Utility Oversight:

Recent Changes in Law Call for Improved Vigilance by FERC

GAO-08-289: Published: Feb 25, 2008. Publicly Released: Mar 6, 2008.

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Under the Public Utility Holding Company Act of 1935 (PUHCA 1935) and other laws, federal agencies and state commissions have traditionally regulated utilities to protect consumers from supply disruptions and unfair pricing. The Energy Policy Act of 2005 (EPAct) repealed PUHCA 1935, removing some limitations on the companies that could merge with or invest in utilities, leaving the Federal Energy Regulatory Commission (FERC), which already regulated utilities, with primary federal responsibility for regulating them. Because of the potential for new mergers or acquisitions between utilities and companies previously restricted from investing in utilities, there has been considerable interest in whether cross-subsidization--unfairly passing on to consumers the cost of transactions between utility companies and their "affiliates"--could occur. GAO was asked to (1) examine the extent to which FERC changed its merger and acquisition and post merger review and oversight processes since EPAct to protect against cross-subsidization and (2) survey state utility commissions about their oversight.

FERC has made few substantive changes to its merger review processes and does not have a strong basis for ensuring that utilities do not engage in harmful cross-subsidization. FERC officials told us that they plan to require merging companies to disclose existing or planned cross-subsidization and to certify in writing that they will not engage in cross-subsidization, but do not plan to independently verify such information. Once mergers have taken place, FERC intends to rely on its existing enforcement mechanisms--primarily companies' self-reporting noncompliance and a limited number of compliance audits--to detect potential cross-subsidization. FERC officials told us that they believe the threat of large fines, as allowed by EPAct, will encourage companies to investigate and self-report any non-compliance. In addition, FERC officials told us that, for 2008, FERC developed its plans to conduct compliance audits of 3 of the 36 holding companies it regulates based on informal discussions between senior agency officials and staffs in key offices. However, FERC does not formally use a risk based approach that considers factors, such as companies' financial condition or history of compliance. A risk-based audit approach is an important consideration in efficiently allocating its limited resources to detect non-compliance. In addition, we found that FERC's public audit reports often lacked a clear description of the audit objectives, scope, methodology, and findings--inhibiting their use in improving transparency with stakeholders or helping FERC staff improve their audit practices. State utility commissions' views of their oversight capacity varied, but many reported a need for additional resources, such as staff and funding, to respond to changes in their oversight after the repeal of PUHCA 1935. State regulators in all but a few states reported that utilities must seek state approval for proposed mergers. State regulators reported being mostly concerned about the impact of mergers on customer rates, but 25 of 45 reporting states also noted concerns that the resulting, potentially more complex company could be more difficult to regulate. Most states reported having some type of audit authority over the transactions between utilities and their affiliated companies, but many states currently review or audit only a small percentage of these transactions, with 28 of the 49 reporting states auditing 1 percent or less over the last five years. On the other hand, some states reported that they require periodic, specialized audits of affiliate transactions. In addition, although almost all states require financial reports from utilities and report they have access to utility companies' financial books and records, many states reported they do not have such direct access to the books and records of affiliated companies. While EPAct provides state regulators the ability to obtain such information, some states expressed concern that this access is narrow and could require them to be extremely specific in identifying needed information, thus potentially limiting their audit access. From a resources perspective, 22 of the 50 states reporting said that they needed additional staffing and funding to a carry out their oversight responsibilities.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: The Chairman of the Federal Energy Regulatory Commission (FERC) should develop an audit reporting approach to clearly identify the objectives, scope and methodology, and the specific findings of the audit, irrespective of whether FERC takes an enforcement action, in order to improve public confidence in FERC's enforcement functions and the usefulness of audit reports on affiliate transactions for FERC, state regulators, affected utilities, and others.

    Agency Affected: Federal Energy Regulatory Commission

    Status: Closed - Implemented

    Comments: During the course of the GAO Audit (11/2007) with issuance of FERC's audit report on Kansas City Power & Light Company, FERC's Division of Audits began providing greater transparency to the audit process by providing more detail of the audit steps completed by the audit staff. All audit reports now reflect the audit objectives and findings, where applicable. FERC is promoting increased transparency in it audit reports to motivate compliance with the Commission's regulations, including company's internal compliance programs, which is a key enforcement objective in FERC's strategic plan.

    Recommendation: The Chairman of the Federal Energy Regulatory Commission (FERC) should, as an aid to developing this risk-based approach, develop a better understanding of the risks posed by each company by doing the following: (1) monitoring the financial condition of utilities to detect significant changes in the financial health of the utility sector, as some state regulators have found it useful to do. To do this, FERC could leverage analyses done by the financial market and develop a standard set of performance indicators; and (2) developing a better means of collaborating with state regulators to leverage resources already applied to enforcement efforts and to capitalize on state regulators' unique knowledge. As part of this effort, FERC may want to consider identifying a liaison, or liaisons, for state regulators to contact and to serve as a focal point(s).

    Agency Affected: Federal Energy Regulatory Commission

    Status: Closed - Implemented

    Comments: In January 2009, FERC issued a rule requiring public utilities to provide additional information on affiliate transactions in FERC Form 1 and 2 in order to assess at each public utility the type, amount, accounting and reporting of affiliate transactions. In addition, FERC's Division of Audits reviews bond ratings, stock prices, various financial and non-financial information from outside databases and purchased software, SEC filings, and FERC Forms 1,2, and 60 to better understand the risks posed by each company. Furthermore, the Division of Audits assesses the level of state commissions' review of affiliated transactions using state rate information about cost recovery mechanisms (formula, state, or fixed rates). The Audit staff also routinely communicates with state commission staff shortly after an audit is initiated to facilitate planning and collaborating with state regulators as needed during the course of the audit. They also typically contact state commission officials at the conclusion of the audit to discuss audit results. FERC's Office of External Affairs also maintains extensive communication with state commissions through its Division of State, International, and Public Affairs.

    Recommendation: The Chairman of the Federal Energy Regulatory Commission (FERC) should develop a comprehensive, risk-based approach to planning audits of affiliate transactions in holding companies and other corporations that it oversees to more efficiently target its resources to highest priority needs and to address the risk that affiliate transactions pose for utility customers, shareholders, bondholders, and other stakeholders.

    Agency Affected: Federal Energy Regulatory Commission

    Status: Closed - Implemented

    Comments: FERC established in its FY 2009-2014 Strategic Plan a performance goal requiring that most audits be planned and prioritized using a risk-based approach. In addition, FERC's Division of Audits implemented a comprehensive risk-based approach to planning affiliated transaction audits using an internally developed screen to rank and select candidates for affiliate transaction audits. The ranking is an important factor in assessing the potential risk of inappropriate cross-subsidization. Furthermore, the Division of Audits has completed 10 of 16 affiliate transaction audits--6 are ongoing--to further implement this recommendation.

    Recommendation: The Chairman of the Federal Energy Regulatory Commission (FERC) should, after developing a more formal risk-based approach, reassess whether it has sufficient audit resources to perform these audits. If FERC believes that it does not have sufficient resources to conduct adequate auditing of the companies that it oversees within its existing staff and budget, FERC should provide this information to Congress and request additional resources.

    Agency Affected: Federal Energy Regulatory Commission

    Status: Closed - Implemented

    Comments: Since issuance of the GAO report in February 2008, FERC's Division of Audits staff has grown from 34 to 61 full-time equivalents. This reflects FERC's increased responsibility for ensuring the reliability and security of the nation's bulk power system as well as its broader responsibility for ensuring compliance in all areas of the Commission's jurisdiction.

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