MANAGING REGULATORY RISK IN A POST-PUHCA WORLD

MACQUARIE SECURITIES2007 UTILITIES & INFRASTRUTURE

CONFERENCEVAIL, CO

FEBRUARY 13, 2007

ROBERT W. GEEPRESIDENT

GEE STRATEGIES GROUP LLC

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PUHCA 101(The 1935 Act)

• No significant utility state regulation existed• PUHCA enacted to address financial abuses facilitated by

complex holding company structures and interlocking directorates resulting in numerous utility insolvencies and little accountability

• Required simplified, limited holding company system• Utility activities limited to a single, geographically integrated

public utility system and to such other businesses as are “reasonably incidental, or economically necessary or appropriate” to the operations of the integrated system

• Imposed significant recordkeeping and filing requirements before the Securities and Exchange Commission

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The Case for PUHCA Repeal• Over time, PUHCA’s restrictions were deemed as not reflecting either

the market structure or regulatory policy priorities affecting the modern electric power industry

– Geographic integration requirement counterintuitive to blunt growth of market power– States had assumed greater ratepayer protection role

• Over 2 decades, SEC favored its repeal

• Perception grew that repeal was necessary to eliminate arcane, duplicative, and unduly burdensome regulations that disserved the interest of the consuming public by hindering needed investment

• FERC and states would be better equipped to protect ratepayers, and not the SEC which is focused on investor protection

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Just when you thought the war was over, the battleground shifted . . .

• PUHCA repealed in Energy Policy Act of 2005 – Victory Declared!

• Because PUHCA repeal premised on adequacy of state authority to protect ratepayers from holding company abuses, states were invited to address any perceived “regulatory gap”

• Result: most states have yet to act, but several are becoming increasingly assertive – Arkansas, California, New Jersey, and Kansas (pending)

• Whether this signals a trend is premature

• Are we witnessing a proliferation of “Mini-PUHCAs” a la Wisconsin?

To the states

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New State Post-PUHCA Measures

• Structural corporate separation of utility, affiliates, and holding companies– California – mandated by rule – Kansas – Staff recommendation– New Jersey – Staff recommendation

• Maintenance and retention of separate books and records for utility and holding company affiliates (Arkansas & California)

• Ringfencing to protect utility credit quality– Arkansas – under certain conditions, can order termination of relationship

between utility and its affiliate if shown to impair utility’s credit quality to below BB+ (S & P) or Ba1 (Moody’s)

– Kansas – Staff proposal to prohibit utility from issuing long-term debt to fund non-utility activities, investments, or businesses

– New Jersey – Staff proposal would empower Board, among other things, to limit or cease payment of dividends or holding company if capital of utility is found impaired

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New State Post-PUHCA Measures (con’t.)

• Caps on non-utility diversification by utility or utility holding company akin to Wisconsin “Mini-PUHCA”

– Arkansas -- 10 percent of the book value of the total assets of the public utility and all its affiliates

– New Jersey – 25 percent of utility and utility-related assets, with latitude to seek increase to 35 percent under certain conditions

• Restrictions on transactions or sharing of services/personnel between utility and holding company & affiliates

– California – limitations on use of common key corporate officers, and personnel for regulatory affairs, legal, & lobbying

– Arkansas – prohibition of affiliate transactions where utility provides to or shares with affiliate any financial resource or financial benefit

• Disclosure of total compensation for executive officers (and those making >$250K/yr. in base salary), including proportion paid, directly or indirectly, by ratepayers (California)

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Corporate Governance Oversight: An Emerging Issue

• New Jersey Staff proposes to require utility annually to certify that:

– 40 percent of its directors are “independent” (i.e., not directors of both the electric or gas public utility and its public utility holding company system)

– It has process in place for selecting new directors and such process identifies New Jersey residency, employment and/or other significant ties with the State of New Jersey (“New Jersey Qualification”)

– If less than 40 percent, made a good faith effort in meeting New Jersey Qualification

• California’s rule -- Indirect effort at governance oversight via required disclosure of share of executive compensation attributable to utility ratepayers – infers utility executive decisions driven by superseding business priorities of holding company and/or affiliates

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Common Drivers for State Post-PUHCA Measures

• A strong preference for ex ante versus ex post sanctions – generic rules versus case-by-case determinations

• Skepticism of effectiveness of existing ratemaking authority to prevent harm to ratepayers from cross-subsidization or risk of non-utility diversification

• Desire for more rigorous oversight over matters previously left to management discretion

• Not persuaded that new rules would chill investment

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Lessons for Investors (thus far)

• State commission’s inclination to impose controls influenced by variety of factors:

– Prior history of utility conduct (e.g., abuses affecting utility creditworthiness)

– General mistrust of utility ownership by large multi-state holding companies or by out-of-state interests

– “Activist” regulatory culture – Commission’s relationship to legislature and/or Governors

• No two commissions are identical, but they talk to one another

• Investors should continue to monitor state actions to see how this evolves

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Robert W. GeePresidentGee Strategies Group LLC7609 Brittany Parc CourtFalls Church, VA 22304U.S.A.703.593.0116703.698.2033 (fax)rwgee@geestrategies.comwww.geestrategies.com