	FERC’S Merger Review and Postmerger Oversight to Prevent Cross- Subsidization in Utility Holding Company Systems Are Limited

FERC has made few substantive changes to either its merger 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. To review mergers and  acquisitions, FERC officials told us that they do not intend to make  changes to their process other than to require companies to disclose any  existing or planned cross-subsidization and explain why it is in the public  interest, and to certify in writing that they will not engage in harmful cross- subsidization. For postmerger oversight, FERC intends to continue to rely  on its existing enforcement mechanisms, as expanded by EPAct, to detect  potential cross-subsidies—primarily companies’ self-reporting of  noncompliance and a limited number of compliance audits. FERC officials told  us that they can, and sometimes do, request that applicants provide  additional information or conduct additional analysis. However, on the  basis of our discussions with FERC staff, this picture of risk may be  somewhat limited in that it is informed only by the views of a few key staff  and does not seek input from stakeholders, such as the financial  community or state commissions, or reflect analysis of key data on risk. In support of the use of  this information, some state regulators told us that such information has  been helpful to them in identifying when companies may engage in  unlawful cross-subsidies. 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. Almost all states report they have some  type of authority over affiliate transactions, although many states report  reviewing or auditing few of these transactions. Almost half of the states report they need  additional staff and funding to respond to changes stemming from EPAct. Almost All States Have Merger Approval Authority but Many States Express Concern about Future Regulation of the Resulting Companies after Merger Approval

On the basis of our survey of state commission staff, all but 3 states (out  of 50 responses) have authority to review and either approve or  disapprove mergers. Officials in Oregon noted  that the state commission was concerned that consumers could be harmed  because regulating the resulting company would be more difficult due to  the financial complexity of the new ownership arrangement. Some states are concerned that they may not have sufficient authorities to  oversee affiliate transactions, after the repeal of PUHCA 1935. The majority of states reported they have  audited 1 percent or less of these transactions over the last 5 years and  dedicated no staff time to reviews or audits over the last year. Some States Report Not Having Access to Holding Company Books and Records

All states regularly require financial reports from utilities and are able to  obtain access to the financial books and records of these utilities that  document costs, but access beyond the utility varies. Develop 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. To specifically determine how FERC has changed its merger review  processes and postmerger oversight to prevent cross-subsidization  affecting utilities, we reviewed the Energy Policy Act of 2005 and the  Public Utility Holding Company Act of 2005 (PUHCA 2005) provisions in  EPAct related to FERC’s review of mergers and acquisitions, access to the  books and records of companies in holding company systems, and  assessment of civil penalties on companies that violate its rules. To be clear, our draft report stated that once a merger  has taken place, FERC intends to rely on its existing enforcement  mechanisms—primarily (1) companies’ self-reporting and   (2) compliance audits—to detect potential cross-subsidization. In addition, as noted in earlier  comments, the development of a risk-based audit planning approach  could also help FERC allocate its existing resources most efficiently  and effectively.
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, 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 (1) examine the extent to which FERC changed its merger and acquisition and post merger review and oversight processes since EPAct to protect against cross-subsidization and (2) survey state utility commissions about their oversight.

What GAO Found

FERC has made few substantive changes to its merger review processes and does not have a strong basis for ensuring that utilities do not engage in harmful cross-subsidization. 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 cross-subsidization, but do not plan to independently verify such information. 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 any non-compliance. In addition, FERC officials told us that, for 2008, FERC developed its plans to conduct compliance audits of 3 of the 36 holding companies it regulates based on informal discussions between senior agency officials and staffs in key offices. However, FERC does not formally use a risk based approach that considers factors, such as companies' financial condition or history of compliance. A risk-based audit approach is an important consideration in efficiently allocating its limited resources to detect non-compliance. In addition, we found that FERC's public audit reports often lacked a clear description of the audit objectives, scope, methodology, and findings--inhibiting their use in improving transparency with stakeholders or helping FERC staff improve their audit practices. State utility commissions' views of their oversight capacity varied, but many reported a need for additional resources, such as staff and funding, to respond to changes in their oversight after the repeal of PUHCA 1935. State regulators in all but a few states reported that utilities must seek state approval for proposed mergers. 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. Most states reported having some type of audit authority over the transactions between utilities and their affiliated companies, but many states currently review or audit only a small percentage of these transactions, with 28 of the 49 reporting states auditing 1 percent or less over the last five years. On the other hand, some states reported that they require periodic, specialized audits of affiliate transactions. In addition, although almost all states require financial reports from utilities and report they have access to utility companies' financial books and records, many states reported they do not have such direct access to the books and records of affiliated companies. While EPAct provides state regulators the ability to obtain such information, some states expressed concern that this access is narrow and could require them to be extremely specific in identifying needed information, thus potentially limiting their audit access. From a resources perspective, 22 of the 50 states reporting said that they needed additional staffing and funding to a carry out their oversight responsibilities.