Madison Gas & Electric Co. v. Securities & Exchange Commission

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued January 13, 1999 Decided March 16, 1999

No. 98-1216

Madison Gas and Electric Company, et al.,

Petitioners

v.

Securities and Exchange Commission,

Respondent

Interstate Energy Corporation,

Intervenor

On Petition for Review of an Order of the

Securities and Exchange Commission

Scott Hempling argued the cause for the petitioners.

Susan S. McDonald, Counsel, Securities and Exchange
Commission, argued the cause for the respondent. Eric
Summergrad, Assistant General Counsel, and Paul Gonson,
Solicitor, were on brief.

Russell E. Brooks and Toni C. Lichstein were on brief for
the intervenor.

Before: Edwards, Chief Judge, Williams and Henderson,
Circuit Judges.

Opinion for the court filed by Circuit Judge Henderson.

Karen LeCraft Henderson, Circuit Judge: Petitioners
Madison Gas & Electric Corp and the Wisconsin Citizen's
Utility Board seek review of a decision of the Securities and
Exchange Commission (Commission or SEC), which approved
the application, filed pursuant to section 10 of the Public
Utility Holding Company Act (PUHCA or Act), 15 U.S.C.
s 79j, of WPL Holdings, Inc. (WPL), IES Industries, Inc.
(IES) and Interstate Power Company (IPC) to merge into a
new holding company, Interstate Energy Corp. (Interstate).
The petitioners assert the Commission's approval of the
merger violated sections 10(b)(1), 10(c)(1) and 10(c)(2) of
PUHCA, 15 U.S.C. ss 79j(b)(1), 79j(c)(1), 79j(c)(2). Finding
no violation of PUHCA, we deny the petition for review.

I.

On July 26, 1996 WPL, IES and IPC filed an application to
merge IES and IPC into WPL which was then to be renamed
Interstate Energy Corp. At the time of the application WPL
was the holding company of Wisconsin Power & Light Com-
pany, which was both a public utility providing electricity in
southern and central Wisconsin and itself the holding compa-
ny of South Beloit Water, Gas & Electric Co., a public utility
serving northern Illinois. IES was the holding company of
IES Utilities, which provided gas and electricity to customers
in Iowa. IPC was a public utility providing gas and electrici-
ty to customers in Minnesota, Iowa and Illinois. Under the
merger proposal Interstate was to become the holding compa-
ny of WP&L (which would in turn continue to hold South
Beloit Water, Gas & Electric Co.), IES Utilities and IPC,
thereby controlling four public utilities. On October 11, 1996
the SEC filed a notice of the application pursuant to 17
C.F.R. s 250.23, directing that comments and hearing re-

quests be filed no later than November 5, 1996. Filing
Notice, 61 Fed. Reg. 54,687 (1996).

During 1997 the merger was approved separately by the
Federal Energy Regulatory Commission (FERC) (November
12, 1997), the Wisconsin Public Service Commission (Novem-
ber 7, 1997), the Illinois Commerce Commission (March 9,
1997), the Minnesota Public Utilities Commission (March 24,
1997) and the Iowa Utilities Board (September 26, 1997). On
June 16, 1997, long after the November 1996 deadline for
comment or hearing requests, the petitioners filed a notice of
appearance, motion to intervene and request for hearing,
opposing the merger.

On April 14, 1998 the SEC released its opinion and order
approving the merger and denying the petitioners' request
for hearing. WPL Holdings, Inc., Holding Co. Act Release
No. 26,856, 66 SEC Docket 2256, 1998 WL 172800 (Apr. 14,
1998), (SEC Op.).1 The petitioners seek review of the SEC's
decision.

II.

As noted above, the petitioners contend the SEC's approval
of Interstate's merger violated three provisions of PUHCA:
section 10(c)(2), 15 U.S.C. s 79j(c)(2); section 10(b)(1), 15
U.S.C. s 79j(b)(1); and section 10(c)(1), 15 U.S.C. s 79j(c)(1).
In reviewing the SEC's decision we must treat its factual
findings as "conclusive" "if supported by substantial evi-
dence," 15 U.S.C. s 79x(a), and accept its interpretation of
PUHCA if it "neither contravenes Congress's intent nor is
'unreasonable,' " City of New Orleans v. SEC., 969 F.2d 1163,
1168 (D.C. Cir. 1992) (citation omitted). We address each
statutory challenge separately.

A. Section 10(c)(2)

Section 10(c)(2) of the Act provides that the SEC "shall not
approve ... the acquisition of securities or utility assets of a

__________
1 The SEC denied the hearing request because it had been "filed
over seven months after the expiration of the notice period in this
matter." SEC Op. at 47.

public-utility or holding company unless the Commission finds
that such acquisition will serve the public interest by tending
towards the economical and efficient development of an inte-
grated public-utility system." 15 U.S.C. s 79j(c)(2). The
SEC made the required finding and the petitioners challenge
it on two grounds: (1) the merged Interstate is not an
"integrated public-utility system" under the Act and (2) there
is no evidence that the merged system will be "economical
and efficient." We conclude that the SEC's finding should be
upheld in each respect.

First, the petitioners contest the finding that Interstate's
merged electrical operation is an "integrated system." Sec-
tion 2(a)(29)(A) of PUHCA defines an "integrated public-
utility system" to mean:

As applied to electric utility companies, a system consist-
ing of one or more units of generating plants and/or
transmission lines and/or distributing facilities, whose
utility assets, whether owned by one or more electric
utility companies, are physically interconnected or capa-
ble of physical interconnection and which under normal
conditions may be economically operated as a single
interconnected and coordinated system confined in its
operations to a single area or region, in one or more
States, not so large as to impair (considering the state of
the art and the area or region affected) the advantages of
localized management, efficient operation, and the effec-
tiveness of regulation;....

15 U.S.C. s 79b(a)(29)(A). The petitioners argue here, as
they did below, that the merged electrical assets are not
"physically interconnected or capable of physical interconnec-
tion" because the assets in Minnesota and Iowa (Interstate
West) are physically separated from the assets in Illinois and
Wisconsin (Interstate East) by the Mississippi River. The
SEC found that, despite the physical separation, the statutory
integration requirement was met because (1) Interstate had a
three-year "firm contract" to use a transmission line owned
by two unrelated parties, which line crossed the Mississippi,
as an interim link between Interstates East and West and (2)

Interstate planned to construct two "tie-lines" of its own to
form a permanent connection.

The petitioners first contend that the Act requires that a
permanent interconnection be in place at the time of the
merger. We believe that the Commission has reasonably
interpreted the statutory definition otherwise. Section
2(a)(29)(A)'s definition does not require that assets be actually
interconnected--only that they be "capable of physical inter-
connection," that is, that it is possible to interconnect them.
The SEC has reasonably construed this requirement to be
satisfied in cases past "on the basis of contractual rights to
use a third-party's transmission lines"2 or "if physical inter-
connection is 'contemplated or ... possible within the reason-
ably near future.' "3 Interstate's showing of a current trans-
mission line contract and of a plan to build two tie-lines of its
own across the Mississippi before the end of the contract
term supports the Commission's finding that Interstate East
and Interstate West are "capable of physical interconnection"
under each of the Commission's two tests.

The petitioners also contend that actual integration of the
assets is too uncertain because construction of the tie-lines
must yet be approved by state regulatory agencies and
because FERC conditioned approval of the construction on
Interstate's addition of transfer capability to the Wisconsin
Upper Michigan System, an interstate transmission facilities
network. See IES Utilities, Inc., 81 F.E.R.C. p 61,187, at
61,828-29 (Nov. 12, 1997); SEC Op. at 21 (JA 40). The

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2 See UNITIL Corp., Holding Co. Act Release No. 25,524, 50
S.E.C. 961, 986 (April 24, 1992) (citing Northeast Utilities, Holding
Co. Act Release No. 25,221, 50 S.E.C. 427, 451 n.85 (Dec. 21, 1990);
Centerior Energy Corp., Release No. 24073, 49 S.E.C. 472 (Apr. 29,
1986); Cities Serv. Co., Holding Co. Act Release No. 35-4489, 14
S.E.C. 28, 53 n.44 (1943)).

3 New Century Energies, Holding Co. Act Release No. 26,748, 65
S.E.C. Docket 277, 1997 WL 429612, at *9 (Aug. 1, 1997) (quoting
North American Co., Holding Co. Act Release No. 3446, 11 S.E.C.
194, 242-43 (Apr. 14, 1942)).

petitioners, however, have offered no evidence suggesting
either that the state agencies, which have already approved
the merger, will not approve the tie-lines as well or that
Interstate will fail to comply with FERC's condition or to
construct the tie-lines as planned. In any event, as the SEC
noted in its decision, Interstate has committed to take mea-
sures "to ensure that the interconnection requirements of
section 2(a)(29) of the Act are satisfied" if the tie-lines are not
constructed and a connection agreement is not in place. See
SEC Op. at 22 n.38.

The petitioners further contend that, even if Interstate's
electric assets form an integrated system, there is insufficient
evidence that the merger will, as the SEC found, result in
efficient and economic operation of the system. The SEC
based its finding in the main on Interstate's estimates that
the merger would result in electrical production cost savings
of approximately $220.9 million. SEC Op. at 23. The peti-
tioners do not challenge this estimate but argue that it is not
economical or efficient to spend a large sum ($4.4 million) to
construct tie-lines that will add little electrical capacity to the
system. The Act, however, requires that the "acquisition" as
a whole, not merely the construction of an interconnection,
tend toward efficiency and economy. Interstate's unchal-
lenged figures, on which the SEC relied, support the Com-
mission's finding that the acquisition so tends.4

__________
4 In their reply brief, the petitioners acknowledged that the
$220.8 million savings "can be cited to satisfy Section 10(c)(2)."
Reply Br. at 6-7. At the same time, however, they argue that the
inefficiency of the tie-lines construction runs afoul of the section
2(a)(29)(A) definition of an "integrated public-utility system." 15
U.S.C. s 79b(a)(29)(A). To the extent that this argument is not
waived, see Board of Regents of University of Washington v. EPA,
86 F.3d 1214, 122 (D.C. Cir. 1996) ("[W]e have generally held that
issues not raised until the reply brief are waived and we do so
here.") (internal citations omitted), it must be rejected because,
similarly to section 10(c)(2), section 2(a)(29)(A) requires that a
system's combined "assets" (and not the interconnection in particu-
lar) be economically operated.

B. Section 10(b)(1)

Next, the petitioners assert that the SEC violated section
10(b)(1) of PUHCA which prohibits approval of an acquisition
if the Commission finds, inter alia, that "such acquisition will
tend towards interlocking relations or the concentration of
control of public-utility companies, of a kind or to an extent
detrimental to the public interest or the interest of investors
or consumers." 15 U.S.C. s 79j(b)(1). In finding no imper-
missible anti-competitive tendency, the SEC relied largely on
the merger's approval by FERC and by "the interested state
commissions," which had "scrutinized the potential competi-
tive effects of the Mergers." SEC Op. at 50. The petitioners
object to the SEC's reliance on analyses of other regulatory
bodies, contending the SEC neglected its statutory duty to
conduct an independent assessment of the merger's anti-
competitive effects. We disagree.

We have previously observed that the SEC is entitled to
"watchfully" defer to the determinations of other regulatory
bodies: "[W]hen the SEC and another regulatory agency
both have jurisdiction over a particular transaction, the SEC
may 'watchfully defer[ ]' to the proceedings held before--and
the result reached by--that other agency." City of Holyoke
Gas & Elec. Dep't v. SEC, 972 F.2d 358, 363-64 (D.C. Cir.
1992) (quoting Wisconsin's Envtl. Decade v. SEC, 882 F.2d
523, 527 (D.C. Cir. 1989)). In City of Holyoke, the SEC had
found that post-merger concentration of control "raise[d] the
potential for anticompetitive behavior" but "decided to defer
to the FERC ... in the delicate matter of crafting conditions
designed to preclude Northeast from engaging in post-merger
anticompetitive behavior." Id. at 363. Accordingly, the Com-
mission conditioned its approval on that of FERC and the
court upheld the SEC's decision to give FERC the final say.
As in City of Holyoke, the SEC here deferred to other
agencies' determinations that, subject to conditions imposed
by FERC,5 there was no anti-competitive effect. Unlike City

__________
5 FERC's approval was subject to "certain specifically tailored
conditions for the Mergers that addressed the alleged anticompeti-
tive effects of the Mergers" and "are specifically intended to

of Holyoke, however, the Commission did so here after rather
than before the other agencies issued their decisions and
therefore had the benefit of the agencies' determinations and
supporting materials before it. The Commission's deference
here was at least as "watchful" as in City of Holyoke and
should therefore be upheld. Cf. Wisconsin's Environmental
Decade v. SEC, 882 F.2d 523, 526-527 (upholding SEC's
"watchful" deference to state regulatory body in determining
utility's diversification did not require hearing and was not
detrimental to public interest and noting court was "not
prepared to say that the Commission abdicates its duty in an
exemption determination by deciding to rely, watchfully, on
the course of state regulation").

C. Section 10(c)(1)

Section 10(c)(1) expressly subjects holding company acqui-
sition approvals to the provisions of section 11 of the Act:
"[T]he Commission shall not approve ... an acquisition of
securities or utility assets, or of any other interest, which is
unlawful under the provisions of section 79h of this title
[PUHCA s 8] or is detrimental to the carrying out of the
provisions of section 79k [PUHCA s 11]." 15 U.S.C.
s 79j(c)(1) (emphasis added). Relevant here, section 11(b)(1)
imposes on the SEC

the duty ... as soon as practicable after January 1, 1938:

(1) To require by order, after notice and opportunity
for hearing, that each registered holding company, and
each subsidiary company thereof, shall take such ac-
tion as the Commission shall find necessary to limit the
operations of the holding-company system of which

__________
'mitigate the anti-competitive effects of this merger, reduce Appli-
cants' market power to safe harbor levels consistent with U.S.
Department of Justice and Federal Trade Commission Horizontal
Merger Guidelines ... and permit the [FERC] to find that the
merger is consistent with the public interest.' " SEC Op. at 50-51
(quoting IES Utilities, Inc., 80 F.E.R.C. p 63,001, at 65,002 (admin-
istrative law judge decision)).

such company is a part to a single integrated public-
utility system.

15 U.S.C. s 79k(b)(1). The statute provides a single excep-
tion to the integration requirement: "That the Commission
shall permit a registered holding company to continue to
control one or more additional integrated public-utility sys-
tems" if the SEC makes specific findings set out in the "ABC
clauses," 15 U.S.C. s 79k(b)(1)(A)-(C). The Commission
made the required findings and therefore concluded that
Interstate comes within the ABC exception. The petitioners
challenge the Commission's determination on two grounds.
We find neither one persuasive.

First, the petitioners argue, as they did below, that section
10 acquisition approvals are subject to section 11(b)(1)'s inte-
gration requirement but not to its ABC exception. According
to the petitioners, the exception is available only to holding
companies existing as of January 1, 1938, PUHCA's original
effective date, because the exception requires the SEC to
"permit a registered holding company to continue to control
one or more additional integrated public-utility systems," 15
U.S.C. s 79k(c)(1) (emphasis added), and only existing hold-
ing companies could continue to control additional systems.
The petitioners' contention rests on a misunderstanding of
the relationship between section 10 and section 11 of the Act.

In enacting section 11, titled "Simplification of holding
company systems," the Congress imposed on the Commission
the duty to "examine" existing public utility holding compa-
nies "to determine the extent to which unnecessary complexi-
ties may be removed, voting power fairly and equitably
distributed among security holders, and the properties in a
holding company system confined to those necessary or ap-
propriate to the operations of a single geographically and
economically integrated public utility system." S. Rep. No.
621, 74th Cong., 1st Sess. 32 (1935). Complementarily, sec-
tion 10, as enforced through section 9 of the Act,6 was
"designed to give the Commission supervision over the future

__________
6 Section 9(a) provides:

development of utility holding systems so that the systems
will be subjected to the limitation of geographic and economic
integration laid down in section 11." Id. at 30, quoted in SEC
Op. at 33-34. To this end section 10(c)(1), as noted above,
expressly incorporates section 11's requirements. By its
terms, however, section 10(c)(1) does not require that new
acquisitions comply to the letter with section 11. In contrast
to its strict incorporation of section 8 (proscribing approval of
an acquisition "that is unlawful" thereunder), with respect to
section 11 section 10(c)(1) prohibits approval of an acquisition
only if it "is detrimental to the carrying out of [its] provi-
sions." The Commission has consistently read this provision
to import into section 10's regime not only the integration
requirement of 11(b)(1)'s main clause but also the exception to
the requirement in the ABC clauses, 15 U.S.C.
s 79k(b)(1)(A)-(C).7 Given the complementary nature of the
two sections and the legislative history suggesting an intent
to subject existing holding companies and new acquisitions to
the same limitations, it is not unreasonable to conclude, as the
__________
Unless the acquisition has been approved by the Commission
under section 79j of this title, it shall be unlawful--

(1) for any registered holding company or any subsidiary
company thereof, by use of the mails or any means or
instrumentality of interstate commerce, or otherwise, to ac-
quire, directly or indirectly, any securities or utility assets or
any other interest in any business;

(2) for any person, by use of the mails or any means or
instrumentality of interstate commerce, to acquire, directly
or indirectly, any security of any public-utility company, if
such person is an affiliate under clause (A) of paragraph (11)
of subsection (a) of section 79b of this title, of such company
and of any other public utility or holding company, or will by
virtue of such acquisition become such an affiliate.

15 U.S.C. s 79i(a).

7 See, e.g., New Century Energies, Holding Co. Act Release No.
26,748, 65 S.E.C. Docket 277, 1997 WL 429612 (Aug. 1, 1997);
UNITIL Corp., Holding Co. Act Release No. 25,524, 50 S.E.C. 961,
986 (April 24, 1992); see also Philadelphia Co. v. SEC, 177 F.2d 720
(D.C. Cir. 1949) (applying ABC clauses but upholding SEC finding
that applicant did not satisfy them).

Commission has, that section 11's implementation will not be
harmed if its ABC integration exception is available to newly
formed holding companies as well as to existing ones. Under
this interpretation, the phrase "continue to control" in section
11(b)(1), on which the petitioners place so much emphasis,
may be viewed simply as reflecting its context (examining
existing holding companies) and not as a conscious restriction
of the ABC exception's reach.

Having concluded that the ABC exception is properly ap-
plied to section 10 holding companies that did not exist as of
PUHCA's effective date, we sustain the SEC's determination
that Interstate fits within the exception. The petitioners
assert the Commission should have required Interstate to
divest itself of its gas systems--which deprive Interstate of
"single integrated public system" status under section
11(b)(1)--because there was insufficient evidence to support
the finding, required under clause (A) of section 11(1), that
"each of such cannot be operated as an independent system
without the loss of substantial economies which can be se-
cured by the retention of control by such holding company of
such system." 15 U.S.C. s 79k(b)(1)(A).8 We conclude that
the Commission's finding that divestiture will result in sub-
__________
8 The ABC clauses provide in full:

Provided, however, That the Commission shall permit a regis-
tered holding company to continue to control one or more
additional integrated public-utility systems, if, after notice and
opportunity for hearing, it finds that--

(A) Each of such additional systems cannot be operated as
an independent system without the loss of substantial econo-
mies which can be secured by the retention of control by
such holding company of such system;

(B) All of such additional systems are located in one State,
or in adjoining States, or in a contiguous foreign country;
and

(C) The continued combination of such systems under the
control of such holding company is not so large (considering
the state of the art and the area or region affected) as to
impair the advantages of localized management, efficient
operation, or the effectiveness of regulation.

stantial "lost economies" is supported by substantial evidence
and must therefore be sustained.

In making its finding the SEC applied the formula it had
recently used to calculate lost economies in New Century
Energies, Holding Co. Act Release No. 26,748, 65 S.E.C.
Docket 277, 1997 WL 429612, at *10 (Aug. 1, 1997). The
Commission compared the ratio of each gas system's estimat-
ed increased costs to its historical amounts of income and
revenue, as calculated in the applicants' study, and found, as
it had in New Century Energies, that clause A was satisfied
because the ratios were "generally consistent with ratios
found adequate to support retention in earlier cases." SEC
Op. at 27. The Commission further noted, although it consid-
ered the ratios by themselves sufficient support,9 that "other

__________
15 U.S.C. s 79k(b)(1)(A)-(C). The petitioners do not challenge the
Commission's findings under clause (B) or clause (C) of the excep-
tion.

9 In early cases the Commission took the view "that increased
operational expenses are not sufficient to show satisfaction of clause
A." New Century Energies, 1997 WL 429612, at 11 (citing New
England Electric Sys., Holding Co. Act Release No. 15,035, 41
S.E.C. 888 (Mar. 19, 1964); Standard Power & Light Corp., Holding
Co. Act Release No. 8242 (Jun. 1, 1948); Engineers Pub. Serv. Co.,
Holding Co. Act Release No. 3796, 12 S.E.C. 41, 62 (Sept. 16, 1942)).
The Commission explained in New Century Energies that it no
longer required other factors such as "the assumption that a
combination of gas and electric operations is typically disadvanta-
geous to the gas operations, and the assumption, conversely, that
the public interest and the interests of investors and consumers (the
protected interests under the Act) are promoted by a separation of
gas and electric operations." Id. at 11. Because of increasing
competition among gas providers, the Commission reasoned, these
assumptions are no longer so compelling, while "[i]ncreased ex-
penses of separate operation may no longer be offset, as they were
in New England Electric System, by a gain of qualitative competi-
tive benefits, but rather may be compounded by a loss of such
benefits, as the Commission finds in this matter." Id. Although
the petitioners attack this change, they have failed to seriously draw

factors operate to compound the loss of economies represent-
ed by increased costs." Id. Specifically, the Commission
found that the combined retention of gas assets "offers Appli-
cants a means to compete more effectively in the emerging
energy services business" and that "[e]ach of the state com-
missions found that gas customers would benefit from the
Mergers." Id. These factors in conjunction with the cost
comparisons from Interstate's study adequately support the
Commission's finding of lost economies.

Apart from the substance of the clause A finding, the
petitioners object to the Commission's exclusive reliance on
studies prepared by Interstate. Citing City of New Orleans
v. SEC, 969 F.2d 1163, 1166 (D.C. Cir. 1992), they contend the
Commission was under a duty to verify the studies' data
independently. In City of New Orleans, however, the court
faulted the Commission for accepting raw data from an
applicant because the Commission did not have before it any
"underlying support for the estimates." 969 F.2d at 1167.
Here, by contrast, it appears that the Commission had not
only the comparison calculations but also the assumptions and
methodology that yielded them. See SEC Op. at 27.

For the preceding reasons, we uphold the SEC's approval
of the Interstate merger. Accordingly, the petition for re-
view is

Denied.

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in question the Commission's reappraisal of its earlier assumptions.
We therefore see no objection to the change of viewpoint.