In a recent order,1 the Federal Energy Regulatory Commission (“FERC”) asserted jurisdiction over a fund manager and a group of funds that intended to acquire a 35 percent stake in a group of public utilities. This order is a good reminder that investments in public utilities can have unique and potentially burdensome consequences. Here are a few things to remember when considering investing in public utilities:
FERC regulates Public Utilities.
What is a Public Utility? The definition is broader than one might expect. Public Utilities are entities engaged (even as an ancillary business) in the sale of electric energy at wholesale in interstate commerce or the transmission of electric energy in interstate commerce. Public Utilities include traditional electric utilities such as Con Edison and Southern California Edison, owners or entities in control of power generating assets, electricity marketers or traders, and regional nonprofit market and transmission managers such as PJM and ISO New England. Power generators that have “Qualifying Facility” status,2 no matter where located, are subject to FERC’s regulation.3 Entities that are engaged in the transmission or sale of electricity solely within a single state and isolated from the interstate grid (such as the ERCOT portion of Texas) are not subject to FERC regulation because they do not use interstate commerce. Utilities and generators in Puerto Rico, Alaska and Hawaii are not subject to FERC rate regulation, but are subject to state utility commission regulation. Power sales by government-owned utilities, such as the Tennessee Valley Authority and the Los Angeles Department of Water and Power, and most customer-owned electric cooperatives are not regulated by FERC. Identifying a Public Utility may require direct inquiry and/or reference to public records, including to information posted by FERC at www.ferc.gov. There is no single master list of FERC-regulated entities.
FERC also regulates sales and other transfers of control of Public Utilities.4
A holder of 10 percent or more of the voting securities (or their equivalent such as partnership or limited liability company interests) is deemed to have control of a Public Utility. Subject to narrow technical exceptions, all equity (including tax equity) investments and dispositions of 10 percent or more in any Public Utility require prior FERC approval. Transfers of indirect interests in a Public Utility such as buying stock in a Public Utility’s parent company are subject to FERC authorization in the same manner as purchases of a Public Utility’s stock or other voting securities. FERC approval can only be obtained after filing a formal, publicly available application to FERC. FERC will review the application to determine, among other things, if a proposed investment will have a negative effect on energy-related competition in the relevant geographic and product market and on rates and services. An investor that is considered to have market power may face limits on other FERC-regulated investments. In a small geographic market, controlling even one large generating plant can confer market power on an investor, resulting in FERC scrutiny of further investments in the same and other markets.
All holdings of voting securities in a Public Utility under direct or indirect common control will be aggregated to determine if FERC approval of an investment in a Public Utility is required.
An investment adviser and the funds and other investment products it manages may be treated as a single entity for purposes of determining whether holdings of voting securities in a Public Utility meet the 10 percent threshold for control of a Public Utility. In the FERC proceeding cited earlier, a fund manager and approximately 100 domestic and foreign advised or sub-advised funds sought permission to acquire, collectively, a 35 percent voting interest in Dynegy Inc., an owner of power generating and marketing Public Utilities regulated by FERC. This voting interest would be acquired as a result of the conversion of Dynegy’s debt to equity as part of Dynegy’s reorganization in bankruptcy. According to FERC, the adviser, in its role as investment manager or sub-adviser for the funds, would exercise all voting rights as well as “dispositional control” with respect to the Dynegy stock on a going forward basis, and consequently the acquisition of the stock could only be made with FERC approval.
An entity or group of commonly controlled entities that acquires control of a Public Utility becomes a “holding company” under the Federal Power Act and FERC’s regulations.
What are the consequences for a manager and its funds that acquire a controlling interest in a Public Utility? Federal Power Act (“FPA”) requirements typically involve disclosure to FERC of all voting equity or equivalent interests of 10 percent or above in any FERC-jurisdictional entity, enterprise-wide. An entity regulated as a Public Utility under the FPA may also be subject to ongoing FERC disclosure requirements relating to its upstream owners and energy-related affiliates. The FPA also prohibits a person appointed as a director or officer of a Public Utility from serving at the same time as a director or officer of another Public Utility, absent prior permission from FERC and public annual disclosure. Unless an exemption is available, the manager will be required to maintain prescribed books and records and allow FERC to inspect those books and records upon request. These rather extensive public disclosure and FERC audit requirements cause many entities to limit investments in Public Utilities in order to avoid FERC jurisdiction.5
Investments can be made in Public Utilities without triggering FERC jurisdiction.
The easiest way to invest in Public Utilities without becoming FERC jurisdictional is to limit investments in any Public Utility to investments that do not confer control. Investing (enterprise-wide) in less than 10 percent of the voting securities of any Public Utility is one way to avoid regulation.
A second alternative is to limit investments to “passive” interests in Public Utilities. To qualify as passive, the investor cannot have authority to manage, direct or control the activities of the Public Utility, especially key regulated activities such as power sales, or its day-to-day operations. Precedent cases permit passive investors to hold limited consent or veto rights that are designed to allow them to protect their investments.6 An investor can structure an investment to match these precedents or make a filing with FERC to obtain a determination as to whether FERC will consider a proposed investment as passive or active. There is no single FERC blanket regulation controlling the issue.
A related group of funds may seek advance blanket authority from FERC to make investments in Public Utilities that exceed the 10 percent control threshold. FERC has granted blanket authority to purchase a greater percentage (often 20 percent) of the voting securities of a Public Utility to groups of funds that stated that they do no seek to exercise actual control over the day-to-day management or operations of Public Utilities.7 These blanket authorizations usually are limited in time (three years, for example) and may include geographic or other limits to prevent a fund group from obtaining market power. Blanket authorizations may not provide pre-approval for all acquisitions — the adviser and related funds in the FERC proceeding discussed earlier held a blanket authorization,8 but they were required nonetheless to obtain approval for the Dynegy transaction.
When all else fails and a decision is made to obtain FERC authorization of an investment in a Public Utility, an application must be filed with FERC (often referred to as a “Section 203 application” for the section of the FPA under which applications are filed). A Section 203 application requires disclosure of extensive information about the Public Utility, its affiliates and the proposed investors. Section 203 proceedings are public, although confidential transaction documents can be protected, in part, from public release. A Section 203 proceeding involving traditional utilities may be concluded in as few as 90 days if no material competition or concentration issues are involved and no interventions or hostile filings are made with FERC; a proceeding not involving traditional utilities that is not protested usually is concluded in 60 or fewer days.
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Investments in FERC-regulated entities involve unique and technical considerations and risks. This alert contains only a high-level discussion of some of the more important regulatory limitations applicable to investments in Public Utilities. We would be happy to help with a more detailed analysis of any proposed investment.
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Persechino-NancyThis article was originally published by Bingham McCutchen LLP.