D.C. Circuit Limits FERC’s Direct Authority Over Corporate Governance of Public Utilities

The D.C. Circuit held that FERC’s authority is limited to practices directly affecting the rates charged by public utilities and does not include aspects of public utilities’ corporate governance that may only indirectly affect rates. However, the Court did recognize FERC’s authority to require changes in corporate governance as a condition for the approval of rates or tariffs.

On June 22, the D.C. Circuit vacated a Federal Energy Regulatory Commission (FERC) order replacing the governing board of the California Independent System Operator Corporation. The Court held that FERC’s authority under §206 of the Federal Power Act is limited to practices directly affecting the rates charged by public utilities and does not include aspects of public utilities’ corporate governance that may only indirectly affect rates. However, the Court did recognize FERC’s authority to require changes in corporate governance as a condition for the approval of rates or tariffs.

The Court’s ruling came on petitions for review of a July 17, 2002 order in which FERC directed the CAISO to replace its governing board with a new board selected with procedures set forth by FERC. The CAISO board currently is appointed by the Governor pursuant to a state law enacted as a result of the 2000-2001 energy crisis. FERC found that the State’s control over the board deprived it of the independence FERC requires of each Independent System Operator or Regional Transmission Organization. It concluded that a State-controlled board rendered the CAISO unable to operate interstate transmission facilities on a nondiscriminatory basis, particularly in light of the State’s significant participation in the electricity market through the California Department of Water Resources.

However, the D.C. Circuit held that FERC has no direct statutory authority to order a public utility subject to its jurisdiction to replace its governing board, and found the order to be an “unprecedented invasion of internal corporate governance.” The Court rejected FERC’s argument that the term “practice...affecting [a] rate” in §206(a) of the FPA granted it authority over aspects of corporate governance or structure. It held instead that in the context of §206(a) the term “practice...affecting [a] rate” is limited to terms that directly affect or are closely related to the rate. The Court did note, though, that FERC may condition its approval of rates and tariffs on changes in corporate governance necessary to ensure that such offerings are just, reasonable, and not unduly discriminatory. Such action would be taken under FPA §§205 or 206. It also suggested that FERC could revoke the CAISO’s ISO status upon finding that the board is not independent. Such a revocation would have to be based on FPA §206(a).

The decision sets an important precedent for how FERC may exercise control over the structure of ISOs and RTOs. Moreover, the decision may affect the validity of other efforts by FERC to use §206(a), or the parallel provisions in §§ 4 and 5(a) of the Natural Gas Act, to impose corporate governance requirements on regulated entities or to mandate actions or practices that do not directly affect or are closely related to rates and contracts. To the extent FERC imposes such requirements directly and not as a condition for its approval of rates or tariffs, its actions may be found to exceed the scope of its authority under the FPA.