Originally Published: 4/16/2008
THE PUBLIC UTILITY HOLDING
COMPANY ACT of 1935
By The Issue Wonk
The Public Utility Holding Company Act (PUHCA) of 1935 was one of the most important federal consumer protection laws ever passed. It regulated parent or “holding” companies that held the stock of electric and natural gas utilities to keep the owners from raising rates by charging high fees to utilities for services from their affiliates. It also forbid speculation in riskier businesses with ratepayer’s money.1 Knowing the history of utility companies is important to understanding why PUHCA was needed.
Rise of the Power Industry
The early electric power industry was developed using direct current (DC) transmission, “a system in which a relatively low voltage of electricity could travel only over short distances.”2 At that time, numerous power plants were built within small, densely populated areas, usually cities, and consumers were able to choose their service provider. This structure created much competition within a local marketplace.”2
According to Frontline:2
This paradigm began to change as technology rapidly transformed the industry. Newer machines, such as steam turbines, were smaller and less complex, and could create a greater amount of power with a much smaller capital investment. The discovery of alternating current [AC] transformers allowed companies to transport power over longer distances at a higher voltage. Savvy entrepreneurs, such as Samuel Insull of Chicago Edison, realized that they could exploit the greater economies of scale afforded by these new technologies, and maximize profits by consolidating the smaller utility companies. Fueled by the rapid growth of electricity consumption, the utilities boomed during the early 20th century.
The utility boom led to monopolization of the industry. By 1907, “The emerging utility monopolies were vertically integrated, meaning they controlled the generation of electric power, its transmission in real time across high-voltage wires, and its low-voltage distribution to homes and businesses. Reformers of the Progressive Era tried to govern these emerging utility monopolies through state regulation. By 1914, 43 states had established regulatory policies governing electric utilities.”2
The new electric power barons began using holding companies to consolidate ownership of many smaller companies. The holding companies could control, partially or completely, their interest in the other companies. Of course, being robber barons, controlling electric utilities led to the exploitation of the 1920s when holding companies began buying up smaller utilities. They said it increased operating efficiencies, but their goal was to maximize profits. The structure worked so well for them that they expanded it, “pyramiding holding company on top of holding company, sometimes such that a holding company was as many as 10 times removed from the operating company. Each new holding company would buy a controlling interest in the holding company below it and the additional costs and fees for the operating companies were passed along in a higher rate base for the consumer.” 2 Even though the operating companies were subject to state regulation, the holding companies were not. The holding companies could issue stocks and bonds without state oversight. “The abuse of holding companies allowed for the consolidation of utilities such that by the end of the 1920s, 10 utility systems controlled three-fourths of the United States’ electric power business.”2
The 1920s utility company boom led to the perception that utility stock was a secure investment and utility stocks were widely held by millions of investors. “The pyramidal holding company structure allowed the holding companies to inflate the value of utility securities.”2 The companies were decimated by the 1929 stock market crash.
Roosevelt and PUHCA
President Franklin D. Roosevelt called the holding companies “evil.” Finally, in 1935, he was able to get passed the Public Utility Holding Company Act (PUHCA). The main points of PUHCA were:
It outlawed the pyramidal structure of interstate utility holding companies, allowing only that holding companies be no more than twice removed from their operating subsidiaries.
It required holding companies which owned 10% or more of a public utility to register with the Securities and Exchange Commission (SEC) and provide detailed accounts of their financial transactions and holdings. Holding companies that operated within a single state were exempt from PUHCA.
It did not allow non-utilities, such as oil companies or investment banks, to own utilities.
It required the SEC to approve any merger or utility acquisition by a holding company, “to prevent the reappearance of the huge electric and natural gas cartels of the 1920s that abuse their customers and went bankrupt in large numbers because of Enron-like speculation and accounting scams.”1
According to Frontline:2
The legislation had a dramatic effect on the operations of holding companies: Between 1938 and 1958 the number of holding companies declined from 216 to 18. This forced divestiture led to a new paradigm for the electricity marketplace which lasted until the deregulation of the 1980s and 1990s: a single vertically-integrated system which served a circumscribed geographic area regulated by either state or federal government.
The Federal Power Act
Roosevelt, also in 1935, pushed through the Federal Power Act, which modified the Federal Power Commission (FPC). The FPC had regulatory authority over interstate and wholesale transactions and transmission of electric power. The FPC had been established under the Federal Water Power Act of 1920 to encourage the development of hydroelectric power plants. The Commission originally consisted of the secretaries of war, interior, and agriculture but the Federal Power Act changed the structure of the FPC so that it consisted of 5 commissioners nominated by the president, with no more than 3 from the same political party. The Federal Power Act gave the FPC a mandate to ensure electricity rates would be “reasonable, nondiscriminatory, and just to the consumer.”2
PUHCA prohibited market manipulation, specifically to prevent super-sized utility conglomerates from forming monopolies and overtaking geographic regions. Utility companies, since 1935, have never stopped lobbying heavily for a repeal of the PUHCA. “For over 70 years, federal laws have played a vital and critical role in the operation, production, distribution and protection of the U.S. electrical power grid. Federal laws in concert with state laws and regulations have necessarily dictated that the power grid be shielded from market manipulation and criminal behavior.”3 PUHCA was repealed in 2005 with the passage of the Energy Policy Act of 2005.
1 Public Citizen. Public Utility Holding Company Act. (PUHCA)
2 Frontline. Blackout: Public vs. Private Power: From FDR to Today. PBS.org.
3 Grassi, Diane M. Fallout From the Energy Policy Act of 2005, Part l. Michnews.com, February 28, 2008
© The Issue Wonk, 2008