	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-regulated companies that are proposing to merge  with or acquire a regulated company must submit a public application for  FERC to review and approve. FERC also requires  company officials to attest that they will not engage in unapproved cross- subsidies in the future. 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. FERC’s postmerger oversight relies on its existing  enforcement mechanisms—primarily self-reporting and a limited number  of compliance audits. One company official noted that the threat of large fines may  “chill” companies’ willingness to self-report 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. We continue to encourage  the FERC Chairman to consider our recommendations.
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.