Over the past ten months or so, from December 31, 2009, through the New York Stock Exchange market close on Friday November 12, you could have earned about 8.5% counting dividends – versus about 9.25% on the same terms for the S&P 500 – simply by buying and holding this basic eight-company portfolio, dominated by financials and consumer products retailers: Bank of America, Citigroup, HSBC, Kimberly Clark, Proctor & Gamble, Safeway, Target, and UBS.

Not so, however, for anyone employed by the PJM Interconnection, the independent operator of the regional electricity grid for the greater mid-Atlantic, covering the historic core (Pennsylvania, New Jersey, Maryland, Delaware, Washington, D.C., Virginia, and West Virginia), and now extending into parts of Kentucky, Ohio, Indiana, Michigan, Illinois, and North Carolina. If you work at PJM, or even if your wife or husband does, well, you can kiss that 8.5% return goodbye – and the 9.25% on the S&P as well.

That’s because federal regulations for regional transmission organizations (RTOs, of which PJM is one) prohibit both staff and directors (other than those holding special stakeholder slots) from holding any financial interest in any market participant, such the local electric utility, a power producer that owns electric generating plants, a trader that buys and sells power at wholesale. And contrary to what you might think, this prohibition actually extends to each of the companies in our mock portfolio, as well as many members of the S&P 500 Index.

How can this be?

Of course, no one should begrudge PJM its code of conduct, or concern over conflicts of interest. That’s what makes RTOs “independent,” and why the U.S. Federal Energy Regulatory Commission (FERC) certifies them to run the grid. You wouldn’t want to have one single agency or firm setting the market price for power and also controlling the transmission grid over which it’s sent. That would be like Delta or United running the air traffic control system, or UPS or FedEx in charge of interstate highways.

But why should Safeway or Target find itself on PJM’s “no fly” list? Well, it seems those two companies are dues-paying members of PJM, along with the other six, making their stock off limits to any investing PJM employees, board members, their spouses, and minor children. And the list of verboten investments is sure to grow, as more businesses dabble in conservation and demand response, which turns energy users into suppliers and sellers, as when they forgo consumption or sell power back to the grid from rooftop solar panels.

 PJM explains the problem.

 “In recent years,” it says, “non-traditional companies whose primary businesses cannot be described objectively as … electricity-related have joined PJM in recent numbers.”  Many of these companies, it continues, “have not previously participated in wholesale electricity market activities.” All of this has made it “unduly complicated and counterintuitive,” PJM claims, not only for employees to comply with codes of conduct, but also for the RTO to hire and retain directors and staff.

And so PJM has filed a formal petition with FERC, asking the commission for a declaratory ruling that would waive the financial interest rule for the stock of any publicly traded company whose primary business purpose is not related to electricity, and provided that the company’s revenues and expenditures in PJM markets are insignificant (one percent or less) in relation to the company’s total revenues, as determined by PJM itself, by reference to public sources – and by aggregating parent company and subsidiary revenues, for the purpose of the one percent test, if the PJM member is controlled by a holding company.

To illustrate how the waiver would work, PJM has provided a list (“Exhibit A”) of companies now off-limits to PJM staff for stock investing, but which likely would qualify for waiver as PJM as proposed. The eight companies in our mock portfolio are all listed in Exhibit A. The question of whether the company’s core business qualifies as “electricity-related” would be answered by reference to its code number under the North American Industry Classification System (NAICS), run by the U.S. Census Bureau. PJM then would post a notice on its web site providing a list of otherwise prohibited companies now open to investment for PJM personnel.

Now if you know anything about this blog, or its author, you know he will now tell you how PJM’s modest proposal as brought the industry up in arms, as in fact it has. Opposition has centered on a number of points:

• Active Stakeholders. Even if power market activities play an insignificant role at Safeway, Target and rest, the Exhibit A companies do play an active role PJM stakeholder processes and policy formulation, conflicts could still arise.
• Holding Company Distortions. A subsidiary could have a significant interest in power markets, yet could pass the one percent de minimus test when its revenues are aggregated with those of a much larger parent company.
• Unavoidable Discrimination. Revenue tests are misplaced; instead focus on PJM employees, whose equity holdings will color their views and perspectives on individual companies.
• Stale Definitions. Census Dept. notions of what is “electricity-related” are out of date, as they don’t  recognize energy storage or other emerging technologies.
• Lack of Disclosure. The proposal fails by not restricting PJM employees in the amount of investment in companies qualifying for waiver, and by not requiring employees to disclose such investments.

 The Ohio Consumers’ Counsel, for example, simply finds it abhorrent to allow PJM to become arbiter of whether its own behavior is or is not a conflict of interest, by assigning to the RTO the task of deciding when power market revenues are de minimus compared to total company operations, noting that “PJM should now be allowed to self-regulate its own independence.”

The Maryland Public Service Commission warns that codes of conduct must pay attention also to public relations campaigns. As the PSC notes, “some market participants place a premium on ‘being green,’ and this may manifest itself in certain important PJM initiatives, such as demand response, variable energy resources, distributed generation, and energy efficiency.

 “In other words,” writes the PSC, “the significance of these programs may transcend their dollar value.”

Clearly, however, PJM finds itself in a tough spot. On one hand, it claims that no employee-investor has asked for relief on his or her own accord. Yet, in its answer to industry protests filed at FERC, PJM cites concerns of its own general counsel that the current code of conduct forces PJM staff virtually to give up any notion of serious personal investing:

“Compliance with an indiscriminate rule prohibiting ownership of any company doing trivial business in the RTO directly, or more problematically, through some distant joint venture of affiliate, presents a standard that cannot be met without effectively barring RTO personnel from investing altogether in individual equities.”

Some industry opposition appears overblown.

 For example, the influential PJM Power Providers Group, representing the generation sector (see www.p3powergroup.com) appears to protest too much in its comments filed at FERC:

“While P3 does not wish to suggest that PJM employees, managers and directors would use a new found opportunity to invest in PJM member companies to compromise their independent judgment … the current proposal would allow [them] to take substantial, even controlling, interests in PJM member companies.”

Say what?

Would a PJM employee – or even a board member – invest millions of dollars in personal wealth in a vain hope of gaining a controlling interest in an industrial or consumer products company that is only marginally involved in power market activities? As PJM has pointed out, acquiring even a 5 percent interest in one PJM member – Citigroup – would put a $5.3 billion dent in an investor’s pocketbook.

 “Yet no solution is offered,” pines PJM, “to the real world problem that the individual might own 100 shares of a multinational steel company or big box store company that it did not realize participated, in some form, in the PJM markets.”