II. Applicability of §854 to this transaction.
A. Background
The scope of this proceeding is governed by Pub. Util. Code §§ 851-856.
B. §854(a) Applies to this Transaction
Pub. Util. Code § 854(a) specifies that, "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 this Commission. The Commission may establish by order or rule the definitions of what constitute merger, acquisition, or control activities that are subject to this section of the statute."4
In the Scoping Memo, the Assigned Commissioner directed the Applicants to continue to provide all the information they believed necessary and appropriate to demonstrate compliance with all of the provisions of Pub. Util. Code §§ 854(a), (b) and (c) to ensure that there would be no unnecessary delay in processing of the application. There is no dispute as to the applicability of §854(a) to this transaction.
C. Application of §§854 (b) and (c) to this Transaction
The plain language of the statute, its legislative history and prior Commission decisions guide our application of this statute to this transaction, specifically the applicability of §§854 (b) and (c).
Pub. Util. Code §854(b) states:
Before authorizing the merger, acquisition, or control of any electric , gas, or telephone utility organized and doing business in this state, where any of the utilities that are parties to the proposed transaction has gross annual California revenues exceeding five hundred million dollars ($500,000,000), the commission shall find that the proposal does all of the following:
(1) Provides short-term and long-term economic benefits to ratepayers.
(2) Equitably allocates, where the commission has ratemaking authority, the total short-term and long-term forecasted economic benefits, as determined by the commission, of the proposed merger, acquisition, or control, between shareholders and ratepayers. Ratepayers shall receive not less than 50 percent of those benefits.
(3) Not adversely affect competition. In making this finding, the commission shall request an advisory opinion from the Attorney General regarding whether competition will be adversely affected and what mitigation measures could be adopted to avoid this result.5
1. §854(b) does not apply to this application because no party to the transaction is a utility with California revenues of at least $500 million within the meaning of §854(b).
Review of a transaction under Pub. Util. Code §854(b) may be triggered when at least one party to the transaction is a "utility" with gross annual California revenues above $500 million. Verizon is a holding company and not a utility within the meaning of 854(b). Although Verizon California is a utility with annual California revenues above $500 million, Verizon California is not acquiring MCI.
Pub. Util. Code §854(f) directs that:
"In determining whether an acquiring utility has gross annual revenues exceeding the amount specified in subdivisions (b) and (c), the revenues of that utility's affiliates shall not be considered unless the affiliate was utilized for the purpose of effecting the merger, acquisition, or control."6
Verizon California was not organized for the purpose of acquiring MCI. Pursuant to §854(f), its income may not be considered in determining whether Verizon, the acquiring company, meets the $500 million annual California revenue threshold of §854(b). Without the inclusion of Verizon California's annual gross California income,, Verizon does not meet the revenue threshold that would trigger application of §854(b). Thus even if we were to treat Verizon as a utility for purposes of this transaction, the acquisition would still not trigger review under §854(b).
MCI is also a holding company and not a "utility" within the meaning of 854(b). MCI's California affiliates, which are being indirectly acquired in this transaction, include a utility, but none meets the threshold of $500 million in annual California gross revenue.
The Legislature's intent to limit this Commission's review under §854(b) and (c) to specific circumstances where a "very large" California utility was the subject of an acquisition could not be more clear. Amendments to §854 added by Senate Bill 52 in 1989 clearly delineate the rationale for adding §854(f) barring the consideration of affiliate revenue for purposes of calculating the $500 million threshold:
"...this Bill as now written would require the CPUC to make certain findings before authorizing any acquisition by a very large utility of another utility, while other entities which are not utilities could acquire the same utility without the same level of CPUC oversight (unless the company to be acquired was a very large utility). This amendment would make CPUC authorization under the requirements of this legislation necessary only when a very large utility was being acquired, whether it was a utility or a non-utility company doing the acquiring" (emphasis added).7
Several protestants argue that according to company data filed in connection with the merger application, the combined gross annual revenues of each merging company's California utility subsidiaries exceed $500 million and Verizon California by itself has gross annual California revenues in excess of $500 million.
However, subsidiaries are affiliates8 for purposes of our review and, as stated above, §854(f) directs that revenues of an affiliate of an acquiring utility that was not organized for the purpose of effecting the merger "shall not be considered" in determining whether the acquiring utility meets the $500 million threshold of §854(b). It is irrelevant whether the combined revenue of Verizon's affiliates meets the threshold or not.
Our interpretation of the applicability of §854(f) is also consistent with Commission precedent. In D.99-03-019, the Commission concluded:
"Pub. Util. Code §854(f) precludes consideration of the revenues of AT&T's California utility affiliates because none of them is being used to effectuate the merger, and because they are affiliates of the acquiring company9.
As to whether MCI's California affiliates would meet the $500 million threshold if their revenues were combined for purposes of calculating the trigger, a plain reading of §854(b) indicates that the revenues of "any" utility that is party to the transaction should be considered separately.
Again, we turn to the legislative history of the relative amendments to §854 for clarification. As discussion of the amendments in the Senate made clear:
"The inclusion of this language in SB 52 would clarify what revenues the CPUC is expected to look to in determining the application of this law. For example, in Pacific's situation this would make it clear that when PacTel Cellular is involved in an acquisition, it is PacTel Cellular's revenues and not Pacific Bell's that would determine the application of the requirements in this bill to the transaction."10
Thus, we conclude that the revenues of MCI's California affiliates should be considered separately in determining whether any utility meets the revenue threshold under §854(b).
2. Exemption under §853(b) makes consideration of affiliate revenues irrelevant.
As the law makes clear, this Commission has broad authority under §853(b) and §854(a) to exempt transactions from review under §§854(b) and (c) regardless of the $500 million threshold. Pub. Util. Code §853(b) states:
"The commission may from time to time by order or rule, and subject to those terms and conditions as may be prescribed therein, exempt any public utility or class of public utility from this article if it finds that the application thereof with respect to the public utility or class of public utility is not necessary in the public interest."11
As established by D. 97-052-092, D.97-07-060 and D. 98-05-022, the Commission has consistently exercised its broad authority under §853(b) to exempt transactions from review under §§854(b) and (c) regardless of the presence of gross annual revenues in excess of the $500 million threshold when a very large ILEC is not the subject of an acquisition or when the subject of an acquisition is an NDIEC or CLEC.
In the MCI-BT case (D.97-07-060) the Commission recognized the sweeping authority granted to the Commission by the Legislature in this regard: "...the extent of our broad exemptive powers in §853(b) is clear on the face of that statute..." The Commission further concluded that "We think this evinces a legislative intent to permit us to use our powers under both §853(b) and §854(a) to exempt transactions from review under §§854(b) and (c), regardless of the presence of gross annual California revenues in excess of $500 million."12
Thus, based on the unambiguous authority granted to the Commission under §853(b), the Commission has clearly and consistently exercised its authority to exempt transactions involving the acquisition of NDIECs and CLECs, regardless of whether the $500 million revenue threshold has been met.
3. It is not reasonable to "pierce the corporate veil" as Verizon California is hot the subject of the acquisition and is not "key to the merger."
In D.97-03-067, the SBC acquisition of Pacific Telesis, the Commission determined that "Although the transaction is technically structured as a merger between SBC and Telesis, the practical result of the proposed transaction...is that it involves Pacific." The Commission found that, since SBC, an out of state corporation, was acquiring California's largest provider of basic local exchange service, it was in the public interest to "pierce the corporate veil" in order to consider the transaction based on "substance rather than form."
The Commission concluded that Pacific was a party to the transaction within the meaning of §854(b) based on the reasoning that the very large California utility being acquired was "key to the merger." Specifically the Commission reasoned that:
· Pacific represented 90% or more of Telesis' assets.
· The economic benefits to be realized from the transaction were based on the joint and combined operations of Pacific and Southwestern Bell Telephone.
· One of the principal reasons SBC pursued the transaction was to add the 15.8 million access lines in California to its existing 14.2 million telephone access lines.
Applying the same criterion used in the SBC-Telesis merger to the instant transaction leads to the opposite conclusions:
· Verizon California is not the subject of the acquisition in this application.
· Verizon subsidiaries in California do not account for a majority of the holding company's assets. In fact, Verizon's California subsidiary accounts for a relatively small portion of Verizon's assets. Public information indicates that Verizon California accounts for approximately 3% of Verizon's annual revenues and proprietary information in the record contains the exact amount.
· The economic benefits to be realized from the transaction are not based on the joint and combined operations of Verizon California and MCI's California affiliate. In fact, the operations of the two entities will not be combined.
· The principal reason stated by Verizon for pursuing the acquisition of MCI is the addition of MCI's national and global enterprise market and fiber network, only a small percentage of which is located in California. The number of MCI access lines in California to be added to Verizon's access lines through this transaction is de minimis.
Applying the criteria used in the SBC-Telesis merger, it is clear that because Verizon California is neither the subject of the acquisition nor "key to the merger," there is no reason to "pierce the corporate veil". .
4. Prior applications of §854(b) to transactions involved the acquisitions of ILECs, not NDIECs or CLECs
In prior decisions, the Commission has distinguished between the application of §854(b) to transactions involving the acquisition of California's largest incumbent local exchange carriers (ILECs) and transactions involving competitive carriers (CLECs) or non-dominant inter-exchange carriers (NDIECs), choosing not to apply this section of the Public Utilities Code to the latter. 13 Each of MCI's California subsidiaries is a CLEC or an NDIEC.
A review of past decisions demonstrates that this Commission has clearly and consistently exercised its authority to exempt transactions not involving the acquisition of a California ILEC from application of §854(b). In all cases over the past 15 years this Commission has exempted transactions involving the acquisition of NDIECs, CLECs, and other non-ILECs, including the following transactions: AT&T-Comcast; AT&T-Media 1; Qwest-US West; AT&T-TCI; MCI-WorldCom; AT&T-TCG; MCI-British Telecom;
In D. 98-08-068 the Commission clearly articulated the historic application of 853(b) authority when acquisition of a large California ILEC is not involved: "As in the BT/MCIC and AT&T/TCG mergers, the acquisition of a heavily-regulated local exchange carrier is not the reason for the instant merger."14 In the footnote to the above citation, the Commission noted: "While AT&T was once more heavily regulated as a dominant carrier, by the time of the TCG merger we had accorded it nondominant status."15
Accordingly, and for the same reasons, we conclude that because all California subsidiaries of MCI are CLECs or NDIECs, it is not necessary in the public interest to apply §854(b) to this transaction.
5. Legislative history demonstrates that the Legislature intended to give the Commission flexibility in the application of §854(b) where traditional cost-of-service utilities are not involved in the transaction.
Prior to 1995, Pub. Util. Code §854(b) required the Commission to review acquisitions, mergers and changes of control in instances where "the acquiring or to be acquired utility has gross annual California revenues exceeding five hundred millions dollars."16 Both subsections (b) and (c), known as the "Edison Amendments," were added to §854 in 1989 following a series of proposed mergers in the electric industry.
At the time, the applicability of §854(b)(1) rested on the assumption that a regulated utility subject to an acquisition or merger operated under a traditional cost-of-service ratemaking scheme and that any savings resulting from a merger that were not anticipated at the time the utility's rates were set would not flow through to ratepayers without regulatory action by the Commission.
The pre-1995 statute was historically interpreted by this Commission to require all transactions, regardless of whether a utility was a party to the transaction, to be analyzed according to the provisions in §854 (b) and (c), unless exempted pursuant to the Commission's authority under §853(b) or §854(a), with 100 percent of quantified economic benefits allocated to ratepayers.
In 1995 the Legislature amended §854(b) and (c) limiting the applications of Section 854(b) to transactions to which a large, traditionally-regulated California utility is a party.17 These amendments were proposed by the CPUC and adopted by the Legislature in response to the Commission's adoption of the "New Regulatory Framework" ("NRF") in which the Commission moved away from traditional cost-of-service ratemaking for telephone service providers and toward a regulatory framework that recognizes the benefits to consumers of increased competition in the telecommunications industry.
Assembly Bill 119 amended Section 854(b)(1) in order to "provide the CPUC with the flexibility needed in the current regulatory environment, where, increasingly, rates are set through a price cap or incentive based mechanism, rather than through traditional command and control method."18 The Commission's analysis in support of the bill indicates the reason the CPUC sponsored the legislation:
"This amendment modernizes' sec. 854 in light of changes in the regulatory environment since 1989. It recognizes that, increasingly, large utilities are being regulated under `price cap' mechanism or a `performance based' system rather than the `command and control' system of traditional, `cost-of-service' regulation. In this new regulatory environment utility cost recovery is not guaranteed to the same extent but innovative, cost-cutting behavior is better rewarded. The idea is to better balance utility risk and reward and to bring lower costs to ratepayers (without decreasing service), by moving toward a `carrot' approach to regulation and away from a `stick' approach. Under these so-called `incentive-based' regulatory systems, ratepayers and shareholders share costs, savings and profits in varying degrees."
The Commission-sponsored amendments to §854(b): (i) removed the requirement that the Commission find that the proposal provides net benefits to ratepayers, and instead require the Commission to find that the proposal provides short-term and long-term economic benefits to ratepayers; and (ii) equitably allocate the short-term and long-term forecasted economic benefits of the proposed transaction as determined by the Commission between shareholders and ratepayers where the Commission has ratemaking authority (emphasis added). In those cases where merger benefits are allocated by the Commission through its ratemaking authority, it requires ratepayers receive not less than 50 percent of the benefits.
The Legislature's intent to provide the Commission with the flexibility to determine which transactions are subject to these requirements and to determine how best to allocate the benefits of those transactions is clear in the statements that were made at the time the amendments were added: "If rates are not regulated because the industry is competitive, it may not be appropriate to require any sharing of benefits."19
We conclude that even if this transaction were not exempt from §854(b) pursuant to §854(f), Legislative history confirms that the Commission is well within its discretionary authority to exempt the transaction from the allocation of economic benefits vis a vis a traditional ratemaking mechanism contemplated under §854(b). We also conclude that these amendments were not intended to countermand the statutory obligation that any such transaction be approved only if it is in the public interest.
6. Exempting this transaction from §854(b) is in the public interest pursuant to the authority granted in §853(b) and consistent with Commission precedent.
After passage of the 1996 Telecommunications Act20 and adoption of the New Regulatory Framework in California21, the Commission consistently relied on a three-part test for telecommunications mergers and acquisitions to guide the determination as to whether a transaction warranted exemption from §854(b) pursuant to §853(b) or §854(a).
Beginning with the British Telecom-MCI merger in 1997,22 the Commission applied three principal questions to transactions involving telecommunications companies where the application of §854(b) was considered:
· Does the transaction involve putting together two traditionally or incentive regulated telephone systems?
· Does the Commission exercise the type of ratemaking authority that would facilitate an allocation of the merger benefits as contemplated under 854(b)?
· Has the acquired company grown under competitive forces at the sole risk of its shareholders?
In the MCI-BT case the Commission concluded:
"The instant application does not involve putting together two traditionally regulated telephone systems, nor are contiguous or nearby service territories involved....The acquisition does not involve merging any BT operations into MCIC operations. No consolidation of MCIC subsidiary management with BT management is contemplated....We do not have traditional ratemaking authority over MCIC's operations. Competitive market forces will distribute any benefits of this merger to ratepayers, therefore, to review this transaction under PU Code §854(b) would be a futile exercise. MCIC has grown under competitive forces at the sole risk of its shareholders without a captive ratepayer base and guaranteed franchise territory to buffer risk and reward. Review of this particular transaction under §§854(b) and (c) will stifle competition and discourage the operation of market forces and is contrary to the main thrust of our telecommunications policy and the Telecommunications Act of 1996."23
Asking these three questions of the instant application leads to similar answers.
First, the instant application does not involve putting together two traditionally regulated telephone systems. The subject of the acquisition, MCI, is a nondominant interexchange carrier and a CLEC that operates primarily in the heavily competitive and rapidly declining long distance market. The Commission has never exercised traditional ratemaking authority over MCI's California affiliate, MCIC.
Moreover, Verizon California is an ILEC no longer subject to traditional cost-of-service rate regulation. It is subject to regulation under the Commission's New Regulatory Framework, designed for transition to a competitive market, with significant or complete pricing flexibility for all services other than basic local exchange service.
Neither MCI nor its California subsidiaries have ever been subject to traditional cost-of-service regulation that would facilitate an allocation of the merger benefits as contemplated under §854(b). Further, although the Commission distributed merger benefits via a surcredit following the acquisition of GTE by Bell Atlantic, five years have passed since that action, and NRF ratemaking and the new regulatory environment do not facilitate an equitable distribution of merger benefits through a traditional ratemaking mechanism as contemplated under §854(b).
Indeed, as contemplated under NRF and the federal Telecommunications Act, the telecommunications industry has become more competitive since 1996. Attempting to mandate the distribution of economic benefits of a merger or acquisition of this type using traditional rate regulation mechanisms today would be detrimental to the operation of market forces and is contrary to the main thrust of the 1996 Telecommunications Act, state telecommunications policy, and this Commission's stated policies under NRF.
MCIC has grown (and shrunk) under competitive market forces at the sole risk of its shareholders without a captive ratepayer base and guaranteed franchise territory to buffer risk and reward.
As a result, even if §854(b) applied to this transaction, granting an exemption would be consistent with past Commission practice and in the public interest. Thus, subjecting such a transaction to §854(b) "is not necessary in the public interest" pursuant to the authority granted us in PU Code § 853(b), as well as § 854(a).
7. Commission precedent and §854(c) provide the appropriate guidelines for determining whether this transaction is in the public interest.
Over time, the Commission has used its discretion in different ways in reviewing mergers. In D.70829 the Commission approved a transfer of control after determining that the transaction "would not be adverse to the public interest."24 Historically, the Commission has sought more broadly to determine whether a change in control is in the public interest:
"The Commission is primarily concerned with the question of whether or not the transfer of this property from one ownership to another...will serve the best interests of the public. To determine this, consideration must be given to whether or not the proposed transfer will better service conditions, effect economies in expenditures and efficiencies in operation."25
D.97-07-060 notes that over the years, our decisions have identified a number of factors that should be considered in making the determination of whether a transaction will be adverse to the public interest.26 More recently, D.00-06-079 provides an overview of these factors:
"Antitrust considerations are also relevant to our consideration of the public interest.27 In transfer applications we require an applicant to demonstrate that the proposed utility operation will be economically and financially feasible.28 Part of this analysis is a consideration of the price to be paid considering the value to both the seller and buyer.29 We have also considered efficiencies and operating costs savings that should result from the proposed merger.30 Another factor is whether a merger will produce a broader base for financing with more resultant flexibility.31
"We have also ascertained whether the new owner is experienced, financially responsible, and adequately equipped to continue the business sought to be acquired. 32 We also look to the technical and managerial competence of the acquiring entity to assure customers of the continuance of the kind and quality of service they have experienced in the past.33"34 (footnotes in this text, with the exception of footnote 39, appeared in the original, but have been renumbered consistent with this sequence).
Subsequently, D.00-06-079 assessed the proposed transaction against the seven criteria identified in § 854(c),35 and included a broad discussion of antitrust and environmental considerations.36 A consideration of these factors constitutes the appropriate scope of this proceeding.
E. Summary of Applicable Law
In summary, we rule that 854(b) and (c) do not apply to this transaction. To determine whether this transaction is in the public interest, the proposed transaction will be assessed against the seven criteria identified in § 854(c),37 and will include a broad discussion of antitrust and environmental considerations, as has been done in previous cases.
The parties should use this ruling to guide them in the preparation of briefs.
The principal hearing officer will bring a proposed decision, including a discussion of applicable law, before the Commission consistent with the timetable adopted previously in this proceeding.
4 §854(a)
5 §854(b)
6 §854(f)
7 Amendments to Senate Bill No. 52 (As amended in Senate April 19, 1989)
8 The Commission's affiliate transaction rules define affiliate as follows:
"Affiliate" means any person, utility, corporation, partnership or other entity 5 percent or more of whose outstanding securities are owned, controlled or held with power to vote, directly or indirectly, either by a utility or any of its subsidiaries or by that utility's controlling corporation..."
Accordingly, all subsidiaries are affiliates.
9 Re. joint application of AT&T and Tele-Communications Inc. March 4, 1999 at n11
10 Amendments to Senate Bill No. 52 (As amended in Senate April 19, 1989)
11 §853(b)
12 D. 97-07-060 (at *24)
13 See, e.g., Re AT&T Corporation, D. 99-03-019, 85 CPUC 2d 249 (March 4, 1999), pp. 254-55
14 D. 98-08-068 Section VI par. 5
15 Ibid, footnote n4
16 §854(b) as amended by SB 52 in 1989
17 Amended Statutes 1995 Chapter 622 Section 1 (AB 119).
18 Report of Assembly Committee on Utilities and Commerce, April 3, 1995 at 1
19 Senate Committee on Energy, Utilities, and Communications, July 11, 1995 at 3
20 U.S. 47
21 D.XX-XX-XXX
22 Re MCI Communications Corporation, D. 97-05-092, 72 CPUC 2s 656 at 664-665
23 In the matter of the Joint Application of MCI Communications Corporation and British Telecommunications, D. 97-07-060 1997 Cal. PUC LEXIS 557, Finding of Fact 15
24 Ibid., Finding of Fact 3, 645.
25 Union Water Co. of California, 19 CRRC 199, 202 (1920) at 200.
26 1997 Cal PUC LEXIS 557 *22-25.
27 65 CPUC at 637, n.1.
28 R. L. Mohr (Advanced Electronics), 69 CPUC 275, 277 (1969). See also, Santa Barbara Cellular, Inc. 32 CPUC2d 478 (1989).
29 Union Water Co. of California, 19 CRRC 199, 202 (1920).
30 Southern Counties Gas Co. of California, 70 CPUC 836, 837 (1970).
31 Southern California Gas Co. of California, 74 CPUC 30, 50, modified on other grounds, 74 CPUC 259 (1972).
32 City Transfer and Storage Co., 46 CRRC 5, 7 (1945).
33 Communications Industries, Inc. 13 CPUC2d 595, 598 (1993).
34 D.00-06-079 (2000 Cal PUC LEXIS 645, *17-*20), footnotes included but renumbered into the current sequence.
35 Public interest factors enumerated under this code section are whether the merger will" (1) maintain or improve the financial condition of the resulting public utility doing business in California; (2) maintain or improve the quality of service to California ratepayers; (3) maintain or improve the quality of management of the resulting utility doing business in California; (4) be fair and reasonable to the affected utility employees; (5) be fair and reasonable to a majority of the utility shareholders; (6) be beneficial on an overall basis to state and local economies and communities in the area served by the resulting public utility; and (7) preserve the jurisdiction of the Commission and our capacity to effectively regulate and audit public utility operations in California."
36 D.00-06-079 (2000 Cal. PUC LEXIS 645, *17-*38); see also D.01-06-007 (2001 Cal. PUC LEXIS 390 *25-*26) for a similar list of factors.
37 Public interest factors enumerated under this code section are whether the merger will" (1) maintain or improve the financial condition of the resulting public utility doing business in California; (2) maintain or improve the quality of service to California ratepayers; (3) maintain or improve the quality of management of the resulting utility doing business in California; (4) be fair and reasonable to the affected utility employees; (5) be fair and reasonable to a majority of the utility shareholders; (6) be beneficial on an overall basis to state and local economies and communities in the area served by the resulting public utility; and (7) preserve the jurisdiction of the Commission and our capacity to effectively regulate and audit public utility operations in California."
