II. Sempra's Argument

The PE/Enova merger application stated that a "principal objective" was to "unite the diverse skills and capabilities of Pacific Enterprises and Enova Corporation ...."⁵ This would permit SoCalGas and SDG&E to achieve "synergies, consisting of cost reductions and cost avoidances," estimated to be $1.2 billion net of costs to achieve over 10 years, the "majority of which will be realized in utility operations." ⁶ Fifty percent of the forecast savings would be passed on to ratepayers through an annual bill credit upon consummation of the merger. The application stated that the "substantial majority of the synergies will be achieved through streamlining corporate, administrative, and field

support functions, as well as the elimination of some duplicative functions in overlapping gas operations." ⁷ And Enova separately stated that the "combination will enhance the cost-efficiency and effectiveness of SDG&E's local distribution operations." ⁸ The "new company's regulated operations" would be led by a single "principal executive officer" with the title of "President."

Prepared testimony identified 12 areas of functional integration - Accounting and Finance, Human Resources, Information Systems, Legal, External Relations, Corporate Services, Support Services, Customer Services, Marketing, Transmission and Distribution, Gas Supply and Operations and Executive Management.

The application did not seek to merge the utilities. Each utility would retain its existing legal and regulatory status, including name, headquarters, corporate identity, separate capital structure, and existing franchises, permits, tariffs and licenses. The applicants' merger case specified only one limit on functional integration - that the combined company's gas operations would be operated independently of, and physically separated from, its gas acquisition. In the course of the merger proceeding, applicants argued successfully that inter-utility transactions of the merged company should be exempt from the Commission's new affiliate rules, because application of those rules in this case would nullify most merger savings and not serve any pro-competitive purpose.

The merger decision largely adopted applicants' merger plan and savings forecast, and adopted no limits on utility integration beyond those proposed by applicants. Significantly, the decision granted Section 851 approval "to the extent necessary to achieve the savings from this merger." ⁹ Moreover, the merger decision's required mitigation measures state:

SDG&E and SoCalGas will be organized in a manner that allows them to provide the highest quality utility service that focuses on safety and reliability, and is responsive to customers' needs. Each utility Affiliate will, to the extent it makes business sense, share resources with the other utility Affiliate. ¹⁰

From those factors Sempra concluded that the merger decision contemplated that the utilities would work out how best to achieve savings by integrating utility operations within the specific limits adopted by the merger decision. Sempra believes the proposed reorganization is consistent with the evidence placed before the Commission in the PE/Enova merger application and with the merger decision itself.

After briefing, but before the Administrative Law Judge (ALJ) issued his proposed merger decision, the Commission, in a separate rulemaking,¹¹ issued its affiliate transactions rules in D.97-12-088. This decision concluded that the new rules would apply to inter-utility transactions, including those contemplated by this merger, unless applicants could show in the merger proceeding, "by clear and convincing evidence" that application of the new rules to SoCalGas/SDG&E transactions would not be in the public interest.¹² The ALJ asked the applicants and other parties to comment on the impact of D.97-12-088 on the merger application. Applicants' comments in response quantified a substantial reduction in forecast merger savings if the affiliate rules were to apply to inter-utility transactions in this merger. Applicants argued vigorously that to apply the new rules in this case would not prevent cross-subsidies or promote competition, and that ratepayers would benefit from a blanket exemption for SoCalGas/SDG&E transactions, with the following limited exceptions (Merger Decision, Attachment B, p. 33):

· Affiliate rules V.G.a, b, and c shall apply to any transfer of employees between SoCalGas Operations or SoCalGas Acquisition and any group at SDG&E engaged in the gas or electric merchant function.

· Rules V.G.2.a, V.G.2.b, and V.G.2.c shall not be applied to transfer of employees between SoCalGas and SDG&E subsequent to the merger other than transfers subject to the preceding paragraph.

Applicants proposed rules to insure there would be no cross-subsidy between the customers of SoCalGas and those of SDG&E after the merger, and that the Commission could track such transactions. These rules would also allow the utilities to maximize efficiencies through shared services that would eliminate duplicative activities. We applied the affiliate transaction rule of D.97-12-088, with the broad exception of utility-to-utility transactions. (D.98-03-073, mimeo., p. 106.)

Sempra believes that the proposed reorganization falls within the scope of the inter-utility integration approved in D.98-03-073.

If the Commission concludes that the merger decision did not grant such authority, Sempra requests that the Commission authorize the reorganization described below of Sempra's regulated California utility operations. This reorganization is based on the following principles:

· For governance and management of ongoing operations, gas and electric functions should be integrated at the executive level to provide consistent vision, values, goals, culture, focus and operational excellence.

· While SDG&E and SoCalGas will remain separate entities, with separate service territories and regulation, most officers will carry responsibility for their functions in both companies.

· The same functional groupings used at the officer level will guide the integration of most subordinate management and supervisory levels. In some cases, at the operational level it may be more effective to integrate based on business drivers such as geography, market segment, scope and scale of operations, or technology, while preserving reporting relationships to the functionally integrated leadership level.

· Employees will be on the payroll of one utility or the other. Sempra will continue the practice of charging work done for another company to that company, to ensure compliance with our merger conditions.

· Most services and support functions will be located at the utility level.

· Overall policy, governance and strategic oversight, as well as some service and support services, will remain at the Corporate Center, and will be charged to the company for which the work is performed.

A. Most Core Utility Functions Would Be Integrated at the Executive Level

Sempra has concluded that grouping gas and electric distribution operations together under common leadership and management could yield benefits, and that although gas and electric transmission operations will report to a common senior officer, it may be beneficial to have these functions report to this senior officer through separate executive leadership at this time, with the potential for further integration in the future as markets evolve. As for customer service, Sempra believes that establishing two groups - Account Management and Customer Service - would best accomplish the goals of the integration effort. Much like distribution, each of these functions would operate under common leadership across the two companies, and may also share some common management below the executive level. The chart below illustrates the concept:¹³

Chart A. Preliminary Integrated Core Utility Functions¹⁴

Accordingly, Sempra requests authorization to integrate core utility functions at the leadership level by appointing common officers who would lead integrated functions for both SDG&E and SoCalGas.

B. Certain Services Now Integrated at the Corporate Parent Would Be Returned to the Utility Group Level

Sempra recommends that certain shared services directly affecting the utilities' bottom line performance be relocated closer to their customers at the regulated business unit level, along with support services integral to the business units' strategy. Services that bear more on Sempra-wide governance and policy would remain integrated at the corporate parent. The chart below illustrates this proposal.

Chart B. Preliminary Integrated Utility Service Functions¹⁵

Sempra requests authority to reorganize shared services as set forth above.

C. Sempra's Request to Terminate Its "No Merger Layoff" Guarantee and Authorize a Similar Guarantee to Support the Proposed Reorganization

Merger applicants established a policy that there would be no layoffs as a result of the merger for non-officer employees, and that any merger-related reductions in force would be achieved through natural attrition and the offer of voluntary separation packages.¹⁶ These provisions are made to maintain the value of the ongoing concern during a merger's pendency by removing perceptions of job uncertainty that might otherwise lead valuable employees to seek work elsewhere. Sempra believes it has achieved virtually all job eliminations made possible by merger synergies, and, to this effect, in December 1999, it notified employees that all but 27 of such job eliminations had been achieved. With respect to those 27 positions, the incumbents have, since December 1999, been offered other positions in the Sempra companies.

To avoid similar perceptions of job uncertainty, Sempra would, on behalf of SoCalGas and SDG&E, like to replace the "no merger layoff" guarantee with Integration Guarantee. This guarantee would assure all management and associate employees, except for the officer group, that there will be no layoff or involuntary separation from employment as a result of this integration project. Assuming timely approval of the instant application, this guarantee would expire on December 31, 2001.

Sempra argues that the Integration Guarantee will prevent uncertainty as to whether any future employment action or any internal utility

reorganization might be deemed merger-related or related to the integration project. Sempra points to a recent California Supreme Court decision for guidance on this issue. In Asmus v. Pacific Bell, (June 1, 2000) 23 Cal. 4^th 1, the Court found that an employer may terminate a unilaterally-imposed employment guarantee, where the policy contains a specific condition if it:

.... is one of indefinite duration, and the employer effects the change after a reasonable time, on reasonable notice, and without interfering with the employees' vested benefits.¹⁷

Accordingly, Sempra asks the Commission to find that Sempra's "no merger-related layoff" obligation has been fulfilled, and that Sempra may replace this policy with the Integration Guarantee to be effective through its expiration on December 31, 2001.

Both Southern California Gas Company and SDG&E negotiated a merger guarantee similar to the one offered management and associate employees with their represented employees through their respective unions. Any guarantee or assurance of continued employment for union-represented employees must, of course be bargained with the represented employees' unions. Sempra does not anticipate any layoff or involuntary separation as a result of this integration project through the end of 2001.

¹⁴ Notes to Chart A

1. Purchased Power, SDG&E Fuels, SONGS will be a functional group that will function separately from gas operations consistent with the merger conditions.

2. SCG Gas Acquisition will be a functional group that will operate independently and be physically separated from gas operations consistent with merger conditions.

3. These are illustrative functions, and will evolve. For brevity, not every function that could be in a particular group has been listed.

4. Training activities will be located in multiple functional groupings.

5. IT technology support activities will be located in multiple functional groupings.

¹⁵ Notes to Chart B

1. These are illustrative functions, and will evolve. For brevity, not every function that could be in a particular group has been listed.

2. Any services provided by the Corporate Center will continue to be charged to the company benefiting from them, consistent with merger conditions.

3. Training activities will be in multiple-functional groupings.