Exhibit 99.2
THE STATE CORPORATION COMMISSION
OF THE STATE OF KANSAS
Before Commissioners: John Wine, Chair
Cynthia L. Claus
Brian J. Moline
In the Matter of the Investigation of Actions of )
Western Resources, Inc. to Separate its )
Jurisdictional Electric Public Utility Business )
from its Unregulated Businesses. ) Docket No. 01-WSRE-949-GIE
ORDER
For the reasons stated below, the State Corporation Commission of the State
of Kansas ("Commission") finds that the presently designed transactions to
restructure Western Resources, Inc. ("WRI") and its affiliates will harm WRI's
electric operations and therefore are contrary to the public interest. The
Commission further finds that because of the harm these transactions would cause
to WRI's electric operations, those transactions are subject to the Commission's
jurisdiction.
Accordingly, to protect the Kansas electric consumers from that harm and to
ensure WRI's ability to provide efficient and sufficient electric service at
just and reasonable rates, the Commission, pursuant to its statutory obligation
to "supervise and control" electric public utilities, makes permanent the
requirements of the May 22, 2001 Supplemental Order. The facts and reasoning
supporting this determination appear in Part I of this Order. Further, as
explained in Part III of this Order, the Commission directs WRI to present a
plan within 90 days, consistent with the prohibitions and parameters set
forth in this Order, to restore WRI to financial health, to achieve a balanced
capital structure and to protect ratepayers from the risks of the nonutility
businesses.
Introduction and Overview
1. On May 8, 2001, the Commission entered its Order Initiating
Investigation into whether the participation by WRI and its affiliates in the
transactions and relationships described in said order, and any other
transactions or relationships which may emerge from the investigation, is
consistent with Kansas law, including WRI's and its wholly-owned subsidiary
Kansas Gas & Electric Company's ("KG&E's") statutory obligations to provide
efficient and reliable service to Kansas customers at just and reasonable rates.
WRI, doing business in parts of Kansas as KPL, and KG&E provide retail electric
service to approximately 636,000 customers in the state of Kansas. WRI and KG&E
are certificated electric public utilities subject to the jurisdiction of the
Commission pursuant to K.S.A. 66-104 and 66-131. 1/1/
2. In the Order Initiating Investigation, the Commission described the
public information concerning actions and immediate plans of WRI to restructure
WRI by separating its regulated public utility business from its unregulated
businesses that provided the factual basis to warrant this investigation. That
public information included a Registration Statement on Form S-1 (No. 333-47424)
(the "Registration Statement") filed with the Securities and Exchange Commission
("SEC"). The Registration Statement
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/1/ 1/WRI was originally an electric and natural gas public utility. During
1997, WRI contributed its natural gas business at book value as of the date of
the transaction of approximately $594 million to ONEOK, Inc. in exchange for a
45 percent ownership interest in ONEOK, Inc. The ONEOK, Inc. stock was
transferred from WRI to Westar in February 2000. According to WRI's 2000 Annual
Report to Stockholders, the current market value of the ONEOK, Inc. stock is
over $1 billion. (KIC Exhibit # 2). A complete historic background of WRI and
its unregulated investments, including the financial losses associated with
WRI's security monitoring business, from 1996 through 2000, is provided in
paragraphs 8-16 of the Post-hearing Brief filed by the Kansas Industrial
Customers.
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was originally filed with the SEC in October 2000 and subsequently amended on
May 18, 2001.
3. The Registration Statement discloses that Westar Industries, Inc.
("Westar"), a wholly-owned subsidiary of WRI, intends to sell up to 12,250,000
shares of its common stock at the cash subscription price of $10 per share and
that Westar will "advance" the net proceeds of the rights offering to its parent
WRI thereby increasing the balance of intercompany receivable owed by WRI to
Westar by the amount of the "advance." Westar is a holding company consisting of
an 85 percent ownership interest in Protection One, Inc. ("Protection One"), 100
percent ownership interest in Protection One Europe, a 45 percent ownership
interest in ONEOK, Inc., approximately 17 percent ownership interest in its
parent WRI and interests in international power plant investments. Currently,
WRI owns 100 percent of Westar's outstanding common stock.
4. The Registration Statement further discloses that WRI entered into a
merger agreement, dated November 8, 2000, with Public Service Company of New
Mexico ("PNM") pursuant to which PNM will acquire WRI's electric business
("Western Resources Electric Business" or "WREB") in a tax-free stock-for-stock
merger. Immediately prior to the PNM merger, WRI's non-utility businesses will
be "split-off" from WRI. The split-off will be accomplished by WRI distributing
all of the outstanding shares of Westar common stock owned by WRI on the
effective date of the PNM merger to WRI shareholders in exchange for a portion
of the shareholders' WRI common stock.
5. The Registration Statement further discloses the existence of an Asset
Allocation and Separation Agreement ("Asset Allocation Agreement") dated May 2,
2001, as amended. The Asset Allocation Agreement arranges WREB's and Westar's
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balance sheets in a manner which assigns substantial amounts of long-term debt
to WREB. The Asset Allocation Agreement takes effect on the consummation of the
rights offering.
6. On May 22, 2001, the Commission issued its Supplemental Order. The
concerns set forth in the Order Initiating Investigation, coupled with
continuing problems in WRI's unregulated investment in Protection One, as noted
in that order, and the continuing intent to carry out structural changes that
pose risk to ratepayers without obtaining this Commission's approval, required
the Commission to take the immediate actions set forth in the Supplemental Order
to prevent irreparable harm to the public interest and safety. Specifically, the
Supplemental Order declared the Asset Allocation Agreement to have no force and
legal effect because WRI has not obtained the Commission approval required by
Kansas statutes. Further, the Supplemental Order directed WRI to take no action,
directly or indirectly through any subsidiary, that would increase the share of
debt in WREB's capital structure. The requirements of the Supplemental Order
prohibited WRI from allowing or causing the rights offering, as proposed in the
Registration Statement, to proceed. Finally, the Supplemental Order set the
matter for hearing to allow interested parties the opportunity to address the
Commission on whether the requirements of the Supplemental Order should be
extended or made permanent. Particularly, the hearing afforded WRI due process
so that WRI could explain why the requirements of the Supplemental Order were
unnecessary and should not be extended. The requirements of the Supplemental
Order were clarified in the Commission's Order Granting Clarification and
Limited Reconsideration, dated June 22, 2001. The Commission clarified that WRI
could make routine short-term borrowings in
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the ordinary course of business to fund WRI's on-going electric utility
operations and meet cash flow needs and working capital needs of WRI's electric
utility operations.
7. On June 26 and 29, 2001, the Commission conducted hearings pursuant to
K.A.R. 82-1-232(c) to consider whether the requirements of the Supplemental
Order should be extended or made permanent. The following appearances were
entered: Ms. Susan B. Cunningham, Acting General Counsel and Mr. W. Thomas
Stratton, Assistant General Counsel, on behalf of Commission Staff ("Staff");
Messrs. Michael C. Lennen; James M. Fischer and Donald D. Barry on behalf of
WRI; Mr. Walker Hendrix and Ms. Niki Christopher, Consumer Counsel, on behalf of
the Citizens' Utility Ratepayer Board ("CURB"); Mr. Timothy E. McKee on behalf
of the City of Wichita, Kansas ("Wichita"); Ms. Sarah J. Loquist on behalf of
United School District 259, Wichita, Kansas ("U.S.D. 259"); Mr. James P. Zakoura
on behalf of Kansas Industrial Consumers ("KIC"); and Mr. Matthew T. Geiger on
behalf of Goodyear Tire and Rubber Company ("Goodyear"). 8. Staff, CURB, U.S.D.
259 and Wichita requested that the Commission take administrative notice of
pleadings and testimony received in the case entitled In the Matter of the
Application of WRI for Approval to Make Certain Changes in its Charges for
Electric Service and In the Matter of the Application of KGE for Approval to
Make Certain Changes in its Charges for Electric Service, KCC Docket No.
01-WSRE-436-RTS. Those pleadings and testimony referenced by Staff, U.S.D.259,
and Wichita shall be noticed and considered by the Commission as a part of the
official record of this proceeding.
9. On June 29, 2001, the parties presented closing arguments on whether the
requirements of the Supplemental Order should be extended or made permanent.
Post
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hearing briefs were received on July 9, 2001, which discussed the scope of the
Commission's jurisdiction over the subject matter of this proceeding.
10. After having conducted a hearing and hearing statements and arguments
of counsel, the Commission issues this Order consisting of three parts that set
forth the relevant facts and law. Part I explains why the transactions to
restructure WRI's electric business, as currently designed, are contrary to the
public interest and must be prohibited to protect the Kansas electric consumers
from harm and to ensure WRI's ability to provide efficient and sufficient
electric service at just and reasonable rates. Part II discusses the relevant
law and reasoning supporting the Commission's determination to exercise
jurisdiction over the subject of this investigation. Finally, Part III directs
WRI to submit a plan, consistent with the prohibition and the parameters set
forth herein, to restore WRI to financial health, to achieve a balanced capital
structure and to protect ratepayers from the risks of the nonutility businesses.
Findings and Conclusions
I. The Commission finds that the split-off, the asset allocation agreement,
the rights offering, the intercompany receivable and the ownership of WRI common
stock by Westar, are interdependent and considered collectively, are contrary to
the public interest and pose substantial risk of harm to Kansas electric
customers.
A. The split-off as designed is inconsistent with the interest of
Kansas electric customers.
11. The split-off, as presently designed, is inconsistent with the public
interest. The split-off presumes the pre-existence of the Asset Allocation
Agreement, the rights offering, the intercompany receivable and Westar's
ownership of WRI's common stock (collectively, the "Transactions"). With the
Transactions in place, the split-off will result in the distribution to WRI
shareholders of up to 85 percent of Westar's common shares,
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one of WRI's most valuable assets, while leaving behind at WRI corresponding
long-term debt incurred by WRI to acquire the assets owned by Westar. The
resulting debt-equity imbalance in WRI harms WREB and its customers. This harm
cannot be erased by a merger with PNM because it necessarily reduces the value
to Kansas ratepayers of whatever benefits a merger would bring.
12. A split-off, in the abstract, need not affect Kansas customers
adversely. This one does, because of its interrelationship with the
Transactions. To understand the adverse effects of the proposed split-off, one
must understand the Transactions and their effects. After describing these
features, the Commission explains how the PNM merger cannot solve the problems
caused by the Transactions but rather illustrates the damage done by them.
1. Description of the Transactions which precede the split-off
13. The main facts concerning the corporate relationships between WRI and
Westar, and concerning Westar's Registration Statement (which in turn describes
the intercompany receivables, the Asset Allocation Agreement and the rights
offering) are set forth in the Order Instituting Investigation in this
proceeding and are incorporated herein by reference. In this section, the
Commission describes more specifically the facts leading to our conclusion that
the split-off does harm to Kansas ratepayers.
14. WRI accumulates debt and advances funds to Westar: By the end of 2000,
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WRI had accumulated some $1.77 billion in additional debt. (Proctor Direct at
10-13). During this same period, WRI advanced significant funds to Westar, and
reflected some of these advances in an intercompany receivable which Westar owed
to WRI./2/
/2/ 2/The precise amount of the funds advanced to Westar is disputed. Mr.
Proctor performed a cash flow analysis demonstrating that of the $1.77 billion
in additional WRI debt, only $342.56 million was necessary for WRI utility
operations. Id. at 13. WRI disputes Mr. Proctor's cash flow analysis. For
purposes of this decision, the Commission need not resolve the dispute over the
exact number. It is clear that a large portion of the $1.77 billion was advanced
by WRI to Westar; and in fact there is no dispute that the amount advanced was
at least $927 million, as discussed in the next paragraph of the text.
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15. WRI converts its loan to Westar into an investment in Westar: The next
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step was a turning point. As Mr. Hill explained (Direct at 10), in the first
quarter of 2000:
WRI management and board of directors elected to reclassify the funds that
WRI had advanced to Westar through an inter-company receivable account as
an investment in, rather than a loan to, Westar. That pivotal decision by
WRI's management and board of directors resulted in the transformation of
$927 Million of debt on Westar's books (a receivable to WRI from Westar) to
$927 Million of common equity (an investment in Westar by WRI [footnote
omitted]).
16. WRI enters into merger agreement with PNM and establishes the terms of
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the split-off: On November 8, 2000, WRI entered into a merger agreement with
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PNM, pursuant to which a holding company established by PNM ("PNM Holdings")
would acquire WREB, but not Westar. At the time of the execution of the merger
agreement, WRI established balance sheets for each of WREB and Westar. The
reason for establishing the separate balance sheets was to specify what it was
that PNM would be acquiring. (See Lennen Tr. 24) ("PNM negotiated to acquire the
assets and the liabilities shown on that balance sheet"). The merger agreement
further provides that transfers of funds from Westar to WRI occurring after the
date of the PNM merger agreement would be treated as loans from Westar to WRI,
giving rise to intercompany receivables. (CURB Exhibit No. 9, Registration
Statement at F-19).
17. WRI and Westar execute the Asset Allocation Agreement: Concurrently
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with that merger agreement, WRI and Westar entered into an Asset Allocation
Agreement. As CURB witness Mr. Hill explained (Direct at 13), "[t]he Schedules
accompanying the Asset Allocation Agreement indicate that, if the separation of
WREB
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and Westar proceeds as planned, WREB would have a negative common equity balance
of approximately $300 million." Id./3/ Staff witness Mr. Proctor derived the
exact capital structure of WREB based on WRI's Annual Report on Form 10-k for
the year ended December 31, 2000 and the allocation of capital set forth in the
Registration Statement. As of December 31, 2000, WREB's balance sheet included
about $2.97 billion (113.02 percent) of long-term debt and about a negative
$0.34 billion (negative 13.02 percent) of common equity. (Proctor Exhibit No.
JMP-3).
18. Second, the Asset Allocation Agreement established the mechanism
"through which Westar could establish an equity ownership position in WRI." This
mechanism was the recognition of the intercompany receivable, owed by WRI to
Westar, and the right of Westar to convert the receivable into, among other
things, WRI common stock. Id. This technique -- the receivable combined with the
conversion option -- would compensate Westar for its fund transfers to WRI.
Through these transactions, WRI would effectuate its intent to maintain a
constant value of WREB as of the date of the PNM Merger agreement. (Martin
Rebuttal at 6).
19. Westar converts its receivable into WRI common stock: In February 2001,
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Westar converted it $350 million intercompany receivable from WRI into 14.4
million shares of WRI common stock, representing approximately 17 percent of
WRI's outstanding common stock. As of April 30, 2001, an intercompany receivable
of $116.6 million from WRI to Westar remained.10 outstanding. (Proctor Exhibit
JMP-6, Schedule
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/3/ 3/CURB witness Mr. Hill explained the "negative common equity balance" as
follows (Direct at 13, note 14):
The amount of equity capital left in WREB is easily estimated using the
balance sheets of WRI and the balance sheet of Westar Industries
published in the S-1[ Registration Statement]. There is approximately
$300 million more equity capital in the balance sheet of Westar than
in the consolidated balance sheet of WRI. Because the consolidated
common equity of WRI is essentially the sum of
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2 at 1). This $116.6 million receivable would grow by $120.25 million if
Westar's rights offering were fully subscribed, because Westar would lend the
proceeds of the rights offering to WRI.
20. Westar retains the right to increase its share of WRI stock: Given the
pre-existing receivables and conversions, if the PNM Merger occurs and if Westar
converts these additional intercompany receivables into shares of WRI common
stock, Westar could own up to 26.1 percent of WRI's common stock on the
effective date of the merger. (Proctor Direct at 25).
2. Direct Effects of the Transactions
21. The facts make clear that the cumulative effect of the Transactions is
to increase the value of Westar, before splitting off Westar from WRI
immediately before the PNM merger. On the consummation of the split off, WRI
would cease to own any Westar common stock. Thus, the value of Westar would be
removed from WRI's balance sheet, but the debt associated with the Westar assets
would remain an obligation of WREB.
22. The rights offering transforms Westar from a privately held subsidiary
of WRI into a stand alone public company: Under the rights offering, Westar
would offer 14.3 percent of Westar common stock to WRI's shareholders at a price
of $10 per share. (Martin Direct at 5). On consummation of the rights offering,
the allocation of assets set forth in the Asset Allocation Agreement becomes
effective. The Asset Allocation Agreement and the Registration Statement
definitively establish Westar's ownership of the assets and liabilities set
forth on its balance sheet dated March 31, 2001, including the
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the common equity balances of Westar and WREB, the common equity balance of
WREB is approximately -[negative]$300 Million.
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intercompany receivables of $350 million and 14.4 million shares of WRI common
stock as a result of Westar's February 2000 conversion to stock of its $350
million intercompany receivable from WRI. This balance sheet confirms the
allocation of WRI assets to Westar and Westar debt to WRI.
23. The rights offering and the Asset Allocation Agreement cause the
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minority shareholders to receive an interest in Westar (WRI net-assets) which is
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significantly in excess of their equity investment: The rights offering, if
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fully subscribed, establishes a class of minority public shareholders owning
approximately 14.3 percent of Westar. This 14.3 percent investment in Westar
means ownership in a company whose net-asset value has been increased by the
series of management and board decisions by the following components: (i) the
existing intercompany receivable ($116.6 million as of April 30, 2001, per the
Registration Statement, Amendment #3, supplemented by the $120.25 million net
proceeds of the rights offering); (ii) the 14.4 million shares of WRI common
stock owned by Westar; and (iii) ONEOK shares, which previously had been
transferred by WRI to Westar at book value, and which, according to WRI 2000
Annual Report to Shareholders, has increased in market value by 91.5 percent to
more than $1 billion. (KIC Exhibit No. 2). Also, the minority shareholders would
own a 14.3 percent interest in Westar's net-asset investments in Protection One,
Inc., Protection One Europe and other miscellaneous investments. As Mr. Proctor,
who conservatively valued ONEOK, Inc. stock at $700,000 rather than $1 billion,
states, "The Commission can see from the exhibit [Proctor Exhibit No. JMP-6,
Schedule No. 1] that the total net-asset value is about $1.30 billion. The
net-asset value of Westar's investments is $15.24 per share of common stock."
(Proctor Direct at 26). The minority shareholders' 14.3 percent share of the
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combined net-asset value of Westar substantially exceeds the $122.5 million paid
by the minority shareholders. That is, the minority shareholders own about 14.3
percent of Westar which has value of about $185.9 million ($1.3 billion X 14.3
percent = $185.9 million).
24. In sum, all of the Transactions are designed to ensure that at the time
of the split off, WRI's electric business will hold significant debt but no
Westar assets, while Westar will own all of WRI's unregulated assets but will
not be responsible for WRI's long-term debt used to acquire them.
3. Description of the harm to WRI caused by the split-off and flowing
from the Transactions
25. The split-off and related Transactions put financial pressure on WRI's
electric business, since their cumulative effect is to allocate to WRI (which at
the time of the split-off would consist only of WREB) the debt associated with
Westar's unregulated investments. Conversely, Westar would have significantly
more equity than debt because its capital structure will have been artificially
enhanced by the Transactions which consolidate Westar's ownership of its assets
but allocate the debt used to acquire the assets to the WREB.
26. A likely scenario would require WRI to service the long-term debt
through electric rates, while those WRI shareholders who receive Westar shares
in the split-off will receive the benefit of the assets without the burden of
the long-term debt incurred to acquire them. Without the Westar assets to offset
the long-term debt used to acquire them, WRI must find some other way to pay off
the debt. Rate increases, or cost-cutting measures which would impair WRI's
ability to perform routine maintenance, retain qualified employees or make the
necessary capital improvements to meet the needs of
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Kansas electric consumers are likely to result. While the Commission cannot say
with certainty that ill-effects will result, the Commission is not required to
subject customers to known risks until likely ill-effects are certain and
irreversible. Rather, the Commission must use rational analysis and make
reasonable assumptions or inferences. A reasonable assumption or inference is
that a utility with heavy debt, lacking assets that can be liquidated to retire
debt, will suffer financial pressures and will reflect those pressures on some
combination of customers, employees and investors.
27. This drag on WREB's well-being exists whether WREB is acquired by PNM,
by another third party or by no one at all. The effect of the split-off and
Transactions is to render Westar's assets unavailable to retire the
Westar-related debt held by WRI. Regardless of the post-split- off scenario, WRI
will be worse off than if the split-off, as designed, had not occurred, because
the split-off leaves WRI with debt related to assets it no longer would own.
28. The effect of the split-off and the Transactions thus is to diminish
the value of WRI, relative to the value that WRI would have in the absence of
the split-off and the Transactions. That WRI might achieve an investment grade
bond rating after a merger with another company does not change this fact; WRI
still will be worse off with the split-off than without it. This diminution in
value of WRI will affect Kansas ratepayers adversely, regardless of an
improvement in WREB's bond rating. Given the absence of any justification for
the Transactions (other than debt reduction, which, as discussed in Part I.B
below, is not a sufficient justification), the Commission declines to subject a
Kansas utility to this harm.
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4. The PNM merger, rather than relieving WRI of its debt problems,
illustrates the harm to WRI caused by the split-off and the
Transactions.
29. WRI has asserted that each of the harms alleged by the various
witnesses will not exist because the PNM transaction will prevent them or
eliminate them. Kansas ratepayers should not have to depend on a merger, no
aspect of which has been presented on the record, to resolve the debt-equity
imbalance that was not necessitated by utility service, and which can be
prevented readily by foregoing the split-off and the Transactions.
30. In any event, the argument that the Commission can disregard the
split-off's ill-effects because PNM will eliminate them is flawed, for four
distinct reasons.
31. First, PNM (and any other prospective acquirer) necessarily will find
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WREB less attractive than if the split-off, with its built-in imbalance, were
not part of the transaction. Dr. Cicchetti in fact explained that this feature
of WREB was reflected in the price PNM negotiated to pay. (Tr. at 189).
32. Due to the cumulative effects of the Transactions, PNM necessarily will
have fewer resources to put into WREB, or to share with the ratepayers, than if
WRI were not so impaired. For example, to the extent a merger will produce
savings, the merger partner will need to deploy those savings first to
correcting the debt-equity imbalance. This need will inevitably reduce the
merger savings available for ratepayers. This effect is not limited to PNM. More
generally, mergers that might be justified by a cost-benefit analysis in the
absence of the split-off and the Transactions could be screened out or precluded
if the split-off and the Transactions are allowed to proceed. To the extent
future mergers reduce total costs for Kansas ratepayers (cost reduction is a
feature of
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every merger and merger order which the Commission has approved since 1990), the
screening out of potential merger partners is contrary to the interest of Kansas
ratepayers. The Commission does not need to wait until the PNM merger proposal
to make this finding, because the finding follows from arithmetic logic and is
acknowledged by Dr. Cicchetti. (Tr. at 189).
33. No matter how the PNM transaction is designed or the benefits PNM
brings, PNM will have to devote resources to correcting the capital structure
imbalance created by the split-off and the Transactions. PNM in theory may be
able to invest enough to bring WRI back to investment grade, but as a matter of
simple arithmetic, whatever resources PNM must devote to correct the imbalance
are resources that will not otherwise be available from PNM to implement the
merged company operations or to engage in other corporate purposes. This
deadweight loss of resources is a direct consequence of a split-off designed to
shift WRI assets to Westar, and Westar debt to WRI. This logic undercuts the
argument that the Commission should await the PNM merger proposal to rule on the
split-off.
34. WRI argues that the resources used to correct the debt-equity imbalance
will come from PNM, not from ratepayers. This argument misses the point. That
the "rescuer" is PNM does not affect the analysis. After the merger, the new
holding company would be the entity owning WRI's utility business. The
Commission has just as much interest in the acquiring company's (here PNM's)
financial condition after the merger and split-off as it does in WRI's financial
condition. PNM, after all, would become the owner of a major Kansas utility.
Were WRI itself, without PNM, to propose a split-off that would leave WREB with
insufficient equity, the Commission would halt the
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transaction. The Commission's concern does not diminish simply because the owner
of WREB is PNM rather than WRI.
35. Second, a PNM merger would produce a company whose consolidated capital
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structure is 80 percent debt and 20 percent equity. (Proctor Tr. at 305). This
result has far more debt than a typical utility, and far more debt than the
Commission finds consistent with a Kansas utility's obligation to serve the
public.
36. Third, the argument that the Commission can address all the issues at
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the time of the PNM merger proceeding assumes that the public interest is
indifferent as to whether the decisions are made now or at some unknown future
time. But time matters. The passage of time (a) drains regulatory resources, as
the Commission's staff must continually monitor events affecting WRI; (b)
extends the time of financial uncertainty, making it more difficult for lenders
and equity holders to determine the value of their existing or future
investments in the company; (c) extends the period of time during which WRI's
bonds are rated below investment grade; (d) causes uncertainty for PNM (and any
other future merger suitor); and (e) creates uncertainty in WRI's labor force,
on whom much of Kansas relies for reliable service. For these reasons, deferring
a decision is not in the public interest. Moreover, by that later point in time,
WRI by waiting for the PNM merger, would have foregone other mergers that might
otherwise be beneficial. Conversely other merger suitors, viewing the situation
at a distance, might decide that their own offers are not worth making due to
"regulatory uncertainty." It is not consistent with Kansas ratepayers' interests
to allow these events to occur.
37. Fourth, even if PNM somehow could correct the imbalance induced by the
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split-off and related Transactions without affecting ratepayers, there is no
record support
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for this proposition. There is no obligation in the PNM merger agreement to
correct the debt-equity imbalance. And, "[t]here is no evidence . . . PNM is
going to be infusing assets that are in any way equivalent to the Westar assets
that are going to be spun off." (Foley Tr. at 275). Indeed, WRI has failed to
provide any specific details about the PNM merger.
38. In sum, there is no record basis to support the notion that whatever
damage is caused by the split-off and the Transactions will be corrected by PNM.
For the Commission to base a decision today on that assertion would be to
abandon its obligations in favor of unknown future management decisions by
unknown future management
5. Split-off without the merger
39. A distinct reason for disapproving the split-off now, rather than
awaiting the PNM merger proposal, is that the split off might occur without the
merger. WRI has stated that if there were not a merger, it still might execute
the split-off if WRI's "electric utility operations [are] receiving an
investment grade rating from both Moody's and Standard & Poor's." (Tr. 389).
(The Commission assumes that this commitment refers to the split-off as
presently designed, i.e, a split-off in the context of the Asset Allocation
Agreement, the pre-existing rights offering, the existing intercompany
receivables and Westar's ownership of WRI common stock.)
40. The Commission must take the possibility of a non-merger split-off
seriously, because there are a significant number of reasons why the PNM merger
might not be approved. These reasons include the willingness of PNM to go
forward; the willingness of WRI to go forward; the Commission's findings as to
the effect of the
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merger on competition, rates, quality of service and the effect on Kansas
ratepayers of possibly transferring ultimate authority over WREB from Kansas
management to New Mexico management, among other factors./4/ Given the real
possibility that a merger whose features are unknown to the Commission will
never occur, the Commission must protect Kansas ratepayers against a split-off
that leaves WRI with Westar's debt but without its assets, regardless of whether
WRI can somehow achieve investment grade status.
41. Indeed, the Commission finds that WRI's promise to forego a split-off
unless the electric utility business is "investment grade" presumes a standard
that is inconsistent with the public interest. Mere "investment grade" is not
sufficient status for a utility whose bond ratings presently reflect financial
weakness, a utility with a management that has engaged in questionable corporate
transactions that create high risks for the ratepayers without commensurate
benefits.
42. "Investment grade" is not a sufficient standard for Kansas utilities.
Kansas utilities should aim for bond ratings comparable to utilities facing
similar utility-related risks. Failure to achieve a bond rating similar to
comparable utilities will mean higher interest costs. And those higher interest
costs pose a dilemma for the Commission. If the Commission were to hold WRI
responsible for a below-average bond rating by setting retail rates as if its
interest costs were lower, arguments certainly would arise that the Commission's
action may result in an even lower bond rating. Merely achieving the lowest
investment grade status would leave WRI with no margin for error. As Mr. Hill
- --------------------
/4/ 4/Further reasons for uncertainty include how the merger will fare under (a)
the Federal Power Act, particularly in light of the Federal Regulatory Energy
Commission's well-known concern about the competitiveness of WRI markets; and
(b) the Public Utility Holding Company Act, in light of that statute's
requirement that the acquisition not unduly complicate the utility's capital
structure and that it "tend[] towards the economical and efficient development
of an integrated public-utility system."
18
pointed out (Direct at 17-18), "operational anomalies" happen, and they create
"business risk." A utility must be prepared to absorb them. A utility hovering
at the "investment grade" level cannot do so readily without running the risk of
a downgrade to junk bond status. Moreover, a split-off is permanent; investment
grade status is not.
43. For these reasons, the Commission must find that the split-off, as
presently designed (in the context of the Asset Allocation Agreement, the
intercompany receivable and the rights offering) is contrary to the public
interest.
6. The Commission is not ruling out a PNM merger, a split-off or
other transactions.
44. The Commission does not rule out mergers, split-offs or rights
offerings in principle. These transactions are not inherently harmful. What is
harmful is their combination in the manner presented here. Were WRI to design
these transactions with the primary purpose of strengthening WREB, the
transactions and Commission's reaction would likely be very different. WRI could
sell off Protection One, applying the proceeds to WRI, and the utility would be
healthier. WRI could design a split-off with the proper allocation of debt
between the utility and the split-off company and WREB would be healthier. WRI
could sell off Westar assets such as its investment in ONEOK, Inc. without the
associated debt but apply the proceeds to retire debt, and the utility business
would be healthier. In any of these situations, a merger could begin without the
acquirer having to spend resources initially to repair the pre-merger
unregulated losses. But the pre-split-off Transactions designed by WRI make the
split-off an adverse event rather than a helpful event.
45. The Commission recognizes that maximizing revenues from the sale of
Westar is a legitimate managerial and shareholder objective, but under Kansas
regulatory
19
law, WRI may not distribute Westar common stock in the split-off, in the
unbalanced manner designed here. This will cause unacceptable harm to the health
of the utility.
46. In conclusion, the Commission is not saying that it would disapprove a
PNM transaction, or a PNM transaction accompanied by a split-off of Westar. What
we are disapproving is a split-off whose premise is a utility with an unbalanced
debt-equity ratio. This disapproval does not interfere with a management
prerogative of WRI, because there is no prerogative to take actions which
diminish the value of the utility.
B. The Transactions will adversely affect Kansas ratepayers for
reasons independent of the split-off.
47. Since this Order prohibits the split off as designed, there is no
reason to permit the rights offering (which was the initial step in the
separation of the Westar from WRI) to proceed in its present form. But the
rights offering, considered independently, is also adverse to the public
interest for the following four reasons:
1. The rights offering is priced at a steep discount to its market
and book value, financially weakening WRI and forcing it to
record a material charge against income.
48. According to Westar's Registration Statement, Westar will issue to WRI
shareholders non-transferable rights to purchase Westar common stock at a
purchase price of $10.00 per share. Westar proposes to offer 12,250,000 shares
of common stock to existing shareholders of WRI (other than Westar itself).
These shares represent approximately 14.3 percent of Westar's outstanding common
stock. If the rights offering was fully subscribed Westar would raise a total of
$122,500,000. Expenses of the rights offering are estimated to be $2.25 million.
49. The $10 price is at a deep discount below the market value of Westar's
net-assets (equity). Staff witness Mr. Proctor estimated the market value of
Westar's net
20
assets to be about $1.3 billion, or $15.24 per share. (Proctor Direct, at 26 and
Proctor Exhibit No. JMP-6, Schedule No. 1). Accordingly, the rights offering
subscribers will receive equity with a market value of $185.9 million for
payment of $122.5 million through the rights offering. The discount below market
value of Westar equity of $63.4 million ($185.9 million - $122.5 million = $63.4
million) represents funds WRI should use to retire debt rather than enrich these
minority shareholders.
50. The $10 price is an even deeper discount below the book value of
Westar's equity. If Westar's common stock is actually worth only $10 per share,
then all of Westar's outstanding common stock would have an aggregate value of
$856.6 million ($122.5 million/14.3 percent). But Westar's balance sheet as of
December 31, 2000 attached to the Registration Statement shows total Westar
shareholder's equity of $2,248 million. (Proctor Exhibit No. JMP-3). On a per
share basis, the book value of Westar's equity is about $26 per share. (Proctor
Tr. at 325).
51. WRI acknowledges the adverse effect the rights offering will have on
its financial statements. Its December 31, 2000 Annual Report on Form 10-K
states that if the rights offering is completed, WRI will record a non-cash
charge against income equal to the difference between (a) the book value of the
portion of WRI's investment in Westar which will be sold in the rights offering,
and (b) the offering proceeds received by Westar. WRI discloses that these
charges would be material and would have a material adverse effect on WRI's
operating results in the period recorded. (CURB Exhibit No. 9, Docket No.
01-WSRE-436-RTS, Registration Statement; see also Lovitch and Foley Direct at
9-10).
21
52. Although the goal of raising funds to reduce WRI's debt is laudable,
the Commission finds that offering WRI shareholders a price well below the
market and book value of Westar's assets is harmful to WRI and therefore
contrary to WRI's responsibilities to its ratepayers.
53. WRI asks the Commission to focus on the fact that the rights offering
can raise $120.25 million of net proceeds; but the proper focus should be on the
impropriety of the rights offering price. This low offering price means that the
debt reduction produced will be at least $63.4 million less than it could or
should be. The debt reduction opportunity foregone due to the low price in the
rights offering is an opportunity foregone permanently. Therefore, our rejection
of the spin-off does not "lose the opportunity for substantial debt reduction to
be made as a result of the PNM transaction," (Lennen Tr. at 25); it avoids
liquidating valuable net-assets of WRI (namely its investment in Westar equity)
at an inappropriately low price while leaving open the possibility of a later
sale at a higher, more appropriate price.
54. Moreover, as discussed in Part I.A, the $120.25 million proceeds of the
rights offering are not even payable to WRI. They are payable to Westar, and
will be loaned to WRI. That loan increases WRI's obligations under the
intercompany receivable. The device of a loan precludes WRI from receiving the
funds from the rights offering in the form of a dividend. Because the proceeds
are only loaned to WRI, WRI (and ultimately, WREB) receives no benefit from the
rights offering. That is, the change in net-asset value of WRI pursuant to the
rights offering is zero because the cash proceeds become the property of Westar
through Westar's loan of the rights offering
22
proceeds to WRI, WRI is merely replacing a debt of $120.25 million owed to
bondholders with a debt of $120.25 million owed to Westar.
55. To pay off its indebtedness to Westar created from receipt of the
proceeds through the intercompany loan of $120.25 million, WRI may be required
to issue to Westar additional shares of common stock. Thus, in effect it is the
issuance of common stock to Westar, not the rights offering, which raises the
$120.25 million in proceeds which WRI may use to retire bondholder debt. But WRI
could have issued common stock to raise proceeds to retire debt without Westar's
rights offering. These are mutually exclusive transactions.
56. If the rights offering proceeds had been provided as a dividend from
Westar to WRI and the minority shareholders, then WRI would have received
$103.05 million of the proceeds ($120.25 million X 85.7 percent = $103.05
million) from Westar's rights offering without incurring an obligation to repay
Westar. Then, if WRI chose to retire bondholder debt further, it could have
issued additional shares of common equity to the public to raise an additional
$120.25 million. That is, if the proceeds from Westar's rights offering had been
provided to WRI as a dividend, WRI could retire $223.3 million ($103.05 million
+ $120.25 million = $223.3 million) of bond holder debt instead of only $120.25
million. Under this approach, WRI would issue the 14.4 million shares of common
stock to the public instead of Westar.
57. If the rights offering does not proceed, WRI will continue to own 100
percent of Westar and will retain unfettered ability to liquidate Westar assets
to reduce WRI long-term debt. Our rejection of the rights offering is not an
interference in a management prerogative, because there is no legitimate
management prerogative to
23
diminish the value of the utility business through a transaction which does not
serve a utility purpose.
2. The rights offering has caused bond rating agencies to view
WREB's finances negatively.
58. The rights offering makes WRI's debt-equity imbalance "real" in the
eyes of important market players whose decisions will affect the Kansas
ratepayers. As Mr. Hill explained (Direct at 20-21):
Once the rights offering proceeds, however, and regardless of the fact
that Westar will continue to be consolidated on WRI's balance sheet,
Westar will report on its own balance sheet. Once that happens there
will be no opportunity to revisit the allocation of WRI's assets and
liabilities. WRI's balance sheet is essentially the sum of the balance
sheets of WREB and Westar and because, following a rights offering,
both WRI's and Westar's balance sheets will be published, WREB's
capital structure will be made "real" as well.
[The bond analysts] understood quite clearly that the assumption of all
of WRI's debt by the utility would be financially detrimental to WREB.
All of the rating agencies commented on the fact that the utility would
be left with essentially zero common equity as a factor in the
significant bond rating downgrade they uniformly imposed on WRI. It is
difficult to believe that all of the major bond rating agencies would
all cite as a rationale for a significant ratings reduction a factor
that did not exist.
59. The Company maintains that, notwithstanding this reality, the two
companies are "still consolidated" for the purposes of generally accepted
accounting principles. To focus on the continued consolidation in light of the
financial reality is to elevate form over substance. While WRI's form will still
be a consolidated capital structure, the economic substance -- the facts that
the market will take into account -- is a reality of two capital structures, one
equity-heavy and one debt-heavy.
3. The rights offering introduces minority shareholders, resulting
in a change in the loyalty, emphasis and priorities of Westar's
management.
24
60. Staff witnesses Lovitch and Foley explained that upon subscription to
the rights offering, "Westar will be a stand alone public company and will,
along with its directors and officers, owe fiduciary duties to Westar's minority
shareholders." (Direct at 5).
61. The same witnesses explained four consequences of this change for
Westar. First, Westar will have "significant ongoing reporting and filing
obligations under the federal securities laws." Second, as a public company
Westar will be subject to potential liability for breaches of the federal
securities laws.
62. Third, in making corporate decisions, Westar management will be
obligated to consider the interests of Westar's minority public shareholders.
This change creates uncertainty and complexity for future corporate
restructurings, including restructurings that might be necessary to comply with
WRI's public utility obligations. As the witnesses explained (id.):
If Westar remains a wholly owned subsidiary of WRI, WRI management
could, for example, cause Westar to liquidate some or all its
investment in Protection One, Inc. or ONEOK, Inc. (Westar's two
principal assets) and declare a dividend of the proceeds to WRI which
could then use the dividend to pay down WRI's long-term debt. Minority
shareholders will have no particular interest in seeing Westar's
assets used to service or retire WRI's long-term debt. This will force
Westar management to assess whether the liquidation of Westar's assets
to pay down WRI debt is a proper corporate purpose.
63. Fourth, the witnesses explain that the issuance of Westar shares to the
public would be "extremely difficult to reverse" because:
The shares of Westar common stock would not be redeemable and, if at
some point in the future WRI wished to reacquire them, it would
probably have to do so by way of a public tender offer. If after the
tender offer WRI owned more than 90% but less than 100% of Westar's
outstanding common stock, a merger could be consummated under the
Kansas Corporation Act which would allow WRI to acquire the remaining
25
outstanding shares. But under Kansas law, minority shareholders would
have appraisal rights if they felt that the merger consideration
offered by WRI was inadequate. This process would be time consuming and
could be very expensive.
Id.
64. In light of WRI's present junk bond rating, the Commission and WRI must
preserve all options to improve WRI's financial condition. The creation of
public minority shareholders would limit WRI's options and, as a result, is
inconsistent with WRI's public utility obligations.
4. The rights offering, in conjunction with the conversion of the
intercompany receivable into WRI common stock, would allow Westar
to increase its ownership of WRI.
65. Westar, rather than WRI, is selling the Westar common stock in the
rights offering. Thus the $120.25 million proceeds of the rights offering will
belong to Westar. The Registration Statement states that Westar will "advance"
the net proceeds of the rights offering to WRI. This advance will increase the
balance of the existing intercompany receivable owed by WRI to Westar. In
effect, Westar will be loaning the proceeds of the rights offering to WRI,
creating an obligation for WRI to repay the loan.
66. This repayment obligation will have a distinct adverse effect on WRI.
As previously discussed, the Asset Allocation Agreement permits Westar at any
time, but not later than the split-off and PNM Merger, to convert WRI's
obligation into: (a) Westar Common Stock; (b) WRI common stock; or (c) WRI
convertible preference stock. The Registration Statement discloses that Westar
already has converted $350 million of a pre-existing intercompany receivable
into 14.4 million shares of WRI common stock (representing approximately 17
percent of WRI's outstanding common stock). The
26
Registration Statement also discloses an additional unconverted $116.6 million
intercompany receivable. The proceeds of the rights offering would increase this
existing intercompany receivable. If these additional intercompany receivables
are converted into WRI common stock, Westar's already significant ownership of
WRI's common stock will increase.
67. While Westar remains a subsidiary of WRI, under Kansas corporate law,
the WRI common stock received on the conversion of intercompany receivables is
non-voting. (Lovitch and Foley Direct at 12 (citing K.S.A. 17-6410(c)). After a
split-off , however, the common stock would become voting, resulting in Westar
having significant influence over WRI or its successors. (Lovitch and Foley
Direct at 12-13). The existence of Westar's significant holdings of WRI common
stock therefore creates an incentive for a split-off type transaction in the
future. Inasmuch as (a) Westar's unregulated activities already have caused harm
to WRI and (b) Westar's management is the same as the current management of WRI,
which management has designed the transactions contributing to the present
complexities and difficulties, the Commission finds that it is not consistent
with Kansas ratepayers' interests for Westar to own such a large share of WRI
common stock. Based on the recent history of intercorporate transactions, as set
forth in the Order Initiating Investigation and in Parts I.A and B of this
Order, the Commission finds that the increased ownership increases the existing
risk that WRI's financial resources will be used not to strengthen the utility
business, but to increase the value of the unregulated businesses, at the
expense of the utility business.
68. The package of transactions proposed here -- the payment of the
proceeds of the rights offering to Westar followed by the loan of the proceeds
to WRI, with the
27
resulting intercompany receivable being convertible by Westar into WRI's common
stock -- is not consistent with the public interest. Whatever the corporate
purpose for these transactions, it is not a corporate purpose aimed at
strengthening the utility business. As Staff witnesses Lovitch and Foley
explained, the more customary result, where a parent sells 14.3 percent of the
stock of a subsidiary, is for the subsidiary to retain and use the proceeds for
the subsidiary's corporate purposes, or for the parent to use the proceeds
directly for the parent's corporate purposes, such as paying down existing debt
of the parent. (Lovitch and Foley Direct at 19-20).
69. In conclusion, the concerns here are not, as was suggested by Mr. Van
Dyke, any loss of the Commission's substantive jurisdiction. The concerns are
(a) the asymmetry of an arrangement in which WRI has, as a result of the low
price of the rights offering, given up more to the new minority shareholders
than it has received; and (b) the reduced feasibility of certain debt reduction
solutions due to the existence of minority shareholders.
II. The Commission has jurisdiction over the transactions, as currently
designed, to separate the jurisdictional electric public utility
business from its nonutility businesses, and that, based upon the harm
they cause, the Commission may take all reasonably necessary actions to
protect the public interest.
70. WRI argues in its Post-hearing Brief that the Commission has unlawfully
invaded the prerogatives and responsibilities of the utility's management by
interpreting the applicable statutes too broadly. According to WRI, the
Commission has no implied or inherent powers and thus cannot investigate
management issues that indirectly relate to rates because such involvement is
not necessary in setting rates. WRI avers that the Commission cannot prohibit
Westar's rights offering because K.S.A. 66-125 does not
28
provide a review and hearing process for securities issuances that are filed at
the SEC. Further, WRI argues that the Commission has unlawfully exerted
jurisdiction over the Asset Allocation Agreement. WRI avers that the affiliated
interests rules contained in the Kansas Holding Company Act, K.S.A. 66-1401 et
seq., do not apply. According to WRI, Westar is not an affiliated interest
because its 17 percent ownership interest in WRI consists of non-voting stock by
reason of K.S.A. 17-6401 and that the Asset Allocation Agreement is not a
"management contract" under K.S.A. 66-1402. WRI further avers that the Asset
Allocation Agreement does not affect WRI's ability to provide electric service
within the meaning of K.S.A. 66-136. According to WRI, the term "affecting" has
been interpreted by the Kansas Supreme Court in Kansas Electric Utilities
Company v. Kansas City, Kaw Valley & Western Railway Co. ("Kansas Electric"),
108 Kan. 285 (1921) to mean "transferred."
71. The Kansas Supreme Court has provided guidance on how to interpret
statutes. When confronted by overlapping statutory provisions, every attempt
should be made to reconcile the differing provisions and make them consistent,
harmonious and sensible. Statutes should be construed to avoid rendering their
application useless, impracticable or inconvenient, or to avoid requiring
performance of a futile act. In construing statutes, the legislative intent
should be taken into consideration as gleaned from a general consideration of
the entire act, giving effect if possible to all provisions of the act. It is
not appropriate to ascertain legislative intent by considering isolated parts of
an act. KPERS v. Reimer & Koger Assocs., Inc., 262 Kan. 635, 643-44, 941 P.2d
1321 (1997). A statute should never be given a construction that would lead to
uncertainty,
29
injustice or confusion if possible to construe it otherwise. KPERS v. Reimer
& Koger Assocs., Inc., 261 Kan. 17, syl. 2, 25-26, 927 P.2d 466 (1996).
72. The Commission has relied upon K.S.A. 66-101 (1997), K.S.A. 66-101h
(1997), and K.S.A. 2000 Supp. 66-101d to initiate this investigation and
subsequently to require WRI to refrain from any actions that would increase the
share of debt in WREB's capital structure except for routine short-term
borrowings in the ordinary course of business to fund WRI's on-going electric
utility operations and meet cash flow needs and working capital needs of WRI's
electric utility operations. These statutory provisions may overlap but provide
sufficient legal basis for the Commission to take reasonably necessary actions
to protect the public interest from harm. The Commission is not exercising
jurisdiction over all of WRI's internal decisions or transaction. Rather, the
Commission, consistent with the overall regulatory scheme of the Kansas Public
Utilities Act, is exercising jurisdiction over transactions that affect the
public interest.
73. In the context of a public utility, intercorporate dealings and
reorganizations can have negative consequences for economic viability of the
utility's operation and visit financial misfortunes not only on the shareholders
but also ratepayers of the utility company. Arizona Corp. Com'n v. State ex rel
Woods, 830 P.2d 807, 817 (1992); Fickinger, supra. at 96. If such transactions
are allowed to damage the assets or net worth, the company will have to seek
higher rates for economic survival. Id. at 17. The requirements of the
Supplemental Order and this Order prevent WRI from endangering its assets
through transactions with its affiliates and saddling the utility business with
debt associated with its nonutility investments. Such requirements are
30
reasonably necessary to protect the public from the harm caused by WRI's
transactions, as currently designed.
74. The Supreme Court of New Mexico recently considered and rejected a
contention by PNM that the New Mexico Public Utility Commission ("NMPUC") had
unlawfully injected itself into the management of PNM. Public Service Co. of New
Mexico v. New Mexico Public Utility Comm'n, 961 P.2d 147 (1998)("PNM"). In that
case, the NMPUC ordered PNM to conduct its "optional service programs" under
which the utility would provide utility-related and nonutility services to some
of its commercial customers, through an unregulated corporate subsidiary. On
appeal, PNM argued that the NMPUC, through its orders, infringed upon the
management prerogative of PNM. In affirming the NMPUC orders, the New Mexico
Supreme Court stated:
PNM also argues that the Commission's order constituted an infringement
upon management prerogative. PNM relies on authority that articulates a
principle that regulatory commissions are limited in their ability to
inject themselves into the internal management affairs of a public utility.
However, we believe that the same broad authority that permits the
Commission to act to ensure that rates are fair, just and reasonable also
answers PNM's contentions regarding management prerogative.
We recognize that the Commission's authority to inject itself in the
internal management of a public utility is limited. See, e.g.,Missouri ex
rel Southwestern Bell Tel. co. v. Public Service Comm'n, 262 U.S. 276,
288-89, 43 S.Ct. 544, 67 L.Ed. 981 (1923); Public Serv. Co. v. State ex
rel. Corp. Comm'n, 918 P.2d 733, 739 (Okla. 1996); Duquesne Light Co. v.
Pennsylvania Pub. Util. Comm'n, 96 Pa.Cmwlth, 398, 507 A.2d 1274, 1278
(1986). However we reject this rational as grounds for reversal. The
"invasion of management" prohibition upon which PNM relies is waned.
General Tel. Co. v. Public Utils. Comm'n, 34 Cal.3d 817, 195 Cal.Rptr. 695,
670 P.2d 349, 353-56 (1983)(en banc) (describing the history of the
"invasion of management" rationale in California and rejecting its
application on specific facts). Furthermore, courts have permitted
commissions substantial latitude in protecting the public. See Arizona
Corp. Comm'n v. State ex rel. Woods, 171 Ariz. 286, 830 P.2d 807, 818
(1992)(en banc). ("The Commission must certainly be given the power to
prevent a public utility corporation from engaging in transactions
31
that will so adversely affect its financial position that.31 the ratepayers
will have to make good the losses . . ."). Even some of PNM's cited
authority notes that commissions are generally empowered to act in areas
seemingly reserved to management prerogative where the regulated action is
"impressed with the public interest." Public Service Co. v. State ex rel.
Corp. Comm'n, 918 P.2d at 739 (quoting Missouri Pac. R.R. Co. v.
Corporation Comm'n, 672 P.2d 44, 44 (Okla. 1983)). PNM's additional cited
authority fails to undermine this position.
Id. at 152 (emphasis added).
75. In addition to the quoted passage from the Arizona Supreme Court in the
PNM case, the Arizona Supreme Court held:
The [Arizona] Commission was not designed to protect public service
corporations and their management but, rather, was established to protect
our citizens from the results of speculation, mismanagement, and abuse of
power. To accomplish those objectives, the Commission must have the power
to obtain information about, and take action to prevent, unwise management
or even mismanagement and to forestall its consequences in intercompany
transactions significantly affecting a public service corporation's
structure or capitalization. It would subvert the intent of the framers to
limit the Commission's ratemaking powers so that it could do no more than
raise utility rates to cure the damage from inter-company transactions.
Thus, we do not believe the Proposed Rules so interfere with management
functions that they constitute an attempt to control the corporation rather
than an attempt to control rates. The Commission must certainly be given
the power to prevent a public utility corporation from engaging in
transactions that will so adversely affect its financial position that the
ratepayers will have to make good the losses, and it cannot do so in any
common-sense manner absent the authority to approve or disapprove such
transactions in advance. To put it simply, the Commission was given the
power to lock the barn door before the horse escapes.
Arizona Corp. Com'n v. State ex rel Woods, 830 P.2d 807, 817-18 (1992).
76. The Kansas Legislature granted the Commission full power, authority and
jurisdiction to supervise and control electric public utilities. The Commission
recognizes that the rights offering was filed at the SEC by Westar and not
WRI. But WRI controls Westar, and thus has the power to prevent Westar from
taking actions which harm WRI's
32
ratepayers. Moreover, in two of the three transactions which the Commission
addresses here, specifically the Asset Allocation Agreement and the intercompany
receivables, WRI is a party. Thus, it is to WRI, not Westar, that this Order is
directed. The economic and regulatory reality of the transactions justifies the
Commission's use of its expertise to view the Transactions, as defined in Part I
of this Order, closely. See Corp. Com'n v. State ex rel. Woods, 830 P.2d 807,
817 (1992)(citing Pacific Telephone & Telegraph Co. v. Public Utilities Comm'n,
251 P2d 441, 445 (1950). The Transactions themselves are not arm's length
transactions. 18A Am Jur 2d Corporations 801 (the transfer of assets (and
liabilities) between parent and its wholly-owned subsidiary is not an arm's
length transaction in which compensation is required). Moreover, the
Transactions are part of a plan to transfer WRI's equity to Westar and assign
long term debt associated with unregulated investments to WRI, which diminishes
the value of the utility business. The fact that K.S.A. 66-125 only requires an
investor owned public utility to make an informational filing for securities
issuances regulated by the SEC cannot be construed to limit the Commission's
power to prevent an electric public utility from dissipating the equity portion
of its capital structure and incurring large amounts of debt not associated with
its electric operations. The Commission is concerned here not with the mere
filing requirement but with the harm done, and to be done, to the utility.
Public utility statutes may overlap and be equally applicable to a given KCC
proceeding. Kansas Pipeline Partnership v. Kan. Corp. Comm, 22 Kan.App.2d 410,
416, 916 P.2d 76, rev. denied, 260 Kan. 994 (1996). For WRI to argue that the
Commission has no jurisdiction to prevent WRI's management from assigning or
"giving away" the equity of the public utility operations, or from taking on
debt unrelated to such electric public utility operations,
33
is to ignore the purpose and meaning of the Commission's jurisdictional grant of
authority to "supervise and control" electric public utilities.
77. The Commission is empowered to do all things necessary and convenient
for the exercise of such power, authority and jurisdiction. K.S.A. 66-101;
Grinsted Products, Inc. v. Kansas City Power & Light Co., 21 Kan.App.2d 435, 443
(1995). Contrary to WRI's assertion, these powers are to be construed liberally
and "all incidental powers necessary to carry into effect the provisions of this
act are expressly granted to and conferred upon the commission." K.S.A. 66-101g
(1997). Thus, the Commission's powers go beyond strictly setting rates and
extend to enactment of rules, policies and regulations that are reasonably
necessary steps in ratemaking to serve the public interest and fulfill the
Commission's statutory obligation to "supervise and control" electric public
utilities. The Commission is expected to fulfill its statutory duties and do
what is reasonably necessary to protect the public. "Great latitude is granted
to the legislature to delegate certain functions to the administrative branch of
government. Courts start with the presumption that the legislature and the
people have right to assume that public officials will exercise their express
and implied powers fairly, honestly and reasonably. While standards must
accompany a delegation of authority, great leeway should be allowed the
legislature in setting forth guidelines or standards, and the use of general
rather than minute standards is permissible." State ex rel. Tomasic v. Unified
Government of Wyandotte County/Kansas City, Kansas, 264 Kan. 293 sly. 12 (1998).
See also Pitts v. Kansas Dental Board, 267 Kan. 775 (1999)(the Kansas Supreme
Court implied a jurisdictional grant of authority to allow an administrative
agency to perform a function the court considered to be vital to the public
welfare). Under the facts and circumstances
34
presented, it is necessary for the Commission to act to protect the public from
the harm caused by the Transactions, and the facts set forth here make eminently
reasonable the course of action taken here--to prohibit WRI from making the
split-off and related Transactions effective at any time. Accordingly, the
Commission, pursuant to its statutory obligation to "supervise and control"
electric public utilities, makes permanent the requirements of the May 22, 2001
Supplemental Order.
78. As an independent ground for jurisdiction, WRI had a statutory
obligation to obtain Commission approval before entering into the Asset
Allocation Agreement. Any transaction that constitutes a "contract or agreement
with reference to or affecting" the certificate of convenience and necessity is
not valid until it is approved by the Commission pursuant to K.S.A. 2000 Supp.
66-136. As discussed above, the split-off and related Transactions, as currently
designed, including the Asset Allocation Agreement, harm WRI's ability to
provide electric service by diminishing the value of the electric utility, a
diminution which the Commission finds will affect WRI's ability to perform
routine maintenance, retain qualified employees or make the necessary capital
improvements to meet the needs of Kansas electric consumers. The Commission is
not applying K.S.A. 66-136 to all transactions that may affect WRI's certificate
of convenience and necessity. Rather, the Commission, having opened an
investigation which has determined jurisdictional facts, has applied K.S.A.
66-136 to certain transactions that harm the utility's ability to provide
electric service and thus affect its certificate of convenience and interfere
with the public's right to sufficient and efficient electric service at just and
reasonable rates. Furthermore, the Commission should be given substantial
deference with respect to interpretation of its own organic statute. The
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Commission is entitled to apply, and in fact has applied, a "rule of reason" to
reach the conclusion that the Asset Allocation Agreement is jurisdictional.
79. Further, as a distinct independent ground for jurisdiction, a
management contract with an affiliated interest must be filed with the
Commission. While the affiliated interest must own at least 10 percent of the
voting common stock, WRI has pointed out that by virtue of K.S.A. 17-6401( c),
Westar is prohibited from voting. However, Westar and WRI have a number of
common officers and directors. Westar has four directors, all of whom are
executive officers of WRI-Messrs. Wittig, Lake, Koupal and Geist. Mr. Geist is a
Director and President of Westar, as well as Vice President, Corporate
Development of WRI. Mr. Koupal is a Director of Westar as well as Executive Vice
President and Chief Administrative Officer of WRI. Mr. Lake is a Westar
Director, as well as a WRI Director. Mr. Wittig is Chairman of the Board of
Westar as well as the Chairman of the Board, President and Chief Executive
Officer of WRI. (CURB Exhibit No. 9, Docket 01-WSRE-436- RTS, Registration
Statement at 65). Because Westar shares one or more officers or directors in
common with WRI, the affiliate rules of the Kansas Holding Company Act, K.S.A.
66-1401 et seq., are applicable for the purposes of that act.
80. While the Asset Allocation Agreement does not specifically give Westar
the authority to manage or supervise WRI's activities, it does give Westar the
authority to manage and control assets formerly controlled by the public utility
and paid for by ratepayers, such as the ONEOK, Inc. stock, which remains on the
consolidated balance sheets of WRI until the split-off is completed. WRI
acknowledges that the Asset Allocation Agreement requires WRI and Westar to
execute a Shared Services Agreement
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under which WRI will provide management services to Westar./5/ Under these facts
and circumstances, the Commission properly reached the conclusion that the Asset
Allocation Agreement constitutes a " management" contract requiring advance
submission and approval under K.S.A. 66-1402.
81. As discussed above in Part I, the Asset Allocation Agreement is harmful
to the public interest and adversely affects WRI's ability to provide sufficient
and efficient electric service at just and reasonable rates. Accordingly, the
Commission, acting pursuant to its statutory authority provided in K.S.A. 66-136
and 66-1402, finds that, based upon the harm it causes, the Asset Allocation
Agreement is contrary to the public interest and shall have no legal force and
effect.
III. WRI shall present a plan, consistent with the foregoing prohibition and
parameters, to restore WRI to financial health, to achieve a balanced
capital structure and to protect ratepayers from the risks of the
nonutility businesses.
82. The preceding sections of this Order have discussed why the split-off
and the Transactions are adverse to the public interest. Those sections of the
Order support the Commission's decision to make permanent the prohibitions
described in the Order Initiating Investigation, and to prohibit the split-off.
A. Requirement of a financial plan
83. As discussed above, the Commission has found that WRI has taken actions
not related to the utility business that have harmed the utility at present, and
created the potential for harm in the future. The Commission also finds that it
is necessary to require WRI to submit a plan that will restore its financial
stability.
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/5/ 5/WRI concedes that the Shared Services Agreement must be filed with the
Commission pursuant to K.S.A. 66-1402 notwithstanding its argument that Westar
is not an affiliated interest. WRI Post-Hearing Brief at P. 33.
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84. The Commission, consistent with its general supervisory powers to
protect the public interest, has one principal objective for requiring WRI to
submit a financial plan, that being to restore WRI's financial ratings to the
investment grade level of similarly situated electric public utilities. This
restoration will require WRI to address the various causes of the problem,
including the financial difficulties created by its unregulated losses.
85. Accordingly, the Commission directs WRI to submit a financial plan to
the Commission within 90 days of this Order, detailing a strategy to achieve the
stated objective and restore WRI's financial ratings to an investment grade
level of similarly situated electric public utilities. The Commission will not
at this time prescribe the elements of the plan. A non-exhaustive list of
elements to be considered could include selling all of Westar's common stock in
an initial public offering, or selling all or part of Westar's investments in
ONEOK, Inc., Protection One, or other Westar assets. The proceeds of these
transactions would be used to retire WRI long-term debt. Although the Commission
will not at this time require WRI to take any particular action, it will
require WRI to explain in its submission its reasons for selecting the actions
it proposes, as well as its reasons for rejecting other alternatives, including
the ones listed in this paragraph.
B. Treatment of the intercompany receivables and Westar's ownership
of WRI stock
86. Some witnesses have urged that the Commission require WRI to cause
Westar to declare a dividend to WRI of (1) all outstanding intercompany
receivables payable by Westar to WRI; and (2) the approximately 14,400,000
shares of WRI common stock previously issued to Westar on the conversion of a
previous intercompany receivable. The concern expressed is that such Commission
action is necessary to reverse
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a series of unconventional transactions which are unrelated to the provision of
utility service to Kansas ratepayers, yet damaging to the utility's ability to
provide that service.
87. The Commission shares the witnesses' concerns about these transactions,
some of which have been described previously in this Order, and which include:
1. Increases in WRI indebtedness for the purpose of loaning money to
Westar to enable Westar to make various investments, including a
major investment in Protection One, an unregulated entity with a
history of financial losses and regulatory difficulties with the
SEC. As previously discussed, this loan from WRI to Westar was
subsequently reclassified as an investment in, rather than a loan
to, Westar, thereby converting the debt into equity.
2. Debt reduction efforts that have favored Westar rather than WRI.
(See Hill Direct at 9, referring to debt reductions at Protection
One).
3. Publication of a balance sheet for Westar reflecting a
high-equity capital structure, which conversely results in a low
or negative equity capital structure for WREB.
88. These transactions, taken as a whole, had an asymmetrical result,
benefitting Westar at the expense of WRI. As CURB witness Crane explained in
connection with the conversion of WRI's loan to Westar into Westar common stock
(Direct at 17-18):
[T]he timing of management's decisions regarding this conversion appears to
have been made based on the most advantageous treatment for Westar. For
example, WRI advanced considerable sums to Westar that were never repaid
. . . Moreover, when the relationship changed and amounts were ultimately
transferred from Westar to WRI, the classification of these amounts as
loans to WRI, rather than repayment of loans from WRI, permitted Westar to
build up large receivables from WRI and to later acquire a significant
ownership interest in its parent company. . . .
89. These actions have no purpose related to WRI's obligation to provide
utility service. Whatever corporate goal WRI was seeking to attain, it could
have done so
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in a symmetrical manner that did not disfavor the utility. As CURB witness Crane
explained (Direct at 18-20):
These funds could have been treated in one of several ways. First, if the
intercompany receivable from Westar to WRI had not been converted into
equity, then these funds could have been used to pay back the amounts owed
to the utility. The utility could then have used these payments to reduce
its outstanding debt to third parties. Second, the funds could have (and in
fact were) classified as intercompany loans from Westar to WRI. Since WRI
effectively forgave the earlier loans to Westar by reclassifying the
earlier net advances as equity, then there were no longer any loans
outstanding on which Westar was required to make payment. The conversion of
the original receivable from debt to equity, coupled with the reversal of
funds flow from Westar to WRI, effectively changed WRI from a net lender to
a net borrower. If the WRI intercompany advance to Westar had remained
classified as debt, then the funds that were returned to WRI by Westar
would simply have been classified as debt repayment. But due to the
reclassification of these loans as equity, the funds flowing to WRI
subsequent to January 2000 were identified as intercompany receivables or
loans to WRI. Moreover, interest on intercompany receivables began to
accrue in November 2000, reportedly at the behest of PNM. As a result, WRI
had foregone the receipt of this interest when WRI was a net lender but WRI
was forced to pay interest when it became a net borrower . . . If WRI had
not converted the receivable from Westar into equity, then these funds
could have been transferred from Westar to WRI as repayment of the
receivable. Given this conversion, these funds could still have been
transferred to WRI as dividends. Neither of these alternatives was used,
however, and the payments were classified instead as net receivable to
Westar, allowing Westar to ultimately convert these payments into a
considerable ownership interest in WRI.
90. At this time, the Commission will not require the dividending by Westar
to WRI of the intercompany receivable or of Westar's ownership of WRI stock. The
harm from these two features of the present WRI-Westar relationship stems from
their relationship to the rights offering, the Asset Allocation Agreement and
the split-off, as discussed throughout this Order. Because this Order prohibits
the rights offering, the Asset Allocation Agreement and the split-off, the
Commission does not need to require the dividending of the intercompany
receivable and the WRI stock at this time. Should
40
the Commission observe, however, activities relating to these two elements that
would cause harm, the Commission will revisit this judgment.
C. Conclusion
91. The Commission acknowledges the statements of WRI witnesses that WRI at
present is operating efficiently and at reasonable cost. But this positive
operational state of affairs does not justify the actions taken by WRI
management discussed in this Order which, if permitted to proceed, would result
in WREB having negative equity. Moreover, the Commission must look to the future
as well as the present. WRI's managerial future, notwithstanding its claims of
efficient service, is clouded by the likelihood that top management have been,
and will continue to be, distracted by the multiplicity of complex transactions
that bear no relationship to providing utility service. The Commission does not
wish future ratepayers to have to bear costs associated with these actions and
circumstances. Establishing the requirements and guidance described above is
necessary to protect against this result.
92. The Commission is well aware that a line exists between regulating a
utility and managing a utility. But that line does not require the Commission to
stand by while a utility's management takes actions which are inconsistent with
the utility's best interests. That a management action does not directly involve
operating the utility business does not mean it cannot adversely affect the
utility business. These actions will not fall outside our purview if the
evidence establishes a reasonable relationship between the action and the
effect.
93. In particular, the Commission rejects the argument that the
Commission's authority is restricted to setting rates, and that it can address
any harm caused the utility
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by disallowing costs in rates. And as Mr. Hill pointed out, it is difficult to
penalize financially a utility that is suffering financially. The general
supervisory authority as discussed in Part II of this Order does not confine the
Commission to rate making. The breadth of that provision grants the Commission
the discretion, and the duty, to prohibit activities harmful to the utility.
IT IS, THEREFORE, BY THE COMMISSION CONSIDERED AND ORDERED THAT:
(A) The foregoing statements, discussions, and analysis are hereby adopted
as Findings and Conclusions of the Commission.
(B) WRI shall refrain, and cause its subsidiary Westar and each other
subsidiary of WRI, to refrain, from entering into any agreement which will
directly or indirectly, increase the share of debt in WREB's capital structure,
including, without limitation, the split-off and related Transactions, as
currently designed.
(C) WRI shall take no action, and cause its subsidiary Westar and each
other subsidiary of WRI to take no action, including but not limited to, actions
pursuant to an interaffiliate contract to which it is now a party, that would
directly increase the share of debt in WREB's capital structure, including,
without limitation, the completion of the split-off and related Transactions, as
currently designed.
(D) WRI shall enter into no other agreements with any of its affiliates
that are inconsistent with the principles set forth in this Order.
(E) Nothing in the above requirements shall limit WRI's ability to make
routine short-term borrowings in the ordinary course of business to fund WRI's
on-going electric utility operations and meet cash flow needs and working
capital needs of WRI's
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electric utility operations. WRI shall make a weekly report to Staff of the net
changes in its short-term borrowings.
(F) The Asset Allocation Agreement is prohibited as contrary to the public
interest and shall have no force and effect.
(G) WRI shall present a plan, consistent with the foregoing prohibitions
and the parameters set forth in this Order, to restore WRI to financial health,
to achieve a balanced capital structure, and to protect ratepayers from the
risks of the nonutility businesses.
(H) This order is effective upon service and shall be served on the parties
by hand delivery or facsimile transmission. Any party may file a petition for
reconsideration of this order within fifteen days of the date that this order is
served.
(I) The failure to comply with this order may result in the Commission
entering default judgment pursuant to K.S.A. 77-520 or taking other appropriate
actions necessary to enforce the Commission's order, as permitted by law.
(J) The Commission retains jurisdiction over the subject matter and the
parties for the purpose of entering such further order or orders as it may deem
necessary.
BY THE COMMISSION IT IS SO ORDERED.
Wine, Chr.; Claus, Comm.; Moline, Comm.
Dated: July 20, 2001
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/s/ Jeffrey S. Wagamann
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Jeffrey S. Wagaman
Executive Director
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