V. The Conditions in the Settlement, Discussed According to the Requirements of Pub. Util. Code § 854(b) and (c)

A. The Settlement

Because some of the settlement language is imprecise and subject to interpretation, the Commission held half a day of hearing on the settlement in order to more clearly understand its terms. Appendix B sets forth the settlement, as annotated by the Commission's specific understanding of the terms of the settlement where appropriate. We approve the settlement based on that understanding and as further set forth in this decision.

Before discussing the settlement according to the individual requirements of § 854(b) and (c), we comment on one overarching issue, that is, the Commission's ability to enforce the settlement, because the settlement's value is significantly diminished if the Commission cannot enforce it. MSD and Thousand Oaks criticize the settlement because they believe RWE, Thames, and American have not submitted to the Commission's jurisdiction to enforce it.

We disagree. Pursuant to § 854, the Commission has broad authority to approve or deny applications for transfers of utility ownership or control. Implicit in this authority is the right to place reasonable conditions upon the transferor or transferee, should the need for conditions arise. This decision includes such conditions, both as embodied in the settlement and as further directed. The right to impose these conditions carries with it the right to enforce the conditions at the Commission in Commission proceedings. "Without the latter right, the former is meaningless." (Re San Diego Gas and Electric Company, D.86-03-090, 20 CPUC2d 660, 686; See also D.02-01-037, 2002 Cal.PUC LEXIS 7, as modified by D.02-07-044.)

Applicants do not dispute our authority to enforce the conditions we approve in today's decision. Applicants' witnesses for both RWE and Thames and American testified that by signing the settlement, they intended the settlement conditions bind RWE, Thames, and American, as well as Cal-Am.⁷

We hold that the Commission can enforce the settlement and additional conditions approved in this decision at the Commission in Commission proceedings. We next embark on a more detailed review of the settlement terms.

B. § 854(b)(1)-Provides Short-Term and Long-Term Economic Benefits to Ratepayers

1. Summary

The settling parties believe the settlement provides ratepayers with both short-term and long-term economic benefits, including quantifiable and non-quantifiable benefits. These include (a) sharing best practices; (b) lowering Cal-Am's cost of debt; (c) deferring a rate increase; (d) implementing two public assistance programs; and (e) adopting affiliate transaction rules.

MSD and Thousand Oaks disagree, arguing that applicants have not, for the most part, quantified or performed any studies or analyses of cost savings, efficiencies, or other synergies savings that may be achieved as a result of the proposed transaction.

We find that the proposed transaction, with the conditions agreed to in the settlement as further conditioned by this decision, provides ratepayers with sufficient short-term and long-term benefits so that we can approve the transaction. First, we briefly discuss each of the benefits asserted by the settling parties. We then include a broader benefits discussion in light of the specific nature of this transaction.

2. Sharing Best Practices

Applicants testified that one of the principal benefits that Cal-Am and its ratepayers would receive from the proposed transaction is the sharing of best practices. These include the following:

a) Security

Applicants believe that Thames, with water operations around the globe, has established and tested security protections that American currently does not have, due to Thames' considerable experience in operating water facilities and systems in regions with heightened ongoing security concerns (i.e., in Great Britain, which has been subject to threat by the IRA for decades, and in the Middle East, which has been problematic since at least the Gulf War.) Applicants also believe that while American currently has secure facilities, it can improve, and Thames will provide American faster access to additional cost-effective security protections. MSD argues that there is no security benefit to this acquisition because American's facilities are already secure.

The record indicates that American has conducted secure water operations. However, the Service Company's Senior Vice President, Daniel L. Keheller, testified that while he believes American currently has secure facilities, there is more that they can do, and he believes that Thames will provide American faster access to cost-effective security protection. We find such enhanced access to additional security protections, although monetarily unquantifiable at this time, to be a benefit of this transaction.

b) Design and Build

Applicants believe Cal-Am will benefit by using the design/build process employed by Thames Water as opposed to the design/bid/build process Cal-Am uses for construction. Their witness, Andrew M. Chapman, provided testimony on how this process has already benefited Elizabethtown Water Company, which Thames recently purchased.⁸

Condition 29 of the settlement commits applicants to "seek to employ Thames' advanced project delivery experience to compliment American's capability." Based on Cal-Am's forecasted capital expenditures for a full rate cycle, applicants believe such savings would reduce its capital expenditure requirements by about $2.2 million. We find using Thames Water's design/build process is a short-term benefit to ratepayers, because reducing capital costs should translate into lower rates than would have occurred if the improved construction methods were not used.

c) Research and Development (R&D)

Applicants expect Cal-Am to benefit significantly from Thames Water's more extensive R&D. American has a $3 million R&D budget and a staff of 14, while Thames Water has a $13 million R&D budget and a staff of about 100 focusing on water production and delivery. Applicants specifically identified desalinization as one area where Cal-Am might immediately benefit, because Thames Water is a world leader in the areas of water reuse and desalinization. Applicants plan to share Thames' existing R&D with American at no cost. According to applicant, Thames Water's ability to significantly use renewable power in London is also supported by RWE's very large R&D budget. Applicants also said that Thames Water developed cutting edge technology in network planning and modeling, pipe leak detection, pipeline renovation systems, and low dig and trenchless technologies. These best practices will also be available in order to improve Cal-Am's operations.

MSD and Thousand Oaks disagree that Thames Water's R&D will benefit Cal-Am's ratepayers. MSD believes that Cal-Am has failed to show that its own R&D programs are deficient, and it is unclear what the ultimate cost to Cal-Am will be for access to this R&D. According to MSD, even if ratepayers benefit in some way from this R&D, the record does not contain information for the Commission to make a cost/benefit analysis.

We find that access to R&D to be a substantial, albeit an unquantifiable benefit of this transaction, because Thames Water will share its embedded R&D with American at no cost, and Thames Water has had a substantially higher R&D budget than has American. Also, Condition 22 of the settlement requires Cal-Am to match in its future rate proceedings the cost of implementing any best practice with a reasonable estimate of savings or increased revenues, and Cal-Am will not implement the best practice if increased revenues or decreased expenses do not justifiably exceed the costs of such practices. This condition will ensure that the Commission will consider both the costs and savings of a best practice in Cal-Am's future rate proceedings.

d) Service Standards

Applicants explained that Thames Water has a 99.89% track record of compliance with the United Kingdom's drinking standards, and a 99.99% compliance record for wastewater effluent. Since 1998, Thames Water has invested in excess of $6 billion to enhance service quality, including constructing an advanced water treatment system and major renovations of water mains and sewage treatment works. This background should be beneficial in enhancing Cal-Am's future service quality.

e) Customer Service

In order to assist integration between the call center and the field service, Thames Water has developed a technology that provides for a direct, real-time link between the Customer Service Center system and the field technicians. We find that Cal-Am's customers can benefit from this system by having their problems ascertained, analyzed, and addressed by field personnel in a more accurate, timely, and efficient manner.

3. Lowering Cal-Am's Cost of Debt

Cal-Am ratepayers will benefit from this transaction because Cal-Am will have a lower cost of debt and cost of capital as a result of the transaction. RWE has an A+ credit and bond rating from Standard and Poors (S&P), and an A1 credit rating from Moody's. American Water Capital Corporation's (AWCC)⁹ comparable ratings from S&P are A- and BBB+, and Baa1 from Moody's. This means that RWE will be able to borrow money at a lower cost than AWCC under the current ratings.

MSD believes that applicants have not demonstrated that there will be material benefits from RWE's enhanced access to capital, arguing that American's embedded cost of debt will change only gradually as existing debt is retired and new debt is issued. MSD estimates the benefit for each customer would be about $1 per year.¹⁰ MSD also argues that applicants did not do any detailed analysis to quantify this benefit, and due to the fluctuating nature of capital markets, RWE's credit rating will change over time and in fact has recently been downgraded (although it is still higher than American's). According to MSD, the difference between RWE's and American's current credit rating is insufficient to demonstrate any material economic benefit over a sustained period of time.

Cal-Am's ratepayers have already benefited from RWE's higher credit rating in receiving a lower cost of debt as a result of this pending transaction. Kelleher testified that in December 2001, Cal-Am received, as part of a debt offering from RWE to AWCC, $123.5 million at a rate of 25 basis points less than what AWCC could have obtained on its own. This resulted in a savings, or benefit, to Cal-Am's ratepayers of about $300,000 per year, or about $1.5 million over a five-year period, which is the length of the bond.

Given the current credit ratings, Cal-Am's ratepayers should benefit in the future from this transaction due to RWE's access to capital at lower costs. In response to arguments that RWE would not maintain its credit ratings, applicants' witness Ahern stated that further downgrade is unlikely, explaining that RWE's high investment grade bond ratings are based upon both its strong historical financial statements and solid business fundamentals. Ahern also noted that S&P recently stated that RWE's acquisition-related event risk appears to have been reduced, and RWE's most recent financial statement supports this testimony.

Moreover, condition 19 in the settlement protects ratepayers because, for a period of five years following the close of the transaction, Cal-Am agrees it will not seek a cost of new debt greater than it would have sought if American had remained an independent entity.¹¹ When asked by the ALJ to clarify this condition, the settling parties agreed it meant that, for the five year period described above, Cal-Am will not seek a cost of debt greater than A- for secured debt and Baa1 for senior unsecured debt. Thus, for this five year period, ratepayers will benefit by any further reduction on the cost of debt provided by RWE, but are guaranteed a cost of debt no higher than American's current cost of debt. This is a significant benefit for ratepayers.¹²

4. Deferring a Rate Increase

Condition 1 in the settlement requires Cal-Am to defer a rate increase for one year in each of its districts (stay out provision). Applicants did not quantify this benefit because they cannot know now what increases, if any, the Commission may order in future rate cases. Nonetheless, the settling parties believe this condition provides tangible benefits because it defers a rate increase where one is likely to occur.

MSD and Thousand Oaks argue that this asserted benefit is speculative, referencing the Cal-Am/Citizens merger, D.01-09-057, 2001 Cal. PUC LEXIS 826 * 50-51, where the Commission did not give weight to the stay out benefits Cal-Am claimed as quantifiable benefits in that proceeding.

The Cal-Am/Citizens merger is not analogous, because in that merger, where the Commission concluded that the stay-out provision was not a quantifiable benefit, the time for Cal-Am to have filed these rate cases had passed, and any rate increases were foregone whether or not the merger was approved. Thus, the alleged benefits were not dependent upon the Commission approving the Cal-Am/Citizens merger. Here, the stay out benefits are contingent upon whether the Commission approves this transaction, and Cal-Am has pending rate case applications for the Monterey, Sacramento, Felton, Montara, and Larkfield districts.

Even though Cal-Am is requesting a rate increase for Monterey, ORA requests a rate decrease of 8.4% for the year deferred by the settlement agreement. The settling parties argue that it is likely the Commission will order a rate increase because the water industry is highly capital intensive, that ratepayers are likely to see increases for years to come, and that the Commission has granted rate increases in the past, notwithstanding ORA's request to the contrary.

Generally, a rate increase deferral should benefit ratepayers to the extent the Commission orders a rate increase for Cal-Am. It may, however, pose the problem of "rate shock," if the rates deferred in one year are imposed on ratepayers the following year together with next the scheduled increase, and the two combined increases are large. For example, if the Commission were to order a rate increase for the Los Angeles districts, under the settlement, the tariffs implementing the rate increase would be deferred for a year and would then be imposed on ratepayers at the same time as the step increase.

We want to guard against the possibility of "rate shock," or a large rate increase occurring at one time. We therefore modify condition 1 so that in each instance where the rate increase is deferred, it may be implemented in the following year. However, the step or attrition year increase for that following year will also be deferred. Pursuant to Assembly Bill (AB) 2838¹³ requiring Cal-Am's districts to file general rate cases every three years, the districts would then begin a new rate case cycle.

Although we find this stay out provision as conditioned will benefit ratepayers to the extent the Commission orders a rate increase for Cal-Am, we cannot quantify on this record the likelihood of our ordering a rate increase in the future, or the amount of such increase, and therefore cannot quantify the benefits associated with this condition at this time.

5. Public Assistance Programs

Applicants have agreed to commit up to $500,000 of shareholder funds for two programs intended to benefit California ratepayers. Applicants have committed up to $50,000 a year for five years to help establish a low-income assistance program for Cal-Am's ratepayers. This commitment is embodied in Condition 23 of the settlement agreement.¹⁴

Applicants have also committed up to $50,000 a year for five years to fund a Small System Technical Advisory Team (SSTAT) that will provide short-term technical and managerial assistance to troubled water systems in California. This commitment is embodied in Condition 24 of the settlement agreement.¹⁵ Applicants would make available assistance in areas such as business practices, compliance with regulatory and water quality requirements, and technical, managerial, and operational support. This assistance would be temporary, with a view to transitioning the troubled system to an effective long-term solution.

Both MSD and Thousand Oaks believe that these programs offer no material benefit to ratepayers because they are ill-defined, and language of the settlement permits applicants not to spend anything on these programs.

The settling parties deliberately left the program parameters open, because these are pilot programs to be developed in conjunction with the Commission. We find these public purpose programs should benefit ratepayers if properly implemented. The Director of the Water Division should immediately designate Commission personnel to participate with applicants in developing these programs, and Commission personnel and applicants should hold their first meeting on these programs no later than 15 days from the effective date of this decision. The Director of the Water Division should explore whether existing programs comparable to each proposal exist, and whether these monies can more effectively be used directed toward these existing programs. We intend that applicants spend the fully allocated annual sum, and require applicants to file annual reports to the Commission's Water Division and ORA with an accounting of monies spent on each of these public purpose programs.¹⁶

6. Affiliate Transaction Rules

Applicants have agreed to a comprehensive set of affiliate transaction rules, which are incorporated in to the settlement. This is a benefit to ratepayers, because currently there are no standardized, Commission approved affiliate transaction rules that apply to transactions between Cal-Am and its parent and affiliates.

Some of the more notable rules include Rule 7 [requiring Cal-Am's affiliates to allocate common costs so that ratepayers do not subsidize Cal-Am's affiliates];¹⁷ and Rules 9 and 11 [requiring Cal-Am to price tangible and intangible goods or assets transferred to affiliates at the higher of cost or fair market value if the item was included in Cal-Am's rate base]; Rules 10 and 13 [requiring Cal-Am to develop a verifiable and independent appraisal of fair market value for goods and assets transferred to an affiliate]; and Rules 15 and 16 [requiring services to and from affiliates be priced so that Cal-Am ratepayers do not subsidize affiliates.] These rules are similar to the affiliate transaction rules the Commission adopted in Re Southern California Water Company, D.98-06-047, 80 CPUC 2d 580, 586-589, but modified by the settling parties to conform to applicants' corporate structure.

7. Discussion Regarding Benefits

MSD and Thousand Oaks argue that applicants have not met their burden in demonstrating that the above items are benefits of the transaction, largely because applicants have not, for the most part, quantified or performed any studies of savings or efficiencies, so that the Commission can immediately pass through a monetary benefit to ratepayers through a rate reduction. These parties argue that absent studies quantifying the alleged benefits, there is no basis for determining whether there will be net economic benefits as a result of the transaction, and how to equitably allocate them between ratepayers and shareholders.

We find that this transaction will generate both quantifiable and unquantifable short and long-term benefits. The quantifiable benefits include the $2.2 million benefits in implementing the design/build process, lowering Cal-Am's cost of debt (estimated at $1.5 million over five years from a recently-completed refinancing), and $500,000 over five years to implement two public service programs. Although remaining benefits discussed above are unquantifiable, we nonetheless find them to be valid and significant benefits in light of the nature of the transaction and the settlement agreement.

The motivation for this transaction is not synergies, or the savings that may result from merging two water companies, such as the mergers involved in CWS/Dominguez and Cal-Am/Citizens. Rather, through acquiring American, RWE and Thames seek to establish a large presence in North America. Although applicants believe operational benefits, which will translate to financial benefits, will accrue over time, and promise that ratepayers will receive these benefits, they state it is difficult to quantify the bulk of them at this time. In fact, applicants have promised they do not intend to make wholesale changes at American, and expect Cal-Am, for the most part, to operate as it has in the past.

Furthermore, unlike CWS/Dominguez and Cal-Am/Citizens, applicants here do not seek to pass through to ratepayers any costs of the transaction, including the acquisition premium, which they believe they are entitled to request pursuant to § 2720. (See Settlement Conditions 17 and 18 and discussion below.) Thus, applicants have waived any right they may have to request this premium, in part to convince us that the transaction is in the public interest. Also, the settling parties have proposed a ratemaking mechanism which commits applicants to pass through 100% of the future benefits of this transaction to ratepayers. Condition 20 requires applicants, for a full rate case cycle, to implement a mechanism to track the savings and costs resulting from the transaction, and a methodology to allocate all net savings, and to submit a detailed written description of this methodology in Cal-Am's future general rate case filings.

MSD criticizes condition 20 as vague, and believes that the ratemaking process is subject to applicants' manipulation so that 100% of the benefits will not be passed through to ratepayers. MSD believes it will be difficult to distinguish the alleged benefits of this transaction from the alleged benefits of the Cal-Am/Citizen's merger, which, under the terms of D.01-09-057, will largely accrue to shareholders in future rate cases. Thus, according to MSD, Cal-Am will have an incentive to attribute future benefits to the Cal-Am/Citizens transaction rather than to the instant one.

Applicants state that they will use the same mechanism to track the savings from this transaction as they have already implemented to track the savings from the Cal-Am/Citizens transaction. Other parties and the Commission also will review these tracking mechanisms in future rate cases, thus providing additional safeguards. Because there exists a future incentive for applicants to find savings attributable to the Cal-Am/Citizens merger rather than to this transaction, we hold here that applicants have the burden of establishing from which transaction the benefits accrue. If applicants do not meet this burden, the Commission will attribute the benefits to this transaction rather than to the Cal-Am/Citizens transaction, to assure ratepayers that they receive 100% of the benefits of this transaction.

We therefore find sufficient short-term and long-term benefits to this transaction to find it in the public interest. Because of the nature of this transaction, the fact that applicants will not pass on to ratepayers any portion of the acquisition premium or transaction costs, and the relevant settlement conditions, we make our finding regarding benefits on a record that includes less up-front quantification of ratepayer benefits than we would otherwise prefer.¹⁸

C. § 854(b)(2)-Equitable Allocation of Benefits

Pub. Util. Code § 854(b)(2) requires that ratepayers receive an equitable allocation of the forecasted total short-term and long-term benefits. According to the statute, an equitable allocation is not less than 50% of those benefits.

Applicants have agreed in conditions 17 and 18 not to pass on to Cal-Am ratepayers any transaction-related costs, and to forego the step up in rate base they believe is authorized by Pub. Util. Code §§ 2718-2720.¹⁹ Based upon applicants' representations and these conditions, we find that applicants are not entitled to recover either the acquisition premium or any transaction-related costs in current or future rates.

Applicants have agreed to pass on to ratepayers 100% of the transaction's benefits. Although many of the benefits are not quantified, applicants intend that ratepayers will realize these future benefits in rates. Condition 20 [requiring Cal-Am to track future savings and costs from this transaction] and condition 22 [where Cal-Am will assess the costs and benefits before implementing any of the best practices] help to assure that the ratepayers realize future benefits from this transaction. In order to most effectively implement condition 22, applicants shall track the (1) savings and increased revenues, and (2) the costs of implementing best practices in separate memorandum accounts.

Both MSD and Thousand Oaks believe that Cal-Am will in fact try to recover the premium or some transaction-related costs from ratepayers in the future, either through a reduction in service quality or through increased rates, and what they term the imprecision of the ratemaking process.

The settlement we adopt precludes applicants from passing through these costs to ratepayers. Further settlement conditions ensuring that Cal-Am's financial condition and service quality will not deteriorate as a result of the acquisition, discussed below, also mitigate these concerns. Pursuant to AB 2838, Cal-Am is now required to file general rate cases every three years, where the Commission will review Cal-Am's operations to ensure that these conditions are fulfilled.

Cal-Am convincingly argues it intends to recoup the premium from future growth opportunities, as well as obtaining operation and maintenance contracts, as applicants suggest. Although, as Thousand Oaks argues, there might not be additional growth opportunities in the Thousand Oaks area, applicants are focused on additional growth opportunities throughout the Untied States.

In its reply brief, MSD explained for the first time specifically how it believes RWE plans to recover at least a portion of the acquisition premium in rates. Essentially, MSD argues that as a result of this acquisition, RWE will pay American and Cal-Am shareholders in full for the premium they incurred in acquiring the water facilities of Citizens. This is so, according to MSD, because this transaction contains a $2.8 billion acquisition premium beyond the book value of the assets. MSD argues that once the shareholders are paid for their interest in American, there is no longer a justification for the Commission to set Cal-Am's rates in former Citizens districts above Cal-Am's cost of service to reflect and pay off the Citizens acquisition premium. According to MSD, to do so (as currently required by the Alternative Sharing Proposal adopted in D.01-09-057) would in fact require Cal-Am ratepayers in the former Citizens districts to pay in their rates a portion of the acquisition premium incurred by RWE. The ALJ requested further briefing from the settling parties addressing this argument.

Applicants respond that RWE will pay American's shareholders who own the shares at the time of sale $46 for each share of American's common stock, and that RWE has not agreed to pay American 2.6 times its book value. According to applicants, at the time of the transaction's closing, American's assets will include Citizens' assets, including the premium Cal-Am paid for the Citizens assets, and the premium is therefore simply an asset of Cal-Am.

In D.01-09-057, we approved an Alternative Sharing Mechanism in the context of the Citizens transaction, which is a separate transaction from the one we consider here. We therefore disagree with MSD and do not eliminate this mechanism because the monies Cal-Am will obtain as a result of the Alternative Sharing Mechanism are incorporated into the asset value of Cal-Am.

D. § 854(b)(3)-Not Adversely Affect Competition

The proposed transaction is an acquisition at the holding company level and does not involve the merger of two California utilities. After the acquisition, Cal-Am will continue to serve the same area as before the transaction. The Commission will have the same jurisdiction over Cal-Am as it does today. Neither RWE nor Thames own or control other water utilities in or contiguous to California. Also, water is a monopoly service. Therefore, this acquisition should not adversely affect competition.

E. § 854(c)(1)-Maintain or Improve Financial Condition

As discussed above, this transaction will benefit ratepayers by providing greater access to capital and a lower cost of debt.

MSD and Thousand Oaks argue that RWE's business ventures have greater risk than American's, and that this transaction will therefore expose Cal-Am's ratepayers to increased business and financial risk. MSD argues that the majority of RWE's revenues come from energy-related businesses, and not water utility and related services, as do American's. These RWE businesses include electric generation, coal mining, nuclear energy, energy commodity trading, and oil and gas exploration and development. MSD argues that the recent bankruptcies of energy trading companies and utilities illustrate this increased business and financial risk. MSD also argues that Cal-Am will have to compete for corporate resources, including capital, with other more lucrative investments.

Applicants offered testimony that RWE's diversified portfolio of businesses mitigates risk and constitutes a source of financial strength and stability, and that RWE's high investment grade bond ratings are based upon, in part, cash flow generation from its diversified portfolio of regulated businesses. Although the theory is that a diverse portfolio mitigates business risk, it is still important to examine the content of the portfolio.

Prior to its acquisition of Thames, the majority of RWE's business was providing electric service and electric energy-related products and services. The riskiest parts of RWE's business, such as energy commodity trading on electricity, gas, coal, and oil, constitute a very small portion of the business. After its acquisition of Thames in 2000, RWE became the third largest company in the global water business. Although a small part of RWE's business is comprised of riskier ventures, this business and financial risk is mitigated by RWE's diverse portfolio, as well as by certain settlement conditions.

Condition 2 ensures that RWE, Thames, and American will provide Cal-Am with the capital necessary for it to conduct its operations. Condition 2 states that "Cal-Am will be provided with adequate capital to fulfill all of its service obligations prescribed by the Commission and Cal-Am will comply with all applicable California and federal statutes, laws and administrative regulations."

MSD says this condition does not impose a binding obligation on RWE, Thames, or American, and does not assure the Commission that, should RWE encounter financial difficulty, Cal-Am's capital requirements will be given priority over competing capital requirements of RWE's other business interests. According to MSD, this condition does not provide an enforceable legal basis for the Commission to exercise jurisdiction over the financial assets of RWE which may be located in other countries.

Applicants disagree, stating that for the last quarter century, American has supplied Cal-Am the capital necessary for Cal-Am to fulfill all of its service obligations prescribed by the Commission, and that by condition 2, RWE and Thames commit to do the same. Thus, applicants understand, and we share the understanding, that condition 2 requires RWE, Thames, and American to provide Cal-Am with all necessary capital to fulfill all of its obligations prescribed by this Commission. Applicants do not promise to give Cal-Am's financial needs "first priority" because American has many United States regulated water subsidiaries in various states, and cannot prioritize Cal-Am to the exclusion of others. We do not believe the absence of "first priority" language with respect to financing is pivotal, because under the settlement, RWE, Thames, and American are required to provide Cal-Am with all necessary capital to fulfill its obligations.

Applicants also understand, and we share the understanding, that the term "capital" as used in condition 2 is broader than just investment in plant and facilities. Specifically, McGivern agreed and we find that the definition of "capital" in condition 2 is the same definition of capital used by the Commission in D.02-01-039, Investigation into Pacific Gas and Electric Company, Southern California Edison Company and San Diego Gas and Electric Company and their respective holding companies, Findings of Fact 5 and 6, 2002 Cal. PUC LEXIS 5 *57. This means that the term "capital" encompasses "money and property with which a company carries on its corporate business; a company's assets, regardless of source, utilized for the conduct of the corporate business and for the purpose of deriving gains and profits; and a company's working capital, " and is not limited to mean only "equity capital, infrastructure investment, or any other term that does not include, simply, money or working cash." (Id.) Finally, although it may be difficult to exercise jurisdiction over RWE's financial assets in other countries if financial difficulties arise, as MSD argues, the reverse is also true. If RWE encounters financial difficulties abroad, it will be difficult for those tribunals to exercise jurisdiction over Cal-Am's assets.

Other conditions mitigate any potential business or financial risk. Condition 5 provides that the transaction will not result in any adverse changes in Cal-Am policies with respect to financing, accounting, and capitalization. In condition 15, as we understand it, RWE, Thames, and American agree to maintain Cal-Am's equity at or about 35% of total capital, and if Cal-Am's common equity falls below 35% of total capital, then Cal-Am shall within 30 days provide a detailed written plan to return Cal-Am's equity capital to a minimum of 35%. Although this number is lower than Cal-Am's traditional equity ratio of 40-45%, it imposes a reasonable limit to trigger notification to this Commission.

As described above, condition 19 also guarantees that for five years, Cal-Am will not seek a cost of debt greater than that based on American Water Capital Corporation's current S&P credit rating of A- for secured debt and Moody's credit rating of Baa1 for senior unsecured debt. Condition 16 requires RWE and AWCC to notify the Commission in writing within 30 days of any downgrading to the bonds of RWE or AWCC, and will include with such notice the complete report of the issuing bonding rating agency. Although not stated in the settlement agreement, we require such notice to be made to the Director of the Commission's Water Division, the Commission's Executive Director, and ORA.

Condition 26 states that Cal-Am has historically transferred on a quarterly basis 75% of its net income to its parent as a dividend, and requires that if Cal-Am's payment of a dividend or transfer of funds to American represents more than the historical percentage of Cal-Am's annual net income, Cal-Am shall notify the Commission. In adopting condition 26, we require Cal-Am to provide the Commission with the required notice no later than 30 days prior to Cal-Am's payment of a dividend or transfer of such funds to its parent. Cal-Am shall provide this notice to the Director of the Water Division, the Commission's Executive Director and ORA.

The settlement's affiliate transaction rules provide additional protection that Cal-Am's financial position will be maintained or improved because these rules provide new protections to ensure that Cal-Am does not subsidize its affiliates. Also, pursuant to condition 27, Cal-Am's parent and affiliates will not acquire Cal-Am assets at any price if such transfer of assets would impair Cal-Am's ability to fulfill its obligation to serve or to operate in a prudent and efficient manner. We find the above-discussed conditions sufficiently mitigate the transaction's business and financial risk.

F. § 854(c)(2)-Maintain or Improve the Quality of Service

We find that Cal-Am's service quality, with the settlement conditions as modified, should not be adversely affected as a result of the transaction. Applicants agree in condition 6 that there will be no adverse impact on customer service as a result of the transaction, and that RWE and Thames will maintain American's and Cal-Am's levels of commitment to high quality utility service and will fully support maintaining Cal-Am's record for service quality. In addition, condition 5 provides that the transaction will not result in any adverse changes in Cal-Am policies with respect to customers, employees, operations, maintenance, or other matters affecting the public interest or utility operations.

Cal-Am has committed to maintaining fully operational field offices to maintain service quality, and has agreed not to close any local field offices as a result of this transaction. (See condition 7.) However, this condition does not preclude Cal-Am from making local operational changes in connection with integrating water and wastewater systems acquired in other transactions.

At the public participation hearings, a number of customers expressed their concern about foreign ownership of Cal-Am to the extent such ownership made it difficult for them to obtain responsive customer service. MSD and Thousand Oaks also voice concerns about foreign ownership of Cal-Am.

Having Cal-Am representatives available locally is an important aspect of customer service. Condition 7 mitigates against this potential lack of responsiveness by providing that the local field offices will not be closed as a result of this transaction. However, the next sentence in condition 7 gives management full discretion to consolidate for any other reason, and severely diminishes the effectiveness of this condition. We therefore impose the following further condition. During the five years following the completion of this transaction, applicants shall not close any of Cal-Am's existing field offices for any reason without first receiving this Commission's permission to do so through filing an application.

Additionally, Cal-Am has recently routed its calls to American's National Call Center located in Illinois. American has developed service level targets intended to place its call center in the top 25% of call center operations as measured by standard measurement techniques used in most major call centers. Completion of the Citizens acquisition on January 15 and subsequent integration of Citizens into the call center resulted in some performance declines. Cal-Am provided the following data with respect to: (a) number of calls answered within 30 seconds; (b) percentage of customers who hang up after entering the queue to speak with a call center representative (abandonment rate); and (c)  percentage of calls answered and resolved by the first operator contact (first call effectiveness).

	Target	Week Ended 1/12/02	Week Ended 8/02/02
% of calls answered within 30 seconds	> 80%	86%	61%
% of calls abandoned after 30 seconds	< 5%	1%	7%
First call effectiveness	>85%	Not available	90% (average for July 2002)

We do not have the record here to comment on whether Cal-Am's targets are too high, but we believe Cal-Am should be, at the very least, meeting its own internal targets. In order to mitigate customer concerns about lack of responsiveness due to foreign ownership, we require Cal-Am's customer call center to meet the above targets for each of the categories listed above, averaged on a quarterly basis. We require that, for five full years following the effective date of this decision, Cal-Am shall make quarterly filings listing the above service quality targets, as well as the rates actually achieved. Cal-Am shall file these reports with the Director of the Water Division and ORA, on January 15, April 15, July 15, and October 15, commencing on the first quarter following the effective date of this decision. The reports shall be for the preceding three months (the January filing will be for October -December, etc.). The Commission may examine these reports in Cal-Am's general rate case or other appropriate proceeding.²⁰

Cal-Am has also agreed that the transaction will not cause it to diminish staffing that would result in service degradation. (See condition 12.) As discussed above, RWE, Thames, and American agree that Cal-Am will have the necessary capital to meet its future service obligations. As mitigated by the settlement and the further conditions we impose, we find that the transaction should not adversely affect Cal-Am's service quality.

G. § 854(c)(3)-Maintain or Improve the Quality of Management

Certain settlement conditions attempt to ensure that there will be no adverse impacts on Cal-Am's management and management structure. By condition 9, applicants agree that there will be no change of Cal-Am's operational control as a result of this transaction. We interpret this condition as binding on RWE, Thames, American, and Cal-Am, and committing them not to change Cal-Am's operational control as a result of this transaction. Additionally, condition 8, as we interpret it, provides that RWE, Thames, American, and Cal-Am shall not change Cal-Am's existing management and officers as a result of this transaction. MSD criticizes these conditions as illusory; however, the conditions as we interpret them, clearly place an obligation on RWE, Thames, American, and Cal-Am.

Condition 10 also prohibits Thames from making any layoffs of management until March 31, 2004, or one year after the transaction closes, whichever is later, thus ensuring continuity of management during this transitional period.²¹

MSD argues that the above conditions, as interpreted by the Commission, are still insufficient to ensure the proposed transaction does not result in a loss of local autonomy, control, and accountability for decisions affecting local water issues and concerns because Cal-Am will be part of the RWE corporate enterprise, which association will inevitably diminish the autonomy, responsibility, and accountability of local managers for local water issues and concerns. Thousand Oaks makes similar arguments.

Applicants' witnesses offered extensive testimony on the issue of local control, explaining their understanding that the water business is a local business, and that the operation of Cal-Am will not change as a result of this transaction. In addition to the conditions listed above, applicants have also given retention bonuses (paid by shareholders) for key managers who remain with Cal-Am for a period after the transaction is complete. Condition 4 provides that Cal-Am's books and records will be maintained and housed in California. Under condition 7, Cal-Am will maintain its business headquarters in California, and as discussed above, Cal-Am has also agreed not to close any of its district offices as a result of this transaction.

The City of San Diego dropped its opposition to the transaction in exchange for applicants' agreement to the following condition: The management of Cal-Am has and will continue to have full authority with regard to any decisions concerning Cal-Am's relationship with the City of San Diego including, but not limited to, any water supply and franchise agreements. We adopt San Diego's condition as part of our approval of this transaction. In fact, San Diego's condition is a functional equivalent of condition 9, where applicants agree not to change Cal-Am's operational control as a result of this transaction.

We add two further conditions to ensure management quality. Applicants have committed that they will not change operational control, nor the management or officers as a result of this transaction. However, no settlement condition addresses the makeup of Cal-Am's board of directors, which, according to McGivern, controls the overall management decisions of Cal-Am. Currently, all 10 Cal-Am board members are United States citizens, and two are California residents. Seven either currently hold or have retired from a management or director position in American.

Because Cal-Am's board of directors sets the policy and direction for Cal-Am, we believe it is important to ensure that the board is responsive to local concerns. We therefore further condition this transaction on the requirement that for a minimum of five years from the effective date of this order, a majority of the individuals appointed to serve on the board shall be United States citizens. Additionally, in order to ensure local input, if applicants make any changes to the current composition of Cal-Am's board, we require that in the future, at least 30% of the members of Cal-Am's board be California residents, as well as United States citizens, and further, be persons who are not employees of RWE, Thames, American, Cal-Am, or any RWE affiliated entity. Finally, we require that familiarity with interests and concerns in Cal-Am's service territory shall be an important consideration in appointing directors to serve on the board.²²

We also require applicants, for at least one year from the date of the consummation of the transaction or until March 31, 2004, whichever is later, to notify the Commission in writing within 10 days of any changes in Cal-Am's board of directors, corporate officers, or management personnel. Such notification shall be sent to the Director of the Water Division, the Commission's Executive Director, and ORA.

H. § 854(c)(4)-Be Fair and Reasonable to Employees

The settlement conditions ensure the transaction is fair and reasonable to Cal-Am's employees. The fact that the Union supports the transaction and is a party to the settlement also supports this finding.

Condition 10 states that the transaction will have no adverse impact on Cal-Am's employees. Specifically, by this condition, Thames commits to no layoffs until the later of either March 31, 2004, or one year after the transaction closes. This condition goes beyond applicants' initial agreement with the unions because it applies to both union and nonunion employees.

Applicants also agree that there will be no changes in compensation and the value of employee benefits will not diminish because of this transaction, and that the transaction will not result in any adverse change in Cal-Am's policies with respect to its employees. (See conditions 5 and 10.) Thousand Oaks believes that applicants have violated this condition by establishing a retention bonus program to keep key managers after the merger. We do not agree, and find the intent of condition 10 is, as explained by ORA, to assure employees that their compensation and benefits will not decrease as a result of the merger.

Under condition 11, applicants agree not to change existing union agreements as a result of this transaction, and to honor all collective bargaining agreements. Union representative Bernardo R. Garcia testified that applicants' commitment to honor all collective bargaining agreements is a very important provision to the Union, because some of the agreements did not have successor provisions that would apply to a new owner.

Garcia also testified that conditions 6 and 12 provide further assurances to employees on work stability after the transaction is complete, because employees are an important part of customer service. Under condition 6, the transaction will not have an adverse impact upon customer service, and under condition 12, Cal-Am will not allow the transaction to diminish staffing that would result in service degradation.

I. § 854(c)(5)-Be Fair and Reasonable to Shareholders

American's shareholders approved the acquisition. We therefore infer that this transaction is fair and reasonable to these shareholders.

J. § 854(c)(6)-Be Beneficial to State and Local Economies and Communities in the Area Served

As discussed in Sections V.B and V.C. above, California ratepayers will receive an equitable share of both short-term and long-term benefits of this transaction. Some of these benefits include, for example, committing up to $500,000 of shareholder funds for two program that will benefit California ratepayers, and thereby, local communities. Furthermore, in Section V.G, we discuss conditions which ensure that Cal-Am's quality of management will be maintained or improved, thereby maintaining Cal-Am's current ability to respond to local concerns. For these reasons, the transaction should be beneficial to the state and local economies and communities in the area served.

K. § 854(c)(7)-Preserve the Commission's Jurisdiction and the Commission's Capacity to Effectively Regulate and Audit Public Utility Operations in the State

As stated above, the Commission has the jurisdiction to enforce the conditions approved in this order against RWE, Thames, American, and Cal-Am at the Commission in Commission proceedings. Condition 3 states existing law, that is, that the Commission will retain jurisdiction over Cal-Am's rates and services. Furthermore, in condition 3, RWE, Thames, American, and Cal-Am commit not to assert that any foreign regulator preempts the Commission's review of the reasonableness of any cost. Condition 4 requires Cal-Am to continue to keep its books and records housed and maintained in California in accordance with Commission rules. As discussed in Section V.G, Cal-Am will keep its business headquarters in California, thus making its operations easily accessible to Commission staff.

The settlement contains further requirements which enhance the Commission's ability to exercise its jurisdiction. Under condition 21, Cal-Am has agreed to provide the Commission with English-language versions of the RWE annual reports, RWE quarterly shareholder reports, and the annual RWE audit reports. This condition also requires RWE, Thames, American, and Cal-Am to convert identified financial statements into U.S. dollars at the exchange rates existing at the end of the time period for such financial reports.

As part of Condition 25, applicants agree to abide by the affiliate transaction rules attached to the settlement to the extent they do not conflict with existing affiliate agreements approved by the Commission. As stated above, these affiliate rules are a benefit to ratepayers because there are currently no standardized, Commission-approved affiliate transaction rules that apply to all transactions between Cal-Am and its parent and affiliates. Affiliate Transaction Rule 3 requires Cal-Am to provide the Commission with an annual report of all transactions between Cal-Am and its affiliated companies. Affiliate Transaction Rule 2 states that Cal-Am and its affiliated companies will provide the Commission with access to books and records in connection with the Commission's exercise of its regulatory responsibilities in examining any costs which Cal-Am seeks to recover in rate proceedings. In response to questions from the ALJ, applicants agreed that the access promised under Rule 2 was greater than access associated with general rate case costs.²³ As we understand Rule 2, the Commission will have access to Cal-Am and its affiliated companies' books and records as necessary in the Commission's judgment to facilitate the Commission's obligation to regulate. Affiliate Transaction Rule 1 requires all applicants to make the officers and employees of Cal-Am's holding companies and affiliates available to appear and testify in Commission proceedings if Cal-Am cannot supply the appropriate personnel to address staff's concerns.²⁴

For the Commission to ensure applicants are complying with the Affiliate Transaction Rules, and to preserve the Commission's capacity to effectively regulate and audit public utility operations in the State, we further condition approval of this application on RWE, Thames, American, and Cal-Am being subject to Pub. Util. Code § 797.²⁵ Although these statutes by their terms do not apply to water utilities, it is necessary that they apply in this instance in order to give effect to the Affiliate Transaction Rules. As mitigated by the settlement and additional conditions, the transaction preserves the Commission's jurisdiction.

L. § 854(c)(8) - Provide Mitigation Measures to Prevent Significant Adverse Consequences

We have discussed above certain additional conditions we impose in order to mitigate adverse consequences. (See also our discussion concerning § 854(d) below.)