3. Discussion
3.1. The Motion to Dismiss is Granted
Applicants request dismissal of this application, because neither the merger nor WP X's subsequent acquisition of options and additional shares of Integra common stock result in a transfer of control for which advance Commission approval is required under Section 854. We note that Applicant bears the burden of demonstrating that this application should be dismissed.
Under Section 852, no public utility, and no subsidiary, affiliate of, or corporation holding a controlling interest in, a public utility, shall purchase or acquire, take or hold, any part of the capital stock of any other public utility, organized or existing under the laws of this state, without prior Commission authorization. Section 854 further requires Commission authorization before a company may "merge, acquire, or control . . . any public utility organized and doing business in this state . . . "The purpose of these and related sections is to enable the Commission, before any transfer of a public utility is consummated, to review the situation and to take such action, as a condition of the transfer, as the public interest may require."9
The Commission evaluates whether a transaction that results in a transfer of control, requires prior approval under Section 854 on a case-by-case basis, based on the relevant facts and circumstances10. Applicants acknowledge that in past decisions the Commission has considered factors such as:
1) whether the acquiring entity's equity interest in the utility or its parent will be greater than 50%;11
2) whether the acquiring entity has the power to appoint a majority of the members of the board of directors or to direct management of the utility or its parent entity;12 and
3) whether the acquiring entity has actual or working control of the day-to-day business of the utility.13
Under our previous decisions, the acquisition of a 50% or greater ownership interest in a public utility has constituted "control directly or indirectly" for the purposes of Section 854.14 Here, where the options and warrants for common stock held by third parties are considered to be exercised, WP X would have only a 48.6% interest in Integra. Only when the options and warrants are withheld from consideration in calculating WP X's ownership interest may a 51.2% ownership interest in Integra be found.
Our previous decisions do not specifically state whether we should consider the ownership interest acquired by WP X on a fully diluted basis or otherwise.15 We recognize, however, that until exercised, neither warrants nor options confer any ownership interest. Holders of options or warrants also cannot vote, elect management, or take any other act affecting corporate operations. Therefore, absent extenuating circumstances, ownership of greater than 50% of a company constitutes control. However, in order to exercise our responsibility under the statute, we consider all relevant circumstances of this case. Since the percentage of the interest acquired by WP X is only one factor to be considered typically in determining whether a transfer of control under Section 854 has occurred, we address other relevant factors below.
Notwithstanding majority ownership interest under the terms of the operating agreement, Applicants argue that no transfer of control has occurred because Integra's shareholders, including WP X, have only limited power to control the corporation, through their ability to appoint directors and their statutory and contractual rights to approve certain transactions, and that the day-to-day business of Integra is managed by its officers and managers.
Integra's Board consists of nine members. As a result of this transaction, WP X has the right to appoint three, and under some circumstances, four members of the Board.16 Two of three other substantial shareholders in Integra, Boston Ventures and Banc of America Capital Investors (Banc of America), remain shareholders of Integra after the merger. Boston Ventures may appoint two Board members. Banc of America may appoint one Board member, unless Banc of America's ownership interest falls below 5%. The remaining two Board members are to be selected by the Board as a whole (at large members). According to the application, the Chief Executive Officer of Integra, Dudley R. Slater, will hold an additional seat on the Board. Therefore, WP X does not have the power to directly appoint a majority of the members of the Board, nor does WP X have control over the Board.
Only if Banc of America's shares were to fall below 5% would WP X have power to appoint four members.17 Even under this scenario, WP X does not have direct control over the Board. Under such
circumstances, WP X would have sufficient votes on the Board to control the selection of the two at-large members, and may thereby indirectly control the composition of the Board.18 However, as applicant notes, under the Shareholders' Agreement, the two at-large Board members may not be affiliated with any primary institutional investor, such as WP X.19 Therefore, WP X would not have control over the Board even under the scenario where Bank of America shares fall below 5%.
Applicants also argue that WP X has not acquired control of Integra, because certain major corporate transactions, such as a sale or merger; the sale, lease or transfer of assets; the payment of dividends; the issuance of equity securities; material changes in Integra's business; the replacement of certain senior executive officers; and amendment of the Shareholder's Agreement, require approval by either a 66-2/3% or a 60% supermajority of the shareholders, and WP X does not have a 66-2/3% or 60% ownership interest.
In addition, WP X argues that a transfer of control requiring our prior approval under Section 854 has not occurred because WP IX will not have actual or working control of the day-to-day operations of Integra and its subsidiaries. Applicants state that the day-to-day business of Integra is managed by the officers of Integra, subject to the oversight of the Board, and that since WP X does not have the power to appoint a majority of Integra's Board or its senior officers, WP X does not control day-to-day operations of Integra or its subsidiaries.
Past Commission decisions do not establish a "bright line" test for determining when a transfer of control subject to our review under Section 854 has occurred.20 The Commission has not promulgated regulations to define "control" in terms of clearly identifiable characteristics applicable to all cases.21 Instead, the Commission has relied on a fact-specific, case-by-case analysis.22 While some of our older decisions refer to a transfer of "actual or working control" as the threshold for Commission review under Section 854,23 other decisions focus on whether the acquiring entity, directly or indirectly, will possess the power to direct or cause the direction of the management and policies of the utility, or has the ability to exercise this control.24
In several past decisions, the Commission has rejected the concept that Section 854 does not require our advance review of a transfer of a utility when the transaction will not change the utility's underlying operations and day-to-day management. For example, in D.96-02-061, we stated that:
...we have sometimes suggested that we lack jurisdiction under the statute to consider particular situations in which formal ownership changed while the underlying operations and day-to-day management remain intact, and in such situations we would sometimes dismiss the application as unnecessary. Because of the variety of arrangements which are possible, however, we now think it preferable to continue development of this area of our responsibility on a case-by-case basis...Thus, we will subject this application and future applications to a public interest inquiry to determine if changes in control arrangements have any necessary impact on the public interest. We do this to assure that changes which have the potential to involve public policy implications are brought to our attention. Adopting a rule that preserving intact existing management be considered no change in control might mask transactions in which the real substance has changed.
The Commission has consistently noted that "application of [Section] 854, and the degree to which issues of ownership and control have registered concern, all turn on the specific facts at issue."25 In D.03-06-069, we determined that a merger at the holding company level resulted in the indirect transfer of control of Wild Goose and required our advance approval under Section 854. The Commission reached this decision from the facts that the merger had resulted in the parent company's "ability to control its subsidiaries," and a large market share of the gas storage market. The specific facts of Wild Goose thus led us to require approval under Section 854.
The specific circumstances of that case, which led us to conclude that a significant transfer of control had occurred as a result of the merger, are not present in this case. For example, the WP X transaction has not resulted in WP X's ability to control the Board or its subsidiaries. The transaction has not consolidated market power or share for the telecommunications companies at issue. The transaction has also not affected the day-to-day management of the companies, nor will it affect the services that Integra and its subsidiaries currently offer. Moreover, the transaction will result in recapitalization of stock of the parent company of ELI, Eschelon, and Advanced Telecom, which are competitive carriers offering local and long distance services in California. The continued operation of these companies is in the public interest for our telecommunications market.
The Commission has not previously addressed a common transaction of this type before, nor do prior Commission decisions provide guidance on whether to consider transactions on a "fully diluted" basis for purposes of Section 854. Having reviewed the factors considered in past decisions of the Commission regarding Section 854, however, we find that a transfer of control has not occurred. We find that WP X has not acquired control of Integra, notwithstanding majority ownership of shares, because it has not gained the power to appoint a majority of the board, or establish control over the day-to-day business of Integra.26
While we find based upon this specific set of facts that the requirements of Section 854 need not be met, we hereby provide notice that we may not grant such exemptions to similar transactions in the future. The Commission maintains the authority to apply the requirements of Section 854 on a case-by-case basis, in light of the facts of each specific case. Moreover, should circumstances change resulting in a transfer of control of Integra, we have the right to examine any transfer of control pursuant to Section 854.
9 San Jose Water Co. (1916) 10 CRC 56.
10 D.07-10-001.
11 D.86-02-059 (In Re Pacific Telesis Group), D.86-12-090 (BellSouth Corp. and Mobile Communications Corp.), D.98-12-056 (MM Holdings Corp.), and D.96-02-061 (San Francisco Thermal.)
12 See D.93-11-063 (In Re Paging Network of San Francisco), D.96-02-061 (San Francisco Thermal).
13 See D.94-01-025 (In Re San Jose Water Company), D.90363 (WUI Inc. v. Continental Tel. Corp.)
14 D.87478 (In Complaint of Lee G. Gale v. Kenneth Teel, et al.); D.03-06-069 (Wild Goose).
15 D.03-08-079, cited by Applicants, does not directly state that the Commission should determine whether a transfer of control has occurred because of consideration of the ownership interest transferred on a fully diluted basis.
16 According to Applicants, WP X could appoint a fourth member to Integra's Board only if Banc of America's ownership interest on a fully diluted voting shares basis were to fall below 5%. In this case, Banc of America would not appoint a member of the Board.
17 Currently, Banc of America shares are not below 5% and therefore, this scenario has not occurred.
18 In this situation, WP X would have appointed four members, Boston Ventures would have appointed two members, Bank of America would appoint no members, and Slater, the Chief Executive Officer of Integra, would hold the remaining seat on the Board. WP X, Boston Ventures, and Slater would then vote to select the remaining two at-large members. Since WP X would have four votes, and Boston Ventures and Slater would only have three votes, WP IX could theoretically control the selection of the two large members.
19 Section 8.1(a)(ii)(E) of the Shareholders' Agreement states that the at-large members of the Board shall be "two (2) representatives not Affiliated with any Primary Institutional Investor designated by the Board (one of which shall initially be Richard A. Smith.) According to Applicant, Richard Smith is the former COE of Eschelon Telecom, Inc., a company acquired by Integra and for which WP X had no involvement.
20 D.03-06-099.
21 Id.
22 D.07-05-061.
23 For example, see D.90363 (WUI, Inc. v. Continental Tel. Corp (l979)), D.94-01-025 (San Jose Water Company and SJW Corp.).
24 See D.07-05-061, fn. 28.
25 See D.03-06-069 at p. 8.
26 We are not finding in this decision that the Commission should review transactions on a fully diluted or nondiluted basis. Instead, given that the stock acquisition was close to 50%, we are reviewing the other factors of this transaction to determine that no transfer of control has occurred.
