5. Discussion
5.1. Objectives for Adopting Rules
The OIR called for consideration of the proper goals and objectives for rules regarding affiliate transaction rules and the use for non-tariffed utility services of regulated assets and employees included in revenue requirements.
Our overall objectives are consistent with the goals articulated in the OIR, and can be simply stated:
1. Ensure ratepayers pay reasonable rates and receive high service water quality,
2. Ensure water and sewer utilities have the opportunity to earn reasonable profits so as to provide a high quality of service,
3. Prevent utilities from assisting their affiliates to unfairly compete against other firms, and
4. Avoid imposing rules which would cause excessive burdens on utilities, as compared to public interest benefits.
These are longstanding and well-established objectives for utility regulation in general, and these objectives are directly applicable to the development of the rules at issue here. These objectives are consistent with the Commission's goals stated in the OIR that these rules should be applied uniformly to all similar utilities; that cross-subsidy of affiliates by the utilities should be prevented; and that anti-competitive behaviors of the utilities, if any, should also be prevented.
Protecting ratepayers and ensuring utility financial integrity are traditional objectives which provide the balancing act of utility regulation. Investor-owned water and sewer utilities cannot consistently provide a high quality of service to their customers without the opportunity to earn reasonable profits. At the same time, ratepayers should only pay rates high enough to allow the utility the opportunity to earn reasonable profits, and neither guarantee such profits nor provide ongoing opportunities to earn excessive profits (the reasonable level of profits, or rate of return in regulatory parlance, is determined by this Commission).
The rules we adopt today must be consistent with these objectives. The adopted rules should not lead to higher rates (or keep rates higher than otherwise) without corresponding value to ratepayers; such rate levels would be considered unreasonable. Nor should the adopted rules lead to sustainably higher profits; in this situation, rates would be unreasonable and should decrease. At the same time, the adopted rules should in no case harm the ability of the water and sewer utilities to provide high quality service, or lead to a decreased opportunity for the utility to earn a reasonable profit.
As an example, water and sewer utilities should not be allowed to employ personnel at ratepayer expense whose sole functions are to work with utility affiliates (whether directly under the control of the utility or not) for the provision of non-tariffed products and services. These functions are not the core functions of the regulated utility, and would result in higher rates than necessary. At the same time, personnel may be properly hired by the utility and have some of their time allocated to (and thus paid for by) utility ratepayers and other time allocated to other entities. For such personnel (as well as shared equipment and other assets), costs can be allocated between the utility and other entities in general rate cases, in conjunction with rules established in this proceeding.
Objective #3 is a broader public interest objective which is needed to ensure that affiliates of water and sewer utilities do not gain an unfair competitive advantage through leveraging utility assets in a way which would harm ratepayers and/or the competitive market. This objective is consistent with the goals of the proceeding as discussed in D.09-04-012 (and agreed upon by parties during workshops) that cross-subsidy of affiliates by the utilities should be prevented, and that anti-competitive behaviors of the utilities, if any, should also be prevented.
Water and sewer utilities should not be able to increase rates (or keep rates higher than they otherwise would have been) to captive ratepayers in order to subsidize unregulated, competitive endeavors, regardless of where such endeavors fit into the corporate structure. Such action would both be unfair to ratepayers and allow the utility (and/or its affiliates) to lower prices for competitive activities to the disadvantage of other competitors. It is not our objective to protect other competitors per se; however, we have a public interest objective to ensure that regulated monopoly assets are not used to harm the overall competitive market.
In general, we will strive to prevent water and sewer utilities from conferring market power on their affiliates to the detriment of the marketplace. However, we differentiate between benefits provided to affiliates based on subsidies and discrimination in favor of affiliates - both of which we seek to prevent - and benefits provided to affiliates simply based on association with the utility. The latter provide no harm to ratepayers and, while potentially conferring a competitive advantage to an affiliate, are less likely to harm the competitiveness of the marketplace. We recognize that this is a difficult balancing act, requiring clearly-written and consistent rules.
CWA opposed many of the Staff Proposed Rules, proposed numerous changes and deletions as reflected in the Workshop Report, and argues for further scaling back of some rules in comments. Beyond comparisons to the energy industry, CWA bases its positions on: (a) an inherent lack of competition in core water service, (b) lack of affiliate competition in utility service areas, and (c) the ability to allocate costs among affiliated entities in general rate cases. CWA and individual water companies essentially argue that we should eliminate many current rules; instead, our focus is to provide consistent rules in line with our objectives. Six of the Class A water utilities have had affiliate transactions rules in place for many years; none of these companies raised significant concerns about compliance with current rules.26
While each of the three CWA arguments has some basis, these points do not obviate the need for comprehensive and detailed affiliate transaction rules such as those in place already for some water utilities. Ensuring reasonable rates requires that the relationship between the utility and its affiliates be transparent, and that the regulated revenue requirement is not the source of funding for competitive or unregulated ventures. Affiliate transaction rules which are consistent across the industry and consistently applied to each utility will ensure transparency and help ensure reasonable rates. Reasonable rates satisfy our objective to ensure utility financial integrity.
We note that water utilities do, in fact, have affiliates operating in their own service territory. By definition, each utility parent company operates in the utility territory. In addition, San Jose Water Company has an affiliate called the San Jose Land Company which operates in the utility territory. Also, Great Oaks has an affiliate named Great Oaks, LLC that operates in its service territory. Our objective to prevent utility subsidies to affiliates is not intended to stifle competition or limit formation of affiliates, but to ensure fair competition.27
The rules we adopt today do not replace the framework of general rate cases; the rules enhance our ability to conduct these proceedings because the affiliate transaction rules can and will be applied in general rate cases consistently across the water industry, eliminating the current hodgepodge of rules. Objective #3 - ensuring fair competition - is an additional, critical factor in establishing transparent affiliate transaction rules, so that the utility cannot unfairly leverage its monopoly resources to harm competitive or potentially competitive markets. However, the objective of ratepayer protection stands on its own merits, without consideration of competitive issues.
Objective #4 - ensuring no undue regulatory burden - is a theme echoed by parties in their comments. We keep this objective in mind throughout this decision, choosing to retain current rules or impose new rules only when there is commensurate benefit to ratepayers and the public interest. While there is no specific analytical metric available to calculate a cost/benefit ratio for any rule, there needs to be a clear rationale which justifies the effort required to comply with each rule.
Other possible objectives have been discussed in the proceeding which we do not consider as appropriate for developing rules in this proceeding. For example, while no party specifically calls for competition in the core utility business of proving safe water and sewer service to customers, we wish to be clear that we have no intent of introducing competition in these areas.
Finally, we do not start with an objective to essentially duplicate the energy affiliate transaction rules for the water and sewer utilities. We recognize, as all parties agree, that there are significant differences between the regulated energy industry and the regulated water and sewer industries in California. The rules we develop here must consider the unique characteristics of the regulated water and sewer companies. Further, we agree with CWA and other parties that there are certain market conditions in the energy industry, such as limited retail competition, which do not exist in the water and sewer industries.
At the same time, we cannot ignore that there are significant similarities among regulated industries. The OIR specifically called for consideration of whether any of the affiliate transaction rules applicable to large energy utilities should be included in affiliate transaction rules for water and sewer utilities, and consideration of the use of regulated assets and personnel for non-tariffed purposes. The most important similarity is that both the regulated energy and water and sewer utilities are monopolies that provide essential services to their ratepayers. Further, while there are significant differences in industry structure and the structures of individual utilities, energy, water, and sewer utilities have (or may have) structures which include parent companies, regulated affiliates and unregulated affiliates.
The combination of regulated monopoly provision of essential services and complex corporate structures requires us to consider parallels in rules for affiliate transactions for energy, water, and sewer utilities. We reject CWA's contention that the energy affiliate transaction rules were developed solely in response to restructuring of the energy industry. Many of the energy industry affiliate transactions rules stem from holding company decisions before the energy restructuring era; most of those rules are still in effect. Similarly, affiliate transaction rules for water utilities date back to 1985.
As the consumer parties point out, there have been a number of instances in the water industry where concerns have arisen about the relationship between water utilities and their affiliates. Much of the discussion in the Commission's energy holding company decisions and affiliate transactions decisions (with the exception of discussions applicable to electric restructuring) is applicable to the water and sewer industries. Indeed, many of the adopted water holding company rules are parallel to those in place for the energy industry. The rules we adopt today are intended to address these similar concerns.
There is no contradiction between considering inter-industry parallels and avoidance of a rote grafting of energy rules onto the water industry. Instead, it is entirely appropriate to look to the generic energy rules, as well as the current rules for five water utilities, for guidance where appropriate when creating generic rules for the water and sewer industries. At the same time, we will make appropriate changes, deletions and additions to the energy rules to ensure that the final rules are crafted with a clear understanding of their impact on the water and sewer industries. We will look at each possible rule to ensure the different size and circumstances of the water and sewer utilities, and individual firms within the industry, are taken into consideration.
In the following sections, we will discuss each of the affiliate transaction rules proposed by staff. The Workshop Report lists seven Staff Proposed Rules as Bucket 3 issues, where no consensus was possible. In several cases, the water utilities fundamentally oppose the proposed rules. We will discuss the seven Staff Proposed Rules individually in the appropriate section, along with many of the Bucket 2 issues. While not all issues are discussed individually, significant controversies are addressed. Unless specifically noted, the Bucket 1 consensus issues are generally adopted as proposed by the parties.
5.2. Commission Authority With Regard to Utility Affiliates
There are no statutes that specifically authorize the Commission to establish affiliate transaction rules for water and sewer utilities. However, as discussed below, our authority to establish these rules derives from Pub. Util. Code, including §§ 451, 701, 706 and 851.
A review of court decisions shows that the Courts have broadened the Commission's authority over affiliate corporations in past decades and this history is important to interpreting the law today. In 1950, in Pacific Telephone & Telegraph Co. v. Public Utilities Commission, the California Supreme Court determined that the Commission only had jurisdiction over affiliated corporations to the extent that the Legislature expressly provided.28 The following year, in response to this stringent ruling, the Legislature passed § 701 to give the Commission jurisdiction over "all things...which are necessary and convenient" to the supervision and regulation of public utilities. Subsequent cases enforced this expanded jurisdiction by determining that the absence of any specific mandate did not necessarily bar the Commission from regulating an issue.29 Furthermore, if the Commission's action was motivated by a desire to improve services to customers, § 701 provided the Commission with the necessary authority.30
The Commission has authority under § 851 to review any water or sewer utility effort to "sell, lease, assign, mortgage, or otherwise dispose of or encumber the whole or any part of its...line, plant, system, or other property necessary or useful in the performance of its duties to the public..." In addition, § 852 provides that "No public utility, and no subsidiary or 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 or by virtue of the laws of this state, without having been first authorized to do so by the commission; provided, however, that the commission may establish by order or rule categories of stock acquisitions which it determines will not be harmful to the public interest, and purchases within those categories are exempt from this section." Next, § 853 provides further guidance regarding ownership changes and transactions.
Under § 854(a):
No person or corporation, whether or not organized under the laws of this state, shall merge, acquire, or control either directly or indirectly any public utility organized and doing business in this state without first securing authorization to do so from the commission. The commission may establish by order or rule the definitions of what constitute merger, acquisition, or control activities which are subject to this section. Any merger, acquisition, or control without that prior authorization shall be void and of no effect. No public utility organized and doing business under the laws of this state, and no subsidiary or affiliate of, or corporation holding a controlling interest in a public utility, shall aid or abet any violation of this section.
The Commission asserted its authority to adopt affiliate transaction rules for energy utilities in D.97-12-088. The Commission summarized this authority in D.97-12-088 as follows:
The Commission has the power and the obligation under Article XII, section 6 of the California Constitution and §§ 451, 701, and 761 of the California Public Utilities Code to actively supervise and regulate natural gas and electric public utilities in California and do all things which are necessary to ensure adequate and reliable public utility service to California ratepayers at just and reasonable rates. See Camp Meeker Water System, Inc. v. Pub. Util. Comm'n (1990) 51 Cal.3d 850, 861-862; Sale v. Railroad Comm'n (1940) 15 Cal.2d 607, 617.
The only court decision to expressly address the issue of the Commission's authority over affiliate corporations was a decision that granted the Commission limited jurisdiction to enforce conditions imposed on holding companies under § 854.31 This decision arose out of an investigation (I.01-04-002) that the Commission initiated in 2001 to determine whether the parent holding companies of three large California energy utilities violated the conditions imposed by the Commission during the formation of the holding companies. The utilities and their parent holding companies were made parties to the investigation.
Soon after I.01-04-002 was initiated, the three parent holding companies involved in the proceeding (PG&E Corporation, Edison International, and Sempra Energy) filed a motion to dismiss the proceeding as it pertained to them for lack of jurisdiction. The parent holding companies argued that they were not "public utilities" subject to Commission regulation. On January 9, 2002, the Commission issued D.02-01-037 to deny the motion to dismiss. The utilities and parent holding companies filed applications for rehearing of D.02-01-037 in February 2002. The rehearing applications were denied in D.02-07-044. The utilities and parent holding companies then sought judicial review. The California Court of Appeal, First Appellate District, affirmed the Commission's decision to deny the motion to dismiss for lack of jurisdiction.32
In its order affirming the Commission's decision, the First Appellate District repeatedly stressed that it was not ruling on the Commission's exercise of general regulatory control over the holding companies.33 This conclusion is nevertheless relevant due to the court's interpretation of § 701. The court explained that nothing in § 701 limits the statute's reach to public utilities, thereby allowing the statute to govern interactions with affiliate corporations.34 Furthermore, the court allowed the Commission to liberally construe § 701 as long as such an interpretation did not disregard express regulatory directives and the authority sought was "cognate and germane" to utility regulation.35
In light of the above, we conclude that we have authority to promulgate affiliate transaction rules for water and sewer utilities, as long as the rules are "cognate and germane" to utility regulation.
5.3. Rule I -- Applicability of Rules
This Rule identifies the jurisdiction of the Commission over utility activities with regard to their affiliates and the use of regulated assets for non-tariffed utility services, and the circumstances when the rules apply. Rule I, which consists of nine sub-rules, is adopted consistent with the discussion below, and consistent with our overall policies and objectives discussed in this decision.
5.3.1. Rule I.A -- Applicability to Different Utility Classes
The OIR did not limit the applicability of the rules to be developed here to any subset of regulated water and sewer utilities and their affiliates. Staff Proposed Rule 1.A states: "These (rules) shall apply to California public utility water and sewer corporations or companies subject to regulation by this Commission."
No party argues that the rules should not apply to Class A utilities. CWA would modify Staff Proposed Rule I.A to give the Division of Water and Audits (DWA) discretion to determine the extent that the affiliate transaction rules would be applied to Class B, C and D utilities. CWA would have the rules initially apply only to Class A utilities, because of minimal concerns about those companies leveraging market power or unfairly advantaging the few affiliates that may exist.36 TURN does not believe that DWA should have sole authority to decide whether to apply these rules to Class B, C or D utilities. Instead, TURN suggests allowing these utilities to request an exemption from the rules through the filing of a Tier 3 Advice Letter. 37 DRA suggests that specific criteria should be developed for granting exemptions, but does not enumerate such criteria.
While the rules we adopt today could in theory be applicable to any water or sewer utility which has affiliates, the practical concerns driving the adoption of the rules decrease substantially with smaller sized utilities. An exemption process would be a resource-intensive method of considering applicability. We agree with the consensus among parties that these rules should be applied uniformly to all similar utilities. Allowing DWA the discretion to determine which non-Class A utilities should be exempt could lead to a lack of uniformity.
Certainly, the concerns which give rise to these rules decrease with smaller size. Class B utilities have the greatest potential for concern among the remaining companies. To promote uniformity and certainty and focus resources on the utilities with the likelihood of significant concern, we will apply the rules adopted herein to all Class A and B water and sewer utilities, but not to Class C and D water and sewer utilities.
Staff Proposed Rule I.B states: "For purposes of a combined water and sewer utility, these (rules) apply to all utility transactions with affiliates engaging in the provision of a product that uses either water or sewer services that relate to the use of water or sewer services." Staff Proposed Rule I.C states: "These (rules) apply to transactions between a Commission-regulated utility and another affiliated entity..." In combination, these Staff Proposed Rules apply the affiliate transaction rules to water and sewer utilities and all of their affiliates, unless there is an exemption.
TURN argues that the affiliate transaction rules should apply both to transactions between the regulated utility and unregulated affiliates, and also between affiliated regulated utilities. TURN contends that applying the affiliate transactions rules consistently to all transactions will increase the transparency of the process for the public as well as the Commission.38 CWA argues that the draft rules should be modified to apply only to transactions between the regulated utility and unregulated affiliates, because the operations of regulated affiliates will be examined in general rate cases.
We agree with CWA that there is sufficient regulatory oversight in general rate cases to deal with transactions between regulated entities, as long as both regulated entities are rate-regulated by this Commission or a utilities Commission in another state. We will adopt modifications to the Staff Proposed Rules to this end, and combine them into a new Rule I.B. However, we adopt Rule IV.B to prevent regulated utilities from subsidizing affiliates, including their regulated affiliates. We also modify Rule I.B to recognize that the adopted rules encompass the use of regulated assets for non-tariffed utility services, in addition to affiliate transactions.
In comments on the Proposed Decision, CWA suggests adding language to Rule I.B so that the Rule would "apply to transactions between a Commission-regulated utility and another affiliated entity that is engaged in the provision of products that use water or sewer services or the provision of services that relate to the use of water or sewer services in the state of California" (proposed additional language in italics). This language would generally parallel language in the energy industry rules. We agree that this clarification is appropriate, as we are generally concerned with market power issues only if there is some connection to water or sewer services (examples would include affiliates involved in plumbing or insurance for water lines). We will not limit applicability to California, as ratepayer subsidies and/or market power would apply out of state as well.
Staff Proposed Rule I.G states: "Existing Commission rules for each utility and its parent holding company shall continue to apply except to the extent they conflict with these (rules). In such cases, these (rules) shall supersede prior rules and guidelines..." Staff Proposed Rule I.H states: "Where these (rules) do not address an item currently addressed in a utility's existing rules, imposed by this Commission, which govern that utility's transactions with its affiliates(s), the existing utility-specific rules shall continue to apply for that item only."
All parties agree that in order to provide certainty, the rules adopted here should supersede existing rules where there is a conflict. Parties also agree that the Commission may add future rules. TURN argues that these rules should be complementary to existing rules, which may be utility-specific, as existing rules can fill in the interstices between the rules adopted today.39 CFC and DRA agree. CWA proposes to delete proposed rule language that would make it a rebuttable presumption that existing Commission rules for each utility or parent company would still apply except where those rules conflict with those adopted today.
The rules we adopt today are wide-ranging, but not all-encompassing. We determine that the affiliate transaction rules we have adopted for specific utilities in the past should be superseded in many or most cases. As anticipated by the OIR, we find that regulatory consistency would be improved by adopting standard affiliate transaction and non-tariffed utility service rules in a single rulemaking. We recognize that there may be current rules that are outside of the boundaries of the rules adopted here; these rules will continue to apply. However, it is not our intent that parties should be able to pick and choose which rules (existing or new) should apply. We will modify the language from Staff Proposed Rules to include a rebuttable presumption that the rules adopted today apply. In this way, only older rules clearly outside of the bounds of the new rules will not be superseded. The adopted Rules are Rule I.D and I.E.
As discussed in the context of Rule VII, we specify that rules developed in holding company decisions pertaining to financial obligations of parent companies are not superseded by the rules adopted today.
In comments to the Proposed Decision, Suburban Water seeks clarification that interim affiliate transaction rules adopted in D.10-09-012 on September 2, 2010 would be superseded by the rules adopted in today's decision. We agree with Suburban and modify Ordering Paragraph #2 to clarify this point.
5.3.4. Rule I.G and Rule I.H -- Applicability of Rules to Operations Outside of California
Staff Proposed Rule I.K (now Rule I.G) would allow water and sewer utilities to seek an exemption from the rules for "transactions between the utility solely in its capacity serving its jurisdictional areas wholly outside of California, and its affiliates." The Commission does not have the authority to regulate the operations of utilities and their affiliates in other states. However, the Commission does have the authority - and has consistently exercised the authority - to adjust rates for regulated utilities which operate in California to account for transactions with their affiliates, including affiliates that operate entirely outside of California.
DRA would add the words "if such out-of-state operations do not affect the utility's operations and the operating costs inside California." CWA supports the proposed rule, but without the DRA addition.40
As proposed, the rule allows utilities to seek exemptions for affiliate transactions related to out of state operations of the California utility, but does not provide any standard for considering the exemption request. DRA's suggestion appropriately clarifies the standard to be used in seeking exemptions to this rule. However, we will add the word "substantially" to DRA's language, so that affiliates of out of state utility operations with de minimus contact with the California utility can still be exempted from the rule. We will adopt the Staff Proposed Rule to allow for the utility to file for an exemption for affiliate transactions related to out-of-state utility operations, with the DRA language added.
We also address the question of affiliates with wholly out-of-state operations in Rule I.H. Our concerns about anti-competitive and market power issues pertain to our jurisdiction in California. We intend that our rules apply to affiliate transactions outside of California only to the extent that such transactions impact the California utility. Therefore, we will exempt affiliates with wholly out-of-state operations from Rule III.B (market advantages to affiliates) and Rule III.C (non-discriminatory access). However, affiliates with wholly out-of-state operations will be subject to other rules such as Rule VIII (regulatory oversight) as they impact the California utility.
5.4. Rule II -- Definitions
This Rule defines a number of terms for the purposes of the rules, including "Parent Company," "Utility," "Water Utility," "Sewer Utility," "Affiliate,"41 "Costs" (including "Direct Costs," "Direct Overhead Costs," "Indirect Overhead Costs," and "Fully-Loaded Costs"), "Transaction," "Property," "Real Property," "Customer," "Customer Information," and "Cross-subsidy." As with other rules, the origin of these definitions was the energy industry rules first adopted in 1997. Several definitions were agreed to in workshops, but parties continue to disagree in a number of areas. These definitions are adopted consistent with the discussion below, and consistent with our overall policies and objectives discussed in this decision.
The key question is whether an affiliate is defined by having 10% or 50% of the voting securities owned or controlled directly or indirectly by a utility or its controlling corporation. DRA argues that 10% is the appropriate percentage, as this is the SEC threshold for effective control. TURN also would use 10% as the threshold, because the advantages conferred to an affiliate by virtue of having access to bills and customer information are the same regardless of the level of ownership.42 CWA argues that 50% is a more appropriate percentage because the Commission defines control under §§ 851-854 as more than 50% for purposes of approval of transfers of control.43
Park Water requests the definition of affiliate be amended to address its specific corporate structure and advocates that the affiliate transaction rules should not apply to out of state regulated utility affiliates of California regulated water utilities. Park Water contends that the current language serves no useful purpose and its suggested change would remove burdensome requirements.44
CWA is mistaken. Pub. Util. Code §§ 851-854 do not define the ownership threshold for its provisions. The energy affiliate rules use a 5% threshold for the analogous rule. DRA and TURN appear to find a higher 10% threshold acceptable in order to accommodate differences with the water industry. We find a 10% ownership threshold reasonable to ensure that any affiliate with a significant relationship to a water or sewer utility is covered by the rules. We will not make the definitional change requested by Park Water, as its regulated affiliates are categorically exempt under adopted Rule 1.B.
For clarity in considering other Rules, we highlight that the Rule II.E definition of "affiliate" includes the utility's parent company.
DRA proposes that a definition of "cross-subsidy" is needed in the rules. DRA proposes the following language: "A cross-subsidy occurs when captive ratepayers pay part or all of the cost of providing a device or expense that provides no benefits to utility ratepayers, such as services offered by the regulated utility's parent or other affiliates." CWA proposes a different definition: "The assignment of costs among affiliates entities inconsistent with the causation of such costs."45
"Cross-subsidy" is not a defined term in the energy affiliate rules. There appears to be a need to define the term here. There are a variety of definitions to be found in economics and accounting references. For example, The Dictionary of Accounting Terms46 uses the following definition: "improper assignment of costs among objects such that certain objects are overcosted while other cost objects are undercosted relative to the activity costs assigned." Similarly, Accounting-Dictionary.com (2010) defines cross-subsidy as "the process of deliberately assigning costs to items in an account in such a way that some items are undercosted and some overcosted." Both of these definitions are reasonable, but do not fully capture the specific issue at hand: our concern that captive ratepayers may be forced to pay more (and potential competitors may be harmed) because the utility and/or its affiliate assigns costs to the utility which should be assigned to the affiliate.
Neither DRA's nor CWA's proposed definitions of cross-subsidy are quite right. DRA captures the ratepayer protection issue, but may be too restrictive. CWA misses the ratepayer protection issue altogether. For the purposes of affiliate transaction rules, we will adopt as Rule II.L a definition of cross-subsidy consistent with ratepayer protection and dictionary definitions: "The unauthorized over-allocation of costs to captive ratepayers resulting in under-allocation of costs to a utility affiliate."47
5.5. Rule III -- Utility Operations and Service Quality
Rule III addresses the Commission's objectives to protect ratepayers, ensure utility financial health, and prevent cross-subsidization. The primary responsibility of each public utility that we regulate is to provide "adequate, efficient, just, and reasonable service" to its ratepayers as is "necessary to promote the safety, health, comfort, and convenience of its patrons, employees, and the public."48 Consequently transactions between a utility and its affiliates should not result in any adverse changes in utility services or be contrary to the public interest policies with respect to service to customers, employees, operations, financing, accounting, capitalization, rates, depreciation, maintenance, or other matters affecting the public interest or utility operations. Moreover, the utility and/or its parents should ensure that there is no adverse impact on customer service as a result of affiliate transactions (e.g., no degradation of reliability, efficiency, adequacy, or cost of utility service).
It is Commission policy to encourage the efficient use of utility capital and to encourage the development of new markets and improved products and services for the benefits of California residents, consistent with continued provision of utility service. As such, the utility's customers should remain at least indifferent as a result of transactions between a utility and its affiliates.49
In its comments on the policy statements, DRA seeks to ensure any such language does not imply that the need to develop new markets and improve services could impair the utility obligation to fulfill its obligations to ratepayers. We see no inconsistency between the statutory obligations of §§ 451 and 2701, and a policy to encourage new products and services through utility affiliates. One major purpose of these affiliate transaction rules is to ensure that actions by affiliates do not harm captive ratepayers. Once captive customers are protected, they should be indifferent to affiliate activities. At the same time, the state of California can benefit from new products and services.50 While we affirm this policy, there is no need to include this or other policy language in the adopted rules, since such general policy statements do not establish separately enforceable requirements.
CFC contends that the utility should be required to maintain local offices so customers can have a place to ask questions, complain, pay bills, etc.51 We do not agree with CFC that the maintenance of local offices should be a general rule. Rather, questions of whether a utility should maintain local offices are best considered in general rate cases.
5.5.1. Staff Proposed Rule III.B - Prohibitions on Specific Utility Interactions With Affiliates
Rule III.B lists seven restrictions on the utility with regard to providing benefits to its affiliates:
1. Providing leads to its affiliates;
2. Soliciting business on behalf of its affiliates;
3. Acquiring information on behalf of or to provide to its affiliates;
4. Sharing market analysis reports or any other types of proprietary or non-publicly available reports, including but not limited to market, forecast, planning or strategic reports, with its affiliates;
5. Requesting authorization from its customers to pass on customer information exclusively to its affiliates;
6. Giving the appearance that the utility speaks on behalf of its affiliates, or that the affiliate speaks on behalf of the utility; and
7. Representing that, as a result of the affiliation with the utility, its affiliates or customers of its affiliates will receive any different treatment by the utility than the treatment the utility provides to other, unaffiliated companies or their customers.
Cal-Am contends that much of the information constraints in Rule III.B should not be applicable to corporate support services provided by its affiliates which provide access to capital and customer service for various regulated water utilities under the parent of Cal-Am. Specifically, Cal-Am objects to restrictions on the utility acquiring and sharing market reports or other types of restrictions in Rule III.B.3, 4, 5, and 6. Cal-Am argues that its corporate structure would no longer be viable, and ratepayers would lose significant benefits, unless these entities can continue to share non-public or proprietary reports and otherwise coordinate activities.
Similarly, CWA proposes to delete provision 4 prohibiting the utility from sharing "market analysis reports or any other type of proprietary or non-publicly available reports, including but not limited to market, forecast, planning or strategic reports, with its affiliates" because some parents (or other affiliates) of water utilities, in particular Cal-Am, provide these types of services to their affiliated utilities.52 CFC disagrees, arguing that an affiliate should not be given, free of charge, information which is the property of the utility.
Our general concern is that the ratepayers should not be required to pay for utility assets which are then used for the benefit of utility affiliates and to the detriment of competitors to these affiliates.53 Rule III.B imposes specific restrictions to this effect. However, the utility is still free to market certain assets in a non-discriminatory manner. For example, Rule III.B.4 does not prevent the utility from selling market information at a market price, either to affiliates or other entities (Rule VI addresses the pricing of this information). We will adopt the proposed Rule III.B.
For the specific case of Cal-Am,54 we determine that it is reasonable to allow the utility to provide certain benefits from a utility to affiliates whose sole purpose is to serve regulated utility functions - in this case, across a number of regulated utilities within and outside of California - or non-profit or governmental organizations. In response to comments on the Proposed Decision, we also add the parent company of regulated utilities as allowable entities. We agree that centralized support functions for regulated entities are beneficial to the regulated entities and their ratepayers due to lower costs and greater efficiencies from this type of entity, as compared to the utility raising its own capital or providing its own customer services. Concerns about cross-subsidies or misuse of confidential information are minimal if the affiliate is a not-for-profit organization (as with Cal-Am) and does not serve profit-seeking organizations. In this specific situation, the restrictions in Rule III.B.3, 4, 5, and 6 are relaxed; we add Rule III.B.8 to the adopted rule for this purpose.
However, we do not allow the exceptions to Rule III.B in situations where the centralized support functions - aside from corporate support services addressed under Rule V - serve both regulated and non-regulated entities.55 Otherwise, the restrictions on sharing of non-public or proprietary information adopted in Rule III.B could easily be circumvented, defeating the purpose of that rule.
In comments on the Proposed Decision, CWA suggests that Rules III.B.4 and III.B.6 need to contain an exception to allow parents of utilities to obtain the proprietary information referenced in this rule, and to speak on behalf of the utility. We agree, and have made these changes. For clarification, we have also modified Rule III.B.4 to eliminate the restriction on affiliates speaking on behalf of utilities, as this provision serves no specific purpose.
In response to comments from Cal-Am, we add a new Rule III.B.9 stating "Utilities may file an Advice Letter seeking an exemption to Rule III.B.8 within ninety days of the effective date of the Commission decision adopting these rules, requesting that a non-profit affiliate subject to Rule III.B.8 be allowed to serve the functions of other affiliates, as long as those other affiliates provide no more than five per cent of the annual revenues of the non-profit affiliate." This one-time process allows Cal-Am and any other similarly situated utility to request to continue provision of certain non-profit support services from an affiliate to a small number of existing affiliates, which would otherwise be prohibited.
Staff Proposed Rule III.C provides that:
Except as provided for elsewhere in these (rules), a utility shall provide access to utility information, services, and unused capacity or supply on the same terms for all similarly situated market participants. If a utility provides supply, capacity, services or non-public or proprietary information to its affiliate(s) for use in competitive markets, it shall contemporaneously make the offering available to all similarly situated market participants, which include all competitors serving the same market as the utility's affiliates.
Staff Proposed Rule III.D provides that:
A utility shall provide customer information to its affiliates and unaffiliated entities on a strictly non-discriminatory basis, and only with prior affirmative customer written consent.
CWA would delete Staff Proposed Rule III.D, and modify Staff Proposed Rule III.C to read:
Except as provided for elsewhere in these (rules)... if a utility provides customer information to an affiliate that is operating in a competitive market in California, it shall make the same information available to all similarly situated market participants in that same competitive market, consistent with state law and the utility's policies on privacy.
CWA argues that there is no evidence that any transactions beyond those involving customer information between a water utility and its affiliate could or would have any adverse impact on a particular competitive market. CWA also claims it is unrealistic and unworkable for the utility to have to identify and contact all similarly situated market participants to make available to them information or services they may or may not want before such information or services can be shared with an affiliate.
These rules provide the heart of the affiliate transaction rules. As described in Section 6.1, our objectives include both ratepayer protection and the public interest protection of competitive markets. Under Rule III.C as modified by CWA, a water or sewer utility would have the ability to provide various services (except for certain information) to its affiliates on different terms and conditions than to competitors of its affiliates. Further, absent Rule III.D, there would be no requirement to provide such services to affiliates and competitors at the same time. In combination, under CWA's proposed rule there would be no obligation to provide any such services to competitors at all.
This is exactly the type of discrimination which would confer an unfair advantage for water or sewer utility affiliates in the competitive marketplace, and exactly the type of unfair advantage we wish to prevent. We do not have a concern with affiliates of the utilities using the name, logo or other association with the utility to attract customers.56 Nor do we wish to prevent affiliates of utilities from competing in various non-monopoly markets. One concern is that utilities (or their parents) would not form affiliates rather than comply with non-discrimination requirements.
The table below shows 422 new energy utility affiliates have been formed since 1998, per Advice Letters filed with Energy Division in that period.57 The table shows that energy utilities operating under rules similar to the Staff Proposed Rule III.C (as well as other affiliate transaction rules more detailed and stringent than we adopt today for water and sewer utilities) have formed numerous affiliates since the energy affiliate transaction rules were adopted in 1998. The affiliate transaction rules did not appear to provide any significant barrier to forming affiliates to energy utilities, and we see no reason the rules we adopt today will have any different impact.
New Energy Utility Affiliates Since 1998
Date |
PG&E* |
SCE |
SDG&E/SoCal Gas |
Others |
Totals |
1998 |
0 |
0 |
3 |
3 | |
1999 |
0 |
6 |
0 |
6 | |
2000 |
6 |
7 |
54 |
67 | |
2001 |
49 |
16 |
16 |
81 | |
2002 |
12 |
2 |
10 |
24 | |
2003 |
8 |
1 |
12 |
21 | |
2004 |
2 |
0 |
21 |
23 | |
2005 |
0 |
8 |
21 |
29 | |
2006 |
5 |
21 |
10 |
36 | |
2007 |
0 |
0 |
20 |
1 |
21 |
2008 |
2 |
19 |
35 |
2 |
58 |
2009 |
1 |
22 |
10 |
33 | |
2010 |
2 |
4 |
14 |
20 | |
Totals |
87 |
106 |
226 |
3 |
422 |
* Pacific Gas and Electric Company.
We will adopt Staff Proposed Rule III.C to ensure that the water or sewer utility and its assets cannot be used exclusively or in a discriminatory manner by utility affiliates in the marketplace. We agree with CWA that it may not be feasible to offer all services and provide information contemporaneously to both affiliates and other market participants. At the same time, the principle of non-discrimination requires that affiliates not be given unfair temporal advantages. We will modify Rule III.C to require that utility and customer information, services, and unused capacity or supply may be offered to both affiliates and competitors in a timely manner, consistent with our policy of non-discrimination. We will not adopt Staff Proposed Rule III.D, as the provision of information to affiliates and market participants is already covered in Rule III.C.58
5.6. Rule IV -- Separation
This section establishes the rules for the utility to maintain accounting records with regards to affiliates. The sub-rules in Rule IV are adopted consistent with the discussion below, and consistent with our overall policies and objectives discussed in this decision.
The Staff Proposed Rule states: "The utility and its parent and other affiliated companies shall allocate common costs between them in such a manner that the ratepayers of the utility shall not subsidize any parent or other affiliate of the utility." The Workshop Report shows that CWA proposed changing this rule to read: "The utility and its parent and other affiliated companies shall allocate indirect costs amongst them in a manner consistent with cost causation principles, so that neither the ratepayers of the utility, nor the utility itself, shall subsidize any parent or other affiliate of the utility."
CWA in its comments also proposes revising the last sentence to add the words "not regulated by the Commission" at the end. CWA claims the Commission will have full jurisdiction over the regulated affiliate and can ensure that neither utility subsidizes the other.59 TURN opposes CWA's proposed revision because TURN contends ratepayers should not be expected to subsidize the services and products provided by any affiliate, regulated or not.60 While there seems little justification to allow one utility to subsidize another, and while the Commission can in theory scrutinize and prevent subsidies between regulated affiliates, without clear guidance on this point, utilities may find it acceptable to propose such subsidies in their general rate cases or implement such subsidies in their operations. The better and simpler approach is to prohibit these subsidies from occurring in the first place.
CWA's Workshop Report revisions mainly add the words "consistent with cost causation principles." It is unclear what the purpose of this phrase would be. To the extent that indirect or overhead costs would not be covered by cost causation principles, CWA's wording could lead to mis-costing of transactions.
We will adopt the rule as proposed in the Staff Proposed Rule, with minor wording changes.
5.7. Rule V - Shared Corporate Support
This section establishes the rules for sharing corporate support services between a utility, its parent company and separate affiliates. Rule V is adopted consistent with the discussion below, and consistent with our overall policies and objectives discussed in this decision.
CWA would reconstitute this section, as compared to the Staff Proposed Rules.61 CWA proposes a general principle that "a utility may share with its affiliates joint corporate oversight, governance, support services, and personnel as further specified..." CWA would add that such permitted sharing "may include the exchange of non-public or proprietary information that is necessary to provide the corporate support services being shared or when necessary or required for appropriate corporate governance or for compliance with financial or corporate governance laws and regulations." CWA contends that this language is necessary because a number of water utilities have parents or affiliates which provide a broad array of services to the utility and its affiliates. Therefore, CWA claims undue restrictions on the flow of non-public or proprietary information would seriously impair existing operations of these entities, and make it difficult to adopt and implement sound corporate governance procedures.62
CWA would also add language stating the general principle that any permitted sharing of services "shall not...provide a means to create an unfair competitive advantage for the utility affiliates, lead to customer confusion, or create opportunities for cross-subsidy by a utility or its affiliates." CWA also includes a list in the proposed rule which would illustrate, but not limit, examples of services which may be shared. This list is the same as in the Staff Proposed Rule V, except that CWA adds corporate governance and oversight to the list of examples.
Alternatively, CWA proposes a new rule (not mentioned in the Staff Proposed Rules) which would permit a utility and its affiliates to jointly employ the same officers and other employees subject to requirements including that all direct and indirect costs be fully allocated among the utility, its parent and other affiliated companies. CWA contends that separating utilities and their affiliates into different legal entities with different boards of directors, officers and employees is unnecessary and impractical in the water industry. CWA claims that implementing this policy would lead to ratepayers bearing the full cost of utility officers and directors, thereby increasing rates.
DRA recommends retaining the Staff Proposed Rule V. However, DRA's position relies on ensuring that the affiliate transaction rules overall include safeguards to ensure protection of ratepayers and the public interest. For example, DRA urges that a strict and efficient cost allocation procedure is needed for shared services (based on cost causation principles), as well as a thorough reporting requirement and full access to the accounting records and officers of the utility and relevant affiliates.63
DRA's concerns are valid, and have been addressed in other parts of the adopted rules. Specifically, Rule IV addresses cost allocations and Rule VIII addresses access to affiliate records and officers. We recognize that it would be impractical for all water and sewer utilities to individually provide various corporate support services which are common functions within the corporate structure. Even with the much larger energy utilities, we allow significant sharing of these types of services. In D.97-12-088, we allowed a utility and its affiliates to use joint corporate support on an exclusive basis, as long as it is priced and reported according to the Separation and Information Standards adopted elsewhere in the rules. As we stated in D.97-12-088 at 59, "sharing of centralized functions generates scope economies and as such can increase production efficiency."
CWA would specifically add "non-public or proprietary information that is necessary to provide the corporate support services being shared" as allowable to share under Rule V. This language was not in the energy utility affiliate transaction rules. We have already provided an exemption in Rule III.B to accommodate Cal-Am's unique organizational structure. However, the energy utilities have done business under this restriction for a number of years. CWA and the utilities have not shown that there is anything different for water and sewer utilities (other than Cal-Am) which compels this modification. We will not allow the sharing of non-public or proprietary information for shared corporate services.
Staff Proposed Rule V lists examples of shared corporate services to which Rule V would apply, but does not limit applicability to this list. We recognize the there may be other legitimate shared corporate services to which Rule V should apply. However, we do not intend to allow unlimited applicability. From the Staff Proposed Rule, we will retain a list of examples of services which cannot be shared under Rule V.
CWA's proposed Rule V would also eliminate certain wording from the Staff Proposed Rule V. Specifically, CWA would eliminate the requirement for verification of the mechanisms in a compliance plan. We adopt a compliance plan for various other purposes in Rule VIII.C. There is no reason shared corporate services should be exempt from such a plan.
5.8. Rule VI -- Pricing of Goods and Services Between the Utility and its Affiliate(s)
Rule VI concerns the pricing of goods or services transferred from the utility to an affiliate, or vice-versa. The sub-rules in Rule VI are adopted consistent with the discussion below, and consistent with our overall policies and objectives discussed in this decision.
Staff Proposed Rule VI.4 (now Rule VI.D) states: "Goods and services produced, purchased or developed for sale on the open market by the utility will be provided to its affiliates and unaffiliated companies on a nondiscriminatory basis, except as otherwise required or permitted by these (affiliate transaction rules) or applicable law." CWA proposes to limit this language to items "offered on the open market." CWA claims there are no such goods and services, and the language in the Staff Proposed Rules is necessary.64 DRA does not disagree with the facts, but argues that the rules are meant to be comprehensive and must take future possibilities into account.
It is not clear that there are no goods and services, beyond regulated water and sewer service, offered on the open market by water and sewer utilities. Some water utilities, for example, appear to be offering antenna services and billing services to the public at this time. We agree with CWA that water utilities do not appear to "produce, purchase or develop" good or services for sale on the open market, but can and do "offer"65 certain good and services stemming from excess capacity. In other words, certain goods and services are or may be produced, purchased or developed for the utility, but are or may be offered on the open market as non-tariffed goods and services. This Rule goes hand-in-hand with Rule X (our non-tariffed products and services rules discussed later in this decision), in particular the new rule that water and sewer utilities can only provide non-tariffed products and services to affiliates through the affiliate transaction rules.
Staff Proposed Rule VI.6 (now Rule VI.E) concerns pricing of transfers from the utility to an affiliate of goods and services not produced, purchased or developed for sale by the utility. This Rule would price such transfers at fully loaded cost plus 5% of direct labor cost for the utility.
CWA would eliminate the 5% adder for this Rule, because CWA contends no justification for this addition has been given.66 DRA argues that adding 5% to the fully loaded cost is intended to eliminate any lower cost advantage that might be created for affiliates who otherwise have to pay fair market costs of these services.67 TURN argues that the true percentage of work performed on behalf of the affiliate by utility employees should be reflected in the application of fully allocated costs, which may be more or less than 5%.68
As with many of the Staff Proposed Rules, the origin of this rule goes back to the Commission's holding company decisions. As noted in Section 2, D.86-03-090 held that "although the holding company structure in part shields the utility from the effects of affiliate riskiness...because of these benefits, costs, and unidentified cross subsidies, we believe SDG&E's ratepayers should be compensated by way of a payment from [the parent company] and its subsidiaries to the utility."
In D.86-10-026, a Pacific Bell (PacBell) general rate case, the Commission considered the recommendation of DRA to require the utility to charge its affiliates fully-loaded costs (direct plus all allocated overheads plus a return on investment), which was PacBell's current practice, but to add a markup of 35% to recognize "the embedded value of PacBell's talent and expertise, developed and refined over the years as a result of reimbursement by PacBell's ratepayers." (D.86-10-026 at 268.) The Commission agreed with DRA that a markup to recognize "the embedded training and development costs," funded by rates over the years, should be imposed; this expertise was now available to PacBell's affiliates, and ratepayers should be reimbursed. The Commission decided that the appropriate markup should be 10%, and imposed this on the transfer price to be used by PacBell when charging its affiliates for work it performs (see D.86-10-026, Finding of Fact 11).
The Staff Proposed Rule is taken directly from the energy utility affiliate transactions rules decision, which reduced the markup to 5%.
The theory the Commission articulated in the two decisions cited above from 1986 and followed upon in the energy affiliate rules still holds: in the provision of certain goods and services from the utility to an affiliate, there are unidentified cross-subsidies which accrue to affiliates from the investments and training funded by ratepayers. CWA has not provided any rationale for why we should change the long-standing policy of adding a percentage to the transfer price to account for this value. A 5% adder is a reasonable percentage. We will adopt the Staff Proposed Rule.
5.9. Rule VII -- Financial Health of the Utility
The sub-rules in Rule VII are adopted consistent with the discussion below, and consistent with our overall policies and objectives discussed in this decision. We note that there are certain rules in holding company decisions which are not addressed by these Rules. For example, there are rules in D.97-12-011 and D.98-06-068 which require the utility to issue its own debt, and which address loans from the utility to the holding company. Rules I.D and I.E establish when existing holding company rules are superseded. To avoid any ambiguity, we specifically determine that certain existing financial rules in holding company decisions are not superseded by the Rules adopted today (see Rule VII.G).
Staff Proposed Rule VII.A states: "The parent shall provide the utility, or enable the utility to acquire, adequate capital to fulfill all of its service obligations prescribed by the Commission."
CWA would strike this language. CWA asserts that it is the utility's obligation, not the parent company's obligation, to acquire adequate capital to fulfill its service obligations. CWA further argues that the utilities have no authority to obligate or otherwise agree to the imposition of requirements on their parent organization.69
DRA would retain the language in the Staff Proposed Rule. DRA argues that the parent must be willing to provide safeguards for the financial well-being of the regulated utility against the poor performance of its parent. DRA contends that a primary obligation of the parent must be to ensure the regulated utility is able to provide service to its customers, which requires adequate capital resources.70
We have discussed above our conclusion that we have sufficient, although limited, authority to impose regulations on a parent company of a utility within our jurisdiction in order to properly regulate the utility. There are clearly circumstances where a parent company could either help or hinder the utility's ability to maintain adequate capital to carry out its obligations. For example, a utility could be required to provide excessive dividends to a parent which would harm the utility, or a parent could infuse capital into the utility to assist it. There may be strategic considerations within the corporate structure for either of these actions, or other actions which impact the utility's ability to acquire or retain sufficient capital.
An enforceable policy is needed that will enable the utility to maintain financial health through adequate access to capital at all times.71 For water utilities which have holding companies, certain of the holding company decisions already provide specific and detailed rules regarding financial obligations of parent companies. For example, D.97-12-011 for Cal Water includes a requirement that states: "The capital requirements of the utility shall be given first priority by the utility and the holding company's board of directors." D.98-06-068 for Golden State Water has similar language. However, other holding company decisions do not include similar language. A major purpose of this decision is to harmonize rules applicable to all similarly-situated water and sewer utilities; in this case, utilities with parent companies. We will adopt Rule VII.A, as it contains appropriate language which should be extended to all water and sewer utilities with a parent company.
The following two suggested financial rules are taken from the OIR (footnotes omitted):
In each year, utility shall not exceed its five-year average payout percentage ($ amount of payout divided by $ total Net Income) of transfer/payment of net income/dividend to parent company. If current year payment/transfer percentage exceeds this five-year average, the utility shall notify the Director of the Commission's Division of Water and Audits.
Debt of utility's parent/affiliated companies shall not be issued or guaranteed or secured by utility.
DRA contends that an area of concern is to avoid any potential threat to the utility's financial health and ability to meet its public service obligations. Thus, DRA believes the utility should be adequately insulated from the financial risks and debts of its unregulated parent and affiliates. As with Rule VII.A, DRA would make conditions imposed on water utility holding companies regarding financial safeguards part of the affiliate transaction rules.72
CWA generally contends that the sample affiliate transaction rules attached to the OIR as Appendix A are more appropriate for the Commission-regulated water utilities than the energy utility rules. CWA recommends that the sample rules - which largely are derived from the affiliate transaction rules adopted for Cal Water, Golden State Water, and Cal-Am - be used as a starting point. However, CWA disagrees with DRA regarding the need for a rule on dividends. CWA contends there are many circumstances that legitimately cause a utility to defer or accelerate paying dividends to the holders of its preferred and common stock, such as short-term needs to invest in capital projects, unfavorable conditions for issuing new debt, or the need to prudently manage its capital structure. Therefore, CWA claims it is important that the utility be able to manage its dividend payment levels in response to complex financial considerations.73
As CWA acknowledges, the proposed financial rules in the OIR were taken directly from existing water utility holding company rules. However, the proposed rule on dividends does not appear in any water utility holding company decision. This rule was derived from the energy affiliate rules. There is no evidence that these specific reporting requirements on dividends are required. The general rule adopted as Rule VII.A suffices to ensure that parents of water and sewer utilities cannot extract dividends from the utility in a way which would harm the financial health of the utility.
On the other hand, the suggested rule on debt from the OIR does exist in various forms in water utility holding company decisions. For example, both D.97-12-011 and D.98-06-068 include a rule stating "Holding Company debt and debt of other affiliates shall not be issued or guaranteed by the utility without prior Commission approval." Similarly, D.02-12-068 includes a rule stating: "Debt of Cal-Am's affiliated companies shall not be issued or guaranteed by Cal-Am without prior approval of the Commission," and D.04-01-051 includes a substantively identical rule for Valencia Water. These rules have not caused any problems, and serve a valid purpose of protecting the utility and its ratepayers. We will adopt the suggested rule on debt from the OIR as Rule VII.D.
Staff Proposed Rule VII.C would require the utility "to maintain a balanced capital structure consistent with that determined to be reasonable by the Commission in its most recent decision on the utility's capital structure." The proposed rule also requires the utility to seek a waiver of the rule "if an adverse financial event at the utility reduces the utility's equity ratio by 1% or more."
CWA would strike this proposed rule. CWA contends this proposed rule has nothing to do with affiliate transactions. While there is such a rule on the energy side, CWA claims it was developed in response to competitive concerns which are not present on the water side. CWA contends that capital structure issues should be considered in cost of capital proceedings. Further, CWA claims the proposed rule is impossible to comply with, as many Class A water companies have imputed capital structures and, for others, borrowing of small amounts of debt would change the utility's equity ratio by 1% or more.74
DRA contends the issue of financial viability of the regulated utility in the context of affiliate transactions and its relationship with its parent must be in these rules. DRA would be willing to increase the waiver requirement to 3% if 1% is onerous, but would not eliminate it.75
We agree with CWA that cost of capital proceedings are the appropriate place to consider capital structure issues. Further, we agree that this rule was imposed on the energy utilities in response to competitive pressures that do not exist in the water and sewer industries. To the extent that further guidance is necessary, rules in water utility holding company decisions (specifically, D.97-12-011 and D.98-06-068) regarding provision of adequate capital are sufficient to protect the utility and its ratepayers from concerns about the parent of a utility negatively impacting the financial health of the utility with regard to capital. We will not adopt this proposed rule.
DRA proposed a new Rule regarding financial separation, calling for a tool (known as ring-fencing) to ensure the utility does not get pulled into a bankruptcy of its parent. The proposed new Rule states:
Within three months of the effective date of the decision adopting this amendment to the Rules, a utility shall obtain a non-consolidation opinion that demonstrates that the ring-fencing around the utility is sufficient to prevent the utility from being pulled into bankruptcy of its parent holding company. The utility shall promptly provide the opinion to the Commission. If the current ring-fencing provisions are insufficient to obtain a non-consolidation opinion, the utility shall promptly undertake the following actions:
1. Notify the Commission of the inability to obtain a non-consolidation opinion;
2. Propose and implement, upon commission approval, such ring-fencing provisions that are sufficient to prevent the utility from being pulled into the bankruptcy of its parent holding company; and then
3. Obtain a non-consolidation opinion.
CWA contends that ring-fencing provisions were adopted in the context of bankruptcy circumstances in the energy industry and are unnecessary in the less risky, less competitive water industry. CWA claims these provisions would increase the costs of providing utility service without corresponding benefits.76 Park Water points out that it is both a regulated utility and a parent company of a regulated utility; if the rule (which Park Water opposes) remains, Park Water requests that the term "parent holding company" be changed to "holding company" so that the rule does not reference a utility being pulled into the bankruptcy of another utility.77
DRA contends this rule is important to insulate a regulated utility's capital and capital-raising ability from the consequences of poor financial performance of its parent or other affiliates.78 DRA points to the recent example of Cal-Am, which was acquired and later spun off by RWE Aktiengesellschaft (RWE), with the spin-off causing the credit rating of Cal-Am's parent, American Water, to be lowered by both Moody's and Standard & Poor's credit rating agencies.79 In D.02-12-068, the Commission adopted conditions related to the utility's financial health in Cal-Am's merger with RWE, along with the set of affiliate transaction rules on Cal-Am.
The ring-fencing rule was not part of the energy affiliate transaction rules in D.97-12-088, but was put in place for the four largest energy utilities in D.06-12-029. CWA is not correct that this provision in the energy utility affiliate transaction rules was developed solely in response to the bankruptcy of an electric utility or the narrow circumstances of electric restructuring. Indeed, there are a variety of circumstances which could lead to the bankruptcy of a parent company of a water or sewer utility, ranging from management problems to market conditions to force majeure situations. D.06-12-029 at 10 states:
The Revised Affiliate Transaction Rules have been designed to close existing loopholes, primarily by ensuring that key utility and holding company officers understand the Rules and their obligations under them, by providing greater security against the sharing within the corporate family, through improper conduits, of competitively-significant, confidential information, and by ensuring a utility's financial integrity is protected from the riskier market ventures of its unregulated affiliates and holding company parent.
The essence of this proposed financial separation rule is that, regardless of the underlying circumstances, the core functions of the water or sewer utility need to be protected from significant problems elsewhere in the corporate structure. This concept is central to protecting the interest of ratepayers, and is as applicable in the water and sewer industries as in the energy industry, as shown in DRA's example of Cal-Am. CWA claims that the benefits of the proposed rule would be outweighed by the cost to the utility. Certainly, there would be legal costs involved in obtaining the proposed non-consolidation opinion, and possibly in modifications to the corporate structure. However, CWA provides no supporting evidence that the costs would be greater than the substantial benefits to ratepayers from removing the risk that bankruptcy of the parent would impose on the water or sewer utility. We will not adopt Park Water's suggested revision; the fact that Park Water is both a utility and a parent of a utility does not change the need to protect the subsidiary utility from a potential bankruptcy of the parent (or vice versa).
In comments on the Proposed Decision, CWA and others contend this Rule would be difficult or impossible to comply with, as it would require fundamental corporate-wide reorganization of most utilities and be prohibitively expensive. Further, because the water affiliate rules considered here (unlike the energy affiliate rules) do not require strict separation of utilities from their affiliates and parent companies (i.e., the water affiliate rules allow shared corporate services), there is an inherent mixing of certain officers, employees , resources and assets between water utilities and their parent companies and affiliates. This mixing would thus preclude the very non-consolidation opinion required under DRA's proposed rule.
We agree with CWA that rigorous non-consolidation opinions may be difficult or impossible to implement, as well as very costly to obtain. We will not adopt the DRA-proposed rule. However, the fundamental concept of protecting the utility from the financial woes of the parent is sound. Therefore, we will require each subject water utility with a parent to file a Tier III Advice Letter proposing provisions that are sufficient to prevent the utility from being pulled into the bankruptcy of its parent company. The process specified by the Advice Letter Filing shall include a verification that the provisions have been implemented and signed by the utility's senior management (e.g., the Chief Executive Officer, Chief Financial Officer, and General Counsel. This rule provides each utility with the flexibility to implement financial separation provisions as appropriate for individual corporate structures, and the ability to modify such provisions as necessary.
5.10. Rule VIII -- Regulatory Oversight
The sub-rules in Rule VIII are adopted consistent with the discussion below, and consistent with our overall policies and objectives discussed in this decision.
Staff Proposed Rule VIII.A states: "The officers and employees of the utility and its affiliated companies shall be available to appear and testify in any proceeding before the Commission involving any transaction between the utility and the affiliate in connection with the provision of products or services, as set forth in Rule 1.B. If, in the proper exercise of the Commission staff's duties, the utility cannot supply appropriate personnel to address the staff's reasonable concerns, then the appropriate staff of the relevant utility affiliated companies including, if necessary, its parent company, shall be made available to the Commission staff."
CWA proposes to delete the words "and its affiliated companies" in the first sentence. This has the effect that the relevant officers and employees primarily available to testify would come from the utility. In the second sentence, CWA proposes what it terms as clarifying language that the issues for which affiliates will be made available, by adding "for specific transactions between the utility and an affiliate or between a utility and its parent."
DRA would retain this proposed rule. DRA contends that there needs to be effective measures in place to monitor and evaluate compliance with laws and rules impacting affiliate transactions, and that this proposed rule is a crucial part of such oversight.80
TURN points to D.10-02-015 (regarding a transfer of control involving Valencia Water) where the Commission imposed several conditions on the approval of the transfer, including a requirement that "the officers and employees of Valencia and its affiliated companies shall be available to testify in any proceeding before the Commission involving Valencia." (D.10-02-015, Appendix C.)81 TURN contends the Commission has clear, although limited, authority over unregulated or out-of-state affiliates of regulated utilities. TURN claims that within the limits is the authority to require officers and employees of those affiliates to appear before the Commission on specific matters.82
We will adopt the Staff Proposed Rule. We agree with DRA that there needs to be effective measures in place to monitor and evaluate compliance with laws and rules impacting affiliate transactions. This rule is within our authority to impose, in that officers and employees83 of utility affiliates would only be required to testify if there is a nexus between the regulation of the utility and its affiliate. This rule is consistent with conditions we have imposed in the past, in all holding company decisions since 1985,84 and in the energy affiliate rules. The rule serves an important purpose to ensure enforcement and compliance with our regulatory program.
Staff Proposed Rule VIII.B states: "The utility and its affiliated companies shall provide the Commission, its staff, and its agents with access to the relevant books and records of such entities in connection with the exercise by the Commission of its regulatory responsibilities in examining any of the costs sought to be recovered by utility in rate proceedings. The utility shall continue to maintain its books and records in accordance with all Commission rules. The utility's books and records shall be maintained and housed available in California."
In recent rate cases, DRA claims that it has found it difficult to obtain parent company and affiliate information to ensure the reasonableness of general cost allocations between regulated and non-regulated operations. DRA cites the most recent case of Cal-Am's audit of its General Office when DRA's auditors (Overland Consulting) encountered difficulties in obtaining requested books and records from the parent company and affiliates, making it impossible to attest to the reasonableness of the cost allocations to Cal-Am.85
CWA agrees with this paragraph,86 except that it would add the words "or in connection with a transaction or transactions between the utility and its affiliates" at the end of the first sentence. CWA agrees that when a transaction with an affiliate has the potential to impact utility service, the Commission should have access to the affiliate's relevant books and records.87
Pub. Util. Code § 314(b) states:
Subdivision (a) also applies to inspections of the accounts, books, papers, and documents of any business which is a subsidiary or affiliate of, or a corporation which holds a controlling interest in, an electrical, gas, or telephone corporation with respect to any transaction between the electrical, gas, or telephone corporation and the subsidiary, affiliate, or holding corporation on any matter that might adversely affect the interests of the ratepayers of the electrical, gas, or telephone corporation.
Concern was raised at the workshop that by leaving water corporations out of this section, the Legislature did not intend to give the Commission authority over the records of the affiliates of water utilities. One Commission decision, D.93-09-006, supports this contention. When San Gabriel refused to produce the financial records of its affiliates and, based on the argument that § 314(b) does not extend to water utilities, DRA's motion to compel discovery was denied. (1993 Cal. PUC LEXIS 629 (Cal. PUC 1993).)
D.93-09-006 is not a broad interpretation of § 314(b). The Commission did not address at the time whether § 701 provides the authority to allow access to water utility books and records. As discussed in Section 6.1 of today's decision, we conclude that § 701 provides sufficient, although limited, authority to regulate affiliates of water and sewer utilities for matters which are cognate and germane to the regulation of the utility.
This requirement is not new. Each of the five water utility holding company decisions by the Commission between 1985 and 2004 includes a provision guaranteeing Commission access to books and records of affiliates, within the context of "the exercise of the Commission's regulatory responsibilities."88 We also note that while CWA raises the concern that § 314(b) may not allow the Commission to examine the books and records of water utility affiliates, CWA has conceded the point that access to the books and records of its affiliates is permissible in the context of utility transactions with an affiliate that have the potential to impact utility service.
No party opposes the proposed rule as modified by CWA. The rule is reasonable as modified, and we will adopt the Staff Proposed Rule with CWA's modification.
Staff Proposed Rule VIII.C would require each utility subject to these rules to file a compliance plan by advice letter. The compliance plan would include a list of affiliates and their purposes or activities, and a description of the procedures in place to assure compliance with the rules. The compliance plan would be updated once every two years, or under specified circumstances. Pub. Util. Code § 587 requires gas, electrical and telephone (but not water or sewer) corporations to prepare an annual report regarding affiliate transactions. As discussed elsewhere in this decision, § 701 provides sufficient authority for the Commission to extend this provisions to water and sewer utilities, as appropriate.
CWA would eliminate Staff Proposed Rule VIII.C, arguing that verification of compliance should not be a difficult task if simple, straightforward rules are adopted. Instead of this rule, CWA would have utilities include a statement in their annual reports that they have taken adequate measures to inform their directors, officers and other management personnel of the requirements of the rules and to ensure their compliance with them. CWA also points out that DRA and DWA can always request additional information if necessary.89
DRA contends that a compliance plan is necessary to ensure the safeguards adopted in this decision are actually complied with. DRA and TURN contend that CWA failed to explain why it would be burdensome to provide the information called for in the compliance plan. TURN argues that providing information to directors, officers and management is insufficient unless the managers also provided such information to field personnel and other relevant staff. DRA and TURN do not object to the filing of the compliance plan concurrently with, or as part of, the utility's annual report.
We agree with CWA that the requirements for ensuring compliance should be simple and straightforward. However, we do not agree that there should be no compliance plan at all but simply a statement of compliance in the utility annual reports. Inevitably, more information will be needed to verify any such statement; this information should be transparent and available to all interested parties. The best way to ensure this occurs is with a clear requirement for a periodic compliance plan. At the same time, the compliance plan should not be onerous. The proposed rule requires potentially many updates of the compliance plan, for every new affiliate or changed circum stance. We consider reporting for new affiliates in Rule VIII.D. We will modify Staff Proposed Rule VIII.C.3 to simply require a biennial report. The first report will be required in 2011 as part of the utility's 2010 annual report.
Staff Proposed Rule VIII.D states: "Upon the creation of a new affiliate, the utility shall immediately notify the Commission of its creation, as well as posting notice of this event on its web page board. No later than 60 days after the creation of this affiliate, the utility shall file an advice letter with the Director of the Commission's Division of Water and Audits and the Division of Ratepayer Advocates. The advice letter shall state the affiliate's purpose or activities, whether the utility claims that Rule I.B makes these (rules) applicable to the new affiliate, and shall include a demonstration to the Commission that there are adequate procedures in place that will assure compliance with these (rules)."
CWA would have this rule apply only to affiliates which have transactions with the utility. CWA points out that the various water utilities have hundreds of affiliates through their parent companies which do not interact with California water utilities. CFC disagrees, contending that the Commission should decide to which affiliates the rules should apply, as opposed to having the utilities decide when notification is appropriate. DRA would apply this proposed rule to reporting of new affiliates that have the potential to affect a utility's regulated operations, assuming that proposed rule VIII.C(3) is adopted regarding a compliance plan.90
We agree with CFC. The Commission, not the utility, should determine whether an affiliate is subject to these Rules. At the same time, we do not want to continuously monitor those affiliates which would have no impact on a utility's operations. DRA's proposal is too vague, as it may not be possible to know which affiliates have the potential to affect a utility's regulated operations. We will retain Staff Proposed Rule VIII.D, but revise it to state that the utility may include in its advice letter a request, including supporting explanation, that these Rules not be applied to the new affiliate.
Staff Proposed Rule VIII.E states: "The utility shall have an audit performed biennially by independent auditors. The audits shall cover the last two calendar years which end on December 31, and shall verify that the utility is in compliance with the (rules) set forth herein. The Division of Water and Audits shall post the audit reports on the Commission's web site. The audits shall be at shareholder expense."
CWA contends this audit is unnecessary because it would duplicate what occurs in general rate cases. Park Water would also remove the proposed rule. Alternatively, due to the expense involved with an audit, Park Water would have the rule be triggered only if unregulated affiliates generate revenue exceeding some percentage of the total revenue of the combined entities.91 CFC would keep the proposed rule, because it believes that affiliate transaction rules are unlikely to be given sufficient attention in a general rate case, given all of the other matters in such a proceeding. DRA similarly claims that general rate cases are becoming very large and complex, and argues that another complex issue should not be added to those proceedings.92
Pub. Util. Code § 314.5 states, in pertinent part: "The commission shall inspect and audit the books and records for regulatory and tax purposes (a) at least once in every three years in the case of every electrical, gas, heat, telegraph, telephone, and water corporation serving over 1,000 customers, and (b) at least once in every five years in the case of every electrical, gas, heat, telegraph, telephone, and water corporation serving 1,000 or fewer customers. An audit conducted in connection with a rate proceeding shall be deemed to fulfill the requirements of this section." The required audit in the statute is essentially a financial audit. The audit in the proposed rule pertains to affiliate transactions. We consider this a separate audit function. Deferring to the required audit from § 314.5 would not ensure that affiliate transactions would be specifically reviewed. In order to ensure this, we will adopt the Staff Proposed Rule. In order to avoid adding shareholder costs for situations with de minimus affiliate activities, we will add a provision such that the audit is required only if all unregulated affiliates of that utility generate revenues exceeding 5% of the total revenue of the utility plus all of its affiliates.
5.11. Rule IX -- Confidentiality
There is no controversy regarding Rule IX. Staff Proposed Rule IX is adopted consistent with our overall policies and objectives discussed in this decision.
26 The concerns of Cal Water and Golden State Water about restrictions on their provision of non-tariffed products and services are discussed in the context of Rule X.
27 The adopted rules recognize that certain situations, such as affiliates with operations outside of California and regulated affiliates, present fewer concerns about fair competition. We have provided exceptions from the rules, or the opportunity for utilities to request exceptions, in these cases.
28 Pacific Tel. & Tel. Co. v. Public Utilities Com., 34 Cal.2d 822, 832 (Cal. 1950).
29 General Tel. Co. v. Public Utilities Com., 34 Cal.3d 817, 825 (Cal. 1983).
30 Id. at 822.
31 PG&E Corp. v. Public Utilities Com., 118 Cal.App.4th 1174, 1201 (Cal. App. 1st Dist. 2004).
32 See PG&E Corp. v. Public Utilities Com., supra.
33 Id. at 1197.
34 Id. at 1198.
35 Id. at 1199.
36 CWA Comments at 10.
37 TURN Comments at 6.
38 TURN Comments at 3-4.
39 TURN Comments at 3.
40 CWA Comments at 11.
41 Under Rule II.E defining the term "affiliate," "substantial operational control" is a defined term. In response to comments, in Rule II.A we change the term "controlling interest" to "substantial operational control" for consistency.
42 TURN Comments at 7.
43 CWA Comments at 12.
44 Park Water Comments at 2-3.
45 CWA Comments at 13.
46 Copyright © 2005, 2000, 1995, 1987 by Barron's Educational Series, Inc.
47 By "unauthorized," we allow for the possibility that the Commission may authorize a utility with a regulated affiliate (such as Park Water), or a utility with more than one district (such as Golden State Water) to allocate costs among regulated affiliates or districts in ways which do not necessarily reflect cost causation or other commonly used cost allocation methodologies.
48 §§ 451 and 2701.
49 These preceding policy statements were originally included as part of Rule III in the Staff Proposed Rules. Since our rules generally do not contain policy statements, we have deleted them from the Staff Proposed Rule III and discuss them as part of this decision.
50 This statement should not be read to require any water or sewer utility to offer any new product or service, or continue to offer any current product or service, through an affiliate.
51 Workshop Report, spreadsheet at 23.
52 CWA Comments at 14.
53 In the non-tariffed products and services rules, discussed later in this decision, we allow the utility itself to use certain assets in limited ways beyond the core provision of water or sewer services.
54 This discussion would also be applicable to any other water or sewer utility which adopts a similar structure in the future.
55 To ensure clarity, notwithstanding Rule V, Rule III.B does not allow sharing of non-public or proprietary information between a utility and an affiliate which provides access to capital, or customer service functions, to both utilities and non-regulated entities.
56 The energy affiliate rules include certain restrictions on use of the utility name and logo, which were not part of the Staff Proposed Rules here.
57 Starting in 2007, Rule II.B adopted in the energy utility holding company decision D.06-12-029, required the energy utilities to report the creation of all new affiliates; before this the energy utilities reported only those they deemed covered by the energy utility affiliate transaction rules. Therefore, this table may undercount new affiliates created before 2007. On the other hand, an unknown number of the reported affiliates may no longer exist.
58 Provision of customer information outside of the utility must be consistent with state and federal privacy laws, as well as applicable Commission regulations.
59 CWA Comments at 16-17.
60 TURN Comments at 14.
61 CWA notes that the Workshop Report does not accurately reflect its position regarding this section.
62 CWA Comments at 18-19.
63 DRA Comments at 11-12.
64 CWA Comments 19-20.
65 We prefer the term "offer" to "sold" for several of the sub-rules in Rule VI, as this term covers all transactions, such as rents and leases, instead of simply including sales.
66 CWA Comments 20.
67 DRA Comments at 13.
68 TURN Comments at 16.
69 CWA Comments at 20-21.
70 DRA Comments at 14.
71 This discussion does not address other circumstances which may threaten the financial health of the utility. For example, poor management or poor regulation may negatively impact the financial health of the utility. In addition, other factors such as weather, changes in supply or demand, and changes in other legal or regulatory structures beyond the Commission may have negative impacts to the extent the utility is not protected from these events through balancing accounts or other regulatory mechanisms.
72 DRA Prehearing Conference Statement at 12.
73 CWA Prehearing Conference Statement at 13.
74 CWA Comments at 20-21.
75 DRA Comments at 15.
76 CWA Comments at 21.
77 Park Water Comments at 9.
78 DRA Comments at 3.
79 Ibid. at 18.
80 DRA Comments at 16.
81 See also D.08-01-018 wherein the Commission imposed an identical condition on a request from Lodi Gas Storage, L.L.C. for transfer of control to Buckeye Gas Storage. In that decision, the Commission required that the officers of the six entities involved in the transaction be made available to testify.
82 TURN Comments at 17-18.
83 In D.97-12-011 and D.98-06-068, the Commission included directors, as well as officers and employees, of the utility and its affiliates to "be available to appear and testify in any proceeding before the Commission involving the utility." Directors were not included in the analogous rules adopted in D.02-12-068 or D.04-01-051.
84 D.85-06-023 did not include an explicit requirement that officers and employees be required to appear and testify before the Commission.
85 DRA Prehearing Conference Statement at 5.
86 CWA categorized this issue as "Bucket 3" in workshops and opposed the Staff Proposed Rule. However, CWA modified its position in comments as discussed.
87 CWA Comments at 23.
88 This or very similar language is found in attachments laying out affiliate transaction rules in D.97-12-011, D.98-06-068, D.02-12-068 and D.04-01-051. D.85-06-023, Ordering Paragraph 4, states "SLW Corp and any other affiliated company transacting business with San Jose Water Company shall, upon request, make all books and records available for Commission review and inspection."
89 CWA Comments at 22.
90 DRA Comments at 18.
91 Park Water Comments at 9.
92 Id.
