BILL ANALYSIS Ó 1
SENATE ENERGY, UTILITIES AND COMMUNICATIONS COMMITTEE
ALEX PADILLA, CHAIR
AB 861 - Hill Hearing Date: June 19, 2012
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As Amended: June 7, 2012 FISCAL B
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DESCRIPTION
Current law vests with the California Public Utilities
Commission (CPUC) the authority to fix just and reasonable rates
and charges for public utilities and requires that expenses for
bonuses paid to an executive officer, when a utility has stopped
paying its debts, are borne by shareholders and cannot be
recovered in rates.
Current law authorizes the CPUC to exercise limited jurisdiction
over the holding company of a utility in order to protect the
public interest and ensure that the utility subsidiary is
providing adequate service at just and reasonable rates.
Current law defines a public utility as common carrier, toll
bridge corporation, pipeline corporation, gas corporation,
electrical corporation, telephone corporation, telegraph
corporation, water corporation, sewer system corporation, and
heat corporation, where the service is performed for, or the
commodity is delivered to, the public.
This bill prohibits rate recovery by an electrical or gas
corporation for earnings or stock-based price-based incentive
pay for its employees or directors.
This bill defines an energy public utility as a gas corporation,
an electrical corporation, or a public utility that is both a
gas corporation and an electrical corporation.
This bill requires an energy public utility to recover excess
compensation, as defined, received by any current or former
officers or directors of the energy public utility, or a holding
company of the utility if the holding company owns more than 80%
of the utility, if a fine or penalty is imposed by the CPUC on
the utility for a safety violation. This is commonly referred
to as a "clawback provision" and would apply to earnings in the
five year period before the fine or penalty is imposed and
applied to excess compensation which would the difference
between what the official or director received and would have
received had a penalty been assess the utility during the time
frame in which the violation occurred..
Current law authorizes the CPUC to impose a fine ranging from
$500 to $20,000 per offense, against any person or entity, other
than a public utility, that fails to comply with a utility law
or commission requirement, or who aids or abets a public utility
in the violation of the same.
This bill increases the maximum fine per offense to $50,000.
Current law establishes a misdemeanor penalty for public
utilities and their officers, agents and employees if they
violate any utility law or commission requirement, or aid or
abet a public utility in the violation of the same. The penalty
is up to one year in jail and/or a $1,000 fine.
This bill increases the potential fine to $5,000.
BACKGROUND
San Bruno Tragedy - On the evening of September 9, 2010 a
30-inch natural gas transmission line ruptured in a residential
neighborhood in the City of San Bruno. The rupture caused an
explosion and fire which took the lives of eight people and
injured dozens more; destroyed 37 homes and damaged 70. Gas
service was also disrupted for 300 customers.
The National Transportation Safety Board (NTSB), which has
primary jurisdiction for investigating pipeline failures, issued
its Pipeline Accident Report on the San Bruno tragedy in August,
2011 and determined that:
1) The probable cause of the accident was PG&E's: (1)
inadequate quality assurance and quality control in 1956
during its Line 132 relocation project, which allowed the
installation of a substandard and poorly welded pipe
section with a visible seam weld flaw that, over time grew
to a critical size, causing the pipeline to rupture during
a pressure increase stemming from poorly planned electrical
work at the Milpitas Terminal; and (2) inadequate pipeline
integrity management program, which failed to detect and
repair or remove the defective pipe section;
2) Contributing to the accident were the CPUC's and the
U.S. Department of Transportation's exemptions of existing
pipelines from the regulatory requirement for pressure
testing, which likely would have detected the installation
defects. Also contributing to the accident was the CPUC's
failure to detect the inadequacies of PG&E's pipeline
integrity management program; and
3) Contributing to the severity of the accident were the
lack of either automatic shutoff valves or remote control
valves on the line and PG&E's flawed emergency response
procedures and delay in isolating the rupture to stop the
flow of gas.
This is one of a series of bills, beginning in 2011, stemming
from the tragedy of San Bruno. Several bills have been passed
intended to ensure a safe gas distribution and transmission
system for the State of California. Fines against public
utilities have been increased, new safety standards established,
and emergency response systems have been improved.
Utility Rates - The CPUC is required to ensure that a public
utility's rates are just and reasonable. Rates are to be set in
an amount that will cover the utility's costs of providing
service and maintaining facilities and provide the utility a
profit, or rate of return. This rate of return is considered to
be the compensation paid to investors for the capital they have
provided for public utility service. The general standard is
that a utility's rate of return should be reasonably sufficient
to assure confidence in the financial soundness of the utility
and should be adequate, under efficient and economic management,
to maintain and support its credit and enable it to raise the
money necessary for the proper discharge of its public duties.
COMMENTS
1. Author's Purpose/Goals . According to the author,
CPUC-regulated utilities, reward executives with incentive
payments for the company's financial performance. Public
utilities however, are not like normal corporations. They
cannot increase their profit by increasing market share or
selling more product. They cannot raise their revenue at
all since the total amount they are able to recover in
rates is set by the CPUC. The only way a public utility can
increase its profit is by cutting its operations and
maintenance costs, as has been demonstrated by PG&E. The
year of the San Bruno explosion, the company cut costs by
laying-off engineers, putting off safety assessments, using
cheaper safety assessments, and reducing its leak surveys.
Compensating executives based on earnings or stock price
creates a perverse incentive and is bad policy.
Under current law, it is up to shareholders to determine
whether or not they want to pay for this policy. This bill,
however, will make sure that ratepayers do not participate
in it. Better aligning the incentives of utility executives
with those of customers and shareholders will help further
the interests of all stakeholders and enhance the long-term
health of California's utilities.
Executives can beef up their quarterly numbers while
steering the company aground, then parachute away without
consequence. Modeled on Section 954 of the 2010 Dodd-Frank
Wall Street Reform and Consumer Protection Act, this bill
will require utilities and their holding companies to
reassess executive performance bonuses retroactively. If
the CPUC fines the company for a violation that occurred in
the previous five years, and if a top executive received a
performance bonus based on corporate earnings during that
time period, the company must reassess what incentive the
executive would have gotten had the fine been levied at the
time of the violation. The executive (or former executive)
must return the difference to the company's shareholders.
This only applies to utility and holding company directors
and executive officers.
Right now, the penalty limit for executive violations is
$20,000, a small number to executives making a million
dollars a year in base pay and millions more in stock and
incentive payments. Raising the penalty limit to $50,000
per violation will help keep executives on the straight and
narrow.
2. Rate Recovery . The CPUC has the latitude to consider
during the general rate cases of each public utility the
level and type of executive compensation that should be
borne by ratepayers. In that context, the Commission can
consider the particular facts and circumstances, including
appropriate incentives for utility performance.
The author argues that "the ways in which the Commission
decides to allow or disallow recovery for incentive-based
compensation has been inconsistent, unpredictable, and
appears not to be based on any particular ratemaking
principle" and that "this vacuum in policy directive
necessitates legislative direction.
The principal issue presented is whether and to what degree
executive incentive pay benefits ratepayers. The author
argues incentives related to safety are in the ratepayer
interest but incentives relative to financial performance
are not and should therefore be restricted from rate
recovery. But if a company has a poor safety record would
that not also affect financial performance of the company
in the market? No empirical evidence was presented to the
committee to show the effect of these incentive pay
structures on the quality of service of the utility.
The CPUC opines that:
Undoubtedly, energy utilities and, by extension,
the customers they serve benefit largely from
competent executives who can operate energy
utilities while balancing safety, efficiency and
profitability needs. Should the need to attract
the best talent remain as a primary goal for
energy utilities and their regulators, given this
prohibition, the utilities' compensation schemes
may simply revert to a more salary-based
remuneration, which itself may not be optimal in
ensuring the best performance and output from
executives.
3. Clawback of Incentive Pay . The author points to two
federal laws as precedent for the clawback provisions in
this bill which would require an energy utility and its
holding company to take back what it defines as "excess
compensation" earned by its employees during a five-year
period before a fine is imposed by the CPUC for safety
violations. The author has fashioned his bill on the
Sarbanes Oxley Act of 2002 and the Dodd-Frank Wall Street
Reform and Consumer Protection Act. These federal laws use
the clawback to address the issue of misrepresentation of
the financial status of a corporation and noncompliance
with financial reporting requirements by an executive.
Those actions by a corporative executive can directly
result in a financial benefit to the executive whose
compensation is directly tied to the market price of the
company's stock. By enhancing a company's financial status
that executive stands to directly gain from an enhanced
stock price in the market.
Several policy and legal concerns have been presented in
opposition to this bill. First, the provisions only
require clawback of incentive pay, not base salary.
Consequently an energy public utility could escape
application of the clawback by merely raising the base
salaries of the executives which would disconnect the
performance of the company for safety, service and market
value from the executive compensation. The likely
unintended consequence of higher executive base pay would
result in with rate recovery and likely decrease the
executive's incentives to maximize performance. The
affected energy public utilities write in opposition to the
bill and argue that these limits would put the utilities at
a competitive disadvantage with other utilities in the
nation in their ability to attract top managers.
The mechanics and application of the clawback provisions of
this bill are not clear. The utility would be required to
go back and override the judgment, and perhaps employment
contract, used to award incentive pay five years hence and
then revise the incentive awarded as it would have acted
had it known at the time the incentives were awarded that
violations of safety standards had occurred. The clawback
would apply to current and former employees and potentially
be applied by new management and/or a board that never
worked with or even knew the former employee.
Many of the issues presented by the bill are speculative
since the author and parties are not aware of any state or
federal experience with applying clawback provisions,
particularly to former employees and in the context of
regulated utilities. Constitutional questions have been
raised including the effect contracts and takings clauses
as well as due process. Several parties, including the
CPUC, have opined that the clawback provision is
"convoluted" and is generally not clear as to how it is
supposed to work.
4. Increased Penalties . The penalties for offenses by a
public utility were increased last year from a maximum fine
of $20,000 per violation to a maximum fine of $50,000 per
violation.
This bill would increase the penalties against
non-utilities which were involved in the tragedy, employees
of the utility, and also non-public utilities regulated by
the CPUC. The author is primarily targeting the executives
of the electric and gas corporations. He argues that
"penalties for corporate malfeasance are too low. Right
now, the penalty limit for executive violations is $20,000,
a small number to executives making a million dollars a
year in base pay and millions more in stock and incentive
payments. Raising the penalty limit to $50,000 per
violation will help remind executives that safety is
equally as important as profits."
However, these increased penalties do not just apply to the
CEO's of California's major public utilities. This
increase would also apply to entities that contract with a
utility (e.g. tree trimmers) and the non-public utilities
that the commission regulates including moving and
limousine companies. Arguably, the fine range starts at
$500 so the upper limits do not have to be applied to all
parties. The CPUC is generally supportive of an increase
in the maximum fine since it has not been modified since
1993. They opine that penalties between utilities and
non-utilities should be comparable.
ASSEMBLY VOTES *
Assembly Floor (75-0)
Assembly Appropriations Committee (17-0)
Assembly Utilities and Commerce Committee
(16-0)
* Prior votes not relevant.
POSITIONS
Sponsor:
Author
Support:
Division of Ratepayer Advocates
The Utility Reform Network
Oppose:
Independent Energy Producers Association, unless amended
Pacific Gas & Electric Company
San Diego Gas & Electric Company
Southern California Edison
Southern California Gas Company
Kellie Smith
AB 861 Analysis
Hearing Date: June 19, 2012