3. Revised Affiliate Transaction Rules

3.1. Overview - Major Amendments

Appendices A-1 and A-2 to this decision show, in redlined format, the complete text of the Affiliate Transaction Rules Applicable to Large California Energy Utilities (Revised Affiliate Transaction Rules or Revised Rules) which we adopt today. Appendix A-3 is a "clean" version of the Revised Rules. These appendices replace the Proposed Decision's Appendix A. The Revised Rules, applicable only to Respondents, are based on the Affiliate Transaction Rules (Original Rules) adopted nearly ten years ago by D.97-12-088, as subsequently amended.6 The Original Rules will continue to apply to all California energy utilities, other than Respondents, except those which have been expressly exempted by prior Commission decisions. To avoid confusion about applicability in the future, we will soon open a rulemaking for the sole purpose of amending the Original Rules to exempt the large energy utilities from them and to include a cross-reference to the Revised Rules.

The Revised Rules are not identical to either the staff proposals released with the September 12 ALJ Ruling, the Proposed Decision's Appendix A, or the proposals released with the November 7 AC/ALJ Ruling. We have refined these working drafts (to clarify, remove ambiguity, or reduce burden, etc.) and we have discarded several proposals altogether. The Comments on the Amended OIR, the workshop discussion, the written workshop statements and the Comments on the Proposed Decision and November 7 AC/ALJ Ruling have all been helpful. Where Respondents have suggested changes to reporting or compliance deadlines so as to allow more lead time for compliance, improve efficiency, or minimize duplication of effort, we have incorporated all reasonable suggestions.

The amendments include the following changes, as well as other, minor revisions intended, for example, to improve internal consistency or delete outdated provisions concerning initial compliance with the Original Rules:7

Respondents' initial Comments and Workshop Statements oppose much of the content of the earlier versions of the Revised Rules. DRA and CFC support most of the earlier versions and in some instances urge us to go further, if the Commission is to exercise adequate utility oversight short of holding company divestiture. Though IEP and TURN each focus on single (and different) issues, they both strongly recommend action -- IEP, to prevent utility favoritism toward generation affiliates and TURN, to insulate utilities from any financial problems at the holding company level.

Respondents' recent Comments on the November 7, 2006 AC/ALJ Ruling are comparatively muted. Respondents acknowledge the efforts the November 7 Ruling has made to address their concerns about the Proposed Decision's perceived compliance burden and impact upon corporate governance. Respondents indicate that they support the changes the Ruling proposes to Rule VI (officer certification) and "are reluctantly willing to accept" the proposals to revise Rule V E to provide an election (shared services versus officer duplication). (Respondents' November 17, 2006 Comments, pp. 5, 8.)

Several rule revisions have been uncontroversial. These include two revisions to Rule VI, Regulatory Oversight. Respondents appear to recognize that the Commission, rather than a utility, should determine whether a new utility affiliate is covered by the Revised Affiliate Transaction Rules (Rule VI A and B) and that it is reasonable for the Commission to take a lead role in selecting the auditor hired to perform the required utility audits (Rule VI C). Neither have Respondents contested the revisions to Rule IV, Disclosure and Information, which remove the requirement to compile, for dissemination to customers, lists of the service providers that compete with utility affiliates in offering gas- or electric-related goods or services. Commission staff have been advised that because customers have not asked for the lists, the ongoing effort to update the lists is unnecessarily time consuming.

Below, we discuss the major issues that Respondents and the other parties raise.

3.2. Discussion

The impetus for our examination of the Affiliate Transaction Rules now is the recent repeal of the Public Utilities Holding Company Act (PUHCA)8 coupled with potentially serious flaws in Respondents' interpretation of and compliance with the Original Rules.

Respondents contend that the repeal of PUHCA does not necessitate further review of the Original Rules, because each of the holding companies was exempt from PUHCA. However, Respondents miss the point. Until PUHCA was repealed, a state commission could always petition the Securities and Exchange Commission (SEC) to remove the exemption if the holding company structure thwarted effective state regulation of a utility. For example, in 1973, the SEC considered but rejected its staff's recommendation to remove the exemption for Pacific Lighting Corporation (PLC), the parent holding company of Southern California Gas Company at that time. The SEC found, among other things, that notwithstanding PLC's expanding diversification, the California Commission could still effectively regulate the utility and protect its ratepayers.9 Because one of the main purposes of PUHCA was to facilitate effective state regulation of the utilities, the SEC gave considerable weight to state commissions' views concerning an exemption.10 Therefore, if a holding company's acquisitions or operations ever threatened effective state regulation of the utility, the state commission had the remedy of petitioning the SEC to remove the holding company's exemption. With the repeal of PUHCA, that remedy no longer exists.11

D.06-06-062, which amended this Rulemaking, discusses a number of interpretation and compliance problems (selective applicability to utility holding companies and unregulated affiliates, overly narrow interpretations of the scope of covered transactions, overbroad interpretations of express exceptions, conflicts of interest, etc.). These problems give rise to two main concerns. One is the likelihood for preferential treatment, unfair competitive advantage, or the sharing of competitively sensitive confidential information within the partly regulated, mostly unregulated corporate family and the consequences such competitive abuse poses for energy markets and captive ratepayers. The second concern is the potential threat to a utility's financial health and ability to meet its public service obligations unless it is adequately insulated from the financial risks and debts of its unregulated parent and affiliates. D.06-06-062 observes that given the "substantial profits or risks at stake, there are strong incentives within the holding company structure to take advantage of confidential utility information or use ratepayer-subsidized utility facilities, whether to help affiliates maximize their profits or bail them out from risks." (D.06-06-062, p. 11, slip op.)

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.

In their Comments and Workshop Statements, Respondents argue that our concerns are largely speculative, that the electric energy crisis is now behind us, and that recent audits of utility compliance with the Affiliate Transaction Rules have reported few, relatively minor violations. Respondents challenge what they characterize as the failure of Commission staff to lay out adequate evidentiary support for the need for revisions to the Original Rules. The September 12 ALJ Ruling notes this controversy and the reliance of Commission staff on D.06-06-062, which states: "We are not interested in conducting additional discovery in this rulemaking or litigating, here, what happened in the past." (D.06-06-062, mimeo., p. 10.)

However, because Respondents have pointed to past audits as proof that no problems exist with their Affiliate Transaction Rules compliance, we feel compelled to take official notice of the auditors' findings and recommendations. All of the compliance audits are public documents. Where the Commission has not reviewed an audit in a formal proceeding and made its own findings, we take official notice merely to highlight the disparity between Respondents' characterizations and the findings in the audits themselves, but make no assessment of the merits.

The most recent and most serious problems appear in several audits for the Sempra companies.12 We also are well aware that in other Commission proceedings (I.02-11-040 and I.03-02-033), Edison has contended that certain conduct by Sempra Energy and its affiliates, including SDG&E and SoCalGas, violated the Original Rules. Recently, these parties have reached an agreement to settle their differences, and in Application 06-08-026 and in motions to withdraw claims in both investigations, they have requested that the Commission close those proceedings without adjudicating Edison's claims or the claims of the auditors. Having sought dismissal on that basis, Respondents may not refer to the past audits as evidence that their past practices have not resulted in violations of the Original Rules. Respondents cannot have it both ways. 13

Respondents also challenge the evidentiary basis for any amendments to the Affiliate Transaction Rules. Because this Rulemaking is quasi-legislative in character, a hearing of a judicial type is not necessary. We are not required to rely upon evidence produced in this proceeding, but may draw upon evidence from past proceedings, our knowledge and experience, comments in this proceeding and our current policies.14 Indeed, when we adopted the Original Rules in 1997, we did not conduct evidentiary hearings. Pursuant to Section 1708.5(f) of the Public Utilities Code, we may revise the Affiliate Transaction Rules in this proceeding through notice and comment rulemaking procedures without conducting an evidentiary hearing.15 There is no dispute of fact concerning the inherent conflict of interest within the holding company structure. There is also no reason why, on a policy basis, we cannot revise the Original Rules to close certain loopholes in order to more effectively address this conflict of interest.

Additionally, the matters at issue in this Rulemaking are not, as Respondents appear to imply, unknown to the attorneys, lobbyists and other representatives of utilities, independent energy producers, and others who appear before the Commission. This has been a matter of substantial public and expert concern since the California energy crisis of 2000-2001. In the intervening five years, there has been no dearth of official reports and recommendations, to say nothing of accounts in the public press. As an example, the California Attorney General issued an "Energy White Paper"16 that discussed the need for a myriad of regulatory reforms. More significantly, this Commission bears an independent obligation to look at anti-trust matters in its endeavors. In Northern California Power Association v. Public Utilities Commission the California Supreme Court rebuked the Commission for its failure to take into account sua sponte the anti-trust aspects of an application:

[I]t is clear that the Commission must take into account the antitrust aspects of applications before it. It is equally obvious that the Commission failed to perform this essential duty in the instant case. Although the Commission heard extensive testimony and legal argument...its decision appears to ignore the antitrust issues entirely...

....

The task of the Commission extends far beyond the passive role of a sounding board. The Commission cannot discharge its duty by merely taking "cognizance of the contracts between PG&E and its steam suppliers," without evaluating their effect upon the interests of the public. It must weigh the opposing evidence and arguments in order "to determine whether the rights and interests of the general public will be advanced by the prosecution of the enterprise which it is proposed to carry on for the service of the public." ...The Commission must place the important public policy in favor of free competition in the scale along with the other rights and interests of the general public. Here, the Commission did not perform this task; it incorrectly found "no need to determine the issues raised by NCPA." (5 Cal. 3d 370, 379 (1971).)

3.2.1. Rule II - Applicability to Holding Companies

In the 1997 decision adopting the Affiliate Transaction Rules, the Commission states, "the development of competitive markets would be undermined if the utility were able to leverage its market power into the related markets in which their affiliates compete." (D.97-12-088, 77 CPUC 2d 422, 449.) The same would be true were a holding company to leverage its utility's market power or govern the utility in a way that provided unfair competitive advantages to utility affiliates over competitors. D.06-06-062 plainly recognizes the potential for holding company abuse, stating: "Unless key aspects of the Affiliate Transaction Rules govern the relationship between a utility and its holding company, these rules and the underlying reasons for them can be totally circumvented at the top of the corporation where the significant decisions are made." (D.06-06-062, mimeo., p. 13.)

Instead of showing that there are no problems with the Original Rules, Respondents' Comments highlight one of the major problems motivating us to adopt these amendments. Commission staff and some auditors have tended to perceive this problem as resulting from Respondents' overly narrow interpretation of when and how the Original Rules apply to the holding companies. Respondents insist that the holding companies are not covered by the Original Rules "unless the holding companies themselves (as opposed to their subsidiaries) directly participate in energy markets." (Respondents' Comments, p. 28.)17

Narrow interpretation of the Affiliate Transaction Rules creates a significant loophole and undermines their use as an adequate regulatory tool for protecting utility ratepayers and ensuring fair competition in energy markets. We examine two, simple hypothetical illustrations.

In the first, a utility provides confidential information to its corporate parent, the holding company, and unbeknownst to the utility, the holding company shares the confidential information with an affiliate or utilizes the confidential information to provide preferential treatment or an unfair competitive advantage to the affiliate.

Under Respondents' narrow interpretation, the utility may report confidential information directly to the holding company, and as long as this exchange does not utilize shared services (which may be used only if they do not create an opportunity for the transfer of confidential information), no violation of the Original Rules has occurred. The reasons? The holding company is not covered by the Rules and shared services were not utilized.

In our second hypothetical, a holding company instructs its utility to submit a particular procurement proposal to the Commission and unbeknownst to the utility, the proposal will provide preferential treatment for an affiliate. Again, if the holding company is not covered, no violation of the Rules has occurred, even though Respondents' narrow interpretation undermines the entire purpose of the Original Rules.

There are two approaches to closing this loophole. The approach we have followed is to amend specific Rules to explicitly provide that they bind the holding company. The other approach would be to interpret "affiliate" to include the holding company by virtue of its governance of the energy products/services provided by marketing affiliates. We have rejected this approach because it creates other problems. For example, if we made the entirety of the Revised Affiliate Transaction Rules applicable to holding companies, they would be unable to keep any communications with their utilities confidential. Also, the greater structural separation required would oblige the holding company and utility to be housed in separate buildings.

The amendments to Rules II B and II C close the loophole without creating new, undesirable consequences. Specifically, Rule II B, as amended, clarifies that whenever a Rule explicitly extends its reach to a utility's holding company, that Rule is meant to apply and does apply to the holding company. The amendment rejects and prevents future use of a circular argument that, based upon the current definition of "affiliate" and the wording of Rule II. B (in the Original Rules), none of the subsequent Rules apply to a holding company which does not provide energy services, even though, the subsequent Rule, by its own terms otherwise would apply.

In Rule II C, we adopt amendments to explicitly prohibit a holding company or any other affiliate from knowingly directing or causing a utility to violate or circumvent the Revised Rules. This amendment revises staff's proposal by inserting the element of scienter, as Respondents' Workshop Statements argue we must. We agree that consistency with Section 2111 of California Public Utilities Code necessitates this amendment.

3.2.2. Rule III - Nondiscrimination

The amendments to Rule III B do two things. One, they strengthen the requirement that any information provided by a utility to an affiliate be limited to that made generally available to all market participants. Two, they close a significant loophole in existing resource procurement transactions by extending the requirement for Commission pre-approval of utility-affiliate procurement to cover all types of resources.

IEP supports both of these amendments and states that they "are useful tools in a multifaceted effort to ensure fair competition among utility generation affiliates and independent power producers." (IEP Post-workshop Statement, p. 4.) IEP remarks that the other Commission tools for protecting against affiliate procurement abuse, the Independent Evaluator and Procurement Review Groups, "have not yet been shown to be effective." (Id., p. 3.) IEP adds:

[T]he Commission must ensure that no favoritism occurs in the procurement process when affiliates are involved. If utility projects or affiliate proposals are allowed to compete with independent, nonaffiliated power producers in solicitations where the utility retains the primary power to select winners, it must be beyond dispute and transparent to all participating parties that the winning projects are selected on a fair and unbiased basis. (Ibid.)

As we noted in D.06-06-062, while recent statutes or Commission decisions generally require some form of Commission pre-approval for utility procurement of electricity, or utility execution of liquefied natural gas (LNG) contracts and interstate pipeline contracts, at present there are no pre-approval requirements for other resources, such as natural gas supplies. Natural gas utilities file reports with the Commission which provide details of their purchases of natural gas from affiliates, but there is no way to determine if the utility is providing preferential treatment to its affiliate or to assess the reasonableness of the affiliate's after-market sales to the utility. Such omissions open the door to the appearance of favoritism and possibly, to actual market abuse. Compliance need not be overly burdensome. For short-term purchases, for example, pre-approval need not require transaction-by-transaction assessment, but might be based on a methodology approved by the Commission.

We have revised the staff proposals to exempt blind transactions from the pre-approval requirement.

The Proposed Decision included a new Rule IV C that would have required semiannual, confidential reports from a utility to the Commission disclosing when and to whom at the holding company or an affiliate the utility has provided non-public information concerning one or more of six commercially sensitive subjects: information supplied by the affiliate's competitor; negotiations with the affiliate's competitor; utility procurement plans; utility operational matters; expansion plans; and the affiliate's competition with other entities.

Respondents contend that sound governance principles and duties under state corporate law, federal securities laws and the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley),18 require that holding company officials must have access to all material information about their subsidiaries' businesses. Such information, they argue, is necessary for a holding company to certify the company's financial statements and internal controls and thereby accurately disclose all material information to investors in a timely manner. We agree. As proposed, new Rule IV C would not have prohibited the utility from providing non-public information to its holding company.

Respondents also maintain that the obligation to report on these six subjects would be so burdensome as to interfere with or even deter the flow of information between the utility and its parent, particularly if the reporting requirements include communications involving the corporate support group of shared services under Rule V E. Respondents also maintain that the reporting obligation would fail to prevent abuse. For example, Respondents state: "Indeed, if the Commission does not trust executives to comply with the existing anti-conduit rules, then a rule that would impose a recording requirement would add nothing because there would be no basis for believing that the covered communications were properly recorded." (Respondents' Comments, p. 21.) One of Respondents' spokesmen made the same point at Oral Argument, stating: "... the key people at the holding company that have the obligation to the board and to - under Sarbanes-Oxley, if they don't intent to honor the anti-conduit rule, none of the rest of this burdensome activity works." (Tr. 39:1-5.) One Commissioner present at Oral Argument, who expressed a strong concern about the burden note taking would impose, nonetheless remarked: "One fellow I used to work for used to say, "Trust, but verify." (Id. at 47:14-15.) The Commissioner also observed: "... somewhere along the line there needs to be some comfort in the public that we get what we need in the process. So the point is really balance..." (Id. at 47:27-48:2.)

In lieu of the Proposed Decision's approach and in our continuing effort to strike the appropriate balance, we endorse the alternative approach offered for comment by the November 7, 2006 AC/ALJ Ruling. This alternative, offered in lieu of the Proposed Decision's new Rule IV C, instead amends Rule VI, Regulatory Compliance by adding a new Rule VI E entitled "Officer Certification." Rule VI E requires each key officer of a utility and its holding company parent to execute an annual certification under penalty of perjury that the officer is familiar with the Revised Rules and either has complied with them or has listed any known violations. One of the concerns underlying this rulemaking is the potential for a utility's parent holding company to serve as a conduit, whether intentionally or inadvertently, for the kinds of information that the Original Rules prohibit the utility and its affiliate from sharing directly. The certification requirement is meant to ensure that responsibility for compliance with the Revised Rules reaches all the way to the top of the corporate enterprise and influences those individuals with the greatest ability to control utility/holding company and utility/affiliate relationships.

3.2.4. Rule V - Shared Services

Our previous adoption of holding company structures for California's major natural gas and electric utilities relied upon corporate separation of the regulated and unregulated entities. When the Commission adopted the Affiliate Transaction Rules in D.97-12-088, however, it found that the development of competitive markets required even more separation between a utility and its affiliate. Rule V, Separation was the result. Nevertheless, in Rule V E (Corporate Support), the Commission allowed an exception and authorized sharing of the corporate support group of services, provided that sharing those services did not give any affiliate an unfair competitive advantage.

As we explained in D.06-06-062, we now question the breadth of some of the exceptions, particularly the exceptions for "financial planning and analysis," "regulatory affairs," "lobbying" and "legal." These exceptions could include matters affecting marketing or operational issues, for example, where an affiliate can be given an unfair competitive advantage. Although Rule V E states that the exceptions should not provide a means to transfer confidential information between the utility and the affiliate, provide preferential treatment or create an unfair advantage, we must question whether such separation is possible. In D.06-06-062, we asked the questions: "How can an attorney or a consultant giving advice to an affiliate, completely avoid transmitting confidential utility information that he or she also holds? Even if the attorney or consultant does not disclose the confidential information, how could it not at least influence the attorney's or consultant's advice?" (D.06-06-062, mimeo., p. 16.)

Respondents contend that professionals can keep the confidential information separate, and they give as examples law firms that may have clients in competing businesses. However, when the same law firm is hired by two clients with contrary interests, those clients typically have an opportunity to decide whether or not to waive any conflict issues. Even then, there may be a firewall imposed in the law firm.

In contrast, for holding company shared services, competitors of the affiliate or groups representing ratepayers have no opportunity to decide whether or not to waive conflict issues that may arise when the same lawyer or law firm provides shared services for the utility and its affiliate. There are no mandatory firewalls within the shared services of the holding company, and firewalls are ineffective if the same person is providing the shared services.

Another problem with shared services in Rule V E (Original Rules) is timing. The shared services allow an affiliate to obtain information prior to public disclosure, if any. In addition, the individuals providing shared services may learn an enormous amount of vital, non-public information from the utility that could be very beneficial to the affiliate. Yet, under the Original Rules, even if an individual had extensive knowledge of one or more of these subjects, he or she could provide shared services for the utility, holding company and affiliate, simply because that individual is an attorney, regulatory affairs official, lobbyist or financial planner. Similarly, under Rule V G of the Original Rules, contractors or consultants could be jointly retained by the utility, holding company and affiliate and thereby learn about a utility's confidential matters while working concurrently for the affiliate.

Respondents claim that the shared services help to ensure that holding company officials receive necessary information and that all entities in the corporate family take consistent positions with respect to material issues that bear on public disclosures. They further contend that these shared services are necessary to enable all entities in the corporate family to take a common, coordinated position before this Commission and other state and federal bodies. However, there is nothing in the Revised Rules which precludes a holding company from obtaining information from its utility without using shared services. For example, holding company officials can call utility officials or receive written or oral reports or presentations from utility officials.

Furthermore, some of the coordination that takes place through use of shared services concerns us. Respondents contend that the corporate family should be entitled to harmonize conflicting goals in order to present coordinated positions before the Commission and other agencies. They further suggest that the First Amendment protects their right to do so. This entirely depends upon what they are harmonizing.

Often it is permissible for a utility, its holding company, and affiliates to take coordinated positions before the Commission. Just like other parties which may jointly file pleadings, the utility and its holding company and affiliate do not have to share services of the same individual in order to do so. However, if a utility, its holding company and affiliates should decide to engage in anti-competitive conduct whereby the utility provides preferential treatment for its affiliate, this harmonization is not proper or protected by the First Amendment.19

We provide a hypothetical example. Suppose SoCalGas and SDG&E were to coordinate with their holding company and affiliates in order to purchase regasified LNG only from Sempra LNG and avoid a fair opportunity for any other potential LNG supplier to compete and offer a better supply arrangement. A coordinated effort, subsequently, to file an application with the Commission for approval of this supply arrangement would not be justifiable or protected by the First Amendment.

Coordination problems are not merely hypothetical, however. In D.06-06-062, we cited examples of significant utility/affiliate/holding company problems in California's past (Edison and Mission Energy, PG&E and PGT, SoGalGas and PITCO). We reiterate that utilities have a public service obligation to provide services in a safe, reliable and environmentally sustainable manner at the lowest reasonable cost. Preferential treatment to affiliates is prohibited. Whether or not these legal obligations conflict with holding company or affiliate goals, it is impermissible for a utility to resolve these conflicts by abandoning its public service obligations.

Because of these concerns, the Proposed Decision recommends revision of the examples of permitted and prohibited corporate support services in Rule V E. The Proposed Decision would exclude sharing by utility and affiliates of regulatory affairs, lobbying, risk management, and legal services (except legal services necessary to the provision of authorized shared services). However, largely based on workshop discussions in which Respondents itemized some of the specific corporate tasks which rely upon the timely sharing of information, the Proposed Decision would expand the examples of permitted sharing to include cash management, banking relations, communications with rating agencies, trust management, and corporate compliance with the Revised Rules. The Proposed Decision also would revised Rule V G (Employees) to extend the prohibition on the sharing of employees by utility and affiliates to ban the sharing of consultants and contractors (though it would expressly exempt auditors and providers of accounting services).

Respondents' Comments strongly oppose the Proposed Decision's approach to Rule V and continue to assert that its suggestions for amendment to Rule V are unwarranted, inefficient and in some cases, unworkable. After considering Respondents' concerns and reconsidering the Commission' regulatory objectives, the November 7 AC/ALJ Ruling suggests an alternative approach, which provides a utility and its holding company with an election. This election involves modifying Rule V to provide that if these corporate entities prefer to retain the provisions on shared services or shared employees, consultant, and contractors found in the Original Rules, they must eliminate any duplication of personnel among key corporate officers. If they prefer not to eliminate overlap among key officers, then they must cease sharing services in the areas of legal, regulatory affairs and lobbying. The definition of key officers for the purposes of Rule V is the same as for the new officer certification requirement in Rule IV. In lieu of the change to Rule V G, we also make a minor, clarifying amendment to Rule I, Definitions to stress that the utility shall not use a consultant or contractor as a conduit to circumvent the Revised Rules.

We think that the election goes far to solve the matters of greatest concern to us, either by directly limiting the scope of shared services or by restricting the potential conflict of interest among top corporate decision makers. The present high degree of overlap among key corporate officers at each utility and its holding company parent means either option will take time to implement. Accordingly, we require implementation by 180 days after the effective date of today's decision.

Our adoption of these revisions strikes a different balance than the Proposed Decision would, but the objectives are the same. Today's decision offers Respondents greater flexibility to determine how to conduct their businesses efficiently, minimize duplication and enjoy any economies of scale that may be available but also requires clearer protections against preferential treatment of utility affiliates.

3.2.5. Rule IX - Protecting the Utility's Financial Health

The new Rule IX consists of four provisions, A-D, previously articulated in various Commission decisions. Rule IX A is designed to ensure that we receive, on an ongoing basis, the same information (about capital budgets, etc.) that we called for in the OIR. Rule IX B imposes on all the utilities the obligation to retain a capital structure consistent with the Commission-authorized structure. We imposed this requirement on PG&E in 1996, in D.96-11-017. Respondents would prefer that we did not add this requirement to the Revised Rules, but have not established that it is unreasonable. As Respondents' suggest, however, we have revised the staff proposal and Proposed Decision so that the Rule tracks the language in D.96-11-017.

We have deleted the final two staff proposals and added two ring-fencing proposals which TURN advocates. One of the deleted rules would prohibit a utility from issuing dividends or repurchasing stocks when its senior, unsecured long-term debt rating falls to the lowest investment grade unless the utility first obtains Commission approval to do so. We imposed this condition in our approval of the PacifiCorp merger, D.06-02-033, where it was offered as one of the many terms of the multi-state settlement. Respondents oppose this staff proposal, partly because it inadvertently referenced the wrong debt benchmarks. Respondents also argue that the rule may have adverse consequences and offer, in support, the opinion of their consultant, Steven M. Fetter.20 We conclude that we should not impose this condition, broadly, without further study. The other deleted rule would prohibit a utility from becoming or remaining liable for the indebtedness of its affiliates without Commission approval, also a condition of approval of the PacifiCorp merger. This condition essentially restates the prohibitions in Public Utilities Code Section 701.5, and as such, need not be restated in the Revised Rules.

Rules IX C and IX D are two of the ring-fencing measures which we approved in the context of the PacifiCorp merger. TURN urges us to adopt these two provisions which focus "on the effect of the intended ring-fencing, rather than the detailed provisions required to achieve such an outcome." (TURN Post-workshop Comments, p. 2.) That effect, of course, is to ensure that a utility is not pulled into the bankruptcy of its holding company, should serious financial problems develop. We have amended the Revised Rules to adopt TURN's recommendation.

Rule IX C simply requires a utility to obtain a non-consolidation opinion that demonstrates that the ring-fencing measures it has in place are adequate to keep the utility out of a bankruptcy filed by its holding company parent. Rule IX C does not mandate what types of ring-fencing measures the utility must adopt. We make no changes to this Rule. However, after further consideration, we have revised Rule IX D to require only that a utility notify the Commission if it subsequently makes changes to its ring-fencing measures.

6 D.97-12-088, 77 CPUC 2d 422, 449, as amended by D.98-08-035, 81 CPUC 2d 607 and D.98-12-075, 84 CPUC 2d 155.

7 Parties' Comments have not objected to these minor changes.

8 The Energy Policy Act of 2005 (EPAct 2005), Public Law 109-58, among other things repealed the Public Utility Holding Company Act of 1935, 12 USC §§ 79 - 79z-6.

9 See In the Matter of Pacific Lighting Corporation (1973) 173 SEC LEXIS 2231.

10 See Sempra Energy (1998) 1998 SEC LEXIS 1310 at *84; see also KU Energy Corporation (1991) 1991 SEC LEXIS 2568 at *20-21.

11 CFC's Comments and Workshop Statements contain an extensive review of the serious abuses that led to enactment of PUHCA. CFC reminds us that similar problems could arise in the future. We share CFC's concern.

12 We refer here to three audits. An Affiliate Transaction Rules compliance audit of SDG&E and SoCalGas in 2004 by auditors hired and managed by Sempra Energy identified violations or partial compliance with eight Rules, including Rule V E, Corporate Support. The auditors reported:

SDG&E's joint utilization of Energy Risk Management as a corporate shared service has resulted in the means and transfer of confidential information from the utility to the affiliate, created the potential for unfair competitive advantage, and provided a conduit for the transfer of confidential utility information to a covered affiliate. Furthermore, Energy Risk Management had conducted hedging related activities specifically forbidden by Rule V.E. NorthStar further concludes that Sempra Energy has not complied with CPUC Decision 02-09-048 related to the receipt and use of time-sensitive non-public information from SoCalGas Acquisition and SDG&E Fuel and Power Supply. (2004 Affiliate Transactions Audit of Southern California Gas Company, May 1, 2005, and 2004 Affiliate Transactions Audit of San Diego Gas & Electric Company, May 1, 2005, by NorthStar Consulting Group, p. 62.)

The auditors recommended that: "Energy Risk Management should not be performed as a shared corporate service." (Recommendation #9); "SoCalGas should stop the transmittal of market related information to Sempra Energy Risk Management." (Recommendation #10.) The SDG&E audit contained a similar recommendation.

An audit four years earlier had identified the same problem. (See Management Audit and Market Power Mitigation Analysis of the Merged Gas System Operation for Pacific Enterprises and Enova Corporation, Vol. 1-3, July 2000, by Larkin & Associates, pp. 1-10.) The audit was ordered by D.98-03-073, which approved the merger of SoCalGas and SDG&E. In D.02-09-048, which issued after review of the audit, the Commission determined that the auditors had identified a serious problem (the transfer of confidential information to the unregulated affiliate, Sempra Energy Trading, through the shared risk management services allowed under Rule V E). The Commission attempted to impose a remedy (a delay in the transmittal of confidential information from the utility to the holding company), but the 2004 audit found this requirement often was ignored. (See 2004 Affiliate Transactions Audit..., p. 59.)

In Investigation (I.) 03-02-033, the Commission required a staff-managed audit of the Sempra companies to identify any Affiliate Transaction Rules violations since 1997. Auditors found that the shared risk management function "acted as a conduit for proprietary information between the utility and its affiliates in violation of Rule V E." (Confidential Report to the CPUC for the Affiliate Transactions Compliance Audits of Sempra Energy's Southern California Gas Company/San Diego Gas and Electric Company, by GDS and Associates, pp. 5 and 51.) The auditors concluded that the parent was a covered affiliate under the applicability provisions of Rule II B since it provides financial credit derivative services to its unregulated trading affiliate. The auditors recommended that the Commission prohibit risk management as a shared service and that Sempra Energy agree to comply with the affiliate rules as a covered affiliate (Id., p. 5). While the report is marked "confidential" it is not. The report was filed in I.03-02-033 by the Commission's Energy Division and served on the service list on February 28, 2006.

13 D.06-06-062 discusses the different business approaches vis a vis the California market the three holding companies have taken in the last decade or so. Sempra has most actively engaged in business operations in California and the market affecting this state. PG&E Corporation emerged from the bankruptcy brought about by the energy crisis without any significant affiliates. Until recently, largely because of affiliate abuse problems related to its Mission Energy affiliate in the time period from 1984 to 1992, Edison International has restricted most of its affiliate operations to other geographic markets. (See D.93-03-021, 48 CPUC 2d 352.)

14 See City of Santa Cruz v. Local Agency Formation Commission of Santa Cruz County (1978) 76 Cal. App. 3d 381, 388.

15 See Southern Cal. Edison Co. v. Public Utilities Com. (2002) 101 Cal.App.4th 982, 994.

16 Attorney General's Energy White Paper: A Law Enforcement Perspective on the California Energy Crisis, April 2004, http://ag.ca.gov/publications/energywhitepaper.pdf. We take official notice of this report.

17 Respondents take somewhat contradictory positions. On the one hand, relying upon the definition of "affiliate" in Rule I, Definitions and upon Rule II B, Applicability, Respondents assert the Original Rules clearly exempt holding companies not directly and actively engaged in the provision of electricity or natural gas services/products. On the other hand, Respondents suggest that we need not be concerned that holding companies might be used as a conduit to pass confidential information to utility affiliates because holding companies are covered by the prohibitions in Rule V E, Separation-Corporate Support.

Rule V E recognizes a corporate support exception to the basic requirement for separation between a utility and its affiliates, explicitly extends this exception to "the utility, its parent holding company, or a separate affiliate created solely to perform corporate support services...," and emphasizes that any shared services "shall not allow or provide a means for the transfer of confidential information from the utility to the affiliate, create the opportunity for preferential treatment or unfair competitive advantage, lead to customer confusion, or create significant opportunities for cross-subsidization of affiliates." The Rule requires mechanisms to effect utility compliance (but does not explicitly require holding company compliance).

18 Pub. L. 107-204 (July 30, 2002).

19 See, e.g., Columbia Steel Casting v. Portland General Electric (9th Cir.1996) 111 F.3d 1427, 1446 ["Applying to an administrative agency for approval of an anticompetitive contract is not lobbying activity within the meaning of the Noerr-Pennington doctrine (which is rooted in the First Amendment protection). In any case, PGE is not being held liable for filing the application . . . PGE is being held liable for agreeing with PP&L to replace competition with area monopolies in the Portland market."]

20 Fetter is President of Regulation, UnFettered, an energy advisory firm. He served as head of the utility ratings practice at Fitch Ratings (1993-2002) and Chairman of the Michigan Public Service Commission (1987-1993). By motion filed September 29, 2006, Respondents seek leave to file Fetter's Declaration. The motion is unopposed.

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