Skip to main contentLast March, Portland General Electric sought permission to raise electricity rates by 9 percent and began submitting a wheelbarrow full of information to the state's Public Utility Commission to support its request.
Unlike most companies, utilities must ask regulators before they can raise prices. That's the tradeoff for being allowed to operate a monopoly.
"The utility sector is about the only place in which regulation takes the place of competition," says Dan Meek, a lawyer with the Utility Reform Project, a watchdog group.
Last week, WW learned that one of the key pieces of evidence that PGE offered in October to support its request for a rate hike—an increase that would cost its Oregon ratepayers $143 million annually—was an ostensibly independent analysis of PGE's financial condition.
The report by Standard & Poor's, the country's second-largest credit-rating agency, says that, without a rate increase, PGE's financial position will be in jeopardy.
Given that the law requires the Oregon Public Utility Commission to let utilities make a "reasonable profit," such a warning from a firm of Standard & Poor's influence provided powerful ammunition for PGE.
But documents show that PGE played a highly unusual role in the S&P report. The utility "redlined" or edited three drafts of the Standard & Poor's report, apparently in an effort to make PGE's financial condition look worse and therefore bolster its rate-hike request.
Such "editing" is extremely rare, experts say, and appears to violate the ethical codes of both companies involved.
"I've never heard of a case like this," says professor Jonathan Macey, who teaches securities regulation and corporate finance at Yale Law School. "It's very unusual, to say the least."
"The revelation that PGE edited a report from a purportedly independent ratings agency is extremely disturbing," wrote lawyers for Industrial Customers of Northwest Utilities (ICNU), a group that represents some of PGE's largest customers, including Intel, Oregon Steel and Weyerhaeuser.
ICNU also accused PGE of "manipulation of evidence" and "attempting to create evidence."
If ICNU and others—including the PUC staff and the Citizens' Utility Board of Oregon, another ratepayer group—who have studied the documents are correct, PGE tried to mislead the PUC and, by extension, the 791,000 Oregonians who buy electricity from the utility.
"I think a lot of people were willing to give PGE the benefit of the doubt when they became independent [in April]," says John Kroger, a Lewis & Clark Law School professor who was part of the federal task force that prosecuted PGE's former parent company, Enron. "This looks more like Enron-style conduct than good business practices."
PGE disagrees. "We would characterize ICNU's claims as 'manufactured controversy,'" says company spokesman Steve Corson, who adds that the utility followed its normal process in communicating with Standard & Poor's.
Neither Standard & Poor's nor its analyst who wrote the report returned WW's repeated requests for comment.
Kristin Stathis, an assistant treasurer at PGE, was the company official who in her own words, "redlined" the three Standard & Poor's drafts. Stathis denies any wrongdoing, as do attorneys for PGE.
"All my comments were suggestions that Standard & Poor's could accept or reject," Stathis said in an affidavit submitted to the PUC on Dec. 1.
It's not unusual for a regulated utility such as PacifiCorp, PGE or NW Natural to include in a rate-hike request an independent assessment of its financial health from a credit ratings agency.
"Utilities are always concerned about what effect a rate case will have on their bond ratings," says Bryan Conway, the PUC analyst overseeing the staff review of PGE's current request, on which the PUC is expected to rule in January.
The nation's oldest ratings firm, New York-based Standard & Poor's has been in business for nearly 150 years, employs 7,500 people and had revenues last year of $2.4 billion.
The firm researches and grades the creditworthiness of companies and governments just as credit agencies such as TRW assess the creditworthiness of people.
Investors who buy a company's bonds and shares depend on Standard & Poor's for objective, arm's-length judgment. "The reports they produce are extraordinarily important to lenders and investors because it is one of the primary ways people assess the health of a company," says Kroger. "It's absolutely crucial they be accurate and independent."
The Sept. 25 Standard & Poor's report PGE submitted argued that, unless the PUC approves a rate increase, Standard & Poor's could downgrade PGE's credit rating, which would raise the utility's cost of borrowing.
In written testimony submitted to the PUC on Oct. 25, PGE vice president of regulatory affairs Pamela Lesh referred to the Standard & Poor's report about the utility.
"Recently, S&P changed its outlook on PGE to 'negative' and cited 'an uncertain regulatory environment,'" Lesh testified.
"S&P also stated that it could restore PGE's outlook to stable if [the PUC agrees to the terms of PGE's requested rate hike]."
The first hint that PGE played a role in shaping S&P's credit report appeared early in November, but only to "intervenors," the customer groups who are parties to the rate-making process. (Rate cases are quasi-judicial, and utilities often seek to shield documents from the public.)
Suspicious about the S&P report, ICNU demanded that PGE produce all correspondence between the utility and rating agency for the 21 months prior to the report being published.
On Nov. 1, after initial resistance, PGE produced what became a smoking gun—a number of emails with attached drafts of the final report that went back and forth between the utility and Standard & Poor's. PGE produced the documents on the condition that the material be kept confidential from the public.
For two weeks, as records now show, intervenors steamed privately about the utility's manipulation of the S&P report.
The matter only became public, for a brief moment, on Friday, Nov. 17. That's when the PUC staff, which acts independently from the three governor-appointed PUC commissioners who rule on rate cases, submitted its analysis of PGE's request.
The staff analysis was posted on the agency's website, and in unusually direct criticism, it took aim at the integrity of Standard & Poor's report:
"What Ms. Lesh fails to reveal," the PUC staff testimony stated, "is PGE's role in drafting the S&P report."
By the following Monday, however, that explosive sentence was removed from the PUC website because it referred to confidential material.
In subsequent filings, ICNU expressed skepticism that PGE had turned over all correspondence between the utility and Standard & Poor's—and asked the judge overseeing the procedural aspects of the rate case to unseal the documents.
ICNU'S concerns were well-founded. On Dec. 1, PGE unsealed the original correspondence it had produced and added into the record two previously unreleased emails from Standard & Poor's analyst Leo Carrillo to PGE's Stathis.
The documents, which WW reviewed over the weekend, show that Stathis received three drafts of the Standard & Poor's report and that Stathis and Carrillo exchanged at least five emails and at least one phone call as the drafts were rewritten.
"Leo, attached are our redlines to your draft report," Stathis wrote in a Sept. 22 email. "Thanks again for the chance to review."
Three days later, in a return email, Carrillo replied, "Thanks for the changes. I've incorporated most of them."
In a written explanation PGE included with the unsealed documents, company attorney Douglas Tingey defended the exchange of drafts between the utility and the ratings agency, saying it is "consistent with S&P's internal Code of Conduct and S&P's standard practice."
According to lawyers familiar with the rating process, however, PGE's involvement in the preparation of an "independent analysis" of the utility went far beyond any accepted standard.
"What's troubling is that if an agency allows one company to essentially write its own report, how can you trust anything it produces?" says Macey, the Yale professor. "The investment community views a credit rating like a report card, and when you look at a report card, you don't think the student wrote it—you think the teacher did."
Corporations such as PGE do communicate with the ratings firms that assess their creditworthiness. That communication can include financial data and exchanges of views on company-specific and broader industry trends.
"Fact-checking between the rating agency and PGE would be appropriate," says Kroger, the former Enron prosecutor. "But it seems curious to me that PGE would be 'editing' the credit report. If that's a common practice, I've never heard of it."
Bert Valdman, chief financial officer at Puget Sound Energy, Washington's largest utility, says his company regularly communicates with rating firms but plays no role in drafting or editing reports. "There's no 'shaping'" of the reports, says Valdman.
The documents PGE released last week show that Stathis suggested at least 48 changes to the various drafts, many of them purely factual. But the criticism the customer groups and PUC staff make is of the more subtle changes that occurred through the "review" process.
For instance, in a section of the S&P analysis labeled "Outlook," the words "uncertain regulatory environment"—the phrase Lesh emphasized in her testimony—exists only in the published version of the report, not any of the prior three drafts.
Other phrases that occur only in the final version of the "Outlook" section reinforce the idea that PGE badly needs the PUC to grant a rate hike. Even the possibility of a ratings upgrade if PGE gets a rate increase is made to seem more distant in time with the inclusion of the word "eventually" in the published version.
In a brief that was made public last week, ICNU states, "PGE fundamentally altered S&P's report."
The Citizens' Utility Board, which represents individual ratepayers, added its voice to the criticism last week. Because of PGE's involvement in the creation of the S&P analysis, "the S&P report should be given no evidentiary value," wrote Jason Eisdorfer, an attorney for CUB.
PGE has plenty of motivation for seeking higher rates from the PUC. Since PGE's former parent company, Enron, began distributing the utility's stock to creditors in April, the company is once again publicly traded.
PGE's stock price and its executives' compensation depend on increasing profits. (One of the first moves the utility made after its stock began trading publicly again was to increase CEO Peggy Fowler's salary by 59 percent.)
But for PGE, getting caught "redlining" an "independent" research report is just the latest in a string of aggressive tactics the utility has employed to boost shareholder profit at ratepayer expense.
For example, PGE continued charging ratepayers for its Trojan nuclear plant for another five years after activists forced the closure of the plant in 1992. (A class-action lawsuit seeking more than $250 million in compensation from PGE for ratepayers is pending.)
Then from 1997 through 2005, while under Enron ownership, PGE collected nearly a billion dollars from ratepayers to go toward its tax bills but never paid the money to authorities. (The City of Portland is suing PGE in an attempt to recapture some of that money for ratepayers.)
The Oregon Legislature plugged the tax loophole for PGE and other utilities last year, though utilities have signaled they will seek to overturn that law in the next legislative session.
In the past, PGE has acted on its own to boost profits. The utility's current ploy is unusual because it includes the cooperation of a company whose integrity is crucial to capital markets.
Understanding why PGE wants higher rates is easy. It's less obvious why Standard & Poor's might be willing to help.
One possibility is that Leo Carrillo, the analyst at S&P who wrote the report, simply failed to do his job. "We could be talking about a lazy or sloppy analyst here rather than a common practice," says Kroger.
Others think that there is a more systemic explanation.
"Rating agencies have an obvious conflict of interest," a 2003 Federal Reserve Board analysis of the ratings industry pointed out. "They have a financial incentive to accommodate the preferences of bond issuers because they are selected and paid by the issuers. This incentive conflicts with agencies' stated goal of supplying independent and objective credit-risk analysis to investors."
In 2003, Congress held hearings on the failure of Standard & Poor's and Moody's Investors Service to alert investors to financial problems and subsequent massive bankruptcies at companies such as Enron and WorldCom, both of which were major clients of the ratings agencies.
"Five days before they went bankrupt, the big agencies still rated them 'investment grade,'" says Larry White, a professor at the New York University School of Business who has written extensively about financial regulation.
Sean Egan, managing director of Egan-Jones, a Pennsylvania credit-rating firm that recognized Enron's problems far sooner than the big two agencies, says his firm "absolutely would not" allow companies to edit draft reports.
"It's extremely difficult to ignore that 90 to 95 percent of S&P's compensation comes from the companies it rates," says Egan, whose firm gets paid by investors rather than borrowers.
Bogus research can have consequences. In 2003, in the aftermath of the bursting of the Internet bubble, 10 Wall Street investment banks agreed to pay $1.4 billion in state and federal settlements. Their offense was producing "research reports that were not based on principles of fair dealing and good faith and did not provide a sound basis for evaluating facts," according to the Securities and Exchange Commission.
The two biggest ratings agencies—Standard & Poor's and Moody's—escaped without disciplinary action because, although their ratings are central to highly regulated financial markets, the two firms have historically argued that their reports are journalism and therefore protected by the First Amendment.
Frank Partnoy, a former Wall Street investment banker, is one of the ratings firms' strongest critics. "What's happening with PGE sounds like another example of what has become a perverse and corrupt part of the financial markets—companies' dependence on credit ratings, which makes ratings agencies more powerful," says Partnoy, who now teaches law at the University of San Diego.
Congressional leaders railed against the failure of the ratings agencies earlier this decade, but the only immediate result was a requirement that the agencies strengthen ethical guidelines.
In October 2005, Standard & Poor's issued a "Code of Conduct," designed to address potential problems.
"To maintain Ratings Services' independence, objectivity and credibility, Ratings Services shall maintain complete editorial control at all times over Ratings Actions and all other materials it disseminates to the public," states the code. "And its Analysts shall use care and analytic judgment to maintain both the substance and appearance of independence and objectivity."
Two months ago, Congress passed legislation that is expected to open the credit ratings business to dozens of companies such as Egan-Jones who have been on the outside looking in.
"The big ratings agencies never had to worry about competition before," says Macey, the Yale law professor. "The world is different now."
A Standard & Poor's rating is based on principles of independence, integrity and disclosure—the same standards that underlie market confidence and acceptance of our ratings by investors worldwide," reads the firm's website.
PGE currently has about $1 billion in outstanding debt, and the utility plans to borrow nearly $600 million over the next three years.
Standard & Poor's is owned by McGraw-Hill, a publicly traded publishing and information company.
About 40 percent of Oregonians get their electricity from PGE, with the average customer paying $872 a year for the privilege. The increase sought by PGE would add about $78 annually.
Historically, Standard & Poor's and Moody's Investors Service control about 80 percent of the U.S. ratings market, according to congressional testimony by University of San Diego law professor Frank Portnoy.
Although much of the testimony in PGE's current rate case is submitted in writing, it is still considered "under oath."
PGE's code of ethics says, "Senior Financial Officers are required to conduct themselves honestly, ethically and with absolute integrity with respect to the Company's business."
WWeek 2015