More fallout from the Enron meltdown surfaced last Wednesday as Democratic Reps. John Dingell (MI) and Ed Markey (MA) asked the Securities and Exchange Commission (SEC) to reconsider its support for the repeal of the Public Utility Holding Company Act of 1935 (PUHCA), “as well as its permissive administration of the act.” In addition, the two leading Democrats on the House Energy and Commerce Committee sought SEC support for the removal of a provision in pending electric restructuring legislation that would allow a PUHCA-registered holding company to use one of its subsidiaries to operate its own unregistered and unregulated investment company.

The latest challenges sprang from the revelation in a Senate hearing Tuesday that Enron Corp. had been given waivers by the SEC of certain requirements of PUHCA and of the Investment Company Act of 1940. The exemptions allowed Enron to expand overseas and make greater use of special partnerships, which were a key element in the company’s overextension and collapse. The Dingell/Markey letters to the SEC were issued as the Senate Committee on Energy and Natural Resources announced it has scheduled a full committee hearing on Wednesday, Feb. 6, to examine the effects of PUHCA amendments on energy consumers and energy markets.

Enron had acted like an investment company — without being subject to investment company regulations, the two congressmen said. Section 125 of the “Barton bill,” or the Electric Supply and Transmission Act (H.R. 3406), titled “‘Grandfather of Existing Holdings,’ appears to create potentially dangerous loopholes in the system of investor protection” of mutual funds by granting an exemption to investment company regulations for any PUHCA holding company affiliate existing as of Dec. 31, 2001 and that holds investment securities of a company engaged directly or indirectly in the electric or gas utility business or other business activities that are allowed for a PUHCA registered company or its subsidiaries. The allowed business activities for a PUHCA registered company have been expanded through amendments in recent years to include investments in foreign utilities, out-of-region generation companies, telecommunications companies and other types of companies.

Section 125 apparently materialized from thin air. Dingell and Markey said there was no reference to the provision in the summary of H.R. 3406, nor in the detailed section-by-section analysis of the bill, nor the summary of changes made to an earlier discussion draft of the bill. Further, “we recall no testimony on this matter at our hearings.”

“Under this provision it appears to us that a registered holding company could sell a company that was an affiliate on Dec. 31, 2001 to a third party that could use it to operate an investment company that would compete directly with registered investment companies.” Alternatively, a PUHCA-registered company could use a subsidiary to operate its own unregistered and unregulated investment company. Since the bill also would repeal PUHCA 12 months after the date of enactment “the diversification and investment restrictions of that act would no longer apply to the portfolio of investments that would be permitted.”

The investment companies that could be established under the act would not be subject to the restrictions applicable to other investment vehicles, such as hedge funds. “They could therefore engage in some of the risky and speculative investment strategies pursued by hedge funds” without restrictions as to the number or nature of investors.

The congressmen asked the SEC for its view on Section 125 and extensive records of holding companies, their affiliates and their holdings, and all records pertaining to the exemption of Enron in 1997 from the investment act.

Regarding repeal of PUHCA, they questioned whether what happened to Enron and its shareholders was not typical of the activities of utility holding companies in the 1920s and 1930s that led to enactment of PUHCA, such as “the issuance of securities based on unsound asset values, inflated capital structures and market manipulation, profiteering on intrasystem transfers of assets, cross-subsidization and financial mismanagement, pyramidal corporate structures resulting in the issuance of excessively speculative securities, expansion of holding company systems without regard to the integration and coordination of related utility properties; and the concentration of economic power not susceptible to state regulation.”

Dingell and Markey said the restructuring bill’s reliance simply on companies submitting books and records for SEC review “would pose unjustifiable risks for both investors and electric consumers.” They questioned whether the federal agency might want to review its position on the repeal of PUHCA after the Enron investigation is complete.

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