U.S. Investment in Foreign Utilities under the Public Utility Holding Company Act of 1935 and the Energy Policy Act of 1992

Moeller, James W., Law and Policy in International Business

INTRODUCTION

On October 24, 1992, President Bush signed into law the Energy Policy Act of 1992,(1) amending the Public Utility Holding Company Act of 1935 (PUHCA).(2) In particular, section 715 of the new law amends PUHCA to facilitate and promote the expansion and increase of U.S. investment in foreign electric and gas utility companies.(3)

The amendment of PUHCA in this regard was precipitated by an explosion of opportunities for U.S. investment in foreign utilities in 1992.(4) For example, in March 1992, the government of Argentina announced the privatization of several state-owned utilities.(5) In August 1992, the government of Brazil similarly announced the privatization of its state-owned electric utility company.(6) To promote the development of additional electric power facilities, Columbia, Costa Rica, and Honduras all legislated the removal of legal barriers to private and foreign investment in their electric utilities.(7)

As in Latin America, in Eastern Europe several nations initiated the privatization of their state-owned electric and gas utility companies in 1991 and 1992.(8) Poland, for example, is expected to privatize thirty-four electric power companies.(9)

Finally, numerous additional opportunities for U.S. investment in foreign utilities arose in 1992 in the Far and Near East and in the Pacific. The need for electric power facilities in China is expected to result in the removal of legal barriers to private and foreign investment.(10) The governments of Malaysia and Pakistan both have decided to proceed with privatization of their state-owned electric utility companies.(11) The governments of South Korea and Thailand announced their promotion and development of new electric power facilities through foreign investment.(12) The governments of Australia and New Zealand also decided to privatize their electric utility companies.(13)

PUHCA, which is administered by the U.S. Securities and Exchange Commission (SEC), regulates the acquisition and ownership by U.S. companies of electric and gas public utility companies. A public utility holding company is basically a company that owns a U.S. or foreign electric or gas utility company.(14) In the absence of an exemption--several of which are provided by PUHCA--A public utility holding company, as well as its public utility and non-utility subsidiaries, is subject under PUHCA to a complex maze of legal requirements. It was argued in 1992 that those legal requirements would pose obstacles to U.S. investment in foreign utilities.(15)

During the same time the Energy Policy Act was under consideration in Congress, the SEC granted several landmark exemptions from the legal requirements of PUHCA to U.S. public utility holding companies wishing to invest in foreign utilities. The exemptions suggested a recognition of unprecedented opportunities for U.S. investment but nonetheless require the resolution of several legal issues unencountered in the administration of PUHCA by the SEC in almost sixty years. The exemptions establish a precedent that is certain to dictate to a significant extent the future course of U.S. investment in foreign public utility companies.

This article describes and discusses the development of the new legal regime under PUHCA for U.S. investment in foreign utilities. Part I provides an overview of the complex regulatory framework PUHCA imposes on public utility holding companies and addresses the several exemptions from those legal requirements provided by PUHCA. Part II discusses the recent exemptions granted by the SEC to public utility holding companies investing in foreign utilities. Part III describes the recent amendment to PUHCA intended to facilitate and promote an expansion in U.S. investment in foreign utilities and discusses the development of the National Energy Strategy and the legislation fashioned to implement it. It also discusses the adoption of the Foreign Investment Amendment. This article concludes with the observation that the Foreign Investment Amendment could actually compromise a principal objective of the National Energy Strategy and the Energy Policy Act, that is, the development of new electric power facilities in the United States.

I. PUHCA REQUIREMENTS AND EXEMPTIONS

A. Regulation Under PUHCA

PUHCA establishes an extensive, complex, and arguably burdensome regime for the regulation of public utility holding companies.(16) The purpose of the regime is to prevent a recurrence of the financial abuses for which the electric and gas utility industries and their holding companies were notorious in the two decades prior to enactment of PUHCA.(17) Those abuses are enumerated within the statute(18) and detailed in its extensive legislative history.(19)

In the absence of an exemption,(20) all public utility holding companies are subject to four general and fundamental requirements. First, each public utility holding company is required to register with the SEC(21) and is required to file an annual report with the SEC.(22)

Second, PUHCA requires prior SEC approval of sale of securities and acquisition of securities and utility assets by registered companies and their subsidiaries. Generally, a proposed issuance or sale of securities requires a declaration which describes the proposed transaction to be filed with the SEC.(23) The declaration will become effective within a reasonable period of time unless the SEC issues an order to show cause and provides an opportunity for administrative adjudication on the order.(24) The public is also provided with notice of the declaration and an opportunity for administrative adjudication thereon.(25) The conditions under which the SEC is to allow the declaration to become effective are detailed in Sections 7(c)-(g).(26) The SEC will issue an order that authorizes or prohibits the proposed transaction either when the declaration becomes effective or after an administrative adjudication.(27)

The requirements for prior SEC approval of acquisition of securities and utility assets are quite similar to those for sale of securities. Under PUHCA, a proposed acquisition of securities or utility assets requires an application describing the proposed transaction to be filed with the SEC.(28) The SEC will issue an order that either approves or denies the application but will provide the applicant with an opportunity for administrative adjudication before denial of the application.(29) The public, again, is provided with notice of the application and an opportunity for administrative adjudication thereon.(30) The conditions under which the SEC is to approve or deny the application are detailed in Sections 10(b)-(c).(31)

Third, PUHCA establishes numerous requirements for prior SEC approval of certain other financial transactions among registered companies and their subsidiaries as well as among subsidiaries within the same holding company system.

Section 12 is largely concerned with certain financial transactions between registered companies and their subsidiaries(32) and imposes a prohibition on loans to registered companies from their public utility subsidiaries.(33) The purpose of the prohibition is "to prevent undesirable upstream loans being made to a top holding company of an operating utility system by its subsidiaries and the consequent milking of the latter."(34) The statute similarly imposes a prohibition on direct or indirect loans, without prior SEC approval, from Registered Companies to their subsidiaries.(35) Section 12 also prohibits the payment of dividends and the redemption of securities by registered companies and their subsidiaries without prior SEC approval.(36) In addition, the statute prohibits the sale of securities in or assets of public utility companies by registered companies without prior SEC approval.(37) The prohibition is "designed to protect investors against any sacrifice of their equity in the sale of their assets."(38)

Section 13 is concerned exclusively with service, sales, and construction contracts between companies within the same holding company system.(39) It imposes an absolute prohibition on contracts with registered companies for the performance of services or construction for or sale of goods to public utility companies within the same holding company system,(40) and requires SEC approval if the contract is with a subsidiary of a registered company. The approval is intended "to insure that such contracts are performed economically and efficiently for the benefit of such . . . companies at cost, fairly and equitably allocated among such companies."(41) The SEC has determined that the cost of service, sales, and construction contracts is generally fair and equitable if it is equal to the cost of the performance of the contracts.(42)

Finally, PUHCA establishes a general and fundamental requirement for the holding company systems of registered companies to be simple and uncomplicated. Indeed, section 11 of PUHCA actually authorizes the SEC to require the simplification of holding company systems--through, for example, divestment of subsidiaries unrelated to the operations of public utility systems--in order to limit the operations of holding company systems to single and "integrated" public utility systems.(43) The requirement for simplification is the cornerstone of PUHCA.(44) It is also the requirement that precipitated numerous constitutional challenges against PUHCA.(45)

Section 11 requires the SEC to examine holding company systems to assess the extent to which they could be and should be simplified.(46) It authorizes the SEC to require the simplification of holding company systems, through, for example, divestment, reorganization, and recapitalization, to limit their operations to "integrated" public utility systems and to "such other businesses as are reasonably incidental, or economically necessary or appropriate to the operations of such integrated" systems.(47)

The SEC may enforce its reorganization plans in the federal district courts.(48) The holding company system may also submit its own simplification plan for SEC approval and to the district courts for enforcement.(49) PUHCA also provides for judicial review of SEC orders for simplification, as well as of SEC approval of submitted simplification plans, in the federal courts of appeal.(50)

B. Exemptions Under PUHCA

The numerous and arguably onerous requirements that PUHCA imposes on registered companies present a significant incentive for companies with electric and gas utility subsidiaries to avoid its grip, if at all possible. PUHCA does provide companies with such subsidiaries several exemptions. Five exemptions are for holding companies.(51) A sixth exemption is for certain subsidiaries of holding companies.(52) The fifth and sixth exemptions are directly relevant to U.S. investment in foreign electric and gas utility companies.

In September 1991, there were 116 public utility holding companies with exemptions from regulation under PUHCA granted by the SEC (exempt companies).(53) Section 3(c) directs the SEC to issue, within a reasonable time after the submission of an application for an exemption, an order that either grants the application or, after an opportunity for administrative adjudication thereon, denies the application.(54) The exemptions issued to holding companies also exempt their subsidiaries from regulation.(55) submission of an application for an exemption exempts the applicant from regulation until an order is issued on the application.(56) An order that denies an application is not an automatic requirement for the applicant to register.(57) An exemption is subject to revocation.(58) Finally, Section 3(d) authorizes the issuance of blanket exemptions, in the form of SEC regulations, for entire classes of subsidiaries of holding companies.(59)

Section 3(a) establishes five exemptions for holding companies and their subsidiaries that would otherwise be required to register and would be subject to regulation under PUHCA.(60) First, section 3(a)(1) provides an exemption for holding companies and their public utility subsidiaries from which the holding companies derive a material part of their incomes, that are "predominantly intrastate in character and carry on their business substantially in a single State . . ."(61) Second, section 3(a)(2) provides an exemption for holding companies that are "predominantly" engaged in public utility operations, the scope of which is confined to their states of incorporation and contiguous states.(62) Third, section 3(a)(3) provides an exemption for holding companies that are "primarily" interested in nonutility companies and that either derive no material income from public utility subsidiaries or that derive a material part of their incomes from public utility subsidiaries that are in their substantial possession.(63) This exemption is often granted to large industrial facilities with electric generation facilities to provide their own electric power needs.(64) Fourth, section 3(a)(4) provides an exemption for holding companies with public utility subsidiaries that are merely the result of acquisitions of securities for purposes of liquidations or distributions in connection with debts.(65)

The fifth and sixth exemptions are directly relevant to U.S. investment in foreign public utility companies. The fifth exception in section 3(a)(5) exempts from regulation holding companies that are not "principally" engaged in public utility operations in the United States and that derive no material income from public utility subsidiaries that operate in the United States.(66) The exemption would be applicable, for example, to holding companies incorporated in the United States, which are not engaged in public utility operations in the U.S. but derive a material part of their income from public utility subsidiaries operating in foreign nations.(67)

The sixth exemption in section 3(b) exempts "any subsidiary company . . .if such subsidiary company derives no material part of its income, directly or indirectly, from sources within the United States, and neither it nor any of its subsidiary companies is a public utility company operating in the United States."(68) While section 3(a)(5) applies to holding companies and their subsidiaries, section 3(b) applies to subsidiaries of holding companies that are required to register and would otherwise be subject to regulation under PUHCA. The latter exemption would thus be applicable, for example, to subsidiaries, engaged in public utility operations in foreign nations, of holding companies that are engaged in public utility operations in the United States and that are thus not qualified for an exemption under section 3(a)(5).(69)

In the years subsequent to the enactment of PUHCA, there were numerous instances of holding companies, with foreign public utility subsidiaries, that also were the subsidiaries of other holding companies. In those instances, the middle-tier holding companies required a section 3(b) exemption as well as a section 3(a)(5) exemption. In those instances, the SEC granted to middle-tier holding companies both exemptions.(70) The exemptions; the SEC has observed that "[s]ections 3(a)(5) and 3(b) indicate an intention that companies operating in foreign countries shall largely be free from the jurisdiction of this Commission with respect to such of their activities as are essentially foreign in their nature and effect."(71) However, the SEC has denied the application of sections 3(a)(5) and 3(b) for reasons of "public interest" although the interested parties complied with the statute's liberal requirements.(72)

The original legislation regarding holding companies that was introduced in the Senate in February 1935 included neither section 3(a)(5) nor section 3(b).(73) Similarly, the legislation introduced in the House falied to include an exemption for foreign utility subsidiaries.(74)

The Public Utility Act of 1935, introduced in the Senate in May 1935, included a version of the five exemptions presently provided in Section 3(a).(75) It provided, however, no version of the present Section 3(b). In a report on S. 2796, the Senate Committee on Interstate Commerce explained that the exemption for foreign public utility companies, as well as the other exemptions, was applicable to U.S. public utility holding companies because those companies are "not essentially holding companies in the utility field."(76) The full Senate approved S. 2796 on June 11, 1935.(77)

The House Committee on Interstate and Foreign Commerce (House Committee) had conducted numerous hearings on H.R. 5423.(78) Nonetheless, S. 2796 was introduced therein in June 1935. The House Committee soon substituted Title I of the legislation with its own version, Section 3(a)(5) of which, however, was identical to the Senate version. There was no discussion in the House report on the legislation of the statute.(79) The House Committee version of S. 2796 was forwarded to the floor of the House, where a version of the present Section 3(b), introduced on June 29, 1935 by Speaker of the House Rayburn, was immediately adopted without discussion or explanation.(80) The full House approved the legislation on July 2.(81) The Senate agreed to the section 3(b) amendment in conference committee in August 1935.(82) Thus the Public Utility Act of 1935, Title I of which was PUHCA, was enacted into law, with exemptions for foreign public utility companies, on August 26, 1935.

II. SEC APPROVAL OF U.S. INVESTMENT IN FOREIGN UTILITIES

A. Exemptions for Exempt Companies

Neither section 3(a)(5) nor section 3(b) have been particularly active in the administration of PUHCA since 1960. This past summer, however, the statutes assumed a prominent role in SEC administration of PUHCA, as applications of exemption status under those sections stepped up in 1992 due to the numerous opportunities for U.S. investment in foreign electric and gas utility companies. The SEC, for its part, granted several landmark exemptions.

The first exemption was granted by the Commission itself,(83) while all subsequent exemptions were granted by the SEC staff in accordance with authority delegated by the Commission to the Office of Public Utility Regulation (OPUR) in the SEC Division of Investment Management.(84)

In SCEcorp, the applicant was a holding company, incorporated in California, with an interest in Southern California Edison Company, an intrastate electric utility subsidiary, as well as in 297 non-utility subsidiaries.(85) SCE is exempt from regulation under section 3(a)(1) because both SCE and Southern California Edison Company are intrastate in character. In March 1992, SCE and Mission Energy Company (MEC), a nonutility subsidiary, requested a section 3(b) exemption for two Australian public utility subsidiaries of MEC.(86) The two subsidiaries, Loy Yang B Venture (Venture) and Mission Energy Management Australia, Limited (MEMA), were formed in order to acquire a forty percent interest in and operate the Venture electric power plant in Victoria, Australia, currently under construction.(87) SCE and MEC requested a section 3(b) exemption for Venture and MEMA because neither foreign subsidiary, it claimed, would derive a material part of its income from U.S. sources or be involved in public utility operations within the United States.(88) In particular, SCE and MEC stated that there would be no financial transactions between Venture or MEMA and Southern California Edison Company.(89)

The Commission granted an unqualified Section 3(b) exemption in June 1992(90) on the basis of the statement that neither Venture nor MEMA would derive a material part of its income from U.S. sources or would be involved in public utility operations in the United States.(91) In addition, the Commission concluded that, in accordance with section 3(b), "the proposed acquisitions [will not] adversely affect the public interest or the interest of investors or consumers."(92) It observed that "regulation under other federal …

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Publication information: Article title: U.S. Investment in Foreign Utilities under the Public Utility Holding Company Act of 1935 and the Energy Policy Act of 1992. Contributors: Moeller, James W. - Author. Journal title: Law and Policy in International Business. Volume: 24. Issue: 2 Publication date: Winter 1993. Page number: 503+. © Georgetown University Law Center Fall 1997. COPYRIGHT 1993 Gale Group.

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