HomeAbout UsServicesClientsContact Us

Case Studies

..Case Studies



Liberty has just issued its final report in a groundbreaking study of holding-company structure and operations involving a financially distressed utility. Liberty performed this study for the New Jersey Board of Public Utilities, which regulates utility rates and service in that state. The Board approved holding company formation in 2001 by NUI, a major gas local distribution company serving over 350,000 retail customers in four states (about 250,000 of them in New Jersey). The Board imposed a number of conditions. They addressed, for example, separation of utility and non-utility finances and resources, corporate governance, affiliate transactions, and transparency of utility financial and operating information.

NUI experienced severe financial distress from major and unsuccessful non-utility growth plans and ventures. Both holding-company and utility debt ratings fell below investment grade as a result. Liberty undertook a major evaluation of performance under the requirements of the holding-company order and the standards of good-utility practice and prudence. Liberty performed the following tasks as part of a six-month examination for the utility regulators:

  • Assessed the quality of performance in meeting holding-company conditions
  • Recommended future changes to assure full satisfaction of utility responsibilities
  • Examined the causes of financial distress
  • Judged the sufficiency of efforts to insulate the utility from them
  • Investigated improprieties in trading operations by an affiliate for itself and for utility operations
  • Looked at accounting and controls issues
  • Identified weaknesses and gaps in financial and operations reporting
  • Reviewed corporate governance structure and performance at the holding company level
  • Evaluated commitment to utility spending
  • Determined the effects on the utility of the weak capital structure that resulted from poor non-utility financial performance.

This work has given Liberty a broad and deep understanding of the regulatory concerns that apply in establishing and in later monitoring and enforcing conditions and requirements affecting utility operations within a holding company context. During Liberty’s audit, the company also placed itself on the market for sale, as the only feasible option for resolving its inability to secure financing at reasonable rates and under serviceable terms and conditions. Liberty has been asked by the New Jersey Board of Public Utilities to monitor sale efforts to assure that the eventual sale and restructuring of the company serves the public interest. This experience deepened Liberty’s insights into and knowledge of the involvement of investment and financial advisors with companies experiencing severe financial distress.

Liberty’s recent experience involving NUI represents the culmination of many years of growing experience in examining holding company operations in the utility industry. That work began some thirteen years ago with Liberty’s audit for the Pennsylvania Public Utility Commission of the operations of Allegheny Power System. This interstate holding company had a subsidiary that provided electricity service to a major portion of the Commonwealth’s western region. Liberty has since evaluated (for state utility regulators) holding company or multi-state energy utility operations in the states of New Hampshire, Tennessee, Illinois, New Jersey, Delaware, the District of Columbia, and Maryland. Liberty has also examined the operations of the country’s largest multi-state telecommunications companies as well, including Bell Atlantic, NYNEX, Ameritech, and GTE.

Liberty’s work has included some of the country’s best known holding-company problems. They include a detailed study of holding-company/utility subsidiary governance, affiliate, and operations problems for the Virginia State Corporation Commission. That study came after an open and very public rift developed between the executive management and the boards of directors of Dominion Resources and its largest and most profitable subsidiary, Virginia Power, the state’s largest electric utility. Liberty also performed one of the country’s first detailed examinations for state utility regulators of the impacts of poorly performing non-utility investments on utility operations. That study, of some twelve years ago, examined holding-company, affiliate, finance, and other issues involving one of the country’s largest electricity and gas providers, Public Service Electric & Gas Company of New Jersey.

Liberty’s investigation for the New Jersey Board covered many topics areas, including financial structure, corporate governance, strategic planning, and affiliate transactions, among others. Liberty provides further insights on some of these topics below, as well as further details on its work involving NUI.


Financial Structure and Interaction

As reported by the Wall Street Journal late in 2002, many energy companies, plagued by disastrous forays into commodity trading and other non-utility businesses, are increasingly seeking to pass some of their financial burden onto their utility units. The utility entities of large energy holding companies are among the few in the business to have maintained strong financial health in the wake of highly public meltdowns in energy sector portfolios. According to the Wall Street Journal, many parent companies would like to take advantage of the relative financial health in their utility operations to prop up other troubled subsidiaries. Utilities are being pushed to buy assets from affiliates, to make loans to financially troubled affiliates, or to pass more money onto parent companies than may be optimum for the utility.   

The question of financial risk and separation of the utility from the finances and risks of affiliates has become an important one. Current events in the electric utility industry underscore the importance of financial relationships among affiliates. The major credit‑rating agencies during the past few years have changed their position on holding company financial relationships, producing a stance that all entities in a holding company structure influence the credit of others. With the development of this new and more robust method for judging holding company credit have come the widely known troubles in the wholesale energy markets across the past several years. Such troubles include the energy marketers that have been a prime target of diversification activities by parents who own electric and natural gas delivery utilities. Some of the financial effects of these ills on utility companies can be readily identified; others may prove more subtle and difficult to detect. 

As part of its investigation of NUI for the New Jersey Board, Liberty examined and evaluated NUI and all affiliates for the following potential financial interaction issues: 

  • Maintenance of appropriate equity levels and capital structure at the utility entity;
  • Assurance that no utility assets are encumbered by the holding company or affiliates;
  • Presence of guarantees or support agreements and their impact on the utility;
  • Money flows and funding within the holding company, including the presence of money pools from which affiliates may borrow;
  • Presence of troublesome clauses, such as Material Adverse Change clauses or cross‑defaults in financing documents;
  • Joint negotiation of bank lines of credit for affiliates;
  • Cumulative impact of affiliates on utility credit and cost of capital. 


Corporate Governance 

Creating the proper balance between executive management and the Board of Directors is a difficult task, especially for corporations moving into new and challenging business areas, as has been the case at NUI over the past several years. On the one hand, it is, as recent and unfortunately widespread experience shows, far too easy to create a structure and a set of operating principles that fails to provide a source of effective outside and critical examination of management’s vision, goals, and plans.  On the other hand, as Liberty found in its extensive examination of corporate governance at DRI/Virginia Power, it is possible to go too far. As a consequence an antagonistic, confrontational environment can be produced that makes it difficult for a corporation to focus on day-to-day requirements, let alone to take steps to adapt and change to emerging opportunities and risks in a changing business environment.

Liberty believes that the tension between producing an effectively functioning Board and keeping it from becoming an inappropriate intrusion on the need for effective, fluid, and timely executive action is a matter of succeeding in meeting a small but critically important set of standards regarding overall corporate governance. Liberty’s investigation of corporate governance issues on behalf of the New Jersey Board included an examination of how NUI has applied each of these standards in designing and in executing its corporate governance process:

  • Conducting an effective Board Member selection process that produces the right skills and attitudes;
  • Creating an effective structure for dividing Board responsibilities ;
  • Assuring sufficient director time commitments;
  • Establishing effective Board participation in executive succession;
  • Providing sufficient initial and ongoing training and education for new and incumbent Board Members;
  • Providing the Board with sufficient and timely information to exercise its responsibilities;
  • Ensuring that the Board is knowledgeable and conversant with the kinds of information it needs to know to perform effectively;
  • Giving the Board real control over executive compensation;
  • Providing the Board with sufficient and appropriate compensation;
  • Recognizing the differences in the needs and requirements of multiple subsidiaries, particularly the public service responsibilities imposed on regulated public utility affiliates;
  • Assuring auditor independence;
  • Properly structuring the roles and interactions between Board Chairman and CEO;
  • Measuring Board effectiveness;
  • Complying with public requirements (e.g., Sarbanes-Oxley Act, New York Stock Exchange).


Strategic Planning and Resource Allocation 

Strategic planning and resource allocation comprise critical top-level processes that determine business direction and resource commitments and allocations for a holding company and its operating subsidiaries. The setting of a specific mission, goals and objectives for an organization at the executive level should establish the foundation on which all planning and operations for an entity and its affiliates proceed. Liberty’s investigation of NUI included the following aspects: 

  • Examination of how the purpose, mission, goals and objectives of the NUI holding company are defined and measured;
  • Identification and assessment of the short and long‑term financial objectives and the drivers for reaching these objectives;
  • Review of holding company processes for establishing and managing resource levels, access to resources, and the allocation of resources to the utility and affiliates;
  • Review of NUI's capital planning and operating budget procedures to determine the impact of planning processes on expenditures at the utility and affiliates;
  • Assessment of the influence of the business environment, markets, individual unit results, utility service levels, and changing business conditions on resource allocation and budgeting;
  • Evaluation of NUI's future expectations and strategic plans and determine if these plans should be changed.  


Affiliate Relationships and Cost Allocation 

Affiliate cost assignment and allocation is an area of significant risk for utility costs. There must be sound procedures and practices for determining how costs are to be assigned and allocated. These procedures and practices must seek the greatest practicable degree of alignment between causation of cost and responsibility for cost. The procedures and practices must also be objective, clearly articulated, easy to administer, and comprehensive, if cross-subsidization is to be avoided. An effective program for preventing incorrect assignment and allocation of costs begins with such proper procedures and practices.

The evaluation criteria that Liberty uses to judge allocation and accounting procedures and practices derive from two fundamental principles:

  • Regulated activities should not subsidize non-utility affiliates;
  • Costs should follow the cause of the costs. Stated another way, assignments and allocations should result in a fair distribution of costs.

Liberty’s investigation into NUI affiliate relationships and cost allocation/assignment issues for the New Jersey Board included:

  • Understanding the nature, scope, and extent of the activities of each affiliate;
  • Determining what business each affiliate does with ETG directly and what indirect relationships there are;
  • Determining the role of each affiliate in each type of transaction, agreement, or project;
  • Determining how ETG is insulated from the business risks faced by each of the wholesale affiliates (this is different from financial risks being addressed elsewhere; this inquiry concerns the specific allocation of risks and benefits of particular agreements or projects);
  • Determining whether the projects or credit of non-utility affiliates are being supported explicitly or implicitly by ETG (again, this examination is more granular, focusing not on overall credit risks, but on those of specific agreements or projects);
  • Assessing how costs, operating, risks, and profits are allocated among the utility and non-utility participants for activities that are conducted jointly.


Copyright © 2009 The Liberty Consulting Group