and are carefully structured to protect consumers.
    Question 2. Do you believe that FERC's cross-subsidization 
protection is adequate?
    Answer. As mentioned in the answer to Question 1, FERC has put in 
place strict regulations applicable to utility-affiliate transactions 
under FPA sections 203, 205, and 206 to protect against inappropriate 
cross-subsidization and encumbrance of utility assets.
    Under these regulations, the Commission must approve any wholesale 
power sales between a franchised public utility with captive customers 
and its market-regulated power sales affiliates. In addition, sales of 
non-power goods and services by a utility with captive customers to a 
market-regulated power sales affiliate or a non-utility affiliate must 
be priced at the higher of cost or market, and purchases by such a 
utility from such an affiliate must be priced no higher than market, 
unless authorized by the Commission. The Commission also may impose 
additional cross-subsidization restrictions on affiliate transactions, 
as appropriate, on a case-by-case basis.
    Further, the Commission examines the potential for cross-subsidies 
and encumbrances of utility assets in the context of mergers and other 
transactions subject to its review authority under FPA section 203, as 
required by amendments to that section in EPAct 2005. The Commission 
also has imposed constraints on sharing of staff and information and 
brokering of power between franchised public utilities with captive 
customers and market regulated power sales affiliates.
    In addition, the Commission's regulations reflect that most state 
utility commissions also oversee utility-affiliate transactions and 
have rules protecting regulated retail customers against inappropriate 
cross-subsidy. The Commission has signaled that it will review such 
measures and seeks to complement rather than preempt them as needed to 
ensure adequate customer protection. The Commission has also shown its 
willingness to step in if state safeguards are inadequate or states do 
not have authority to impose conditions to protect consumers from 
improper cross-subsidization or encumbrance of utility assets.
    Together, these regulations effectively prohibit cross-subsidy or 
encumbrance of utility assets for non-utility purposes absent 
Commission approval based on a public interest determination. They also 
ensure that a utility's regulated customers are well protected against 
inappropriate cost-shifts in transactions between a utility and an 
affiliate. In summary, the Commission has significant means to prevent 
cross-subsidization, including its broad ratemaking and merger review 
authorities under the FPA, and it is exercising that authority actively 
to protect electricity consumers.
     Responses of David K. Owens to Questions From Senator Domenici
    Question 1. Does FERC have in place sufficient customer protections 
in light of PUHCA repeal? Has the repeal of the Holding Company Act 
resulted in any regulatory gaps?
    Answer. In EEI's view, FERC has robust, effective, and complete 
customer protections in place. The Commission has built a comprehensive 
framework of regulations and enforcement to ensure that:

   electricity generators have transmission access to wholesale 
        customers, so the generators can compete to offer the services 
        customers need at competitive prices;
   transmission providers provide fair, equal, and open access 
        to the transmission grid while also ensuring reliability;
   integrated utilities maintain very strict separation of 
        generation and transmission functions;
   utility-affiliate transactions are carefully scrutinized to 
        prevent inappropriate cross-subsidization and encumbrance of 
        utility assets to the benefit of an affiliate unless in the 
        public interest;
   utility mergers and acquisitions are carefully scrutinized 
        to ensure that they are in the public interest;
   utility wholesale and transmission rates are just and 
        reasonable;
   competitors in markets cannot exercise market power or 
        manipulate markets; and
   utilities and service companies keep detailed records and 
        file detailed reports that enable the Commission and the public 
        to review and understand utility assets, finances, and 
        operations.

    These protections complement equally effective measures by state 
utility commissions, the Securities and Exchange Commission (SEC), and 
the Federal Trade Commission (FTC). State utility commissions oversee 
the full range of utility activities, in particular as those activities 
may affect retail customers. Most states have counterpart regulations 
and oversight to complement the FERC provisions just described. In 
addition, the states actively oversee resource planning and siting 
activities. The SEC regulates stock issuances and transactions by 
shareholder-owned utilities, holding companies, and affiliates. The SEC 
regulations ensure that companies provide accurate financial 
information through its reporting requirements such as the annual Form 
10-K, through regulations implementing the Sarbanes-Oxley Act of 2002, 
which ensures that companies maintain robust internal and external 
accounting controls and auditing oversight to ensure accuracy of their 
financial records and reports, and in oversight of company prospectuses 
associated with stock transactions and the stock exchanges. The FTC has 
regulations and guidelines that govern the accuracy of consumer 
advertising and claims, including by participants in electricity 
markets. Along with state consumer advocates, the FTC also participates 
in FERC rulemakings to provide its views on consumer protection issues.
    Repeal of the Public Utility Holding Company Act of 1935 (PUHCA 
1935 or the 1935 Act), and its replacement by PUHCA 2005 and revised 
FPA section 203, has not created regulatory gaps. Instead, repeal of 
the 1935 Act appropriately recognized that an array of other fully 
effective consumer protection measures are now in place, and the 1935 
Act was imposing unnecessary additional constraints that were impeding 
investment in needed new utility facilities.
    Question 2. You testified that increased federal oversight over 
non-utility corporate activities could create substantial barriers to 
investment and competition in electricity markets--the reason PUHCA was 
repealed. Please elaborate.
    Answer. As Congress was considering legislation that ultimately 
evolved into EPAct 2005, EEI and a wide array of others encouraged 
Congress to repeal PUHCA 1935 because that Act was viewed as layering 
unnecessary federal statutory and regulatory constraints on the utility 
industry, thereby impeding investment in the industry. The 1935 Act, 
for example, imposed geographic constraints on utility holding 
companies that prevented holding companies from engaging in utility 
activities in non-contiguous states. This discouraged consolidation of 
companies that could otherwise have provided economies of scale to the 
benefit of utility customers and the development of companies that 
could specialize in certain aspects of the utility business (nuclear 
generation, transmission, etc.) on a national basis. In addition, the 
1935 Act effectively prohibited investment in the utility industry by 
investors in other industries. It also failed to recognize the host of 
protections that have been put in place in the decades since the 1935 
Act was enacted, so that FERC, the SEC, the FTC, and states now 
robustly regulate utility, holding company, and affiliate activities, 
without the need for the PUHCA 1935 constraints.
    In addition, Congress, FERC, and state commissions have put very 
effective cross-subsidy and utility asset protections in place, to 
ensure that utility assets are not inappropriately used for the benefit 
of affiliate or other companies to the detriment of utility consumers. 
With these significant protections in place, there is no regulatory gap 
and simply no need for additional federal regulation of non-utility 
activities.
    The investment community recognizes that with repeal of PUHCA 1935, 
Congress removed unnecessary impediments to investment in energy 
infrastructure, and granted new authorities to FERC and the states to 
protect consumers. As stated earlier, FERC is working closely with the 
states to address any gaps in their regulatory authority to protect 
consumers from improper cross-subsidizations or encumbrance of utility 
assets.
    Increased federal oversight is unnecessary and would be 
inappropriate because it would intrude into areas of investor 
activities that are unrelated to utility activities. Additional federal 
oversight also would add confusion and raise uncertainty within the 
investment community. At a time when the energy industry's capital 
investment is expected to be at its highest level in recent decades to 
address growing demand, aging infrastructure, and environmental 
concerns, unnecessary additional mandates or restrictions would be a 
major step backwards. Instead, we should be striving to provide 
simplicity, clarity, and stability in the rules to stimulate major new 
investment, especially given that existing federal and state laws 
already amply protect utility consumers.
                                 ______
                                 
   Responses of Joseph T. Kelliher to Questions From Senator Bingaman
    Question 1. We gave the Commission new authority and obligations in 
the review of mergers as a partial compensation for repeal of PUHCA. 
GAO reports that you have not changed the review of mergers 
sufficiently to fulfill the obligation to be sure that no cross-
subsidization or encumbrance of assets will result from a merger. You 
disagree. What has the Commission done to ensure that no harmful cross-
subsidization or encumbrance of assets will occur as a result of a 
merger?
    Answer. In December 2005, the Commission revised its regulations 
specifically to address possible cross-subsidization or encumbrance of 
assets resulting from a merger or other FPA section 203 transaction. 
Merger applicants must make what is called an ``Exhibit M'' filing, 
which is a detailed showing (based on facts and circumstances known or 
reasonably foreseeable) that the merger will not result (at the time of 
the transaction or in the future) in the following activities by a 
traditional public utility that has captive customers or that operates 
Commission jurisdictional transmission facilities, in each case for the 
benefit of an associate company: (a) the transfer of facilities, (b) 
the issuance of securities, (c) the pledge or encumbrance of assets, 
and (d) the execution of contracts other than approved contracts for 
non-power goods and services. Also, the applicants must disclose any 
pledges or encumbrances of utility assets existing at the time of the 
application. If the applicants cannot provide adequate assurances 
against such activities, they must demonstrate that the activities are 
consistent with the public interest.
    Following two technical conferences, which sought input from state 
commissioners and others on what additional measures (including ring-
fencing) the Commission should take to protect customers against 
inappropriate cross-subsidization, in July 2007 the Commission also 
issued an FPA section 203 Supplemental Policy Statement. This policy 
statement provided clarification and guidance on the types of section 
203 transactions that do not raise cross-subsidy concerns and guidance 
on the types of commitments applicants could make and the ring-fencing 
measures applicants could offer to address potential cross-subsidy 
concerns. First, the Commission adopted a policy to defer to state 
commissions where the state adopts or has in place ring-fencing 
measures to protect customers unless those measures are inadequate to 
protect wholesale customers. If, based on the record of the transaction 
before the Commission, however, the state measures are inadequate to 
protect customers in a given case, the Commission will adopt 
supplemental measures as appropriate. Or, if the state does not have 
authority to act on a section 203 transaction, the Commission will fill 
any regulatory gap by imposing ring fencing protections where 
appropriate. It is important to note that where the Commission does 
defer to ring-fencing protections adopted by the state, the 
Commission's approval of the proposed section 203 transaction is 
premised on compliance with those ring-fencing protections and the 
Commission may audit and enforce compliance with those protections just 
as it enforces any additional protections it may accept or impose for a 
particular transaction; failure to abide by the restrictions 
constitutes a violation of the Commission's order approving the 
transaction. In addition, the Commission made clear in the Supplemental 
Policy Statement that, if it approves a transaction under section 203 
(with or without ring-fencing measures), the Commission retains 
authority under FPA section 203(b) to later impose additional cross-
subsidy protections or modify any previously-approved measures.
    Second, the Supplemental Policy Statement also provided specific 
guidance on the types of protections companies might adopt to make the 
demonstration required by Exhibit M, referred to above, where a state 
has not required or does not have authority to require ring-fencing 
provisions. For example, the Commission stated that a ring-fencing 
structure related to internal corporate financings, i.e., money pool or 
cash management transactions, could include some or all of the 
following elements, depending on the circumstances of the proposed 
transaction:

          (1) the holding company participates in the money pool as a 
        lender only and it does not borrow from the subsidiaries with 
        captive customers;
          (2) where the holding company system includes more than one 
        public utility, the money pool for subsidiaries with captive 
        customers is separate from the money pool for all other 
        subsidiaries;
          (3) all money pool transactions are short-term (one year or 
        less), and payable on demand to the public utility;
          (4) the interest rate formula is set according to a known 
        index and recognizes that internal and external funds may be 
        loaned into the money pool;
          (5) loan transactions are made pro rata from those offering 
        funds on the date of the transactions;
          (6) the formula for distributing interest income realized 
        from the money pool to money pool members is publicly 
        disclosed; and,
          (7) the money pool administrator is required to maintain 
        records of daily money pool transactions for examination by the 
        Commission by transaction date, lender, borrower, amount and 
        interest rate(s).

    Thus, while not adopting a set of mandatory one-size-fits-all 
federal ring-fencing protections in the Supplemental Policy Statement, 
the Commission gave detailed guidance regarding the types of 
restrictions that, from the federal viewpoint, might be appropriate 
depending upon the particular facts presented. It made clear that the 
forms of ring-fencing protections listed were examples of protections 
the Commission would consider in evaluating proposed ring-fencing 
measures and stated that appropriate ring-fencing measures would depend 
on the facts presented and the specifics of an applicant's corporate 
structure, to be evaluated on a case-by-case basis. It also noted that 
the listed measures were among those typically approved by the 
Securities and Exchange Commission (SEC) and/or adopted by state 
commissions.
    In addition to the adoption of the new FPA section 203 requirement 
for an Exhibit M filing and the policies and guidance set forth in the 
Supplemental Policy Statement, the Commission announced in one of the 
first mergers following the effective date of the new section 203 
provisions, National Grid plc, 117 FERC  61,080 (2006), that it would 
impose on all section 203 transactions involving a holding company a 
condition that members of the holding company adhere to specific 
pricing restrictions on non-power goods and services transactions 
between ``unregulated'' companies and their public utility affiliates 
with captive customers. Further, because cross-subsidy concerns 
regarding both power and non-power goods and services transactions can 
arise not only at the time of a proposed merger, but rather on an 
ongoing basis, the Commission in July 2007 also adopted in its 
regulations non-power goods and services pricing restrictions on all 
transactions between unregulated companies and their public utility 
affiliates with captive customers. Similar restrictions were adopted 
with respect to affiliate power sales in June 2007. The Commission also 
adopted recordkeeping and reporting requirements for utility holding 
companies and their service companies, and detailed accounting 
requirements for centralized service companies. These requirements will 
enhance the ability of the Commission and the public to monitor for 
cross-subsidization.
    Also, in response to PUHCA 2005, the Commission's Office of 
Enforcement is auditing affiliated transactions to detect and deter 
cross-subsidization. Three such audits are scheduled for FY08. These 
three audits include some of the largest utility holding companies. If 
information gained from these audits or elsewhere indicates a need for 
increased auditing, I will either shift resources to such audits or, if 
necessary, seek additional resources from the Congress.
    Importantly, all of these new requirements are in addition to the 
Commission's traditional and broad ratemaking authority to disallow 
rate recovery of costs found unjust and unreasonable as improper cross-
subsidies. This authority applies to all utilities, whether or not they 
engage in cross-subsidies resulting from a merger.
    Question 2. GAO reports that your cross-subsidization protection is 
largely dependent on self-reporting by violators. You indicate that 
your enforcement authority gives you assurance that such self-reporting 
will be protective. Does not the possibility of large fines or 
penalties discourage self-reporting? Why would utilities report 
violations if they expect to be faced with a stiff fine?
    Answer. The Commission does not rely on self-reporting to prevent 
improper cross-subsidization. In the context of cross-subsidization, 
the Commission does not assume utilities will self-report violations. 
As stated in my testimony, cross-subsidization by its very nature does 
not lend itself to being self-reported. Ratemaking is a complicated 
process which relies on the development of an extensive record on costs 
and revenues, and determination of the proper allocation of costs 
between jurisdictional and non jurisdictional operations, the 
appropriate distribution of costs between and among the various 
jurisdictional services, and the selection of an appropriate rate of 
return. Under these circumstances, self-reports would not be an 
effective method to monitor cross-subsidization. Further, with respect 
to the Commission's pricing standards imposed on non-power goods and 
services transactions between regulated and non-regulated affiliates to 
prevent inappropriate cross-subsidization (i.e., pricing at cost or at 
market), while it is possible that an accounting or similar type of 
error resulting in inappropriate pricing or an inappropriate allocation 
of costs might be self-reported, for the most part a violation of the 
pricing standards also would not lend itself to self-reporting. Rather, 
violations of these standards would be detected in a rate case or 
through audit.
    In contexts other than cross-subsidization, however, self-reports 
are an important part of the Commission's enforcement efforts. The 
Commission first announced its views on self-reports in the October 
2005 Enforcement Policy Statement. We stated there that we place great 
importance on self-reporting, as companies are in the best position to 
detect and correct violations of our orders, rules, and regulations, 
both inadvertent and intentional, and should be proactive in doing so. 
Moreover, as we pointed out, when companies self-report violations to 
the Commission it facilitates remedies to affected parties. 
Accordingly, the Commission decided to give credit to companies that 
self-report, and indicated that such credit could eliminate or reduce 
the otherwise applicable penalty for the violation.
    The Commission's experience since the issuance of the Enforcement 
Policy Statement confirms that self-reports reinforce the agency's 
enforcement program. Even though a majority of the investigations 
settled under the guidelines of the Enforcement Policy Statement have 
involved penalties for self-reported violations, the number of self-
reports has actually increased during the relevant period. Thus, for 
example, so far in FY08, we have received 33 self-reports, whereas at 
this time a year ago, we had received only 16 self-reports.
    Utilities consider reporting violations even if they face stiff 
fines because of the credit that the Commission gives to companies for 
self-reporting. Since issuing the Enforcement Policy Statement, the 
Commission has approved twelve settlements totaling $42.2 million where 
the investigations were initiated after a company self-reported a 
violation. In each of these settlements, the penalty amount would have 
been higher if the particular company had not self-reported the 
violations.
    Again, however, self-reports are not relied upon and have never 
been relied upon as an effective means of monitoring inappropriate 
cross-subsidization.
    Question 3. You point to the recent order conditioning the Puget 
Sound acquisition on your review of Washington state's ring-fencing 
requirements. Your merger policy statement indicates that you will 
follow this pattern in all merger reviews, i.e., that you will 
determine if the state's protection is sufficient and if it is not will 
impose conditions of your own. Washington is acknowledged by many to 
have a vigorous ring-fencing requirement. How will you determine if a 
state's requirements are sufficient in this and other cases since there 
does not appear to be a set of specific criteria for making this 
determination in the merger policy statement, nor a minimum set of 
actions that you would take if the state's protections were found to be 
insufficient?
    Answer. The Commission will review the adequacy of a state's ring-
fencing requirements on a case-by-case basis. The diversity of 
transactions addressed by FPA section 203 cautions against adoption of 
one-size-fits-all criteria or a minimum set of ring-fencing 
restrictions, at least at this early stage of the Commission's 
experience with its broader authority under FPA section 203. For 
example, the acquisition of a franchised public utility with captive 
customers by a holding company with unregulated subsidiaries may raise 
very different issues than the acquisition by such a utility of a 
similar, neighboring utility with captive customers. As the Commission 
gains experience analyzing cross-subsidization issues under its 
expanded section 203 authority, its case-by-case analysis may lead to 
adoption of generic policies or minimum actions applicable to certain 
types of cases. Finally, as noted in the response to Question 1, the 
Commission's recent Supplemental Policy Statement already identifies 
seven specific ring-fencing protections a merger applicant might 
propose where a state has not required or does not have authority to 
require ring fencing provisions.
   Responses of Joseph T. Kelliher to Questions From Senator Domenici
    Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct? 
If not, what does FERC rely on to police cross-subsidization?
    Answer. The GAO Report is not correct. As I pointed out in my 
response to GAO, the Commission has never relied on self-reports as its 
primary enforcement mechanism to prevent inappropriate cross-
subsidization. Cross-subsidization, by its very nature, does not lend 
itself to being self-reported.
    The Commission relies on other tools to police cross-subsidization. 
The Commission has in place affiliate pricing restrictions--applicable 
to all public utilities, not just those involved in mergers--addressing 
both power and non-power sales between affiliates. The Commission also 
has specific and detailed record retention rules for holding companies 
and their affiliates, as well as a new standardized Uniform System of 
Accounts (adopted in October 2006) that must be followed by all 
centralized service companies, thus providing greater transparency to 
protect ratepayers from paying improper service company costs. 
Centralized service companies must also file an annual report (Form No. 
60) containing financial information and information related to non-
power goods and services provided to affiliates. Information collected 
in this form is available electronically to market participants and the 
public for use in detecting potential cross-subsidization. Other types 
of service companies (e.g., a special purpose service company) also 
have an annual reporting requirement containing a narrative description 
of the service company's functions during the prior calendar year. 
These measures coupled with our ratemaking authority, compliance 
measures, auditing, and the penalty authority under EPAct 2005 provide 
adequate customer protection and policing over regulated entities' 
transactions.
    Question 2. Is the Commission doing enough follow-up to ensure that 
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based 
audit approach as GAO suggests? GAO also notes that FERC has only 3 
ongoing audits on cross-subsidization. Why isn't FERC taking a more 
proactive approach to auditing?
    Answer. Given the Commission's other responsibilities, especially 
with respect to its new authority to oversee reliability of the 
nation's bulk power system and to police against market manipulation, 
we believe that we are taking appropriate steps to ensure that 
companies are complying with merger conditions and that inappropriate 
cross-subsidization is not occurring.
    With respect to audits, we have already performed an audit 
involving merger conditions (NSTAR, Docket No. FA07-1) and are in the 
process of conducting audits of several holding and service companies' 
books and records. Also, as part of our annual audit planning cycle, 
the Commission will take additional audits into consideration with our 
other priorities and the number of available resources.
    Contrary to GAO's understanding, the Commission does and will 
follow a risk-based approach in selecting the merger and PUHCA audit 
candidates. Our risk-based approach entails a comprehensive review of 
audit materials obtained from the SEC; examination of financial 
information contained in FERC Form No. 60, FERC Form No. 1, and SEC 
filings; rate information gathered from Commission filings; and 
discussions with the Commission's legal and technical experts. The 
risk-based approach described above results in a preliminary risk 
assessment that takes into account, for example, the amount and type of 
costs reported in the FERC Form No. 60 and FERC Form No. 1; compliance 
problems gleaned from the non-public audit reports previously issued by 
the SEC; information on affiliated transactions included in SEC filings 
as well as other pertinent financial information affecting stock and 
bond prices; a review of the federal and state commissions' actions 
regarding affiliated transactions; and discussions with Commission 
legal and technical experts. Finally, shortly after the audit 
commences, the Commission audit staff discusses the audit scope, 
objectives and any other matters with state commission officials.
    Moreover, it is important to note that the Commission commenced the 
three audits shortly after PUHCA 2005 went into effect in February 
2006. The companies selected for the FY08 audit cycle were initial 
audits and included some of the largest utility holding companies in 
the nation.
   Responses of Joseph T. Kelliher to Questions From Senator Menendez

                             THE GAO REPORT

    Question 1. My home state of New Jersey has a strong Board of 
Public Utilities, one which has implemented strong regulations which 
protect electricity consumers. But consumers in other states are not so 
lucky, and rely on the Federal Energy Regulatory Commission. This GAO 
report comes at a time when consumers are paying high and rapidly 
rising prices for electricity. Consumers are being hit by rising prices 
for food, fuel, and electricity, and their trust in government is at an 
all time low. This is a dangerous combination, and even the appearance 
of weak oversight is simply unacceptable. It is not enough to rely on 
self-reporting, and your audits need to be more transparent. I am 
concerned that the FERC does consider the rising electricity prices to 
be a priority. I would like you to explain how you determine which 
companies to audit. What evidence leads you to investigate one company 
or another? What are the tell-tale signs of cross subsidization?
    Answer. The Commission uses a risk-based approach in selecting the 
merger and PUHCA audit candidates. This risk-based approach entails a 
comprehensive review of audit materials obtained from the SEC; 
examination of financial information contained in FERC Form No. 60, 
FERC Form No. 1, and SEC filings; rate information gathered from 
Commission filings; and discussions with the Commission's legal and 
technical experts. The risk-based approach described above results in a 
preliminary risk assessment that takes into account, for example, the 
amount and type of costs reported in the FERC Form No. 60 and FERC Form 
No. 1; compliance problems gleaned from the non-public audit reports 
previously issued by the SEC; information on affiliated transactions 
included in SEC filings as well as other pertinent financial 
information affecting stock and bond prices; a review of the federal 
and state commissions' actions regarding affiliated transactions; and 
discussions with Commission legal and technical experts. Finally, 
shortly after the audit commences, the Commission audit staff discusses 
the audit scope, objectives and any other matters with state commission 
officials.
    Question 2. Surely, after a report like this, you must see the need 
to improve the transparency of your audits and oversight if nothing 
else. What opportunities do you see to improve how you protect 
consumers?
    Answer. The Commission audit process provides transparency to the 
public when an audit is initiated and completed. Companies that are the 
subject of an audit from the Commission receive an audit commencement 
letter that is available to the public. The commencement letter alerts 
the public to the audit scope areas, the time period to be covered by 
the audit, and the legal basis for conducting the audit. Further, 
contact information is included in the commencement letter for the 
audit team members and management in the Division of Audits in the 
Commission's Office of Enforcement.
    The Commission's audit reports are also public and provide the 
users of our public audit reports the opportunity to get information 
about the audit objectives and scope, audit methodology, background 
information, as well as audit findings and recommendations, where 
applicable. As a result of the GAO report, the Commission has improved 
its audit reporting by including an enhanced audit methodology section 
in all of its public audit reports. In contrast, the SEC previously 
issued non-public audit reports at the completion of its holding 
company audits. Thus, the Commission's enhanced audit methodology and 
practice of publishing audit reports provide the public and the 
regulated community with greater transparency than was previously 
provided by the SEC.

                                MERGERS

    Question 3. The concerns raised by the GAO report ring true for me 
because I watched the FERC review the proposed merger between PSEG and 
Exelon a few years ago. This proposed merger would have created the 
largest utility in the country. At that time, the New Jersey Board of 
Public Utilities raised a host of concerns, ranging from market power 
to reliability of service to increased consumer costs. At the time, it 
appeared to me that the FERC approved this merger without addressing 
these questions. Obviously, the Energy Policy Act of 2005 has increased 
the FERC's responsibilities. If the FERC was reviewing this merger 
today, would the process be different? What steps would the FERC now 
take to investigate the impact of this proposal on consumer prices? 
After such a merger, could New Jersey still enforce its own strong 
consumer protections?
    Answer. In the order authorizing the merger of Exelon and PSEG, the 
Commission addressed the issues of the merger's effect on market power 
and consumer rates and imposed conditions to mitigate market power. 
First, in order to address any market power concerns, the Commission 
required the merger applicants to abide by a commitment they had made 
to divest 6,600 megawatts of generation, consisting of 2,600 megawatts 
of ``virtual divestiture'' of nuclear generation (in the form of 
required long-term energy sales from nuclear generating units) as well 
as the divestiture of 4,000 megawatts of fossil-fired capacity. This 
was the largest divestiture ever ordered by this agency. Moreover, the 
divestiture was applied to both baseload and peaking units, in order to 
more completely address the merged firm's ability and incentive to 
withhold output and potentially drive up the price of power in the 
relevant markets. In addition, as a further condition of the 
Commission's authorization, Exelon was required to make a subsequent 
demonstration, based on the plants that were ultimately divested and 
the buyers of those plants, that actual market concentration would be 
sufficiently reduced to mitigate any merger-related harm to 
competition.
    Second, while the Commission does not have jurisdiction over retail 
rates, it does protect consumers from cost increases by looking at the 
merger's effect on wholesale rates, which in turn can affect retail 
rates. In the Exelon case, and consistent with Commission policy, the 
merger applicants were required to hold customers harmless from any and 
all merger-related costs. Specifically, the Commission accepted 
applicants' commitment not to seek to recover any merger-related costs 
in wholesale rates without showing quantifiable offsetting savings. In 
this way, the Commission ensured that wholesale customers were fully 
protected from any merger-related costs.
    Regarding concerns about reliability, only two claims about 
reliability were raised in the FERC proceeding. One was found to be 
unrelated to the merger, but it was considered in another case where 
the Commission found that a joint operating agreement between Midwest 
Independent Transmission System Operator, Inc. and PJM Interconnection, 
L.L.C. (PJM) addressed the concern. The Commission found that the other 
concern was fully addressed by an applicant study of the PJM-East 
capacity market in the merger proceeding. In fact, the applicants 
argued that, given Exelon's record in operating nuclear power plants, 
the merger would enhance reliability by combining Exelon's expertise in 
running nuclear plants with PSEG's existing fleet of nuclear plants. No 
party questioned Exelon's claims that its expertise in operating 
nuclear plants could enhance reliability.
    After EPAct 2005, as part of its merger analysis, the Commission 
specifically considers whether a merger will result in inappropriate 
cross-subsidization of a non-utility associate company or pledge or 
encumbrance of utility assets for the benefit of an associate company. 
Merger applicants must file evidence demonstrating that the merger will 
not result in inappropriate cross-subsidization at the time of the 
merger or in the future. We impose additional ring-fencing protections 
as needed on a case-by-case basis, giving deference to state regulatory 
ring-fencing requirements unless we find those requirements 
insufficient or the state does not have authority.
    In addition, in the Commission's order on the merger of National 
Grid and KeySpan Corporation,\1\ the Commission announced a new policy 
to require all merging parties to abide by a code of conduct regarding 
power and non-power goods and services transactions between the utility 
subsidiaries and their affiliates. The code of conduct: (1) requires 
our approval of all power sales by a utility to an affiliate, (2) 
requires a utility with captive customers to provide non-power goods or 
services to a non-utility or ``non-regulated utility'' affiliate at a 
price that is the higher of cost or market, (3) prohibits a non-utility 
or non-regulated utility affiliate from providing non-power goods or 
services to a utility affiliate with captive customers at a price above 
market price, and (4) prohibits a centralized service company from 
providing non-power services to a utility affiliate with captive 
customers at a price above cost. These requirements offer further 
protection of a utility's captive customers against inappropriate 
cross-subsidization.
---------------------------------------------------------------------------
    \1\ National Grid plc, 117 FERC  61,080 (2006).
---------------------------------------------------------------------------
    In EPAct 2005, Congress largely ratified the merger test the 
Commission used to render the proposed Exelon/PSEG merger. For that 
reason, if the FERC were reviewing the Exelon/PSEG proposed merger 
today, the process would not be different except that the Commission 
would address the new requirement to make specific findings that the 
proposed merger will not result in inappropriate cross-subsidization or 
encumbrance of utility assets. Applicants would be required to file an 
``Exhibit M'' making this demonstration and the Commission would 
determine whether the record supported a finding that the new statutory 
requirement was met. The authority of the New Jersey Commission to 
protect its retail customers would not be affected by a Commission 
decision to approve the merger.

                       RELIABILITY PRICING MODEL

    Question 4. Chairman Kelliher, I would also like to discuss a 
regional consumer protection issue. As you know, our nation faces an 
urgent need for increased investment in transmission and generation 
infrastructure. To provide the market signal needed to build this 
infrastructure, you have approved the so-called ``Reliability Pricing 
Model'', or RPM, for the RTO which included New Jersey. I hear many 
different things about RPM. Some people tell me that it's working, 
paying for upgrades to old plants, and that new generation is in the 
queue. Others disagree. But I know two things for certain: The RPM is 
costing New Jersey consumers billions of dollars, and we are seeing 
very few new entrants bringing generation online. In PJM as a whole, 
consumers have made $26 billion in forward capacity payments, but only 
2,500 megawatts of new generation have come on-line. This is about 10 
times what 2,500 megawatts of new generation should cost. Do you see 
anything wrong with this picture? Is the RPM system working? What steps 
is the FERC taking to ensure that these vast sums of money will result 
in new generation? Does FERC have any plans on how to change RPM if the 
new capacity they have projected does not come online? When considering 
changes to the RPM system, how can FERC reduce its costs to consumers?
    Answer. The principal goal of RPM is to address the long-term 
reliability needs of all electricity customers within the PJM 
footprint, including New Jersey customers. During the past several 
years, reliability concerns arose within several areas within PJM due 
to: (1) a surge in planned generator retirements, (2) steadily growing 
demand, and (3) a slowdown of new generation entry.
    RPM was proposed to the Commission as the solution to these 
problems. The RPM proposal was submitted to the Commission following 
extensive, multiyear, stakeholder discussions and was supported by the 
vast majority of PJM stakeholders, including generators, load serving 
entities, municipalities, state commissions and consumer groups.
    In the RPM market design, all existing as well as new capacity 
resources--generation, demand-side resources (including energy 
efficiency resources), and transmission enhancements--that meet 
specified criteria are eligible to offer capacity into the auction and 
receive capacity payments. This provision, the uniform price auction 
method, and various other features and provisions of the RPM were 
agreed to by the parties to the RPM Settlement Agreement. Furthermore, 
to increase the opportunities for competition from new generation 
entry, suppliers enter into forward contracts for delivery three years 
in advance to ensure that reliability goals are met and that existing 
as well as new capacity resources are assured of sufficient revenues to 
either retain their current investment in PJM, or invest in new 
capacity resources.
    Over the four auctions completed through January 2008, 
approximately 4,375 MW of new, upgraded, or reactivated generation 
capacity was offered and accepted. In addition, 7,443 MW of demand-side 
resources, imports, and withdrawn or cancelled retirements were also 
offered and accepted into the RPM auctions. The breakdown is as 
follows:

New Generation                                                  1,036.1
Generation Upgrades                                             2,989.9
Generation Reactivation                                           348.7
Forward Demand Resources                                        1,373.0
Withdrawn or Canceled Retirements                               3,082.0
Net Increase in Capacity Imports                                2,987.5

Total Impact (MW)                                              11,817.2

    These initial results appear promising, particularly compared to 
the capacity market construct that was in place prior to RPM. That 
earlier capacity market failed to produce market-clearing prices 
sufficient to induce new generation or forestall planned generation 
retirements in PJM. However, at this early stage in the RPM process, it 
is too early to draw conclusions on the success of the RPM. The RPM has 
only been in place for less than one year, and its first four auctions 
have been transitional in nature, and were undertaken at relatively 
short intervals in rapid succession with forward periods of less than 
three years.
    Nevertheless, the Commission is already undertaking several 
initiatives to ensure the proper functioning of markets operated by 
PJM, including RPM. These include a thorough assessment of the 
performance of RPM and determination of the changes that may be 
necessary in order to ensure better performance in terms of market 
efficiency and costs to consumers.
    The Commission recently issued a Notice of Proposed Rulemaking on 
Wholesale Competition in Regions with Organized Electric Markets,\2\ 
which proposes changes that will improve the operation of organized 
wholesale electric markets in the areas of: (1) demand response and 
market pricing during a period of operating reserves shortage; (2) 
long-term power contracting; (3) market-monitoring policies; and (4) 
the responsiveness of regional transmission organizations (RTOs) and 
independent system operators (ISOs) to stakeholders and customers, and 
ultimately to the consumers who benefit from and pay for electricity 
services. In comments to that proceeding, stakeholder groups such as 
the American Forest and Paper Association and the Portland Cement 
Association put forth specific proposals to modify existing capacity 
markets.
---------------------------------------------------------------------------
    \2\ Wholesale Competition in Regions with Organized Electric 
Markets, Notice of Proposed Rulemaking, 73 Fed. Reg. 12,576 (March 7, 
2008), FERC Stats. & Regs.  32,628 (2008).
---------------------------------------------------------------------------
    The Commission held a technical conference on May 7, 2008, to 
discuss such proposals and more generally the operation of forward 
capacity markets in the PJM and ISO New England regions. The conference 
featured, for example, different perspectives on the markets from a 
broad cross-section of stakeholders, including RTOs, independent 
experts, and customer representatives.
    Also, in a recent order on a motion filed by RPM Buyers\3\ 
requesting a technical conference to examine the performance of RPM,\4\ 
the Commission directed PJM to expand the scope of an independent 
assessment of RPM that is currently being undertaken by an outside 
consultant, the Brattle Group, to include the concerns raised by RPM 
Buyers. The consultant's report is expected to be completed by the end 
of June 2008. The assessment will be presented to PJM stakeholders 
shortly thereafter and it is expected that any necessary changes to RPM 
will be fully considered at that time. The Commission directed PJM to 
submit a summary of the proceedings of the stakeholder deliberations on 
the report within 15 days of the conclusion of those proceedings.
---------------------------------------------------------------------------
    \3\ RPM Buyers include: state regulatory commissions, municipal 
electric utilities, joint power agencies, a rural electric cooperative, 
end-use customers, state consumer advocate offices, and load serving 
entities (LSEs) in the PJM region.
    \4\ PJM Interconnection, L.L.C., 123 FERC  61,037 (2008).
---------------------------------------------------------------------------
    Based on the outcome of these and related initiatives, the 
Commission will determine whether changes to the RPM capacity market 
are required and take appropriate steps to implement any necessary 
reforms. Among other things, the Commission is evaluating the merits 
and demerits of alternative capacity market designs and resource 
adequacy approaches. It is also actively working to foster much greater 
participation of demand-side resources in RTO capacity markets, which 
will reduce the overall need for investment in new generation 
facilities. The significant impact and greater potential of these 
resources are already evident from the results of both PJM's and ISO 
New England's Forward Capacity Market auctions thus far.

                      RGGI, TRANSMISSION, PLANNING

    Question 5. Chairman Kelliher, my home state of New Jersey is one 
of several states which are leading the nation in the fight against 
global warming. New Jersey has joined the Regional Green House Gas 
initiative. To meet its goals, New Jersey has embarked on an ambitious 
program which aims to get 20% of its energy from renewable sources by 
2020. In order to do this, they use revenues from a cap and trade 
system to fund investments in renewables and energy efficiency. 
However, some neighboring states are not members of RGGI but are part 
of PJM regional transmission organization. What will the FERC do to 
help New Jersey meet its clean energy goals?
    Answer. The Commission has been working to remove regulatory 
barriers to development of renewables and to ensure that demand-side 
resources, including energy efficiency, have access to wholesale power 
markets and the transmission grid comparable to that of supply-side 
resources. For example, the Commission recently modified its policy 
concerning the allocation of some of the costs of interconnecting 
certain generators to the grid. The Commission recognized that the 
original policy, which was developed when most generators had 
considerable flexibility on where they located, had become a barrier to 
many generation projects under development now, particularly renewable 
projects. See California Independent System Operator Corp., 119 FERC  
61,061, reh'g denied, 120 FERC  61,244 (2007). The Commission is also 
acting to improve the speed with which proposed generation projects, 
many of which are renewable projects, are interconnected with the grid. 
The Commission held a December 11, 2007 technical conference to explore 
the current backlog in the interconnection request ``queues'' of ISOs 
and RTOs, including PJM, and recently followed up with a March 20, 
2008, order providing guidance on possible reforms and directing the 
ISOs and RTOs to report on the status of their reform efforts. See 
Interconnection Queuing Practices, 122 FERC  61,252 (2008).
    Question 6. The FERC has designated a broad swath of the mid-
Atlantic as a ``National Interest Electrical Transmission Corridor''. 
While building some new transmission is certainly necessary, new power 
lines could also be used to deliver coal-fired electricity from older, 
less efficient plants into RGGI states, completely undermining the 
initiative. How will the FERC regulate PJM in order to prevent this 
from happening?
    Answer. The Secretary of Energy, rather than the Commission, is 
responsible for designating National Interest Electric Transmission 
Corridors under section 216(a) of the Federal Power Act. Nevertheless, 
I share your view that transmission upgrades are needed in the PJM 
footprint. Such upgrades are critically important to ensuring access to 
new renewable generation. Precisely which transmission lines might be 
the subject of an application for a Commission construction permit 
under FPA section 216, or which transmission lines will ultimately be 
constructed in the Mid-Atlantic Area National Interest Electric 
Transmission Corridor, let alone the sources of power that those lines 
would access (coal, natural gas, nuclear, or renewable), is speculative 
at this time.
                                 ______
                                 
   Responses of Philip D. Moeller to Questions From Senator Bingaman
    Question 1. Do you believe that FERC has acted to fulfill 
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a 
merger?
    Answer. Yes, I believe the Commission has acted to sufficiently 
fulfill its statutory obligation to ensure that no inappropriate cross-
subsidization or encumbrance of assets will occur as a result of a 
merger. I endorse Chairman Kelliher's comprehensive response to this 
question, and I wish to emphasize several points. Notably, it should be 
recognized that our most significant and long-standing authority 
relates to our ratemaking review and FERC's ability to find and prevent 
inappropriate cross subsidization prospectively through the ratemaking 
process.
    Recent actions taken by the Commission include the a new regulation 
that requires the filing of a statement demonstrating that a proposed 
merger will not result in cross-subsides, and imposition of pricing 
restrictions on all non-power goods and services transactions between a 
holding company's affiliates and any of its other affiliates with 
captive utility customers. In July 2007, a Supplemental Policy 
Statement was issued to clarify Section 203 of the Federal Power Act. 
That statement adopted a policy that included deference to state 
commissions on ring fencing measures and provides guidance when a state 
has not implemented ring fencing measures.
    Additionally, since the enactment of Energy Policy Act of 2005 
(EPAct 2005), merger applicants must pledge, under penalty of law, that 
they will not engage in inappropriate cross-subsidies as the result of 
a merger.
    Question 2. Do you believe that FERC's cross-subsidization 
protection is adequate to protect ratepayers?
    Answer. Yes. In light of my answer above, I believe the 
Commission's cross-subsidization protections are currently adequate 1 
to protect ratepayers. If the circumstances were to change, I would act 
quickly and forcefully to ensure that cross-subsidies will not occur.
    Question 3. Is there anything that we need to change in the law to 
give you sufficient authority to protect consumers adequately, or to be 
sure that you do so?
    Answer. No, at this time I do not believe that a change in the law 
is necessary to enhance the Commission's authority to protect 
consumers. However, I remain open to supporting a statutory change if 
it can be demonstrated that such a change is warranted to better 
protect consumers.
   Responses of Philip D. Moeller to Questions From Senator Domenici
    Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct? 
If not, what does FERC rely on to police cross-subsidization?
    Answer. No, the GAO report is not correct. While self-reports are 
an important mechanism for public utilities to self-identify prohibited 
conduct, the Commission primarily relies on audits and the ratemaking 
review process to detect inappropriate cross-subsidization.
    Question 2. Is the Commission doing enough follow-up to ensure that 
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based 
audit approach as GAO suggests? GAO also notes that FERC has only 3 
ongoing audits on cross-subsidization. Why isn't FERC taking a more 
proactive approach to auditing?
    Answer. I believe the Commission is conducting adequate follow-up 
to ensure that companies are both complying with merger conditions and 
that inappropriate cross-subsidization is not occurring. After 
conferring with our Audit staff, I have been assured that the 
Commission employs a risk-based audit approach, but this approach is 
not formalized; allowing sufficient flexibility in a case-by-case 
application.
    With respect to the question of why the Commission does not conduct 
more cross-subsidization audits, the Commission made a conscious 
decision to allocate its audit resources to concentrate on other more 
serious matters, such as market manipulation, that have a more 
significant impact on customers' rates. Ultimately, I believe that our 
allocation of audit resources reflects the agency's priorities and 
yields the highest return; that is, the maximum protection for the 
nation's ratepayers.
    Question 3. Do you all agree with Chairman Kelliher that ratemaking 
is a powerful enforcement tool for detecting cross-subsidization? 
Please elaborate on how the Commission uses its ratemaking authority to 
protect consumers.
    Answer. Yes, I completely agree with Chairman Kelliher that our 
ratemaking authority is a powerful enforcement tool for detecting 
inappropriate cross-subsidies. The ratemaking process requires 
extensive documentation of relevant costs corresponding to the function 
these costs are assigned to for accounting purposes. During our review 
of public utility rates, inappropriate cross-subsidies can be detected 
and removed.
    The states have similar tools to prevent the recovery of 
inappropriate costs in their ratemaking processes. Moreover, the 
ratemaking function applies to all utilities, not just the few that may 
be involved in mergers at any given time.
   Responses of Philip D. Moeller to Questions From Senator Menendez

                             THE GAO REPORT

    My home state of New Jersey has strong Board of Public Utilities, 
one which has implemented strong regulations which protect electricity 
consumers. But consumers in other states are not so lucky, and rely on 
the Federal Energy Regulatory Commission.
    This GAO report comes at a time when consumers are paying high and 
rapidly rising prices for electricity. Consumers are being hit by 
rising prices for food, fuel, and electricity, and their trust in 
government is at an all time low. This is a dangerous combination, and 
even the appearance of weak oversight is simply unacceptable. It is not 
enough to rely on self-reporting, and your audits need to be more 
transparent.
    I am concerned that the FERC does consider the rising electricity 
prices to be a priority.
    Question 1. I would like you to explain how you determine which 
companies to audit. What evidence leads you to investigate one company 
or another? What are the tell-tale signs of cross subsidization?
    Surely, after a report like this, you must see the need to improve 
the transparency of your audits and oversight if nothing else. What 
opportunities do you see to improve how you protect consumers?
    Answer. I endorse the answers given by Chairman Kelliher but as I 
noted in my testimony before the Committee, the Commission should 
always be open to suggestions on improving the transparency of all of 
its functions, including the audit function. I welcome any specific 
suggestions on improving the transparency of our audit function. 
Moreover, my experience here at the Commission has proven that its 
staff is highly sensitive to rising prices, and is doing all that it 
can ensure rates are just and reasonable.

                                MERGERS

    Question 2. The concerns raised by the GAO report ring true for me 
because I watched the FERC review the proposed merger between PSEG and 
Excelon a few years ago. This proposed merger would have created the 
largest utility in the country. At that time, the New Jersey Board of 
Public Utilities raised a host concerns, ranging from market power to 
reliability of service to increased consumer costs. At the time, it 
appeared to me that the FERC approved this merger without addressing 
these questions.
    Obviously, the Energy Policy Act of'2005 has increased the FERC's 
responsibilities. If the FERC was reviewing this merger today, would 
the process be different? What steps would the FERC now take to 
investigate the impact of this proposal on consumer prices? After such 
a merger, could New Jersey still enforce its own strong consumer 
protections?
    Answer. Chairman Kelliher thoroughly describes the Commission's 
actions pertaining to the proposed merger between PSEG and Exelon, 
which occurred prior to my arrival at the Commission. However, as a 
result of changes to our regulations in December 2005, the Commission 
now requires that merger applicants file an ``Exhibit M'' to 
demonstrate that a merger will not result in inappropriate cross-
subsidies to (or from) an affiliate.

                       RELIABILITY PRICING MODEL

    Question 3. Chairman Kelliher, I would also like to discuss a 
regional consumer protection issue. As you know, our nation faces an 
urgent need for increased investment in transmission and generation 
infrastructure. To provide the market signal need to build this 
infrastructure, you have approved the so-called ``Reliability Pricing 
Model'', or RPM, for the RTO which included New Jersey.
    I hear many different things about RPM. Some people tell me that 
it's working, paying for upgrades to old plants, and that new 
generation is in the queue. Others disagree. But I know two things for 
certain: The RPM is costing New Jersey consumers billions of dollars, 
and we are seeing very few new entrants bringing generation on-line.
    In PJM as a whole, consumers have made $26 billion in forward 
capacity payments, but only 2,500 megawatts of new generation have come 
on-line. This is about 10 times what 2,500 megawatts of new generation 
should cost. Do you see anything wrong with this picture? Is the RPM 
system working?
    What steps is the FERC taking to ensure that these vast sums of 
money will result in new generation?
    Does FERC have any plans on how to change RPM if the new capacity 
they have projected does not come online?
    When considering changes to the RPM system, how can FERC reduce its 
costs to consumers?
    Answer. I again endorse the answer given by Chairman Kelliher 
relating to your questions on the Reliability Pricing Model (RPM). I am 
closely monitoring the status of the RPM design, including the 
promising results of the most recent forward capacity auction (held in 
May 2008). These results, reflecting a downward movement in capacity 
prices, are trending in the right direction for ratepayers.

                      RGGI, TRANSMISSION, PLANNING

    Question 4. Chairman Kelliher, my home state of New Jersey is one 
of several states which are leading the nation in the fight against 
global warming. New Jersey has joined the Regional Green House Gas 
initiative. To meet its goals, New Jersey has embarked on an ambitious 
program which aims to get 20% of its energy from renewable sources by 
2020. In order to do this, they use revenues from a cap and trade 
system to fund investments in renewables and energy efficiency. 
However, some neighboring states are not members of RGGI but are part 
of PJM regional transmission organization.
    What will the FERC do to help New Jersey meet its clean energy 
goals?
    Answer. From my perspective, the Commission can best help New 
Jersey meet its clean energy goals by promoting policies that allow the 
needed transmission lines to be constructed. Although New Jersey 
certainly has some renewable resources that can be developed within its 
state, other regions have better access to lower cost and more reliable 
renewable resources. As a percentage of a consumer's electricity bill, 
transmission lines are a relatively inexpensive way to move the best 
renewable energy resources to the markets that require (and demand) 
them.
    One of my efforts has focused on the development of hydrokinetic 
technologies for in-river, wave and tidal power that has the potential 
to produce significant amounts of renewable energy. FERC has promoted 
changes in its hydropower licensing process to develop such renewable 
resources.
    Question 5. The FERC has designated a broad swath of the mid-
Atlantic as a ``National Interest Electrical Transmission Corridor''. 
While building some new transmission is certainly necessary, new power 
lines could also be used to deliver coal-fired electricity from older, 
less efficient plants into RGGI states, completely undermining the 
initiative.
    How will the FERC regulate PM in order to prevent this from 
happening?
    Answer. I concur with the response provided by Chairman Kelliher. 
The Secretary of Energy, rather than our Commission, is responsible for 
designating National Interest Electric Transmission Corridors under 
section 216(a) of the Federal Power Act.
                                 ______
                                 
      Responses of Marc Spitzer to Questions from Senator Bingaman
    Question 1. Do you believe that FERC has acted to fulfill 
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a 
merger?
    Answer. Yes. As I stated in my testimony before the Committee, I 
believe that FERC has fulfilled its statutory obligation to ensure a 
proposed merger or other transaction will not result in the improper 
impairment of utility assets or subsidization of non-utility 
affiliates.
    Since the enactment of the Energy Policy Act of 2005, FERC has 
undertaken several initiatives to establish regulations and policies 
governing cross-subsidization and asset impairment attendant to review 
of transactions under section 203 of the Federal Power Act. While FERC 
initiated several rulemakings after the enactment of the Energy Policy 
Act of 2005 to implement the new authorities granted by Congress, FERC 
knew that it needed to revisit these issues as it gained additional 
experience under the new regulations. Accordingly, FERC held two 
technical conferences that specifically addressed how FERC should 
supplement the protections against cross-subsidization that were 
implemented in the original rules and whether the Commission's existing 
competition analysis is sufficiently rigorous to analyze mergers. As 
described in Chairman Kelliher's response, the result of these 
technical conferences was a Supplemental Merger Policy Statement which 
provides, among other things, guidance to the industry regarding the 
types of measures applicants could offer to demonstrate that their 
proposed transaction does not raise cross-subsidization concerns. The 
technical conferences also led to the adoption of restrictions on 
affiliate transactions between franchised public utilities that have 
captive customers or that own or provide transmission service over 
jurisdictional transmission facilities, and their market-regulated 
power sales affiliates or non-utility affiliates.
    These measures, in addition to our ratemaking authority, compliance 
measures, auditing, and the penalty authority under the Energy Policy 
Act of 2005, provide adequate consumer protection and discipline over 
regulated entities' transactions. They ensure that when FERC examines 
any proposed merger--a review that is based on the specific facts 
developed in the record--no improper impairment of utility assets or 
subsidization of non-utility affiliates will take place.
    All of FERC's activities in this regard have focused on fulfilling 
Congress's objective for the repeal of the Public Utility Holding 
Company Act of 1935--encouragement of greater investment in the utility 
industry and removal of unnecessary burdens while at the same time 
ensuring that there is no harm to competition and no harm to 
ratepayers.
    Question 2. Do you believe that FERC's cross-subsidization 
protection is adequate to protect ratepayers?
    Answer. Yes. After the enactment of the Energy Policy Act of 2005, 
FERC adopted supplementary measures to focus on the potential for 
improper cross-subsidization in addition to the ongoing scrutiny and 
consumer protections through FERC's traditional ratemaking authority. 
These measures include, but are not limited to: specific pricing 
standards for non-power goods and services transactions between 
affiliates if one of the affiliates has captive customers or 
transmission customers; specific and detailed record retention rules 
for holding companies and their affiliates; a new standardized Uniform 
System of Accounts that must be followed by all centralized service 
companies; and annual reporting requirements for various forms of 
service companies. Each of these measures is detailed in Chairman 
Kelliher's response. Notably, the application of these protections is 
not limited to mergers and other corporate transactions. Rather, these 
protections facilitate FERC's statutory mandate to ensure that no 
entity receives or grants an undue preference with respect to any 
transmission or sale subject to FERC's jurisdiction.
    Question 3. Is there anything that we need to change in the law to 
give you sufficient authority to protect consumers adequately, or to be 
sure that you do so?
    Answer. I do not believe statutory change is required. FERC has 
implemented and continues to implement the beneficial authority granted 
by Congress in 2005 to ensure reliable and plentiful wholesale energy 
supplies at just and reasonable rates. At this time, I believe FERC has 
sufficient resources to implement its responsibilities. However, FERC's 
efforts to protect ratepayers are evolving. Therefore, I concur with 
Chairman Kelliher that FERC will seek additional authority or funds 
from the Congress if we believe that more resources are necessary to 
ensure FERC's continued vigilance to protect ratepayers.
      Responses of Marc Spitzer to Questions from Senator Domenici
    Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct? 
If not, what does FERC rely on to police cross-subsidization?
    Answer. GAO's finding that FERC relies primarily on self-reports to 
detect inappropriate cross-subsidization is not correct. As detailed in 
Chairman Kelliher's response, cross-subsidization does not lend itself 
to self-reporting. While self-reports are an important part of FERC's 
overall enforcement efforts, they are not the primary way by which FERC 
detects inappropriate cross-subsidization. As discussed above, FERC has 
adopted supplementary measures after the enactment of the Energy Policy 
Act of 2005 to focus on potential cross-subsidization. However, one of 
FERC's most effective policing mechanisms is the continued use of its 
traditional ratemaking authority to protect ratepayers.
    Question 2. Is the Commission doing enough follow-up to ensure that 
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based 
audit approach as GAO suggests? GAO also notes that FERC has only 3 
ongoing audits on cross-subsidization. Why isn't FERC taking a more 
proactive approach to auditing?
    Answer. FERC is taking the necessary measures to ensure that 
regulated entities are complying with merger conditions and that 
improper cross-subsidization is not occurring. FERC does and will 
follow a risk-based approach in selecting audit candidates. As Chairman 
Kelliher describes in his response, FERC's risk-based approach is part 
of a comprehensive review that considers various issues including, but 
not limited to, financial information.
    Further, I concur with Chairman Kelliher's assessment that, given 
FERC's other responsibilities, FERC has been diligent to ensure 
utilities are complying with merger conditions and that inappropriate 
cross-subsidization does not occur. The number and scope of audits on 
cross-subsidization will be determined in consideration of all FERC's 
priorities and the number of available resources as FERC maintains its 
oversight over cross-subsidization and other matters required by 
statute or rule.
    Question 3. Do you all agree with Chairman Kelliher that ratemaking 
is a powerful enforcement tool for detecting cross-subsidization? 
Please elaborate on how the Commission uses its ratemaking authority to 
protect consumers.
    Answer. I agree with Chairman Kelliher that ratemaking is a 
powerful enforcement tool for detecting cross-subsidization. As 
Commissioner Kerr testified on behalf of the National Association of 
Regulatory Utility Commissioners, ``. . . the GAO report probably 
underestimates the pervasive, positive role that rate making authority 
plays. I don't mean to be trite. But I do believe that the old 
expression that if you have them by the rates, their hearts and minds 
will follow is in fact, an accurate assessment of the importance of 
rate making authority as it affects the totality of the 
relationship.''\1\ The same is true for federal ratemaking. Having 
adjudicated both Federal and State rate cases, I can assure the 
Committee such proceedings are an effective means of both discerning 
financial chicanery and absolving the innocent.
---------------------------------------------------------------------------
    \1\ Tr.79:17-24.
---------------------------------------------------------------------------
    Before any costs can be recovered from wholesale customers served 
under cost-based rates, FERC reviews those costs to determine if their 
recovery would be just and reasonable. A public utility may not charge 
rates subject to FERC's jurisdiction (wholesale sales in interstate 
commerce) without notice to the public and approval by FERC under 
section 205 of the Federal Power Act. A public utility may not recover 
costs that are imprudently incurred. If a utility in a section 205 rate 
proceeding seeks to flow through to wholesale customers costs of non-
power goods or services purchased from an affiliate, FERC will disallow 
those costs if they are determined to be unreasonable or imprudently 
incurred. Moreover, for any cost-based rate that is filed for approval 
with FERC, FERC may institute a proceeding on its own motion or in 
response to matters raised by others, including claims of potential 
cross-subsidization. Additionally, an entity may file a section 206 
complaint for FERC review to challenge allegedly improper cost 
recovery.
      Responses of Marc Spitzer to Questions from Senator Menendez

                             THE GAO REPORT

    Question 1. My home state of New Jersey has [a] strong Board of 
Public Utilities, one which has implemented strong regulations which 
protect electricity consumers. But consumers in other states are not so 
lucky, and rely on the Federal Energy Regulatory Commission. This GAO 
report comes at a time when consumers are paying high and rapidly 
rising prices for electricity. Consumers are being hit by rising prices 
for food, fuel, and electricity, and their trust in government is at an 
all time low. This is a dangerous combination, and even the appearance 
of weak oversight is simply unacceptable. It is not enough to rely on 
self-reporting, and your audits need to be more transparent. I am 
concerned that the FERC does consider the rising electricity prices to 
be a priority. I would like you to explain how you determine which 
companies to audit. What evidence leads you to investigate one company 
or another? What are the tell-tale signs of cross subsidization? 
Surely, after a report like this, you must see the need to improve the 
transparency of your audits and oversight if nothing else. What 
opportunities do you see to improve how you protect consumers?
    Answer. With respect to audits, I concur with Chairman Kelliher 
that FERC uses a risk-based approach in selecting audit candidates. 
However, as I stated in my testimony, the GAO Report does provide some 
lessons for FERC. There is always room for improvement in our programs. 
FERC continues to take steps to improve the transparency of its audit 
and oversight functions. For example, as Chairman Kelliher notes in his 
response, as a result of the GAO Report, FERC has improved its audit 
reporting by including an enhanced audit methodology section in all of 
its public audit reports.
    Furthermore, FERC has recently taken actions to improve 
transparency as to all of its enforcement activities. On May 15, 2008, 
FERC issued a series of orders that provide further guidance regarding 
our enforcement policies and regulations. FERC's Revised Policy 
Statement on Enforcement provides guidance as to FERC's approach to 
audits and investigations; the factors FERC's Enforcement Staff will 
consider and processes they will follow in conducting audits and 
investigations; and considerations that FERC will evaluate when 
choosing an appropriate remedy for enforcement violations. I believe 
that vigorous enforcement is critical to ensuring fair, open, and 
transparent competitive markets. However, I also recognize that clarity 
in our regulations and policies is essential to compliance by market 
participants. Our existing enforcement program is new and will continue 
to evolve as the Congress' objectives change. These orders demonstrate 
FERC's commitment to responsiveness and to ongoing improvements in our 
program.

                                MERGERS

    Question 2. The concerns raised by the GAO report ring true for me 
because I watched the FERC review the proposed merger between PSEG and 
[Exelon] a few years ago. This proposed merger would have created the 
largest utility in the country. At that time, the New Jersey Board of 
Public Utilities raised a host [of] concerns, ranging from market power 
to reliability of service to increased consumer costs. At the time, it 
appeared to me that the FERC approved this merger without addressing 
these questions. Obviously, the Energy Policy Act of 2005 has increased 
the FERC's responsibilities. If the FERC was reviewing this merger 
today, would the process be different? What steps would the FERC now 
take to investigate the impact of this proposal on consumer prices? 
After such a merger, could New Jersey still enforce its own strong 
consumer protections?
    Answer. Under the statutory requirements both before and after the 
Energy Policy Act of 2005, FERC carefully reviews all merger 
applications on a fact-specific basis to ensure any proposed 
transaction is consistent with the public interest. I did not assume my 
position on FERC until July 2006. However, as observed by Chairman 
Kelliher in his response, FERC's review of the proposed Exelon/PSEG 
merger after the Energy Policy Act of 2005 would address the new 
requirement to make specific findings that the proposed merger would 
not result in inappropriate cross-subsidization or encumbrance of 
utility assets.
    I agree with Chairman Kelliher that FERC's current merger test is 
sufficient to analyze the effect a proposed merger may have on 
competition, rates and regulation. FERC specifically sought comment on 
this issue and carefully considered the matter in a technical 
conference prior to issuance of FERC's 2007 Supplemental Merger Policy 
Statement. If FERC finds that a proposed merger will have adverse 
effects, it has the option to deny the merger, to condition merger 
approval on measures to mitigate any resulting market power, or to 
impose additional structural changes necessary to protect consumers. In 
addition, FERC not only makes the finding that a proposed merger will 
not result in inappropriate cross-subsidization of non-utility 
affiliates or the encumbrance of utility assets for the benefit of an 
affiliate, as required under the Energy Policy Act of 2005, but it has 
in place affiliate pricing restrictions--applicable to all public 
utilities not only those involved in mergers--to address both power and 
non-power sales between affiliates.

                       RELIABILITY PRICING MODEL

    Question 3. Chairman Kelliher, I would also like to discuss a 
regional consumer protection issue. As you know, our nation faces an 
urgent need for increased investment in transmission and generation 
infrastructure. To provide the market signal need to build this 
infrastructure, you have approved the so-called ``Reliability Pricing 
Model'', or RPM, for the RTO which included New Jersey. I hear many 
different things about RPM. Some people tell me that it's working, 
paying for upgrades to old plants, and that new generation is in the 
queue. Others disagree. But I know two things for certain: The RPM is 
costing New Jersey consumers billions of dollars, and we are seeing 
very few new entrants bringing generation on-line. In PJM as a whole, 
consumers have made $26 billion in forward capacity payments, but only 
2,500 megawatts of new generation have come on-line. This is about 10 
times what 2,500 megawatts of new generation should cost. Do you see 
anything wrong with this picture? Is the RPM system working? What steps 
is the FERC taking to ensure that these vast sums of money will result 
in new generation? Does FERC have any plans on how to change RPM if the 
new capacity they have projected does not come online? When considering 
changes to the RPM system, how can FERC reduce its costs to consumers?
    Answer. There are numerous proceedings through which FERC is 
examining the effectiveness of the PJM markets, including RPM. These 
proceedings are the appropriate forum for parties to raise concerns 
about the functioning of the markets and have the opportunity to be 
heard. FERC's task in these docketed proceedings is to ensure adequate 
new generation at just and reasonable rates.
    On May 7, 2008 the Commission held a technical conference to 
discuss the operation of forward capacity markets, specifically 
focusing on RPM and its equivalent in the New England region. This 
technical conference raised a number of issues, including those posed 
by your question. FERC is considering the comments from that conference 
as well as related filings in connection with bringing new, clean 
generation into constrained load pockets.

                      RGGI, TRANSMISSION, PLANNING

    Question 4. Chairman Kelliher, my home state of New Jersey is one 
of several states which are leading the nation in the fight against 
global warming. New Jersey has joined the Regional Green House Gas 
initiative. To meet its goals, New Jersey has embarked on an ambitious 
program which aims to get 20% of its energy from renewable sources by 
2020. In order to do this, they use revenues from a cap and trade 
system to fund investments in renewables and energy efficiency. 
However, some neighboring states are not members of RGGI but are part 
of PJM regional transmission organization. What will the FERC do to 
help New Jersey meet its clean energy goals?
    Answer. I am personally committed to ensuring FERC does what it can 
to support states' efforts to implement renewable portfolio standards. 
As a member of the Arizona Corporation Commission I supported a state 
renewable portfolio standard of 15% by 2025. As someone who designed 
two renewable portfolio standards at the state level (in 2001 and 
2006), I am deeply respectful of state efforts in this regard.
    I agree with Chairman Kelliher's description of FERC's efforts to 
remove regulatory barriers to renewables and energy efficiency. FERC 
has taken steps to support regulated entities' efforts to comply with 
state renewable portfolio standards and the states' efforts to require 
reductions in greenhouse gas emissions. For example, FERC supported the 
proposal of the California Independent System Operator to finance 
facilities to interconnect location-constrained renewable resources 
such as wind, geothermal and solar generation to its transmission grid 
.\2\ In this order FERC approved a mechanism that would remove barriers 
to increased development of renewable energy.
---------------------------------------------------------------------------
    \2\ California Independent System Operator Corporation, 119 FERC  
61,061, order on reh 'g, 120 FERC  61,244 (2007).
---------------------------------------------------------------------------
    Question 5. The FERC has designated a broad swath of the mid-
Atlantic as a ``National Interest Electrical Transmission Corridor''. 
While building some new transmission is certainly necessary, new power 
lines could also be used to deliver coal-fired electricity from older, 
less efficient plants into RGGI states, completely undermining the 
initiative. How will the FERC regulate PJM in order to prevent this 
from happening?
    Answer. The U.S. Department of Energy designated the National 
Interest Electric Transmission Corridors in 2007. That designation 
underscores the systemic under-investment in transmission across the 
country, which Congress acknowledged in enacting section 219 of the 
Federal Power Act (section 1241 of the Energy Policy Act of 2005). 
Transmission congestion imposes reliability and economic burdens upon 
consumers and requires greater transmission investment. Moreover, I 
believe investment in the transmission grid will also support 
investment in renewable generation and energy efficiency. However, 
denial of an application for transmission or interconnection based upon 
the fuel source of the generator could raise serious legal concerns. 
The matter is perhaps better addressed as part of the consideration of 
carbon policy pending in the Congress.
    I concur with Chairman Kelliher's response. Until there is a 
specific application related to the U.S. Department of Energy's 
designation of a Mid-Atlantic Area National Interest Electric 
Transmission Corridor, it is difficult to anticipate what actions FERC 
should take in response.
                                 ______
                                 
    Responses of Jon Wellinghoff to Questions From Senator Bingaman
    Question 1. Do you believe that FERC has acted to fulfill 
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a 
merger?
    Answer. I take seriously the Commission's statutory obligation to 
review applications filed pursuant to section 203 of the Federal Power 
Act to ensure that a proposed transaction will be consistent with the 
public interest, and will not result in cross-subsidization of a non-
utility associate company or the pledge or encumbrance of utility 
assets for the benefit of an associate company, unless the Commission 
determines that the cross-subsidization, pledge, or encumbrance will be 
consistent with the public interest. I believe that the Commission has 
acted appropriately to fulfill this statutory obligation by taking the 
steps described in the response to your first post-hearing question to 
Chairman Kelliher. I would particularly like to highlight the 
Commission's commitment to adopt supplemental measures to protect 
consumers against improper cross-subsidization where the record before 
the Commission indicates either that a regulatory gap exists because a 
state lacks the authority to act or that the measures adopted by a 
relevant state commission are inadequate.
    Question 2. Do you believe that FERC's cross-subsidization 
protection is adequate to protect ratepayers?
    Answer. Yes, for the reasons stated in my response to Question # 1 
above. I also agree with Chairman Kelliher's statement that the 
Commission's actions taken in the context of reviewing applications 
filed pursuant to section 203 of the Federal Power Act are in addition 
to the Commission's traditional and broad ratemaking authority to 
disallow rate recovery of costs found unjust and unreasonable as 
improper cross-subsidies.
    Question 3. Is there anything that we need to change in the law to 
give you sufficient authority to protect consumers adequately, or to be 
sure that you do so?
    Answer. No. I believe that the Commission has sufficient authority 
to prevent improper cross-subsidization, and that the Commission 
exercises that authority to provide adequate protection for consumers.
    Responses of Jon Wellinghoff to Questions From Senator Domenici
    Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct? 
If not, what does FERC rely on to police cross-subsidization?
    Answer. As Chairman Kelliher states in response to your first post-
hearing question, the Commission does not rely on self-reports as its 
primary enforcement mechanism to prevent improper cross-subsidization. 
I also agree with Chairman Kelliher's identification of several other 
tools on which the Commission does rely for that purpose.
    Question 2. Is the Commission doing enough follow-up to ensure that 
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based 
audit approach as GAO suggests? GAO also notes that FERC has only 3 
ongoing audits on cross-subsidization. Why isn't FERC taking a more 
proactive approach to auditing?
    Answer. Chairman Kelliher states in response to your second post-
hearing question that in light of the Commission's other 
responsibilities, especially with respect to the Commission's new 
authority to oversee reliability of the bulk power system and to police 
against market manipulation, the Commission is taking appropriate steps 
to ensure that improper cross-subsidization is not occurring and that 
companies are complying with merger conditions. Chairman Kelliher 
further states that the Commission does and will follow a risk-based 
approach in selecting companies for audits that address cross-
subsidization, and that the companies selected for the FY08 audit cycle 
include some of the country's largest utility holding companies. I 
agree with these statements. I would add that the Commission will seek 
additional funds from the Congress if we determine that more resources 
are needed to carry out our essential auditing responsibilities, 
including cross-subsidization audits.
    Question 3. Do you all agree with Chairman Kelliher that ratemaking 
is a powerful enforcement tool for detecting cross-subsidization? 
Please elaborate on how the Commission uses its ratemaking authority to 
protect consumers.
    Answer. The Commission has broad ratemaking authority to disallow 
recovery in rates of costs found unjust and unreasonable as improper 
cross-subsidies. I agree with Chairman Kelliher that exercising this 
traditional authority is an important part of the Commission's 
commitment to protecting consumers against improper cross-
subsidization.
    Responses of Jon Wellinghoff to Questions From Senator Menendez

                             THE GAO REPORT

    Question 1. My home state of New Jersey has strong Board of Public 
Utilities, one which has implemented strong regulations which protect 
electricity consumers. But consumers in other states are not so lucky, 
and rely on the Federal Energy Regulatory Commission.
    This GAO report comes at a time when consumers are paying high and 
rapidly rising prices for electricity. Consumers are being hit by 
rising prices for food, fuel, and electricity, and their trust in 
government is at an all time low. This is a dangerous combination, and 
even the appearance of weak oversight is simply unacceptable. It is not 
enough to rely on self-reporting, and your audits need to be more 
transparent.
    I am concerned that the FERC does consider the rising electricity 
prices to be a priority.
    I would like you to explain how you determine which companies to 
audit. What evidence leads you to investigate one company or another? 
What are the tell-tale signs of cross subsidization?
    Surely, after a report like this, you must see the need to improve 
the transparency of your audits and oversight if nothing else. What 
opportunities do you see to improve how you protect consumers?
    Answer. I served as the State of Nevada's first consumer advocate 
for customers of public utilities, and I recognize the importance of 
ensuring that consumers' electricity rates are just and reasonable. I 
agree that even the appearance of weak oversight can undermine public 
trust in government.
    The need for effective oversight extends to preventing improper 
cross-subsidization. In responding to this question, Chairman Kelliher 
states that the Commission does and will follow a risk-based approach 
in selecting companies for audits that address cross-subsidization. I 
agree with that statement, as well as with Chairman Kelliher's 
description of sources that are relevant to that risk-based approach. 
It is also noteworthy that the companies selected for the FY08 audit 
cycle include some of the country's largest utility holding companies. 
I would add that the Commission will seek additional funds from the 
Congress if we determine that more resources are needed to carry out 
our essential auditing responsibilities, including cross-subsidization 
audits.
    More generally, I agree with you that it is important to improve 
the transparency of the Commission's audits. Both the GAO Report and 
comments at a conference that the Commission held in November 2007 
demonstrated that some aspects of the Commission's enforcement policies 
are not well understood. Such confusion does not help consumers who are 
the ultimate beneficiaries of those policies. To address this problem, 
the Commission last week issued a package of orders that provide 
greater transparency in our enforcement process. As the Commission 
gains further experience in implementing our expanded enforcement 
authority under EPAct 2005, we will continue to review our enforcement 
policies and will make further changes as appropriate to improve 
protection of consumers.

                                MERGERS

    Question 2. The concerns raised by the GAO report ring true for me 
because I watched the FERC review the proposed merger between PSEG and 
Exelon a few years ago. This proposed merger would have created the 
largest utility in the country. At that time, the New Jersey Board of 
Public Utilities raised a host concerns, ranging from market power to 
reliability of service to increased consumer costs. At the time, it 
appeared to me that the FERC approved this merger without addressing 
these questions.
    Obviously, the Energy Policy Act of 2005 has increased the FERC's 
responsibilities. If the FERC was reviewing this merger today, would 
the process be different? What steps would the FERC now take to 
investigate the impact of this proposal on consumer prices? After such 
a merger, could New Jersey still enforce its own strong consumer 
protections?
    Answer. In EPAct 2005, the Congress largely ratified the 
Commission's test for reviewing applications filed pursuant to section 
203 of the Federal Power Act. With regard to such applications, 
however, the Congress also directed the Commission to ensure that a 
proposed transaction will not result in cross-subsidization of a non-
utility associate company or the pledge or encumbrance of utility 
assets for the benefit of an associate company, unless the Commission 
determines that the cross-subsidization, pledge, or encumbrance will be 
consistent with the public interest. The Commission has taken a number 
of steps since the enactment of EPAct 2005 to implement this new 
statutory obligation, as Chairman Kelliher described in his prepared 
testimony.
    If a merger affecting the State arose today, New Jersey could still 
enforce its own consumer protections. Indeed, the Commission would 
consider the State's actions in determining whether to adopt 
supplemental measures to protect consumers against improper cross-
subsidization.

                      RGGI, TRANSMISSION, PLANNING

    Question 3. My home state of New Jersey is one of several states 
which are leading the nation in the fight against global warming. New 
Jersey has joined the Regional Green House Gas initiative. To meet its 
goals, New Jersey has embarked on an ambitious program which aims to 
get 20% of its energy from renewable sources by 2020. In order to do 
this, they use revenues from a cap and trade system to fund investments 
in renewables and energy efficiency. However, some neighboring states 
are not members of RGGI but are part of PJM regional transmission 
organization.
    What will the FERC do to help New Jersey meet its clean energy 
goals?
    The FERC has designated a broad swath of the mid-Atlantic as a 
``National Interest Electrical Transmission Corridor''. While building 
some new transmission is certainly necessary, new power lines could 
also be used to deliver coal-fired electricity from older, less 
efficient plants into RGGI states, completely undermining the 
initiative.
    How will the FERC regulate PJM in order to prevent this from 
happening?
    Answer. I believe that climate change is one of the most serious 
problems now facing our country. I commend the State of New Jersey for 
its leadership on this issue, including its focus on increased 
investment in renewable generation and energy efficiency. I agree that 
renewables and demand resources, including energy efficiency and demand 
response, are among our vital tools in combating climate change.
    The Commission is taking important steps to remove regulatory 
barriers to development of renewables and to ensure that demand 
resources have appropriate access to wholesale power markets. For 
example, the Commission has required transmission providers, including 
PJM, to develop an open, transparent regional transmission planning 
process. I believe that these planning processes will facilitate the 
development of demand resources, in part because the Commission has 
determined that demand resources capable of performing needed functions 
should be permitted to participate in the planning process on a basis 
comparable to other resources. Moreover, these planning processes can 
account for regional and state energy initiatives such as New Jersey's 
participation in the Regional Greenhouse Gas Initiative (RGGI). These 
planning processes will ultimately reduce costs to consumers and 
increase the competitiveness of utilities.
    Chairman Kelliher's response to this question identifies other 
examples of the Commission's efforts in these areas. I strongly support 
the Commission's recent orders that modified our policy for allocating 
some costs associated with transmission lines that are needed to 
connect renewable generation to the grid. It is also noteworthy that 
the Commission is seeking to dislodge the backlog in interconnection 
request queues of independent system operators and regional 
transmission organizations, including PJM.
    In addition, it is worth noting that if a PJM market participant 
were to incur increased costs of complying with environmental 
requirements--including climate change legislation that may be enacted 
at the federal level--that change would likely be reflected in bids 
that the market participant submits into PJM's wholesale markets 
subject to the Commission's jurisdiction. Based on PJM's economic 
dispatch, market participants submitting higher bids generally would be 
selected less frequently to serve consumers in PJM, including those in 
New Jersey. Therefore, the plants owned by such market participants 
would remain idle more often and would produce fewer greenhouse gases.
    Finally, Chairman Kelliher correctly states that the Secretary of 
Energy, rather than the Commission, is responsible for the designation 
of any National Interest Electric Transmission Corridors (NIETC). The 
Commission, however, may be presented with applications to site 
transmission lines within a NIETC. The Commission has adopted 
regulations that would apply in that situation. Those regulations make 
clear that in reviewing a proposed project, the Commission will 
consider all relevant factors on a case-by-case basis. As part of that 
review, the Commission will look at alternatives, including--where 
appropriate--alternatives other than new transmission lines. Such 
alternatives may include demand resources, as well as upgrades to 
existing facilities. This review will promote efficiency and 
environmentally-sound solutions.
                                 ______
                                 
     Response of James Y. Kerr II to Question From Senator Bingaman
    Question 1. Would it be appropriate for FERC to establish specific 
criteria for when it would consider state protections inadequate to 
protect consumers, and to issue rules that would specify what kinds of 
protections they would institute in those cases?
    Answer. If FERC were to establish specific criteria for when it 
would consider State protections inadequate to protect consumers or 
issue rules that would specify what kinds of protections it would 
institute in those cases, this approach might produce unnecessary 
conflict between federal and State regulators. A prescriptive ``one 
size fits all'' federal approach would limit the ability of State 
commissions to craft appropriate safeguards. The underlying regulatory 
relationships and transactions are unique and are best dealt with on a 
case by case, fact specific basis. The appendix attached to NARUC's 
written statement addressing the North Carolina Utility Commission's 
decision in the Duke merger case describes the nature and scope of this 
case by case approach.
    The Commission sought input from State commissions before 
finalizing its regulations under Federal Power Act (``FPA'') Section 
203. FERC asked for the State views on the best way to prevent cross-
subsidization and how to coordinate federal/State merger review. The 
current FERC policy on merger applications is to defer to State cross-
subsidization protections, unless there is evidence that additional 
measures are needed to protect wholesale customers, or where States 
lack authority to provide sufficient protections. This flexible 
approach properly manages the jurisdictional overlap in this area. It 
also reflects the reality that a wide variety of transactions are 
subject to FPA Section 203 review and that there is more than one 
mechanism to guard against improper cross-subsidization. NARUC 
appreciates that FERC declined to impose a uniform federal rule on 
cross-subsidization protections. A generic approach could have 
displaced State merger conditions even if those conditions guarded 
against improper cross-subsidization as effectively as the federal 
rule. A potentially conflicting approach assumes a ``regulatory 
failure'' on the part of State commissions. Federal and State 
regulators have the common interest in policing improper cross-
subsidization. To that end, States have been vigilant in guarding 
against cross-subsidies in the course of State merger review and in 
other contexts.
    Responses of James Y. Kerr II to Questions From Senator Domenici
    Question 1. Does FERC have in place sufficient customer protections 
in light of PUHCA repeal? Has the repeal of the Holding Company Act 
resulted in any regulatory gaps?
    Answer. The Commission has sufficient customer protections in 
place. The exercise of complementary federal and State authority 
results in comprehensive regulation. FERC has powerful regulatory tools 
to prevent cross-subsidization, including the disallowance of the 
recovery in rates for those costs found to reflect improper cross-
subsidies. As described in detail in the FERC Commissioners' testimony, 
the Commission has adopted numerous implementing regulations and 
policies under the Energy Policy Act of 2005 (``EPAct 2005'') to 
enhance its ability to police cross-subsidization. In addition, FERC 
has further strengthened its enforcement function to better protect 
consumers.
    The repeal of PUHCA has not resulted in any regulatory gaps. In 
fact, EPAct 2005 filled in statutory gaps regarding holding company 
mergers and generation facility acquisitions. For example, the Statute 
added to the public interest determination for FPA Section 203 reviews. 
The determination now requires a finding that a transaction will not 
result in cross-subsidization of a non-utility associate company or the 
pledge or encumbrance of utility assets for the benefit of an associate 
company, unless such cross-subsidization, pledge or encumbrance is in 
the public interest. Also, for every transaction approved under FPA 
Section 203, FERC retains the authority to issue supplemental orders as 
it may find necessary or appropriate with respect to that transaction.
    State commissions have the obligation under State law to ensure the 
establishment and maintenance of such energy utility services as may be 
required by the public convenience and necessity. We have to ensure 
that such services are provided at rates and conditions that are just, 
reasonable and nondiscriminatory for all consumers. State commissions 
have powerful regulatory tools to protect customers. Each State has 
extensive ratemaking authority, which includes the right to disallow 
recovery in rates of inappropriate or improper costs, including those 
deemed to represent cross-subsidies. The exercise of State merger 
review authority provides a means to protect consumer interests by 
imposing conditions on any proposed transaction. In fact, the broad 
statutory mandates to uphold the public interest and ensure reliable 
service at just and reasonable rates have allowed State commissions to 
establish detailed consumer protections not directly spelled out under 
their broad statutory authority. State regulatory commissions have 
traditionally had jurisdiction over the regulation of utilities in 
various areas, including mergers and acquisitions, affiliate 
transactions, audits and financial reporting. The repeal of PUHCA did 
not change the States' authority in these areas.
    Question 2. Do you believe any supplemental federal authority is 
needed to police crosssubsidizations such as a federal ring-fencing 
provision?
    Answer. Supplemental statutory authority, such as a federal ring-
fencing provision, added to the FPA is not needed to police cross-
subsidizations. As per our response to Domenici Question 1, the 
Commission already possesses extensive federal authority. And, FERC 
effectively exercises its broad statutory authority to protect against 
improper cross-subsidization. In fact, increased federal oversight over 
non-utility corporate activities and structure could create substantial 
barriers to investment in electricity markets, which would be contrary 
to the intent of PUHCA repeal. Supplemental federal authority could 
unnecessarily duplicate, and possibly contradict, consumer protections 
already in place at the State level.
    Question 3. What are your thoughts on Mr. Hempling's argument that 
we should revisit the federal-state relationship to achieve consistent 
regulatory policies across jurisdictional lines?
    Answer. There is no need to revisit the federal-State relationship 
to achieve consistent regulatory policies across jurisdictional lines, 
given the absence of evidence of consumer harm caused by a regulatory 
failure. The Commission and the States exercise their complementary 
authority to result in consistent and comprehensive regulation. The 
current approach properly balances the federal-State interests in this 
area. It also promotes an efficient use of resources and fosters 
greater federal-State coordination. For example, FERC collaborates with 
the States on audits, recognizing that maintaining contact with State 
regulators is mutually beneficial. NARUC has had an extensive and 
constructive working relationship with FERC. The three NARUC/FERC 
Collaboratives that cover cross jurisdictional areas--demand response, 
competitive procurement and smart grid--demonstrate that the precedent 
exists to continue working together.
                                 ______
                                 
     Responses of Scott Hempling to Questions From Senator Bingaman
    Question 1. In EPAct 05 we gave FERC new authorities and 
obligations to review mergers, specifically, we required them to find 
that there would be no cross-subsidization or encumbrance of assets for 
the benefit of an affiliate as the result of a merger. Have FERC's 
modifications of their merger rules adequately implemented this 
requirement?
    Answer. A rule prohibiting cross-subsidies, by itself, does not 
prevent cross-subsidies, any more than a speed limit prevents speeding. 
The risk of cross subsidies arises from corporate structures which make 
cross subsidies (a) possible, and (b) desirable to the companies 
involved. Given possibility and desirability. the rational actor's 
decision to engage in cross subsidies is a product of the probability 
of detection and the magnitude of the penalty.
    The gap in cross subsidy prevention exists because FERC has not 
identified, and discouraged, the types of corporate structures that 
create the possibility and desirability of cross subsidies. Prior to 
repeal, PUHCA 1935 limited the possibility of cross subsidies by 
prohibiting, limiting or requiring advance review of structures that 
mixed, within the same corporate family, utility and nonutility 
businesses, or competitive and non-competitive businesses. FERC has 
statutory authority, under the ``consistent with the public interest'' 
phrase in Section 203 of the Federal Power Act, to identify and limit 
corporate structures and affiliations. FERC's decision not to do so 
means that the risks of cross subsidies are higher now than prior to 
2005, regardless of FERC's rules.
    Given the increase in corporate complexity allowed by the 
combination of PUHCA 1935 repeal and the absence of new FERC limits on 
corporate structure, one would expect the resources devoted to cross 
subsidy detection, and the frequency of detection efforts, to match the 
greater risk. There is no evidence of such matching. Rational corporate 
planners therefore can assume that if the rewards of cross subsidies 
are high enough, the risk is worth taking.
    Question 2. Some have argued that you can't prove a negative, i.e., 
that it is impossible to establish that there will be no cross-
subsidization. Would not a structural barrier between the holding 
company and its utility affiliate provide the insurance that we were 
seeking?
    Answer. Please see response to Bingaman Question 1. The phrase 
``structural barrier'' deserves some elaboration. FERC and state 
regulators should insist that attention to the core utility business be 
the focus of a utility corporation. Any distraction from that business 
is inherently inconsistent with the core function. Regulators therefore 
should define the types of businesses which may co-exist in a utility 
corporate family without causing risks to customers. Such limits cause 
shareholders no loss in legitimate value, because shareholders on their 
own face no barriers in investing, separately, in whatever mix of 
businesses best serves their portfolio.
    Question 3. Is there something else that needs to be done in either 
statute or rule to fulfill this obligation or to protect adequately 
against cross-subsidization.
    Answer. Should FERC adhere to its decision not to address cross 
subsidy risk through structural limits, then it should identify with 
more precision the detection procedures and resources. The GAO's 
thoughts on the allocation of audit resources according to risk 
principles are worth considering. Moreover, those who through their 
structural choices increase the risk of cross subsidies should pay the 
freight for audit detection, just as any public corporation pays for 
its own audit. FERC therefore should consider a schedule of audit fees 
that vary with a corporate family's structural complexity. Otherwise a 
cross subsidy occurs at the outset, as all ratepayers or all taxpayers 
must pay for higher audit costs necessitated by the structural choices 
of a discrete set of companies.
     Responses of Scott Hempling to Questions From Senator Domenici
    Question 1. 1. Does FERC have in place sufficient customer 
protections in light of PUHCA repeal? Has the repeal of the Holding 
Company Act resulted in any regulatory gaps?
    Answer. Based on my career of advising over 20 state commissions 
while I was in private practice, and on my current responsibilities 
which involve ascertaining and fulfilling the research needs for all 
state commissions, I conclude that there are gaps in consumer 
protections due to the repeal of PUHCA 1935. As explained in my 
submitted written testimony, the following factors combine to create 
uncertainty and insufficiency in the area of consumer protection: (a) 
the elimination of all federal limits on utility corporate structure, 
which elimination allows structures that create a direct conflict 
between the utility's public service obligation and its opportunities 
to seek profit outside of its utility service business; (b) FERC's 
over-reliance on rate cases, as distinct from structural limits, to 
identify and correct cross subsidies; (c) insufficient information 
about the frequency, quality and consequences of regulatory efforts to 
detect and eliminate cross subsidies; and (d) the gap between 
regulatory resources (both human and statutory) and the new 
opportunities to engage in conflict-causing structures and behaviors.
    Question 2. I understand you opposed PUHCA repeal. Do you think 
Congress made a mistake when it repealed the Holding Company Act? Do 
you think the 1935 Act should be reenacted?
    Answer. Throughout the long debate about the future of PUHCA 1935, 
in which I was active as early as 1989, I avoided the bipolarity of 
statements such as ``I oppose PUHCA repeal'' and ``I support PUHCA 
repeal.'' The bipolarity of the debate moved to the margin the correct 
question, which is: ``How do we modernize federal structural regulation 
so as to promote the diversity and competitiveness of electricity 
markets while ensuring that customers receive the best possible service 
at reasonable cost?'' This more complex question requires one to ask: 
``Is it wise to permit corporate structures that place utility 
executives in a conflicted position, where they have the choice of 
actions which are profitable but which undermine customer interests?'' 
My position throughout the debate was that stark repeal caused such 
conflicts, whereas leaving the statute unchanged impeded the injection 
of diversity and competitiveness.
    Given this statement of the issue, I believe Congress erred in not 
replacing PUHCA 1935 with a modern statute that accommodated the 
concerns set forth elsewhere in my comments. Re-enactment of PUHCA 1935 
would not be the answer; creating a statute that allowed those 
corporate structures that promote diversity and competitiveness but 
precluded structures that embodied conflicts of interest would be the 
answer.

As explained in my written testimony, my views set forth here are my 
own; not those of NRRI or of any state commission.

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