Shareholder activism in the regulated utility sector

July 2022 | SPOTLIGHT | BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

July 2022 Issue

Historically, regulated utilities in the US were more insulated from the scrutiny of shareholder activists than companies in other industries. Starting in the late 1970s, however, the regulated utility industry began to restructure. The many smaller companies that each produced and sold electricity or natural gas separated their business into wholesale production and retail distribution divisions and started merging with one another. Today, there are fewer and larger, multistate-competitive wholesale electricity producers and gas pipelines; and a few very large, publicly-traded holding companies with multiple single-state gas & electric retail distribution company wholly-owned subsidiaries, as well as some smaller, single-state retail utilities. Additionally, new technologies, consumer-driven demand for renewable energy and rising inflation are catalysing more change. These industry changes, together with changes in laws in the mid-2000s, eliminated the types of legal and regulatory restrictions that had previously limited the ability of activists to acquire stock of public utilities and wage campaigns to influence their management and corporate policies.

Approval from federal and state utility regulators is almost always required to gain control of a regulated public utility through the acquisition of its publicly traded common stock (or voting securities). Under the Federal Power Act, the Federal Energy Regulatory Commission (FERC) presumes ‘control’ to exist at ownership of 10 percent of the voting securities of a public utility. ‘Control’ can also be found to exist even absent direct ownership of voting securities. Many states have similar regulatory regimes, either by statute or rule of the applicable state utility regulatory commission, under which ‘control’ is presumed to exist at a level below 51 percent of common stock ownership. Thus, FERC approval for ‘change of control transactions’ under the Federal Power Act will be required (and often state regulatory approval will be required) even if no equivalent shareholder approval under state corporate law is required.

FERC’s 2007 Supplemental Policy Statement provided a limited safe harbour presuming non-control for acquisitions of voting securities under 10 percent of the total outstanding voting securities of a public utility. This 2007 policy statement may have emboldened activists to take stock positions in public utility companies because, by clarifying that acquisitions of less than 10 percent of the voting securities of a public utility could proceed without FERC review, an unquantifiable regulatory risk for activists in their manner of doing business was reduced. Recent examples of activist campaigns targeting public utilities bear out that activist positions rarely surpass the 10 percent threshold.

Recent practice of activists is to acquire an economic stake in a public utility and then obtain board seats and, if formed, a role on a special committee through which to advocate for changes in corporate policy, governance or strategic direction. A change in corporate policy or the adoption of a new strategic direction or plan alone should not necessarily trigger FERC or state utility commission regulatory review. However, the smaller the position an activist takes in a public utility and the shorter the timeframe over which that position is held, the less incentivised that activist may be to ensure the stability and long-term performance of the utility for the benefit of all stakeholders. Recent activist campaigns have resulted in the activist’s nominees being appointed as directors to the boards of utility holding companies, posing the question of whether such arrangements constitute a ‘change of control’ of a regulated utility for which FERC and state utility commission regulatory approval is required.

For example, in January 2020, Elliott Management Corporation disclosed a significant stake in Evergy in a letter advocating for Evergy to pursue either a merger or a standalone plan with the goal of increasing investment in infrastructure and optimising operating costs. Shortly thereafter, Evergy announced an agreement with Elliott, pursuant to which Evergy agreed to appoint two new independent directors to Evergy’s board and to form a special committee to explore ways to enhance shareholder value. State utility commissions in Kansas and Missouri expressed scepticism over Elliott’s influence over long-term planning and the potential impact on retail rates and opened investigatory proceedings. Public Citizen, a non-profit consumer advocacy organisation that has filed a number of complaints at FERC against public utilities and financial institutions under the Federal Power Act, intervened in an unrelated proceeding involving an Evergy affiliate to have FERC declare that Elliott is an ‘affiliate’ of Evergy. Public Citizen also argued that the activities of financial investors, generally, are detrimental to ratepayers because financial investors will exert their influence over utilities in a way that will cause energy prices to rise. FERC has not yet responded to Public Citizen’s protest in this matter.

In March 2021, FirstEnergy and Icahn Capital entered into an agreement pursuant to which FirstEnergy added two Icahn employees to its board. The agreement includes customary provisions but also states that certain regulatory approvals must be obtained before the two new directors will have voting rights. Furthermore, it was stipulated that Mr Icahn and his associates would not exercise substantial influence or control over FirstEnergy or any of its subsidiaries. The arrangement with Icahn suggests a new sensitivity to regulatory considerations, perhaps in response to the Evergy situation or the fact that the two new directors are employees of Icahn rather than directors who are independent of the activist investor. FERC approved FirstEnergy’s application for a ‘change of control’, holding that the ‘proposed transaction’ was “consistent with the public interest” considering: (i) the effect on competition; (ii) the effect on rates; and (iii) the effect on regulation. FERC expressly refused to take up the arguments that Icahn was an ‘affiliate’ of, or exercising ‘control’ over, FirstEnergy and its subsidiaries. Subsequently, the Maryland Public Service Commission opened an investigation, which is ongoing, into whether the Icahn-appointed directors exercise ‘substantial influence’ over FirstEnergy’s Maryland public utility subsidiary, among other matters.

Elliott acquired a stake in Duke Energy Company in May 2021 and, according to Elliott’s press release, became one of Duke’s 10 largest shareholders. Elliott called for an independent review to study whether Duke should separate into three regional utilities. Elliott couched its criticisms of and proposals for Duke’s performance with a view toward gaining broader stakeholder buy-in, including from customers, arguing that Duke had consistently underperformed the market and suffered several public missteps resulting in billions of write-offs. Duke resisted Elliott’s overtures and accused Elliott of short-termism. Duke and Elliott entered a truce by which two new independent directors were appointed to Duke’s board. In Spring 2022, Elliott dissolved its stake in Duke and turned its sights to Suncor Energy Inc., making similar requests for Suncor to add new independent directors, overhaul management and begin a strategic review.

When Southwest Gas Holdings, Inc. agreed to acquire Dominion Energy Questar Pipeline, LLC from Dominion Energy, Inc. in October 2021, an Icahn affiliate (an investor in Southwest) objected. Southwest completed its acquisition of Questar in December 2021, but Icahn commenced a proxy fight to take control of Southwest’s board and launched a tender offer for any and all shares of Southwest. Unlike other examples of shareholder activism in the utility industry, Icahn acknowledged that it was seeking ‘control’ of Southwest, and would need state regulatory approval. In January 2022, Icahn publicly stated that it would agree to vote only 24.9 percent of the shares tendered to eliminate the risk that state regulators would deny approval of the acquisition. In May 2022, Icahn issued an open letter to Southwest’s shareholders announcing a settlement with Southwest by which Icahn would have four seats on Southwest’s board and various governance protections.

With increased regulatory scrutiny at the federal and state level, activists have become more sensitive to couching their campaign in language that tries to demonstrate their plans benefit both shareholders and ratepayers. But state regulators now appear to be on the lookout for agreements with activist investors that influence companies in ways that could have rate implications for the general public without the type of substantive review that would be required in a full takeover. It is an open question whether this will result in state utility commissions seeking increased oversight on the front end with respect to activists’ acquisition of shares and resulting settlement agreements or on the back end by setting rates that require shareholders to absorb the costs of strategies, actions or plans that are determined to have been imprudently implemented or incurred. After the fact rate reviews make utilities overall a less attractive option for investors.

Separately, in a new development, there are indications that FERC may start to rethink its practice of allowing investment managers and other funds to accumulate voting securities of public utilities above the 10 percent level without FERC approval. For several years, FERC has permitted investment managers to acquire and vote up to 20 percent of the voting securities of public utilities, subject to periodic reauthorisation and reporting, in part based on an analysis that investment managers and funds were unlikely to seek to exercise influence over management decisions that could affect the wholesale markets. In an April 2022 FERC order reauthorising one of these arrangements, however, two FERC commissioners suggested that it may be appropriate to re-examine this analysis in light of changed circumstances, both in the wholesale markets and in the ability and willingness of investment managers to advocate for ESG policies.

Tia Barancik is a special counsel and Audra Cohen is a partner at Sullivan & Cromwell LLP. Ms Barancik can be contacted on +1 (212) 558 4415 or by email: barancikt@sullcrom.com. Ms Cohen can be contacted on +1 (212) 558 3275 or by email: cohena@sullcrom.com.

Tia Barancik and Audra Cohen

Sullivan & Cromwell LLP