Audra Cohen is partner and Tia Barancik is special counsel at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell memorandum by Ms. Cohen, Ms. Barancik, George Sampas, Matthew Goodman, and Lauren Boehmke. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).
Regulated utilities have historically been more insulated from the scrutiny of activists than companies in other industries. Starting in the late 1970s, however, the regulated utility industry began to restructure in response to political pressure for energy independence following the Arab Oil Embargo and rising environmental concerns. As a consequence, the many smaller companies that each separately produced and sold electricity or natural gas at retail in local markets no longer exist as public companies. First, these companies separated their business into wholesale production and retail distribution divisions, and then they started merging with one another and reconfiguring their business lines. Today, there are fewer and larger, multistate-competitive wholesale electricity producers; fewer and larger, multistate gas pipelines; and a few very large, publicly traded holding companies with multiple single-state electric and gas retail distribution company wholly owned subsidiaries, as well as some smaller, single-state retail utilities. Just as this restructuring is coming to a settling point, new technologies, consumer driven demand for renewable energy and fuel choice and rising inflation are catalyzing 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 crash the regulated utilities’ private party.
Acquisition of control of a regulated public utility through the acquisition of its publicly traded common stock (in regulatory terms, the “voting securities” conferring upon the holder thereof the right to vote for the election of directors) will almost always require approval from both federal and state utility regulators. The Federal Energy Regulatory Commission (“FERC”) presumes “control” to exist at a level substantially below 51% of common stock (or “voting securities”). Thus, FERC approval for “change of control transactions” under the Federal Power Act will be required even if no equivalent shareholder approval under state corporate law is required. Under the Federal Power Act, FERC presumes “control” to exist at ownership of 10% of the voting securities of a public utility, and can be found to exist even absent direct ownership of voting securities. [1] In the 1997 Enova Corp. Order, FERC stated that “control” means:
