SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) APRIL 12, 1995
DOMINION RESOURCES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
VIRGINIA 1-8489 54-1229715
(STATE OF OTHER JURIS- (COMMISSION (IRS EMPLOYER
DICTION OF INCORPORATED) FILE NUMBER) IDENTIFICATION NO.)
P.O. BOX 26532, 901 EAST BYRD STREET, RICHMOND, VIRGINIA 23261-6532
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (804) 775-5700
(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT.)
<PAGE>
ITEM 5. OTHER EVENTS
On April 12, 1995, the staff of the Virginia State Corporation Commission
(the Commission) submitted the following final report as prepared by two
consultants engaged by the Commission in connection with its investigation
in Case No. PUE940051.
<PAGE>
COMMONWEALTH OF VIRGINIA
STATE CORPORATION COMMISSION
STAFF REPORT
STAFF INVESTIGATION OF CORPORATE RELATIONSHIPS,
AFFILIATE ARRANGEMENTS, AND FINANCIAL AND
DIVERSIFICATION ISSUES OF DOMINION RESOURCES, INC.
AND VIRGINIA POWER
PUBLIC VERSION
CASE NUMBER PUE940051
FILING DATE: APRIL 12, 1995
<PAGE>
Table of Contents
PART I
STAFF INTRODUCTION
PART II
FINAL REPORT: REVIEW AND EVALUATION OF
CORPORATE RELATIONSHIPS AND AFFILIATE
ARRANGEMENTS OF DOMINION RESOURCES, INC.
AND VIRGINIA ELECTRIC AND POWER COMPANY
PUBLIC VERSION
Prepared By
The Liberty Consulting Group
PART III
INVESTIGATION OF DOMINION RESOURCES, INC. AND
VIRGINIA ELECTRIC AND POWER COMPANY:
FINANCIAL ISSUES AND DIVERSIFICATION IMPACTS
Prepared By
J. Robert Malko
Financial Economist
<PAGE>
PART I
STAFF INTRODUCTION
<PAGE>
STAFF
INTRODUCTION
In its Opinion and Final Order in Case No. PUE830060, issued June
30, 1986, the Commission reviewed the public service implications of the
reorganization of Virginia Electric and Power Company ("Virginia Power")
into a holding company structure. The Order stressed the important role
of the board of directors of Virginia Power and that board's
responsibility for the proper management of the electric utility. The
independence of the Virginia Power board within the Dominion Resources,
Inc. ("DRI") structure was a paramount concern.
During the Spring of 1994, an unprecedented public dispute between the
boards and management of DRI and Virginia Power raised concerns about
the regulated utility's continued performance of its public service
obligations and potential impacts of the dispute upon utility customers.
On June 17, 1994, the Commission instituted Case No. PUE940040 against
DRI and Virginia Power in response to this corporate battle. The
Commission sought to determine whether requirements placed upon the
companies in Case No. PUE830060 adequately protected the public interest
and whether they were being observed.
From mid-June to mid-August 1994 the Commission Staff conducted an
investigation of the DRI/Virginia Power relationship. Interrogatories
were sent to the companies, interviews with senior officers were
conducted and affiliate arrangements were reviewed. In addition, several
filings from both DRI and Virginia Power included charges and
counter-charges related to activities since the reorganization. The
concerns of the Staff and the significance of the investigation
continued to increase.
On August 16, 1994, the two companies filed a settlement agreement with
the Commission intended to resolve certain governance issues raised
during the dispute. While recognizing that the settlement could help
resolve, at least on an interim basis, certain issues
1
<PAGE>
related to the role of Virginia Power's board, the Commission believed
that other issues, such as inappropriate affiliate transactions and
potential conflicts of interest, had not been resolved or fully
addressed. In addition, there have been significant changes in the
electric industry in general, and Virginia Power in particular, since
the 1986 Order. On August 24, 1994, the Commission instituted a new
investigation in Case No. PUE940051 to address: a.) identified issues
and potential problems within the relationship of DRI and Virginia
Power; b.) the adequacy of the 1986 Order; and c.) protection of the
public interest. The new case framed an investigation directed not at
averting a crisis but toward protecting the public interest in the
future.
The comprehensive investigation ordered by the Commission was
designed to ". . . assess every aspect of the holding company structure,
the benefits it presents, the risks, our current regulatory policy
toward it, and the question of how we should alter or develop that
policy prospectively." (PUE940051, page 5). Specifically, the Commission
directed investigation of the following questions:
1. How have the protections and conditions related to affiliates
agreements established in the 1986 order worked in practice?
Have there been problems with these controls? If so, what
guidance do the facts furnish for the future regulation of existing
arrangements, or of those which have yet to be proposed?
2. Should any existing affiliates arrangements between the
companies be terminated or modified? Are all such arrangements
currently beneficial to Virginia Power? What costs or burdens do
these arrangements impose on Virginia Power? Is Virginia
Power's operational flexibility or independence hampered by the
existence of any of these arrangements?
3. Are Commission and company procedures adequate to ensure that
all de facto affiliates arrangements are subjected to the statutory
review and approval process of Virginia Code (2 section marks)56-76,
et seq.? Have problems occurred in this regard, and if so, how could
they be prevented in the future?
4. What is DRI's strategy for the future and what role will Virginia
Power's core business--the provision of electric service in
Virginia--play in this evolving strategy? How might this strategy
affect Virginia Power's customers?
2
<PAGE>
5. What impact, for good or ill, can the investments of DRI and its
other subsidiaries have on Virginia Power? What regulatory
controls are appropriate to avoid or lessen any adverse impacts?
6. What impact does federal legislation, including PUHCA and
possible amendments thereto, and EPACT, have on DRI,
Virginia Power and the holding company relationship?
7. How should questions of conflicts of interest in the DRI/Virginia
Power situation be addressed? What controls on this subject do
the companies, and the Commission, have in place now? Are
they effective? How should such conflicts be defined, controlled
and prevented?
8. Have any aspects of the DRI/Virginia Power relationship
adversely and improperly affected rates paid by Virginia Power's
customers in the past? What control mechanisms could prevent
similar problems in the future?
9. Are there aspects regarding the flow of benefits, services and
funds between these companies and/or their affiliates which might
adversely affect Virginia Power? If so, how should these matters
be addressed?
The investigation was not limited to these questions, however. The
Commission stated that "...the scope and subject matter of this new
proceeding [should] be interpreted in its broadest sense, and that no
aspect of this situation be considered beyond the bounds of matters
relevant to this case." (PUE940051, page 8).
The Staff was directed by the Commission to file an Interim
Report. Recognizing the scope of the investigation, the diverse skills
necessary and the short time frame for the Interim Report, the Staff
concluded that the use of consultants would be required and therefore
selected two contractors for the investigation. The Liberty Consulting
Group, with headquarters in Baltimore, Maryland, was selected to conduct
an audit of the affiliate interest arrangements and a review of
DRI/Virginia Power corporate relationships. Dr. J. Robert Malko, an
independent consultant and Professor of Finance at Utah State
University, was selected to analyze financial and diversification
issues. Dr. Malko acted as a consultant for the Commission Staff in the
DRI reorganization case (PUE830060) which resulted in the 1986 Order.
3
<PAGE>
An Interim Report was filed with the Commission on December 1,
1994. The Interim Report presented the preliminary findings and
recommendations of the consultants on corporate governance, affiliate
issues and a host of other matters relating to the DRI-Virginia Power
relationship based upon the extensive discovery and interviews conducted
up to that point. The report also identified areas for further analysis
and scrutiny.
The Commission issued an order inviting DRI and Virginia Power to
respond to the Interim Report, and on December 21, 1994, the companies
filed a joint response. In the response, the companies stated their
"desire and determination to work with the Staff and the Commission to
find a satisfactory answer to the issues raised that will assure
harmonious operations in the future. . .". (Joint Response of DRI and
Virginia Power, December 21, 1994, p. 1) The companies agreed with some
of the recommendations in the Interim Report and indicated that certain
actions had already been taken in response to the recommendations. The
companies disagreed with others, including several related to corporate
governance issues.
There has been another ongoing Staff effort that is related to
this investigation. The Division of Energy Regulation conducted a review
of the rate effects of the Virginia Power/CSX coal transportation
contract, as directed by Commission order, and a report was submitted by
the Division on January 23, 1995. Based on its findings, the Staff
recommended that Virginia Power credit its fuel factor in the amount of
$8.3 million for the Virginia jurisdiction for the period ending May 31,
1994. The companies responded to the report by filing a joint motion
essentially denying any wrongdoing but agreeing to refund the $8.3
million identified by Staff as inappropriate and proposing to address
any additional amounts in a future proceeding. They also noted that
Virginia Power would initiate negotiations and pursue other possible
alternatives to reduce coal transportation charges. The Liberty
Consulting Group addresses additional, non-rate related issues regarding
the coal transportation contract in its Final Report.
4
<PAGE>
There have been other developments which have affected the course
of this investigation and which continue to affect the analysis required
for the Final Report. A difference of opinion between DRI and the
Commission became evident during the Virginia General Assembly's 1995
session regarding legislation intended to clarify the Commission's
authority to take action if a public utility was harmed by an affiliated
party's actions. The legislation was strongly opposed by DRI, the only
vocal opponent of the bill. After overwhelmingly passing the House, the
bill was withdrawn based on an agreement between DRI, Virginia Power and
the Commission regarding certain governance matters.
A Consent Order was issued by the Commission on February 20, 1995,
that, among other things, enjoined DRI from acting in the place of or
changing the composition of the board of Virginia Power without prior
written approval of the Commission. It also designated the Virginia
Power board as having sole responsibility for hiring and supervising
Virginia Power officers and for managing the business affairs of the
utility. The Consent Order is to remain in effect until July 2, 1996.
Shortly after the issuance of the Consent Order, on February 25,
1995, a DRI/Virginia Power "Stewardship Proposal" was offered by a group
of directors for the purpose of resolving certain perceived problems,
but with the effect of creating additional concerns. This proposal
included the immediate resignations of the CEOs of DRI and Virginia
Power and a major restructuring of both boards. At a February 28, 1995,
joint board meeting, the Stewardship Proposal was rejected and instead
each board adopted a resolution. These resolutions stated an intention
to expand the authority of the four-member joint committee that was
formed in the 1994 settlement agreement. The CEOs of DRI and Virginia
Power announced their intention to resign on July 31, 1996. In addition,
corporate officials and employees of each company were directed to
cooperate fully with the joint committee and with each other in "matters
of official business" before the Commission.
5
<PAGE>
In response to these recent developments, the Commission Staff
expressed concerns to the companies about certain aspects of the
resolutions, including the role and scope of authority of the joint
committee and potential "chilling" of Virginia Power officers and
employees in their future discussions with the Commission or Staff. The
Chairman of Virginia Power's board commented by letter on these issues
and Staff has stressed its position that at all times the officers and
employees of Virginia Power must feel free to communicate their views
fully and candidly with the Commission and its Staff.
The work of the consultants has involved scores of interviews and
thousands of pages of documents in an attempt to understand the problems
and potential solutions to a bitter and protracted dispute which
continued well beyond the events of the summer of 1994 and which could
resurface in the future. The remainder of this report must be read with
the history of the last year in mind and the understanding that the
facts necessary for this evaluation continue to change. There have been
too many abrupt changes in direction by the companies to conclude that
management and governance issues have been fully resolved.
This Final Report includes two consultants' reports. The report of
The Liberty Consulting Group addresses corporate governance, operating
relationships between the companies, affiliate agreements and
transactions and certain finance issues. The report of Dr. Malko
addresses financial and diversification matters. Liberty's report
concludes that structural problems and tensions remain regarding
corporate governance and operating relationships, that changes are
needed in affiliate transactions and allocations and that new procedures
and policies are necessary in the financial relationships between
Virginia Power and DRI and its nonutility subsidiaries. Dr. Malko
analyzes several diversification issues and their potential impact on
Virginia Power and recommends measures to protect Virginia Power and its
customers from possible adverse impacts from DRI diversification
activities.
6
<PAGE>
This Final Report is published in two versions, one public and one
confidential in order to protect commercially sensitive information. The
consultants prepared their own reports, and Staff has not tried to limit
or restrict their recommendations or conclusions.
The consultants' reports identify existing and potential problems
and suggest solutions. There may be other appropriate solutions which
the companies can suggest. Staff recommends that the companies be
required to respond to the consultants' reports, developing specific
remedial proposals where appropriate and explaining the reasons that no
remedial action is appropriate where the companies take that position.
After the companies have had an opportunity to respond to the
Final Report, the Staff may make additional recommendations and propose
implementation of specific measures. Depending upon the companies'
response and any voluntary actions the companies take related to the
recommendations in the Final Report, the Staff may propose added
measures regarding past events as well as future developments. Staff
believes, for example, that changes may be necessary to affiliate
agreements and procedures between Virginia Power and DRI and that
certain expenses allocated to Virginia Power should be removed from cost
of service. The Staff also supports efforts to coordinate strategic
planning at DRI and Virginia Power and to establish stronger conflict of
interest policies designed to avoid even the appearance of any
compromise of Virginia Power's interests. Staff recommends that this
docket remain open for the Commission to receive the companies' response
to this report and take appropriate action on recommendations received.
This would also provide Staff with an opportunity to monitor future
developments regarding DRI and Virginia Power.
The Staff and its consultants are aware of the importance of this
investigation to Virginia Power and its customers, DRI and the
Commission. Our overriding objective in presenting this Final Report is
to help fulfill the Commission's goal of protecting the public interest
in the future.
7
<PAGE>
PART II
<PAGE>
FINAL REPORT
REVIEW AND EVALUATION OF
CORPORATE RELATIONSHIPS AND
AFFILIATE ARRANGEMENTS OF
DOMINION RESOURCES, INC. AND
VIRGINIA ELECTRIC AND POWER COMPANY
A REPORT TO THE STAFF OF THE
VIRGINIA STATE CORPORATION COMMISSION
PUBLIC VERSION
(THE
LIBERTY
CONSULTING
GROUP LOGO
APPEARS
HERE)
APRIL 11, 1995
<PAGE>
TABLE OF CONTENTS
EXECUTIVE SUMMARY .....................................................iii
I. Introduction ...............................................iii
II. Corporate Governance .........................................v
III. Operating Relationships ....................................vii
IV. Affiliate Service Arrangements ...............................x
V. Utility/Non-Utility Financial Issues ........................xi
I. INTRODUCTION .........................................................1
A. Background ......................................................1
B. Chronology of Dispute Events ....................................2
C. Overall Company Performance During the Dispute .................12
D. Study Goals and Objectives .....................................13
E. Purpose of this Report .........................................14
II. CORPORATE STRUCTURE ................................................15
A. Background .....................................................15
B. Conclusions ....................................................17
C. Recommendations ................................................31
III. OPERATING RELATIONS ...............................................35
A. Background .....................................................35
B. Conclusions ....................................................45
C. Recommendations ................................................59
IV. AFFILIATE SERVICE ARRANGEMENTS .....................................62
A. Background .....................................................62
B. Conclusions ....................................................71
C. Recommendations ................................................82
V. UTILITY/NON-UTILITY FINANCIAL ISSUES ................................86
A. Background .....................................................86
B. Conclusions ...................................................107
C. Recommendations ...............................................114
VI. CRITICAL QUESTIONS ADDRESSED ......................................116
APPENDIX A: Affiliate Company Descriptions ............................A-l
APPENDIX B: Summary of Affiliate Services .............................B-l
APPENDIX C: DRI Board of Director Guidelines ..........................C-l
i
<PAGE>
APPENDIX D: DRI Stock Price Closing During Dispute .....................D-l
ii
<PAGE>
EXECUTIVE SUMMARY
I. INTRODUCTION
The Virginia State Corporation Commission (Commission) examined the
creation of the holding company Dominion Resources, Inc. (DRI) in a case
that was opened in 1983. The creation of DRI changed Virginia Electric
and Power Company (Virginia Power), the Commonwealth's largest energy
utility, into a wholly-owned subsidiary of DRI. A 1986 Commission order
in that case established Virginia Power's independence and authority
with respect to conducting public service as important values that
needed to be maintained in the new, holding company structure. That
order also established a service wall that was designed to limit the
services that Virginia Power could provide to affiliates and that they
could provide to each other. The two companies operated under this order
for a period that approached eight years, over which the provisions of
the 1986 Order continued to provide an accepted set of guidelines for
relationships between the companies. Utility operational performance was
sound and the financial performance of DRI's growing non-utility
business compared favorably with the experience of other energy
utilities that had commenced major diversified ventures.
An open dispute between the DRI and the Virginia Power CEOs occurred in
the spring of 1994. As several months passed, the dispute spread to the
boards, which divided into camps, generally along lines that were
determined by which of the two CEOs their members supported. The failure
to resolve the dispute gave the Commission concern about potential
impact on utility authority and independence to continue to perform its
public service obligations. The Commission brought the directors of both
companies together at a June 8, 1994 meeting. Within several days,
concrete settlement proposals were being exchanged by the companies.
Those efforts broke down and the DRI CEO engineered on June 16, 1994 the
mid-term election of four new DRI directors whom he brought to DRI to
change a nearly even split on that board. The unexpected and singular
actions of this meeting provoked a crisis. The next day the Commission
opened a case that was designed to determine whether the companies were
complying with the 1986 Order. On July 26, 1994, the reconstituted DRI
board attempted to remove three directors from Virginia Power's board
and to adopt restrictive utility bylaw changes that would substantially
increase direct holding company control over utility corporate
governance.
The two companies ended the crisis atmosphere with an August 16, 1994
settlement of their dispute. That settlement placed on the Virginia
Power board the four DRI directors who were elected on June 16, 1994. It
also placed four Virginia Power directors on the DRI board. The
settlement also created and filled the position of DRI president and
COO, to serve as an intermediary between the two CEOs. It also
established a four-person joint committee of the two boards, for the
purpose of overseeing intercompany relationships and dealing with
shareowner litigation issues that arose from the dispute. The settlement
also rescinded the July 26, 1994 removal of the three Virginia Power
directors and utility bylaw amendments. The Commission decided to
continue with an examination of the holding company structure, its
benefits and risks, regulatory policy concerning this structure, and
potential changes in that policy.
iii
<PAGE>
The Liberty Consulting Group (Liberty) was asked to assist Staff in
preparing a report about corporate governance, operating relationships,
and affiliate service arrangements to the Commission. Liberty began work
in the Fall of 1994 and submitted an interim report on December 1, 1994.
Liberty observed throughout that preliminary stage that substantial
tension remained between the companies, although the joint committee
members and DRI executive management were loathe to admit it. Liberty's
interim report preliminarily recommended significant changes in
corporate governance. Those changes were intended effectively to restore
Virginia Power's governing authority and board membership to the
practical level that existed before the dispute. Liberty did not believe
that the August 1994 settlement was proving successful in restoring
long-term effective relationships between the companies, nor was it
establishing a reasonably effective and efficient governing structure
that preserved necessary levels of utility authority and independence
with respect to meeting public service responsibilities. Liberty's
interim report also observed that there were significant problems in
operating relationships, cost allocation methods, and financial matters
between the companies.
The companies submitted in late December of 1994 a joint response to the
interim report. The response agreed with a number of administrative and
cost allocation recommendations of the interim report. It also agreed with a
key operating relationship recommendation concerning the return of
utility finance functions from DRI, where they were performed in
conjunction with other DRI entity finance functions, to Virginia Power,
where they would be conducted for the utility only and under its direct
management. Despite substantial agreement on many recommendations of the
interim report, the companies took issue with the thrust of the
corporate governance recommendations and the recommendations that sought
to end a direct reporting relationship between the Virginia Power CEO
and any DRI officer. DRI remained reluctant to agree to any structure
that would limit what it perceived to be important property rights in
its governance of and control over the affairs of Virginia Power. The
response also cited the success of the settlement agreement as grounds
for opposition to making any significant governance changes.
That settlement agreement would soon thereafter show itself to have
failed to produce lasting peace between the boards and management of the
companies. It broke down over disagreements between DRI and Virginia
Power over the desirability of new legislation dealing explicitly with
the Commission's authority to take action in circumstances where a
holding company might be jeopardizing the ability of a utility
subsidiary to meet its public service responsibilities. The breakdown
and a desire by DRI to put consideration of new legislation at least
temporarily aside led to the entry of a February 20, 1995 consent order.
This order enjoined DRI from eliminating, acting in place of, or
changing the composition of the Virginia Power board. The consent order
also enjoined DRI from acting in place of the utility's officers or
changing its bylaws. The principal provisions of the consent order were
to be effective until July 2, 1996.
The consent order appeared to have brought another respite from the
resumed crisis atmosphere. However, the joint committee almost
immediately began to contemplate further action. Concern about the
appearance of a lack of action in the face of shareowner claims
apparently gave strong inducement to those deliberations. The joint
committee proposed on February 25, 1995 the immediate resignations of
both CEOs, the naming of temporary placements, the search for a single
CEO to serve both companies, and reducing the boards through the retirement
or non re-election of a number of directors who were described as
"interlocking." This proposal failed
iv
<PAGE>
to gain sufficient support to secure its adoption. An alternative
proposal was adopted by both boards on February 28, 1995. It began from
the premise that both CEOs would, as they had agreed to declare, retire
by July 31, 1996. The February 28 resolutions stored the direct reporting
of the Virginia Power CEO to the DRI CEO. It extended the term of the
existing joint committee to July 31, 1996 and it enlarged its powers to
address matters affecting Virginia Power and DRI. It also reduced the
size of each board by two members, which reflected the just-submitted
resignations of four directors.
The February 28, 1995 resolutions remain the most recent pronouncement on
corporate governance at DRI and Virginia Power. Liberty's final report,
therefore, comes just after the current structure has been put into
place. As with the August 1994 settlement, the joint committee expresses
unqualified optimism that the dispute has finally been put behind the
companies. Virginia Power executives hope that they are correct, but
continue to see significant uncertainties on the horizon. This
collective attitude represents a marked improvement over the unreserved
insecurity and frustration that Liberty observed in them last fall, but
it nevertheless comes up well short of the climate that Liberty
typically observes among utility executive management.
Liberty's conclusion is that the future of relationships between the
companies is clouded as well. The companies continue to operate under a
governing structure that is at least clumsy. Depending upon the actions
of a number of those who hold central positions in that structure, it
may suffer significantly worse defects. The problem lies in determining
what level of trust to place in statements of good motivations,
peacemaking intentions, and respect for Virginia Power's public service
responsibilities. In each of these areas, past expectations have proven
misplaced, disappointments have resulted, and problems with potentially
significant repercussions have flared.
II. CORPORATE GOVERNANCE
Liberty did not consider the inclusion of the four DRI June 16, 1994
directors and the DRI COO on the Virginia Power board to be sound at
the time of the interim report. That conclusion remains the same. It
entrenches at the utility one of the most significant, partisan actions
of the dispute. Those directors were placed on the DRI board to restore
the DRI CEO's control over it, and that legacy has added to tensions and
concerns at Virginia Power.
Developing a greater overlap between members of the board will help to
forestall future, disruptive disagreements, although extending that
overlap to a majority of directors on each board in the short term is
too aggressive, given the lessons that history teaches here. However,
the key to building successful overlap should start from a baseline in
which all can have reasonable confidence. That baseline cannot exist
when these four directors remain under present circumstances. The
Virginia Power board has never had the opportunity of review and
nomination that DRI's own recently-adopted board guidelines would require.
They do not sit on the Virginia Power board as a result of a
dispassionate and unconstrained deliberative process about what skills
and experience the Virginia Power board requires. They sit there because
of a litigation settlement that required compromise that must have been
intended as much to end
v
<PAGE>
controversy as it was to do what was best for the utility. They are
certainly qualified in the abstract to sit as utility directors and
Liberty does not question their personal integrity. However, they bring
no unique skills to the board of the utility; in fact, none of the four
outside directors has experience with regulated retail utilities.
The Virginia Power board to be elected at the upcoming annual meeting,
or whatever will act in place thereof, should be limited to the
remaining seven members who predated the June 16, 1994 events. That
board, all of whose members were, after all, elected by DRI, can be
trusted to gradually increase its total membership and overlap with the
DRI board under circumstances where questions about its motives or
intent, from the point of view of utility independence and authority,
are mooted. The growth in that overlap should give the Virginia Power
board the control over its own membership that typically exists for
utility corporations.
The interim report also did not consider the joint committee to be
likely to promote constructive change. That conclusion applies still and
with greater vigor, given the apparent change in its powers. The
February 28, 1995 resolutions can be read to give the joint committee
unfettered initial discretion to choose those utility management and
operations matters in which to involve itself. Even if this is not so,
the joint committee suffers other problems that make it unsuitable as an
organ of utility corporate governance. First, it inherently tends to
chill executive action because the first level of problem resolution is
not within executive management nor is it between senior executive
management and its full board. Structural barriers to decisive executive
action on operating matters is inappropriate.
Forcing Virginia Power's CEO to consider the potential for disagreement
at DRI or even for latent concern among the committee is unwise as an
operating precept. Yet that is exactly what the existence of the joint
committee inherently does. Moreover, that is one of its intents, at
least according to more than one of its members, who say that it forces
the CEOs to get along or risk the irritation or outright opposition of
the joint committee. It is difficult to understand how such a motivation
can justifiably become a material factor in structuring corporate
governance. Fear and uncertainty are very poor long-term motivators of
executive performance. They are almost certain to produce hesitance at a
time when decisive action is required. If becoming competitive is a
major Virginia Power objective, its board should ask whether the boards
of its competitors have shackled their top executives in this fashion.
Liberty has not seen so in its experiences in the industry. Nor does it
believe that Virginia Power will serve itself well in attracting other
executive candidates if this is its message about the level of executive
discretion that it will allow.
Another, related problem with the joint committee is that it deprives
the remaining seven utility board members of an opportunity to consult
with their peers until after decisions are made, and, moreover, made in
a way that makes them difficult to overturn. The four-person committee
will make decisions before having to consult with the full board. These
four, it has been said, are Virginia Power directors. However, they are
not even a quorum of those directors. Moreover, they are also DRI
directors - two of them (those elected at the June 16, 1994 meeting) in
a way that is particularly meaningful to dispute issues. Sustaining a
vote of the joint committee is likely to require only two more votes. In
this context, it is important to remember that the other seven Virginia
Power directors include an additional June 16, 1994 DRI director and the
DRI COO.
vi
<PAGE>
Its powers and anomalous existence are not the only problems with the
joint committee. The inability of its four members, who have not changed
since August 1994, to improve executive relations in half a year do not
bode well for its ability to do so in the future. Moreover, its actions
do not give substantial confidence that it will serve as a moderating
influence.
CSX issues formed a material part of Liberty's interim conclusions that
connections among DRI and Virginia Power board members were too great.
Two CSX directors resigned from the DRI board in February of 1995. One
resigned from the Virginia Power board but remains on the DRI board. He
is joined now only by the former CSX subsidiary employee who serves on
both boards and is the chairman of the joint committee. These changes
have substantially mitigated concerns about the connections of board
members, but they have not eliminated them. There is still significant
overlap by virtue of common membership on another board.
The DRI board has adopted guidelines about such matters, but they are
not strong enough to address these particular concerns. The DRI
guidelines need to be strengthened and the Virginia Power board needs to
adopt meaningful and comprehensive standards for its members.
Liberty made conclusions and recommendations on three other corporate
governance issues. They included establishing a range of 9 to 11 members
as the optimum board size, moving promptly to a full-time a Virginia Power
board chairman, and assuring that Virginia Power article and bylaw changes
remain, as they are now under the consent order, the exclusive province
of the utility board.
III. OPERATING RELATIONSHIPS
Some took the position that the dispute reflected the difference in
outlook between a forward-looking parent company and a conservative
utility. That dichotomy captures very well the changes that are now
moving through the industry, as traditional outlooks give way to an
increasing focus on becoming competitive. Yet, however well this
distinction depicts the current industry crossroads, it is far off the
mark in characterizing the dispute between Virginia Power and DRI. DRI
and Virginia Power have both had strong leadership since the creation of
the holding company. The utility has been at the forefront in embracing
change and in welcoming non-traditional forces to the business. It has
been recognized as a leader in a number of respects. At the same time,
it has built a reputation for solid utility performance. It is now
engaged in a planning process, which it calls Vision 2000, that will use
its strengths as an innovator and as a dependable supplier of
electricity to move forward as the industry changes.
It is tempting to leap to the conclusion that the risks and
opportunities of the non-utility business make the holding company
aggressive, while the history of the electric utility business makes
Virginia Power slow or plodding. However, it is wrong to make that leap.
The operating relationship issues of substance in this case are not
nearly so simple as this dichotomy would suggest. They concern matters
such as the nature of executive interaction between the companies, the
use of central financial, legal, and other services, compensation for
the transfer of employees between companies, control over the selection
of utility officers, and coordination of planning activities.
v
<PAGE>
Liberty observed a climate of anxiety and concern among Virginia Power
officers in the Fall of 1994. This anxiety had been produced by their
reaction to the management style and to some specific actions of the DRI
CBO, by intervention of the CEO in at least one significant operations
matter, and, most importantly, by the harsh tone that the dispute had
taken. That climate had already played an important role in the
departure of one key utility executive. It had the potential to cause further
disruption. It was clear to Liberty that Virginia Power executives had
to face daily uncertainties and pressures in areas that their peers did
not have to concern themselves about normally. It could only be a matter
of time before continuation of that environment would produce more
departures or would begin to produce adverse effects on performance.
The August settlement order had produced temporary relief, but, in the
minds of Virginia Power's executives, it was dissipated quickly. The
February 20, 1995 consent order appeared to do the same. Moreover, the
CEO retirement window set by the February 28, 1995 board resolutions
(July 31, 1996 for each company's CEO) was viewed as potentially
freezing out abrupt management changes for a long enough period to allow
a refocus and a rededication to normal responsibilities. There remains
anxiety about how the joint committee will operate and about the degree
to which free expression may be curtailed by the cooperation and
communication clauses of the February 28th resolutions. However, most
officers seem able to put worrying about those possibilities off into
the future. This willingness to be optimistic is also a positive
development.
However, it remains clear that a return to prior relationships must be
avoided. The officers of the utility clearly like the increased focus on
day-to-day responsibilities that exists. So do their counterparts at
DRI. Down-the-road interference in exercising those responsibilities,
however, will hasten the return of a disruptive climate; in fact, one that
would probably be worse than the past.
Intercompany operating relationships were a major cause of that past
climate. Therefore, preventing its return is in major part a matter of
preventing a recurrence of the ineffective elements of those
relationships. Those elements included the unstructured communications
style and the lack of adherence to the chain-of-command by the DRI CEO.
Whatever their cause and whatever the abstract merits of working through
superiors versus "management by walking around", no one can now claim
ignorance of the importance of communications protocols to the utility's
functioning at present and likely well into the future.
Another issue of significance was the location of the finance function.
As with communications styles, there is no one correct model for
performing finance functions in a holding company. However, it is clear
that DRI eventually began to use the centralized finance structure to
exclude (intentionally or not) Virginia Power from material elements of
the utility's financing activities. The two companies were not making
the structure work effectively. They have responded by returning finance
functions to the utility, which represents a sound approach. There have
been transition pains, some of which are to be expected. The companies
must continue to refine the alignment of functions, they must examine
again whether all the needed resources have been reassigned, and they
need to place special emphasis on promoting communication and
cooperation between the financial personnel of the two companies. If
they do so, which they
viii
<PAGE>
appear committed to do, they are on a track that will complete the
transition effectively and promptly.
Services related to raising equity and to managing investor relations
fairly well define the limits of common services from DRI to Virginia
Power. The utility's organization and staff look much as a stand-alone
company's would. DRI executives state that they have had little direct
responsibility for utility matters outside these areas. This relatively
limited scope of holding company services has been an important element
in maintaining the ability of Virginia Power to keep responsibility for
fulfilling its public service responsibilities. There has inevitably
been friction when DRI has raised issues about such services. Finance
services are the most recent example. Sometime earlier in 1994, federal
regulatory relations was another matter of contention. After several
years in which the same outside firm was used on a consolidated basis,
Virginia Power succeeded in separating the contract in a fashion that
allowed it to give separate direction to the outside personnel that were
used in this role. The central services issue of contention in late 1993
was legal services. Different outlooks about the best way to structure
internal legal resources and a lack of communication about the holding
company role in utility legal services produced a major clash between
the companies.
The contentiousness that has accompanied changes in central services,
and even the mere discussion and planning of them, establish that
leaving utility services at the utility is the appropriate framework.
Changing the 1986 Order to state this presumption explicitly will help
to prevent a recurrence of divisiveness over such issues. Placing
specific limits on DRI services to Virginia Power will assure a more
rational and less disruptive process for considering changes in the
future. It will also help the Commission to assure that Virginia Power
retains that degree of independence and authority that the Commission
considers necessary for meeting public service responsibilities.
A related matter arises from uncompensated transfers of personnel among
affiliates. By one measure, yearly Virginia Power employee transfers to
DRI comprise three percent of total DRI staffing. Over a period of nine
years, this percentage is significant. The interim report recommended
that DRI compensate Virginia Power for the costs that these transfers
impose on the utility. Liberty estimated that a reasonable proxy for
these costs is the fee that search firms charge, which is generally not
less than 25 percent of annual salary. The companies have agreed to such
a procedure, but wish to apply it to transfers in both directions. Their
approach is sound, but it must recognize that no payments should apply
to transfers that reflect the return of whole functions (e.g., the recent
move of financial personnel) that are determined to be best located at
the utility.
The lack of effective coordination between Virginia Power planning and
that of DRY was observed in the interim report. The need for
coordination was especially important, given the potential for Virginia
Power to identify new initiatives that might conflict with DRI
strategies. Of particular concern was the fact that the lack of a
structured approach to strategic planning at DRI made it difficult to
identify potential conflicts or overlaps. DRI has agreed to begin a more
structured planning process, which is now underway. Commitments have
been made to assure its integration with Virginia Power efforts, such as
Vision 2000.
ix
<PAGE>
IV. AFFILIATE SERVICE ARRANGEMENTS
At least 14 affiliate service DRI/Virginia Power agreements have come
before the Commission for approval. Most of them cover one-time
transfers, have since expired, or were never used. A number of them
(e.g., the intercompany credit agreement) concern utility/non-utility
financial matters, which are addressed in the next section. The
principal service agreement, in terms of the magnitude of services and
flow of costs, is the Cost Allocation and Service Agreement (CASA). The
1986 Order approved the CASA and the attached Costs and Accounting for
Affiliated Transactions (CAAT). The CASA and CAAT together authorize,
limit, and prescribe the scope and the general costing provisions for
services between Virginia Power and DRI. They provide for directly
charging those costs for activities that can be discretely measured and
determined to be for the benefit of specific DRI entities. They also
provide for allocations of those costs that serve all DRI entities and for
which activity-based time reporting is not practical. The CASA delineates
the specific services that Virginia Power may provide to DRI. It
specifies a minimum billing cycle and it describes each component of
cost that goes into determining the costs that are billed for directly
charged and allocated services costs.
Liberty found several problems with the CASA and CATT. First, they allow
DRI to charge Virginia Power for services that provide it minimal value
and for which the utility would not have to pay if it were not part of a
holding company. Executive services costs, which amounted to $1.08
million in 1993, do not benefit Virginia Power substantially and would
not be incurred if Virginia Power stood alone. In addition,
DRI-to-Virginia-Power charges previously allowed under the CASA and CAAT
should materially decline in 1995. Examples are public policy (which
cost the utility $414,000 in 1993) and controller and CFO (which cost
Virginia Power $1.8 million in 1993). These cost categories include
services in areas that have been transferred back to the utility. Using
allocated charges in areas such as these will not be appropriate in the
wake of significant diminishment in DRI's services to Virginia Power.
The Commission should verify that general allocations in areas where
services have markedly declined do not return to Virginia Power's
account costs that cannot be justified for billing on a direct basis.
The Commission should expect, however, that DRI corporate secretary
costs to Virginia Power will remain at high levels, because of the
continuing existence of a common equity acquisition and investor
relations function. One exception in this category is DRI human and
administrative resources (which cost Virginia Power $564,000 in 1993).
They should fall because they are a function of direct costs, which
should fall significantly in the executive and financial areas.
The CASA and CAAT provisions are also contradictory and difficult to
interpret. In other cases, the companies merely do not apply them
properly. Liberty recommends that they be restructured to cure specific
defects and that the Commission take the opportunity to review and
approve them. A related concern was the inability to determine
compliance with the provision of the 1986 Order that limits Virginia
Power to providing incidental services whose billings comprise less than
five percent of the billings for specifically allowable services to DRI.
The bills do not allow for easy determinations of compliance with this
limit. Insufficient control on charge-backs may constitute another
problem. Charge-backs allow DRI to charge back to Virginia Power costs
that the utility charges DRI for services that are incidental to
services that DRI provides in part to Virginia Power. The companies
could not demonstrate adequately that
x
<PAGE>
the amount charged back is the appropriate Virginia Power share and that
its components have been properly determined.
Liberty also found that DRI and Virginia Power failed to apply proper
controls to assure that the affiliate, service provisions of the 1986
Order were applied. There were many instances of unauthorized and
unapproved services, although their cost was not substantial. There was
ineffective recording and control of service requests. Deloitte & Touche
was brought in by the companies after the interim report to examine
these controls. The firm made a series of recommendations that, if
implemented, will address Liberty's concerns. Virginia Power has nearly
completed implementation of the recommendations; the Commission needs to
monitor DRI's actions, which are not so nearly advanced.
The number of problems that Liberty found with cost allocations and
related CASA and CAAT matters raised issues about the scope of proper
affiliate transactions auditing. Liberty found that Virginia Power needs
to improve the examinations that are done by its internal auditors.
Liberty also recommends improved annual reporting and cyclical
independent review of affiliate transactions at intervals not exceeding
three years.
Liberty examined Virginia Power's use of space at its headquarters, which
it leases from DRI. Liberty believes that Virginia Power could vacate
between two and five floors of that building. Its right to such vacation
was a condition of the Commission's approval of the lease with the
affiliate. First-year Virginia Power savings per floor vacated would be
about $115,000 and recurring annual savings thereafter would be
$215,000. Virginia Power is examining its space needs and vacation
options now.
V. UTILITY/NON-UTILITY FINANCIAL ISSUES
Liberty examined the sources of funding for DRI's non-utility
subsidiaries. The purpose of this review was to identify any major risks
to utility costs and to determine the extent to which the resources of
Virginia Power were providing valuable support to the credit of those
subsidiaries. Liberty found that Dominion Energy had made use of project
financing, one of whose goals is to limit lender recourse on default to
project assets. Successful use of such financing insulates the
subsidiary's assets and those of its affiliates. Liberty's study did not
include a detailed review of the 17 Dominion Energy projects. However,
project financing was the primary financing vehicle for those projects.
Thus, it is reasonable to conclude that there is a significant level of
asset insulation from the use of project financing. Even so, Commission
oversight in this area is appropriate. What begins as an insulated
project financing vehicle might well change in nature, particularly when
long construction schedules and the uncertainties of international
economies (which some of Dominion Energy's projects involve) are
factors.
Liberty's examination of the portfolios of Dominion Capital disclosed no
major apparent problems. There are some relatively more risky
investments in this portfolio. However, individual investments and the
overall portfolio size are not of magnitudes that present significant
current risk, even under reasonably pessimistic scenarios. Recent
activities, such as the consideration of entry into the commercial loan
business, escalate risks, however. The potential
xi
<PAGE>
magnitude and nature of future investments makes it appropriate for the
Commission to undertake periodic reviews. Those reviews would require DRI
to inform the Commission about current and projected investment types,
levels, contingencies, risks, protective measures, and returns. Such
review will allow the Commission to assure that DRI is not changing its
non-utility risk profile in a manner that adds threats to utility
capital costs or availability.
All three of DRI's principal non-utility subsidiaries, Dominion Energy,
Dominion Capital, and Dominion Lands, have required credit support from
DRI to acquire debt at favorable rates. These subsidiaries have not had
the financial history or individual strength to attain investment-grade
ratings. DRI has undertake the common industry practice of providing
credit support (e.g., guarantees at it will maintain a minimum net worth
in these subsidiaries or that creditors may sue DRI if subsidiary assets
prove insufficient to cure defaults) that enables its non-utility
subsidiaries to secure more favorable rates. These support agreements
have not harmed Virginia Power, which does not make guarantees or assume
liability in the event of affiliate default. However, DRI credit support
has reached a level that has invited inquiry by the rating agencies, in
the context of their assessments of Virginia Power securities. There can
be an indirect impact, and these actions by the rating agencies show that
assuring that no adverse ratings for Virginia Power result from DRI
credit support needs to begin receiving attention.
Apart from the question of harm is that of benefit. It is clear that
Virginia Power's credit strength is the real source of comfort to
lenders who seek credit support from DRI. The holding company has no
major source of funds, other than the steady flow of Virginia Power
dividends. It is DRI's ability to influence that flow that gives meaning
to DRI credit support. Thus, Virginia Power is the real source of credit
support for the DRI subsidiaries. Liberty was not asked to quantify the
value of this support, but it is clearly substantial. Neither DRI nor
the subsidiaries compensate Virginia Power for providing this support.
This policy stands in contrast to the DRI policy on consolidated federal
income taxes. Virginia Power pays its stand-alone level of taxes and
DRI and its non-utility subsidiaries retain all the benefits of tax
consolidation.
What remains the same, despite this inconsistency, however, is where all
the benefits go, which is to the non-utility subsidiaries. Liberty
believes that a proper consideration of stand-together and stand-alone
financial calculations requires rationalization of these competing
theories and a sharing of benefits in a way that is fair to both
sectors. Beyond simple fairness, however, one must also remember that
utility affiliates compete with other entities for these investments. If
the balancing process produces net disincentives to non-utility,
tax-leveraged investment, then the practical result will not be benefit
sharing, but benefit elimination, to the detriment of both groups.
The intercompany credit agreement is one of the key affiliate interest
arrangements that was listed in the prior section. There is one such
agreement between DRI and Virginia Power and there are similar
agreements between DRI and the non-utility subsidiaries. Under these
agreements, DRI issues commercial paper and lends the proceeds to the
subsidiaries. The non-utility subsidiaries use those agreements as
their primary source of operating funds. Virginia Power's commercial
paper is more highly rated than DRI's is. The utility has not used DRI's
intercession since it established its own commercial paper program in
1992. The Commission has required Virginia Power to examine alternatives
to the use of the intercompany credit
xii
<PAGE>
agreement as a source of short-term financing. Liberty believes that it
will be cost effective for Virginia Power to independently determine the
sizing of its own commercial paper program, and to independently solicit
bank lines of credit and revolving credits on its own. DRI's insistence
on joint negotiation of lines of credit among all affiliates provides
another source of benefit to the non-utility sector. However, in this
instance, it may well be at real cost to the utility, because of higher
fees.
DRI continually raises equity funds through the automatic dividend
reinvestment plan, the employee savings plan, and the customer stock
purchase plan. These devices offer cost efficiencies, but they do not
time equity injections to coincide with defined needs. Equity funds that
have been raised but are currently not needed must be invested. DRI
retains the returns on these short term investments. It does not
allocate the equity received until the fourth quarter. Therefore,
Virginia Power must sometimes borrow when it would have preferred
equity, for which it must wait. Virginia Power should have the ability
to time its equity injections from DRI in a way that minimizes the
utility's cost of capital.
Liberty also examined DRI's dividend policies. Overall, DRI's dividend
payout is within the usual parameters for utility-based stocks. The more
difficult question to probe was the basis on which DRI assigned to its
subsidiaries, including Virginia Power, the responsibility for making up
the holding company's dividend payments. Specifically, dividend payments
for unallocated equity (the issue raised in the preceding paragraph)
were of concern. Historically, an allocation based on the relative size
of each subsidiary's total equity meant that Virginia Power was
responsible for more than 90 percent of the dividend requirement for
unallocated equity, even if it were ultimately allocated much less of
that equity. That policy has recently been changed to make each
subsidiary's share of the dividend on unallocated equity equal to its
budgeted equity. Thus, if Virginia Power has budgeted for only 25
percent of the equity it will pay only 25 percent of the dividend
requirement for that equity. This change makes the DRI dividend policies
more rational, albeit not free of problems.
xiii
<PAGE>
I. INTRODUCTION
A. BACKGROUND
The utility industry witnessed a unique and surprising phenomenon in the
spring of 1994. An open dispute occurred between the executive
management of the holding company, Dominion Resources, Inc. (DRI), and
Virginia Electric and Power Company (VIRGINIA POWER), its largest and
wholly-owned subsidiary. The dispute reflected significant
communications problems between the CEOs of the two companies. These
problems called into question the ability of the two executives and
their companies to work together in harmony and raised concerns about the
level of independence and authority appropriately to be exercised by
utility management and its board of directors.
The dispute extended to the boards of directors of the two companies as
time passed. Each board divided into camps supporting either the DRI or
the Virginia Power CEO. The larger camp on the DRI board supported the
DRI CEO and the Virginia Power board supported the Virginia Power CEO.
The companies have taken a number of steps to resolve the matters at
issue. The principal milestones have been:
(bullet) An unusual mid-term election of four new DRI directors in June 1994.
(bullet) An August 1994 settlement agreement.
(bullet) A February 20, 1995 consent order that was entered by the Commission
upon the request of the two companies.
(bullet) A series of resolutions adopted by the boards of the two companies
on February 28, 1995.
This dispute has brought to the forefront concerns that most observers
would have conceded to be a theoretical possibility, but an almost total
improbability. Its continuance for essentially a full year after it
became open and its expansion to the companies' directors show the
difficulties involved in dealing with those concerns, when they become
actualities.
Many utilities have diversified operations, and some of them hold
non-utility portfolios of magnitudes larger than DRI's. For example, the
Edison Electric Institute (NON-UTILITY BUSINESS ACTIVITIES OF
INVESTOR-OWNED ELECTRIC UTILITIES, 1994) reports that eight electric
utilities had 1992 non-utility assets that exceeded DRI's. The
non-utility assets of 19 electric utilities exceeded those of DRI on a
percentage-of-total-revenue basis. Few of the non-utility portfolios of
diversified electric utilities have experienced particularly strong
performance; some were nothing short of disappointing; and a few
approached disaster proportions. Yet, open disputes between holding
company and utility subsidiary leaders simply do not happen. This
proposition is true, even where there have been significant financial or
utility operating problems. Lingering turmoil is antithetical to
effective management and operations. Diversity of opinion and
perspective are certainly healthy in any large organization. However,
the ability to harmonize them efficiently and without notoriety are
equally important. Thus, the existence of such a dispute as the one
between DRI and Virginia Power is most unusual and troubling in any
case.
1
<PAGE>
DRI's non-utility portfolio had stronger and weaker elements, as is to
be expected. However, earnings performance has historically been very
competitive with the company's utility industry peers. DRI's non-utility
earnings levels were the seventh highest in 1992, while its asset levels
were twentieth, according to the Edison Electric Institute's 1994 study.
Post-holding company Virginia Power operating and financial performance
has also been strong. The utility has stood out by virtue of the strong
recovery that it has made from what all concede were very difficult
times in the late 1970s. Virginia Power has also more recently made
particularly notable improvements in its nuclear program, which
comprises a substantial portion of its generating capacity. The Nuclear
Regulatory Commission's latest ratings of licensee performance
(Systematic Assessment of Licensee Performance, or SALP) place the
company's North Anna units in the highest category for each attribute of
performance measured. The Surry units attained the highest ratings in
all but one category. Such ratings are not frequently attained in the
industry. The NRC uses SALP ratings to determine the level of attention
it should pay to plants across the country, based on their relative SALP
rankings. The common measurement basis and the comprehensive nature of
these rankings have also led them to become a commonplace measure of
nuclear performance in the industry.
Virginia Power had strong operating performance in 1994, as measured
against the company's goals and the experience of the past several
years. The utility has also been recognized as an innovator in
strategies and interactions involving non-traditional electricity
generation sources. The lack of apparent problems in the operations of
DRI's utility and non-utility sectors make the recent dispute even
harder to understand.
B. CHRONOLOGY OF DISPUTE EVENTS
Perhaps the most astonishing aspect of the conflict arises from DRI's
reaction to the role of the Virginia State Corporation Commission
(COMMISSION) as a mediator in the summer 1994, as the concerns played
out between DRI and Virginia Power. The June 30, 1986 Order in Case No.
PUE830060 set the conditions under which the holding company structure
would be cast and would operate with respect to Virginia Power, which is
the Commonwealth's largest energy utility and one of the country's
biggest. That holding company structure significantly altered Virginia
Power's direct relationship with the financial marketplace. Virginia
Power was publicly traded prior to the creation of DRI. Thereafter, DRI
became the publicly-traded company, and it has been the owner of all the
common stock of Virginia Power. Despite this change of form, however,
DRI in substance continues to have the essential characteristics of an
electric utility stock in the minds of the shareowners of DRI and the
management of the companies.
The 1986 Order established the utility's operating authority and
independence as important values. The Order's historical and regulatory
context, as well as its contents, make it clear that independence
vis-'a-vis the utility's new parent was a principal concern of the
Commission. The 1986 Order set a number of conditions that were intended
to assure that those values applied in the interrelationships among
Virginia Power, DRI, and non-utility affiliates.
2
<PAGE>
The 1986 Order did not detail the specific attributes of the
independence and authority that it sought to preserve after creation of
the holding company structure. However, it makes clear the Commission's
paramount interest in assuring that the directors of Virginia Power
would remain responsible for management of those utility activities that
were necessary to assure reliable and efficient service at reasonable
rates. The order also recites the Commission's interest in seeing that
Virginia Power's board elects utility officers. The order further
required the establishment of a service "wall" between DRI and Virginia
Power. DRI services were to be limited to financial and general
corporate services. Virginia Power was to provide no services to or for
the benefit of subsidiaries of DRI. All affiliate transactions involving
Virginia Power were to be reported to the Commission annually. The 1986
Order provisions related to this wall show that the Commission
considered minimizing the operating relationships between Virginia Power
and affiliates to be an important element in securing the authority and
independence of the utility.
These provisions of the 1986 Order make it clear that supporting the
full power and authority of the Virginia Power board of directors, as
opposed to that of DRI, forms a central element of utility authority and
independence. Making the executives of the utility fully accountable to
that board is equally important Finally, leaving the utility in direct
control over the services needed to manage it, except for those
identified in the agreement or thereafter added or deleted, after
Commission review, also constitutes a primary element of maintaining
utility authority and independence.
The 1986 Order's framework has formed an essential aspect of the
relationship that has existed between the Commission and the companies
ever since. More than eight years of regulatory decision making have
grown from this framework, which the companies accepted without apparent
misgiving in 1986. The critical observer must recognize that substantial
opportunities have accrued to DRI under the structure that it first
sought and the Commission then approved.
This perspective has much significance in evaluating arguments about the
burdens that the 1986 Order may impose on freedom of holding company
action. In other words, the dynamic of the 1986 Order cannot be ignored.
Ending the restrictions and preserving the opportunities has no more
inherent validity than curtailing the essential opportunities while
maintaining restrictions. Moreover, arguments that rely on comparisons
with other companies in other circumstances cannot be determinative. The
inquiries here must take account of the particular relationship that has
been created and developed over eight years.
The relationship has been severely tested recently. The break between
the CEOs of DRI and Virginia Power became open in the fall of 1993. The
precipitating event came at a joint board committee meeting that
included a presentation about legal services at the utility. The
situation deteriorated thereafter. A group of Virginia Power board
members sought to instigate the retirement of the DRI CEO in the spring
of 1994, on a schedule that would lead to an announcement at the April
annual meeting. That effort had apparently succeeded, but it soon fell
apart as more board members became involved in the matter. Counter
efforts to remove the Virginia Power CEO began. The alignment of the
boards had become entrenched by May and appeared to become intractable
in June. Neither side appeared to have sufficient votes to take decisive
action, even as the dispute took on an increasing public dimension.
3
<PAGE>
The Commission became concerned about the management dispute's potential
impact on utility authority and independence to perform its public
service obligations, particularly in the context of the continuity of
utility management. The potential impacts involve much more than
abstract arguments about decision-making authority and shareowner
rights. Two particular aspects of Virginia Power's position demonstrate
the practical importance of the issues involved. The first aspect arises
from the major changes that the electric industry faces today. The
prevailing belief that competition will increase markedly in the ensuing
years has led electric utilities commonly to reassess their strategic
direction, dramatically increase their customer focus, and closely
examine the resources and costs of delivering service. Virginia Power
has been conducting such an assessment. Its work, as part of an effort
that it calls Vision 2000, is approaching the stages where critical
decisions must take place and important actions must be planned and
initiated.
The management dispute has taken senior-level attention away from Vision
2000 activities. Uncertainty about continuity in executive-utility
management has also threatened progress in this important front. Vision
2000 may ultimately call for very significant business, structural, and
resource changes at the utility. Making those changes effectively will
require a cohesive executive team acting with a common belief in their
propriety and commitment to their execution. The potential for
disruption among that team can affect the quality of the decisions that
have to be made and the effectiveness and timeliness of their
implementation.
The second pertinent aspect of Virginia Power's position is its
dependence on nuclear generation. Much of the utility's generating
capacity and asset base rests with its North Anna and Surry nuclear
units. The Nuclear Regulatory Commission places great importance on
senior executive capabilities and commitment with respect to nuclear
operations. Any material threat to management continuity is, therefore,
of consequence to the agency. Losing its confidence has proven very
costly to other utilities. Those consequences have been financially
catastrophic when extended outages have resulted. Less apparent, but
still very significant, are the resources that must be applied to
additional engineering justifications or, alternately, more costly
solutions to operations issues.
This concern is not only hypothetical at Virginia Power. The management
dispute has already contributed to the loss of Virginia Power's
well-respected and very experienced senior nuclear executive. Its
current CEO, who also has a particularly strong nuclear background, has
been at the center of the controversy, and DRI has recently attempted to
remove him. He and the recently-departed nuclear executive have played
critical roles in establishing an effective relationship with the
Nuclear Regulatory Commission. More near-term changes, if they give
appearance of lessening the company's full commitment to safe plant
operation (or even if they suggest the lack of a coherent executive
strategy for nuclear operations) are, therefore, one of the utility's
most significant high-level operational concerns.
The Commission requested a June 8, 1994 meeting with directors of both
companies, in order to:
(bullet) Impress upon them the duties that Virginia law gives the Commission.
(bullet) Relay the concerns of the Commission about the dispute.
(bullet) Stress the need for prompt and effective solutions.
4
<PAGE>
(bullet) Obtain a commitment to provide the Commission with advance notice of
changes in the Virginia Power board or management.
(bullet) Obtain confirmation by June 15, 1994 that a satisfactory interim
solution had been found.
(bullet) Obtain approval of that solution by the DRI and Virginia Power
boards at their scheduled June 17, 1994 meeting.
(bullet) Require that a long-term solution be proposed to the Commission by
August 1, 1994.
A group of Virginia Power directors had made, within several days of
this meeting, a proposal to resolve the dispute between the companies.
It consisted of:
(bullet) Three-year terms for directors.
(bullet) Precluding removal of directors by their own board.
(bullet) Member conflict-of-interest standards concerning company employment,
family relationship, individual receipt of other compensation from
the company, employment relationship with a major vendor, or
relationship with a securities underwriter or investment advisor
involved with the companies' securities.
(bullet) A twelve-member Virginia Power board, consisting of incumbent
members plus two incumbent DRI directors.
(bullet) Nine-member boards for the DRI non-utility subsidiaries.
(bullet) A fifteen-member DRI board, consisting of existing members plus
the current Virginia Power directors.
(bullet) Identification of the two persons to fill expected 1995 DRI board
vacancies.
(bullet) Assignment to Virginia Power's board of the responsibility for
utility management oversight and policy setting, for nominating
utility board directors, and for hiring and firing all Virginia
Power officers.
(bullet) Assignment to DRI's board of the responsibility for electing
Virginia Power directors, for DRI management and oversight and
policy setting, and for nominating DRI directors.
(bullet) A two-year transition plan leading to a permanent solution.
(bullet) A Commission consent order approving resolution of the differences.
(bullet) Retention of a new DRI president and election to the DRI board by
May 1995.
(bullet) Assuring over the long-term that a majority of DRI directors would
also be Virginia Power directors.
The organization and compensation (O&C) committees of the two boards met
on June 13, 1994. Virginia Power's O&C committee proposed the following
to its DRI counterpart:
(bullet) Retirement of the DRI CEO by January 1, 1995 and approval of his
replacement by the DRI and Virginia Power boards.
(bullet) Elimination of the office of DRI vice chairman.
(bullet) A new Virginia Power board chairman, to be selected by the board
from candidates other than the DRI or the Virginia Power CEOs.
(bullet) Resignation of the DRI and Virginia Power CEOs from the boards of
the other's company.
(bullet) Reporting by Virginia Power to the DRI board through the utility
chairman and its CEO.
(bullet) A two-year period (or sooner, should the Commission agree) during
which only Virginia Power could elect and remove its officers and
during which there would be 30 day notice to the Commission of
changes by DRI in utility directors.
5
<PAGE>
(bullet) Provisions to remain effective for two years unless placed
prior thereto by permanent arrangements approved by the Commission.
(bullet) Prior consent of both boards and the Commission to any
changes in these provisions.
The chairman of the DRI O&C committee transmitted a response on June 14,
1994. The response:
(bullet) Eliminated the deadline for retirement of the DRI CEO.
(bullet) Eliminated the need for Virginia Power board consent to the new
DRI CEO.
(bullet) Provided for reporting by the Virginia Power CEO to an officer
designated by the DRI board, but reporting to the Virginia Power board
with respect to the utility's public service mission.
(bullet) Eliminated all limitations on the power of DRI to change the
Virginia Power board, which power was described as a "major corporate
asset."
(bullet) Eliminated the prohibition against changes without the
consent of both boards.
(bullet) Required both boards to adopt resolutions declaring that the
Commission "has no jurisdiction to select the management of the Power
Company or to dictate to Dominion Resources how it shall exercise its
stockholder rights with respect to the Power Company or to deprive
Dominion Resources of those rights. "
DRI took actions that moved the dispute to crisis proportions in the
midst of these settlement activities. Representatives of the boards of
both O&C committees briefed the Commission on June 16, 1994. Each said
that no agreement had been reached, but that work toward an agreement
was continuing. A major spokesman for the Virginia Power board (and past
DRI CEO) took ill and went to the hospital under what appeared to be
potentially life-threatening conditions. Conversations subsequent to
that event led Virginia Power and the Commission to expect no
significant action from the DRI board that same evening. DRI disputes
the reasonableness of those expectations, asserting that the only
relevant commitment was that no action affecting Virginia Power's board
and officers would take place.
DRI, in any event, took major action at that meeting. It accepted the
resignation of one DRI director and it added four new DRI directors, for
the purpose, as the DRI CEO put it, of restoring his control over the
DRI board. These actions were not previously made known to the
Commission, with whom the DRI board representatives had been in contact
that very afternoon. The DRI board also resolved not to take any action
on removal of Virginia Power officers and to refrain from meeting again
until the end of June 1994. Both of these latter actions were consistent
with prior representations to the Commission.
The Commission opened Case Number PUE940040 the next day, in order to
determine whether DRI and Virginia Power were complying with the
provisions of the 1986 Order. The dispute escalated in the weeks
thereafter. DRI acted on July 26, 1994 to remove three directors from
the Virginia Power board and it unilaterally adopted utility by-law
amendments restricting the powers that Virginia Power could exercise in
its own right.
6
<PAGE>
The two companies attempted to resolve their dispute by executing a
settlement agreement, which they jointly filed with the Commission on
August 16, 1994. This settlement:
(bullet) Replaced the Virginia Power CEO as the utility's board chairman
with a Virginia Power outside director.
(bullet) Named an existing DRI vice president to the newly-created
office of DRI president/COO and to the boards of Virginia Power and
DRI.
(bullet) Created a four-person joint committee to oversee the working
relationship between the CEOs of Virginia Power and DRI; the committee
consisted of two Virginia Power directors and two DRI directors (the
latter from among the four new DRI directors added at the June 16
meeting).
(bullet) Placed four Virginia Power board members on the DRI board and
removed four (all of these latter four had been supporters of Virginia
Power in the recent dispute) two of the latter were former CEOs of DRI
and Virginia Power, and one of them was the Virginia Power CEO; two of
the four Virginia Power directors added to the DRI board were the two
Virginia Power directors who were named to the joint committee.
(bullet) Rescinded DRI's July 26, 1994 removal of three Virginia Power
directors from the utility's board.
(bullet) Expanded the Virginia Power board by a net of four members, who
consisted of the four DRI directors elected at the June 16, 1994
meeting and the DRI president and COO, less an existing director
slated for retirement at the end of 1994.
(bullet) Rescinded DRI's July 26, 1994 amendments to the utility's
by-laws.
(bullet) Established staggered, multi-year terms for the Virginia Power
board members.
The Commission found that the settlement agreement had helped to avert
the crisis atmosphere at the two companies and it generally continued
the proceedings in Case No. PUE940040. The Commission did not object to
the implementation of the board and management changes of the
settlement. However, the Commission opened a new docket, in Case Number
PUE940051, on August 24, 1994. The purpose of the inquiry initiated by
this later docket is to examine long-term relationships between DRI and
Virginia Power. The investigation contemplated under this docket is very
bad in scope. It extends to "...every aspect of the holding company
structure, the benefits it presents, the risks, our (the Commission's)
current regulatory policy toward it, and the question of how we should
alter or develop that policy prospectively."
Events after the settlement agreement show clearly that it did not serve
to resolve the dispute. The dispute between the companies remained and
it grew to a point where board members, who have been described as
having formed into opposing camps, took an increasingly direct role in
trying to manage dispute events. It was clear to Liberty that, by late
February 1995, the senior executives of the two companies were no longer
participating in discussions about the resolution of continuing problems
to the degree that one would normally expect of company CEOs. Their
lessened role demonstrates the increasingly board-oriented focus of the
dispute and efforts to resolve it.
Investigations related to potential shareowner litigation have also
become a material factor in the companies' actions about corporate
governance. The DRI board formed a special committee to examine issues
raised in a shareowner demand letter. That committee retained Debevoise
& Plimpton, a law firm with expertise in shareholder litigation, in
order to assist it in late 1994
7
<PAGE>
in evaluating the issued raised by shareowners. These circumstances
indicate that concern over potential personal liability had become an
operating factor in board deliberations. The frequency and context of
this firm's mention in Liberty's latest interviews of board members and
executives show that it has become a major factor in planning a course
of action for the two companies.
The DRI board considered guidelines that the California Public
Employees' Retirement System (CalPERS) offered for DRI's consideration
on May 12, 1994. Those guidelines were adopted by the General Motors
board of directors. The board adopted at its February 17, 1995 meeting
guidelines similar to those proposed in many areas. Those DRI guidelines
and any significant differences from the GM guidelines are set forth in
Appendix C of this report.
The most significant differences between the DRI and the GM guidelines
fall in the areas of freedom of communication by and to independent
directors, the frequency and nature of meetings by outside directors,
and the participation by inside directors in governance issues. A
comparison with respect to the independence of directors cannot be made
because GM's applicable by-law, which has been in existence since 1991,
was not available. DRI has no by-law treatment of this issue.
Liberty prepared a December 1, 1994 interim report that provided its
preliminary findings, conclusions, and recommendations in this study.
DRI and Virginia Power submitted a joint, December 21, 1994 response to
the interim report. The response stated the companies' desire to work
with the Staff and the Commission to find a means for assuring
harmonious operations that would serve the public and customer interest,
while preserving the rights of public shareholders. The companies stated
that their objective was to put the dispute behind them and that the
August 1994 settlement was a major step in that direction.
The companies considered Liberty's corporate governance recommendations
to conflict substantially with the August 1994 settlement agreement and to
impose unique or extraordinary limits on DRI and Virginia Power
governance. The companies considered the settlement agreement to be the
best solution for the present and objected to changes until, at the
earliest, the completion of current strategic planning efforts. The
companies stated that the settlement agreement had numerous features
that had already proven effective. They specifically cited:
(bullet) Common board membership had increased the DRI board's
appreciation for the public service obligation of Virginia Power.
(bullet) Common board membership had increased the Virginia Power
board's appreciation of responsibilities to the public shareholders.
(bullet) The joint committee was effective in overseeing the
relationship between the companies and their top managements.
(bullet) The joint committee's commitment to cooperation and its ability
to provide a constructive means of communication with the Commission.
The companies also said that the settlement agreement was carefully
considered and constructed and that it would be dangerous to change it.
The companies agreed to study many of the specific governance
recommendations and cited that actions had already been taken to
implement aspects of several of them. A number of the recommendations
were claimed to be unnecessary because there had been no harm to
customers.
8
<PAGE>
Specific responses to other Liberty recommendations included:
(bullet) Controls over affiliate service arrangements in light of
substantial numbers of unapproved and uncompensated services: The
companies agreed that errors were made and committed to correct them
by making payments for past services and by developing controls,
training, record keeping, and coordination of the types recommended.
(bullet) Elimination of allocations to Virginia Power for executive
services: The companies proposed to analyze the portion of such
costs that actually reflected services to Virginia Power, the
extent to which Virginia Power would not incur such costs if it
were not part of a holding company, and the allocation
practices of other holding companies for such costs.
(bullet) Analysis of tax consolidation benefits: The companies agreed to
examine how benefits may change, but argued that any change in
sharing policy would be contrary to precedent and
inappropriate.
(bullet) Virginia Power's vacation of OJRP office space that is leased
from an affiliate: The companies recited that Virginia Power
was studying the potential for added space consolidation at
OJRP and was analyzing its work pace standards in comparison to
those of other employers.
(bullet) Compensation for intercompany employee transfers: The companies
agreed to pay each other compensation at the low end of
Liberty's range of transfer proxy costs (25 percent of annual
salary) for transfers of affiliate employees to their companies.
(bullet) Limitation on added DRI centralized services to Virginia Power:
The companies opposed a limitation because of the need for
Commission approval in any case.
(bullet) Transfer of utility financial functions from DRI to Virginia
Power. The companies agreed and have taken substantial action
to do so already.
(bullet) Allowing Virginia Power solely to determine how to manage and
operate its legal services function: The companies said that this
already was the case.
(bullet) Elimination of a direct DRI role in utility management and
operations: The companies position on this recommendation is not
clear.
(bullet) Establishment of DRI strategic plans and coordination of them
with Virginia Power: The companies agreed to development of
strategic plans by both companies and coordination of them.
The dispute between the companies again reached crisis proportions in
February 1995, in connection with proposed legislation (Virginia House
Bill 2447) dealing with the Commission's regulatory powers concerning
holding companies. DRI took concerted action to oppose the bill, which
eventually passed the state House of Delegates overwhelmingly. The
Virginia Power CEO had supported legislation after he was called to
testify about it before a House committee.
9
<PAGE>
His board had earlier urged DRI to seek a compromise form of legislation
that would satisfy the Commission's concerns about utility governance,
without proving disruptive to the companies' operations and existing
rights and privileges. DRI, however, consistently and strenuously
opposed any significant new legislative proposal concerning the powers
of the Commission to act in disputes of the type at issue here. The
Virginia Power board had adopted a position of neutrality on the
specific provisions of House Bill 2447, as it was drafted at the time of
the testimony.
House Bill 2447 passed the House overwhelmingly, was amended in a Senate
sub-committee, and then came before a full Senate committee. The
legislation was withdrawn by its sponsor immediately after the entry by
the Commission of a February 20, 1995 consent order in Case No.
PUE940051. That order, which had been solicited by a joint motion of DRI
and Virginia Power, provided that:
(bullet) DRI be enjoined from eliminating the Virginia Power board of
directors.
(bullet) DRI be enjoined from acting in place of the Virginia
Power board or officers.
(bullet) DRI be enjoined from making any changes in the composition,
size, or membership of the utility's board.
(bullet) DRI be enjoined from amending the utility's articles or
by-laws.
(bullet) Virginia Power's board exercise sole responsibility for hiring,
retention, management, and supervision of the utility's officers.
(bullet) Virginia Power's board be solely responsible for exercising all
utility corporate powers and for managing the utility's
business and affairs.
(bullet) DRI be enjoined from taking any action inconsistent with these
specific provisions.
(bullet) DRI and Virginia Power be permitted to take joint actions not
inconsistent with these provisions.
(bullet) The order continue in effect until July 2, 1996.
The sponsor of House Bill 2447 referred to the consent order in his
announcement of the withdrawal of the bill. He noted that the interim
rules under the consent order would give time for passage of similar
legislation, if there was a failure to find a long term solution.
Within a week of the consent order, the joint committee prepared a
February 25, 1995 proposal for resolving the continuing governance
problems. This group is the same joint committee that the August 1994
settlement created to serve as an arbiter of disputes between the
executives of the two companies. That proposal was to be presented at a
specially-called February 28, 1995 joint meeting of the boards of the
two companies. The proposal consisted of the following elements:
(bullet) Immediate resignations of the CEOs of Virginia Power and DRI.
(bullet) Naming a current utility senior vice president as acting
Virginia Power president and CEO.
(bullet) Naming the current president of DRI as the holding company's
acting CEO.
(bullet) Recommendations by these acting CEOs for actions needed to
retain key executives.
(bullet) Initiation of a search for a single CEO for DRI and Virginia
Power, to be undertaken under the oversight of the joint
committee.
10
<PAGE>
(bullet) Retention of the current and past Virginia Power CEO (Rhodes
and Berry) as consultants to advise in the CEO search.
(bullet) Solicitation of the Commission's views concerning the
candidates identified as part of the CEO search.
(bullet) Examination of DRI's strategic financial direction, including
possible future separation of utility and non-utility assets.
(bullet) Reducing the number of interlocking directors by removal through
retirement or non-re-election of the following DRI directors:
Gottwald, Snow, Lindsay, Randall, Roos, Royal, Capps.
(bullet) Reducing the number of interlocking directors by removal through
retirement or non-re-election of the following Virginia Power
directors: Berry, Lindsay, Roos, Royal, Rhodes.
(bullet) Virginia Power board membership after the April 1995 meeting to
be: Adams, Baucom, Betts, Lambert Leatherwood, Sharp, Spilman, Thomas,
and the to-be-chosen DRI/Virginia Power CEO.
(bullet) DRI board membership after the April 1995 meeting to be: Adams,
Baucom, Bernhardt, Lambert, Leatherwood, Sack, Sharp, Simmons,
Spilman, and the to-be-chosen DRI/Virginia Power CEO.
(bullet) Election of a new DRI board chairman from the above members.
(bullet) Adoption of a resolution of the Virginia Power board and of
affidavits from Rhodes, Berry, Brown, and other Virginia Power
executives involved in the CSX renegotiations between 1989 and 1991
stating that CSX and its officers and directors breached no duty to
Virginia Power during that time.
This proposal was apparently made without securing the opinions or
approval of all board members and executives involved. It was, however,
informally reviewed with the Commission. The DRI and Virginia Power
boards did not adopt this proposal at the February 28, 1995 meeting.
They adopted the following proposal instead:
(bullet) Enlarging the August 1994 settlement's joint committee's powers
to enable it to exercise the authority of the DRI and Virginia
Power boards on (a) matters that are brought before it by the
management of either company, or (b) matters that the joint
committee decides itself are appropriate for its resolution,
subject to later review by the full boards.
(bullet) Empowering the joint committee to retain outside experts and
consultants as it deems necessary.
(bullet) Extending the joint committee's-term of existence to July 31,
1996.
(bullet) Directing corporate officials and employees of both companies
to cooperate in their corporate and individual capacities with
the joint committee, to support its determinations, and to take
no action inconsistent with the joint committee's
determinations.
(bullet) Directing DRI and Virginia Power employees to cooperate fully
with officials of the other company in matters concerning
official business before the SCC and to keep each other timely
and fully informed of all communications to and from the SCC.
(bullet) Commencing a succession plan for the company CEOs, both of whom
declared an intention to retire by July 31, 1996.
(bullet) Reducing the size of the boards of each company by two members.
(bullet) Declaring that Virginia Power has no knowledge of any
impropriety by the CSX directors in matters concerning the
renegotiation of the 1988 contract with CSX.
11
<PAGE>
(bullet) Creating a Virginia Power "joint committee" to implement these
resolutions, to exist though July 31, 1996, and to be composed
of members who are also DRI directors.
(bullet) Making these changes effective 24 hours after consultation with
the SCC.
The actions of the boards on February 28, 1995 have also led to:
(bullet) Restoration of the pre-August 1994 settlement agreement
reporting of the Virginia Power CEO to the DRI CEO.
(bullet) Resignation of Snow and Gottwald from the DRI board.
(bullet) Resignation of Berry and Royal from the Virginia Power board.
(bullet) Recognition of the board membership conflict of intest policies
adopted by the DRI board at its February meeting.
The chairman of the Virginia Power board, who is also a member of the
joint committee, wrote to the Commission Staff on March 7, 1995 to make
clarifications and to provide several assurances (in these two
capacities) about the resolutions adopted on February 28, 1995. These
assurances included the following statements about the communications
and cooperation clauses:
(bullet) That the communications and cooperation clauses of the
resolutions of February 28, 1995 merely state the "unwritten
rule" that management is expected to support and implement
board policies and actions, including those of the joint
committee.
(bullet) That the cooperation and communication clause properly reflect
the relationship between the two companies and the fact that
the companies have resolved disputes between them.
(bullet) That Virginia Power and its officers are committed to full
cooperation with the Commission on all matters.
(bullet) That Virginia Power employees may, and were advised that they
may, cooperate fully and honestly in the current investigation
without fear of retribution.
(bullet) That Virginia Power was preparing definitive communications
guidelines that would be made available as soon as they were
adopted.
C. OVERALL COMPANY PERFORMANCE DURING THE DISPUTE
The continuation of this dispute has absorbed vast amounts of board and
management time and resources. It has also captured and held the
attention of the local and trade presses and the financial marketplace.
Despite these factors, however, it is difficult to identify any
tangible, net negative operating or financial impacts across the dispute
period. Lagging DRI performance at times of crisis has been essentially
offset by leading perfomance at times following apparently positive
events, such as the August 1994 settlement. The charts set forth as
Appendix D track the daily performance of DRI stock prices against the
Dow Jones Electric Utilities Industry Group. No significant divergence
for the dispute period as a whole is evident. Moreover, Virginia Power's
1994 operating performance has been in line with goals for the year and
shows no sign of deterioration from the levels of recent, prior years.
12
<PAGE>
Common sense dictates that persistent management problems of the type
that exist here will inevitably cause a degradation of performance.
Experience also requires the conclusion that a year is an
extraordinarily long time for disputes of this sort to remain.
Nevertheless, objective evidence does not support a conclusion that
significant financial or operating performance harm has yet occurred.
It is against this backdrop and in recognition of the continuing
inability to secure an effective resolution of the dispute that one must
evaluate the situation at DRI and Virginia Power. It is clear that
recourse to traditional diversified utility structures and models alone
are insufficient. Those structures presume a level of management and
board cooperation, not to mention mere communication, that simply have
not existed between DRI and Virginia Power for an extended period of
time.
D. STUDY GOALS AND OBJECTIVES
Liberty's study scope encompasses a comprehensive review of the
relationships between Virginia Power, on the one hand, and DRI and its
non-utility subsidiaries, on the other. This study has two principal
purposes:
(bullet) The determination and evaluation of current relationships
between DRI and Virginia Power in light of past experience and
current circumstances.
(bullet) The formulation of appropriate recommendations for any
improvement measures that may be necessary to assure that
Virginia Power performs its public duties and responsibilities
as anticipated by the 1986 Order or as may be otherwise
appropriate under current and expected circumstances.
The objectives of Liberty's study fall into four broad categories:
(bullet) General Considerations: (a) an evaluation of DRI and Virginia
Power actions in light of the requirements of the 1986 Order,
(b) a determination of the continuing appropriateness of the
conditions of that order and affiliate agreements under which
the companies operate, and (c) appropriate recommendations for
change.
(bullet) Corporate Governance and Related Issues: an evaluation of DRI's
rules, directives, policies, and actions to promote and secure
effective management and Virginia Power independence.
(bullet) Affiliate Arrangements and Contract Issues: an evaluation of
adherence to existing agreements, the reasonableness and
propriety of charges for service, the propriety of cost
assignment and allocation methods, the auditability of
affiliate transactions, the propriety of service
centralization, and the sharing of resources among affiliates.
(bullet) Finance Issues and Evaluation of Diversification Impacts: an
evaluation of overall non-utility financing, the existence and
sources of credit support for non-utility operations, the
intercompany credit risks to Virginia Power, and federal income
tax consolidation.
13
<PAGE>
E. PURPOSE OF THIS REPORT
This report presents the results of Liberty's review and evaluation of
the corporate relationships and affiliate arrangements of DRI and
Virginia Power. It responds to the Commission's objectives for this
review and evaluation. It provides recommendations for dealing with
weaknesses in the structure or relationships that exist between Virginia
Power and DRI. It sets forth Liberty's conclusions about compliance with
the 1986 Order and about any changed or additional requirements that the
Commission may wish to consider imposing, in light of the nature of
relationships and interactions between the utility and non-utility
subsidiaries.
The structure of this report provides the reader with a summary-level
view of the results of Liberty's review and evaluation. Sections two
through five set forth the findings and conclusions that Liberty has
made in the four subject areas that are significant in determining
whether Virginia Power has the level of authority and independence that
is contemplated by the 1986 Order. Those sections are:
(bullet) Two: Corporate Structure.
(bullet) Three: Operating Relationships.
(bullet) Four: Affiliate Service Arrangements.
(bullet) Five: Utility/Non-Utility Financial Matters.
These four sections of the report provide Liberty's recommendations for
responding to any areas of weakness or deficiency observed in these four
areas.
Section six provides Liberty's responses to the nine questions that the
Commission set for specific study in the August 24, 1994 order in Case
Number PUE940051. These nine responses provide an overall summary of
Liberty's study work.
This report also contains four appendices:
(bullet) Appendix A: Affiliate Company Descriptions, which provides
background information on the members of the DRI family.
(bullet) Appendix B: Summary of Affiliate Services, which lists and
describes services that affiliates provide for each other.
(bullet) Appendix C: DRI Board of Director Guidelines, which compares
the February 17, 1995 DRI board-adapted guidelines and the GM
guidelines, which CALPers proposed to the DRI board.
(bullet) Appendix D: DRI Stock Price Closings During Dispute, which
compares the five-day rolling average of DRI closings with those of
the Dow Jones electric utility index.
14
<PAGE>
II. CORPORATE STRUCTURE
A. BACKGROUND
The August 1994 settlement brought a temporary respite from the crisis
atmosphere that had existed between the DRI and Virginia Power boards
and executive management. The settlement made major changes in the
structure under which the boards operated and how the CEOs of the two
companies interacted. These changes took DRI and Virginia Power far away
in some respects from more typical forms of board and executive
organization and operation. Both sides to the recent dispute considered
these compromises to have been necessary for short-term resolution of
the dispute.
The August 1994 settlement served for a time its paramount immediate
purpose. It allowed the boards and executive management to increase the
time and attention available for managing and operating the companies'
day-to-day activities. The February 28, 1995 actions taken by the boards
demonstrate consensus on its inappropriateness as a platform for long
range progress. Examining the wisdom of the August 1994 settlement is no
longer relevant. More to the point are issues concerning the present and
likely future state of relations between the managements of the two
companies, the relative roles of the boards of the two, and the
structure and composition under which those boards will operate.
The resumption of a crisis atmosphere in February 1995 demonstrated to
the boards of the two companies that the August 1994 settlement was not
succeeding in producing a lasting resolution of the dispute. Liberty
believed that this failure was clear when it filed its preliminary
report in December 1994. Events surrounding House Bill 2447 showed that
significant tensions and disagreements remained, and appeared to have
grown. Relief seemingly returned again with the February 20, 1995
consent order. At least two major and inconsistent course corrections
would be attempted in the space of a week, however. Neither restored the
pre-dispute composition of the Virginia Power board. Both also differed
materially from the status quo as of the date of the consent order.
The changes attempted in late February 1995 are surprising. The February
20 consent order was apparently sought by the parties on the basis that
no preemptive changes directly affecting Virginia Power would be made.
This expectation appears to have been material to the Commission's
acceptance of the order. The context and timing of the consent order
allow an inference that its entry obtained public, Commission, and some
legislative support from the desire to assure that there would not be
material changes at Virginia Power without first giving the legislature
the chance to reconsider the desirability of legislation affecting the
Commission's powers to deal with matters such as the dispute.
The February 28, 1995 actions concerning the joint committee still retain
some of the interim characteristics of the August 1994 settlement.
Continuation and, in fact, enlargement of the powers of the joint
committee, are the most evident example. The representatives of both
companies generally did not, in the months immediately following the
August 1994 settlement, give substantial thought to the companies'
future corporate structure. Liberty believed that such attention was
required, if only to validate that the unusual features of the structure
and means
15
<PAGE>
of executive interaction created by the settlement. Some aspects of the
February 28, 1995 actions, however, appear to be directed at longer term
concerns. Reduction in board size, elimination of the intermediary role
of the president of DRI, the placement of a finite term on the joint
committee, and the combination of the adoption of board
conflict-of-interest standards and several board member resignations
illustrate this aspect of those actions. However, short-term fears of
shareowner litigation also gave strong impetus to those actions.
Joint committee membership remained the same after the February 28, 1995
resolutions. The committee's members played a central role in developing
and securing the approval of those resolutions and other complementary
actions. The four members worked to secure a common basis for moving
forward in the management of DRI and Virginia Power. Their efforts have
produced a hope among DRI and Virginia Power personnel that better
relations will follow. It is less clear, however, that those actions
have made meaningful changes in the structure under which the companies
will operate and that they have placed Virginia Power in a position of
authority over utility affairs that is commensurate with the
expectations of the 1986 Order and consistent with the level of pre-
dispute authority that the utility exercised in fact.
An overriding sense of caution must guide the examination of what the
recent changes mean. The August 1994 settlement's terms constrained the
ability of those directly affected by it to express reservations or
concerns that may exist. The settlement required its signers to support
it. This requirement followed the thinly veiled, June 1994 threats of
legal action to Virginia Power directors by DRI's chairman concerning
communication with the Commission. A June 20, 1994 letter from the DRI
CEO and board chairman shows the harshness of the positions taken by DRI
during the dispute. That letter to the individuals on Virginia Power's
board claimed the Commission investigation into management practices and
affiliate relationships to be unnecessary. It instructed the utility
board members that support for the Commission's June 17, 1994 order was
contrary to the interests of DRI. It also instructed those directors
that any expenditures to limit DRI's "statutory rights", which implicitly
refers to the June 17 order, would constitute "corporate waste." The
letter specifically states that DRI's position was to "oppose any
intrusion into governance issues." The letter then threatened adverse
consequences for acting against DRI's view of what DRI's best interests
were. It clearly sought to stifle efforts by the Virginia Power board to
seek resolution of the dispute at the Commission.
The February 28, 1995 resolutions also can be interpreted to take
constraints on expression to a greater length. The cooperation clause of
those resolutions states that Virginia Power officials and employees "in
both their corporate and individual capacities ... are to support the
determinations of the Joint Committee as to matters upon which it has
taken final action and in no event to take any action inconsistent with
the determinations of the Joint Committee." Furthermore, the
communications clause of those resolutions states that "Virginia Power
officials and employees are directed to cooperate fully with Dominion
officials and employees in all matters of official business before the
Virginia State Corporation Commission (the "Commission") and to keep
each other both timely and fully informed of all communications to and
from the Commission."
These cooperation and communication clauses give grounds for concern
about the ability of Virginia Power personnel to state their individual
positions on matters of governance and corporate relationships if they
diverge from those of the joint committee or of their peers at DRI.
16
<PAGE>
Such a limitation would pose an insurmountable barrier to the ability to
probe important aspects of interrelationships, where individual opinions
and perceptions, rather than formal positions or decisions of board
members, are also relevant.
Liberty asked for assurances from Virginia Power that its employees were
told that they could speak freely in interviews, whether or not the
opinions that they might express conformed to board decisions or the
views of DRI. Interviewees told Liberty that they felt free to discuss
matters freely for the present, particularly because the joint committee
had not yet made any post-February 28 decisions that would require
employee support. Many, however, expressed anxiety about post-joint
committee rulings and a belief that the ability of Virginia Power to act
in the future on its own authority was very much a function of the level
of interventionism that the joint committee would adopt.
These assurances and the nature of Liberty's recent interviews provide
adequate confidence that key personnel at Virginia Power were candid
about past and current events. However, the anxiety about future
conditions remains troubling. The feelings of the participants about the
current state of affairs and likely progress in the future must
therefore be examined carefully. There still exists the significant
possibility that the causes and consequences of the dispute have not
really been addressed, but merely driven underground to less overt
means, but with consequences that are potentially just as adverse.
Liberty's findings and conclusions about corporate structure are
designed to address three kinds of issues:
(bullet) The suitability of the currently proposed governance structure for
the future.
(bullet) The degree to which the current proposal may prove to be more than
another temporary solution.
(bullet) Whether it establishes a sound platform for assuring the Commission
that Virginia Power will operate with the expected degree of
independence over the long term.
B. Conclusions
1. COMMON MEMBERSHIP BETWEEN THE BOARDS OF DRI AND VIRGINIA POWER IS A
SOUND LONG RANGE CONCEPT, BUT IT HAS NOT BEGUN FROM A PROPER STARTING
POINT. (Recommendations 1,2, 3, and 7)
The August 1994 settlement's notion that greater common membership
between the boards of DRI and Virginia Power can foster long-term
communications and effective working relationships is certainly sound.
Substantially common membership should help in the long run to minimize
the potential for the creation of factions. It will also promote a
commonality of information and analysis among the directors. If all act
from a largely common fact base, it is more likely that their
independent judgments will be capable of sound rationalization. Virginia
Power is, and is expected to remain, the largest and most important
asset of DRI. The utility should, therefore, also be the primary focus
of the DRI board, and remain the sole focus of the Virginia Power board.
17
<PAGE>
However, the long range benefits of greater common membership should not
obscure the divisions that have characterized the boards'
interrelationships over the past months. It is not realistic to expect
the board members immediately to abandon allegiances that grew in a
tense and combative atmosphere. The settlement placed on the Virginia
Power board those four DRI directors who were elected at the June 1994
meeting. One resigned from the Virginia Power board in February 1995,
but retains his seat on the DRI board. The August 1994 settlement also
placed on the Virginia Power board the president and COO of DRI, who is
the DRI officer who was named to serve as an intermediary between the
CEOs of the two companies. The February 28, 1995 actions removed this
intermediary role formally, although he remains the president and COO of
the holding company.
The circumstances of the August 1994 Virginia Power board election of
these DRI directors and the ties that connect them are an unfortunate
legacy of the dispute. Their continuation on the board has prevented a
return to its pre-dispute composition. Notably, that dispute and their
election were directly connected with a plan by the DRI CEO and a
contingent of the holding company's board to control the company.
Keeping a DRI officer on the board, especially, but not solely, in the
absence of the intermediary role, raises similar concerns. Moreover, the
settlement gave these new directors longer than average tenure, as
compared with the terms of the pre-dispute Virginia Power directors.
The February 1995 resolutions did not erase this legacy. Only one of
those four June 16, 1994 directors has resigned from the Virginia Power
board. He remains a DRI director. Moreover, his resignation was accompanied by
that of a Virginia Power director who had been a supporter of Virginia
Power management throughout the dispute. Balance-of-power considerations
led to the election of these four directors and to the placement of the
DRI COO on the Virginia Power board. Claims that those considerations
are no longer relevant should not be taken on public faith, because
these directors will remain on the board for an extended period of time
if the August 1994 settlement provision remain effective. The claims may
or may not prove valid. The February 28, 1995 actions do not restore the
balance that existed previously. That balance presents the proper
starting point for long term plans to grow common membership on the two
boards. It will give adequate assurances that the dispute has been put
behind the companies.
The current Virginia Power board composition serves to entrench at the
utility one of the most significant, partisan actions of the
dispute--namely the addition of directors named to alter the balance of
power in favor of those DRI directors who favored the DRI CEO and who
voted to take three Virginia Power directors off the utility board and
to sharply curtail the utility board's authority through by-law
amendments.
Those directors also supported DRI actions that sought to stifle
Virginia Power directors last June from seeing Commission intervention
in resolution of the dispute. They supported DRI claims at that same
time that there was no need for any Commission review of relationships
between the companies. Even as late as February of this year, the DRI
board, presumably with no opposition from these directors, continued to
take in the recent legislative debate a particularly strident view about
Commission authority to act to assure that a public service company's
ability to perform its public duties was not disabled by holding company
action.
18
<PAGE>
DRI strenuously opposed House Bill 2447, which would have added the
following new section to the statutes empowering the Commission to
regulate public service companies:
No affiliated interest owning, directly or indirectly, fifty
percent or more of the voting securities of a public service
company shall engage in conduct which causes the probable disabling
of such public service company from continuing to perform
adequately its public duties. In addition to its authority to
penalize for or enjoin a violation of this section, the Commission
shall have the authority to issue a mandatory injunction requiring
such actions as may be in the public interest to remedy the
violation.
This section essentially codified the utility independence and authority
provisions of the 1986 Order and it granted explicit powers to the
Commission for remedying circumstances and conditions that contravened
those provisions. An amended bill before the Senate restricted the
definition of harm and the remedies available to prevent and correct it.
Moreover, its provisions were to expire in 1998, unlike those of House
Bill 2447, which were of indefinite term.
Liberty does not question the integrity of any board members. One cannot
forget, however, that the stated intention for their selection as DRI
board candidates was to give the DRI chairman a working majority on what
was then an almost evenly divided group. Those members now include the
three remaining DRI directors who were elected at the June 1994 meeting
and the DRI COO. That intention and the circumstances of their election
certainly pose substantial questions about the soundness of proceeding
on a basis that leaves them on the utility board without independent
confirmation by that board's other members.
Liberty also does not question the capabilities of the four DRI members
added to the boards of each company. They are qualified to hold their
positions. However, a proper examination of competence and objectivity
issues starts from the proposition that there are many persons who have
the capabilities to serve as directors of companies such as DRI and
Virginia Power. This field of candidates also includes many with no
significant connections that have the potential to compromise
objectivity, or that appear to do so. Absent unique skills or
background, boards should, quite simply, select from among capable
persons who have no such encumbrances, because there is no need, absent
such skills or backgrounds, to risk any connection that could arguably
influence objectivity. Arguments about fiduciary duty miss the point. If
that legal duty were alone sufficient, there would be no need for any
other restrictions on membership. Yet, the strongly prevailing practice
among boards in American industry is to avoid the appearance that
objectivity could be compromised. The common industry practice does not
exist without reason, and it provides a convincing response to the
argument that the fiduciary duty alone substantially mitigates concerns
about objectivity. The practice holds greater significance for utilities
who occupy special positions and have unique advantages of public trust.
Questions about independence and objectivity are all the more
appropriately addressed to companies who ask the Commission to place
trust in their ability to move forward in a manner that they say will
fully protect the interests of the largest body of the Commonwealth's
electricity customers. Liberty believes that restoration of the pre-June
16, 1994 balance and its maintenance through the 1996 annual meeting
would, like no other feasible and likely action,
19
<PAGE>
lay a suitable foundation for restoring confidence in (a) the ability of
Virginia Power to assume the role envisioned for it in the 1986 Order
and (b) the support of DRI for putting the utility in that position.
2. THE JOINT COMMITTEE'S STRUCTURE AND COMPOSITION CONFLICT WITH THE
NORMS OF EXECUTIVE/BOARD INTERRELATIONSHIPS AND DEPRIVE OTHER
VIRGINIA POWER BOARD MEMBERS OF A MEANINGFUL OPPORTUNITY TO
PARTICIPATE IN KEY DECISIONS ABOUT THE UTILITY'S OPERATIONS.
(Recommendations 4 and 7)
Fundamental differences exist in the outlooks of the DRI and the
Virginia Power CEOs. It is now known to board members that they have
existed since before the open break in the Fall of 1993. Those two
outlooks have not been successfully rationalized since that time,
despite the significant, potential personal and corporate consequences
that have attached to them. There were earlier assurances that these
difficulties were being successfully managed, that relationships were
improving, and that there was a basis for optimism about further
improvements. Those assurances proved faulty and the optimism has not
been borne out to date. Board members emphasize that the plan to ask
both CEOs to resign immediately (presented to the Commission on February
25, 1995) has served as a catharsis for the relationship. They sense a
true dedication to cooperation between the two CEOs.
Executive relationships are not the only gap to bridge. There have also
been differences in the boards as well. They divided into camps early in
the dispute, and their disagreements took on a significance that at
least equaled those of the two CEOs. Some of those differences remain,
despite efforts to reach resolution--efforts that have been undertaken
at various times since August of 1994. One example is the CSXT matter.
DRI's board members, including one who serves on the joint committee,
have continued to focus attention on managing the activities associated
with the portrayal of historical aspects of that matter.
The recent record shows a number of efforts to restrict the scope of
statements that Virginia Power personnel may make about CSXT-related
events, which are now several years old, to refresh the recollections of
participants in those events (sometimes with facts about which those
participants had no contemporaneous knowledge), and to seek from
Virginia Power personnel declaratory statements about propriety of
actions by DRI directors. Virginia Power personnel have felt themselves
to be under substantial pressure about the portrayal of those past
events to the Commission. Concerns extend to fairly recent efforts by
counsel retained by a special board committee to examine CSXT matters in
the context of potential shareowner litigation, which remains a current
issue.
Another difference between the boards concerns the recent legislative
efforts. The communications and cooperation clauses of the February 28,
1995 resolutions respond in part to the fact that the Virginia Power and
DRI boards disagreed about the desirability of some new legislation on
the subject of House Bill 2447.
Those February 28, 1995 resolutions have been clarified by subsequent
correspondence. The March 7, 1995 letter of the Virginia Power board
chairman, which explains the February 28, 1995 resolutions, addresses
the joint committee's expected role. The letter states that:
20
<PAGE>
(bullet) The joint committee would not involve itself in Virginia Power
matters other than to deal with disputes between the utility
and DRI.
(bullet) The Virginia Power directors would remain responsible for the
proper management of Virginia Power and for managing the
utility to assure reliable and efficient service to customers
at reasonable rates.
(bullet) The Virginia Power board would be solely responsible for hiring
and managing utility officers.
(bullet) The Virginia Power board would remain solely responsible for
the exercise of all corporate powers and for the management of
Virginia Power.
(bullet) The Virginia Power board has the power to review and reverse
joint committee resolutions of issues.
(bullet) The joint committee expects to have to exercise its authority
rarely, if ever.
The joint committee members have noted that the actions of February 25,
1995 and the resolutions of February 28, 1995 provide a strong
inducement for the two CEOs to work out problems between them, because
it is clear that there will be no more board patience with disagreement
and because neither CEO can count on the support of the joint committee.
Overt disagreement that is brought to the joint committee at least is
assured of attention and disposition on a fairly immediate basis. Such
disposition will support needed actions or changes, or will at least assure
a timely consideration of them. This self-censoring notion therefore has
superficial appeal. However, it does not account for a situation that
is potentially more dangerous than open disagreement.
This more difficult situation will arise when one of the CEOs is loathe
to take an action when he is not certain that he can gain the agreement
of his counterpart. The very fact that a CEO cannot count on board
support tends to have a chilling effect on taking action. That effect
will probably not impose a barrier to instituting major initiatives or
responding to important external circumstances that require prompt
response. However, it is almost certain to be present to a material
degree as a background force that influences executive thinking about
less critical issues. Any such constraint should be seen as a barrier to
the kinds of decisive executive action that Virginia Power is likely to
have to take as the industry moves in new competitive directions.
It is also clear that this chilling effect will work almost universally
in one direction, i.e., to impede Virginia Power's management. In the
first place, there have been no allegations that Virginia Power has
sought to interfere in holding company operations. Moreover, by virtue
of the roles that the two companies occupy, there are likely to be many
fewer, if any, opportunities for the power company to make any such
interference.
Thus, the operation of the joint committee may be seen as a barrier by
its very nature, to the extent that it creates a level of uncertainty in
the Virginia Power CEO about the confidence and support of his board.
The same may be also true for the DRI CEO, which will lessen his
willingness to stand in opposition to the position of his Virginia Power
counterpart.
The next major flaw in the structure of the joint committee is that it
deprives all but four Virginia Power board members (those four who are
joint committee members) of meaningful consultation prior to important
decisions. The joint committee's authorizing resolution may be read as
broad enough to allow it to consider any matter brought to it by either
CEO, without
21
<PAGE>
limitation as to subject matter. Those matters could range from
operations details to strategic or policy matters. Moreover, the
committee can, under a broad reading of the February 28, 1995
resolutions, take up matters on its own initiative. Nothing explicit
prevents the committee from considering the kinds of matters that are
typically decided by boards sitting as a whole. Nothing explicit
requires the committee to consult with its Virginia Power board
colleagues (or its DRI board colleagues either) before taking action
that is material to relations between the companies or that would
normally be decided by the entire board.
The opportunity to consult with one's colleagues is a major part of
exercising responsibility as a director. It should not be curtailed
lightly or indefinitely. Anticipation of exigency has led some boards to
appoint executive committees that are designed to permit a corporation
to act efficiently between board meetings on normal matters requiring
director decisions. However, the language of the resolutions do not
limit the joint committee to exigent circumstances.
It has been argued that the ability of the full boards to overrule joint
committee decisions adequately limits its powers and preserves full
participation by other Virginia Power board members in exercising board
responsibilities. An examination in practical terms of how the Virginia
Power board may affect the outcomes of the joint committee will expose
the practical hazards in relying on this safeguard. The Virginia Power
board has 11 members. The joint committee members comprise four of the
members of this board. Each of those four is a member of the DRI and the
Virginia Power boards. The members' own stated objectives, and common
sense as well, indicate that the joint committee can be expected to act
unanimously in efforts to resolve disagreements (otherwise, they are
likely to be deadlocked at two votes on each side). Accordingly, votes
by the Virginia Power board on review of joint committee actions
essentially begin at 4-0 in favor of the joint committee's determination.
This beginning leaves 7 other Virginia Power board members. It takes 6
votes to make a majority of the utility's board. Of those remaining 7
directors, one was initially a DRI director (placed on the DRI board at
the June 1994 board meeting and on the Virginia Power board by the
August 1994 settlement). Another is the DRI president and COO, who was
named as the intermediary between the two CEOs in August 1994. Thus,
sustaining a joint committee requires no supporting votes from any of
those 5 remaining directors who were Virginia Power directors before the
August 1994 settlement, unless joint committee members change the
positions that they took in committee.
Put another way, it seems that decisions on review of the actions of the
joint committee are likely not to depend at all on the votes of those
who were initially Virginia Power directors, but are very likely to
depend on the votes of those who were first DRI directors or executives.
This situation tends to dilute the control of Virginia Power directors
in exercising authority over the utility's management and operations.
Moreover, it shows that, in practice, the decisions of the joint
committee are likely to prevail as the decisions of the Virginia Power
board. On its face, this imbalance is contrary to the authority expected
of the Virginia Power board. Even more troubling is that these hard-
to-change decisions of the joint committee will be made even before the
Virginia Power board considers them. The two initial Virginia Power
members of the joint committee will make these decisions after
consulting with their initial DRI counterparts on the committee, not
with their colleagues on the Virginia Power board. Thus, the remaining
Virginia Power directors lose even the opportunity to consult before
decisions are made. At most, they
22
<PAGE>
will be given the great burden of overturning a vote that their colleagues
took without including them in the first place.
The joint committee's operation may thus effectively take over the
Virginia Power board's role in acting to resolve disagreements between
the companies. Arguments that the committee hopes not to meet often, if
ever, miss the point. That point is that, every time the committee does
meet, it is because (a) there is a difference between the companies or
(b) some member of the committee develops his own concern about a matter
involving Virginia Power' s management or operations. All its meetings
are by definition over material matters---and matters from which most of
the Virginia Power board is precluded from participating in until they
have a significantly diminished practical power to affect the result.
The argument that the joint committee's decisions may be reviewed by the
Virginia Power board thus must be seen for the insubstantial force that
it is, for all practical purposes. The uncertain scope of the joint
committee's powers and the failure to require meaningful consultation
with those utility directors who are not joint committee members raise
substantial doubts that the committee's operations can be conducted in
accord with the provisions of the 1986 Order in more than a legalistic
sense.
The fact that the joint committee did not succeed in restoring effective
intercompany relations in the six months of its existence between August
1994 and February 1995 is also pertinent. Its inability to act
successfully as a moderating force for the six months prior to the
February 28, 1995 resolutions is relevant to judging its likely future
impact.
The joint committee is structured in a fashion that deprives many
Virginia Power board members of prior consultation on matters of
disagreement between the companies, that gives it the power to speak for
practical purposes as the first and final voice of the board, and that
has significant potential for displacing the authority typically
exercised by executive management.
3. THE SIZE AND INSIDE MEMBERSHIP OF THE BOARDS OF DIRECTORS OF VIRGINIA
POWER AND DRI ARE STILL NOT OPTIMUM. (RECOMMENDATIONS 2 AND 7)
The DRI board as reconstituted in June 1994 contained 16 members. It has
been reduced to 14 as a result of the February 28, 1995 resolutions and
the resignation of two members. The reconstituted Virginia Power board
contained 13 members. The February resolutions and the resignations of
two of its members have reduced it to 11 members.
Major corporations have generally been reducing the sizes of their
boards of directors. Membership of between 9 or 11 would be optimum. One
of the consequences of large boards is that committees often develop
powers that are more appropriate for exercise by the whole board. This
phenomenon was evident in actions by the DRI board's O&C committee.
Among them were the May 1994 actions, which included the decision about
selecting a search firm as part of an effort to replace the Virginia
Power CEO. Another potential problem with large boards is that
communications and dialogue can suffer. The negative impacts of poor
communications are many and they include an increased likelihood of
factionalization. There is ample evidence of ineffective communications
among board members in the recent dispute. It appears that a significant
portion of the problems encountered can be traced to the overuse of committees.
This problem has been magnified by what may be a significant increase in
powers that came to the joint committee under the February 28, 1995
resolutions.
23
<PAGE>
Given the value in restoring the pre-June 16, 1994 composition of the
Virginia Power board, the utility would fall beneath the low end of the
range of optimal board sizes. Only seven pre-June 16, 1994 Virginia
Power board members remain. However, a board of those seven members is
appropriate in the short term, provided that a proper means for moving
to a board with several more members can be structured.
4. THE VIRGINIA POWER BOARD'S LACK OF CONTROL OVER ITS OWN MEMBERSHIP IS
NOT CONSISTENT WITH THE INDEPENDENCE AND AUTHORITY NEEDED TO REMAIN
DIRECTLY RESPONSIBLE FOR THE FULFILLMENT OF ITS PUBLIC SERVICE
RESPONSIBILITIES. (Recommendations 3 and 7)
There can be no real sense of authority at a board whose members must
deal with e possibility of abrupt changes to its powers and membership.
DRI unilaterally made such changes in 1994 by altering the utility
corporation's by-laws and removing some of its board members during the
dispute. These steps were taken for the clear purpose of removing the
authority of the Virginia Power board as then comprised. Those steps
would have been effective had they not been negated after Commission
intervention.
DRI's board and executive management have withdrawn the threat of
imminent, unilateral action. They did so in the August 1994 settlement
agreement and they confirmed it in the February 20, 1995 consent order.
However, they have neither questioned the propriety of its use as
intended in the immediate past crisis nor repudiated the possibility
that it could be taken again, after the expiration in 1996 of the
consent order's provisions. The executive and board incumbents at the
two companies have made a significant effort to take intercompany
relationships to a more cooperative level. However, the need for
effective and appropriate interaction will outlast the tenures of any of
these incumbents.
Apparent and actual power are crucial if the utility is to function as
the 1986 Order contemplated. Authority and accountability comprise the
keys to Virginia Power's continuing to meet the Commission's expectation
that it will remain responsible for assuring fulfillment of public
service responsibilities to the Commonwealth. The actions taken by DRI
as sole shareowner demonstrate that any unresolved matter can become a
crisis with the potential for significant adverse consequences.
Moreover, whether it will become so is at the sole discretion of DRI
executive and board management. Virginia Power's board has no certain
role in defining the dimensions of any such dispute, nor can it even be
assured of an opportunity to participate in its resolution.
That such a dispute could happen once remains difficult to comprehend. In
fact, no other utility has experienced such a public display of internal
disagreement. Nevertheless, DRI has demonstrated that it can take an
aggressive legal position with respect to the Commission's authority.
That position challenged Commission powers that are essential to making
the relationship envisioned by the 1986 Order work. Moreover, its abrupt
actions at the June 1994 board meeting were taken at the same time that
intense efforts were under way to find a resolution, as the Commission
had requested. The re-emergence of the dispute in 1995 shows that it was
not resolved, despite the optimism that many board members expressed as
late as December 1994. Some of them expressed that optimism in the weeks
leading up to the consent order in February 1995.
24
<PAGE>
Disagreements continued to plague the companies nearly a year after the
dispute became public. Therefore, it would be judicious to recognize the
potential for a reversion to challenge, rather than compromise, as the
DRI strategy for addressing Commission concerns about Virginia Power's
authority and independence. In fact, none of the proposals for resolving
the disagreements, including especially the February 28, 1995
resolutions, makes substantive changes in the area most significant
under the 1986 Order, i.e., assuring the independence of Virginia Power
and the authority of its board of directors in circumstances where
material disagreements exist.
The potential for such disagreement must remain in the forefront of any
debate about the wisdom and propriety of the Commission's 1986 Order or
about what DRI and Virginia Power should do or agree to do now. Many
would have scoffed at the need for, propriety of, or effectiveness of
assuring utility independence from a holding company. History then would
have weighed heavily on the side of the skeptics. Prudence now requires
skepticism about any solution that depends alone on good intentions.
The action at the June 1994 DRI board meeting to add four directors is
illuminating in this respect. These DRI board membership changes had the
evident purpose and the actual effect of influencing Virginia Power
management and operations. For example, the DRI board soon thereafter
acted to remove three directors from the Virginia Power board and to
make restrictive amendments to the utility's by-laws. The circumstances
surrounding the June 16, 1994 changes to the DRI board were most
unusual. That same day, a board member and former CEO (along with a
representative of DRI) met with the Commission to discuss the status of
settlement discussions relating to issues that the Commission felt were
integral to the 1986 Order. That former CEO later that day entered the
hospital under what were considered to be possibly life-threatening
circumstances. No notice was given that DRI board changes were to be
considered. One new board member learned hours before the meeting of an
intent to nominate him for membership. This lack of notice is unusual in
any circumstances. It is more so when the public service interests and
the involvement of the Commission in settling the dispute are
considered. DRI representatives also communicated with the Commission
that day. They addressed the fact that no action would be taken about
Virginia Power board members and officers, but they failed to mention
the very significant actions that were later taken concerning the DRI
board. It is impossible not to draw a significant connection between
those actions and the status of the dispute involving Virginia Power--a
dispute that all clearly knew to be of major concern to the Commission.
DRI has argued that the actions of that meeting and others that it took
during the dispute were in accord with Virginia law and beyond the
jurisdiction of the Commission to question. For immediate purposes, it
is not necessary to question the correctness of this legal view. One may
provisionally presume it to be valid, then ask, "What does it
demonstrate about the ability of Virginia Power to manage and operate
independently, as intended by the 1986 Order?"
The action shows that the DRI board and executive management have the
capacity to take unilateral actions that can profoundly affect Virginia
Power's authority and independence, such as:
25
<PAGE>
(bullet) To use its corporate powers to preempt meaningful dialogue
about matters of disagreement.
(bullet) To preempt Commission-sponsored efforts to promote negotiated
agreement.
It is clear that these actions, even if they were wholly within the sole
discretion of the DRI board or its executives, cannot be judged to be
consistent with management and operation of Virginia Power as
contemplated by the 1986 Order. They had the intent of producing the
votes necessary to resolve in a preemptory way a matter of serious
dispute and almost evenly divided disagreement about what was
appropriate to the utility's needs.
Agreeing to temporary restraints on the exercise of those powers is a
constructive start. However, there remains the need to put ongoing
measures into place. The recruitment and nominating process for the
Virginia Power board of directors is not appropriate. Effective control
over the process for director succession is critical to maintaining the
authority and independence of Virginia Power. Companies typically
exercise control over director succession through the joint candidate
identification efforts of senior executive management and the board
(acting through a nominating committee).
Nominating a new director will require the support of DRI's board,
acting through its two members on the four-person committee (different
from the joint committee) that has been established to nominate
directors for both companies. Two members were originally Virginia Power
directors and two were originally DRI directors. All four members of
this nominating committee have been members of both boards since the
August 1994 settlement. The two members who were initially DRI directors
came from those four who were placed on the DRI board at the June 1994
meeting. These new directors also already occupy special positions of
trust--such as one would ordinarily expect to be held by members of
longer standing and experience with the company. The joint nominating
process for the DRI and Virginia Power boards provides the possibility
to stymie the succession process. It requires as much concurrence from the
DRI board as it does the utility board.
5. THE CONNECTIONS AMONG THE DRI AND VIRGINIA POWER DIRECTORS REMAIN TOO
SIGNIFICANT. (Recommendations 5 and 7)
A Virginia Power director who resigned in February of l995, but who
remains a DRI director, also served as a CSX director. Another Virginia
Power director has significant CSX connections. The company that he led
was taken over by CSX as a white knight, after another potential
acquirer had begun a hostile takeover attempt. This person is now a CSX
pensioner and has unexercised options to acquire CSX stock. CSXT, a
major subsidiary of CSX, is a principal vendor of Virginia Power. Rail
carriage payments by Virginia Power to CSXT for coal transportation
exceed $60 million per year. These two Virginia Power directors with CSX
connections, along with two other CSX directors, also sat on the DRI
board. Those other two CSX directors resigned from the DRI board in late
February 1995, but the two mentioned above remain on the DRI board.
There is not a sufficient distinction of interest between DRI and
Virginia Power to make it appear proper for a very large utility vendor
to sit on the board of the utility's parent, particularly in the face of
persistent efforts to keep DRI in a central role in the chain of
responsibility for Virginia Power matters.
26
<PAGE>
Virginia Power has a very substantial and long-term contract
relationship with CSXT. That relationship has involved sensitive and
high-value contract administration issues in the past, there are major
negotiations underway now, and future issues of significant magnitude
are possible and may even be likely. The prior board composition
included 4 DRI directors and 2 utility directors with significant CSX
connections. That level of commonality with such a vendor was unsound.
It has been mitigated substantially, but Liberty believes that it
continues to be ill-suited to the circumstances of Virginia Power and
DRI. The CSXT issue is more thoroughly addressed in a following section.
One must begin from the proposition that many are capable of serving as
directors, while few have interconnections that create problems of
appearance with respect to objectivity. The independence of board
members from one another should form one important element of selection.
Another important criterion is independence from executive management.
The unusual events surrounding the CSXT rail rate settlement make it
similarly impossible for the appearance of such objectivity to be
maintained hereafter.
More subtle but still important is the role that the CSX chairman and
the law firm of McGuire, Woods, Battle, & Boothe played in selecting new
DRI directors. A senior member of the firm was brought in to advise the
DRI O&C at the May 1994 meeting (at which efforts to replace the
Virginia Power CEO were put into motion). He was brought in by the CSX
chairman, who had immediately prior thereto replaced the chairman of the
DRI O&C committee. McGuire, Woods, Battle, & Boothe later served as DRI's
law firm in the dispute with Virginia Power. This firm, which had
defended DRI's interests as opposed to Virginia Power's, became counsel
for Virginia Power on matters covered in the August 1994 settlement.
This reversal placed the utility in the strange position of being
represented before the Commission by a firm that had opposed the
positions of Virginia Power before that same Commission mere days
earlier.
The initial contacts with three of the four June 1994 DRI directors were
by the CSX chairman or a senior lawyer of McGuire, Woods, Battle &
Boothe. The initial contacts about board membership were made in the two
weeks prior to their election; one was advised that very day. None said
they knew of any plans to elect them on June 16, 1994, until that day.
At least one member of the DRI board of directors nominating committee
knew nothing of their candidacies before they were brought before the
board for election. These circumstances support a rational inference
that objectivity and multiplicity of perspectives have not been driving
forces in recent changes to the DRI board.
The DRI board has also included a number of directors of the Virginia
Union University board of trustees and the university's president. Two
of those with connections to the university had, in turn, relationships
with CSX. DRI's CEO sent DRI's general counsel (in April 1994, during
the DRI/Virginia Power management conflict) to assist the university
president with significant university management and contract issues
before that board. These interconnections also demonstrate the close
professional and personal connections that tie certain members of the
DRI board.
Other interconnections on the boards of the two companies have existed
as well. One DRI director is connected with an investment firm that
underwrites and has made recommendations on the securities of DRI or a
subsidiary. This member has also undertaken for separate compensation at
least two consulting engagements for DRI or a subsidiary. Two other
directors
27
<PAGE>
(one current and one recently-retired) are from law firms retained by
DRI or a subsidiary. In the case of the retired director, a partner of
the firm served until recently as general counsel. Its revenues from DRI
and its subsidiaries have been very substantial. Another recently
retired director had a sizeable consulting contract with DRI or a
subsidiary. Yet another director stands to gain a sizeable commission as
agent for the sale of a DRI subsidiary property.
The financial interests under these individual arrangements have
approached or exceeded the compensation received as directors. Limiting
the value of such other arrangements is important to maintaining the
independence of directors. It is also important to minimize potential
conflicts of an institutional nature, even where they are not inherently
inappropriate, when taken individually. A collective judgement about
director independence can be appropriately made on examining the overall
interconnections that arise from factors such as employment or other
connections with major vendors, other relationships that produce
compensation or value from the company, or common memberships on other
boards.
Again, Liberty emphasizes that it has not, through its study activities
found any evidence of improprieties by any of the current or former
outside board members covered by this conclusion. Nor does Liberty
question the talents, backgrounds, or personal integrity of any of them.
Liberty's concern in this matter is strictly a function of (a) composing
a board that is free from questions that any of its members have other
interests that do or could appear to conflict with those of DRI and
Virginia Power and (b) assuring that board members have a minimum of
common business interest or relationships with each other and with the
companies, even if those relationships are not per se in conflict with
the interests of DRI or Virginia Power.
6. A PART-TIME CHAIRMAN OF THE BOARD FOR VIRGINIA POWER DOES NOT OFFER A
SOUND LONG-TERM APPROACH TO PROVIDING THE ATTENTION NEEDED TO
PROVIDE AN OPTIMUM STEWARDSHIP ROLE. (RECOMMENDATION 7)
An outside chairman of a utility board is unusual, as is a chairman who
has material outside professional responsibilities. The county's largest
electric utilities have not often taken this approach. The industry now,
more than ever, requires dedicated focus and attention. Apart from any
considerations of individual talents or capabilities, which Liberty does
not here question, a large electric utility, particularly one that has
recently undergone what Virginia Power has, requires a full-time
chairman.
There is certainly merit to the theory that an outside chairman approach,
if it is carefully implemented, can augment the objectivity of the board
in overseeing the performance of executive management. However, even if
that were DRI's approach, it has not been consistently applied between
DRI and Virginia Power. In any event, successful application of the
approach would require a full-time chairman, which is not the case
presently for Virginia Power.
DRI's CEO is the chairman of the parent's board, but the utility CEO is
not the chairman of Virginia Power's board. The two were the principal
protagonists in the recent management dispute. There is little merit in
applying the outside approach to the utility but not to the parent,
particularly given the relative size of the utility and the non-utility
businesses of DRI. Moreover, this apparent lack of even-handed treatment
gives the appearance either that it is more
28
<PAGE>
important for the holding company to have a CEO/chairman, or that some
element of the dispute made it appropriate to remove the Virginia Power
CEO as chairman, but not the DRI CEO. Neither of these conclusions would
be valid.
It is, however, true that there does not appear to be substantial
current support for electing the Virginia Power CEO as the chairman of
the utility's board. He would be the most likely candidate to succeed
the current chairman. Absent such support, the preferred approach is for
the Virginia Power board to select its own chairman at the first 1995
meeting following the election of new directors, without constraint or
limitation from the August 1994 settlement or DRI. The current utility
board chairman took office as a result of the August 1994 settlement
agreement. Election solely by the Virginia Power directors would return
the authority for this choice to the proper location. This conclusion
does not imply, given the recent history of intercompany relations, that
re-election of the current chairman, if by the Virginia Power board alone,
would raise problems. However, eventual return to a full-time chairman
remains the preferred approach.
7. VIRGINIA POWER'S PRE-DISPUTE ARTICLES AND BY-LAWS GIVE THE UTILITY
ROLES AND RESPONSIBILITIES THAT IT NEEDS TO PRESERVE ITS INDEPENDENCE
AND AUTHORITY, EXCEPT AS RESPECTS DRI ACTIONS AS THE SOLE
SHAREHOLDER. (RECOMMENDATION 6)
Events demonstrate that Virginia Power's articles and by-laws must be
constructed and implemented to give the utility sufficient authority and
independence to carry out its public service responsibilities. The
pre-dispute by-laws gave the Virginia Power board the power to fix the
number of directors and to fill vacancies. The utility board also had
the power to elect its officers, chairman, and vice chairman. The
Virginia Power board also had the authority to make by-laws for the
utility. The provisions of the pre-dispute articles and by-laws gave
Virginia Power the ability to act in a manner that is typical of the
boards of other major energy utilities. They gave the company generally
sufficient control over its own membership and governance, which are
both essential to exercising independence and authority. The August 1994
settlement agreement and the February 20, 1995 consent order,
respectively, restored and have temporarily maintained the pre-dispute
by-laws.
Recent attempts by DRI to change these governance documents show their
importance to the utility's authority and independence. DRI, as sole
shareholder, changed the Virginia Power by-laws unilaterally on July
26, 1994. These changes:
(bullet) Made the DRI chairman an ex officio member of all utility board
committees, with voting power where designated by the DRI board.
(bullet) Prohibited Virginia Power equity issuances, except by unanimous
vote of all Virginia Power directors, who included the DRI chairman.
(bullet) Required a unanimous vote of directors to remove the chairman.
(bullet) Prohibited the Virginia Power board from changing these by-law
amendments.
DRI removed three Virginia Power directors at the same time.
These actions were rescinded by the August settlement. However, DRI
retained the right to amend Virginia Power by-laws and to remove
Virginia Power directors upon a majority vote by DRI directors. The
February 20, 1995 consent order enjoins DRI from changing the articles
29
<PAGE>
or by-laws of Virginia Power prior to July 2, 1996. This provision
precludes unilateral action by DRI during that period.
Shareowners should have the rights to remove directors and to change
company by-laws. Theirs is the ultimate power to establish the structures
and exercisers of corporate powers. However, the public service
obligations of a utility make it different from other corporations.
Moreover, a practical, rather than legalistic, view of the dispute must
recognize that the shareowners of DRI took no direct actions. Had
Virginia Power not moved to a holding company structure, the utility's
shareholders would have had to exercise the power that DRI exercised.
Even after the creation of that structure, a pragmatic view of DRI must
recognize that the utility has been and, by concession of the executives
of both companies, will continue to be the dominant value producer in
DRI. It is likely therefore to also be the principal interest of DRI
shareowners.
DRI and Virginia Power executives describe DRI's attractiveness in the
marketplace in terms that still emphasize the utility attributes of
performance. They seem to agree that investors continue to seek the same
essential characteristics that Virginia Power demonstrated when it was a
publicly traded company.
The argument that the DRI CEO and his supporters acted as the representative of
the ultimate shareowners is not meaningful in a pragmatic sense. It is
impossible to see the direct "will" of those shareowners in any actions
taken here. Had either side been interested in divining the intent of
those shareowners, then resolution of the dispute at the next annual
meeting would have provided a much more accurate reflection of the will
of the owners. The ownership of DRI shareholders is the beneficial
interest at stake with respect to Virginia Power. DRI, in acting through
its officers and directors, has, in contrast, an administrative form of
ownership.
30
<PAGE>
C. RECOMMENDATIONS
1. ELECT ONLY THOSE SEVEN CURRENTLY SITTING VIRGINIA POWER DIRECTORS WHO
WERE ON THE UTILITY BOARD PRIOR TO THE JUNE 1994 MEETING AT WHICH
FOUR NEW DRI DIRECTORS WERE ELECTED. (Conclusion 1)
This change can be implemented at the next meeting of the DRI board as
Virginia Power's sole shareowner. DRI has substantial control over the
timing of this meeting and has the ability to assure that the intended
result can be effected. Virginia Power would have a board that consists
of seven members. Those not standing for reelection would consist of the
DRI COO and the three remaining DRI directors who were placed on the
Virginia Power board by the August 1994 settlement. The settlement would
not bar the implementation of this recommendation if those four
directors decline to run. A similar situation resulted from the recent
resignations of directors who had been slated under the settlement
agreement to fill future terms on the Virginia Power and DRI boards. As
their resignations imposed no settlement agreement problems, so would
the declaration of intent by these other four directors not to stand for
election at the 1995 Virginia Power board meeting.
Agreeing to this recommendation would demonstrate that DRI is committed
to moving forward on a basis that frees Virginia Power from the
principal legacy of efforts that the holding company made to take
control of its and the utility's boards during the heat of the dispute.
It would leave in office a group of directors in whom DRI placed
sufficient pre-dispute trust to merit their election as utility
directors.
Comprising a Virginia Power board of these members would give
significantly greater confidence that future changes in relations
between the companies and in membership and interaction of the two
boards resulted from unconstrained action by the board to whom the
Commission looks for the management and oversight of utility
responsibilities. Accordingly, the terms of these directors should be
limited to one year, or until the 1996 utility annual meeting, whichever
is later. This limitation will allow for consensual changes after a
limited period time that is sufficient to test the ability of the
companies to cooperate under present management.
2. PERMIT THE VIRGINIA POWER BOARD, BEGINNING IN 1996, TO ADD ONE NEW
DIRECTOR POSITION PER YEAR UNTIL A MAXIMUM OF ELEVEN IS REACHED, AND
TO INTRODUCE MULTI-YEAR AND STAGGERED TERMS. (Conclusions 1 and 3)
A seven-member board may prove insufficient in size to provide, for the
long term, the desired level of diversity of skills perspectives,
experience, and backgrounds. Moreover, a policy of increasing
commonality of membership is consistent with promoting effective
communications and coordination between the boards. Longer terms will
also provide assurance of stability in membership, which will tend to
encourage board members to take a longer range view and may be expected
to make board membership somewhat more attractive, which should enhance
efforts to draw strong candidates. Keeping a maximum size of eleven will
also assure that the board does not reach a size that becomes more
cumbersome to operate.
31
<PAGE>
3. PLACE RESPONSIBILITY FOR VIRGINIA POWER BOARD NOMINATIONS AND
CHAIRMAN SELECTION WITHIN THE SOLE CONTROL OF THE VIRGINIA POWER
BOARD. (Conclusions 1 and 4)
Involving DRI board members directly in the nomination process is not
necessary and the experiences of the past year show that it can be
counterproductive. DRI directors, acting on behalf of the holding
company as sole shareholder, already have sufficient involvement through
their rights of election. They can choose not to elect candidates
nominated by a Virginia Power nominating process. Effectively giving the
DRI directors a veto power that is short of an electing power, should
provide sufficient motivation for the Virginia Power directors to find
candidates that pass DRI muster. At the same time, their sole power to
nominate will assure that they retain sufficient authority and
independence to assure the Commission that the objectives of the 1986
Order can continue to be met.
4. DISBAND THE CURRENTLY DEFINED JOINT COMMITTEE AND REPLACE IT WITH ONE
THAT HAS A DIFFERENT STRUCTURE AND PURPOSE. (Conclusion 2)
This change can be accomplished through board action by the two
companies. Each company's members should be selected solely by its own
board. Company employees or directors would bring to their joint
committee members (or to their own full board if that were the wish of
the board) matters involving the interactions or interrelationships
between DRI and Virginia Power. The joint committee would then address
such of these matters as were brought to it. This committee would have
no authority vis-a-vis the officers and employees of the two companies.
Nor would it have the power to act in the name of the full boards. These
limitations distinguish it from the current joint committee. The
alternate joint committee, as does the current joint committee, would,
however, provide a vehicle for addressing issues between board meetings
and in a less structured or formal environment. This committee could be
given narrowly prescribed executive committee powers to the extent
necessary to deal with circumstances requiring action before the next
board meeting.
This alternate joint committee would serve to provide a board-to-board
vehicle for DRI's communications as shareowner with Virginia Power. In
other words, it would allow DRI to exercise powers as shareowners
normally do, which is through the board of directors. In fact, it allows
DRI substantially more influence, inasmuch as its dialogue is not
limited to annual meetings or to extraordinary meeting requests or
demands.
5. ADOPT SUPPLEMENTAL DRI AND VIRGINIA POWER CONFLICT-OF-INTEREST
STANDARDS. (Conclusion 5)
These standards should preclude:
(bullet) Board membership by persons having present or former employment
or contract relationships with major vendors on a dollar-limited
(Rather than percentage-of-revenue-limited) basis.
(bullet) Provisions of personal services of significant value to board
members.
(bullet) Contracts or other arrangements by which members receive
significant value for services rendered to the companies.
32
<PAGE>
These standards should also set forth objectives to minimize cross-board
membership and other direct and indirect professional connections among
board members.
6. GIVE THE VIRGINIA POWER BOARD THE SOLE AUTHORITY TO ADOPT ARTICLES
AND BY-LAWS FOR THE UTILITY CORPORATION. (Conclusion 7)
This recommendation is intended to assure that the powers of Virginia
Power's board as exercised through election of members and through
exercise of discretion are not constrained by governing documents that
take from them the kinds of powers that corporate boards generally
exercise.
There is no compelling reason to give DRI unusual powers to review
actions of the Virginia Power board in these regards. Their role in
director election should be sufficient to give them all the powers that
even outside shareowners typically exercise. However, if concessions in
this area are necessary, they should take the form of a structured
process for DRI board override of Virginia Power board actions and for
resolution of intractable disputes at the annual meeting of DRI
shareowners. DRI board challenges to utility board actions should
require a superior majority (e.g., a majority-approved utility action
requires a two-thirds DRI board majority to override, two-thirds utility
vote requires three-quarters DRI vote, three quarters utility vote
requires unanimous DRI vote, unanimous utility vote not subject to
override). This recommendation would still acknowledge the holding
company's legalistic rights as shareowner, without unduly constraining
the authority of the Virginia Power board, to which the Commission looks
for management of utility activities.
7. PROVIDE FOR ONGOING COMMISSION MONITORING OF CORPORATE GOVERNANCE
ISSUES. (Conclusions 1 through 7)
The current docket should remain open, in order to allow the Commission
to monitor developments in what remains a fluid and uncertain set of
circumstances. The directors continue to seek the Commission's
forbearance, but they have made few substantive changes since the failed
August 1994 settlement. It bears remembering that similar forbearance
was urged in late 1994 (in the joint response to the interim report) and
its basis was in major part that same August 1994 settlement.
The current structure relies for its success on no new organizations and
on the efforts of a number of people who took or supported a strong
stand against Virginia Power's independence and against the role of the
Commission not very long ago. That structure, absent commitment to
change as recommended above, will continue to rely on atypical
alignments of board responsibility, which pose potential threats to
executive latitude and activism, when those characteristics may be most
critical to Virginia Power.
Liberty has recommended a balanced process for increasing board overlap.
Hindsight teaches two important lessons about almost complete separation
of the two boards. First, if major problems of utility independence
arise, separateness is more likely to expose them to regulatory
scrutiny. Second, separateness is inherently more likely by a
significant margin to cause such problems. Separate boards necessarily
means distinct missions, which implies different interests, which leads
to actions to defend those differences, which produces conflicts. How,
then, to
33
<PAGE>
resolve the resulting dilemma of visibility versus causation becomes the
challenge, particularly when a power tilt toward DRI is the current
starting point.
Liberty believes that an eventual mix that falls short of a majority
would provide the best resolution of this dilemma for the intermediate
term. For example, 11-member boards for each company, with 4 to 5
overlapping members would be appropriate. It is important that the
Commission monitor the movement toward overlap, given the unbalanced
starting position. Confidence that the Virginia Power board members are
exercising independent judgement in their votes on overlapping members
is important. Monitoring of ongoing relationships is also an appropriate
means for examining progress in moving toward a full-time role for the
Virginia Power board chairman.
If Liberty's approach to resolving governance issues is not accepted,
ongoing Commission monitoring is particularly appropriate. Uncertainties
about the cooperations and communications clauses remain. The scope of
the joint committee's role and powers, and its basic functionality as
well, are also not settled. In the event that the present authority of
the joint committee is not changed, all meetings held, all issues
raised, and all decisions reached should be documented clearly and
furnished to the Commission within 10 days, during the pendency of the
consent order.
Only time will disclose the future intentions of board members. Keeping
this docket open and continuing the Commission's monitoring of relationships
will properly test the intent and resolve of the companies to make their
interactions work in a fashion that meets the public service
responsibilities.
34
<PAGE>
III. OPERATING RELATIONSHIPS
A. BACKGROUND
Much has been made of the structure under which the DRI and Virginia
Power's boards and top executive management should operate. Addressing
elements of structure is appropriate, particularly because organization
and governance issues can strongly influence authority and independence,
which are major concerns of the 1986 Order. However, efforts to assure
authority and independence should not exalt the form of the organization
over the substance of operating relationships. Many forms of
organization can work effectively in circumstances where commonality of
purpose and unity in outlook prevail. Many fewer forms of organization
can work successfully where such harmony does not exist or where it is
particularly fragile. Thus, the nature of operating relationships as
they exist and may be expected to develop must be examined carefully, if
the prospects for effective interaction in accord with expectations of
utility authority and independence are to be reasonable. This section
presents Liberty's findings, conclusions, and recommendations about
these relationships.
1. CONTENTIONS ABOUT VIRGINIA POWER'S PROGRESSIVENESS
Portrayals of the recent dispute between DRI and Virginia Power, as a
struggle between a traditional approach to the utility business
(Virginia Power's) and a forward-looking one that recognized growing
competition in the industry (DRI's) are inaccurate. Such a dichotomy of
outlook would raise material questions about the effectiveness of
management and operations at both companies. Utilities across the
country have initiated actions to respond to increasing competitiveness,
which has already had some impact, and which promises to cause more over
the next decade. Even among those who have not yet taken discrete
actions, the greater number of companies are engaged in analysis and
planning of competitive response measures. If it were true that Virginia
Power lagged in this regard, then the quality of its management might be
open to questions. Any such questions would cast involvement by DRI in
utility matters in a different light.
It is ironic that Virginia Power and its board of director supporters in
the recent dispute would be described as staid. The Company's reputation
in the industry has been quite different over the past decade. One DRI
board member (the former DRI CEO) who was a Virginia Power supporter in
the recent conflict was proactive and aggressive in recognizing change
in the business by embracing competition in power production at a time
when many peers willing to take a public stand on independent power
production opposed it. The Company became one of the first purchasers of
independently produced electricity, and it was a leading electricity
industry supporter of the Energy Policy Act of 1992. This former CEO was
instrumental in the move to the holding company structure in the first
place and many of the officers and executives of the power company can
trace their introduction to or advancement within DRI and Virginia Power
to his tenure.
Moreover, Virginia Power is now engaged in a major strategic planning
effort that it calls Vision 2000. This effort involves a bottoms-up look
at the utility's direction, methods of operation, and future business
opportunities, some of them potentially as entrepreneurial as those that
DRI
35
<PAGE>
has pursued. This re-baselining effort is looking to the industry's
future and is assessing Virginia Power's pertinent strengths and
weaknesses, in an effort to define a future role for the Company and to
make the changes needed to prepare it to fill that role.
There is simply no merit to any claim that Virginia Power lacks the
willingness to make the changes that competition will require. Moreover,
such claims imply that competition is imminent or extant to a wide
degree, which it is not, or that it will require fundamental changes in
utility values or approaches, which it may not. In any event, Virginia
Power cannot be said to be slow or deficient in the pace of its efforts
to anticipate and prepare for a different kind of industry. Moreover,
its actions over the past 10 years give reason for substantial
confidence that it recognizes and knows how to deal with external
sources of change. Finally, Liberty's interviews with executives at DRI
and Virginia Power showed that both have an eye on the uncertainties of
the future and that neither has a particular advantage in dealing with
them.
2. DRI and Virginia Power Finance and Treasury Organizations
Through the end of 1994, DRI's finance organization acted as an agent
for Virginia Power in the issuance of debt and preferred stock
securities. DRI planned the securities issuances, negotiated all terms,
set pricing, and made timing decisions on all securities sales
issuances. However, Virginia Power officers had to sign all documents
related to the securities financings. Such documents include securities
financing agreements, SEC filings, State Corporation Commission filings,
mortgage documents, and all legal documents. Virginia Power is legally
responsible to preferred stock and debt investors, regulators, and
utility customers for securities issued by the Company. Virginia Power's
senior vice president for finance and the treasurer signed securities
documents that formed part of the process for making all legal
representations that such documents commit Virginia Power to the terms.
The organization structures of DRI and Virginia Power on December 1,
1994 specified that DRI was to execute financings, and that Virginia
Power and its officers had responsibility to all stakeholders for such
financings. The disconnection of control and responsibility for these
functions was of concern because it could have caused problems for the
power company in the future. Virginia Power employees should be
responsible for representing the Company in securities issuances and for
performing due diligence for the Company regarding these transactions.
The finance and treasury staffs at Virginia Power and DRI have undergone
significant changes since 1990, as certain treasury functions and
personnel were shifted from Virginia Power to DRI. At the beginning of
Liberty's review in the fall of 1994, portions of the Virginia Power
finance and treasury responsibilities were performed at DRI, while other
financial functions continued to be performed at the power company.
Following the issuance of Liberty's interim report of December 1, 1994,
DRI and Virginia Power agreed to send certain financial functions back
to the utility. Liberty has had the opportunity in early 1995 to discuss
these changes and the envisioned new financial functions and procedures
with the companies. The ability of the financial staffs at Virginia
Power and DRI to function efficiently and effectively in meeting the
power company's financial policy, financial management, capital
acquisition requirement, cash management, and investor-relations needs
are crucial to the ongoing financial health of the utility.
36
<PAGE>
The DRI finance organization in the fall of 1994 was under the vice
president - finance and treasurer. Four assistant treasurers reported to
this vice president. DRI's treasurer was responsible for investor
relations for all DRI companies, for the debt and preferred stock
financing of Virginia Power, for cash management operations at all DRI
companies, for the equity financing of all DRI companies, and for the
debt financings of Dominion Energy and Dominion Capital.
Investor relations and shareholder service functions had also been
performed at DRI since the holding company was established. The Virginia
Power cash management function was moved from Virginia Power to DRI in
1990. The Virginia Power long-term financing team was moved from
Virginia Power to DRI in 1992. As of the fall of 1994, DRI performed all
of the capital raising, cash management, and investor relations
activities as agent on behalf of Virginia Power.
As of the fall of 1994, the finance and treasury responsibilities of
Virginia Power were the organizational responsibility of its senior vice
president - finance and controller. Prior to October 1, 1994, the senior
vice president - finance and controller also held the titles of
treasurer and corporate secretary. A separate treasurer and corporate
secretary position was created and filled at the utility at the
beginning of October 1994. The finance and treasury- related employees
at Virginia Power comprised a small group of four professionals who were
managed by the assistant treasurer and assistant corporate secretary.
The senior vice president - finance and controller of Virginia Power was
responsible for the following financial activities: finance and
treasury, property accounting and corporate taxes, rates, regulation and
legal issues, customer and payroll accounting, field accounting, and
corporate goal setting and corporate planning. The retirement of the
senior vice president - finance and controller in December 1994 created
the potential for a void in the financial expertise and management
oversight of upper management of Virginia Power.
Virginia Power has specific financial targets for the key financial
indicators of the utility. Such targets were consistently expressed to
Liberty by both DRI and Virginia Power financial personnel. Virginia
Power has a target credit rating of a strong "A." The company's credit
rating is currently "A" with Standard & Poor's, "A2" at Moody's, and
"A+" at Duff and Phelps and at Fitch. The Company is knowledgeable of
the various criteria that must be met in order to maintain an "A"
rating. These criteria are well-known from credit rating agencies, and
guidelines are published by Standard & Poor's. The Company considers a
"BBB" rating to be too risky to assure consistent access to the capital
markets, while a "AA" credit rating is deemed to be too expensive. The
Company also noted that the targeting of a "BBB" credit rating for the
Company's mortgage bonds would result in the Company's medium-term notes
and preferred stock being rated at below investment grade.
The financial officers at DRI expressed the desire for Virginia Power to
have a strong "A" rating. This opinion was also consistently shared by
financial employees at the utility. DRI and Virginia Power targeted a
utility equity ratio of between 42 percent and 4 percent of capitalization,
in order to maintain the "A" credit rating. Virginia Power also intended
to keep as low an equity ratio as required to maintain this rating. Some
important negative credit considerations in the formulation of the "A"
rating are Virginia Power's high level of purchased power from third
parties, its off-the-books accounts receivable program, and the
Company's
37
<PAGE>
substantial variable rate debt and money market preferred stock programs.
In addition, the substantial nuclear exposure of the utility also
creates a negative credit consideration. Nuclear exposure and some level
of power purchases are not avoidable; however, the equity level, the
level of floating rate debt exposure, and the accounts receivable
program are all elements that were being effectively managed by the
finance staffs of DRI and Virginia Power in the fall of 1994.
Virginia Power financial policies have been formulated over a long
period of time, and are reviewed as part of the corporate planning
process on an annual basis. Financial issues are brought up on occasion
at the strategic planning conference at Virginia Power each spring.
During the summer of each year, targets and goals are set at a financial
conference. The procedure in the fall of 1994 called for Virginia Power
and DRI each to have a financial conference on the morning of a
specified day, followed by a joint conference in the afternoon.
Independent determinations of earnings per share and cash flow targets,
capital structure targets, and other financial indicators were mined by
Virginia Power and DRI. Any disagreements were to be discussed during
the afternoon of this financial conference. Employees at DRI emphasized
that financial policy decisions and strategy were made on a "joint
basis" by DRI and the power company. There seemed to be no major
divergence of opinion between Virginia Power and DRI executives
regarding target credit rating, optimal capital structure, and the
general structure of the power company debt portfolio. Therefore, the
involvement of DRI in Virginia Power financial policy making did not
seem to be controversial in these specific areas.
Virginia Power reports that monthly finance team meetings that were
regularly held at DRI included a Virginia Power representative. However,
renewed studies of Virginia Power policies, such as the optimal target
credit rating and capital structure, had not been performed since
approximately the 1989-1990 time period. Virginia Power employees
considered the idea of revisiting the optimal bond rating and capital
structure issues with investment bankers in 1992. However, the long-term
financial functions of Virginia Power were transferred to DRI at
approximately this time, and the issue has apparently not been studied
in depth by either group since.
Financial forecasting and planning for Virginia Power's financing needs
continues to be performed at the utility. Its forecasting is performed
in the Corporate Planning group, which reports to the senior vice
president - finance and controller. The Virginia Power assistant
treasurer's group reviews the Company's forecasting runs and prepares
financing plans for refined forecasts. The assistant treasurer
eventually prepares a final financing plan for the Virginia Power
financial forecast. The financing plan is structured to meet the
utility's capital structure targets of 42 percent to 45 percent equity,
8 percent to 10 percent preferred stock, and the remainder in long-term
debt. Virginia Power notes that the three-year financing plan was
consistently coordinated with DRI as of the 1994 time period.
DRI finance employees reported that the forecasting and financing
requirements planning for the power company continued to be prepared at
Virginia Power. However, the financing group at DRI also prepared a
financing plan for the utility. DRI reported that Virginia Power has
input to the financial planning, which was performed on a "joint" basis.
DRI emphasized that the holding company was the execution group for the
capital market needs of Virginia Power and DRI's non-utility
subsidiaries as of late 1994.
38
<PAGE>
Virginia Power also prepares a financing plan that is included with the
10- and 20-year resource requirement forecasts that are filed with the
Commission. Virginia Power reports that the Company's three-year
financial forecast and the 20-year financing plan filed are consistent
at all times.
The cash management functions for Virginia Power were performed at DRI
in the fall of 1994. DRI performed banking relations, cash management,
short-term financing, and the investment of short-term funds for the
power company. An assistant treasurer and four professional employees
performed these functions for Virginia Power, DRI, and DRI's non-utility
subsidiaries at the holding company. DRI employs its own commercial
paper salesman for a DRI commercial paper program, a Virginia Power
commercial paper program, and a program for the Rincon Securities
subsidiary of Dominion Capital.
DRI operated Virginia Power's $200 million commercial paper program in
1994. The Virginia Power commercial paper program finances the utility's
short-term operating cash needs. Virginia Power's commercial paper
program carries an A1/P1 credit rating. DRI reported that it sold 99
percent of the Virginia Power paper through its own salesmen. DRI also
used Merrill Lynch and Lehman Brothers as back-up commercial paper
dealers and as information providers for the commercial paper market.
As of the fall of 1994, DRI had arranged approximately $406 million in
bank lines of credit, which were shared among Virginia Power, DRI, and
the non-utility subsidiaries. The amount reserved for credit lines is
subject to change. Commercial paper programs required bank lines of
credit for liquidity back-up, should a crisis in the corporate
commercial paper market arise. Virginia Power had claim in 1994 on $100
million on the back-up lines of credit, and paid DRI for this credit
capacity. Virginia Power could also call on up to $200 million of
additional back- up lines of credit and borrowing capacity (through the
intercompany credit agreement, which is discussed immediately below), if
required by the power company and available from the other DRI entities.
The lines of credit may also have been borrowed upon by DRI, which could
then have lent the proceeds of that loan to Virginia Power. However,
Virginia Power rarely used this mode of financing. Its cost is higher,
as compared to commercial paper.
Virginia Power and DRI have also been parties to an inter-company credit
agreement (ICA). DRI issued commercial paper on behalf of the entire
holding company and all subsidiaries from 1986 to 1991. DRI then loaned
the proceeds of these commercial paper borrowings to Virginia Power and
the non-utility subsidiaries at the cost of such paper plus related
expenses. There was a downgrade of the credit rating of DRI commercial
paper to A2/P2 in 1992. DRI then established a separate Virginia Power
commercial paper program for the utility's sole use. As a result, the
short-term borrowing required by Virginia Power is obtained under the
Virginia Power commercial paper program. Virginia Power reports that
there have been no borrowings by the power company under the ICA since
the Virginia Power commercial paper program was established in January
1992. Virginia Power has continued to have an ICA with DRI, and the
various DRI entities continued to share joint back-up lines of credit
through the late-1994 time period.
39
<PAGE>
DRI also has acted as an agent for Virginia Power in the sale of
long-term debt and preferred stock. Virginia Power had approximately
$2.8 billion in first mortgage bonds outstanding at September 30, 1994.
Virginia Power also has a $1 billion medium-term note program, which was
established in 1985. The Company had $820 million of medium-term notes
outstanding at September 30, 1994.
Virginia Power also had $460 million in tax-exempt floating rate bonds
outstanding at this time. These bonds had an average maturity of 30
days. Virginia Power also had $375 million of money market preferred
stock outstanding at September 30, 1994.
DRI finance employees managed the Virginia Power debt and preferred
stock portfolios and maintained contact with the investment banking and
capital market communities from January 1992 through the end of 1994.
DRI reported that it performed a number of first mortgage bond
refinancings for Virginia Power in 1992 and 1993. Varying maturities
applied to the refinancing debt instruments. DRI also reported that
maturity schedule, yield spreads, the general shape of the yield curve,
and judgement and advice from investment bankers were all used in the
determination of the types of debt instruments to issue. DRI also
emphasized that a self-imposed constraint was to have no more than
$300-$350 million in maturities in any one year for the Virginia Power
debt portfolio, in order to control refinancing risk. The average
maturity of the Virginia Power debt portfolio was 10.0 years in late
1994. Virginia Power employees also reported that they were heavily
involved in the quantitative analysis that assisted in determining the
optimal refinancing vehicles in the 1992 and 1993 period. The Virginia
Power employees acted as analysts and advisors in the determination of
the optimal refinancing packages.
Virginia Power also noted that the refinancings in 1992 and 1993 caused
a shortening in the maturity of the overall mortgage bond portfolio.
Prior to the refinancings, Virginia Power had prepared criteria for the
investment bankers and for employees to use in the refinancing
operations. The Company's driving criterion was to shorten the average
debt maturity, in order to save interest cost, recognizing the shape of
the standard yield curve. Virginia Power worked with an investment
banker to develop a linear programming model, in order to analyze all of
its callable bonds. The model sought to maximize interest cost
reductions due to refinancing, under a restriction of no more than $350
million of maturities in any one year. The Company also emphasized the
end effects of continued refinancings as part of the analysis. Virginia
Power notes that this study was performed before the "capital market"
long-term finance employees moved to DRI in 1992. DRI and Virginia Power
also prepared a fixed versus variable rate debt study in 1988. It
recommended the use of increasing amounts of variable rate debt.
The long-term finance employees at DRI as of late 1994 performed most of
their capital market duties for the power company. These finance
employees maintained a database of maturities and of debt and preferred
stock payments, tracked the performance of debt, performed consolidated
financial forecasts, prepared 10-Ks and 10-Qs, prepared financial
analyses, and monitored rating agency financial ratios. The DRI finance
employees, with support from Hunton & Williams as outside counsel, also
provided administrative support required for capital market financings.
Support activities included work on documentation on financings, SEC
filings, SCC approval filings, due diligence financing meetings,
mortgage bond indenture compliance requirements, and all other legal and
document-related support for financings.
40
<PAGE>
DRI issues common equity for the holding company and its subsidiaries.
The holding company and its subsidiaries have not required a public
common stock offering since 1983. However, the holding company has
acquired a consistent flow of equity capital from its ancillary equity
issuance programs. DRI's dividend reinvestment plan raised $115 million
in equity funds; DRI's customer stock purchase plan raised approximately
$50 million; and an employee stock purchase plan raised approximately
$30 million in 1993, for example. The total for all DRI equity programs
in 1993 was $196 million. These programs were expected to raise
approximately $200 million per year in 1994 and in the future.
DRI maintained that more equity was being raised than Virginia Power and
the non-utility subsidiaries needed. DRI therefore began to buy equity
on the open market, in order to meet the needs of the employee stock
plan. DRI also planned in December 1994 to provide the dividend
reinvestment plan with the capability to buy shares in the open market,
in order to meet its needs. The change in the status of these two
programs to open-market programs should significantly reduce the flow of
equity capital to DRI in the future.
DRI maintained in late 1994 that Virginia Power had the first call on
equity capital raised by DRI, in order to maintain the utility's "A"
credit rating. DRI and Virginia Power determined the amount of equity
capital that Virginia Power required each year, in order to maintain
this target rating. The equity capital was paid down to the utility in
exchange for Virginia Power common stock in the fourth quarter of each
year. The timing of this equity injection to Virginia Power was
apparently governed by an "unwritten" policy for DRI and the utility for
several years. The implications of this policy are discussed later in
this report.
The DRI assistant treasurer for investor relations handles investor
relations functions for DRI and all subsidiaries. The incumbent
maintains contact with equity market analysts, mostly by telephone.
Investor Relations also sends financial information to equity analysts;
e.g., quarterly news and earnings releases. Investor Relations'
functions also include developing and coordinating presentations for key
investor concentrations in several cities nationwide. Investor Relations
is responsible for presenting the Dominion Resources story to New York
equity analysts, Richmond-area equity investors, and equity investors in
key cities, such as Boston, Chicago, San Francisco, et al. A
presentation for fixed-income investor groups occurs every two or three
years.
As of late 1994, DRI reported that the holding company selected the
"appropriate" executive representatives for each investor group. DRI
emphasized that it brought the key Virginia Power employees to the
equity investor meetings. However, DRI stressed that most equity
investors wanted an "overall view" of the holding company, rather than a
utility-specific one. DRI investor relations works directly with the
public policy group at the holding company, with public relations
personnel at Virginia Power, and with the Virginia Power president and
CEO and senior vice president - finance and controller.
Contacts with credit rating agencies were also performed by DRI in late
1994. The DRI finance employees responsible for Virginia Power financing
maintained ongoing relationships with the credit rating agencies. DRI
advised that it did not perform annual presentations to the rating
agencies, as had historically been the policy at Virginia Power. Most
credit rating relationships were handled by DRI by telephone, and were
conducted on a more informal basis. An exception
41
<PAGE>
to this general rule was Virginia Power's meeting with Standard & Poor's
in November 1994. The DRI group representing Virginia Power for this
meeting included utility executives.
Virginia Power executives were apparently excluded from equity analysts
and credit rating agency meetings for a period of at least 18 months as of
late 1994. Managing investor relations and credit rating relationships was
formerly a joint effort coordinated by DRI. The holding company
apparently came to control these functions and to exclude Virginia
Power. DRI and Virginia Power reported that both sides agreed as of late
1994 that Virginia Power would be represented at investor relations and
credit rating agency functions related to Virginia Power in the future.
Virginia Power personnel maintained the responsibility for a number of
ancillary treasury functions as of late 1994. These responsibilities
have always been performed at Virginia Power. These functions did not
move to DRI with the capital market functions in 1990 and 1992. The
Virginia power assistant treasurer and assistant corporate secretary
maintained responsibility for these miscellaneous treasury functions. A
key function of this organization at the time was the management of the
nuclear decommissioning trusts. Four distinct decommissioning trusts
have been formed for Virginia Power's nuclear power plants. These trusts
have been combined into a master trust, which is managed by the Treasury
group. The Treasury organization also performs lease-versus-purchase
analyses, and reviews and approves all financings and decisions of this
type. The Treasury group provides guidelines and occasional economic and
financial analysis on major and special projects.
As of late 1994, the Virginia Power Treasury organization also performed
research and provided an advisory role on the various alternative
financing techniques that investment bankers and financial vendors
proposed to the Company. The Virginia Power assistant treasurer's group
would be responsible for project financing or leasing for various,
proposed disbursed energy facilities (DEFs), if they are authorized and
constructed. These facilities include electric and steam plants at the
sites of industrial customers. Virginia Power may provide financing for
the construction of electric and steam facilities for industrial
customers as a means of competing with cogenerators and independent power
producers, subject to the approval of the Commission
3. Legal Services
There were more than ten lawyers employed by Virginia Power in 1993.
They conducted their activities under the direction of the utility's
departments who were their clients and they reported administratively
and functionally to the heads of those groups. Thus, there was no
central legal department at Virginia Power. Direct assignment of
in-house lawyers to client groups is not a widely-accepted approach.
Independence of advice, quality control, career development, and
training objectives are typical of the reasons why most companies
combine in-house lawyers within a separate department. Moreover, the firm
of Hunton & Williams had traditionally served as general counsel to the
utility. Thus, Virginia Power had no in-house senior legal official.
The DRI CEO asked the then-incumbent Virginia Power vice president -
regulatory in 1993 to examine the consolidation of legal services at the
utility. This vice president had been transferred to Virginia Power, at
the request of the DRI CEO, who asked Virginia Power to
42
<PAGE>
place him in an executive position for career development objectives.
The Virginia Power vice president conducted his analysis with virtually
no input from Virginia Power personnel. The proposal that he developed
generally followed the typical utility model for in-house legal
departments. Left somewhat uncertain, however, was the issue of the
position to whom the lawyers would report. There is no uncertainty as to
whether they would report directly to a single Virginia Power counsel. The
issue was whether the Virginia Power counsel would report, on a matrix
basis, to the DRI general counsel.
The Virginia Power vice president was asked by the DRI CEO to present
his conclusions at the October 1993 joint meeting of the DRI and Virginia
Power O&C committees. The CEOs of the two companies attended that
meeting. The vice president did not brief the Virginia Power CEO on the
substance of his presentation before the meeting. Moreover, the Virginia
Power CEO understood that there would be no presentation of results, but
rather only a status report. The Virginia Power vice president presented
a specific proposal to restructure the utility's legal resources. The
presentation of the restructuring proposal surprised and frustrated the
Virginia Power CEO. His reaction effectively brought consideration of
restructuring to a halt. It also set in motion a series of events that
precipitated the crisis in relations between DRI and Virginia Power.
4. Federal Regulatory Relations
Virginia Power remained responsible for managing relationships with
federal officials after DRI's creation. However, in the 1992/1993 time
frame, DRI consolidated this function for DRI and Virginia Power, citing
unity of position and cost savings as grounds. Consolidation occurred
through the use of a joint contract for both companies with a single
firm. Virginia Power opposed the consolidation, and was able to retake
authority for its own federal liaison work in 1994. Virginia Power is
operating provisionally with the same firm, but under a separate
contract. Plans for the future are for complete separation and for
potentially bringing the function in-house, to be performed by an
employee.
5. Employee Transfers
Personnel transfers between Virginia Power and DRI during the years
1986-1993 are summarized in the following table. There has been an
average net transfer of approximately seven employees per year from
Virginia Power to DRI and its non-utility subsidiaries since 1986. As of
October 1994, 83 of DRI's approximately 200 employees had transferred
from Virginia Power.
43
<PAGE>
Year To DRI From DRI
1986 38 3
1987 13 4
1988 11 3
1989 11 2
1990 8 6
1991 8 3
1992 14 3
1993 3 1
1994 4 2
Total 114 29
The post-1986 net transfer represents approximately three percent of
DRI's staff per year, which comprises a significant portion of DRIs
yearly hiring needs. Approximately one-third of the transfers to DRI had
expertise in treasury, accounting, cash management, and other finance-
related functions. In 1990, a portion of the cash management function
was moved to DRI, and treasury followed in 1992. In 1987, 12 of the 13
transfers from Virginia Power to DRI had expertise in engineering and
construction, or in project management. The skills and experience of
these employees match the needs of Dominion Energy in the independent
power market. Only one of these employees has since returned to Virginia
Power.
Of the 29 DRI transfers to Virginia Power, 11 originally came to DRI
from Virginia Power. The length of stay at DRI ranged from 8 months to
6.5 years, with an average of just over 3 years. An additional 3
transfers to Virginia Power came back to DRI within 2.5 years of their
transfer to Virginia Power. Of the remaining 15 DRI-to-Virginia Power
transfers, 8 occurred during the 1986-1988 period. Transfer records only
go back to 1986; therefore, Liberty cannot confirm that some of these
employees did not also originally come from Virginia Power to aid in
DRI's start-up.
Employees are not routinely assigned temporarily to other affiliates.
However, services are periodically performed by Virginia Power employees
at the request of a non-regulated affiliate, and the Company has found
instances where that affiliate has not been charged. A discussion of
these instances is provided in section four of this report.
44
<PAGE>
B. Conclusions
1. A CLIMATE OF ANXIETY AND CONCERN AMONG VIRGINIA POWER OFFICERS WILL
LIKELY HAVE NEGATIVE CONSEQUENCES IF IT CONTINUES. (Recommendation 1)
There existed among Virginia Power's senior executives in late 1994 a
widespread feeling of mistrust over the motives and intentions of top
DRI executive management. Virginia Power had already lost a senior
executive as a result of poor relationships, and they were a factor in
the departure of another. Others had initiated contacts with search
firms or expressed insecurity over their tenure at Virginia Power. Such
a climate was manifestly inconsistent with the need for such people to
devote less divided attention to important job responsibilities.
The February 28, 1995 resolutions have altered the climate. Virginia
Power's executives express hope that dispute-related problems will
recede increasingly into the background. However, there remains a
significant level of anxiety. The breadth of the joint committee's
future role and the way it chooses to intercede in utility matters
comprise a primary source of this anxiety. The cooperation and the
communication clauses of the resolutions also have bred uncertainty. The
level of tension has decreased notably in comparison to the late 1994
environment. However, continuing uncertainty in the relationships
between DRI and Virginia Power give rise to concern over the continuity
of Virginia Power's officer group. The resulting anxiety deprives the
utility of the stability that normally accrues in the industry, and it
is very important to the utility's ability to meet its public service
commitments. This anxiety will probably not produce precipitous
consequences if there are no major disruptive intercompany events over
the next few months. However, any further problems are likely to have
significant consequences. The recurrence of such problems will evidence
a continuing and perhaps intractable inability to establish effective
operating relationships in the context of the current overall governance
structure, which the boards are clearly unwilling to alter
significantly.
The fact that Virginia Power depends heavily on nuclear generation in
providing reliable and economic service underscores the significance of
this climate. The Nuclear Regulatory Commission (NRC) was aware of the
management dispute between DRI and Virginia Power as early as late
spring of 1994. From June 1, 1994 through late summer, the NRC and
Virginia Power conducted numerous communications about the relationship
between DRI and the utility. There was also much communication regarding
the proceeding before the Commission. Communications between the NRC and
any nuclear utility regarding a variety of subjects are commonplace.
Most of this routine contact was with licensing personnel and concerned
ongoing plant operations issues, performance statistics, regular
reports, and regulatory concerns. Daily communications between NRC
resident inspectors and local managers at Virginia Power's operating
nuclear generating plants also routinely occur. The status of the DRI
and Virginia Power management dispute was a common topic of discussion
during such conversations in 1994.
Despite the routine nature of much of the discussion between Virginia
Power and the NRC, the level of communications during the summer of 1994
suggests potentially significant concern on the part of the NRC. Concern
over the management dispute may have been exacerbated by recollections
of problems that Virginia Power had experienced with one of its nuclear
plants a
45
<PAGE>
number of years earlier. These problems had been satisfactorily
resolved, but NRC personnel may have had remaining questions, especially
in view of the recent departure of the utility's senior nuclear
executive during the dispute.
Virginia Power's senior vice president - nuclear opted for early
retirement and left the Company in late May 1994. He immediately
accepted a similar position with another utility. His decision was to a
great extent based on his distrust of DRI's top management. He was also
uncomfortable with their level of understanding of the nature of nuclear
operations. Day-to-day involvement by DRI in nuclear operations matters
was minimal, but he did not sense that holding company interest in
cutting costs was sufficiently balanced with the need to maintain good
regulatory relations. He was aware that there was NRC concern over his
departure, but felt that this concern was mitigated by the strength of
Virginia Power's nuclear program and the experience and qualifications
of his successor and the Virginia Power CEO. Moreover, neither he nor
any other Virginia Power employee could identify any specific decision,
action, or change with identifiable safety consequences.
The DRI/Virginia Power management dispute was a significant factor in
Virginia Power's untimely loss of its top nuclear executive. Moreover, a
continuation of relationship problems has the potential for creating
unnecessary obstacles to effective operations and harmonious regulatory
relations. Avoiding any management disruptions that the agency perceives
to pose a potential for significant change to the current nuclear
program, in which the agency clearly has much confidence, should be of
paramount concern to DRI and to Virginia Power.
2. THE JOINT COMMITTEE WAS NOT ABLE TO IMPROVE UNDERLYING RELATIONSHIPS
BETWEEN AUGUST 1994 AND FEBRUARY 1995, AND NO CHANGE TO IMPROVE ITS
EFFECTIVENESS ARE APPARENT. (Recommendation 1)
The August 1994 settlement established a special board committee to
resolve problems between senior executive management of the two
companies. This committee consisted of four members who were common to
both boards. Two were Virginia Power directors, and two were DRI
directors before settlement of the dispute in August 1994. The February
28, 1995 resolutions did not change the membership of the joint
committee. The two initial DRI members come from among the four
directors added to the DRI board on June 16, 1994.
The August 1994 settlement created the position of DRI
president and COO, whose function was to act as an intermediary between
the DRI and the Virginia Power CEOs. He appears not to have a formal
role in the aftermath of the February 28, 1995 resolutions. However, the
DRI CEO has said that he expects him to continue to serve in an
intercompany coordination role.
A few matters of executive disagreement have come before this committee.
One was significant. The chairman resolved it without prior recourse to
the remaining committee members. He recalls informing the other joint
committee members after the fact. Those with whom Liberty discussed the
matter, however, presently do not recall being informed. The matter
involved a request by the DRI CEO to meet with Virginia Power employees
who had been involved in the CSX contract settlement matter. Virginia
Power superiors of the Virginia Power employees involved were to be
excluded from the meeting. The chairman of the joint committee (a former
CSX subsidiary's chief executive) allowed the meeting; he added the
condition that the DRI
46
<PAGE>
COO be present to assure that there was no intimidation. Also present
were a lawyer from McGuire, Woods, Boothe, & Battle and a lawyer from
Hunton & Williams, who were jointly representing the companies. Virginia
Power personnel were at the time being subjected to significant pressure
from company lawyers about recollections concerning the CSXT settlement
of several years earlier. To place these employees in this position and
to deny them the support of their superiors under the circumstances at
issue here was likely to cause turmoil for them and in the utility
organization. The participants to the meeting did not feel that there
was any noticeable form of pressure or intimidation at the meeting.
Liberty observed during late 1994 a significant level of tension,
concern, and mistrust of DRI motives among the senior executives of
Virginia Power. The DRI COO who was named by the settlement to serve as
the intermediary between the two CEOs stated during this period that he
was not aware of the existence of these factors when interviewed by
Liberty during its preliminary study. He believed that posturing by
lawyers for the two sides contributed more to the companies' problems
than did disagreements between employees. He also believed that the
management dispute was not widespread among company personnel. He
recognized that some problems existed in early February 1995 when
Liberty interviewed him again. However, he believed that the
disagreements of that period arose only from the consequences of
positions taken in the dispute era prior to the settlement. He did not
believe that any of the intercompany problems were independent of
current difficulties, particularly those associated with the CSX
matters, which arose from dispute era posturing.
The joint committee members also did not feel that there were
significant problems when Liberty interviewed them in late 1994. The
committee's collective position has changed dramatically since that
time. They came to the realization that relationships between the CEOs
remained ineffective. Moreover, the fact that the boards deemed
significant new action to be necessary in February l995 shows the
ineffectiveness of the settlement at restoring effective relationships
between the companies.
Several directors, including some who have been given direct roles in
managing relations between Virginia Power and DRI, believed that the
existence of the current investigation by the Commission, of which
Liberty's study is a part, was acting as a hindrance in the process of
restoring effective relationships between the companies. Much to the
contrary, many at Virginia Power believed its pendency to be more
effective than the committee in assuming some sense of stability in the
environment in which they must operate.
The joint committee members now recognize that the August 1994
settlement agreement was not serving effectively to resolve the dispute.
However, they express optimism that the February 28, 1995 resolutions
will do what the August 1994 settlement did not. The joint committee
remains the key link in dealing with disagreements. Moreover, it is
clear that ongoing relationships between the companies can be
cumbersome, can involve the boards (and only a committee of the boards
at that) deeply in operational matters, and can insert DRI into Virginia
Power management and operations matters. These arrangements continue the
model that holds that Virginia Power's CEO should have a direct
reporting relationship to DRI. The preferred model is to have the
Virginia Power CEO report directly and solely to the Virginia Power board,
and for DRI to exercise its authorities primarily through election of
Virginia Power directors who have been nominated by a Virginia Power
board-conducted process.
47
<PAGE>
3. THERE HAVE BEEN INAPPROPRIATE ATTEMPTS BY DRI TO CONTROL OFFICER
SELECTION AT VIRGINIA POWER. (Recommendation 2)
DRI's O&C committee attempted inappropriately to influence the selection of
Virginia Power's CEO. The May 1994 actions of the DRI O&C committee initiated
action to authorize the employment of an executive search firm to make
recommendations to the DRI board for a new Virginia Power CEO. That
action was not consistent with securing the authority and independence of
Virginia Power. The same conclusion would hold if the action had come from the
full DRI board. Virginia Power officer selection and removal should be
by the utility's board. That it came from the O&C committee highlights
the fragility of the Commission's expectations about Virginia Power's
independence under the holding company structure. That DRI has placed
self-revocable limits on its powers to intrude in officer selection and
retention does not make that control any less fragile. The DRI O&C
committee's efforts threatened an intrusion on the autonomy of the
utility's management and operations.
The proposed solution of February 25, 1995 would have proceeded from
immediate resignations by the CEOs of Virginia Power and DRI.
Technically, the resignation of the Virginia Power CEO would have been
solicited by the Virginia Power board. However, it is clear that much of
the impetus from the utility's board came from the recognition that the
resignation of their CEO was necessary to secure the resignation of the
DRI CEO. In other words, even this act was inseparable from continuing
efforts to achieve a resolution through consensus, which would require
concessions, whose individual merits alone would not have justified the
actions involved in the minds of utility board members.
Liberty has observed from the comments of directors and senior DRI
executives that the absorption with shareowner litigation concerns has
recently played too strong a role in resolving the controversy. More
than one director has expressed the opinion that some action is by
definition better than no action in light of the so called "business
judgment" rule that their lawyers tell them will be material in any such
litigation. The consequent pressure for action in the short run forces
all sides to be appeased. The problem is that appeasement may not be the
best standard for judging the management and operations effectiveness of
proposed solutions. In any case, it has produced a situation in which
DRI issues, objectives, and personalities have become completely
intertwined with matters of more direct concern to Virginia Power
management and operations. That entanglement risks making the perceived
need for a quick fix more important to directors than what is best for
the utility in the long run. Perhaps such pressure would ordinarily be
constructive in promoting an effective and lasting solution. One cannot,
however, have optimism that this salutary effect will result when
decisions still appear too much to require concessions to those who took
strong adversarial positions in the recent past.
Virginia Power executive management has been generally free to select
its own officers and managers. In fact, the Company has a comprehensive
and well-administered management succession program. There has been,
with one notable, pre-dispute exception, no significant influence from
DRI. That exception involved the general counsel of DRI, who was a
former associate of the DRI CEO when the two practiced law some years
earlier. The DRI CEO asked Virginia Power to find an executive position
at the utility for the general counsel and to include him in senior
executive staff meetings at the utility. Virginia Power's succession
plans did not include this employee, and the utility did not have an
executive position for which it considered
48
<PAGE>
his skills and capabilities particularly fitting. However, Virginia
Power made this employee the vice president - regulatory, in order to
accommodate the DRI request.
The addition of this executive posed two problems. First, the inclusion
of this more junior person in senior executive staff meetings at
Virginia Power was out of character for the utility. It caused
uncertainty at the senior executive level and it is likely that it
raised questions among the other, more junior utility officers. Second,
Virginia Power executives developed the belief, through later
communications with others at DRI, that its vice president - regulatory
was relaying detailed reports of the contents of staff meetings back to
DRI.
Virginia Power's directors must retain control over the selection of the
utility's senior officers if the Company is to have the authority and
independence to remain directly and fully responsible to the Commission
for meeting public service requirements. DRI has not exerted substantial
control over the management and operations of Virginia Power through
influence on officer selection. However, insensitivity on the part of
the senior management of the holding company to utility reaction and the
appearance of reporting from a more junior utility executive back to DRI
(excluding senior utility executives) were contributing factors to the
recent problems between the companies.
4. THE CURRENT SEPARATION OF RESPONSIBILITIES AND REPORTING OF OFFICERS
OF DRI AND VIRGINIA POWER IS SUFFICIENT TO GIVE THE UTILITY THE
STRUCTURAL MEANS FOR EXERCISING SUFFICIENT AUTONOMY OF MANAGEMENT AND
OPERATIONS AT THE EXECUTIVE LEVEL; IT COULD BE JEOPARDIZED BY
INTRODUCING MORE DRI CENTRAL SERVICES. (Recommendation 3)
There is a generally effective separation of responsibilities and
authorities between DRI and Virginia Power. The utility has a structure
and a complement of senior officers that are capable of supporting the
activities needed to fulfill the utility's public service
responsibilities. Maintaining the integrity and effectiveness of that
structure will provide reasonable assurances of the utility's ability to
meet the Commission's requirements and expectations about separation
from the holding company and its non-utility subsidiaries.
Virginia Power has gained little benefit from common services that have
been provided by DRI. The utility is large enough to produce by itself
economies of scale. The addition of incremental DRI services is not of
substantial benefit. In contrast, DRI is generally not large enough to
produce those economies for itself. Therefore, it gains substantial
efficiencies by combining services with those of Virginia Power. The
relative size differentials argue for Virginia Power control over
meeting its own needs, which are much greater, given its size. Moreover,
because of the marginal, if any, added efficiencies, Virginia Power
should not extend more services to DRI. Virginia Power has little to
gain, but is exposed to risk through issues of management control,
insufficient allocations, and continuance of the opportunity for
unbilled services, which has been a problem to date.
5. IT WAS NOT EFFECTIVE FOR DRI TO PERFORM VIRGINIA POWER FINANCIAL
FUNCTIONS TO THE EXTENT THAT DRI PERFORMED THEM PRIOR TO THEIR RECENT
RETURN TO VIRGINIA POWER.
49
<PAGE>
The formulation of financial policies for Virginia Power through late
1994 was being clearly controlled by DRI officers. Virginia Power's
target credit rating of "A" seemed to be agreed upon by both DRI and
Virginia Power executives. However, Virginia Power employees were not
involved in discussions about the continuance of these policies since
the late 1980s. The last involvement by Virginia Power employees
regarding optimal credit rating and capital structure was their
participation in studies in the late 1980s.
The Virginia Power debt and preferred stock portfolio structure and new
financings were clearly controlled and executed by DRI as of late 1994.
DRI received very little input from Virginia Power employees regarding
the debt and preferred stock portfolio. Effectively, DRI was in charge
of Virginia Power's securities execution function and many of the power
company's financial policies. DRI also monitored the floating rate debt
exposure of the consolidated corporation and Virginia Power. The level
of floating rate debt exposure was discussed with credit rating agencies
by DRI employees on behalf of Virginia Power. The floating rate debt
issue has an impact on the credit rating of Virginia Power securities,
and logically should have been handled by Virginia Power officers.
No demonstrative cost or operational advantage was derived by performing
Virginia Power financing and cash management at DRI. DRI emphasized that
a consolidation of the treasury functions of Virginia Power and the
non-utility companies caused operational advantages and synergies.
However, Dominion Energy and Dominion Capital did not provide "economies
of scale" to Virginia Power's financing portfolio. On the other hand,
Virginia Power did provide market muscle to the overall DRI corporate
entity, as well as a "coat tail" effect to Energy and Capital. DRI was
not able to show that demonstrative benefits accrued to Virginia Power
for performing these treasury operations at the holding company.
The DRI employees who were responsible for Virginia Power long-term
financings in late 1994 worked primarily on Virginia Power projects. One
employee charged a portion of his time to the non-utility subsidiaries.
On the other hand, Dominion Energy devoted an assistant treasurer to
that company's financing operations. In addition, Dominion Capital in
late 1994 hired a finance employee to specifically work on Capital's
financing portfolio.
Any slim benefit provided by the consolidation of the treasury functions
at DRI was overridden by the problems, both real and perceived, that
were caused by such a structure. Virginia Power officers did not have
organizational control over the negotiation and execution of securities
issuances and the due diligence activities related to those issuances,
for which these officers are responsible to the Company's stakeholders.
Second, Liberty perceived a real communication and information gap
between DRI and the Virginia Power officers who are responsible for
financings and financial information. Third, the Virginia Power
commercial paper program was rated higher than the DRI commercial paper
program. Certainly the utility credit did not benefit at that time from
any close association with the non-regulated entities. Finally, the
movement of Virginia Power's treasury operations to DRI had removed
important financial and capital market expertise and viewpoints from
executive management of the utility. Such capital market viewpoints can
be important in making strategic decisions at the utility level.
DRI's management of Virginia Power's treasury operations did not
negatively affect the utility's financial health. Virginia Power
officers did not have effective control of the Company's
50
<PAGE>
treasury operations; however, the financial policies, financial
management, and execution of these policies by DRI was efficient and
commendable. Virginia Power was operating with an appropriate credit
rating and capital structure targets, which allowed for appropriate
access to capital markets and the aggressive pursuit of a low-cost
financing structure. Virginia Power's debt and preferred portfolio
strategies, which were primarily formulated and executed by DRI, were
well planned and executed. Liberty found no evidence that Virginia
Power's financing structure or operations were negatively affected in
any way by DRI's effective control of such operations through late 1994.
DRI and Virginia Power finance and treasury personnel previously did not
work effectively and efficiently together where cooperation was
required. Virginia Power officers were not included in all investor
relation activities, especially during the 18-month period leading up to
late 1994. A variety of corporate officers generally can be expected to
seek inclusion in investor relations activities, but only those officers
who present topics of interest to investors should be included. However,
a lack of communication and coordination between DRI's investor
relations activities and Virginia Power utility expertise was evident.
Equity analyst investor relations should properly have been coordinated
at the holding company level, representing both the utility and
non-regulated points of view and information. As DRI representatives
frequently noted, DRI should "speak with one voice"; however, this does
not necessarily mean to speak with only one person. Virginia Power
should have been represented in investor relations activities,
especially since the utility represented over 90 percent of the holding
company operations.
Virginia Power executives should have prepared and been included in all
presentations regarding the utility's credit ratings. The credit ratings
on Virginia Power debt were specific to the power company, and the
credit rating agencies were interested primarily in the operations,
financial results, and strategies of the power company.
Utility personnel had not been adequately included in Virginia Power
financings. Certainly, there was a perceived lack of communication and
information transfer between the holding company and the utility
regarding financing issues. As of late 1994, Virginia Power employees
and officers seemed to be belatedly informed of their own securities
issuances, and to have little input to the financing decisions.
Issues of disclosure, especially to the Securities and Exchange
Commission, could have been missed under the financing organization
structure of late 1994. DRI finance employees were responsible at the
time for Virginia Power disclosure, but the utility was located in
another building and in another business environment. Virginia Power
officers were ultimately responsible for disclosure on behalf of the
Company and were responsible for ensuring that such disclosure was
complete. However, coordination and cooperation on disclosure issues
were difficult with the organization structure of late 1994.
6. THERE HAS BEEN A SUBSTANTIAL RESPONSE TO THE FINANCE FUNCTION
LOCATION RECOMMENDATIONS OF THE INTERIM REPORT.
51
<PAGE>
Liberty made the following preliminary recommendations in its December
1, 1994 preliminary report:
(bullet) Move the Virginia Power long-term financing and cash management
functions now performed at DRI back to the utility and place
them under the Virginia Power treasurer.
(bullet) Appoint a Virginia Power CFO and a Treasurer who are
responsible to the Virginia Power board of directors for all
financing activities, financial policy, and financial
management for the utility.
(bullet) Keep the investor relations functions at DRI, but ensure that
Virginia Power officers are represented at all equity investor
activities, where warranted.
The DRI and Virginia Power joint December 27, 1994 response to the
interim report committed that the finance and cash management functions
performed by DRI for Virginia Power would be transferred to Virginia
Power over the following three months. The companies intended that the
transfer process would begin on January 1, 1995, with the transfer of
the debt and preferred financing functions and would conclude before
March 31, 1995, with the transfer of the cash management function. When
these transfers were complete, Virginia Power personnel would oversee
and be responsible for all aspects of the financial needs of Virginia
Power, except for common equity issuance.
The details of this transfer of responsibilities are included in a joint,
December 27, 1994 memorandum from the senior financial officers of DRI
and Virginia Power to their respective presidents. The memorandum set
forth the understanding of the parties about the duties and employees to
be transferred to Virginia Power from DRI and the activities that DRI
will perform for or with Virginia Power. A description of the duties
being transferred to Virginia Power for financing and cash management
was included as an attachment to the memorandum.
The key provisions of the memorandum are as follows:
(bullet) Debt and preferred issuances - "Virginia Power will have
responsibility for all of its short-term and long-term debt and
preferred issuances and activities related thereto. Virginia
Power and DRI personnel will work together to keep both
companies informed as to these activities. DRI personnel will
be available, on an as-needed and as-requested basis, for
consultation by Virginia Power on financial strategy and timing
and to provide general support."
(bullet) Commercial per issuances - "DRI will continue to act as agent
for Virginia Power in the sale of Virginia Power commercial
paper." The single DRI person who performs this function for
both companies will report to Virginia Power on his commercial
paper work for the utility.
(bullet) Banking relations - "In order to keep the companies informed
and coordinate banking activities, Virginia Power and DRI
banking relations personnel will work together, as appropriate,
to jointly arrange banking services for each of the companies,
including, but
52
<PAGE>
not limited to, lines and revolving credit arrangements, cash
management services, etc.
(bullet) Cash management - "Virginia Power will assume as soon as
possible the daily cash management functions presently provided
by DRI. This will include, but not be limited to, cash
forecasting, bank wires, oversight of collection bank
performance, etc."
(bullet) Investments - "The short term investment of excess Virginia
Power cash will be done by Virginia Power personnel."
(bullet) Employee transfers - DRI specified three employees to be
transferred to Virginia Power. "All of these individuals were
previously Virginia Power employees and we feel that a
commitment should be made to provide them with every career
opportunity since they have been valuable employees of the DRI
family of companies for a number of years and they bring
valuable experience and expertise to Virginia Power."
Another representation of the memo was that "while DRI will be
responsible for arranging and coordinating presentations to and meetings
with financial analysts and visits to rating agencies, Virginia Power
and DRI will jointly participate in such presentations, meetings, visits
and related activities, as appropriate."
Financing activities will be managed by Virginia Power's assistant
treasurer and assistant corporate secretary. The three cash management
employees transferred back from DRI will report to this person, as do the
current staff of four professionals that was described previously in
this section. This person will be responsible for the cash management
activities of Virginia Power, the long-term debt and preferred
financings and financing portfolios, input on financial policy and
financial management issues, and miscellaneous treasury activities (such
as lease-versus-buy analysis, economic analysis, and the other,
previously described activities).
7. VIRGINIA POWER OFFICERS AND EMPLOYEES SHOULD BE RESPONSIBLE FOR
PLANNING, NEGOTIATING, AND ARRANGING THE UTILITY'S BANKING SERVICES,
LINES OF CREDIT, REVOLVING CREDIT AGREEMENTS, AND CASH MANAGEMENT
SERVICES. (Recommendation 4)
DRI and Virginia Power have appropriately arranged for the transfer of
the financing responsibilities of the utility. The December 27, 1994
memorandum clearly indicates that Virginia Power will be in control of
its debt and preferred stock issuances, cash management, and short-term
investment of funds. Liberty believes that the consolidation of the
planning and execution of these financing activities under the Virginia
Power officers responsible for them is important for assuring Virginia
Power's operating independence.
The December 27, 1994 memorandum envisioned a continuance of the past
policy of jointly negotiating lines of credit for all of the DRI
entities. This practice is more fully discussed elsewhere in this
report. Liberty believes that the Virginia Power senior finance
officials, which consist of the senior vice president - finance and the
treasurer, should have the freedom and responsibility to determine the
most beneficial banking and lines of credit arrangement for the utility
without the prior constraint of being a DRI "package deal." Virginia
Power financial officers should be free to pursue the cash management
and lines of credit courses of action that are quantitatively and
qualitatively the most beneficial for the utility.
53
<PAGE>
8. THE COMMUNICATION, COORDINATION, AND COOPERATION BETWEEN VIRGINIA
POWER AND DRI REGARDING FINANCING RESPONSIBILITIES NEED IMPROVEMENT.
(Recommendation 5)
Virginia Power does not possess substantial, "hands on" experience in
conducting long-term financings. The transfer of three cash management
personnel from DRI to Virginia Power should bring it significant
capability, experience, and knowledge in cash management operations.
However, the same type of transfer has not occurred in long-term
financing, financial policy making, and financial management personnel.
When Liberty began its review in the fall of 1994, the execution of
long-term financing activities for Virginia Power was performed by the
DRI treasurer, a DRI assistant treasurer and a subordinate, and a DRI
employee who has coordinated all Virginia Power financing documents for
many years. A second former Virginia Power treasurer, and two other DRI
assistant treasurers who had been responsible for Virginia Power
long-term financing in the recent past also remain at DRI.
Upon the transfer of the long-term financing functions to Virginia
Power, none of these employees, who have hands-on, long-term financing
experience, was transferred back to Virginia Power. Liberty considers
this resource imbalance to be a concern, because the new Virginia Power
senior vice president - finance, the new treasurer, and the employees in
the Virginia Power Treasurer's group do not have substantial hands-on
experience with the execution of long-term financings. These employees
are capable on a financial theoretical and quantitative basis, but they
lack the depth of hands-on experience.
These employees are competent and should be able to learn quickly.
However, the Virginia Power financing portfolio includes not only first
mortgage bonds, but also pollution control revenue bonds, medium-term
notes, variable rate debt, money market preferred stock, and other debt
and quasi-debt instruments. The administrative and financing document
duties for these types of securities are complex and important. DRI and
Virginia Power have not set forth for the transfer of the long-term
financing functions and the related administrative functions a complete
plan that will ensure a smooth transition.
Liberty has observed a significant level of tension between some DRI and
some Virginia Power financing employees during the past few months.
Liberty is concerned with the current state of communications between
DRI and Virginia Power regarding long-term financings. Virginia Power
employees seem somewhat reluctant to ask for help from DRI about their
additional responsibilities. Moreover, DRI employees do not seem to be
going significantly out of their way to help the power company. Hunton &
Williams' experience should help to some extent. Liberty nevertheless is
concerned that the lack of a cooperative approach may cause disruptions
in the transfer of functions and extension of the time that it takes for
Virginia Power personnel to develop the internal experience that they
should have.
9. ACTIONS INVOLVING THE CONSOLIDATION OF LEGAL AND FEDERAL REGULATORY
SERVICES HAVE BEEN CONTRARY TO PRESERVING THE AUTHORITY AND
INDEPENDENCE OF VIRGINIA POWER. (Recommendation 4)
54
<PAGE>
The unusual nature of Virginia Power's legal organization and the
potential problems that can result from such an organization made
attention to the matter appropriate. There is a fundamental difference
in the services that a lawyer provides to an engineering or purchasing
manager, as compared with the services that are provided by the
engineers or purchasers to those same managers. That an engineering or
purchasing manager can properly direct the activities of those in their
disciplines is not critical to determining whether they can similarly
direct the activities of lawyers whose work is necessary to support
their contribution to the company's business.
Apart from the question of objectivity are matters of career development
and training. There cannot be a fully developed career path for company
attorneys if their role is marginalized to one of an adjunct service
provider. However good the current roster of attorneys may be, it is
unquestionable that, over time, Virginia Power cannot expect to attract
and retain persons of comparable skills to those of companies with more
robust legal functions. As a consequence, Virginia Power will be forced
to remain more dependent than it needs to on outside legal advice, which
comes at a significant cost premium. Training will also be more
effectively provided under a centralized legal function. The legal
profession has properly entered an era of substantially increased
support for functional and ethical training. Isolation of attorneys
within line departments makes it more likely that training needs will
either be less well recognized or supported.
Like lawyers, financial, human resources, information services, public
relations, and a number of other service providers also support the line
disciplines and functions. They are, however, managed separately on the
organizations that they support. No lesser considerations apply to legal
services.
These findings are not intended to express opinions about the quality of
legal services that Virginia Power obtains under its present
circumstances. Liberty's study scope did not include this question.
However, it is relevant to address the existence of these issues,
because they are the ones cited by the DRI CEO and the then-Virginia
Power vice president in support of their efforts to examine alternate
structural arrangements for the utility. Moreover, it is clear that the
Virginia Power CEO was not inclined to examine these issues, given his
clear and strong ideas about lawyers and legal services in the electric
utility business. What these issues demonstrate is that there is nothing
inherently suspicious or devious in DRI's interest in these matters. Nor
can it be deemed inappropriate for the DRI CEO and the Virginia Power
vice president - regulatory, both of whom have substantially legal
experience, to seek a focused examination of an area that Virginia Power
treats differently from most other utilities.
Despite the relevance of DRI's interest in Virginia Power's legal
organization, it is clear that DRI undertook actions that were likely
and foreseeably to be divisive and counterproductive. First, DRI
abandoned efforts to induce Virginia Power to examine legal
reorganization on its own. This abandonment was not sensitive to
preserving the confidence that must exist between attorney and client.
Second, DRI caused the analysis to be performed by a Virginia Power
executive who, for practical purposes, reported to DRI on this
assignment. Third, DRI failed to recognize adequately that most Virginia
Power executives had already lost substantial confidence that their vice
president (who performed the analysis) considered his primary duty to be
to the utility. Fourth, the Virginia Power vice president who performed
the analysis did
55
<PAGE>
not adequately seek the concurrence of those who would be affected by
his analysis. Circumstances indicate that communication and consultation
with them were appropriate, even if it would not change his opinions.
Fifth, the DRI CEO did not take sufficient action to assure that the
means and time of presenting the analysis would be perceived by the
Virginia Power CEO and O&C committees as a mutually supportive effort at
constructive change.
Important differences between the companies and the critical public
policy juncture at which the electric utility industry finds itself
make it inappropriate for DRI to control federal relations for all
affiliates. One clear difference between the companies is DEI's business
interest as a non-utility generator that sells electricity to utilities
and Virginia Power's business as a utility purchaser of power from
entities like DEI. Federal legislation and regulatory policy have been
important definers of the relationships between such sellers and buyers.
If the interests of both sides were generally consistent, then there
would not likely have been the intense debate, and in some cases
acrimony, that has characterized the industry since the first days of
PURPA back in the 1970s.
Weakening the chain of utility vertical integration remains an important
cauldron of contention at the federal level. Some feel that retail
wheeling is imminent. Wholesale power sales had already been freed of
many traditional ratemaking structures and concepts before passage of
the Energy Policy Act. Federal policy now allows competition in the
generation business without what many considered to be PURPA's
artificial restrictions on ownership and control. The issues that will
define the business at this level for the next several years may add to
the divergence of interests between DRI's other subsidiaries and
Virginia Power. It will at least require them to develop differing
agendas at the federal level. This difference alone requires that
Virginia Power have substantial control over the establishment of its
federal legislative and regulatory priorities, strategies, and
communications.
It did not serve the objectives of Virginia Power to consolidate federal
regulatory relations at DRI. Severing the responsibility was a prudent
move, considering the nature of the relationships between the two
companies and the importance that the Commission places on the
independence and authority of Virginia Power.
10. THE CEO OF DRI HAS USED COMMUNICATIONS PATHS THAT UNNECESSARILY
COMPLICATE THE UTILITY'S MANAGEMENT AND OPERATIONS. (Recommendation
1)
The CEO of DRI excluded the Virginia Power CEO and others from
communications involving the utility. Virginia Power senior executives
reported frequent recommendations for action from the DRI CEO, under
circumstances that made it clear that he did not first discuss them with
the Virginia Power CEO. Moreover, on several occasions, the DRI CEO
bypassed the Virginia Power CEO on matters where the latter's likely
opposition to the requested action could be anticipated. Especially
under the latter circumstances, such bypassing undermines the authority
and independence of the utility to act through its own management to
remain responsible to the Commission for meeting public service
responsibilities.
This form of communicating can operate with reasonable effectiveness
under otherwise normal circumstances, even though it necessarily tends
to increase friction and adds efforts to assure
56
<PAGE>
common understandings among co-workers. At other times, however, it can
cause significant problems, as it has for Virginia Power in the case of
the CSXT rail rate dispute, for example.
Virginia Power and CSXT had been negotiating a rail rate dispute for
close to a year prior to April 1990. The dispute concerned the
application of a cost adjustment factor to rates in a contract between
the parties. Virginia Power had thoroughly researched the company's
position. It concluded that it had a strong position, but that it would
discuss concessions to CSXT if the carrier could show that the
application of the factor in question would cause it to suffer operating
losses on the contract (i.e., revenue insufficient to cover variable
costs). CSX did not offer the information needed to perform this
calculation.
Little progress was being made in the resolution of the dispute by the
spring of 1990. The soon-to-be-confirmed DRI CEO asked for a briefing,
which the president of Virginia Power does not recall being informed of
prior thereto. The Virginia Power director - fuel transportation,
manager - transportation, vice president - procurement, and senior vice
president - corporate services presented the briefing on April 30, 1990.
No actions were directed or suggested.
A second briefing was made by the Virginia Power director - fuel
transportation, manager - transportation, vice president - procurement,
and senior vice president - corporate services, again at the DRI CEO's
request, on July 24, 1990. The Virginia Power personnel presented an
analysis of the loss that the utility would suffer under CSXT's
then-current proposal. They estimated the loss to be very significant
over the life of the contract. The Virginia Power officials considered
the DRI CEO to be uninterested in the details of the situation. They
reportedly expressed the view that they could not justify any
concessions to CSXT, but that the DRI CEO nevertheless pressured them to
solve the issue through a contract negotiation that was fair to CSXT,
but not out of reason on the company's part. The DRI CEO subsequently
phoned the vice president - procurement about progress on settlement and
mentioned having spoken with a CSXT executive about the contract. Thereafter,
the DRI CEO dealt directly with subordinates of the utility's vice
president - procurement. The DRI CEO went successively down the Virginia
Power chain of command, after each person he contacted failed to
respond. The Virginia Power CEO typically did not know of these contacts
with Virginia Power employees until after they were made.
Virginia Power and CSXT settled the dispute on June 10, 1991. Virginia
Power personnel consider the concessions to CSX to be one-sided, and to
be the result of pressure from DRI to settle the dispute over the cost
adjustment factor. Two months after the time of the settlement, Virginia
Power estimated the value of concessions made by CSXT. Those
contemporaneous estimates substantially offset the increased costs to
the electric company for its concessions to the railroad on the cost
adjustment factor. Virginia Power personnel believe that their
estimation of the benefits to the electric company from accepting CSXT's
proposal were overly optimistic and speculative at the time they were
made.
These circumstances evidence an attempt by DRI to influence Virginia
Power's response to a utility matter. Moreover, that matter has
significant utility cost-of-service implications. Virginia Power's
transportation personnel had carefully analyzed their contractual
position, had retained qualified expertise to assist them in doing so,
and had adequately surveyed companies in similar positions. Virginia
Power had also taken a posture in negotiating with CSXT that was
57
<PAGE>
reasonable under the reported facts. Virginia Power expressed a
willingness to consider changes in the event that the action by the ICC
caused CSXT to lose money under the contract at issue.
It is not improper for senior executives of two companies in a dispute
to talk directly with each other, in order to resolve an impasse.
However, the DRI CEO sent a message that Virginia Power employees
understandably read to mean that he was more interested in a settlement
than he was in the merits of the Virginia Power position. He also excluded
the most senior Virginia Power executives from his efforts. He made
inquiries during the negotiations at a number of different times and
levels, which created the impression of a strong and personal interest.
His means of addressing the problem had the natural effect of causing
Virginia Power employees to believe that they should make concessions
beyond those that they felt were justified by their analysis of the
business and legal aspects of the problem that they faced with CSXT. In
fact, they did make such concessions and they also produced estimates of
benefits of the settlement that they considered at the time to be both
speculative and unduly optimistic.
The DRI CEO should have recognized that the nature and content of his
communications, combined with his apparent lack of interest in the
particulars of the work that Virginia Power had undertaken to analyze and
resolve the dispute, were very likely to affect not only the speed of
resolution that he nominally sought but also the quality of it.
11. THE LACK OF EFFECTIVE PLANNING BY DRI MAKES IT UNCLEAR WHETHER DRI'S
PLANS, GOALS, AND OBJECTIVES ARE CONSISTENT WITH VIRGINIA POWER'S.
(Recommendation 6)
DRI has not in the past articulated its strategic plans. Goals have
characteristically been financial in nature. The CEO has professed a
lack of support for detailed strategic planning, describing DRI's
strategy as one of "pragmatic opportunism." In response to Liberty's
interim report, DRI has agreed that both companies should engage in
strategic planning, and that both companies should review, comment on,
and otherwise coordinate their planning efforts. DRI has begun the
process of developing a strategic plan for the holding company, and has
indicated that its efforts will be coordinated with those of Virginia
Power.
Virginia Power is engaged in a major strategic planning exercise, which
it calls Vision 2000. The Company has made major progress in this
effort. It is preparing now to begin some of the baseline steps that its
has identified as being necessary to position the utility to succeed in
a more competitive environment. The companies will have to decide how to
handle areas of potential overlap and inconsistency; e.g., which of them
will pursue opportunities that both feel capable of pursuing and that
fit the vision that each has for its own future, or where Virginia
Power's generating assets should be located if splitting generation
becomes prevalent in the industry.
12. VIRGINIA POWER IS NOT RECOVERING THE COST OF PERSONNEL TRANSFERRED
TO DRI AND THE NON-UTILITY AFFILIATES. (Recommendation 7)
Virginia Power provides a large pool of specially trained and
experienced personnel, and the Company's customers have borne the cost
of developing this group of skilled people. DRI and the non-utility
affiliates are able to hire Virginia Power employees whose value has
already been been proven, who are available when the need arises, and
for whom no recruiting or training costs are required. These
circumstances produce direct savings of costs that would apply for
external
58
<PAGE>
hires. Virginia Power, on the other hand, not only loses a functioning
resource, but must also bear the cost of recruiting or training any
required replacement for the transferred employee. These are the same
costs that the acquiring affiliate has avoided.
There may be cases where Virginia Power benefits by transferring to DRI
an employee that is no longer required. Virginia Power can avoid
outplacement expenses and severance payment in these cases. There would
be no monetary harm to the company as it would not have to replace these
employees.
Effective January 1, 1995, the Virginia Power human resources staffing
and development department began work with DRI human and administrative
resource department to establish procedures by March 15, 1995. There has
been one transfer between the entities as of February 17, 1995.
Effective February 1, 1995, one DRI employee transferred to Virginia
Power's North Anna Power Station.
C. RECOMMENDATIONS
1. ELIMINATE ANY DIRECT REPORTING BY VIRGINIA POWER'S OFFICERS TO ANY
DRI OFFICER OR TO THE JOINT COMMITTEE. (Conclusions 1, 2, and 10)
This recommendation is designed to assure that Virginia Power officers
are accountable fully and solely to the Virginia Power board of
directors. The means for assuring that accountability is to make all
reporting of Virginia Power officers through the Virginia Power board of
directors. Section Two of this report, which addresses corporate
governance, addresses the board-to-board aspects of the joint committee.
It also addressed the ability of the DRI board to exercise its proper
role with respect to Virginia Power through the board of Virginia Power.
Implementing this recommendation will assure Virginia Power's executives
that they can rely upon the fact that their activities will undergo the
same kinds of oversight that their peers in the industry experience.
These assurances are material to allowing Virginia Power to attract and
retain the most capable and experienced executives cost effectively. It
will also place in the hands of those executives the power and
discretion that companies like Virginia Power need to delegate to
management to be effective. Otherwise, it is reasonable to expect that,
on a long-term basis, senior executive incumbents and candidates will
view employment at Virginia Power to be inferior in this particular
respect. Continuance of the dispute will moreover produce a strongly
undesirable work climate, which will encourage turnover and discourage
capable replacements. Virginia Power is one of the country's largest and
best known utilities. It should be able to attract the best candidates
available. Whether it will be able to do so will depend very much on the
extent to which those candidates consider the executive team of the
company to be fully empowered, as compared with its peers.
2. ASSURE THAT VIRGINIA POWER'S BOARD RETAINS SOLE AUTHORITY OVER THE
SELECTION OF UTILITY OFFICERS. (Conclusion 3)
59
<PAGE>
That authority should be exercised on the basis of what is best for
management and operations of the utility. It should not be constrained
by a need to make what concessions are necessary to support a perceived
need for definitive, immediate action. It seems clear that what is best
for management and operations of the utility in the long run is in the
interests of DRI, particularly if short-term actions continue to raise
substantial concerns about compliance with the conditions of the 1986
Order. It is logical to assume that continuation of uncertainty about
such compliance is itself one of the most, and perhaps the most
significant threats to shareholder value.
3. REQUIRE COMMISSION APPROVAL FOR DRI TO PERFORM ANY MORE SERVICES FOR
VIRGINIA POWER. (Conclusions 4 and 9)
Section Four of this report, which addresses affiliate service
arrangements, notes that it can be argued that additional DRI services
can be provided without prior Commission consent. Even if the consent
order were to be construed to bar them, its protections end in 1996. The
1986 Order should be changed to require Commission approval of any
services beyond what is currently provided or limited by the Commission.
This constraint should not apply merely to categories of services, but
to specific services.
Moreover, Virginia Power should remain solely responsible for
determining how it manages and operates its legal services function. There
is certainly merit in continuing examination about the structure and
resources used to serve Virginia Power in this important area. However,
the most significant aspect of the matter for purposes of this study is
that Virginia Power in control and authority over that examination.
Improvement opportunities may or may not exist. However, there can be
little doubt that marginal improvements in costs or service quality are
less significant than is the need for Virginia Power to remain secure in
the knowledge that, as the client, it remains responsible for managing
relationships with those who serve its interests.
Virginia Power should also continue its current efforts to internalize
its federal regulatory relations function.
4. PLACE VIRGINIA POWER FINANCIAL OFFICERS FULLY IN CHARGE OF UTILITY
SHORT TERM FINANCING, LINES OF CREDIT, REVOLVING CREDITS, AND ALL
cash management services, without any prior constraint to jointly
NEGOTIATE FINANCING STRUCTURES WITH DRI AND THE NON-UTILITY ENTITIES.
(Conclusion 7)
This recommendation will ensure that least cost to Virginia Power is
sufficiently emphasized.
5. TEMPORARILY PROVIDE AN EXPERIENCED, DRI FINANCIAL MANAGEMENT EMPLOYEE
AND A FINANCIAL ADMINISTRATIVE EXPERT TO VIRGINIA POWER, IN ORDER TO
AID IN THE TRANSITION OF THE LONG-TERM FINANCING FUNCTIONS.
(Conclusion 8)
Make them jointly accountable and responsible with the Virginia Power
financial officers for making the transition of the financing functions
occur smoothly.
6. ESTABLISH DRI STRATEGIC PLANS AND DERIVE GOALS AND OBJECTIVES FROM
THESE PLANS. (Conclusion 11)
60
<PAGE>
Unless it does so, and unless tactical plans are shared, it is
impossible to determine whether DRI or its non-regulated subsidiaries
are supportive of or counterproductive to Virginia Power's goals and
objectives. Virginia Power should have the opportunity to review the
strategic plans, goals, and objectives of DRI and of its non-regulated
affiliates, and to provide constructive feedback to DRI. This linkage is
necessary if Virginia Power is to protect its interests and fulfill its
public service obligations to provide efficient and reliable service.
Virginia Power will be better situated to accomplish this only if it has
an opportunity to provide constructive feedback to other DRI affiliates
about potential adverse consequences to Virginia Power of their plans or
intended actions. This recommendation is consistent with the
expectations that the February 28, 1995 resolutions state about
planning.
7. COMPENSATE VIRGINIA POWER FOR THE COSTS OF NET EMPLOYEES TRANSFERRED
FROM THE UTILITY. (Conclusion 12)
It is impracticable to trace individual transaction costs, which may be
reflected in indirect areas, such as training and development or
temporarily decreased efficiency as new job skills are learned. Such
impacts can occur at management levels removed from the source of the
transfer, if the organization draws upward to replace the gap. The best
means to capture costs is to use the 25-35 percent of annual salary that
search firms typically charge for their services. This approach reflects
the value that the providing organization offers, which is a pool of
identified and available talent. The fees charged are also a rough proxy
for costs, presuming that search firms overall must price their services
at a level that does not exceed the costs that the client would bear by
performing replacement services directly. There are some benefits to the
providing employer in cases of intercompany transfers. Therefore, use of
the low end of the range of fee percentages is appropriate as the basis
for determining the costs to be assigned to such transfers.
The companies have agreed to a procedure under which each would
compensate the other for transfers, at the low end of Liberty's
recommended range. This procedure should not apply to any transfers that
return to Virginia Power any utility-related functions deemed more
appropriately to be performed by the utility itself.
61
<PAGE>
IV. AFFILIATE SERVICE ARRANGEMENTS
A. BACKGROUND
The 1986 Order imposed conditions on the interchange of services and the
transfer of costs between Virginia Power and DRI. The provisions of the
Order and of Virginia Code (Section Mark)(Section Mark)56-76, et seq.
require Commission approval for transactions between affiliates. The
1986 Order generally seeks to minimize transactions and operational
relationships between the companies. DRI and Virginia Power have created
largely separate executive management and support organizations in response to
that order. Virginia Power and its affiliates share a lower level of
common services and interaction than is often true of similar companies
that have combined utility and non-utility operations.
This section presents Liberty's findings, conclusions, and
recommendations with respect to compliance with the affiliate
transaction aspects of the 1986 Order and of the Commonwealth's
affiliate transaction statutes. It also addresses the assignment and
allocation of costs and benefits from affiliate arrangements. It
examines the effectiveness of centralizing services at DRI, as well.
There are many agreements between DRI and Virginia Power. They include:
PUA820002 - Transfer of oil and gas rights to Dominion Energy
In 1983, Virginia Power granted oil and gas rights to Dominion Nuclear
on several parcels of Company-owned land in Tucker and Grant Counties,
West Virginia. In 1987, the rights were transferred to Dominion Energy.
These rights, outlined in agreements entitled "Deed of Bargain and Sale
with Royalty" allow Energy to perform all activities related to the
production of oil, gas, gas condensate, gas distillate, etc., that lie
within a specified tract of land. According to the agreements, Energy
also has the right to lease the land to a third party for oil and gas
purposes.
The payment to Virginia Power for these rights, more commonly called the
royalty, were to equal one-eighth of the market price of all oil and gas
produced and saved from the land, or delivery of one-eighth of the total
production to Virginia Power for its own use. A royalty payment of
one-eighth of total production is considered standard in the oil and gas
industry for properties with marginal reserves.
PUA830051- Approval of the Intercompany Credit Agreement
The Commission's October 31, 1983 order approved DRI's provision of a
short-term commercial paper sales capability to Virginia Power. Under
this program, DRI would issue commercial paper and lend the proceeds to
its subsidiaries, for periods of up to 18 months. Payment to DRI would
be at its actual borrowing costs, plus the actual expenses and costs
involved. This agreement is discussed more fully in Section Five of this
report.
62
<PAGE>
PUE830060 - The 1986 Order approved the Cost Allocation and Service
Agreement (CASA), which describes the services that Virginia Power and DRI
are permitted to provide to each other, and which sets forth the basis
for charging for those services. This agreement and the specific
policies and procedures that implement it are the most significant
reference documents for examining affiliate service arrangements. They
govern how most of the costs transferred among companies are determined
and allocated. CASA and its subsidiary documents comprise the major
focus of this section of the report.
PUA850036 - Authority for Virginia Power to assign its One James River
Plaza lease to DRI
This order approved the assignment of Virginia Power's third-party
lease, with slight modifications, to DRI.
PUA850053 - Authority to enter into agreements with Sovran Bank
This order approved a Virginia Power request to enter into a line of
credit agreement with Sovran Bank, N.A. and Sovran Financial Corporation
of Richmond, Virginia. Sovran Bank was deemed an affiliate interest,
because of common membership among the respective companies' board of
directors.
PUA860043 - Authority to allow Virginia Power to sell real estate to
affiliates
This order approved real estate transactions between Virginia Power and
DRI. In 1986, Virginia Power sold four properties to Capital and one to
DRI. In 1987, the Company sold a sixth parcel to Lands. The parcels,
which were deemed no longer useful to the public utility business, sold
for a total of $8,850,786. Two independent appraisals were performed on
each parcel, and the Company was paid book value plus one half the
difference between book and appraised value.
PUA870039 - Authority to extend and amend Inter-Company Credit Agreement
with DRI
The Inter-Company Credit Agreement with DRI gives Virginia Power the
capacity to borrow up to $100 million. The Intercompany Credit Agreement
also allows Virginia Power to share up to an additional $200 million of
short-term borrowing capacity that is assigned to the DRI non-utility
businesses, if it is available from them.
PUA870059 - Authority to transfer utility assets to DRI
This order approved Virginia Power's transfer of office equipment,
furniture, and automobiles to DRI. The value of and payment for the
assets was based on Virginia Power's net book value and totaled $737,071.
PUA870070 - Approval to transfer utility assets to DRI
This order approved the sale of certain Virginia Power office equipment
and furniture to DRI at book value. Book value of the assets was
$11,651. Original cost was $13,743.
63
<PAGE>
PUA870074 - Approval of supplement to affiliate agreement with DRI
This order approved a supplemental agreement to the Virginia Power-DRI
Affiliates Agreement, which had been approved in Case No. PUA830060.
This supplement detailed additional services that were to be provided to
DRI by Virginia Power, including engineering, project management,
construction, environmental and operating personnel and facilities to
enable DRI to evaluate and participate in cogeneration projects outside
of Virginia Power's service territory. Services were to be limited to a
two year period and total costs were not to exceed two million dollars
or twelve-person years in either twelve-month period.
PUA880038 - Authority to sell equipment and furniture to DRI
This order approved the sale to DRI of certain Virginia Power office
equipment, furniture, and an automobile that had been used by
transferred executives. Net book value of the assets was $38,234.
PUA920004 - Authority to provide services to Dominion Capital and to
participate in America's Utility Fund
Since the early 1980's, Virginia Power and DRI had been offering utility
customers a stock purchase program. Virginia Power had been providing to
DRI the remittance processing and data processing services related to
this investment program. DRI proposed in 1992 to extend that program by
also offering customers a diversified utility mutual fund called the
America's Utility Fund. This order approved the use of Virginia Power
remittance and data processing services in connection with the America's
Utility Fund.
PUA920019 - Authority to acquire a computer software package from and
enter into a license agreement with Tech Resources, Inc.
Virginia Power purchased from Tech Resources, Inc., an affiliate of
Dominion Energy SIC code modeling software for use in economic
development. Virginia Power's vendor search identified two software
packages that would meet its needs, and Tech's software was the less
expensive.
PUA930029 - Approval of an Inter-Company Transportation agreement
DRI purchased an airplane in 1993 for its use in conducting holding
company business and the business of its affiliated companies. The
Commission recognized that Virginia Power use of the aircraft may at
times be cost effective. This order outlines the allowable charges to
Virginia Power for its use of the DRI plane.
PUA940016 - Authority to extend employee financing program to DRI
employees and retirees
In June 1993 Virginia Power initiated an employee financing for energy
efficiency measures program, which provides interest free financing to
employees of Virginia Power for energy efficiency improvements to the
employee's home. This order approved the extension of that program to
employees and retirees of DRI.
64
<PAGE>
Most of these agreements comprised one-time asset transfers, have
expired, or have not been used. The principal agreements under which
significant costs and benefits flow are the CASA and the Intercompany
Credit Agreements. The last is discussed in detail in Section V of this
report. There is also an unexecuted tax allocation agreement between DRI
and its affiliates. This agreement, which covers the allocation of
federal taxes among the affiliates, was never submitted to the
Commission for approval. The impacts of this agreement are discussed in
Section Five of this report.
1. COST ALLOCATION AND SERVICE AGREEMENT
The 1986 Order noted that DRI would provide financial and general
corporate services to Virginia Power. It also prohibited Virginia Power
from providing services on behalf of or for the benefit of any DRI
subsidiary, except upon the prior approval of the Commission. The
Virginia Power services to be provided are limited to those specified in
the Cost Allocation and Service Agreement (CASA), which was approved, as
amended, by the order. Virginia Power may not acquire additional
employees or plant in order to provide services to DRI. The 1986 Order
also requires Virginia Power to file an annual report that provides a
narrative description of all transactions and a summary of charges by
month, transaction type and account number. DRI allocations to Virginia
Power must also be reported.
The CASA authorizes, limits, and prescribes the general cost provisions
for services from DRI to Virginia Power and from Virginia Power to DRI.
The CASA limits DRI services to financing, financial services, and
general corporate matters. The CASA specifies one of two methods for
charging for these services:
DRI SERIES CHARGING BASIS
General Corporate Allocation
Financial Management Allocation
Equity Financing Allocation
Banking Allocation
Investor Relations Allocation
Regulatory Filings Allocation
Shareholder Relations and Records Allocation
Preferred Stock Financings Direct Charge
Long-Term Debt Financings Direct Charge
Special Financial Consulting Direct Charge
The CASA states an expectation that DRI's charges will not be more than
what Virginia Power would have incurred otherwise. It states a
requirement that they be no higher.
65
<PAGE>
The CASA also specifies the services that Virginia Power may provide to DRI:
(bullet) Accounting: books of account and supporting records, financial
statements and reports, standardization of accounting methods,
procedures, and systems, and other accounting matters.
(bullet) Budgeting: budgets, forecasts, and other financial modeling
services.
(bullet) Taxation: tax returns and reports, tax law interpretations, tax
audit administration, tax payment, and related matters.
(bullet) Internal Auditing: books and records examinations and internal
control practices.
(bullet) Administrative Services: risk management.
(bullet) Regulation: forecasting and economic analysis, regulatory
analysis.
(bullet) Public Affairs: public relations and communications programs,
corporate contributions, community affairs.
(bullet) Personnel: benefits and pension program formulation and
administration.
(bullet) Procurement: contracting and transportation services.
(bullet) Information Services: management information services and
computer resources.
(bullet) Incidental Services: Other services whose costs in the
aggregate do not exceed five percent of the costs of other
allowed services.
The CASA requires billings at least monthly, with payment within 20
days.
The document titled Costs and Accounting for Affiliated Transactions
(CAAT) forms an appendix to the CASA. The CAAT provides for billing of
all services at cost, which includes a return component whose rate is
the last-approved Virginia Power overall rate of return. Directly
charged and allocated costs include the following components:
(bullet) Direct Charges: salary costs for direct labor and direct
expenses, which include transportation, expenses, materials and
supplies, publications and similar expenses specifically
incurred in performing direct or allocated services.
(bullet) Indirect Labor Charges: labor costs that cannot be directly
charged but that support labor that is directly charged or
allocated, on a work group (as opposed to a total) basis.
(bullet) Indirect Miscellaneous Charges: miscellaneous expenses that
cannot be directly charged but that support the direct or
allocated provision of services.
(bullet) Fringe Benefit Charge: payroll taxes and benefits associated
with directly charged or allocated labor.
(bullet) Equipment/Facilities Charge: depreciation, amortization, office
rents, property taxes and insurance, telephone and utilities
costs, allowed return, custodial and maintenance costs.
(bullet) Overhead Charges: incidental costs required for the existence
of DRI as a corporate entity and in support of direct services.
(Note that the description of these costs calls only for their
application to direct services, although the CAAT paragraph
introducing the descriptions of these six cost components
states that they apply to direct and to allocated costs).
66
<PAGE>
The CAAT then prescribes the basis for charging these costs in the case
of directly charged (as distinguished from allocated) costs:
(bullet) Direct Charges: on the basis of actual services rendered, as
recorded on time sheets.
(bullet) Indirect Labor Charges: in relation to the direct costs of
providing services to Virginia Power (e.g., if services to
Virginia Power account for 10 percent of total direct DRI labor
costs of particular work group, then 10 percent of the group's
indirect labor costs will be assigned to Virginia Power, and if
services to Virginia Power account for 5 percent of total
direct DRI labor costs of another particular work group, then 5
percent of that group's indirect labor costs will be assigned
to Virginia Power).
(bullet) Indirect Miscellaneous Charges: in relation to the direct costs
of providing services to Virginia Power (e.g., if services to
Virginia Power account for 10 percent of total direct DRI labor
costs, then 10 percent of indirect costs will be assigned to
Virginia Power).
(bullet) Fringe Benefit Charge: a single rate will be applied to all
direct and indirect labor costs (e.g., if DRI's fringe benefits
costs are 15 percent of its labor costs, then 15 percent will
be added to all direct and indirect labor costs to be assigned
to Virginia Power).
(bullet) Equipment/Facilities Charge: (e.g., if services to Virginia
Power account for 10 percent of total direct DRI labor costs,
then 10 percent of equipment and material costs will be
assigned to Virginia Power).
(bullet) Overhead Charges: a single overhead rate will be applied to
direct and indirect labor charges (e.g., if services to
Virginia Power account for 10 percent of total DRI direct and
indirect labor costs then 10 percent of DRI's overhead costs
will be assigned to Virginia Power). Note again that the
description of these costs calls only for their application to
direct services. These two expressions of limitation on
overhead charges appears to exclude them from being applied to
allocated direct labor charges.
The CAAT then provides for allocation of costs on the basis of an
allocator that averages the ratios of Virginia Power's total assets,
total payroll, and total revenue to those of all DRI companies taken
together (e.g., if Virginia Power's ratio of total DRI assets is 96
percent, payroll is 88 percent, and revenue is 86 percent, then it will
be allocated 90 percent of the costs of all those services that are
charged on an allocated, versus a directly charged, basis). There is no
provision in the CAAT for specifying how the five remaining categories
of costs, other than direct labor, are to be assigned for allocated
service costs. One must presume an intent to apply them in the same
fashion as they are applied to direct labor costs that are directly
charged. One exception to this inference may be overhead charges, which,
unlike other categories, were explicitly limited to directly charged
services in those earlier references in the CAAT. At the least, the CAAT
provides a confusing description of the means for charging the five
indirect categories of costs to allocated, rather than directly charged,
services.
The CAAT also provides a description of costs that are to be charged on
an allocated basis. This description is less inclusive than that provided in
the CASA and it uses somewhat different terminology than the CASA uses.
This CAAT description confuses the description in CASA and should
probably therefore be ignored in favor of CASA, which is clearly a
parent document to the CAAT.
67
<PAGE>
The CAAT establishes an important cost charging principle for Virginia
Power's benefit. It provides that Virginia Power should bear no costs
that it would not have borne in the absence of a holding company
structure. The CAAT expresses this standard as an overriding one, which
limits costs that could otherwise be charged through any of the six
components of costs allowed to be charged. Related CAAT-established
principles include:
(bullet) Precluding charges or allocations to Virginia Power for costs
associated with developing or managing other DRI business or
investments.
(bullet) Prohibiting allocations to Virginia Power for costs associated
with the temporary investment of funds where benefits are
retained by DRI.
(bullet) Providing that all costs that would be more appropriately
charged to another affiliate or retained will not be allocated
to Virginia Power.
(bullet) Retaining at DRI costs it incurs as part of corporate reorganization.
These four principles have imprecise dimensions, but it is clear that
they appear generally intended to construe doubt about cost
responsibility in favor of Virginia Power.
The final portion of the CAAT provides similar charging categories and
bases for services from Virginia Power to DRI.
2. CONTROLS
Virginia Power has provided numerous services to DRI without the prior
approval of or the annual reporting to the Commission at is required by
the third ordering paragraph of the June 30, 1986 Order. Most of these
services benefitted subsidiaries of DRI. The services, according to
Virginia Power, include:
(bullet) Transportation and lodging services to DRI and its non-utility
subsidiaries by Virginia Power's employee travel services, with
no charge for overhead costs.
(bullet) Internal audit services for the benefit of non-utility DRI
subsidiaries.
(bullet) Records retention program development for DRI and its
non-utility subsidiaries, with charges only for labor.
(bullet) Retirement benefits calculation and employee notification for
retiring DRI and non-utility subsidiary employees by Virginia
Power's benefit administration staff.
(bullet) Unbilled provision to Dominion Energy, Inc. (DEI) of technical,
cost, and load shape information about heat pumps, for marketing
purposes.
(bullet) Financial and economic data provision to DRI and non-utility
subsidiaries by Virginia Power's forecasting group.
(bullet) Unbilled weather forecasts to DRI and non-utility subsidiaries by
Virginia Power's air quality group.
(bullet) Unbilled environmental assessment services (concerning 12th
Street power station asbestos removal) to Dominion Lands, Inc.
(DLI) by Virginia Power's air quality group.
(bullet) Unbilled water pumping and discharge at 12th Street power
station for DLI by Virginia Power's water quality department.
(bullet) Unbilled technology assessment services as part of investment
analyses for DRI and DEI by Virginia Power's corporate
technical assessment department.
68
<PAGE>
(bullet) Unbilled power production training materials provision to DEI by
Virginia Power's fossil and hydro training division.
(bullet) Unbilled engineering review of technology of a firm seeking
venture capital from Dominion Capital, Inc. (DCI) by Virginia
Power's conservation department.
(bullet) Unbilled engineering review of technology of another firm seeking
venture capital from DCI by Virginia Power's conservation
department.
(bullet) Unbilled engineering review of technology for DCI by Virginia
Power's conservation department.
There was no request for prior Commission approval for any of these
services. None of these services was included in annual reports of
affiliate transactions. The companies' joint response to the December 1,
1994 interim report by staff and consultants made the following statements
about these services:
WHILE ALL OF THEM WERE UNREPORTED, AN ANALYSIS BEING PERFORMED BY THE
COMPANIES INDICATES THAT THE AMOUNTS INVOLVED WERE SMALL, THERE WAS
AUTHORIZATION FOR A NUMBER OF THEM, AND PAYMENT WAS MADE IN MANY CASES.
A MEMORANDUM SUMMARIZING THIS ANALYSIS WILL BE FURNISHED TO THE
STAFF WHEN IT IS COMPLETED.
VIRGINIA POWER HAS ALREADY BILLED DRI, AND DRI HAS ALREADY PAID,
$77,857 FOR SERVICES MENTIONED IN THE VIRGINIA POWER INTERROGATORY
RESPONSE THAT SHOULD HAVE BEEN PAID FOR PREVIOUSLY AND REVIEW IS
CONTINUING TO DETERMINE IF OTHER PAYMENTS ARE REQUIRED.
The on-going Virginia Power study has determined that an additional $1,991
should have been billed to DRI, which would bring the total underbilling
to $79,848. Virginia Power provided the workpapers that showed how the
billable amounts for each of the above 14 items were developed.
Liberty also asked for procedures and guidelines that govern time
reporting. The response to that request provided information from the
Virginia Power corporate policies and procedures manual. The response
contained no time reporting instructions. DRI employee time reporting is
recorded on a weekly employee work diary. It includes a description of
the work activity and an appropriate account number. The account code
contains digits that classify the expense to one of DRI's cost pools:
retained, direct, allocable, or indirect. The DRI summary of inter-
company services, which is included within the intercompany billing
procedures, serves as the reference for deciding which account code to use
for a particular work activity. This document lists for each DRI
division a representative list of activities and the cost pools to which
they should be coded.
Virginia Power maintains a listing by department of project numbers
(akin to DRI's work activities) and associated suspense codes (akin to
DRI's account numbers). The suspense code determines the affiliate
(including Virginia Power) that will incur the costs. Employees
performing work for DRI list on the timesheet the appropriate project
number and the corresponding number of hours worked.
69
<PAGE>
Neither DRI nor Virginia Power was able to produce any documentation
that details the procedures that each uses to control and monitor
employee time reporting for services provided to affiliates. The issue
is not whether there is an auditable report trail of time reporting
results. Such a trail exists at both companies. Rather, the issues are
(a) to what extent controls are consistently applied to assure that time
performed on an affiliate service is actually reported and (b) whether
the hours actually reported represent the totality of time spent on the
activity.
Liberty requested all Virginia Power and DRI internal employee communications
that described the activities required for them to comply with the terms and
conditions of the 1986 Order. The companies were only able to produce one
memo, which came from the 1988 time period. This memo was the only
acknowledged correspondence to employees. Similar issues arose in the
internal audit report of DRI billing to Virginia Power for the 1992 year.
The auditor recommended * * * * * * * * * * * * * * * * * * * * * * * *
* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * * * * * * * * CONFIDENTIAL INFORMATION * * * * * * * * * * * * * *
* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * * * * * * * * A letter was distributed in 1994. However, it does
not fully address the needs that Internal Audit has found to exist.
3. OJRP LEASE
The 22-story, 445,700 square foot One James River Plaza (OJRP) has served
as Virginia Power headquarters since its completion in 1978. The company
supervised the design and construction of the $34.7 million project.
Virginia Power entered into a sale/leaseback agreement with a third
party, The James River Plaza Company, which purchased the land and
building after the construction was complete, and leased it to the
utility under a thirty-year lease.
The long-term, triple-net lease runs through the year 2010. It has four
5-year optional extensions. The annual base rent due on the property
during the primary term is equal to 8.62 percent of the total
construction costs, or $2,993,417 per year. This rent corresponds to
$7.97 per usable square foot, including real estate taxes. Operating
expenses on the building currently run $6.23 per square foot. They
bring the building's total costs to $14.20 per square foot. The rent
payment will drop to 4.75 percent of total project costs during the
optional five-year extensions. Virginia Power provides for all
maintenance and insurance on the building. The lease provides the
company with purchase options in the 21st through 26th years of the
primary term.
The James River Plaza Company sold the building to DRI in 1985. With the
approval of the Commission, Virginia Power's lease with the partnership
was assigned to DRI, and virtually all terms and conditions remained the
same. The Commission did, however, insist on a new condition that allows
Virginia Power to reduce the amount of space it leases in the building at
any time during the lease term, after a 180-day notice. The Commission
must be notified if Virginia Power intends to vacate space. Virginia Power
has not exercised its option to vacate a portion of the building,
although it has experienced significant work force reductions.
70
<PAGE>
Virginia Power did, however, perform limited reconfiguration at OJRP and
the Innsbrook Technical Center in 1990, in order to accommodate work
force reductions related to its activity resource review allocation
study. These rearrangements resulted in the termination of
downtown-Richmond leases that totaled approximately 70,000 square feet
and $1.1 million per year in rent payments. A portion of the remaining
staff from those leased sites was moved to OJRP, where space utilization
rates then improved.
A review of the number of Virginia Power employees housed at OJRP from
1989-1994 shows that progress occurred during the 1990 reconfiguration.
The early-1989 space utilization rate at OJRP, however, did not return to
the pre-1989 levels. The utilization rate at OJRP was 221 usable square
feet per employee. The rate was 240 after the 1990 reconfiguration. In
theory, had Virginia Power further reconfigured its building to return a
space utilization rate to 221 usable square feet per employee, it could
have vacated 2 of the 17 rentable floors in the building, even after
absorbing the staff from the Richmond lease terminations.
B. CONCLUSIONS
1. THE FLOW OF BENEFITS THAT DRI DERIVES FROM AFFILIATE SERVICE ARRANGEMENTS
IS SUBSTANTIAL AND THAT OF VIRGINIA POWER IS MINIMAL. (Recommendation 1)
Some of the services for which DRI charges Virginia Power are of
questionable value. DRI provides financial and corporate secretary
services that Virginia Power would otherwise have to provide for itself.
Financial services, however, have become much more limited after the
recent transfer of financial functions to Virginia Power.
DRI also charges Virginia Power for executive services. The CASA
specifically authorizes charges for general corporate and financial
management services. These authorizations are separate from those
authorizing services for equity financing, banking and investor
relations, and shareholder relations and records. Virginia Power's
executive organization looks much as a stand-alone utility's would be
expected to look. This conclusion is particularly true for general
corporate management and regulatory services. Minor exceptions to
Virginia Power's stand-alone look exist in the corporate secretary and
financial areas that are the subject of the separate DRI service
authorizations in these areas under the CASA. There are no apparent gaps
in functions or resources. Virginia Power would not require any significant
increase in internal resources if it were operating on a stand-alone
basis. Such self sufficiency is to be expected, given the separation
requirements of the 1986 Order.
This self sufficiency reveals the lack of substantial value that
Virginia Power receives for the executive services costs that DRI
allocates to the utility. Liberty has interviewed nearly all the
executives of DRI. None, except in the finance and corporate secretary
areas, acknowledges the performance of services for the utility, and all
note that the utility is structured to operate independently. Liberty
has found no substantial benefits to Virginia Power from these executive
services. Moreover, there is no sound basis for concluding that Virginia
Power secures higher quality or lower costs as a result of the
consolidation of those services that DRI does provide for it.
71
<PAGE>
These charges also raise significant problems under CAAT provisions,
which state (on page 5) that:
IT IS INTENDED THAT COSTS WILL BE CHARGED OR ALLOCATED TO THE POWER
COMPANY ONLY IF SUCH COSTS WOULD HAVE BEEN INCURRED BY THE POWER
COMPANY IF IT HAD NOT BEEN REORGANIZED AS PART OF A HOLDING COMPANY
SYSTEM.
Virginia Power believes that this criterion has not been met by two DRI
groups: Executive and Controller.
With respect to the Executive group, Virginia Power has stated:
IN PRACTICE, THE LEVEL OF EXECUTIVE GROUP EFFORT EXPENDED AND
CONSEQUENT COSTS, $1.5 MILLION IN 1993, DEPENDS UPON THE MANAGEMENT
JUDGEMENT OF DRI OFFICERS INVOLVE. THE REASON FOR CHARGING MANY OF THE
INDIRECT AND ALLOCATED COSTS BY THE EXECUTIVE GROUP TO VIRGINIA POWER
IS THE FACT THAT IT IS A SUBSIDIARY OF A CONSOLIDATED GROUP. WHILE
VIRGINIA POWER WOULD HAVE TO PERFORM CERTAIN OF THE FUNCTIONS, OTHER
EXECUTIVE GROUP CHARGES WOULD NOT BE INCURRED BY VIRGINIA POWER IF IT
WERE NOT A MEMBER OF A CONSOLIDATED GROUP.
With respect to the Controller's group, Virginia Power has indicated:
THE REASON FOR CHARGING THE ABOVE COSTS TO VIRGINIA POWER IS THE
FACT THAT IT IS A SUBSIDIARY OF A CONSOLIDATED GROUP. THESE COSTS
WOULD NOT BE INCURRED BY VIRGINIA POWER IF IT WERE NOT A MEMBER OF A
CONSOLIDATED GROUP.
VIRGINIA POWER CONTINUES TO PREPARE ITS OWN TAX RETURNS, PREPARES ITS
OWN FINANCIAL REPORTS THAT ARE FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION AND MAINTAINS ITS OWN FINANCIAL AND BUDGETING SYSTEMS.
DRI Executive charges to Virginia Power were $1.08 million in 1993. DRI
documents note that some of the charges under this category include
"direction" in the development of a common equity program for all DRI
entities. However, Virginia Power already pays over $3 million in costs
(most of them allocated) for the services of the DRI corporate
secretary, whose responsibilities include raising equity. There is no
basis for concluding that Virginia Power benefits directly or indirectly
from the $1.08 million charged to it. Moreover, it does appear that
Virginia Power would not bear these added costs in the absence of the
holding company structure. Public policy forms a separate part of
executive group charges. DRI charged Virginia Power $414,000 for public
policy services in 1993. The return of that function to Virginia Power in
1994 and its stand-alone capacity to handle its public policy functions
make future charges for these services inapt.
Financial charges from DRI to Virginia Power fall under the Controller
and the CFO categories. DRI charges to Virginia Power in those two
categories amounted to $1.8 million. The return of financial functions
to Virginia Power should sharply curtail these charges. For example, the
controller's charges should essentially disappear, inasmuch as they are
described in terms of consolidation functions (tax, accounting, and
planning). Consolidation would not be required in the absence of a
holding company structure. The CFO group charges largely apply to
functions that
72
<PAGE>
have been returned to Virginia Power. Therefore, there remains no sound
basis for allocating these costs to Virginia Power. Those costs that
remain should be identifiable to distinct and directly billable services.
Corporate secretary costs, which amounted to $3.1 million in 1993, fall
under the categories of corporate secretary, stock records, pension
investment, and human and administrative resources. The first three
categories represent functions that DRI has performed and will continue
to perform for all entities. Only the last should be expected to change
significantly. It should reflect a significant reduction because its
costs are charged as indirect costs. Thus, a reduction in direct and
allocated costs for other groups should produce a commensurate
reduction in costs from this group.
2. DRI AND VIRGINIA POWER HAVE NOT APPLIED SUFFICIENT PROCEDURAL CONTROLS
TO ASSURE THAT THE AFFILIATE SERVICE LIMITATIONS OF THE 1986 ORDER ARE
ROUTINELY APPLIED. (Recommendation 2)
There have been at least 14 occasions on which Virginia Power has
provided services to DRI in violation of the procedural and substantive
requirements of the 1986 Order. Virginia Power is appropriately
addressing the cost consequences of these particular instances
after-the-fact. However, assuming that such activities do not continue
requires procedural changes.
Virginia Power does apply some procedures to requests for services that
fall beyond those allowed in the 1986 Order. Two requirements from the
accounting and finance section of Virginia Power's 1993 corporate
policies and procedures manual require written requests:
WHEN AN AFFILIATED COMPANY REQUESTS A VIRGINIA POWER DEPARTMENT TO
PERFORM A SERVICE NOT SPECIFICALLY PROVIDED FOR IN THE SERVICES
AGREEMENTS, THE AFFILIATED COMPANY WILL SUBMIT A WRITTEN REQUEST TO
THE DEPARTMENT REQUESTED TO PERFORM THE SERVICE AND FORWARD A COPY OF
THE WRITTEN REQUEST TO: MANAGER, REGULATION SERVICES. REGULATION
SERVICES WILL REVIEW THE REQUEST TO DETERMINE IF THE REQUESTED SERVICE
CAN BE PERFORMED AS AN INCIDENTAL SERVICE AND NOTIFY THE APPROPRIATE
VIRGINIA POWER DEPARTMENT OF THEIR FINDINGS.
WHEN A VIRGINIA POWER DEPARTMENT REQUESTS AN AFFILIATE TO PERFORM A
SERVICE NOT SPECIFICALLY PROVIDED FOR IN THE SERVICE AGREEMENT, THE
DEPARTMENT REQUESTING THE SERVICE WILL SUBMIT A WRITTEN REQUEST TO
THE REGULATION SERVICES DEPARTMENT FOR REVIEW. REGULATION SERVICES
WILL REVIEW THE REQUEST TO DETERMINE IF THE REQUESTED SERVICE CAN BE
PERFORMED AS AN INCIDENTAL SERVICE AND NOTIFY THE REQUESTING
DEPARTMENT OF THEIR FINDINGS.
However, no procedures control the review of these work requests.
Virginia Power indicated that a Regulation Services attorney reviews the
requests. Regulation Services does not formally track work requests and
their subsequent disposition. Statements that Virginia Power and DRI
supplied in response to Liberty data requests illustrates this lack of
effective controls:
(bullet) "No records were maintained by DRI of the requests and their
subsequent resolution for intercompany services from Virginia
Power."
73
<PAGE>
(bullet) "No affiliate submitted a work request directly to the Manager -
Regulation Services during 1993 or 1994."
(bullet) "There is no listing of work requests ... to Virginia Power
from DRI and each affiliate."
(bullet) "Virginia Power does not maintain formal records of "requests"
for services from its affiliates."
Virginia Power did list the number of service requests it received from
affiliates, despite the lack of formal tracking of requests:
YEAR NUMBER OF REQUEST
1990 16
1991 47
1992 36
1993 41
1994 26
Total 166
Virginia Power stated that it declined to perform the requested services
on "at least ten occasions". Virginia Power apparently, therefore, did
perform services in response to most or all of the remaining 156
requests. Virginia Power's annual report to the Commission for 1993
includes no listing or discussion of these additional services. Liberty
was unable to verify whether Virginia Power billed DRI for these
services and which of these are currently ongoing. DRI and Virginia
Power also lack the formal time reporting procedures and guidelines that
are necessary for assuring proper charges to the entities who benefit
from the efforts of affiliates. The companies' joint response to the
interim report indicated that Deloitte and Touche (D&T) would perform a
special review of the DRI and Virginia Power intercompany billing
procedures. D&Ts final report indicated that, contrary to the information
provided to Liberty, DRI did (a) maintain a list of services requested
of Virginia Power final report and (b) provide for legal review for
concurrence with the Cost Allocation and Service Agreement and the 1986
Order. Specifically, D&T says:
IN ORDER TO DETERMINE THAT ALL SERVICES PERFORMED ARE CONSISTENT WITH
THE COST ALLOCATION AND SERVICE AGREEMENT, DRI REQUESTS SEMI-ANNUAL
LISTINGS OF ALL SERVICES THAT EMPLOYEES HAVE REQUESTED VIRGINIA POWER
PERFORM. THE LISTING IS SUMMARIZED AND FORWARDED TO A DRI VICE
PRESIDENT FOR REVIEW. THE SUMMARY IS ALSO FORWARDED TO RATE COUNSEL
CONCURRENCE THAT THE SERVICES PERFORMED ARE IN ACCORDANCE WITH THE
AGREEMENT AND THE ORDER. ACCOUNTING DOES NOT RECEIVE A COPY OF THIS
SUMMARY.
74
<PAGE>
The practices that D&T cites are appropriate as a declaration of future
intent; however, the information that the companies provided to Liberty
does not confirm them as a statement of historical practice. The D&T
recommendations included:
(bullet) An annual memo to employees stressing need for full time
reporting for affiliate work.
(bullet) A request for service form to be used for all service requests.
(bullet) Processing of requests through a single Regulation Services employee.
(bullet) Establishment of job numbers.
(bullet) Formal, documented request between officers for services
requiring Commission approval.
(bullet) Annual memo to supervisors stressing importance of assuring
proper coding of all costs for affiliate services.
(bullet) Annual department list of job numbers and service descriptions.
(bullet) Informing Accounting of new job numbers.
(bullet) Electronic controls limiting total costs to a job number.
(bullet) Budgets by job number or service, not by function.
(bullet) Monthly and annual comparisons between budgeted and actual costs.
(bullet) Forwarding all Regulation Services-approved requests to Accounting.
(bullet) Specific training for intercompany billings.
(bullet) Limiting special bill to incidental items.
(bullet) Charging recurring direct charges through suspense codes.
(bullet) Service request forms to monthly bills.
(bullet) Internal Audit review of disputed billings.
The companies responded to these issues in their joint response to the
December 1, 1994 interim report as follows:
THE COMPANIES HAVE ALREADY BEGUN TO DEVELOP AND IMPLEMENT CONTROLS,
TRAINING, RECORD KEEPING AND COORDINATION OF THE TYPES THAT LIBERTY
RECOMMENDS, AND THEY HAVE EMPLOYED DELOITTE & TOUCHE TO PROVIDE
LONG-TERM RECOMMENDATIONS FOR IMPROVEMENTS IN THEIR HANDLING OF
AFFILIATE TRANSACTIONS. IN ADDITION, SINCE DRI FURNISHES AFFILIATE
SERVICES TO VIRGINIA POWER, IT WILL, LIKE VIRGINIA POWER, APPOINT A
COORDINATOR TO ASSURE PROPER ESTABLISHMENT AND IMPLEMENTATION OF THE
NECESSARY CONTROLS AT DRI.
Virginia Power indicated that it agrees with all 15 D&T final report
recommendations to enhance controls over intercompany billing and that
it will implement 14 of them. One recommendation is awaiting the results
of a cost-benefit study. The D&T report also included 16 recommendations
that were designed to enhance DRI controls over intercompany billing.
DRI has implemented six of the recommendations. Liberty was not provided
information on DRI's response to the remaining ten recommendations.
The joint response also agreed with the interim report's recommendation
that Virginia Power customers not be responsible for transaction costs
that arise from affiliate transaction control procedures. They cited the
"stand alone" standard in support of this agreement. DRI indicated that
all such costs will be categorized as retained costs, which are not
subject to affiliate cost
75
<PAGE>
allocation. Virginia Power indicated that any of its incremental costs
will be accumulated and charged as a non-operating expense.
The intentions that the companies have expressed to date satisfy most of
the concerns about establishing proper controls over affiliate
transactions. However, DRI's intentions with respect to the remaining
ten D&T commendations are not yet clear.
3. THE PROVISIONS AND DRI'S IMPLEMENTATION OF CASA AND CAAT ARE
CUMBERSOME, CONTRADICTORY, AND UNSUITABLE FOR ASSURING APPROPRIATE
CHARGES TO VIRGINIA POWER. (Recommendation 3)
The CAAT reaffirms that preferred and long-term debt financing and
special financial consulting work are the only services for which DRI
will directly change (as apposed to allocate costs to) Virginia Power.
DRI's intercompany billing procedures document significantly expands the
list of CASA- and CAAT-authorized services for which direct charges from
DRI to Virginia Power are allowed. Liberty reviewed the activity
analysis by DR division. That review revealed numerous directly charged
activities that go beyond those delineated in the CASA and CAAT.
The CAAT also lists additional services that DRI is authorized to
perform on behalf of Virginia Power on a basis where costs cannot be
directly assigned. It states that these costs will be allocated to
Virginia Power under the three-part allocation factor. The CAAT
identifies only two DRI divisions (Corporate Secretary and the Chief
Financial Officer) that may provide the services whose costs will be pro
rated to Virginia Power. The CAAT fails to cite general corporate and
financial management services, even though the CASA provides that costs
for these services are to be allocated.
DRI's intercompany billing procedures document identifies four cost
pools: retained, allocable, indirect, and direct. The allowed DRI
services from the Corporate Secretary and Chief Financial Officer
divisions, which are identified as resulting in a pro-rata cost
allocation to Virginia Power, are inappropriately defined as a "direct"
cost pool. Other activities of these departments result in "allocable"
and "indirect" costs to Virginia Power. However, neither the CASA or
CAAT defines the inclusion of nor allows the assignment to Virginia
Power of indirect or overhead costs associated with the services being
allocated on a pro-rata basis. Moreover, it is illogical to allow for
adders on directly charged direct labor costs, but not to allow them on
allocated direct labor charges. Nevertheless, CASA and CAAT may be read
together as requiring this anomalous result.
Attachment 2 of Virginia Power's 1993 Annual Report of Affiliated
Transaction (Annual Report), filed in March 1994, details the services
that DRI provided to Virginia Power in 1993. The Executive Group is
listed as providing "... financial expertise and special financial
consulting work. These costs are billed ... on a direct services
rendered basis." Neither the CAAT or CASA identify "management
expertise" as an allowable direct billed service from DRI to Virginia
Power. The stated DRI service "special financial consulting work"
conforms to the words from the CASA; however, DRI's intercompany billing
procedures, Appendix 1: "Executive - Summary of Intercompany Services",
does not list this activity as a "direct - Virginia Power activity.
Therefore, the tenant of this activity in the Annual Report appears to
have no foundation in the procedures. The Executive Group listing goes
on to identify
76
<PAGE>
another service to Virginia Power as officers of DRI represent the
consolidated entity at several civic boards and committees to enhance
and promote public relations." This activity is not identified as an
allowable billable activity in either the CASA or the CAAT. Moreover, it
is also true that Virginia Power officers conduct such activities. There
is no rational argument that they are any the less acting spokesmen or
representatives for all of DRI at those times. Thus, such charges not
only are not allowed by CASA and CAAT; they are not soundly or
consistently applied.
The Controller group (tax, accounting, planning) description of services
provided to Virginia Power shows none that require direct assignment,
yet a review of DRI's billing to Virginia Power reveals that the
Accounting and Planning departments have directly assigned labor
dollars. A review of the activities identified as "direct" in the
intercompany billing procedures reveals only one item,
"financial/project analysis", that would correlate with CASA's listing
of services allowed to be directly billed.
The Annual Report's description of the Chief Financial Officer's
division states that "costs incurred by the Legal, Assistant Treasurer
and Investor Relations divisions are billed to the affiliates primarily
as allocable costs." A view of DRI's intercompany billing procedures
lists for this division several activities that are directly assigned to
Virginia Power. All of those activities, however, are related to the
allocated billing activities that are described in the CASA.
The Annual Report indicates that the Corporate Secretary costs are
allocated "... on each Company's pro rata share of equity received."
However, an examination of billing reports from DRI to Virginia Power
indicated direct labor charges, which is contrary to the Annual Report.
The Annual Report also states that the Pension Investment division
charges are billed to affiliates based on the basis of their pro-rata
share of employees. A review of DRI billings to Virginia Power indicates
that, contrary to this provision, direct labor billings from this
division to Virginia Power occur.
DRI has misinterpreted the CASA and CAAT's definition of direct and
allocable costs. Moreover, there exists an inconsistency between DRI's
intercompany billing procedures' intercompany services definition and
Attachment 2 of the Annual Report, which lists services provided by DRI
to Virginia Power.
According to the CAAT, indirect costs are to be allocated on the basis
of corresponding direct costs (e.g., salary and expenses). A reasonable
interpretation of this standard is that the indirect costs incurred by a
DRI division should be allocated among affiliates based on the direct
costs incurred by the division for each affiliate. DRI does not use an
indirect allocation factor for each DRI division.
4. INADEQUATE ATTENTION IS GIVEN TO VERIFYING THAT THE FIVE PERCENT
LIMIT ON INCIDENTAL SERVICE TO DRI IS BEING MET. (Recommendation 4)
The 1986 Order limits the miscellaneous service category to 5 percent of
all other billings by Virginia Power to DRI for services. The CASA
reinforced this limit; however, it refers to the services as incidental:
77
<PAGE>
INCIDENTAL SERVICES - IN ADDITION TO THE FUNCTIONS DESCRIBED ABOVE,
THE POWER COMPANY WILL FURNISH SUCH INCIDENTAL SERVICES AS MAY BE
MUTUALLY AGREED UPON, BUT LIMITED IN THE AGGREGATE TO FIVE PERCENT
OF ALL OTHER SPECIFIED SERVICES.
Virginia Power's definition of incidental services provides no
delineation of them. Moreover, Virginia Power's monthly bills to DRI
show no line item titled either "incidental services" or
"miscellaneous billing." There is, however, a so called "special bill"
line item. Virginia Power stated that the "special bill" line item does
not cover "incidental/miscellaneous" service. However, a review of
Virginia Power's intercompany billing procedures reveals the following
definition:
THE SPECIAL BILL CONSISTS OF PAYMENTS MADE Y VIRGINIA POWER FOR THE
BENEFIT OF THE OTHER AFFILIATES, I.E., ALL EXPENDITURES NOT INCLUDED
IN THE SERVICE BILL. THESE COSTS ARE USUALLY THOSE EXPENDITURES
DESCRIBED IN THE INTERCOMPANY AGREEMENT AS 'INCIDENTAL'.
Liberty reviewed the 1993 annual report to the Commission, in order to
ascertain if any documentation of Virginia Power's
incidental/miscellaneous billing was provided and whether there was any
discussion of Virginia Power's compliance with the 5 percent limit.
5. THE PROPRIETY OF CHARGE-BACK BILLING TO VIRGINIA POWER FOR CERTAIN
ITEMS BILLED BY VIRGINIA POWER TO DRI CANNOT BE ADEQUATELY CERTIFIED.
(Recommendation 5)
Section B of the CAAT states with respect to Virginia Power overhead
charges that are authorized for billing to DRI the following:
A PORTION OF THE COSTS DESCRIBED ABOVE WILL BE ALLOCATED TO THE POWER
COMPANY, WHERE APPROPRIATE, ALTHOUGH THERE WILL BE INSTANCES IN
WHICH SUCH COSTS WILL BE APPROPRIATELY ABSORBED BY DOMINION
RESOURCES AND NOT ALLOCATED TO ANY AFFILIATE.
DRI charges some of these costs, which Virginia Power has charged to
DRI, back to the utility as a "chargeout." The term is formally defined
in DRI's intercompany billing procedures:
CHARGE-OUTS - CHARGE-OUTS ARE COSTS INCLUDED ON DRI'S BILL TO THE
POWER COMPANY WHICH WERE ORIGINALLY CONTAINED ON THE POWER COMPANY
BILL TO DRI. CHARGE-BACKS ARE PRIMARILY CHARGES FROM THE POWER
COMPANY'S INFORMATION SERVICES DEPARTMENT FOR COMPUTER SERVICES
PROVIDED TO THE STOCKHOLDER RECORDS DEPARTMENT OF DRI.
These "charge-out" expenses to Virginia Power are included in the DRI
billing line item called allocated costs. DRI computes separate labor
and expense "charge-out" cost pools. The labor charge-out cost pool
aggregates two items: (a) the direct labor that is billed by Virginia
Power's Information Services and (b) the Virginia Power Special Bill
entries for payroll, programmer analyst, and temporary services. The
expense charge-out cost pool aggregates the direct miscellaneous expense
and the direct fringe benefits that are billed by Virginia Power's
Information Services.
78
<PAGE>
Responses to three different Liberty data requests indicate that this
computation may not be accurate. One response indicated that a portion
of Virginia Power's Special Bill - Payroll change was associated with
incidental activities and not with Stockholder Records Services. Another
data request response provided specific project information associated
with Virginia Power's Special Bill - Payroll charge. A review of these
identified projects reveals several that would not be associated with
the DRI Customer Stock Purchase Plan (CSPP) or the Automatic Dividend
Reinvestment Plan (ADRP). In that regard, a third response stated that:
...BASED ON A JANUARY 19, 1995 CONVERSATION BETWEEN DRI AND
VIRGINIA POWER INTERCOMPANY BILL PERSONNEL, IT WAS DISCLOSED THAT A
PORTION OF THE PAYROLL CHARGES LISTED ON THE SPECIAL BILL ARE NON
CSPP AND ADRP CHARGES. THEREFORE, THE CHARGEBACK AMOUNTS FOR 1994
HAVE BEEN OVERSTATED. AN ANALYSIS IS BEING PERFORMED TO DETERMINE
THE AMOUNT OF THE OVERSTATEMENT. THE AMOUNT OF THE OVERSTATEMENT IS
ESTIMATED TO BE MINIMAL.
DRI and Virginia Power interpret the above-quoted statement from Section
B of the CAAT as referring solely to overhead charges:
DRI'S INTERPRETATION OF THE PARAGRAPH IS THAT DRI MAY RETAIN SOME
OF THE OVERHEAD CHARGES BILLED TO DRI FROM VIRGINIA POWER. ENCLOSED
IS A LIST BY MONTH OF VIRGINIA POWER'S OVERHEAD COSTS THAT WERE
BILLED TO DRI IN 1993 AND 1994.
VIRGINIA POWER BELIEVES THAT THE ABOVE QUOTATION FROM THE PUE830060
AFFILIATE AGREEMENT; ATT. A. APPENDIX I; PAGE 9 REFERS TO OVERHEAD
CHARGES BILLED EACH MONTH TO DOMINION RESOURCES BY VIRGINIA POWER
AS REFLECTED ON SCHEDULE 4. DRI RETAINS 100 PERCENT OF THESE
OVERHEAD CHARGES.
The CAAT paragraph discussing DRI retention versus charge-back of costs
does not limit itself to overhead charges. DRI and Virginia Power's
assertion to the contrary is incorrect. The context of the paragraph and
its structure make it clear that it refers to all six categories of
cost. The paragraph refers generally to Virginia Power's entire billing
to DRI. Moreover, if it does not apply to all six categories, then it
logically should in any event. DRI's and Virginia Power's position on the
meaning of this paragraph create doubt how charge-backs outside the
overhead charges area are treated.
Virginia Power was asked to provide documentation supporting its
statement that "DRI retains 100 percent of these overhead charges." The
response was:
THERE IS NO FORMAL DOCUMENTATION THAT STATES DRI RETAINS 100
PERCENT OF THESE OVERHEAD CHARGES. BASED ON CONVERSATIONS WITH DRI
PERSONNEL RESPONSIBLE FOR INTERCOMPANY BILLING AND DRI'S RESPONSE
TO DR 141, VIRGINIA POWER IS CONFIDENT THAT DRI RETAINS THESE
CHARGES.
79
<PAGE>
6. THE SCOPE OF INTERNAL AUDIT'S YEARLY AUDIT OF DRI BILLINGS TO
VIRGINIA POWER AND VIRGINIA POWER BILLINGS TO DRI IS NOT SUFFICIENT
TO ENCOMPASS A REVIEW OF COST ALLOCATION METHODS AND COMPLETENESS OF
EMPLOYEE TIME REPORTING. (Recommendation 6)
Liberty reviewed recent audit reports issued by Internal Audit related to
intercompany billings. Each audit report states the scope of work. For
the intercompany billings from Virginia Power to DRI audit, the scope
was defined as:
THE AUDIT OBJECTIVES OF THE 1994 AUDIT WERE TO REVIEW PROCEDURES
AND EXAMINE 1993 TRANSACTIONS FOR COMPLIANCE WITH PREVIOUSLY ISSUED
SCC ORDERS AND ASCERTAIN WHETHER THE SYSTEM OF INTERNAL CONTROLS WERE
EFFECTIVE AND FUNCTIONED AS INTENDED.
Likewise, the scope for the intercompany billings from DRI to Virginia
Power audit was defined as:
THE OBJECTIVES OF THE 1994 AUDIT WERE TO PROCEDURES AND EXAMINE THE
TYPES OF TRANSACTIONS FOR COMPLIANCE WITH THE ABOVE MENTIONED ORDER
AND TO ASCERTAIN WHETHER THE SYSTEM OF INTERNAL CONTROLS IS
EFFECTIVE AND FUNCTIONING AS INTENDED.
An examination of each audit's workplan reveals several deficiencies.
First,**********************************************************************
****************************************************************************
****************** CONFIDENTIAL INFORMATION ********************************
****************************************************************************
****************************************************************************
**********************************************************************.
Analyzing employee time reporting in this fashion does not address
whether the amount of tune charged is reasonable. The adequacy of the
amount of time reported can only be verified through interviews with
employees and analysis of contemporaneous work-effort documentation that
supports the time charges.
Audit testwork also did not adequately examine affiliate service work
requests that came to Regulation Services pursuant to the corporate
accounting procedures. Internal Audit does not examine the procedures
used by this group in determining that additional requested affiliate
services are allowable. Internal Audit also does not verify, on a
judgmental sample basis, that billing for these new services was
performed. Virginia Power has inferentially indicated that over 150
affiliate service requests were approved by Regulation Services since
1990. These requests should be subject to an audit review for proper
billing. The audits have not sufficiently examined the application of
controls on affiliate services.
Recent internal audit report recommendations have been few and not
particularly significant. There has been timely management response,
with one exception. A memo related to DRI employee billing of costs came
nearly two months }ate from a promised issue date, which itself was six
months after the audit report was issued.
80
<PAGE>
7. THE PROVISIONS OF THE 1986 ORDER, IF THEY ARE FOLLOWED, CONTINUE TO
PROVIDE AN EFFECTIVE MEANS FOR CONTROLLING AFFILIATE SERVICE
ARRANGEMENTS EXCEPT FOR THE ABILITY OF DRI TO EXPAND SERVICES TO
VIRGINIA POWER WITHOUT PRIOR APPROVAL. (Recommendation 7)
The provision for annual reports and the recommendation for audits
provides an effective review mechanism for monitoring compliance with
applicable guidelines and procedures. There is a relatively low level of
routine service sharing and interaction between Virginia Power and its
affiliates. The 1986 Order can be effectively used by the Commission to
regulate the level of services that are to be allowed. However, the CASA
now allows for DRI provision of general corporate and financial services
to Virginia Power. Such services are presently at low levels,
particularly since the return of financial functions to Virginia Power.
It may be argued, however, that the open-ended nature of the terms
general corporate and financial services would allow for a significant
increase in those things that DRI does for Virginia Power. That increase
could arguably be made without prior Commission review and approval
under the terms of the 1986 Order.
8. VIRGINIA POWER HAS NOT EXERCISED ITS RIGHTS TO REDUCE OFFICE SPACE
RENTAL COSTS UNDER A LEASE WITH AN AFFILIATE, DESPITE SIGNIFICANT
REDUCTIONS IN STAFF NUMBERS. (Recommendation 8)
The October 19, 1994 space utilization rate at OJRP was 294, which means
that the building currently has a significant amount of underutilized
space. In fact, four hundred fewer employees are housed at OJRP today
than were there in 1989. Virginia Power recognizes that it has more
space than it needs, especially after the latest work force reductions.
It has begun an analysis of potential reconfiguration of OJRP. It
expects to complete those analyses later in 1995 and to begin
re-packing, if warranted, in 1996. Successfully reconfiguring OJRP to
meet square feet per employee would allow Virginia Power to vacate a
maximum of nearly 90,000 square feet, which represents almost six
floors. The company's real estate planners estimate that a
reconfiguration would result in at most the vacation of just two floors.
These estimates do not appear to be consistent with 1988 experience,
because they would still leave a space utilization rate of 269 usable
square feet per employee.
A reconfiguration of OJRP is neither simple nor without expense. Efforts
required for a rearrangement would include, among others, removal and
installation of floor-to-ceiling walls and office cubicle partitions,
and relocation of furniture and business equipment. Relocation would
also cause disruptions among employees affected by the move. The company
estimates that one-time reconfiguration costs would be approximately
$100,000 per floor, or $1.7 million for the whole building.
Each floor that Virginia Power vacates and releases to DRI would reduce
expenses by approximately $215,000 annually. Virginia Power stated that
savings could potentially be increased by subleasing those floors
instead to commercial tenants.
Liberty believes that the cost benefits of a reduction of leased space
will warrant a reconfiguration of OJRP and the release of several floors
to DRI, as allowed under the current lease terms.
81
<PAGE>
C. RECOMMENDATIONS
1. ELIMINATE ALLOCATIONS TO VIRGINIA POWER FOR GENERAL CORPORATE
SERVICES AND FINANCIAL MANAGEMENT SERVICES. (Conclusion 1)
It is clear that DRI general corporate and executive services do not
benefit Virginia Power. There is no meaningful DRI executive interaction in the
affairs of Virginia Power. These services also impose on it costs that
it would not incur as a stand-alone company. Virginia Power has its own
executive officers and board of directors. They would not need to be
augmented by those of DRI in the absence of a holding company. These
services also involve holding company costs, which should not be borne
by Virginia Power under the CASA. The position of the DRI COO and the
need for various board committees and counsel to them and the boards
would not have arisen except for the existence of the holding company.
The annual reports of transactions for 1994 and beyond should contain
sufficient detail to allow these costs to be sufficiently identified to
ensure that they are retained by DRI.
DRI's role in providing financial services has also been greatly reduced
recently. That role now has dimensions that do not call for standing
allocations. Financial services should be charged on the basis of time
reporting. Direct charging is already required for preferred red stock
and long-term debt financings. Allocations for equity financing,
banking investor relations, and shareholder relations and records are
separately provided for under the CASA. There should be little in the
way of financial management services by DRI for Virginia Power.
Thus, the only renaming allocated costs should be for investor
relations, regulatory filings, and shareholder relations and records.
The cost allocations for these functions should include no indirect
costs or overheads for senior executives who manage them. Such costs
would by their nature involve costs for officers that Virginia Power
already provides for itself. Virginia Power officers have
responsibilities with respect to equity investors as well. DRI and
Virginia Power should retain their own senior executive time that is
applied to this activity. Moreover, the salary and the fringe benefits
categories for these persons should include no incentive compensation
that is tied to performance against DRI goals, because the financial
results of positive performance of their DRI functions does not benefit
Virginia Power.
2. ENHANCE CONTROLS OVER ARRANGEMENTS FOR SERVICES TO AFFILIATES.
(Conclusion 2)
There should be a more structured process for logging service requests,
for producing work orders for those requests that are granted, for
assuring proper requests to the Commission for any necessary approvals,
for training and communication about such controls, for recording all
time and expenses, and for assuring the recovery of fully allocated
costs. Virginia Power should have a coordinator to assure that these
controls are properly established and effectively implemented. The
companies should implement the recommendations of the D&T report.
Virginia Power has already committed to implementing these controls. DRI
has agreed to implement some, but has not yet decided about the majority
of them. These recommendations provide for a comprehensive means of
providing the necessary controls that have been lacking in the past. The
D&T recommendations will provide for substantial improvement in efforts
to comply with the 1986 Order.
82
<PAGE>
Virginia Power and DRI should provide annual certifications by each of
its officers that the annual reports to the Commission contain listings
of services that they believe to be complete, as respects their areas of
responsibility.
None of the costs of establishing and implementing these controls should
be borne by or allocated to Virginia Power. These costs are part of the
DRI transaction costs of doing business with Virginia Power. Virginia
Power should recover all those costs from affiliates in any event.
3. CHANGE THE CASA AND CAAT AND RESUBMIT THEM FOR COMMISSION REVIEW AND
APPROVAL. (Conclusion 3)
The documents need to begin from a revised baseline of allowed services
and must then provide for an internally consistent and appropriate
charging basis. DRI should provide a listing of current services to
Virginia Power. This listing should exclude executive, board, and
general corporate services, which Virginia Power would not require as a
stand-alone company or for which Virginia Power already has adequate
resources of its own. This revised listing should also exclude all
services that Virginia Power now performs for itself after the transfer
of finance functions back to the utility. Financial management services
shall be eliminated as an allocated service.
The remaining allocated services that are allowed should be limited to
equity financing, banking, investor relations, and shareholder relations
and records. Each DRI group and the individuals within those groups
involved in providing these allocated services should be identified. The
extent to which the members of those groups perform holding company or
non-utility services only should be identified, as should the direct
charges associated with those services. For example, any time spent by
the DRI corporate secretary on non-utility subsidiary governance should
be removed from the costs subject to allocation.
Payroll and revenues should be eliminated from the three part allocator.
These two factors have virtually nothing to do with causation of the
equity financing, banking, investor relations, and shareholder relations
and records services whose costs are allocated. Those services are much
more a function of relative asset values. This change alone would
roughly double the allocation of such costs to DRI, as compared with the
allocation under the three-part allocator.
Allocated charges for the categories for which direct charges are
required i.e., preferred stock financings, long-term debt financings,
and special financial consulting) should be clearly prohibited.
Moreover, there should be prior documented Virginia Power approvals for
all such directly charged services.
Direct labor charges that are directly billed and those that are
allocated should have the same adders (i.e., the indirect labor,
indirect miscellaneous charge, fringe benefit charge,
equipment/facilities charge, and overhead charge categories of the
CAAT). DRI generally does so now, but the CAAT as currently structured
does not appear to authorize this approach.
The companies should also adopt formal time reporting procedures. In
limited cases, pre- determined time allocations may be acceptable as a
substitute for daily employee time reporting if they are supported by
appropriate time studies.
83
<PAGE>
4. VERIFY IN THE ANNUAL AFFILIATE TRANSACTION REPORT VIRGINIA POWER'S
COMPLIANCE WITH THE FIVE PERCENT LIMIT ON INCIDENTAL SERVICES.
(Conclusion 4)
Virginia Power's billings to DRI and its annual affiliate transactions
report to the Commission should classify services by the CASA-allowed
areas (i.e., accounting, budgeting, taxation, internal auditing,
administrative services, regulation, public affairs, procurement,
information services, and incidental services). The categories of
billing cost (i.e., direct charges, indirect labor charges, indirect
miscellaneous charges, fringe benefit charges, equipment/facilities
charges, and overhead charges) should be shown separately for each of
the 10 allowed areas. Direct charges for each individual incidental
service should also be shown.
The annual report to the Commission should explicitly show that
incidental services comply with the five percent limitation and an
officer of Virginia Power should certify such compliance.
5. VERIFY THROUGH ANNUAL STATEMENTS AND CYCLICAL INDEPENDENT EXAMINATION
THAT CHARGE-BACKS TO VIRGINIA POWER AND RETENTIONS BY DRI ARE NOT
INAPPROPRIATELY ASSIGNED OR ALLOCATED TO VIRGINIA POWER. (Conclusion
5)
Virginia Power should annually verify that charge-backs and retentions
are handled in a fashion that assures no inappropriate flow-back to
Virginia Power. Charge-backs of costs from DRI to Virginia Power are appropriate
to the extent that Virginia Power benefits from the services that underlie
the charges. However, in no case should DRI continue to apply its
overheads to charge-backs. The services involved are supported by
Virginia Power, not DRI, resources.
The Commission should require independent examinations on a three-year
cycle. These examinations should use transaction analysis techniques to
trace costs to assure that intended retention and charge back methods
are followed sufficiently to assure no back-flow of costs to Virginia
Power. These examinations should be at company expense and should not be
charged to utility customers.
6. ESTABLISH EFFECTIVE AND COMPREHENSIVE ANNUAL COMMISSION REPORTING AND
AUDIT PROGRAMS FOR AFFILIATE TRANSACTIONS, INTERCOMPANY BILLINGS, AND
COMPLIANCE WITH 1986 ORDER REQUIREMENTS. (Conclusion 6)
Virginia Power should submit to the Commission an annual Internal Audit
report that addresses these matters. It should accompany the annual report
of affiliate transactions. Internal Audit should expand the scope of its
intercompany billing audits to ensure compliance with the 1986 Order
requirements and subsequent SCC directives and to test the
reasonableness of employee time charges to various service categories.
All Company responses to issues and problems identified in audit reports
should be filed with the Commission. Virginia Power should also provide
at its own expense for an outside examination and review of these
matters at intervals not in excess of three years.
84
<PAGE>
7. AMEND THE 1986 ORDER TO REQUIRE PRIOR COMMISSION APPROVAL FOR DRI TO
PROVIDE TO VIRGINIA POWER ANY SERVICES THAT IT IS NOT PROVIDING NOW.
(Conclusion 7)
This provision would eliminate any perceived blanket authorization to
perform broad categories of services. It would require a
service-by-service review by the Commission. This recommendation is the
same as that made as Recommendation 3 in Section Three of this report.
8. PREPARE A DETAILED PLAN FOR OJRP HOUSING THAT MINIMIZES SPACE USE TO
THE EXTENT THAT IS COST EFFECTIVE AND CONSISTENT WITH MODERATE SPACE
REQUIREMENT ASSUMPTIONS. (Conclusion 8)
This plan should apply 1998 space utilization rates as the standard.
Virginia Power should specifically justify any variance from that
standard that is required by the name of its space requirements now and
in the future. The study should be completed in time to permit
reconfiguration and space reduction in early 1996. The 180 day notice of
space reduction and rental reduction should be waived as necessary to
provide that any reduced rentals that would result after reconfiguration
will apply as of January 1, 1996. This waiver is appropriate in light of
the extended period of time over which excess space has been and will
continue to be in existence. This recommendation seeks to place Virginia
Power in a position that is similar to that which might have been
expected had the lease for its headquarters been with a third party whose
returns are not of consequence to Virginia Power.
85
<PAGE>
V. UTILITY/NON-UTILITY FINANCIAL ISSUES
A. BACKGROUND
The non-utility subsidiaries of DRI were essentially start-up businesses
in the mid-1980s. As is characteristic of start-up companies, these
businesses needed assistance from some credit source to obtain general
business credit. Certain of their other financings, however, could be
tied directly to assets or projects that provided the necessary lender
collateral. DRI has, for the most part, provided the credit support and
capital conduit for the various non-regulated businesses to become
established.
DRI's non-utility subsidiaries have received funding from five basic
sources: a) equity injections from DRI in exchange for common stock, b)
payments from DRI for the contribution of tax losses and credits to the
parent's consolidated income tax statement, c) debt financing with DRI
credit support, d) asset or project-backed, non-recourse debt financing,
and e) borrowings from DRI under the intercompany credit agreements.
1. DOMINION ENERGY FINANCING
Dominion Energy is a cogeneration, independent power production,, and
oil and gas company that operates on both a national and international
basis. The principal source of Dominion Energy power project financing
is non-recourse project financings. Energy has 17 power projects; the
company and its partners finance these projects primarily with a highly
leveraged financing structure, and with non-recourse project financing.
Non-recourse project financings depend on the cash flow and assets of a
specific project to provide security for creditors. The non-recourse
feature of such financings means that creditors of the project cannot
pursue other assets of the corporate entity, such as Dominion Energy,
should the creditors not be paid principal and interest on the project
debt. Such non-recourse financings shelter the Dominion Energy corporate
entity, and they protect DRI and its subsidiaries. Dominion Energy's
equity contributions to project-financed power projects (with the
exception of a hydro project in Argentina) are all that appear on the
financial statements of the subsidiary.
Dominion Energy's development has created the need for more generalized
capital facilities, such as term loans and revolving credit facilities.
Such financing facilities supplement operating lines of credit and also
act as stand-by facilities for immediate use, should an attractive
project become available. Energy's business focus in the l990s has been
placed more on the addition of oil and gas properties and less on power
projects; therefore, its need for term loans and revolving credit has
increased. The following table shows Dominion Energy's long-term debt on
the books as of year end for the years since 1986.
86
<PAGE>
DOMINION ENERGY LONG-TERM DEBT AT YEAR-END
Year Amount
1986 $0
1987 $0
1988 $0
1989 $25,000,000
1990 $28,500,000
1991 $42,500,000
1992 $250,429,000
1993 $319,381,000
Dominion Energy is, in effect, a double-leveraged company. Many of its
power projects are financed with project financing. The Company has also
acquired financing for its oil and gas projects and for company
operating needs. This combination effectively double-levers the interest
in power projects and oil and gas projects. Energy has obtained
financing through various bank credit facilities. For instance, Energy
has a $100 million revolving credit facility with Fuji Bank, which it
originally established in 1988. The original maturity of the revolving
credit was two years. Energy and Fuji Bank annually renew the revolving
credit for the following two-year period. The revolving credit, as of
late 1994, offered loans at variable rate pricing, such as LIBOR plus
***CONFIDENTIAL INFORMATION***, or a U.S. certificate of deposit rate plus
***CONFIDENTIAL INFORMATION***. The Fuji Bank revolving credit pricing
was very recently renegotiated to LIBOR plus ***CONFIDENTIAL
INFORMATION***. Energy also pays a non-utilization fee of
***CONFIDENTIAL INFORMATION*** for this facility. Energy uses the Fuji
revolving credit for short-term funding and for bidding on the
acquisition of projects.
Energy also has a $100 million term loan. Fuji Bank as the lead creditor
represents a consortium of seven banks. The term loan was made in July
1993 for a five-year period. The loan is amortized at a level of $5
million per quarter. The loan balance was approximately $75 million in
the fall of 1994. The interest rate for the term loan is also set at a
spread over LIBOR. The effective interest rate in late l994 was
approximately 5.25 percent.
Energy has a $55 million term loan with Long Term Credit Bank of Japan.
The term loan was made in 1989. This loan is Energy's only secured one.
The assets of an Enron/Dominion Energy joint venture company are tied to
this financing. The transaction is a qualified hedged transaction under
IRS regulations. Long Term Credit Bank of New York effectively lends to
Energy under a complicated set of exchange agreements. The loan
originally had an interest rate of approximately 10.13 percent, which
was negotiated in 1989. Energy and LTCB renegotiated to an effective
rate of 7.22 percent in 1993.
Energy also borrows funds from DRI under the intercompany credit
agreement, which was signed in October 1987. The borrowing limit for
Energy under this agreement is $150 million. DRI lends funds to Energy at
the holding company's cost (primarily for A2/P2 commercial paper) plus
expenses. Energy advises that the cost of funds from the intercompany
credit agreement and from the Fuji Bank revolving credit are
approximately equal.
87
<PAGE>
DRI has provided credit support for the required equity contributions of
Energy during construction of Energy power projects. For the Clear Lake
and Belize projects credit support from DRI remains in effect. Such
obligations usually end when project construction is completed and
permanent, takeout financing is arranged for the project. Liberty did
not review projects now in operations for previous credit support
provided by DRI.
The Fuji revolver, the Fuji term loan, and the LTCB term loan each
benefit from a DRI-to-Energy support agreement that relates specifically
to these financings. The creditors involved would not make loans
directly to Energy at the same terms and conditions if there were no
support from DRI. The larger portfolio of projects and a more steady
cash flow from 17 projects show that Energy's independent power business
and credit picture is maturing.
*************************************************************************
************************CONFIDENTIAL INFORMATION*************************
**************************************************. The addition of
Energy's oil and gas assets to the portfolio also places a drag on
credit quality. Oil and gas projects tend to be more risky, which makes
the total Energy portfolio somewhat riskier than those of some other
independent power producers.*********************************************
*************************************************************************
************************CONFIDENTIAL INFORMATION*************************
************************************************** .
2. DOMINION CAPITAL FINANCING
Dominion Capital is a financial services and financial investment
subsidiary of DRI. Dominion Capital (which also includes Dominion Lands
as of 1994) was valued on the books at September 30, 1994 at over $780
million. The key businesses of Dominion Capital are as follows:
(bullet) Rincon Securities. Rincon Securities is a self-contained
investment company that invests in utility and bank preferred
stocks. Rincon Securities was the first big investment of
Dominion Capital; the portfolio was purchased from Tucson
Electric Power for approximately $270 million in 1984. Rincon
Securities leverages its investments in preferred stocks by
funding a large percentage of the portfolio with debt
financing.
(bullet) The Vidalia Hydroelectric Plant. The Vidalia plant is a
hydroelectric power plant in Louisiana. Capital, as a partner
with Catalyst Energy, bought the project during construction.
Capital is a 50 percent limited partner with Catalyst. Catalyst
runs the project through the Great Lakes Power Corporation.
(bullet) Vidalia sale and leaseback agreement. Capital was a 10 percent
participant as lessor/owner in a sale and lease-back of the
Vidalia plant. In other words, Capital is a 50 percent equity
owner and a lender to the equity owners of the project.
Capital's partners in the sale and leaseback agreement are
Philip Morris and Mission Energy.
(bullet) Common equity portfolio. Capital owns a diversified common
equities portfolio that is managed by three portfolio managers
who are employees. A public common equity portfolio at January
11, 1995 had an acquisition value of approximately $101.7
million.
88
<PAGE>
The market value of this portfolio as of the same date is estimated at
$83.8 million. Capital also has a private equity portfolio with an
acquisition cost of about $70 million.
(bullet) Low income housing projects. Capital has invested in low-income
housing projects for the purpose of obtaining the substantial
tax credits available on these investments. Total investments
are approximately $25 million as of late 1994.
(bullet) Venture capital and merchant banking operations. Dominion
Capital has advised that the Company continues to look for
market opportunities in venture capital and merchant banking. A
recent investment, which has not closed as of early l995, is a
joint venture with Household Finance Corporation on a large
commercial loan portfolio.
Additional information regarding the Capital investment portfolio is
included elsewhere in this report.
Dominion Financing, which is a financing subsidiary of Capital, operates
a $200 million medium term note program. The MTN provides a key
component of the Dominion Capital financing structure. Merrill Lynch
acts as agent for this program, which was set up to be available to
acquire new projects and to match-fund assets. The outstanding notes
have maturities of up to 4.5 years. Dominion Financing contracts
directly with Sumitomo Bank (as the lead bank for a consortium of
lenders) for a letter of credit to support Dominion Financing's
medium-term-note facility. Financing pays Sumitomo **CONFIDENTIAL
INFORMATION on unutilized portions of the $200 million capacity and
**CONFIDENTIAL INFORMATION on utilized portions. In order to induce
Sumitomo to provide this credit sport to Dominion Financing and Capital,
DRI has entered a support agreement with Capital. This support agreement
specifies that DRI maintain Capital's net worth at a minimum of $80
million. DRI provides the net worth maintenance support to Capital for
Sumitomo's benefit, and Sumitomo charges Dominion Financing the above
rates for its credit support of the MTN program.
DRI also provides direct financing to Dominion Capital through the
intercompany credit agreement (ICA). This facility has a limit of $65
million outstanding at any one time. The terms and conditions of
Capital's ICA are similar to those of Dominion Energy's ICA.
Most of the other debt financings of Capital relate to specific projects
or assets of Capital's investment portfolio. Rincon Securities' two
major debt financing vehicles are structured specifically for the Rincon
preferred stock portfolio. Rincon had outstanding at September 30, 1994
senior notes of approximately $102 million. About $52 million of these
notes benefit from a support agreement from DRI. The guarantor on the
other $50 million of senior notes is Capital. Rincon also has a
commercial paper program, which is operated by DRI. The commercial paper
program has a limit of $100 million, and is rated A1/P1. The commercial
paper program receives credit enhancement from Trust Company of Atlanta,
which enables it to maintain this rating. The Trust Company charges
**CONFIDENTIAL INFORMATION* for this credit enhancement. The Rincon
commercial paper program provides working capital funds for the
preferred stock portfolio.
89
<PAGE>
Capital has also acquired various other debt instruments that are
specific to its portfolio projects. For instance, Capital had
outstanding at September 30, 1994 loans of about $9.5 million. These
loans included a $2 million note to Catalyst Energy Corporation and a
$7.5 million term loan with First Union National Bank of Via Capital had
outstanding at September 30, 1994 non-recourse Vidalia project debt of
approximately $43 million. Capital also had outstanding debt for a lease
on a Blue Ridge Securities portfolio of approximately $29.5 million.
Total long- and short-term debt outstanding for Dominion Capital at
September 30, 1994 was $481.5 million.
3. DOMINION LANDS FINANCING
Dominion Lands is an operating subsidiary of Dominion Capital. Lands was
established in 1987 with the acquisition of four parcels of land from
Virginia Power. These parcels were deemed by the utility to be excess.
The transfer was approved by the Commission. The real estate transfer
consisted of four major sites: Bath County, Stafford County-Widewater,
Harborside, and the 12th Street Power Station in Richmond. Dominion Lands
projects are primarily high- end residential developments. Lands
purchased two major tracts on the market: Governor's Land near
Williamsburg, Virginia and Uwharrie Point in North Carolina. Lands also
invested in Goodman-Seager-Hogan of Norfolk in 1987.
Lands' primary financing facility is an $85 million revolving line of
credit with ABN/AMRO. This credit line finances the Uwharrie, Governor's
Land, and Harborside real estate development projects. The ABN/AMRO loan
is a five-year bullet loan that is structured specifically for real
estate development At September 30, 1994 Lands had drawn down $25 million
for each of the Governor's Land and Uwharrie projects, and $18,044,000
for the Harborside project, for a total of $68.044 million. DRI has
extended credit support to Dominion Lands. It takes the form of an
assurance of net worth of $5 million, or 28.5 percent of loans.
Dominion Lands also has an intercompany credit agreement with DRI. It
has a limit of $25 million. At September 30, 1994 Lands had
approximately $42 million outstanding under the ICA, which was $17
million in excess of the stated limit.
4. INTERCOMPANY CREDIT AGREEMENTS
The various intercompany credit agreements (ICAs) between DRI and the
non-regulated subsidiaries provide key financing vehicles for these
companies. For Virginia Power, the ICA has been a controversial element
of short-term financing capacity over the last several years. DRI funds
short-term loans to the non-utility subsidiaries or to Virginia Power by
issuing DRI commercial paper, and in turn by lending the proceeds to
each subsidiary in accordance with individual ICAs. The DRI commercial
paper program is currently rated A2/P2 by the credit rating agencies.
The non-utility subsidiaries use the ICA as their primary source of
operating capital on a day-to-day basis. Virginia Power established its
own separate commercial paper program in 1992. It is rated A1/P1 and it
has a stated maximum capacity of $200 million outstanding at any one
time. Virginia Power has not utilized its intercompany credit agreement
with DRI after establishment of its own commercial paper program.
90
<PAGE>
DRI financing under the various ICAs is limited to $430,750,000. The
various DRI subsidiaries pay the administrative cost of the DRI commercial
paper program in proportion to their credit limit under their ICA. The
limit of each company under the ICC as of February 10, 1995 was as
follows:
Virginia Power $100.00 million
Dominion Energy 150.00 million
Dominion Capital 65.00 million
Dominion Lands 25.00 million
DRI 90.75 million
TOTAL $430.50 million
Virginia Power, Energy, Capital and Lands reserve and pay for a portion
of DRI's total capacity for liquidity back-up credit facilities. The
liquidity back-up facilities are required to support issuance of
commercial paper in the marketplace. Virginia Power has reserved $100
million of DRI's total back-up facilities, in order to back up its own
$200 million commercial paper program. To the extent that Virginia Power
requires short-term borrowings of more than $100 million, it may
annually reserve additional bank support capacity from DRI, up to a
limit of $300 million. DRI says that Virginia Power has a "first call on
reserving bank support capacity on an annual basis. On a short-term or
emergency basis, additional capacity could be provided to Virginia Power
if it is not in use by the non-utility subsidiaries or DRI. Those
amounts not reserved by Virginia Power or the non-utility subsidiaries,
i.e., $90.75 million, are the responsibility of DRI. However, DRI does not
ultimately bear the cost responsibility for this full amount, as Liberty
addresses later in a discussion of unallocated equity.
91
<PAGE>
The following table shows the commercial paper back-up facilities for
DRI at December 31, 1994:
DOMINION RESOURCES, INC.
COMMERCIAL PAPER BACKUP FACILITIES
REVOLVERS AMOUNT FEE* ANNUAL COMMITMENT TERMINATION
DATE DATE
ABN/AMRO Bank $20,000,000 ******* ******** 11-31-94 11-30-97
Chase Manhattan
Bank $40,000,000 ******* ******** 8-01-92 9-29-95
Fuji Bank, Limited $25,000,000 ******* ******** 9-30-94 9-30-96
Morgan Bank/
Delaware $20,000,000 ******* ******** 7-31-94 7-31-97
Nations Bank $25,000,000 ******* ******** 5-31-94 5-31-97
Toronto Dominion
Bank $20,000,000 ******* ******** 5-01-94 4-30-94
Wachovia Bank $25,000,000 ******* ******** 7-01-94 6-30-97
Union Bank of
Switzerland $25,000,000 ******* ******** 11-29-94 11-29-27
TOTAL $200,000,000 ******* ********
LINES OF CREDIT AMOUNT FEE* ANNUAL COMMITMENT TERMINATION
DATE DATE
Bank of Boston $10,000,000 ******* ******* 5-24-94 5-24-95
Bank of New York $10,000,000 ******* ******* 7-01-94 7-01-95
Chemical Bank $35,000,000 ******* ******* 6-30-94 6-30-95
Citibank $20,000,000 ******* ******* 12-01-94 11-29-95
Consolidated Bank
& Trust $ 750,000 ******* ******* 2-01-94 2-01-95
Credit Suisse $15,000,000 ******* ******* 6-03-94 6-02-95
Crestar Bank $25,000,000 ******* ******* 7-31-94 7-31-95
First National
Bank of Chicago $20,000,000 ******* ******* 5-30-94 5-29-95
First Union
National Bank $20,000,000 ******* ******* 6-30-94 6-30-95
NationsBank $25,000,000 ******* ******* 6-30-94 6-30-95
Signet Bank $10,000,000 ******* ******* 5-01-94 4-30-95
Sumitomo Bank $15,000,000 ******* ******* 8-01-94 8-01-95
Trust Company
Bank $10,000,000 ******* ******* 5-31-94 5-31-95
Wachovia Bank $15,000,000 ******* ******* 6-30-94 6-30-95
TOTAL $230,750,000 *******
* INDICATES CONFIDENTIAL INFORMATION
Total Back-up Liquidity = $430,750,000
92
<PAGE>
The Virginia Power intercompany credit agreement was last approved by
the Commission for a two-year period ending December 1994. However,
Virginia Power has not borrowed from DRI under the ICA since 1992. The
Commission authority was reviewed in late 1994. DRI and Virginia Power
filed an application requesting an extension to the intercompany credit
agreement in substantially the same form as previously approved. On
November 30, 1994, the Commission gave interim approval to the ICA. The
Commission directed Virginia Power to study possible alternatives to the
ICA, including the steps necessary and costs associated with securing
its own lines of credit, if ordered by the Commission. As of February
1995, the Company was gathering information regarding the ICA and the
possibility of securing its own lines of credit for a Virginia Power
only short-term borrowing plan. It must file a report with the
Commission by March 31, 1995.
5. SUPPORT AGREEMENTS
DRI has provided credit support in the form of support agreements to
practically all of the outstanding debt of its non utility subsidiaries,
except for debt that is specific to a non-recourse power plant project
financing. The original reason for the support agreements was that banks
and other lenders were not willing to make loans solely on the credit
and balance sheets of start- up businesses, such as Energy, Capital, and
Lands. Some of the individual projects of these companies were also deemed too
risky by the banks to finance without credit support from the parent.
The key provisions of the support agreements are approximately the same
in each of the agreements. DRI also agrees to maintain the ownership of all of
the stock of the subsidiary whose credit is being supported. DRI also agrees
to maintain the net worth of the subsidiary at a specified positive
level in each of the support agreements. The level of net worth to be
maintained varies by company and from agreement to agreement. Some of
the support agreements also have cash flow support requirements and
minimum investment provisions.
The net implied liability to DRI of the eight support agreements
currently in effect is approximately $700 million. The support agreements
apply to the three bank credit facilities of Energy: a support agreement
attaches to each of the $100 million Fuji Bank revolver, the $100
million Fuji Bank term loan, and the $55 million LTCB term loan. DRI
also provides support agreements for the financing of two power projects
of Energy: the Clear Lake project loan for $62.5 million, and the Belize
Hydro project loan for $46 million. The flow of credit support from DRI to
the non-regulated subsidiaries is charted below.
93
<PAGE>
FINANCING ASSISTANCE FOR NON-REGULATED SUBSIDIARIES*
DOMINION RESOURCES, INC.
$330.75 MM DRI Credit Facilities Supporting Commercial Paper Program
Plot points include $150 MM Intercompany Credit Agreement
(ICA)-Dominion Energy
$65 MM ICA-Dominion Capital and $25 MM ICA-Dominion Lands;
$100 MM Energy/Fuji Revolver
$100 MM Energy/Fuji Term Loan
$55 MM Energy/LTC Term Loan
$46 MM-Belize Project-Project Loan
$125 MM-Clear Lake Project-Project Loan
$200 MM Medium-Term Note Program
$85 MM Revolver-ABN/AMRO
$52 MM Rincon Securities-Senior Notes
(Financial Support Flow Chart goes here)
94
<PAGE>
DRI provides to Dominion Lands a support agreement that Sumitomo Bank
relies upon to provide credit to Dominion Financing's A+ rated
medium-term note program. This agreement takes the form of a net worth
assurance; i.e., that positive equity will be maintained. This support
agreement indirectly supports all of Capital's (including Dominion
Financing's) outstanding debt financings. DRI also provides a support
agreement for Rincon Securities' senior notes. The support agreement
provides for the maintenance of Rincon's cash flow by DRI, and is in
effect for approximately $52 million worth of the Rincon senior notes.
DRI also provides to Dominion Lands a support agreement that is related
to the revolving credit agreement with ABN/AMRO. This credit is used for
working capital and construction financing. The revolving credit
facility has a maximum loan outstanding limit of $85 million.
The DRI support agreements give the holding company backstop
responsibility on these financings. Rating agencies generally seem not
to take account of them if they are small in magnitude. These
obligations have a credit impact similar to that of a purchased power
obligation for a utility company, or a lease for equipment and offices.
Such obligations do not appear directly in financial statements, except
as footnotes. These obligations can be overlooked at times by rating
agencies, debt investors, and other creditors, except on close
examination of the full financing structure of the Company. A key concern
regarding DRI's support agreements is their potential impact on the
Virginia Power debt rating. At some level of credit support by DRI, the
rating agencies will be more likely to recognize the potential liability
to DRI (and potentially the utility) if the provision of such sport
grows.
Other than the typical non-recourse debt of the Dominion Energy
projects, all substantive debt of DRI's non-regulated subsidiaries is
credit-supported by the holding company, either directly or indirectly.
The creditors of the non-regulated entities have required DRI credit
support to provide attractive financing terms to the subsidiaries.
Energy, Capital, and Lands have not been able to obtain debt financing
at attractive rates on a stand-alone basis. Dominion Capital management
states that the Company is interested in moving toward a more
stand-alone financing approach for Capital. Dominion Energy management
notes that the Company has talked to banks about debt that is
unsupported by DRI. However, Energy also notes that banks do not want to
eliminate DRI's credit support, because existing agreements have
support, and bankers tend to want the same level of credit protection as
other creditors.
A standard requirement of most state regulatory commissions is that a
regulated utility entity be protected from any "harm" from non-utility
affiliate operations. DRI states that the extensive support agreements
mentioned previously have historically "not been mentioned" in
discussions with rating agencies about Virginia Power debt. However, DRI
states that DRI and Virginia Power have not specifically asked the
rating agencies about any such potential credit impact.
Standard & Poor's Credit Week rating update of DRI commercial paper from
October 11, 1993 stated:
Credit support for Dominion Resources' ratings is mainly derived
from its primary unit, Virginia Electric and Power, which provides
96 percent of total gross operating cash flow for the consolidated
concern. Its commercial paper is however rated A-2, one notch below
95
<PAGE>
its (power company) unit due to: the parent's senior implied rating is
one notch below Virginia Electric's senior secured rating, since the
holding company is one step removed from these assets; and an 'A-l '
is generally not assigned to an entity that carries a senior implied
rating of 'A-', unless liquidity is exceptionally strong. Parent
commercial paper borrowings have been primarily funneled to the non-
utility subsidiaries. While this is not a significant concern, there is a
higher risk associated with these cash flow streams. (emphasis
added.) About $1.3 billion of Dominion's assets represent non-utility
investments (about 10 percent of total assets). Most of these are
associated with non-utility electric generating projects held by the
Dominion Energy and Dominion Capital units. Only about 13 percent
of total long-term debt on the Dominion Resources' balance sheet
reflects non-utility financings. Most of the debt at the project level is
financed nonrecourse. Dominion is expected to expand aggressively
its role in the independent power industry, but the availability of
nonrecourse debt is expected to limit any negative impact these
investments could have on the company's credit profile.
In a rating analysis of Virginia Power dated January 31, 1994, Standard
& Poor's similarly opines at:
Risk associated with diversification is limited, since most debt at the
subsidiaries is project finance, which is nonrecourse. However, the
parent borrows in the commercial paper market and lends to these
non-utility subsidiaries. Also, these subsidiaries have liquidity and net
worth maintenance support agreements with the parent.
Moody's Investors Service appears to consider DRI's diversified
businesses more of a credit risk than does Standard & Poor's. In a
October 31, 1994, Moody's Bond Survey discussion of Virginia Electric &
Power Co., Moody's states:
The utility's competitive position is especially strong relative to
that of the Company's northern neighbors. However, the desire to
expand its traditional market; its sizeable construction program;
substantial power purchase obligations; and diversification by the
parent, Dominion Resources, introduce risk into the utility's
credit profile. (emphasis added)
DRI is cognizant of the fact that Moody's believes that the diversified
businesses add a credit risk to Virginia Power. DRI insists that there is
no contractual connection between the non-utility DRI subsidiaries and
Virginia Power; therefore, the creditors of the non-regulated businesses
would have no legal recourse against Virginia Power, should the
diversified businesses fail. Liberty agrees that there is no direct
contractual obligation on the part of the utility to make non-regulated
investors whole. However, the credit support agreements provide
important indirect support for non-utility credit. DRI is also insistent
that the credit rating agencies are well aware of the DRI non-regulated
businesses, and are not concerned.
96
<PAGE>
6. DIVIDEND POLICIES
DRI's dividend policy for its common shareholders follows the familiar
pattern regarding payout ratio of earnings and cash in the utility
industry. DRI's dividends had increased by $.08/share annually for
several years through 1994. In October 1994, DRI declared a dividend
increase for the following year of $.04/share. DRI had an investment
banker prepare a dividend analysis and recommendation, in order to
analyze whether the dividends should be increased, and the size of any
such increase. DRI's consolidated dividend payout ratio was 76 percent
for 1990, 79 percent for 1991, 87 percent for 1992, and 80 percent for
1993. The payout ratio was above 90 percent for 1994. DRI's high
dividend payout ratio is similar to that of other utilities and utility
holding companies.
The allocation of the responsibility for the holding company dividends
among the utility and non-regulated entities form a key affiliate
relationship. DRI must receive funds for the payment of dividends from
its subsidiaries, because the holding company has no substantial
business of its own. DRI established a 1986 subsidiary dividend practice
to govern calculation of the dividend requirement from each subsidiary
of the holding company. Dividends were to be paid by the DRI
subsidiaries on a quarterly basis, and were to be calculated in
accordance with this policy as follows:
(bullet) The chief financial officer of Dominion Resources will
calculate and advise the treasurer of each subsidiary of the
percentage of the equity capital employed by that subsidiary
that should be declared as a dividend for the quarter.
(bullet) The percentage should be designed to produce an amount
sufficient to allow Dominion Resources to pay its quarterly
dividend to shareholders and to provide for the pro-rata
allocation of any unrecovered holding company overhead to the
subsidiaries.
DRI asserts that the second paragraph of the subsidiary dividend policy
was intended to recognize that DRI needed resources to pay holding
company expenses that are not allocated to subsidiaries. However, DRI
emphasizes that the second clause of the dividend policy was never used.
In other words, the dividend requirement for Virginia Power and the
non-regulated subsidiaries was never adjusted in order to pay for
unallocated holding company expenses. DRI reports that this clause was
never required because the holding company found that it could get
earnings sufficient to cover these unallocated holding company costs by
investing unallocated equity funds of the holding company. The
unallocated equity issue is addressed later in this chapter of the
report.
The calculation of subsidiary dividends to DRI was further defined by a
memorandum dated March 16, 1994 entitled "Allocation of DRI Dividend
Requirements to DRI Subsidiaries." This policy became effective in the
second quarter of 1994. The policy defined the current dividend
calculations as well as changes for the policy effective in the second
quarter of 1994: The policy stated:
97
<PAGE>
Presently the Corporate Secretary is responsible for calculating the
quarterly dividend requirements of DRI and its subsidiaries. Since the
approval occurs prior to the date of record, an estimate of the
dividend requirement is used. The estimate is calculated with
assistance from Shareholder Records.
The allocation of the subsidiaries' dividend requirements is calculated
by the Corporate Secretary. It is based on the ratio of each
subsidiary's shareholders' equity balance to the total of DRI's
subsidiaries' shareholders' equity balances. The source of this
information is Corporate Accounting.
The intention of present corporate dividend policy is that the
subsidiaries' dividends paid to DRI cover the dividend requirement
of DRI's common stock. Since the dividend request to the
subsidiaries is based on an estimate, the dividends paid to DRI
shareholders rarely if ever match the dividends received from the
subsidiaries. Presently, there is no subsequent true-up for the
amount of dividends received from the subsidiary and the dividends
paid by DRI.
The following were changes that DRI suggested be incorporated in the
dividend allocation and payment procedures effective in the second
quarter of 1994:
The calculation of the subsidiaries' shareholders' equity will exclude
any non-income producing items, such as FAS 115 adjustments,
foreign currency adjustments, etc.
A true-up representing the difference between the dividends paid by
DRI to the common shareholders and the dividends received by DRI
from the subsidiaries will be calculated. The true-up will be included
in the succeeding quarters' calculation of the dividend allocation.
These adjustments to the dividend allocation procedure will provide a
more equitable allocation of the dividend responsibilities among the
DRI subsidiaries.
The foregoing method means that DRI requires its regulated and
non-regulated subsidiaries to pay all dividends to support the holding
company's dividend payments, including unallocated holding company
equity. DRI clarified this policy to adjust for true-ups in 1994. DRI's
policy of requiring a pro-rata sharing (based on equity outstanding) of
the dividend requirement by the non-regulated entities is one which is
not always found at utility holding companies. Such non-regulated
subsidiaries, whose earnings and cash flow are more volatile than those
of a utility, generally have some difficulty in maintaining a high
dividend payout ratio of the utility entity.
DRI provided some clarification of the actual procedure at DRI for the
calculation of subsidiary dividend requirements:
98
<PAGE>
The memo (Subsidiary Dividend Practice) indicated that unrecovered
holding company overhead would be included in the total amount
collected by DRI from the subsidiaries. However, in practice, no such
expenses have ever been included. Because of the practice of
allocating equity at year-end, there has always been enough cash
generated from earnings on the unallocated equity to cover the
necessary holding company expenses.
Each subsidiary's liability for DRI's total common stock dividend is
calculated by applying the subsidiary's proportionate share of the
allocated equity to the total dividend requirement. The subsidiaries'
proportionate share of the allocated equity is defined as the ratio of
each subsidiary's shareholder equity over the total of all the
subsidiaries' shareholder equity. The result is that the subsidiary pays
the same proportionate share of the dividend requirement on both
allocated and unallocated equity.
Virginia Power and the non regulated entities pay for the dividend
requirement on DRI's holding company equity in proportion to their
equity balances. As a result, Virginia Power has historically paid over
90 percent of the dividend requirement of DRI's holding company-specific
equity.
In February 1995, DRI employees mentioned in interviews that additional
changes to procedure for the calculation of subsidiary dividends to DRI
were being prepared. In a memorandum dated January 6, 1995 from the DRI
CEO to the Dominion Energy president, the Virginia Power treasurer, and
the Dominion Capital senior vice president, the following was prepared:
I propose that beginning with the first quarter 1995 dividend we
change the way the subs pay dividends on the unallocated equity.
Each sub would pay dividends on the unallocated equity based on the
amount of equity that the sub has budgeted for in the budget. For
example, in 1995 Virginia Power has budgeted $36 million, DEI $57
million, and DCI $90 million. If there is less unallocated equity
in the "pot" than requested, there will be a proration of the
dividends to be paid by the subs.
Liberty has not reviewed the calculation of actual DRI subsidiary dividend
requirements under this prepared procedure.
7. UNALLOCATED EQUITY
DRI has said that:
The unallocated equity dollars are held by the holding company, and
invested by the holding company. The earnings generated by the
investment of the unallocated equity funds has been the source of cash
used by the holding company to cover its unrecovered overhead costs.
<PAGE>
99
DRI's raises equity funds for all of the DRI subsidiaries through equity
programs that are ongoing. DRI has an automatic dividend reinvestment
plan, an employee savings plan, and a customer stock purchase plan,
which all raise equity funds. As of early 1994, the DRI equity programs
were expected to raise approximately $200 million per year in the future
for DRI's various businesses.
DRI has noted that funds remaining from the common equity raised by the
holding company in 1993 would be invested in Virginia Power or one of
the non-regulated subsidiaries as needed to finance their construction
program or acquisitions. DRI noted that "excess funds, if any, will also
be used to repurchase shares in the open market." Beginning on September
1, 1994 DRI began buying shares in the open market to supply shares for
the employee savings plan and the optional cash portion of the automatic
dividend reinvestment plan. It was also expected that beginning in
December 1994, DRI would begin buying in the open market shares to
supply shares for the dividend portion of the automatic dividend
reinvestment plan. DRI expected that the three stock purchase plans
would produce proceeds of about $175 million in 1994, but drop to only
$50 million in 1995 and 1996, assuming that the plans to go to open
market purchase of shares continue.
DRI has emphasized that the proceeds from the various equity plans would
first be available for investment at Virginia Power. Any remaining
equity would be available for investment in the non-regulated
subsidiaries or for purchasing shares in the open market to supply
shares for the various equity plans. DRI reports that equity injections
are made to the non-regulated subsidiaries on an "as-needed" or
"as-requested" basis, and that the non-regulated entities require equity
capital on a deal-specific basis.
Prior to 1995, DRI was providing equity capital to Virginia Power in
amounts that DRI anticipated were needed in order to maintain the
utility's "A" credit rating. The Virginia Power equity injections have
been made for several years in the fourth quarter of each year. DRI
states that the injection of equity into Virginia Power in the fourth
quarter has been a practice, but not a written policy. DRI insists that
Virginia Power did not ask for equity capital at times other than in the
fourth quarter of each year. DRI also noted that the injection of equity
capital toward the end of the year would tend to "dress up" the Virginia
Power balance sheet as of year end for consideration by the capital
markets.
DRI states that the ongoing equity plans provide a low cost source of
raising equity capital, due to the lower issuance costs, as compared to
a public sale of common equity. DRI believes that the negative arbitrage
caused by raising funds at an equity cost of capital and reinvesting
these funds at a short-term rate-of-return is offset by the savings from
raising equities in these efficient forms. However, this position does
not consider that Virginia Power could issue its own common equity
through the same type of programs, and have the funds to invest for its
own account, if it were a "stand-alone" company.
DRI also reports that any DRI losses in individual years were initially
funded by commercial paper issuances. In the long term, any such holding
company-specific losses would be funded by DRI equity issuances that
were not allocated to Virginia Power or to the non-regulated
subsidiaries. DRI reported this unallocated equity to be funding that
"nobody needed" on a short-term basis.
100
<PAGE>
DRI has an account that segregates the income earned on the investment
of unallocated equity funds. The income on unallocated equity funds for
DRI for the year 1986 through 1994 are shown in the following table; also
shown is DRI's net income for each of these years.
DOMINION RESOURCES, INC. - HOLDING COMPANY ONLY
INCOME ON UNALLOCATED EQUITY FUNDS AND NET INCOME
1986-1994
Income on Unallocated Equity Net Income
1986 $855,410 $(2.9 MM)
1987 $1,282,530 $3.2 MM
1988 $708,403 $0
1989 $1,176,541 $0
1990 $4,528,425(1) $17.4 MM
1991 $1,731,065 $7.333 MM
1992 $2,047,283 $.642 MM
1993 $1,551,372 $(2.302 MM)
1994 $3,331,807 $(5.142 MM)
(1) For 1990, interest on marketable securities increased
significantly due to the investment of the proceeds from
the sale of Virginia Natural Gas. Income from these
proceeds is not distinguishable from income on the equity
proceeds for this year.
Discussions with Virginia Power's current financial personnel revealed
that the utility company has not been comfortable with DRI's historic
timing of equity funds allocations. The power company is aware that DRI
has raised the equity funds and invested these funds in order to offset
DRI expenses. However, Virginia Power notes that during the last several
years, it has not had the management oversight to be able to request
equity funds at a time other than the fourth quarter of each year. Since
DRI had control over the timing of these equity injections, there was no
Virginia Power-specific representative to present the utility company's
position on this policy.
Virginia Power believes that the holding company's position was that
since the utility could not earn a return on these equity funds until
they were invested in the regulatory rate base and included in the
capital structure, the utility company did not need the funds earlier.
This policy has at times caused Virginia Power to issue commercial paper
and pay the interest expense, when the Company could have had a common
equity injection from DRI to cover such responsibilities. The
Commission's current ratemaking practice of updating the ratebase and
capital structure is also at odds with DRI's rationale.
101
<PAGE>
As of 1994, the equity allocation policy caused DRI to temporarily keep
the funds from equity programs in order to earn interest. However, Virginia
Power and the non-regulated entities must pay the dividends on all
outstanding DRI equity. Therefore, Virginia Power was responsible for over
90 percent of the dividends on these unallocated equity funds.
In the previously-mentioned January 6, 1995 memo from the DRI CFO, the
DRI equity injection timing is also addressed:
Each sub may also want to request that the equity actually be
placed at the sub earlier in the year than normal as a result of
this new dividend payment procedure.
We are currently buying back stock but still have about $155
million unallocated and will increase that at least another $50
million from the CSPP (Customer Stock Purchase Plan).
Please let me know when you would like to draw down equity so that
we can get Board approval and SCC approval in the case of Virginia
Power.
8. DOMINION CAPITAL INVESTMENT PORTFOLIO
The investment portfolio of Dominion Capital is a potential source of
risk for DRI, and in turn, the utility company. Liberty interviewed
Dominion Capital executives in order to determine the Company's
investment strategy, the types of assets involved, and inherent risks of
the various investment groupings of the company.
RINCON SECURITIES
Dominion Capital's first investment was in a self-contained portfolio of
preferred stocks called Rincon Securities. Rincon is a preferred stock
portfolio which contains 40 percent variable-rate, preferred and 60
percent fixed-rate, preferred stocks of utilities and banks. DRI reports
that Rincon was acquired by Capital for approximately $270 million; $40
million of the purchase price was financed by equity and $230 million
was financed by debt. The Rincon debt securities were structured to
provide a matched funding of assets; i.e., 40 percent of the debt was at
floating rates and 60 percent of the debt was at fixed rates. Rincon
Securities, as a result, is a fairly self-contained portfolio, which is
managed as a separate entity.
VIDALIA HYDRO PLANT
Capital began investment in a hydroelectric plant in 1987 as limited
partner. Catalyst Energy was the other 50 percent owner and the general
partner of the project. The power project was a greenfield project with
a high projected rate-of-return. The majority of the electric output of
the plan was to be sold to Louisiana Power & Light.
The Vidalia project cost was approximately $540 million; the project was
originally financed with debt of $390 million, and equity from each
partner of $75 million. Eventually, the project was sold to a
partnership of Philip Morris, Mission Energy, and Dominion Capital and
leased
102
<PAGE>
back from the lessor. Capital reports that Philip Morris wanted
DRI/Capital as a part owner in the sale/lease back project in order to
tap DRI's utility expertise. Currently, Capital's total investment is
approximately $**CONFIDENTIAL INFORMATION** in the Vidalia project;
$**CONFIDENTIAL INFORMATION** as the lessor and approximately
**CONFIDENTIAL INFORMATION** as the lessee, according to the company.
As with most independent power projects, the key to the project is the
power contract with the utility. The partnership has a 40-year power
contract with Louisiana Power & Light with a stepped payment schedule.
***********************************************************************
*************************** CONFIDENTIALINFORMATION *******************
**********************************************************************.
COMMON STOCK PORTFOLIO
Dominion Capital began accumulating common equities for a portfolio in
the mid-1980s. The acquisition cost of the investments in Capital's
common-equity and preferred-stock portfolio was slightly above $100
million in January 1995. The investment portfolio also included private
equity investments of approximately $70 million. The key industries in
which the portfolio has invested are biotech, waste management, security
and surveillance, pharmaceutical, and telephone. The portfolio includes
public and private equities, preferred stocks, some convertible stocks,
and a small portion of debt. Ninety-five percent of portfolio is
domestic and five percent is international.
Dominion Capital has three portfolio managers and the senior vice
president. One manager is in charge of Rincon and a portion of the
common stocks; another manager is responsible for private equities and a
portion of the common stock; and a third manager acts as a trader.
Capital's largest investment positions are in the following companies:
the real estate investment company of Goodman, Seager, Hogan & Hoffman,
which was part of the Dominion Lands real estate package; a long
distance telephone company in Russia; a medical products company; and a
biotechnology company. The senior vice president of Capital concentrates
on the private market equity investments for Capital.
DOMINION LANDS
DRI's investments in real estate previously were assets of Dominion
Lands. At March 31, 1994, Lands became a subsidiary of Dominion Capital.
Lands began operations in 1987 with the purchase of excess properties
from Virginia Power. Lands also purchased in 1987 the Real estate
company Goodman, Seager, Hogan, and Hoffman. At December 31, 1993, the
total assets of Dominion Lands were included on the company's books at
approximately $140 million.
HOUSEHOLD FINANCE VENTURE
Dominion Capital has recently been negotiating a new investment in a
venture with Household Finance Corporation of Chicago. As of February
10, 1995, this investment had not closed. Dominion Capital roughly
described the Household investment as a joint venture of HFC and
Capital. Capital and HFC each planned to put up $50 million of equity
and $25 million of
103
<PAGE>
subordinated debt to form an investment package of $10 million. Five
hundred million dollars of debt would then be raised by a special
purpose company at a 4:1 debt-to-equity ratio. The special purpose
company would then invest in a $600 to $760 million portfolio of working
capital and mezzanine loans to commercial borrowers.
**********************************************************************
****CONFIDENTIAL INFORMATION******************************************
******** The joint venture investment with HFC is beyond Capital's
guidelines for everyday investment; this investment had to be approved
by the Capital board of directors. Dominion Capital sees the HFC
opportunity as a move into financing and merchant-type banking.
DOMINION CAPITAL INVESTMENT POLICY
Capital has set up investment guidelines that the Company considers to
be fairly liberal. These guidelines include diversification guidelines
for equity portfolios, collateral guidelines, and approval guidelines.
Any investment that would amount to over 10 percent of portfolio must be
approved by the senior vice president. Any investment of over $5 million
must be approved by the DRI president and the Capital board of
directors.
The Capital equity portfolio has guidelines regarding concentration of
investments and diversification of the portfolio. No more than 20
percent of the portfolio is to be invested in any one industry, and no
more than 6 percent in any one common stock, according to the Company.
The Capital investment committee includes the DRI controller, the DRI
CFO, the DRI general counsel, the president of Capital, and the DRI CEO.
Liberty notes that the guidelines for debt investments for Capital are
fairly conservative, in that highly rated investments are all that is
allowed. Preferred stocks must be rated a minimum of A- by Standard and
Poor's or A3 by Moody's. Money market preferred stocks may carry ratings
equal to or greater than BBB (Standard and Poor's) or Baa3 (Moody's).
On the other hand, there are few quality restrictions on Capital's
common stock portfolio. The portfolio does have diversification
restrictions. The common stock portfolio may not comprise more than 15
percent of Capital's total assets on a cost or market value basis. No
more than 50 percent of the portfolio can be invested in small market
capitalized stocks. No more than 6 percent of the total portfolio can
invested in any one stock. No more than 20 percent of the portfolio can
be invested in any one industry. Finally, no more than 4.9 percent of
the total outstanding common shares of a single company can be
purchased.
The purchase of options is restricted in that the number of options
purchased will be no greater than the number of shares of the underlying
stock owned in the portfolio. In addition, the use of call options is
not permitted. In other words, Capital cannot own options that are not
covered by shares in the portfolio, which limits the risk involved in
investing in options. All transactions of more than $5 million must be
approved by the DCI board of directors. In addition, a section of the
investment policy allows exceptions and modifications by the investment
committee. Certain reporting and approval requirements are required in
order to make exceptions from the Capital investment policy. The
investment committee of DRI adopted the investment policy on January 3,
1994.
104
<PAGE>
Another investment restriction of Dominion Capital and DRI is the
restricted stock trading policy. The purpose of this policy is:
To avoid conflicts or apparent conflicts between the interest of
employees (as defined in the conflict of interest statement of
policy) and the company and its shareholders. Restricted stocks
refer to those stocks in such the Company's position is significant
enough to influence, or appear to influence, the market value of
such stock. Restricted stocks are to be identified and monitored on
an ongoing basis by the senior vice president of Capital. The
restricted stock trading list should be communicated in writing to
all the DRI officers, officers of non-regulated subsidiaries and
all DCI employees.
DRI does not allow either the ownership or trading of the restricted stocks.
DOMINION CAPITAL INVESTMENT LEVELS
Dominion Capital reported anticipated capital expenditures in the three
year plan for 1994-1996 of the following: $34.9 million in 1994; $19.6
million in 1995; and $18.2 million in 1996. Obviously, investments such
as that of the joint venture with HFC are over and above these estimated
expenditure levels. Dominion Capital, as do all DRI companies, does not
attempt to estimate for planning purposes currently unknown major
investments. The Company's investment strategy is intended to be
flexible and opportunistic.
HIGHEST RISK INVESTMENTS
Dominion Capital executives were asked to name the current investments
that carry the highest degree of risk. *************** CONFIDENTIAL
INFORMATION ********************************************************
***************************************************************** The
real estate portfolio was carried on the books in 1994 at approximately
$80 million.
Liberty asked whether Dominion Capital has derivatives, collateralized
mortgage obligations, or other high-risk financial derivative
investments in its portfolio. Dominion Capital employees reported that
the Company does not have any CMOs, futures, leveraged debt
transactions, derivatives, or naked option positions at this time.
However, the Company does acknowledge that in late 1990, Capital bought
index options, supposedly to hedge Capital's common portfolio. However,
the index option position was not fully covered by common stocks. The
investment in indexed options resulted in an after-tax loss of
approximately $9 million. As mentioned previously, the January 3, 1994
investment policy prohibits the investment in options which are not
covered by common stock investments at this time.
**********************************************************************
******************CONFIDENTIAL INFORMATION****************************
************************************************. On the other hand,
Capital claims to have thoroughly reviewed the relevant legal and
political positions prior to investing, and notes that the Louisiana
Public Service Commission has signed off on the power purchase contract.
Capital notes that this power purchase contract has the potential for
forced renegotiation in the future.
105
<PAGE>
9. THE TAX ALLOCATION AGREEMENT
The tax allocation agreement provides that DRI will file a consolidated
holding company tax return annually. Each subsidiary of DRI designates
the holding company as its agent for the purpose of taking all actions
necessary to file the tax return. Each subsidiary represents under the
agreement that it will not file a separate return for the subsidiary or
be excluded from the consolidated return in any way. Each DRI subsidiary
also agrees to pay the holding company the tax liability allocated to it
as part of the total holding company bill, and that the parent will pay
the subsidiary all amounts allocable to it under IRS Code Section
1.1502-33 (2) (ii). In other words, each subsidiary brings a stand-alone
federal tax liability to the consolidated return, and the subsidiary must
pay DRI as if the holding company were the Internal Revenue Service.
This type of quarterly tax payment to DRI is the normal situation for
Virginia Power, which has had a stand-alone federal tax bill of between
$158 million and $273 million annually since 1990.
On the other hand, DRI pays the subsidiaries for net tax losses and
credits that each subsidiary brings to the consolidated tax bill. The theory
behind the payments to or from DRI is that each company either pays DRI
or receives payment from DRI equal to its net contribution to the DRI
consolidated tax bill. DRI subsidiaries receive quarterly cash payments
from the holding company for tax losses that are recorded on their
books. DRI funds such quarterly payments with the quarterly tax payments
from Virginia Power.
The use of DRI's consolidated tax bill according to the tax allocation
agreement provides a source of funding for the non-regulated subsidiaries
and accelerates the cash flow of various non-regulated projects. Project
returns are thereby significantly enhanced. DRI's non-utility entities invest
in projects with the full expectation that they will be able to use the
consolidated companies' positive tax bill and the tax allocation
agreement in order to provide cash flow. The following chart shows the
magnitude of annual payments by its Virginia Power to DRI for its stand-alone
share of the federal tax liability. The chart also shows the total annual
net payments made by DRI to the non-regulated entities in payment for
tax losses and credits under the tax allocation agreement. These
payments to the non-utility entities have grown along with DRI's
construction of asset portfolios at Dominion Energy and Dominion
Capital. The amount of payments for tax losses and credits has risen from
about $14 million in 1987 to over $86 million in 1993. Obviously, the
payments to the non-regulated businesses for their net contributions to
the consolidated tax bill is a key source of cash flow, which also
increases the internal rate of return for their non-utility projects.
106
<PAGE>
ALLOCATION OF FEDERAL TAX LIABILITY
DOMINION RESOURCES AND SUBSIDIARIES
1987-1993
Virginia Power Net Non-Regulated DRI Consolidated
1993 $272.7 MM $(86.4) MM $186.3 MM
1992 158.3 (49.4) 108.9
1992 25l.8 (35.8) 216.0
1990 259.5 (38.8) 220.7
1989 180.9 (33.3) 147.6
1988 173.0 (25.2) 147.8
1987 174.5 (14.0) 160.5
DRI's non-utility subsidiaries have a strategy of investing in
tax-oriented projects in order to boost the return of such projects, if
such tax benefits are available. This practice is common among American
businesses, and DRI must take advantage of tax consolidation in order to
compete for certain investments. DRI's key tax-oriented investments
include Dominion Energy's oil and gas investments, which qualify for IRS
Code Section 29 tax credits and credits for intangible drilling costs.
Energy also invested in the late 1980s in a number of power production
projects that qualified for five-year ACRS accelerated depreciation, as
well as investment tax credits on certain "transition" projects.
Dominion Capital has also invested in low-income housing projects that
qualify for a special federal tax credit.
The Virginia Power corporate tax department prepares corporate tax
statements on a stand-alone basis. The power company works directly with
the IRS regarding tax issues specific to Virginia Power. DRI has its own
tax staff, which is devoted to preparing tax statements for the
non-utility subsidiaries and the holding company. The DRI tax
organization is responsible for consolidating the tax filings of all DRI
entities, and making the DRI filing with the IRS.
B. CONCLUSIONS
1. DOMINION ENERGY'S USE OF NONRECOURSE PROJECT FINANCING FOR ITS
COGENERATION AND INDEPENDENT POWER PROJECTS CAN MITIGATE THE CREDIT RISK
OF THESE PROJECTS TO DRI AND VIRGINIA POWER.
Energy's large portfolio of 17 cogeneration and independent power projects is
primarily financed by project finance debt and the required equity
contributions of the project partners. Project financing creditors tend to
rely solely upon the cash flow and assets of the specific project in
finding assurance as to the repayment of principal and interest. The
corporate entities owning the equity capital of such projects (such as
Energy) are protected from project creditors by the legal framework of
project financing. Affiliates of the equity owners are likewise protected.
107
<PAGE>
Liberty has not performed an in-depth analysis of Dominion Energy's
power projects or of its oil and gas projects. Project financing may
protect DRI and Virginia Power from individual project creditors;
however, the failure of a project could have cash flow and credit
implications for DRI. Virginia Power, in turn, could be implicated in such
a failure, because it is one of the few remaining sources of cash for
DRI.
The Dominion Energy power projects that carry relatively higher degrees
of risk are the Cerros Colorados and the Alta Valla projects, which are
located in Argentina. They have the customary risks of similar
domestic projects. They have added exposures as well. The political
environment in Argentina tends to be somewhat unstable, especially as
compared to the United States. The currency in the host country has also
been unstable in the past. Furthermore, portions of project output are
sold on the wholesale market, which opens them to potential problems in
the Argentine economy. These exposures make these projects more risky,
all other things equal, than counterparts in this country.
There is a need for awareness, even where project financing is used.
Care must be taken to assure that events do not produce material changes
to such financing without notice to the Commission. Changes from project
financing to a less insulated form have the potential for increasing
risk to the utility. Such changes highlight the need for ongoing
dialogue with and reporting to the Commission. It is not correct to
assume that non-utility operations should be kept from Commission
scrutiny merely because they consist of non-utility operations. They
shall be open to the Commission to the extent necessary to support an
independent judgement of the potential for impact on the utility's rates
or service. Moreover, even after initial arrangements are disclosed,
ongoing review is appropriate. Material terms and conditions can
change.
2. DOMINION ENERGY, CAPITAL, AND LANDS HAVE EACH REQUIRED CREDIT SUPPORT
FROM DRI TO ACQUIRE UNSECURED DEBT CAPITAL AT FAVORABLE RATES.
In the mid-1980s, Energy, Capital, and Lands were start-up businesses
with no significant earnings history or credit history. DRI also had
neither earnings nor operations, except for those of Virginia Power. Other
than nonrecourse project financings, the DRI non-regulated entities would
have had to borrow from banks or in private placements at high rates.
Utility holding companies have used the long-standing and lucrative
business of their utility subsidiaries to persuade creditors to provide
favorably priced financing for non-utility affiliates. It is common
practice for holding companies to dangle the carrot of the "easy
financings" of the utility in order to persuade lenders to provide
credit for the non-utility businesses. Jointly conducted banking
relations at a utility holding company can open the door to bankers for
the non-utility businesses; the non-regulated businesses thereby
piggy-back on the market muscle of the utility.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * * * * * * * * * * CONFIDENTIAL INFORMATION * * * * * * * * * * *
* * * * * * * * * * * * * * * * * * * * * * * * * * * * * The necessity
for DRI support agreements to provide credit support to financings is still
evident. At September 30, 1994, Energy long-term debt (which was not
project finance-related) was reported as $294.8 million.
108
<PAGE>
Capital and Lands total long-term debt was reported at $590.7 million.
DRI provides support agreements for the potential obligations of most of
these financings. The support agreements for Energy, Capital, and Lands
have potential obligations to DRI that total approximately $700 million.
Clearly, DRI credit support has been required in order for the
non-regulated subsidiaries to obtain capital at rates that they find
attractive.
3. THE SUPPORT AGREEMENTS PROVIDED BY DRI HAVE NOT TO DATE RESULTED IN A
SIGNIFICANT DECREASE IN THE CREDIT STANDING OF VIRGINIA POWER.
(Recommendation 1)
Virginia Power directly provides no credit guarantee for any of the
non-regulated businesses. The non-recourse debt of the Dominion Energy
power projects is non-recourse to DRI and to Virginia Power. The support
agreements provided by DRI give the subsidiary creditors the ability to
sue DRI (but not Virginia Power) if liquidation does not cure
deficiencies of the creditor. Liberty has not found any direct
contractual link between non-utility credit and Virginia Power.
However, Moody's cites DRI's diversified businesses in its recent credit
write-up as a "credit risk" to Virginia Power. Standard & Poor's, in a
recent meeting with Virginia Power, requested DRI's support agreement
list, and is apparently now analyzing the list. Duff and Phelps also
reportedly sees some credit risk for Virginia Power securities from
non-utility affiliate activities. In the near future, Virginia Power
credit reports will probably be released by Standard & Poor's, Duff and
Phelps, and Fitch. These credit reports should be monitored for mentions
of diversified credit risk to Virginia Power following the recent
reviews.
4. DRI AND VIRGINIA POWER CURRENTLY ARE NOT COGNIZANT OF THE RATING AGENCIES'
TOLERANCE FOR DRI SUPPORT AGREEMENTS, THE INCREMENTAL IMPACT ON VIRGINIA
POWER, AND THE RATING AGENCIES' COMFORT LEVEL FOR THIS TYPE OF CREDIT
SUPPORT. (Recommendation 2)
The credit rating agencies are aware or are becoming aware of DRI's support
agreements, and factor an incremental amount of credit risk into their
Virginia Power evaluation. Virginia Power and DRI should determine the extent
of this incremental impact. Liberty believes that at some level of DRI-provided
credit support, such support will be recognized by the rating agencies as
a more significant potential credit danger to Virginia Power.
Liberty also notes that Moody's included the following passage in its October
1994 Electric Utility Industry Outlook:
UTILITIES AND HOLDING COMPANIES HAVE GENERALLY UTILIZED DIRECT OR
INDIRECT KEEP WELL OR SUPPORT AGREEMENTS TO FINANCE THEIR UNREGULATED
INVESTMENTS. IN ONLY A FEW CASES HAS A HOLDING COMPANY ACTUALLY
GUARANTEED THE DEBT OBLIGATIONS OF THE NON-UTILITY SUBSIDIARY. WHERE
PERMITTED, A HOLDING COMPANY STRUCTURE MAY BE USED TO HELP INSULATE
THE ELECTRIC UTILITY AND ITS BOND HOLDERS AND CUSTOMERS. HOWEVER,
SOME STATES DO NOT PERMIT THE FORMATION OF SUCH A STRUCTURE. AND,
EVEN WHEN A HOLDING COMPANY STRUCTURE IS USED, the debt rating of the
utility owned by the holding company can be adversely impacted by
failures in the unregulated businesses. (emphasis added)
109
<PAGE>
Moody's further writes:
WHERE THE (DIVERSIFIED) INVESTMENT WAS UNSUCCESSFUL, SEVERE COMMON
EQUITY EROSION FOR THE UTILITY OR HOLDING COMPANY RESULTED. LIKEWISE,
SIGNIFICANT WRITE-DOWNS DEPLETED RETAINED EARNINGS TO THE POINT THAT THE
UTILITY OR PARENT COMPANY COULD NOT SUSTAIN THE PAYMENT OF COMMON
DIVIDENDS. IN THESE CASES, THE COMPANY'S FINANCIAL FLEXIBILITY WAS
JEOPARDIZED AND ITS ABILITY TO ACCESS CAPITAL (BOTH DEBT AND EQUITY) WAS
SEVERELY IMPAIRED, RESULTING IN RATING DOWNGRADES.
5. THE CREDIT SUPPORT PROVIDED BY DRI TO THE NON-UTILITY SUBSIDIARIES HAS
EFFECTIVELY COME FROM VIRGINIA POWER, WHICH HAS RESULTED IN A BENEFITS
TRANSFER FROM THE UTILITY TO ITS AFFILIATES. (Recommendation 3)
Virginia Power is the only DRI operating entity that has built the consistent
earnings, cash flow, and diversified business base required to earn an
investment grade credit rating solely on the basis of its own business.
Non-regulated creditors are effectively looking through DRI to
Virginia Power for credit support and comfort in the financings of non-utility
subsidiaries. Specifically, creditors get comfort from the steady flow of
dividends from Virginia Power to DRI. Creditors are cognizant of DRI's
potential ability to influence this dividend flow, which gives them more
assurance that their loans will eventually be repaid. Creditors are also aware
of the ability of DRI to issue common stock to provide cash for the cure of
creditor liabilities. There is, however, a limit to this ability. If common
equity were to be issued by DRI in the case of non-utility venture failure,
equity investors will look to the utility financial strength and dividend flow
if they were to invest in DRI stock under such conditions.
A transfer of benefits with real value has occurred from Virginia Power through
DRI to the non-utility entities. However, Virginia Power has not been
compensated by DRI or the subsidiaries for the value of such a transfer.
6. VIRGINIA POWER HAS BEEN CONSTRAINED BY THE DRI INTERCOMPANY CREDIT AGREEMENT
AND JOINT LINES OF CREDIT IN DETERMINING ITS OPTIMAL SHORT-TERM CREDIT
FACILITIES. (Recommendation 4)
Liberty has reviewed the documents from the proceedings for Commission approval
of an ICA for Virginia Power over several years. In Case No. PUF910034, a staff
memorandum dated September 18, 1992 concluded: a) "Therefore, the reasons used
(by DRI) to justify the ICA in the reorganization case no longer exist."; and
b) "Therefore, the ICA can no longer be justified from either a cost standpoint
due to ratings or for the economies of scale of combining the needs of two
utilities." (Virginia Power and Virginia Natural Gas.) Liberty fully agrees
with these conclusions and emphasizes that the ICA is primarily a vehicle for
the non-utility entities to benefit from the credit of the utility company.
Certainly this situation is clear in a comparison of the credit ratings of
Virginia Power (standing alone) and DRI. The utility merits an Al/Pl rating
from Standard & Poor's and Moody's, while DRI is rated a full rate level
below, at A2/P2. Because Virginia Power represents over 90 percent of the
DRI entity, the credit rating agencies see a substantial negative credit
drag from the non-utility subsidiaries and DRI.
110
<PAGE>
DRI's control of the Virginia Power financing operations historically precluded
in-house discussion of whether the ICA part of an optimal short-term financing
structure for Virginia Power. The Commission has recently requested that
Virginia Power analyze possible alternatives to the ICA, including the steps
necessary and costs associated with securing its own lines of credit to provide
liquidity for its commercial paper program. Liberty believes that the results of
the study will shed substantial light on the optimal course of action for
Virginia Power's short-term financing.
7. VIRGINIA POWER FINANCIAL EXECUTIVES HAVE NOT HAD CONTROL OF OR
SIGNIFICANT INPUT THE AMOUNT AND TIMING OF EQUITY INJECTIONS FROM DRI.
(Recommendation 5)
Since the transfer of the financing functions to DRI in the 1990s, the holding
company has controlled the timing and amount of equity injections to Virginia
Power. Equity had been injected in sufficient amounts to keep the utility's
credit rating at least at an "A" level. The timing of such injections has,
however, benefited DRI, to the detriment of the utility.
The continual raising of equity funds through the automatic dividend
reinvestment plan, employee savings plan and the customer stock purchase plan
are attractive when equity is needed, due to low issuance costs. However, to
the extent that equity is not needed immediately, the funds raised must be
invested on a short-term basis. The investment of these funds causes a
significant "negative arbitrage" as high-cost equity proceeds (with an
after-tax cost of perhaps between 11 and 13 percent) are invested in short-term
instruments (with an after-tax return of perhaps 4 to 5 percent). On a
consolidated basis, such a negative arbitrage of funds is obviously not
economic or desirable. However, in DRI's case, the holding company
has raised funds from the equity programs throughout the year, but has injected
equity funds into Virginia Power in the fourth quarter. In the meantime, DRI
invests these funds to the benefit of the holding company. Virginia Power must
at times borrow funds over the short-term because DRI has not allocated this
equity to the utility. Virginia Power also has been responsible for the
dividend stream of all equity eventually allocated to the utility, as well as
over 90 percent of dividends for DRI's retained equity. DRI addresses these
issues in the January 6, 1995 memorandum from the DRI CFO. If this proposed
policy is enacted, much of the problem with equity injection timing will be
resolved.
Liberty believes that the aforementioned practices were detrimental to the
utility and for the benefit of the holding company and its earnings. Virginia
Power financial officers have not been allowed, prior to 1995, to plan for and
request equity injections from DRI based on what is best for the utility.
8. DIVIDEND PAYMENTS FROM VIRGINIA POWER AND DRI'S NON-REGULATED BUSINESSES TO
SUPPORT UNALLOCATED EQUITY AND DRI HOLDING COMPANY EQUITY ARE NOT EQUITABLY
DIVIDED. (Recommendation 6)
Virginia Power has been responsible for over 90 percent of the dividend
requirements for DRI's unallocated equity and holding company retained equity.
The January 6, 1995 memorandum proposes to change the calculation of these
dividend payments.
111
<PAGE>
Assigning Virginia Power over 90 percent of the dividend requirements of the
holding company was akin to allocating over 90 percent of holding company
expenses to the utility. The holding company has not provided this proportion of
incremental benefits to the utility. Liberty believes that the holding company
structure is primarily providing benefits to the non-utility entities,
which should support the bulk of holding company-specific dividend requirements.
The January 6,1995 memorandum effectively allocates the subsidiary dividend
responsibility for equity required by the DRI subsidiaries in the coming fiscal
year. However, the dividend responsibility for remaining DRI-unallocated
equity will continue to be allocated at a proportion of over 90 percent to
Virginia Power even after the proposed change.
9. DOMINION CAPITAL DOES NOT CURRENTLY POSE A SIGNIFICANT RISK TO VIRGINIA
POWER'S UTILITY BUSINESS CREDIT STANDING. (Recommendation 7)
Liberty's review of the investments of Dominion Capital was intended to examine
whether such investments posed an imminent danger to the financial health of
the utility. An in-depth analysis of Capital's investments might reveal that
such investments have not resulted in substantial economic gains. However, the
much more modest standard of risk to Virginia Power customers, rather than gain
to shareowners, is the proper basis of this review.
Elements of Capital's investments can cause concern regarding their
viability. Capital's investments in the Vidalia Hydro project carry
substantial risks that are related to future regulatory and political
uncertainties. Capital's common equity portfolio at January 11, 1995 had
a market value of $18 million less than its acquisition costs. The
Company notes that it has sold many of the "winners" and retained most of
the "losers". Capital has had a substantial loss in the past as a
consequence of its taking uncovered option positions; Capital's current
investment policy prohibits this practice. Capital's executives are also
concerned about Capital/Land's real estate investments, which, like
those of many utility holding companies, have been unprofitable.
However, Capital has not taken stakes in individual business ventures
that, by themselves, are large enough to threaten the utility. Capital
has not reached the magnitude where the failure of one of its
investments could currently significantly harm the utility.
However, Capital's pending joint venture with Household Finance Corporation
seems to be the type of investment that could eventually threaten the utility.
The Commission should monitor these types of investments to ensure that they do
not have a future impact on the utility. Entry into the commercial loan
business, as is anticipated in the HFC venture, is of particular concern.
10. DRI'S NON-REGULATED ENTITIES HAVE BENEFITED FROM VIRGINIA POWER'S
CONSISTENTLY POSITIVE TAX BILL UNDER THE CONSOLIDATED TAX ALLOCATION
AGREEMENT. (Recommendation 3)
Virginia Power's regular generation of a large, stand-alone federal tax
liability provides resources for the non-utility subsidiaries to make
tax-oriented investments. The presence of a large and steady tax payer in the
consolidated group allows affiliated entities to bid for projects
that generate tax losses.
112
<PAGE>
Standard industry tax consolidation practices grant these investing entities
with cash on a quarterly basis as compensation for their tax losses. The
cash originates with the tax paying entities (in this case Virginia
Power), which pay to DRI the amount that they would have paid in taxes,
but for the netting effects of affiliation with companies that have
losses for tax purposes. DRI's non-regulated subsidiaries use this cash
to provide funding for their businesses, in order to boost the cash
internal rate of return of projects, and to augment the financeability
of their projects.
This use by DRI's non-regulated subsidiaries of the benefits of tax
consolidation is not unusual. Moreover, it does not cause any harm to Virginia
Power, unless the foregoing of potential opportunities to sell the tax benefits
to third parties is construed as harm. The power company pays taxes to DRI on a
stand-alone basis; i.e., as if the holding company and the non-utility
affiliates did not exist. The benefits of consolidation, however, are entirely
one-sided, in that all flow to the non-utility sector.
This stand-alone tax policy is inconsistent with the policies regarding DRI's
non-regulated financings, in which those entities are dependent on financing
supported by DRI and, implicitly, the cash flow of the utility. In other words,
DRI has adopted a stand-alone policy for taxes, but a stand-together policy for
credit support. In both cases, all the benefits flow to non-utility operations.
Consistency militates in favor of a sharing of benefits on the credit support
side. Such a sharing would adopt a posture that is closer to a stand-alone
credit support position. However, even in that case, a sharing of benefits of
credit support would still provide substantial net savings to the non-utility
subsidiaries.
It is equally true, however, that DRI's non-utility subsidiaries must compete
in the marketplace for investments against others who make similar use of
consolidated tax payment practices. It is doubtful that DRI could compete on a
large scale for such investments if it did not assign much of the benefits of
consolidation to its non-utility sector. It follows that the elimination of
DRI's ability to consolidate taxes would necessitate that non-regulated
projects invested in with tax consolidation assumptions be sold to a tax paying
entity in order to be economic. Such a forced transfer of assets, or
"fire sale" could cause substantial losses of asset value for DRI if
it were to occur.
Virginia's practice has been to follow an entirely stand-alone approach
to computing federal income tax expenses for ratemaking purposes.
However, the range of approaches taken by the states covers the full
spectrum. Pennsylvania, for example, does not allow retention of
consolidation benefits, on the theory that actual, not hypothetical,
expenses (and, therefore, consolidated, not stand- alone, taxes) are the
proper ratemaking measure.
113
<PAGE>
C. RECOMMENDATIONS
1. "CARVE OUT" THE ASSETS AND CASH FLOW OF VIRGINIA POWER IN
ANY FUTURE SUPPORT AGREEMENTS PROVIDED BY DRI TO THE
NON-REGULATED BUSINESS. (Conclusion 3)
It would be helpful and of a clarifying nature to explicitly place the assets
and cash flow of Virginia Power beyond the reach of non-regulated creditors in
any such credit support agreements.
2. DETERMINE THE COMFORT LEVEL OF THE CREDIT RATING AGENCIES FOR DRI-SUPPORTED
DEBT THAT MAY BE MAINTAINED WITHOUT HAVING A SIGNIFICANT INCREMENTAL CREDIT
IMPACT ON VIRGINIA POWER. (Conclusion 4)
DRI and Virginia Power must prevent credit support instruments from having a
substantive impact on the utility company's credit. Virginia Power and DRI
should specifically determine what each rating agency's comfort level is for
these types of support agreements. For instance, if rating agencies are not
comfortable with support agreements over $1 billion, this sum should become a
strict limit on these types of support agreements.
DRI should set limits below this level for the provision of support agreements
to the non-utility entities. The objective of this recommendation is to assure
that there is no substantive credit harm due to the diversified activities, and
that the adequacy of such protection is monitored on an ongoing basis.
3. COMPENSATE VIRGINIA POWER IN THE FUTURE FOR A REASONABLE PORTION OF THE
VALUE OF CREDIT ENHANCEMENT TRANSFERRED BY THE UTILITY. (Conclusion 5)
DRI or the non-regulated businesses should compensate Virginia Power for a fair
value of the credit value transfer. Payments for credit support are common in
the financial marketplace, as is evidenced by various credit enhancement
facilities that have been purchased by the DRI non-regulated businesses in the
marketplace. Compensation to Virginia Power would also be more consistent with
DRI's stance on tax consolidation that the utility and the non-regulated
businesses should "stand alone" for tax consolidation purposes.
A reasonable determination of the value of such a credit transfer should be
determined among the Commission, Virginia Power, and DRI. This determination
should recognize and commonly determine the tax consolidation policy to be
followed in the future.
4. DETERMINE THE OPTIMAL SIZING FOR VIRGINIA POWER'S COMMERCIAL PAPER PROGRAM,
AND INDEPENDENTLY SOLICIT BANK LINES OF CREDIT AND REVOLVING CREDITS FOR THE
UTILITY ON A STAND-ALONE BASIS. (Conclusion 6)
Only by soliciting lines of credit on a stand-alone basis will Virginia Power be
able to determine the optimal course of action for the Company with regard to
lines of credit and revolving credits. Again, Liberty believes that DRI's
insistence on the joint negotiation of lines of credit
114
<PAGE>
among all of the DRI entities is designed for the non-regulated entities to
down from the credit strength of the utility.
The determination of the optimal short-term financing program for the utility
should be based on the analysis currently performed by Virginia Power for
presentation to the Commission by March 31, 1995. The stand-alone credit
options currently being analyzed by Virginia Power should also be compared to
the joint options which are available with DRI to determine the optimal
structure for the utility.
5. GIVE VIRGINIA POWER FINANCIAL EXECUTIVES CONTROL OVER THE AMOUNT AND TIMING
OF EQUITY INJECTIONS FROM DRI BY MAKING THEM RESPONSIBLE FOR INITIATING
EQUITY REQUESTS TO DRI. (Conclusion 7)
This recommendation is consistent with, and is an extension of, the move of
financial responsibility and control to the utility company, as recommended in
Chapter 6. On the other hand, Virginia Power's equity requests should not be
timed so as to cause an unreasonable hardship on the holding company.
6. JOINT DETERMINE A MORE EQUITABLE DIVISION OF DIVIDEND REQUIREMENTS ON
UNALLOCATED EQUITY AND DRI HOLDING COMPANY EQUITY. (Conclusion 8)
Virginia Power should not be responsible for over 90 percent of the dividend
requirements which are caused by the holding company structure. The holding
company was formed in order to allow the company to enter non-utility
businesses. As noted in other sections, Virginia Power does not gain the
benefit of over 90 percent of holding company activities.
DRI's proposed subsidiary dividend allocation set forth in the January 6, 1995
memorandum should be enacted. A similar policy should also be formulated to set
forth for DRI's remaining unallocated equity a dividend responsibility policy
that is more equitable to Virginia Power.
7. PROVIDE FOR REGULAR COMMISSION MONITORING OF THE INVESTMENT TYPES AND
MAGNITUDE OF THE DOMINION ENERGY AND DOMINION CAPITAL ENTITIES FOR THEIR
POTENTIAL IMPACT ON THE UTILITY BUSINESS. (Conclusion 9)
A periodic review of the non-regulated businesses should be conducted (annually
at the outset, and as determined appropriate after an initial period). The
purpose of such review is to keep the Commission currently informed about the
potential risks of the diversified investments on the utility business. A
significant investment in the commercial loan business is occurring at this
time. A single, major investment in a risky business could change the risk
profile of the DRI non-regulated businesses from unthreatening to threatening
to the utility. Periodic updates of the non-regulated subsidiary businesses
will ensure that risky positions taken by the diversified businesses are not
steadily grown on an unmonitored basis.
115
<PAGE>
VI. CRITICAL QUESTIONS ADDRESSED
The Commission's order of August 24, 1994, which opened Case No.
PUE940051, placed emphasis on nine specific questions. The Commission
considered these questions central to the investigation of the
DRI/Virginia Power relationship and its impacts on the utility's ability
to discharge its obligation to provide adequate and reliable service at
reasonable rates.
A. HOW HAVE THE PROTECTIONS AND CONDITIONS RELATED TO AFFILIATES
AGREEMENTS ESTABLISHED IN THE 1986 ORDER WORKED IN PRACTICE? HAVE
THERE BEEN PROBLEMS WITH THESE CONTROLS? IF SO, WHAT GUIDANCE DO THE
FACTS FURNISH FOR THE FUTURE REGULATION OF EXISTING ARRANGEMENTS, OR
OF THOSE WHICH HAVE YET TO BE PROPOSED?
The answer to this question has two parts: (a) compliance with technical
requirements about services and (b) operation in accord with the
Commissions requirement that Virginia Power retain the authority and
independence to remain directly and fully accountable to the Commission
for the satisfaction of its public service responsibilities. The first
part of this answer can flow from well-definable and objective evidence.
The second, however, is a matter of considerably more subtlety and
subjectivity.
DRI has not acted in accord with the overall intent of the protections
and conditions of the 1986 Order. The actions taken during the recent
management dispute demonstrate that DRI has considered it within its
power to restructure the utility's board of directors in order to
resolve important differences between the managements of the two
companies. DRI also took actions to restructure its own board. Those
actions did not immediately affect Virginia Power; however, it is very
clear that their purpose and their likely effect was to gain leverage in
a dispute among directors about what was best for Virginia Power. The
inclination that DRI has shown to act in this manner must have a
substantial chilling effect on Virginia Power in any area of doubt or
disagreement concerning the utility's operation.
DRI has generally taken a more conciliatory tone since the August 1994
settlement. It has also been willing to impose try limits on powers that
it said during the dispute were central to its property rights as
Virginia Power's sole shareowner. Moreover, it is clear that members of
its board now have more evident concern about the role and authority of
the Commission in matters that concern the fulfillment of Virginia
Power's public responsibilities. However, the long-term significance of
these changes remains uncertain. Moreover, there remains a reluctance to
return Virginia Power's board composition to its pre-dispute status.
Liberty considers such a return to be an essential aspect of assuring
that DRI and Virginia Power create a governance structure that preserves
an appropriate measure of utility independence, recognizing at the same
time that it must operate within a holding company structure that seeks
complementary objectives and results.
After a return to pre-dispute status, Liberty believes that there will
exist substantially greater confidence that the Virginia Power board,
acting in concert with its DRI counterpart, will move in the direction
of cooperation that meets proper holding company objectives, while still
allowing the Commission to look to the utility's directors for the
proper exercise of utility responsibilities. Establishing substantial
but not majority overlap of directors, if their selection involves the
116
<PAGE>
unconstrained participation of Virginia Power's board, should help to
promote a more cooperative approach between the companies. More
importantly, it will increase assurances that the DRI board will operate
with a fuller understanding of the utility's responsibilities and the
Commission's role in seeing that those responsibilities are met.
DRI has called some of Liberty's governance recommendations unique and
extraordinary. Those recommendations are, in contrast to this
characterization, designed essentially to restore the pre-dispute
governance circumstances and to use them as a basis for going forward.
Alternatively, the going forward basis incorporates unnecessary and
inappropriate vestiges of the dispute actions that were designed to
change the balance of power in corporate governance at the two
companies. One example is the retention on the Virginia Power board of
directors added to the DRI board at the June 16, 1994 meeting. Moreover,
Liberty's recommended basis for proceeding would eliminate the
management interface role of the joint committee, which itself is an
extraordinary and cumbersome way to handle intercompany relationships.
DRI has not generally acted to impose unilateral requirements in
specific areas or issues of management or operation. It has made direct
recommendations about utility actions in some situations. In most of
those cases, Virginia Power executives have been able to operate as they
determined to be appropriate, notwithstanding those recommendations.
There are some notable exceptions. Foremost is the settlement of the
CSXT rail contract dispute. In that case persistent pressure exerted at
multiple levels of the Virginia Power organization led utility employees
to make concessions that Virginia Power would not otherwise have made.
Moreover, those concessions were recognized at the time to have imposed
substantial costs on Virginia Power. Utility personnel performed
estimates of compensating benefits. Those estimates of benefits netted
out much of the costs of the concessions. However, Virginia Power
personnel now indicate that those estimates of benefits were known to be
speculative and optimistic when they were made.
The protections and conditions related to affiliates agreements have not
been fully effective in practice. For the most part, services have been
provided in accordance with the limitations of those agreements and with
filing requirements. However, there have been a number of instances
where services have been provided outside the scope of the 1986 Order
and those provisions related to prior approval, annual reporting, and
compensation requirements. Many of them have been for the benefit of
DRI's non-utility subsidiaries, which is contrary to the 1986 Order.
The provision of these services demonstrates that there is a need for
greater control over and limitations on the exchange of services between
Virginia Power and its affiliates, particularly in light of three
specific concerns:
(bullet) Services benefitted DRI subsidiaries.
(bullet) DRI and Virginia Power failed to secure prior Commission
approval for the rendering of these services.
(bullet) The services cover a wide range of Virginia Power's
departments, which suggests that the utility is considered a
generally available source of assistance for DRI and its
subsidiaries.
117
<PAGE>
The most significant concerns about the implementation of the 1986 Order
involve the Commission's intent to assure that Virginia Power has the
authority and independence necessary to remain directly and wholly
accountable to the Commission for the performance of its public service
responsibilities. The Commission adopted several technical requirements
about board membership and officers, with which the companies have
complied. However, experience has shown that such technical compliance
simply is not sufficient to assure the necessary authority and induce
under circumstances where holding company and utility boards and
executives have significantly differing outlooks.
Any confusion over the ability of DRI to expand its current types and
levels of services for Virginia Power should be eliminated. Any
additional or changed services should require prior notice to and
approval by the Commission. Virginia Power should not pay DRI for
executive service costs that are now allocated to the utility. There are
no significant benefits other than those solely associated with the
existence of a holding company structure, which, in any event, should
not be allocated to Virginia Power. This limitation should not prohibit
proper allocations for costs associated with acquiring equity in the
market, with maintaining relationships with equity investors, and with
maintaining proper shareholder records. Those functions have been and
should remain with DRI.
B. SHOULD ANY EXISTING AFFILIATES ARRANGEMENTS BETWEEN THE COMPANIES BE
TERMINATED OR MODIFIED? ARE ALL SUCH ARRANGEMENTS CURRENTLY
BENEFICIAL TO VIRGINIA POWER? WHAT COSTS OR BURDENS DO THESE
ARRANGEMENTS IMPOSE ON VIRGINIA POWER? IS VIRGINIA POWER'S
OPERATIONAL FLEXIBILITY OR INDEPENDENCE HAMPERED BY THE EXISTENCE OF
ANY OF THESE ARRANGEMENTS?
The agreements that exist are generally adequate and appropriate.
However, there should be an explicit prohibition placed on the provision
of any DRI services beyond those now being provided. Moreover, the CASA
and the CAAT require substantial revision if they are to serve as a
proper basis for defining and for allocating the costs of affiliate
services.
There existed an arrangement for services between the companies under
which DRI performed various finance and treasury services for Virginia
Power. That arrangement did not produce any notable benefits for
Virginia Power, as compared with service levels and costs that could be
expected if the utility retained these functions. The claimed benefit of
unity of message did not require centralization at DRI. Moreover, the
exclusion of Virginia Power from certain key roles in its own financial
planning and financings threatened harm to the utility, should DRI have
failed to satisfy communications requirements or expectations that
related to areas specific to utility management and operations. The lack
of DRI day-to-day involvement in or knowledge concerning those areas are
material factors in assessing the significance of those risks. Finally,
DRI's means of handling Virginia Power's financial and treasury
functions contributed significantly to the mistrust between the
companies. All concede that Virginia Power is and will remain the
largest element among DRI's assets. The utility should retake direct
responsibility for managing those utility-specific finance and treasury
functions that reside at DRI. The companies have agreed to this change
and have taken steps to return the appropriate functions to Virginia
Power.
118
<PAGE>
Another key operating affiliate arrangement is that DRI executive
management has traditionally taken a direct role in supervising the
activities of the CEO of Virginia Power. This role can be performed
effectively in relatively harmonious circumstances. However, that
climate does not exist here and it is not likely that it will in the
immediate future. DRI should have no management role vis-a-vis Virginia
Power except that it should elect Virginia Power directors from
candidates proposed solely by the Virginia Power board. There should be
no superior/subordinate direct employment relationship between the DRI
and the Virginia Power CEOs, until circumstances clearly and
convincingly show that a proper environment for that relationship has
returned. That it will return during the co-tenures of the two existing
CEOs is most unlikely.
DRI has also attempted to establish other affiliate arrangements for
services; e.g., federal regulatory services. These attempts may also
have included legal services, depending on the intent of recent
proposals, which the parties dispute. It is important for the Commission
to recognize, in any event, that these two areas of service are among
the more critical to a utility's management and operations. There can be
no substantial benefit in consolidation of them under present
circumstances. Even in a less charged atmosphere, it is unlikely that
consolidation at the holding company level would be preferred. Virginia
Power should retain responsibility for all functions required to provide
utility service.
There have been a wide range of other temporary arrangements for
services from Virginia Power to DRI, many of which were not reported to
or authorized by the Commission. Providing these services produced no
net benefits to Virginia Power. They produced net detriments in those
cases where DRI made no payment for the services, or where DRI did not
pay fully allocated costs. Existing procedures should have been adequate
to bring these matters to Commission attention. However, they were not
reported or approved as required. The lack of notice and requests for
approval of these services reflects problems in controlling the
arrangements between the companies.
Consolidated federal tax arrangements provide substantial benefits to
DRI's non-utility subsidiaries, but none to Virginia Power. However,
they do not harm the utility either. There has also been a significant
transfer of value from Virginia Power to DRI through credit support
agreements that effectively use Virginia Power resources to provide
benefits to those subsidiaries, again without any benefits to the
utility.
Apart from the relationships themselves, there remains the question of
how cost assignment and allocation are implemented. This question can
have substantial bearing on issues of benefits and costs. The agreements
that exist are generally adequate and appropriate. However, an allowance
for incidental services should be modified to require advance notice to
and approval by the Commission.
119
<PAGE>
C. ARE COMMISSION AND COMPANY PROCEDURES ADEQUATE TO ENSURE THAT ALL DE
FACTO AFFILIATES ARRANGEMENTS ARE SUBJECTED TO THE STATUTORY REVIEW
AND APPROVAL PROCESS OF VIRGINIA CODE (SECTION MARK)(SECTION MARK)
56-76, ET SEQ.?
No. The Commission's reporting requirements require reporting of all
services provided, but there has clearly been a failing in company
reporting of such services. Many were omitted from annual reports, only
to be discovered as part of an apparent management surveying process
incident to interrogatories in recent Commission proceedings addressing
the management dispute. DRI and Virginia Power should log all requests
for service, regardless of whether they are ultimately granted. Those
that are granted should produce a unique work order or similar
designator. Time, expenses, and other costs should be faithfully tracked
by that designator. Employees should receive periodic training and
announcements concerning the importance of recording requests and
tracking jobs carefully.
Virginia Power should designate a coordinator to assure that all service
requests are logged and that all required Commission approvals are
requested on a timely basis. The costs of this function should be borne
by DRI as part of the fully allocated costs of Virginia Power services
to them.
These measures, like any practical ones that can be proposed, will
require good faith in their execution. Regular, thorough review,
analysis, and evaluation under the direction of Commission staff, by
persons having substantial experience in utility affiliate relations,
may be the only means under the circumstances to assure satisfactory
levels of compliance with the Commission's requirements, which have not
been followed carefully to date.
There is also the potential issue of de facto arrangements by
individuals seeking to exert control or influence in a manner that would
make them affiliates under the statute. Liberty has discovered no
significant indication that any such arrangements exist at this time.
D. WHAT IS DRI'S STRATEGY FOR THE FUTURE AND WHAT ROLE WILL VIRGINIA
POWER'S CORE BUSINESS--THE PORTION OF ELECTRIC SERVICE IN
VIRGINIA--PLAY IN THIS EVOLVING STRATEGY? HOW MIGHT THIS STRATEGY
AFFECT VIRGINIA POWER'S CUSTOMERS?
DRI does not operate under a well-defined and structured strategy or set
of plans. Its CEO believes that the utility will remain the largest DRI
asset, but there are no goals or plans regarding the ultimate size of
the non-utility operations. The CEO describes its non-utility strategy
as one of "pragmatic opportunism." The focus of those plans is
investment opportunities. He says that these opportunities have come to
DRI; DRI has not sought them. Virginia Power has exercised substantial
control over the development of its utility operations strategies and
plans. The utility has informed DRI of progress in planning and it
integrates the results of its planning activities into overall corporate
plans. DRI executives recognize that Virginia Power's performance has
dominated and will continue to dominate overall DRI results. There is no
substantial indication that DRI seeks to move significantly from its
current mix of utility and non-utility operations.
120
<PAGE>
Virginia Power is now engaged in a major planning process, which it
calls Vision 2000. The scope of this project includes an examination of
the businesses that Virginia Power should consider for the future. This
planning project anticipates continuing change in the industry and it is
among Virginia Power's strengths and weaknesses in meeting those
changes. The utility is seriously examining business opportunities
outside those that fall within traditional definitions of utility
service. Wholesale competition has been present for some time, and
recent federal legislative changes will increase it. Moreover, retail
wheeling is a current policy battleground in many regions. There is no
certainty that federal authorities will not extend their recent
wholesale policies to the state level. Moreover, a strong move by state
authorities in this area may in itself have repercussions for Virginia
Power's own policy making.
DRI and Virginia Power already have inherently competing interests in
the wholesale arena--the former through new, non-utility generation
projects and the latter through bulk power capacity and energy sales
from facilities built largely to serve retail customers. Utility
financial strength in the future may come to depend more on the
existence of a vibrant competitive posture, even where the direct
benefits thereof do not flow back to retail customers. If DRI were to
capture all or most of the opportunities in new wholesale generation
markets, it is not clear that Virginia Power would retain sufficient
financial vitality to keep rates at competitive levels. If this is so,
then there are clear, adverse implications for captive customers. Thus,
the lack of full integration between DRI plans, which are not well
developed, and those of Virginia Power does not lay a sound basis for
assuring that the risks of the emerging marketplace do not unduly
threaten Virginia Power. There can be no realistic expectation that
total insulation from these risks is achievable. However, the Commission
should be concerned that Virginia Power retain sufficient levels of
opportunity to provide an appropriate balance with those risks.
DRI should strive for an overall corporate strategy that optimizes
performance. This striving necessarily implies substantial concern for
the future operations of its utility subsidiary, which dominates
performance. However, one must keep in mind the lack of emphasis on
strategic planning, on the one hand, and the opportunism, on the other,
that are self-described elements of DRI's approach to the future. These
values do not instill confidence that DRI will properly examine Virginia
Power's needs. DRI has, however, in response to Liberty's interim
report, committed to a more formal strategic planning process, which it
will coordinate with similar activities at Virginia Power. Moreover,
there also remains the question of optimizing for the benefit of
shareowners versus customers. The Commission maintains the most direct
control over Virginia Power. It therefore may be expected to have more
control over the optimization process to the extent that it takes place
at Virginia Power, rather than at DRI.
E. WHAT IMPACT, FOR GOOD OR ILL, CAN THE INVESTMENTS OF DRI AND ITS
OTHER SUBSIDIARIES HAVE ON VIRGINIA POWER? WHAT REGULATORY CONTROLS
ARE APPROPRIATE TO AVOID OR LESSEN ANY ADVERSE IMPACTS?
This question is more fully addressed in the report of J. Robert Malko,
which forms Part III of the Staff report. Liberty's examination in this
area focused on the risks involved in DRI's major non-utility
investments. DRI has made use of project financing to limit credit risk
and its credit instruments and agreements nominally insulate Virginia
Power from direct consequence, should particular problems arise in
non-utility ventures. On the other hand, those investments have not
produced substantial benefits to Virginia Power, nor are they likely to
do so. The non-utility
121
<PAGE>
businesses have benefitted from consolidated federal tax treatment and
from credit support that effectively comes from the financial strength
that Virginia Power brings to the holding company's balance sheet. The
non-utility businesses have not compensated Virginia Power for these
benefits.
DRI's current non-utility portfolio has a level of diversification (size
and nature of individual investments) that mitigates risk to the
utility. However, growth in the non-utility portfolio and recent
consideration of investments that appear to have higher risks may
produce a change in the future. Liberty believes that it is important
for DRI to share with the Commission on an ongoing basis its plans for
non-utility investment growth or change. This sharing should include the
Company's projections of financial results and its views of significant
risks and contingencies. Ongoing dialogue will give the Commission a
prior opportunity to determine whether any changes in DRI's course or in
its business environment give rise to specific concerns about possible
harm to utility finance and operations.
F. WHAT IMPACT DOES FEDERAL LEGISLATION, INCLUDING PUHCA AND POSSIBLE
AMENDMENTS THERETO, AND EPACT, HAVE ON DRI, VIRGINIA POWER AND THE
HOLDING COMPANY RELATIONSHIP?
Much of this answer was provided in response to Question D. Moreover,
federal legislation has expanded the competitive opportunities of
utilities and other generators of electricity who are exempt from
utility regulation. Liberty's answer to Question D summarizes issues
that have been raised by or may result from federal actions. Potential
changes to PUHCA raise added issues. DRI has examined mergers with at
least two other large utility systems within the past several years.
Consummation of those mergers, neither of which is actively being
considered any more, may have raised substantial questions under PUHCA.
Repeal or substantial relaxation of this statute's requirements and
restrictions could substantially increase the importance of state-level
regulation of multi-state holding companies. Merger with other major
systems would likely involve substantial changes in common management
and services. To the extent that it did, it would also probably change
drastically the operating environment under which questions of Virginia
Power authority and independence would have to be addressed. Utility
mergers generally involve significant realignment and consolidation of
organizations.
G. HOW SHOULD QUESTIONS OF CONFLICTS OF INTEREST IN THE DRI/VIRGINIA
POWER SITUATION BE ADDRESSED? WHAT CONTROLS ON THIS SUBJECT DO THE
COMPANIES, AND THE COMMISSION, HAVE IN PLACE NOW? ARE THEY EFFECTIVE?
HOW SHOULD SUCH CONFLICTS BE DEFINED, CONTROLLED AND PREVENTED?
The Commission has an important interest in assuring that directors who
exercise actual, apparent, or potential influence over Virginia Power's
management and operations meet meaningful standards of objectivity and
independence. All three classifications of influence apply to DRI
directors in recent past circumstances. Directors of DRI altered
Virginia Power's articles or by-laws and effectuated changes in the
composition of Virginia Power's board of directors for the clear purpose
of influencing the outcome of disputes between DRI and Virginia Power
over the operation of the utility. Moreover, DRI's directors directly
participated in activities designed to produce a change in Virginia
Power's chief executive officer, again as part of an effort to influence
the outcome of such disputes.
122
<PAGE>
These circumstances make it clear that any distinction between DRI and
Virginia Power directors, for purposes of assessing the ability to
control utility actions, is contrary to both reality and appearances.
Therefore, the Commission should act upon the premise that it has an
interest in DRI board membership and actions that are not, for these
purposes, fundamentally different from its interest in Virginia Power
board membership and actions. To proceed otherwise, as the companies are
now structured, would be to make fulfillment of the authority and
independence aspects of the 1986 Order impossible at those junctures
when fulfillment is the most important, such as the recent management
dispute.
With the notion of any categorical distinctions between the DRI and
Virginia Power boards put aside, recent events demonstrate that outside
relationships of certain board members create the appearance of
conflicts of interest that are material to their need to act objectively
in the interests of Virginia Power as the principal asset of DRI. Common
board memberships, personal services arrangements between directors and
the companies, vendor relationships, and other business ties create
appearances that are not consistent with the need for assurance that
board members are free of potentially competing influences as they
deliberate over DRI or Virginia Power management and operations.
There have been no allegations of misconduct against any company
directors, nor do any lack the capability and experience necessary to
serve the companies. The issue is that companies such as Virginia Power
and DRI should, as their peers do, seek to maintain very high standards
concerning director objectivity and conflict of interest. They should
act firmly and comprehensively to avoid even the appearance of
compromise, even though their directors may be of the highest
professional caliber.
There were no formal controls over such potential or apparent conflicts
when Liberty prepared its interim report. Some were proposed during
negotiation of the August 1994 settlement; however, they were not
adopted. The DRI board has recently adopted guidelines that cover this
issue, but they are weak. More strict guidelines are needed.
Specifically, conflicts should be defined to include any relationship
that produces personal annual revenues or services to a director in an
amount or value that exceeds a defined percentage of compensation as a
director (25 percent would be reasonable as an upper bound). Conflicts
should also be defined to preclude membership by any person with
employment, contract, or similar affiliation with any entity that does
more than $1 million in business with Virginia Power annually, excepting
tariffed electricity purchases from the utility. Membership by persons
who serve together on other corporate or large institution boards should
be minimized, if not eliminated. The provision of personal services to
members should also be precluded.
H. HAVE ANY ASPECTS OF THE DRI/VIRGINIA POWER RELATIONSHIP ADVERSELY AND
IMPROPERLY AFFECTED RATES PAID BY VIRGINIA POWER'S CUSTOMERS IN THE
PAST? WHAT CONTROL MECHANISMS COULD PREVENT SIMILAR PROBLEMS IN THE
FUTURE?
DRI actions and its relationship with Virginia Power have not had a
major influence on the rates of Virginia Power customers in the past.
However, they have had some impact and can have impact in the future.
Past impacts arise from the CSXT settlement, which, as explained
elsewhere, appear to have caused substantial additional costs, some of
which have already been dealt with before the Commission.
123
<PAGE>
Other aspects of the relationship have imposed unnecessary costs on
Virginia Power. These costs would typically form part of test-year
expenses in a base rate case. Whether Virginia Power customers have paid
or will pay such costs is a function of the timing of the company's base
rate cases in the past (which liberty has not examined) or in the future
(which Liberty cannot predict). Nevertheless, reasonable estimates of
the costs that Virginia Power has paid can be made.
DRI allocates costs to Virginia Power for DRI executive services. DRI
executives state that there is little interaction between the companies
and that Virginia Power manages and operates its own affairs. Liberty's
interviews with DRI disclosed no tangible executive services of value
from DRI to Virginia Power. Moreover, holding company operations should
not be charged to Virginia Power in any case, because they would not be
required except for the existence of the holding company structure that
provides the ability to generate non-utility revenues. In other words,
executive management of the holding company is redundant to that of the
utility. It is, however, essential to the non-utility subsidiaries,
which should therefore pay for it. DRI charged Virginia Power $1.080
million for executive costs in 1993 and $857,000 in 1994. These costs
should have been retained by DRI. DRI controller costs, which DRI
describes as largely a function of consolidation, should also have been
retained by DRI. The costs that should have been retained amounted to as
much as $410,000 in 1993 and $359,000 in 1994.
The companies have recognized this issue. In their Joint Response to
Interim Report of Staff and Consultants, they suggested an analysis of
executive costs be undertaken to determine:
a) the portion of executive service costs that actually reflect
services to Virginia Power, b) the extent to which those services
involve costs that Virginia Power would not incur if it were not in a
holding company system, and c) how such executive and related costs
are allocated in other holding company systems.
The companies have not completed work on these topics. In any case, it
bears note that there is a relatively low level of common services
between DRI and Virginia Power Company, as compared with similar holding
companies. This situation, which the 1986 Order was designed to produce,
creates a lower than usual potential for misallocation of costs to the
utility.
I. ARE THERE ASPECTS REGARDING THE FLOW OF BENEFITS, SERVICES AND FUNDS
BETWEEN THESE COMPANIES AND/OR THEIR AFFILIATES WHICH MIGHT ADVERSELY
AFFECT VIRGINIA POWER? IF SO, HOW SHOULD THESE MATTERS BE ADDRESSED?
The Commission should be concerned about three possible forms of adverse
impact:
(bullet) To utility capital access or costs.
(bullet) To utility operating authority and independence.
(bullet) To utility operating costs as a result of improper cost
assignment or allocation.
124
<PAGE>
CAPITAL ACCESS AND COST
Non-utility investments have the theoretical capacity to adversely
affect utility costs. The extent to which they may have such an effect
results principally from the size, nature, and performance of those
investments. Serious potential for any substantial impacts here would
probably require a significant change in the size or the risk
characteristics of the non-utility investment portfolio. Liberty
believes that the size and performance of DRI non-utility investments to
date have not had the kinds of characteristics that raise potential for
significant impact on the utility's access to capital needed for current
and long-term provision of public service or on the cost of acquiring
that capital.
This is not to say that the Commission should have no concern or take no
action to prevent possible negative impacts. The Commission should
require DRI to maintain a dialogue with the Commission about its future
plans, projected investment levels, return targets, investment
performance, and perceptions of risk levels. There are no overridingly
large DRI investments. Therefore, the risk of a single contingency
financial catastrophe is relatively low. More likely (not to say
probable) is a scenario in which progressively deteriorating financial
performance by non-utility affiliates causes a reaction by the financial
community. The Commission should monitor the key performance factors (at
the holding company, utility, and subsidiary level) that affect market
perception. If it does so, then it should have reasonable confidence
that it will obtain warning signals in advance of any potential need to
order responsive action.
OPERATING AUTHORITY AND INDEPENDENCE
The organizational location of services has a significant potential for
adversely affecting Virginia Power. The utility remains, and by all
accounts will remain, the dominant element of value within DRI. It will
also remain the entity with the most significant management and
administrative needs. Over the past several years, the organization
locations of Virginia Power's finance, legal services, and federal
regulation have been objects of action or discussion. Each of these
functions include activities that are critical to the success of the
utility.
It is not necessary that all of these services be operated within the
utility itself. However, long-term prospects for utility success are not
strong if such services are not carried so that the providers have
utility senior management's full confidence and trust. That environment
has not existed between DRI and Virginia Power for some time, and it
would require more than reasoned optimism to expect such environment to be
developed in the near term. Moreover, the decline in the relationship
between the companies has focused to a very large extent on these
functions. There is consequently substantial reason to believe that
stripping a company like Virginia Power of direct control over such
functions itself will tend to strain relationships and build mistrust.
In any case, prudence would suggest that such functions remain within
the utility's direct control for the foreseeable future. Arguments about
efficiency of consolidation are as well, and perhaps better, served by
the purchase of services by the non-utility sector, given its much
smaller size and its past arguments about the degree to which the
Commission may control its activities and assets.
125
<PAGE>
OPERATING COSTS
The most direct influence on operating costs, as a category distinct
from the two discussed above, will come from cost assignment and
allocation for common services. The separation imposed by the 1986 Order
and emphasized by the executives of DRI make it difficult to relate
allocated costs for DRI executive services to tangible benefits to
Virginia Power. Moreover, Liberty found significant problems in the
application of allocation methods to common costs. Only periodic,
detailed examinations of transactions, assignments, and allocations will
give adequate assurance that utility customers are not subsidizing
non-utility enterprises.
126
<PAGE>
APPENDIX A: AFFILIATE COMPANY DESCRIPTIONS
SUBSECTION 1: DOMINION RESOURCES, INC. (DRI)
DRI was incorporated under the laws of the State of Virginia on Mach 17,
1983. DRI owns all of the outstanding common stock of Virginia Electric
and Power Company, its largest subsidiary, in addition to all the
outstanding common shares of Dominion Capital, Inc., and Dominion Energy,
Inc. Dominion Lands, Inc. was also a wholly owned subsidiary of DRI until
March 1994, when it became a subsidiary of Dominion Capital. Until
January 1990, DRI owned Virginia Natural Gas, Inc., a gas provider in the
Hampton Roads area of Virginia, and at the time the second largest
distributor of natural gas in Virginia. DRI also owns the building at One
James River Plaza, Richmond, Virginia, in which Virginia Electric and Power
Company has its principal offices. Figure 1 below shows DRI's first tier
subsidiaries.
Figure 1
Dominion
Resources Inc.
Dominion Dominion Virginia Electric
Capital Inc. Energy Inc. and Power Company
Dominion
Lands, Inc.
The officers of DRI as of August 16, 1994 are:
Thomas E. Capps Chairman of the Board and CEO
Tyndall L. Baucom President and COO
David Heavenridge Senior Vice President
Linwood R. Robertson Vice President-Finance and Treasurer
J. Kennerly Davis, Jr. Vice President and Corporate Secretary
Everard Munsey Vice President-Public Policy
Donald T. Herrick, Jr. Vice President
Thomas N. Chewning Vice President
Paul J. Bonavia Vice President and General Counsel
James L. Trueheart Vice President and Controller
A-1
<PAGE>
DRI's consolidated net income has grown from $379.8 million in 1986 to
$516.6 million in 1993, a 36 percent increase over the seven year period.
This increase slightly understates DRI's true overall growth due to the
1990 sale of Virginia Natural Gas, which contributed $5.8 million to DRI's
consolidated earnings in 1989. At the end of 1993, DRI listed consolidated
assets of over $13.3 billion.
The contribution to consolidated net income of the non-utility affiliates
increased from $5.9 million in 1986 to $20.1 million in 1993. DRI's
non-utility assets have grown from $354.6 million in 1986 to $1,963
million in 1993. Non-utility asset growth has been uneven with large
increases in 1987-1989, and 1992, but small or negative growth in other
years.
Figure 2 below shows the percentage contribution of earnings and assets
of DRI's non-utility subsidiaries to the total for DRI, including Virginia
Power. As shown, the growth in assets in the 1990s has not been accompanied
by a comparative increase in net income. As a percent of consolidated
assets, the non-utility subsidiaries' assets increased from 4 percent in
1986 to 20.3 percent in 1992, before dropping to 14.7 percent in 1993.
Non-utility net income, also erratic, has averaged 7 percent of DRI's
consolidated net income.
Figure 2
Dominion Resources
Non-regulated Income and Assets
as a Percent of Consolidated Totals
Approximate
Net Income Assets
1986 1.8% 4.0%
1987 7.6% 9.5%
1988 8.5% 13.5%
1989 8.1% 16.5%
1990 11.8% 17.3%
1991 4.9% 19.2%
1992 9.1% 21.0%
1993 4.0% 19.0%
[bar graph]
A-2
<PAGE>
The table below shows total DRI employees at year-end.
Year Number Year Number
1987 86 1991 86
1988 82 1992 93
1989 89 1993 106
1990 82 1994 (Oct.) 106
SUBSECTION 2: VIRGINIA POWER
Virginia Electric and Power Company is a regulated public utility engaged in
the generation, transmission, distribution and sale of electric energy in
Virginia and northeastern North Carolina. Although its service area comprises
approximately 65 percent of Virginia's total land area, it provides electricity
to over 80 percent of the state's population. Virginia Power's service areas
include the populous Northern Virginia area as well as metropolitan Richmond,
Norfolk, Newport News, and Virginia Beach. Virginia Power owns and operates
nuclear, coal, natural gas, oil and hydroelectric power stations. Virginia
Natural Gas was a division of Virginia Power until July 1986 when its
assets and liabilities were transferred to Virginia Natural Gas, Inc., a wholly
owned division of DRI. Effective January 1, 1990 DRI sold Virginia Natural
Gas to Consolidated Natural Gas Company.
Table 1, on the following page, is a summary financial statement for Virginia
Power.
A-3
<PAGE>
TABLE 1
VIRGINIA POWER
CONSOLIDATED INCOME STATEMENT
1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total Operating Revenues $3,021.2 $3,117.9 $3,174.2 $3,500.4 $3,461.5 $3,688.1 $3,688.1 $3,679.6
Total Operating Expenses 1,975.2 2,101.3 2,255.5 2,520.4 2,460.0 2,653.5 2,653.5 2,698.9
Total Operating Income 1,046.0 1,016.6 918.7 980.0 1,001.5 1,034.6 1,034.6 980.8
Other Income 1.3 2.0 1.8 3.7 38.2 41.5 41.5 22.7
Fixed Charges 348.6 356.6 373.8 418.5 438.6 411.3 411.3 371.4
Net Income Before Taxes 698.7 662.0 546.7 565.2 601.1 664.7 664.7 632.1
Income Tax 325.9 255.4 139.7 190.0 209.0 228.8 228.8 208.2
Net Income $372.8 $406.6 $407.0 $375.2 $392.1 $435.9 $435.9 $423.8
</TABLE>
VIRGINIA POWER
CONSOLIDATED BALANCE SHEET
DEC 31, 1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Current Assets $667.4 $761.1 $744.6 $857.5 $714.1 $624.4 $743.6 $745.4
Property, Plant & Equip. 7,235.3 7,699.2 8,051.3 8,545.0 8,879.7 9,106.5 9,295.7 9,459.0
Investments 38.8 190.1 166.9 153.4 174.9 258.9 275.1
Deferred Charges 692.2 757.0 509.2 516.1 358.1 299.2 1,028.6 1,041.0
Total Assets $8,594.9 $9,256.1 $9,495.2 $10,085.5 $10,105.3 $10,205.0 $11,326.9 $11,520.5
Liabilities
Current Liabilities $606.2 $683.3 $713.2 $811.9 $810.0 $692.6 $950.7 $919.1
Long-Term Debt 3,505.4 3,631.3 3,695.5 3,977.6 3,817.4 3,818.0 3,800.2 3,899.9
Deferred Credits 1,272.6 1,376.1 1,317.1 1,312.2 1,252.8 1,256.7 1,929.6 1,931.5
Preferred Stock 531.3 690.0 743.7 787.7 765.8 739.1 829.3 818.0
Stockholders Equity 2,679.4 2,875.4 3,025.7 3,196.1 3,459.3 3,698.4 3,817.1 3,952.0
Total Liabilities and $8,594.9 $9,256.1 $9,495.2 $10,085.5 $10,105.3 $10,205.0 $11,326.9 $11,520.5
Equity
</TABLE>
The following table shows the number of Virginia Power employees at year-end.
YEAR NUMBER YEAR NUMBER
1987 13,577 1991 12,678
1988 13,458 1992 12,033
1989 12,753 1993 11,861
1990 12,876 1994 (Oct) 10,554
SUBSECTION 3: DOMINION CAPITAL, INC. (CAPITAL)
Dominion Capital, DRI's first non-regulated subsidiary, provides investment
management services to the holding company and the other non-regulated
subsidiaries. Capital was formed to diversify DRI's investments and potentially
earn higher returns than the regulated utility. The principal assets of
Capital are a 50 percent limited partnership interest in a Louisiana
hydroelectric project, investments in marketable securities, and Rincon
Securities Inc. Capital also has investments in affordable housing, real
estate and leases. Dominion Financing, a wholly owned subsidiary of Capital,
engages in the issuance of medium-term notes to finance a portion of Capital's
activities. As of March 1994, Dominion Lands, Inc. became a subsidiary of
Capital.
A-4
<PAGE>
In 1986, Capital purchased the assets of Rincon Securities, Inc. primarily
high grade preferred stocks and securities. Dominion Capital manages Rincon's
portfolio of investments and Rincon is operated as a wholly-owned subsidiary
of Dominion Capital.
In 1987, Capital purchased a 50 percent interest in a $500 million
hydroelectric project with Catalyst Vidalia Corporation in Louisiana.
Electricity from the project, completed in 1990, was sold primarily to
Louisiana Power and Light. Vidalia took a small portion for its own
production needs. The partnership sold the hydro-electric plant in 1990,
and entered in to a leaseback and operation agreement with the new
ownership consortium.
Capital's real estate investments are primarily commercial real estate
properties concentrated in eastern Virginia. The investments have been
impacted by overbuilding in the retail and office space sectors.
Table 2 below lists Capital's investments and ventures to date.
TABLE 2
DOMINION CAPITAL INVESTMENTS AND VENTURES
<TABLE>
<CAPTION>
Investment/Venture Partners/Owner/Investors Ownership
<S> <C> <C>
Catalyst Old River Hydroelectric Partnership Dominion Capital 50.0%
Catalyst Vidalia Corp. 50.0%
Dominion Financing Dominion Capital 100.0%
Vidalia Audit Dominion Capital 100.0%
Rincon Securities Dominion Capital 100.0%
Blue Ridge Securities Dominion Capital 100.0%
America's Utility Fund Services Company Dominion Capital 100.0%
Project America Dominion Capital 100.0%
Stanton Associates Dominion Capital 83.0%
Bob Stanton 17.0%
</TABLE>
Source: Response to Data Request 5.7
A-5
<PAGE>
The following table, Table 3, is a summary financial statement for Capital.
TABLE 3
DOMINION CAPITAL
INCOME STATEMENT
1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total Operating Revenues $10.8 $11.5 $33.4 $35.8 $22.1 $32.6 $35.8 $70.0
Total Operating Expenses 0.2 0.8 3.3 2.5 (1.9) 4.7 6.9 15.3
Total Operating Income 10.6 10.7 30.1 33.3 24.0 27.8 28.9 54.7
Other Income 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Fixed Charges 0.6 1.5 24.5 26.6 27.6 37.7 31.4 28.4
Net Income Before Taxes 10.0 9.2 5.6 6.7 (3.6) (9.9) (2.5) 26.3
Income Tax 0.1 (6.8) (8.1) (8.1) (26.0) (14.1) (13.4) (1.7)
Net Income $9.9 $16.0 $13.7 $14.8 $22.4 $4.2 $10.9 $28.0
</TABLE>
DOMINION CAPITAL
BALANCE SHEET
DEC 31, 1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Current Assets $16.3 $12.0 $13.3 $4.4 $10.0 $50.0 $55.3 $83.5
Property, Plant & Equip. 7.6 1.9 486.6 1.9 15.3 0.6
Investments 161.1 366.4 429.0 1.9 447.8 448.6 489.3
Deferred Charges 77.9 0.2 11.5 10.7 11.5 10.8 27.4 24.9
Total Assets $101.8 $173.3 $391.2 $446.0 $510.0 $510.4 $546.6 $598.4
Liabilities
Current Liabilities $5.5 $1.9 $10.5 $16.1 $68.0 $99.0 $159.6 $11.5
Long-Term Debt 24.3 121.7 322.5 363.3 357.8 313.7 270.8 434.7
Deferred Credits (2.9) 5.7 4.7 19.2 17.6 29.0 36.6
Preferred Stock 52.5
Stockholders Equity 72.0 52.6 61.9 65.0 80.2 87.2 115.6
Total Liabilities and $101.8 $173.3 $391.2 $446.0 $510.0 $510.4 $546.6 $598.4
Equity
</TABLE>
The table below shows total Capital employees at year-end.
YEAR NUMBER YEAR NUMBER
1987 0 1991 6
1988 8 1992 11
1989 6 1993 8
1990 6 1994 (Oct.) 8
SUBSECTION 4: DOMINION ENERGY, INC. (ENERGY)
This entity was originally incorporated as Virginia Nuclear, Inc. on
August 28, 1975, as a wholly-owned, uranium reserve exploration subsidiary
of Virginia Power. Its name was changed to Dominion Exploration in 1984,
and its charge was to enter into the natural gas exploration and development
market. Until 1987, this subsidiary was relatively inactive, acquiring the
mineral rights to just a few properties in West Virginia. Effective July 1,
1986, Virginia Power declared a special dividend to DRI of its investment
in the common stock of Dominion Exploration. The name was changed to
Dominion Energy in 1987, to reflect DRI's efforts to enter into the
independent power production field.
A-6
<PAGE>
Dominion Energy is active in a number of partnerships to develop non-utility
electric power generation projects outside the territory served by Virginia
Power. Energy is involved in projects in six states and two foreign countries
with a total of approximately 2,000 MW as of year end 1993. In total, Energy's
current planned and operating generating projects include six gas fired units,
two geothermal units, seven hydro-electric units, one wood- and coal-fired
unit, and one solar unit.
Energy has experienced fairly rapid growth in its first six years of
operations. Energy's first cogeneration investment was a limited partnership
in a 75-megawatt, wood- and coal-fueled plant in Rumford Maine at a Boise
Cascade paper mill. In March of 1987, Energy actively began its foray into
the competitive power market by entering a partnership with CSX Transportation
to develop cogeneration projects at industrial host sites throughout the
country. Energy also purchased a 50 percent interest in the cogeneration
subsidiary of Enron, the large natural gas pipeline operator. The partnership
thus changed its name to Enron/Dominion Cogen Corporation. The partnership
has an interest in four gas-fueled cogeneration projects with a total capacity
of 1,290 MW. By 1991, Energy was operating or had interests in 15 competitive
power projects, and had plans for two others. Also in 1991, Energy entered
the international power market through an agreement with the government
of Belize for a 22-megawatt hydro-electric project with a planned startup in
early 1995. Energy's first actual foreign operating facility, a 450 megawatt
hydro-electric station, was acquired with a partner in 1992 during Argentina's
privatization effort.
Energy is also still active in the acquisition and development of natural
gas reserves, primarily proven and/or producing oil and gas reserves. In
1989, Energy established a new subsidiary, Dominion Reserves, to manage
these natural gas interests. By year-end 1993, Dominion Reserves held the
equivalent of 342 BCFE in natural gas reserves, 151 BCFE of which were
acquired in 1993. Production from company holdings totaled 34 BCFE in
1993. Since Energy's acquisition are mostly proven reserves, its financial
performance in this area is highly dependent upon the market price of
natural gas.
Table 4 is a summary financial statement for Energy.
TABLE 4
DOMINION ENERGY INC.
INCOME STATEMENT
1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C>
Total Operating Revenues $1.1 $4.6 $24.2 $29.3 $34.1 $40.9 $144.2
Total Operating Expenses 3.1 4.4 17.0 8.4 15.7 28.0 126.0
Total Operating Income (2.0) 0.2 7.2 30.9 18.4 12.9 18.2
Other Income 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Fixed Charges 0.0 3.1 8.7 11.3 10.9 10.4 21.2
Net Income Before Taxes (2.0) (2.9) (1.5) 9.6 7.5 2.5 (3.0)
Income Tax (0.9) (10.5) (16.0) (3.2) (4.1) (7.0) (32.6)
Net Income ($1.1) $7.6 $14.5 $12.8 $11.5 $9.5 $29.6
</TABLE>
A-7
<PAGE>
DOMINION ENERGY INC.
BALANCE SHEET
DEC 31, 1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C>
Assets
Current Assets $1.0 $4.7 $9.6 $6.8 $18.3 $49.7 $53.8
Property, Plant & Equip. 0.8 16.7 20.3 34.6 66.1 260.3 599.8
Investments 7.3 136.8 185.6 206.4 209.8 233.7 224.1
Deferred Charges 0.4 1.7 2.2 2.1 4.9 12.2 38.1
Total Assets $9.5 $159.9 $217.7 $249.9 $299.1 $555.9 $915.8
Liabilities
Current Liabilities $0.9 $2.5 $(11.8) $9.2 $6.3 $16.9 $177.2
Long-Term Debt 2.1 95.1 135.8 131.8 164.4 249.6 319.4
Deferred Credits 0.1 3.7 26.8 36.3 51.6 82.2 171.0
Preferred Stock
Stockholders Equity 6.4 58.6 66.9 72.6 76.8 207.3 248.2
Total Liabilities and $9.5 $159.9 $217.7 $249.9 $299.1 $555.9 $915.8
Equity
</TABLE>
The table below shows total Energy employees at year-end.
YEAR NUMBER YEAR NUMBER
1987 0 1991 49
1988 13 1992 64
1989 20 1993 75
1990 19 1994 (Oct.) 80
Table 5, on the following page, lists Energy's investments and ventures to
date.
A-8
<PAGE>
TABLE 5
DOMINION ENERGY INVESTMENTS AND VENTURES
INVESTMENT/VENTURE PARTNERS/OWNER/INVESTORS OWNERSHIP
Dominion Cogen, Inc. Dominion Energy, Inc. 100.0%
Dominion Cogen CA, Inc. Dominion Energy, Inc. 100.0%
Dominion Cogen NY, Inc. Dominion Energy, Inc. 100.0%
Dominion Cogen WV, Inc. Dominion Energy, Inc. 100.0%
Dominion Cogen DC, Inc. Dominion Energy, Inc. 100.0%
Dominion Reserves, Inc. Dominion Energy, Inc. 100.0%
Dominion Energy Services, Inc. Dominion Energy, Inc. 100.0%
Dominion Demand Side Services, Inc. Dominion Energy, Inc. 100.0%
Tech Resources, Inc. Dominion Energy, Inc. 50.0%
Battelle Memorial Institute 50.0%
Dominion Generating S.A. Dominion Energy, Inc. 100.0%
Dominion Black Warrior Basin, Inc. Dominion Energy, Inc. 100.0%
Dominion Reserves-Utah, Inc. Dominion Energy, Inc. 100.0%
Dominion Energy Central America Dominion Energy, Inc. 100.0%
Enron/Dominion Cogen Corp. Dominion Energy, Inc. 50.0%
Enron Corp. 50.0%
Morgantown Energy Associates Dominion Cogen, WV, Inc. 50.0%
Cogen Technologies Morgantown 35.0%
Hickory Power Corp. 15.0%
Dominion Gas Processing MI, Inc. Dominion Reserves, Inc. 100.0%
Dominion Southern Michigan, Inc. Dominion Reserves, Inc. 100.0%
Frederic HOF, L.P. Dominion Gas Processing MI, Inc. 94.0%
Mercury Exploration Company 6.0%
Wilderness Energy, L.C. Dominion Energy, Inc. 50.0%
Mercury Exploration Company 50.0%
A.V. Holding S.A. Dominion Generating S.A. 60.0%
Cooperativai Provincial de Servicios 100.0%
Publicos Y Comunitariuos de 100.0%
Neuquen Limitada (CALF) 40.0%
Patagonia Holding S.A. Dominion Generating S.A. 65.0%
Louis Dreyfus Argener S.A. 35.0%
Central Termica Alto Valle S.A. A.V. Holding S.A. 90.0%
Employees of CTAV 10.0%
Hidroelectrica Cerros Colorados S.A. Patagonia Holding S.A. 59.0%
Government of Argentina 41.0%
Belize Electric Company Ltd. Dominion Energy Central America 95.0%
Belize Social Securities Board 5.0%
Source: Response to Data Request 5.7
A-9
<PAGE>
SUBSECTION 5: DOMINION LANDS (LANDS)
Dominion Lands was established in November 1986 as DRI's non-regulated real
estate subsidiary with the intention of capitalizing on the corporate knowledge
of the area real estate market. Lands does not provide real estate related
services the Company, and is operated as a wholly separate organization.
At its largest, Lands employed just five people. In the early years of its
operations, Lands was an active real estate investor and developer,
concentrating on high-quality residential and mixed-use communities in and
around Virginia. It also acquired an inventory of land for future use or sale.
Since 1991, Lands has been relatively inactive, focusing on sales of land
parcels and units in its development projects.
Like most utility real estate affiliates, Land's operating plans and expansion
strategy was interrupted by the slumping real estate market of the late 1980s
through early 1990s, and its financial results suffered correspondingly.
However, because it invested in amenity-oriented communities rather than those
sectors hardest hit by overbuilding, the commercial office building and retail
development markets, its prospects have improved recently.
Land's began its development efforts by utilizing a number of parcels that had
been bought from Virginia Power by DRI and Capital. In total, Virginia
Power sold six parcels for $8.8 million, which were no longer considered
useful to utility operations. All but one were no longer in the utilities
rate base. In total, Lands developed or owned an interest in four development
projects. Currently, only three of Land's development projects have progressed
to the point of unit sales.
Table 6 below lists Lands ventures and investments to date.
TABLE 6
DOMINION LANDS INVESTMENTS AND VENTURES
INVESTMENT/VENTURE PARTNERS/OWNER/INVESTORS OWNERSHIP
Bridgeway Dominion Lands, Inc. 100.0%
Chesterfield Lands Associates Dominion Lands, Inc. 50.0%
East West Community Development
Associates, L.P. 50.0%
Haasch Property Dominion Lands, Inc. 100.0%
Lakin Badin Associates Dominion Lands, Inc. 67.1%
Bishop & Gray, Inc. 5.0%
Ololorock Corporation 27.9%
Governors Land Associates Dominion Lands Williamsburg, Inc. 50.0%
Governors Land, Inc. 50.0%
Harborside Dominion Lands, Inc. 100.0%
12th St. Power Station Dominion Lands, Inc. 100.0%
Suffolk Gas Plant Dominion Lands, Inc. 100.0%
Widewater Associates Dominion Lands, Inc. 99.0%
RB Limited Company -1.0%
Source: Response to Data Request 5.7
A description of Land's major development projects and holdings follows.
A-10
<PAGE>
The first major development to be attempted by Lands was to be a mixed-use,
1,100 acre waterfront community in Stafford County Virginia called Widewater.
This joint venture's plans were to include recreation-oriented residential
construction, a golf course, a conference center, and a town center complex
with a yacht club and marina. The land used for this project was purchased
from Virginia Power. However, the project was postponed in 1988 following
adverse zoning actions by the Stafford County government. The property
is currently being held for future use or sale.
Harborside, a high quality condominium townhouse development along the
Potomac River in the "Old Town" central business district of Alexandria,
Virginia, began marketing its units in the fourth quarter of 1990. The land
for this project was purchased from Virginia Power.
Governor's Land is a 1,400 acre residential community near Williamsburg.
This development along the James and Chickahominy Rivers includes 772 homes.
The partnership, 50 percent owned by Lands, began marketing in late 1990.
Lake Badin Associates, 67 percent owned by Dominion Lands, developed a 900-acre
community of resort homes called Uwharrie Point on Lake Badin near Charlotte,
North Carolina. The development also began marketing its homes late in 1990.
Harbour View, a 3,000 acre development in Suffolk Virginia, near Newport
News and Hampton Road, includes residential, commercial and industrial areas.
This parcel was purchased from Virginia Power.
Table 7, which can be found on the following page, is a summary financial
statement for Lands.
TABLE 7
DOMINION LANDS INC.
INCOME STATEMENT
1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total Operating Revenues $0.6 $9.0 $0.8 $0.6 $12.7 $20.6 $24.3
Total Operating Expenses 0.3 4.4 0.3 (0.9) 11.3 20.6 31.5
Total Operating Income 0.3 4.6 0.5 1.5 1.4 (0.0) (7.2)
Other Income 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Fixed Charges 0.1 0.0 0.0 0.0 0.0 0.5 1.6
Net Income Before Taxes 0.2 4.6 0.5 1.5 1.3 (0.5) (8.8)
Income Tax 0.0 1.6 0.1 0.5 0.5 (0.2) (3.2)
Net Income $0.2 $3.0 $0.4 $1.0 $0.9 $(0.3) $(5.6)
</TABLE>
DOMINION LANDS INC.
BALANCE SHEET
DEC 31, 1986-1993
(MILLIONS)
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Current Assets $17.1 $3.1 $4.2 $0.3 $3.5 $3.5 $6.7 $6.2
Property, Plant & Equip. 0.8 12.0 28.6 32.1 40.7 96.7 112.9 104.7
Investments 4.5 3.2 11.0 20.3 11.1 10.4 10.3
Deferred Charges 0.4 0.4 1.8 8.9 13.6 19.3
Total Assets $17.9 $19.6 $36.4 $43.8 $66.3 $120.3 $143.6 $140.6
Liabilities
Current Liabilities $0.3 $1.0 $2.8 $22.3 $2.5 $3.0
Long-Term Debt 13.4 18.5 38.7 63.2 96.6 101.3
Deferred Credits 0.1 1.2 4.5 5.8 16.7 23.5 22.8
Preferred Stock
Stockholders Equity 17.9 19.5 21.5 19.8 19.0 18.0 21.0 13.4
Total Liabilities and $17.9 $19.6 $36.4 $43.8 $66.3 $120.3 $143.6 $140.6
Equity
</TABLE>
A-12
<PAGE>
APPENDIX B
SUMMARY OF AFFILIATE SERVICES
B-1
<PAGE>
SERVICES PROVIDED BY DOMINION RESOURCES, INC.
TO VIRGINIA POWER DURING 1993
Dominion Resources, Inc. is organizationally divided into the functional
groups of Executive, Controller, Chief Financial Officer, and Corporate
Secretary.
The Executive group provides managerial expertise and special financial
consulting work. These costs are billed to Virginia Power on a direct services
rendered basis. This group also provides direction in the development of a
program of common equity financing and the preparation of Dominion Resources
financing documents on instruments required in connection with the issuance
and sale of equity securities under Federal and State laws. These costs are
allocated to Virginia Power based on the three-part formula. Some officers of
Dominion Resources represent the consolidated entity at several civic boards
and committees to enhance and promote public relations. The costs of
participating in such committee meetings are charged on an indirect basis to
all affiliates of Dominion Resources. The Public Policy division provides
writing and policy analysis and policy management on issues of importance to
Virginia Power. The costs are charged directly to Virginia Power when they are
the sole beneficiary.
The Controller group provides services principally on an indirect basis.
The costs associated with consolidation functions performed by the Corporate
Tax, Accounting and Planning divisions are billed as indirect costs. Costs
associated with payroll responsibilities are billed on an indirect basis.
Corporate Accounting also prepares the Forms 10-K and 10-Q which are
required by the Securities and Exchange Commission. The labor and expenses
required to prepare these documents are charged as allocated costs.
The Chief Financial Officer group, which is comprised of Legal, Assistant
Treasurer, Cash Management and Commercial Paper, Investor Relations, Banking
Relations and Treasury divisions, is responsible for general financial
services. Costs incurred by the Legal, Assistant Treasurer and Investor
Relations divisions are billed to the affiliates primarily as allocated costs.
The Cash Management and Treasury divisions' costs are billed directly to the
appropriate affiliate. The Commercial Paper division is billed based on the
utilization of commercial paper proceeds, in accordance with the Intercompany
Credit Agreement. Banking Relations' costs are primarily bank fees associated
with the lines of credit and are billed to each affiliate based on their
monthly borrowings under the Intercompany Credit Agreement.
The Corporate Secretary group is comprised of the Corporate Secretary,
Stockholder Services, Pension Investments and the Human and Administrative
Resources
B-2
<PAGE>
divisions. The Corporate Secretary division is principally responsible
for the preparation and filing of required reports relating to common
stock and arrangements for meetings of Stockholders. The Corporate
Secretary's division also incurs costs with respect to raising equity
for the affiliates. These costs are charged to the affiliates based on
each company's pro-rata share of equity received.
The Stockholder Services division is primarily responsible for the
maintenance of records of holders of common stock and the communication with
such holders. The majority of the costs of the Corporate Secretary and
Stockholder Services divisions are billed as allocated costs. The Stockholder
Services division also maintains the records of holders of preferred stock and
is responsible for communication with such holders. These costs are billed to
Virginia Power directly.
The Pension Investment division is responsible for monitoring the DRI
pension plan investments. The charges for this responsibility are billed to
the affiliates based on their pro-rata share of employees.
The costs associated with the personnel duties of the Human and
Administrative Resources division are billed as indirect costs.
B-3
<PAGE>
Summary of Service Charges for Virginia Power
By Functional Group
Summary for January thru December 1993
FRINGE ALLOCATED
LABOR EXPENSE BENEFITS CHARGES TOTAL
Executive:
Executive $451,846 $193,701 $0 $434,857 $1,080,404
Public Policy 10,783 151,359 0 251,911 414,053
Internal Audit 0 0 0 0 0
Chgouts/Spec Proj. 0 0 0 242,047 242,047
Controller:
Corporate Tax 38,680 18,385 0 45,577 102,642
Corp Accounting 81,258 6,939 0 195,317 283,514
Corp Planning 12,961 5,219 0 10,607 28,787
Chief Fin Officer:
Asst. Treasurer 18,654 1,244 0 99,265 119,163
Commercial Paper 14,846 2,521 0 4,208 21,575
Cash Mgmt 90,708 863,714 0 50,520 1,004,942
Treasury 129,934 14,733 0 7,149 151,816
Bank Relations 110 745 0 4,165 5,020
Inv Relations 5,658 15,018 0 73,373 94,049
Corporate Secretary:
Corp. Secretary 38,378 15,317 0 1,325,131 1,378,826
Stk Records 27,392 1,138 0 1,024,653 1,053,183
Pension Inv- 72,709 15,384 0 1,745 89,838
H & A Resources 126,689 206,041 0 231,116 563,846
Total $1,120,606 $1,511,458 $0 $4,001,641 $6,633,705
Support Costs $255,432
Line of Credit Fees $153,337
Deferred Charges $114,136
Special Bill $1,125,072
Total Bill $8,281,682
B-4
<PAGE>
DRI affiliate interest charges:
Notes to Intercompany Billings
1. Support Costs: DRI's costs for the use of DRI's equipment and
facilities, include depreciation and a return component on fixed assets,
office rental expense (for Riverfront Plaza), property taxes, and building
O&M.
2. Line of Credit Fees: VP share of the cost for the $395,750,000 line
of credit DRI maintains. VP amount decreased from $250 million to $100 million
during 1993, reflecting increased reliance on the line by non-regulated
affiliates and because VP doesn't need $150 million line of credit.
Note: This line of credit arrangement may be seen as a significant benefit
to the non-regulated affiliates, because they may be able to secure financing
that may not be available without Virginia Power as part of the consolidated
group.
3. Deferred Charges: DRI bills the cost of raising debt and preferred
stock for VP as deferred charges.
4. Special Bill: Includes miscellaneous items such as Performance
Achievement Plan (PAP) and Management Incentive Plan (MIP) awards, equity
costs, director's insurance, and some pension expenses.
B-5
<PAGE>
SUMMARY OF SERVICES PROVIDED BY VIRGINIA POWER
TO DOMINION RESOURCES, INC. DURING
1993
1. Controller
Financial Services - Supported DRI financial models.
Taxes and Plant Accounting - Assisted in the preparation and filing of
consolidated tax returns and other tax informational filings and
administered tax audits.
Accounting Services - Processed the Customer Stock Purchase Plan coupons
for DRI and the American Utility Fund coupons for DCI.
2. Treasurer - Provided general cash management support.
3. Information Services - Provided mainframe computer resources and
development/maintenance support of automated systems.
4. Human Resources - Provided limited personnel services for the employees of
DRI and the administration of certain benefit plans.
5. Senior Management - Administrative support to DRI with respect to auditing
and financing functions; expenses related to DRI Board meetings, financial
analyst meetings, etc.
6. Administrative Services -
Safety - Provided general safety standards for DRI.
Loss Prevention and Insurance - Provided acquisition of certain insurance
coverages.
Support Services - Provided press printing and duplication services;
research services; records management services; courier service;
production of and processing of computer generated slides, graphic design
and layout of materials printed, and video production consultation, access
to the Virginia Power communications network. Provided maintenance
services for executive vehicles through the Transportation Department.
Performed background and internal investigations, security coverage for
stockholders meeting and executive protection services.
7. Auditing - Provided internal audit services.
B-6
<PAGE>
SUMMARY OF SERVICE CHARGES FOR DOMINION RESOURCES, INC.
BY FUNCTIONAL GROUPS FOR THE YEAR ENDED
December 31, 1993
<TABLE>
<CAPTION>
Fringe Misc Equipment/
Labor Benefits Expenses Facilities Total
<S> <C> <C> <C> <C> <C>
CONTROLLER
Administration 0 0 0 0 $0
Financial Services 650 200 0 102 952
Taxes & Plant Accounting 3,261 962 0 731 4,954
Accounting Services 16,982 4,741 10,431 3,788 35,942
TOTAL CONTROLLER 20,893 5,902 10,431 4,622 41,848
TREASURER
Forecasting & Economic Analysis 0 0 0 0 0
Cash Management 137 37 0 26 200
TOTAL TREASURER 137 37 0 26 200
INFORMATION SERVICES 24,038 6,666 90,823 5,339 126,866
REGULATIONS
Regulations Management 0 0 0 0 0
Rates 0 0 0 0 0
Revenue Development 0 0 0 0 0
Regulation Services 0 0 0 0 0
TOTAL REGULATIONS 0 0 0 0 0
HUMAN RESOURCES
Human Resources-Management 0 0 0 0 0
Employee Health Services 0 0 0 0 0
Compensation Services 0 0 0 0 0
Employee Relations 0 0 0 0 0
Staffing & Employment 655 185 0 156 996
Management & Professional Development 0 0 0 0 0
TOTAL HUMAN RESOURCES 655 185 0 156 996
SENIOR MANAGEMENT - EXECUTIVES 0 0 3,822 0 3,822
ADMINISTRATIVE SERVICES
Administrative Services-Management 0 0 0 0 0
Security 0 0 0 0 0
Claims 0 0 0 0 0
Safety 119 33 0 27 180
Loss Prevention & Insurance 3,146 808 0 737 4,691
Support Services 6,035 1,678 4,880 1,299 13,892
TOTAL ADMINISTRATIVE SERVICES 9,300 2,519 4,880 2,064 18,763
PROCUREMENT 0 0 0 0 0
FINANCE/EDP AUDITING 44,617 12,326 1,793 10,829 69,565
OVERHEAD CHARGES 4,508 1,250 4,607 1,049 11,414
TOTAL SERVICES 104,148 28,886 116,356 24,084 273,474
SPECIAL BILL 518,706
$792,180
</TABLE>
B-7
<PAGE>
SUMMARY OF SERVICE CHARGES FOR DOMINION CAPITAL, INC.
BY FUNCTIONAL GROUPS FOR THE YEAR ENDED
December 31, 1993
<TABLE>
<CAPTION>
Fringe Misc Equipment/
Labor Benefits Expenses Facilities Total
<S> <C> <C> <C> <C> <C>
CONTROLLER
Administration 0 0 0 0 $0
Financial Services 0 0 0 0 0
Taxes & Plant Accounting 0 0 0 0 0
Accounting Services 9,566 2,684 6,232 2,179 20,661
TOTAL CONTROLLER 9,566 2,684 6,232 2,179 20,661
TREASURER
Forecasting & Economic Analysis 0 0 0 0 0
Cash Management 0 0 0 0 0
TOTAL TREASURER 0 0 0 0 0
INFORMATION SERVICES 6,139 1,611 23,263 1,419 32,431
REGULATIONS
Regulations Management 0 0 0 0 0
Rates 0 0 0 0 0
Revenue Development 0 0 0 0 0
Regulation Services 0 0 0 0 0
TOTAL REGULATIONS 0 0 0 0 0
HUMAN RESOURCES
Human Resources-Management 0 0 0 0 0
Employee Health Services 0 0 0 0 0
Compensation Services 0 0 0 0 0
Employee Relations 0 0 0 0 0
Staffing & Employment 0 0 0 0 0
Management & Professional Development 0 0 0 0 0
TOTAL HUMAN RESOURCES 0 0 0 0 0
SENIOR MANAGEMENT - EXECUTIVES 0 0 0 0 0
ADMINISTRATIVE SERVICES
Administrative Services-Management 0 0 0 0 0
Security 0 0 0 0 0
Claims 0 0 0 0 0
Safety 0 0 0 0 0
Loss Prevention & Insurance 0 0 0 0 0
Support Services 0 0 0 0 0
TOTAL ADMINISTRATIVE SERVICES 0 0 0 0 0
PROCUREMENT 0 0 0 0 0
FINANCE/EDP AUDITING 5,343 1,502 0 1,253 8,098
OVERHEAD CHARGES 957 263 898 221 2,339
TOTAL SERVICES 22,005 6,080 30,393 5,072 63,530
SPECIAL BILL 57,997
$121,527
</TABLE>
B-8
APPENDIX C: DRI BOARD OF DIRECTOR GUIDELINES
(bullet) Separate titles, but, for the present, common CEO and
chairman of the board, with reconsideration based on the
future holders of the positions.
(bullet) Use of the joint committee to monitor (a) relationship
between the managements of DRI and Virginia Power and (b) the
legal affairs of both corporations, but no lead outside
director to lead meetings of outside (i.e., non-management
directors).
Note that this structure differs significantly from the GM lead director
concept, which has the outside directors selecting a lead director to
assume responsibility for chairing regularly scheduled meetings of the
outside directors; DRI has no such director and no such meetings.
(bullet) No statement on optimum or preferred board size, but a
recitation of the then-current and maximum allowed number
of 16.
(bullet) Review by the O&C committee with the board of skills and
characteristics required of board members, considering
diversity, age, skill, work experience, and
decision-making ability, with the O&C committee's findings
to be reported to the board nominating committee.
(bullet) Membership on the board by the current CEO, and allowance
of membership by a former CEO for the longer of one year
or the end of the former CEO's term of board membership.
GM does not restrict the term of a former CEO's board membership.
(bullet) A majority of board membership to consist of
non-management, unaffiliated directors, a majority of the
board members of DRI and Virginia Power to be in common, and
allowance of management members on the board.
Note that this provision excludes the GM guideline that only outside
directors are to make governance decisions; DRI allows participation by
its inside directors on the DRI and the Virginia Power boards.
(bullet) Non-management, unaffiliated director to mean (a) no close
family relationship to current or former officers, (b) no
personal employment on a consulting basis to DRI or any
subsidiary, (c) no direct or family personal transactions
exceeding $60,000 with DRI or any subsidiary, (d) no
officer or +10 percent ownership of an entity with
transactions with DRI or any subsidiary involving more
than 5 percent of the entity's or DRI's consolidated
revenues or loans involving more than 5 percent of such
consolidated assets, excluding director-service-related
payments, competitively bid transactions, or common
carrier or utility payments, publicly offered debt
securities in the case of loan transactions, purchases
subject to usual trade terms.
GM's definition of independence is not provided in the guidelines;
therefore no comparison is possible.
C-1
<PAGE>
(bullet) Offer of voluntary resignation by members who change job
responsibilities after becoming members, review by board of
the appropriateness of keeping such members on the board.
(bullet) Opposition to term limits.
(bullet) Member retirement not later than the year end that
follows 66th birthday.
GM's board retirement age is 70.
(bullet) Selection by the board itself of board nominees, through
the nominating committee, with input from the chairman, CEO,
and other board members.
(bullet) Extension of invitations to board membership by the
board itself, speaking through the chairman of the nominating
committee, the chairman of the board, and the CEO.
(bullet) Maintenance of the following standing committees: audit,
finance, O&C, and nominating.
(bullet) Nomination of committee members by the chairman and CEO,
with election by the full board, with rotation of committee
membership to be considered but not mandated.
(bullet) Audit committee membership entirely composed of
non-management, unaffiliated directors.
(bullet) A majority of finance committee membership composed of
non-management, unaffiliated directors.
(bullet) O&C committee membership entirely composed of directors
meeting SEC Rule 16b-3 (c) (2) (i).
(bullet) Nominating committee composed as required by the August
1994 settlement agreement, with chairman and CEO to regularly
attend and interview and comment on potential board nominees.
(bullet) Frequency and length of committee meetings to be decided
by the committee chairman, in consultation with the chairman
and CEO.
(bullet) Committee agendas to be decided by the committee
chairman, with advice from the chairman, CEO, committee
members, and board members.
GM's guidelines also call for the issuance of a schedule of agenda
subjects for the ensuing year.
(bullet) Full board meeting agenda set by chairman and CEO with
best efforts to include at earliest possible meeting items
suggested by members.
(bullet) Written information important to the board's
understanding of business to be distributed in advance of
meeting.
(bullet) Advance distribution of presentations on specific
subjects except for sensitive matters.
(bullet) Regular invitation, with right of exclusion, to senior
management and outside counsel to attend board meetings.
Regular joint meeting of DRI and subsidiary boards.
(bullet) Regular meetings of joint committee in executive
session.
C-2
<PAGE>
GM's guidelines are significantly different; they call for three yearly
executive sessions of all outside directors.
(bullet) Access of board members to CEO, COO, CFO, general
counsel, and to non-director senior management, the latter to
be through the CEO or COO, with written communications to be
provided to the chairman and CEO.
GM's guidelines give the board substantially more freedom; they do not
require or even expect that the board members will secure access to
management through the CEO or COO; however, notice of written
communications is similar.
(bullet) Annual report on comparative board compensation to the
nominating committee; recommendation of changes to
compensation by the nominating committee; concurrence by the
full board.
(bullet) Recognition that some form of regular assessment of
board performance would be beneficial, and statement of
intention to determine the structure and content of such an
assessment.
(bullet) Annual CEO performance evaluation by the O&C committee.
(bullet) Annual report by the CEO on succession planning and
management development.
(bullet) Statement that management speaks for the company, with
requests to board members for comment to be referred to
management.
GM's guidelines do not require referral to management, but anticipate that
members would inform management and on most occasions would be
communicating at the request of management.
(bullet) Disclosure of the material facts of any interest under
Virginia Code (section) 13.1-691, which include material
financial interests and position as an officer, director,
or trustee of the party to a transaction to be considered
by the board.
C-3
<PAGE>
APPENDIX D
DRI Stock Price Closings During Dispute
D-1
<PAGE>
DOW JONES ELECTRIC UTILITY INDEX
December 31, 1993 - March 1994
[Chart which displays Index price at December 31, 1993 as approximately 253,
and approximately 223 at March 30, 1994]
<PAGE>
DOW JONES ELECTRIC UTILITY INDEX
April 1994 - June 1994
[Chart which displays Index price at April 1, 1994 as approximately 223,
and approximately 202 at June 29, 1994]
<PAGE>
DOW JONES ELECTRIC UTILITY INDEX
July 1994 - September 1994
[Chart which displays Index price at July 1, 1994 as approximately 202,
and approximately 205 at September 28, 1994]
<PAGE>
DOW JONES ELECTRIC UTILITY INDEX
October 1994 - December 1994
[Chart which displays Index price at October 3, 1994 as approximately 205,
and approximately 210 at December 29, 1994]
<PAGE>
DOW JONES ELECTRIC UTILITY INDEX
January 1995 - Present
[Chart which displays Index price at January 2, 1995 as approximately 210,
and approximately 223 at February 21, 1995]
<PAGE>
DRI STOCK PRICE
December 31, 1993 - March 1994
[Chart which displays Stock Price at December 31, 1993 as approximately $45 1/2,
and approximately $40 at March 30, 1994]
<PAGE>
DRI STOCK PRICE
April 1994 - June 1994
[Chart which displays Stock Price at April 1, 1994 as approximately $40,
and approximately $36 1/2 at June 29, 1994]
<PAGE>
DRI STOCK PRICE
July 1994 - September 1994
[Chart which displays Stock Price at July 1, 1994 as approximately $36 1/2,
and approximately $37 1/4 at September 28, 1994]
<PAGE>
DRI STOCK PRICE
October 1994 - December 1994
[Chart which displays Stock Price at October 3, 1994 as approximately $37 1/4,
and approximately $36 at December 29, 1994]
<PAGE>
DRI STOCK PRICE
January 1995 - Present
[Chart which displays Stock Price at January 2, 1995 as approximately $36,
and approximately $37 1/2 at February 21, 1995]
<PAGE>
ROLLING 5-DAY PERCENTAGE CHANGE
DRI STOCK VS. ELECTRIC UTILITY INDEX
[Chart which displays the following]
APPROXIMATE ROLLING PERCENTAGE CHANGE
JANUARY 7, 1994 FEBRUARY 25, 1994
DRI Stock -0.25 0.1875
Electric Index -0.5 0.25
<PAGE>
ROLLING 5-DAY PERCENTAGE CHANGE
DRI STOCK VS. ELECTRIC UTILITY INDEX
[Chart which displays the following]
APPROXIMATE ROLLING PERCENTAGE CHANGE
MARCH 1, 1994 APRIL 28, 1994
DRI Stock -0.125 0.25
Electric Index -0.125 0.125
<PAGE>
ROLLING 5-DAY PERCENTAGE CHANGE
DRI STOCK VS. ELECTRIC UTILITY INDEX
[Chart which displays the following]
APPROXIMATE ROLLING PERCENTAGE CHANGE
MAY 2, 1994 JUNE 29, 1994
DRI Stock 0 -0.0625
Electric Index -0.1875 0
<PAGE>
ROLLING 5-DAY PERCENTAGE CHANGE
DRI STOCK VS. ELECTRIC UTILITY INDEX
[Chart which displays the following]
APPROXIMATE ROLLING PERCENTAGE CHANGE
JULY 1, 1994 AUGUST 30, 1994
DRI Stock 0.25 0.125
Electric Index 0.375 0.125
<PAGE>
ROLLING 5-DAY PERCENTAGE CHANGE
DRI STOCK VS. ELECTRIC UTILITY INDEX
[Chart which displays the following]
APPROXIMATE ROLLING PERCENTAGE CHANGE
SEPTEMBER 1, 1994 OCTOBER 31, 1994
DRI Stock 0 -0.0625
Electric Index -0.125 0.375
<PAGE>
ROLLING 5-DAY PERCENTAGE CHANGE
DRI STOCK VS. ELECTRIC UTILITY INDEX
[Chart which displays the following]
APPROXIMATE ROLLING PERCENTAGE CHANGE
NOVEMBER 1, 1994 DECEMBER 29, 1994
DRI Stock -0.125 -0.125
Electric Index 0.1875 -0.125
<PAGE>
ROLLING 5-DAY PERCENTAGE CHANGE
DRI STOCK VS. ELECTRIC UTILITY INDEX
[Chart which displays the following]
APPROXIMATE ROLLING PERCENTAGE CHANGE
JANUARY 2, 1995 FEBRUARY 21, 1995
DRI Stock -0.125 -0.1875
Electric Index -0.125 -0.125
<PAGE>
PART III
<PAGE>
FINAL REPORT
Investigation of Dominion Resources, Inc.
and Virginia Electric and Power Company:
Financial Issues and Diversification Implications
Prepared For
Virginia State Corporation Commission Staff
Prepared By
J. Robert Malko
Financial Economist
April 1995
Case No. PUE940051
Virginia State Corporation Commission
<PAGE>
PREFACE
This Final Report was prepared for the Virginia State Corporation Commission
Staff by Dr. J. Robert Malko, Financial Economic Consultant and Professor of
Business Finance in the College of Business at Utah State University. The
following graduate students in the College of Business at Utah State University
provided research assistance to Dr. Malko in the preparation of this report:
David Brock, Rajiv Mallick, Zane Ravsten, and Michael Sharp.
i
<PAGE>
TABLE OF CONTENTS
PAGE
I. Introduction.................................................. 1
II. Financing Dominion Resources, Inc.
Diversification: A Utility Perspective
A. Debt Financing/Credit Support........................... 2
B. Sources and Uses of Funds............................... 7
III. Changing Business Risks In The Electric
Utility Industry
A. Industry Issues......................................... 15
B. Holding Company Profiles................................ 16
C. Regulatory Tools and Financial Agency Problems.......... 20
IV. Financial Insulation of Virginia Power
A. Financial Integrity..................................... 22
B. Dividend Policy......................................... 24
C. Capital Structure Policy................................ 26
D. Cost of Capital......................................... 28
E. Financial Forecasting................................... 30
F. Size of Diversification Activities Relative to
Virginia Power.......................................... 32
G. Stock Price Changes..................................... 34
V. Commission Staffing Needs..................................... 36
VI. Conclusions and Recommendations............................... 36
Exhibits
<PAGE>
I. INTRODUCTION
The primary purpose of this Final Report, INVESTIGATION OF DOMINION
RESOURCES, INC. AND VIRGINIA ELECTRIC AND POWER COMPANY: FINANCIAL ISSUES AND
DIVERSIFICATION IMPLICATIONS, is to examine various financial issues related
to diversification activities and associated impacts on the electric utility
from a public policy perspective. Financial issues and questions, including
specific study questions 4, 5, and 9 presented on pages 6-7 in the ORDER
CONTINUING PROCEEDING GENERALLY, AND INSTITUTING NEW PROCEEDING, Case No.
PUE940051 (August 24, 1994), are also addressed in this Report. This Final
Report is an extension of and addresses unresolved issues presented in the
previously filed Interim Report.(1)
This report is organized into the following major sections. First,
financing of Dominion Resources, Inc.'s (DRI) diversification activities is
examined. Financing issues, including credit support and sources and uses
of cash, are addressed in this section. Second, changing business risks in the
electric utility industry, including financial agency problems associated
with utility diversification, are discussed. Third, financial insulation of
Virginia Electric and Power Company (Virginia Power) from non-utility holding
company activity is analyzed. Issues, including financial integrity, dividend
policy, capital structure policy, cost of capital, financial forecasting,
relative size of diversification activities, and stock price changes, are
addressed. Exhibit I shows the relationship among important issues and
activities relating to the previously specified three sections of this report.
(Exhibits are included at the end of the report and are labeled according to
the applicable sections of the report.) Fourth, Commission staffing needs for
monitoring and analyzing diversification activities and associated impacts
on the regulated utility are discussed. Fifth, conclusions and recommendations
are presented.
(1) Interim Report, INVESTIGATION OF DOMINION RESOURCES, INC. AND
VIRGINIA ELECTRIC AND POWER COMPANY: FINANCIAL ISSUES AND
DIVERSIFICATION IMPLICATIONS, prepared for the Virginia State
Corporation Commission Staff by J. Robert Malko, December 1, 1994.
1
<PAGE>
II. FINANCING DOMINION RESOURCES, INC. DIVERSIFICATION: A UTILITY PERSPECTIVE
A. Debt Financing/Credit Support
In a utility holding company structure, the issue of credit support from
the utility to non-utility subsidiaries is a financial issue that needs to be
examined.(2) This section of the report will analyze this issue, propose a
methodology for quantifying the value of the credit support, and discuss
various aspects of credit support which need additional examination.
DRI is the parent company of Virginia Power, which is DRI's largest
subsidiary. This energy utility is the largest electric utility in Virginia
and serves approximately 80 percent of the state's population. The companies
described the formation of the holding company as follows:
Dominion Resources, Inc. was organized as a Virginia corporation in
1983. It was formed to allow the organization of existing business
activities into separate companies and to provide flexibility in
pursuing new business opportunities beyond the traditional
regulated utility business. Substantially all of its operations are
conducted by its wholly-owned subsidiaries.
Dominion Resources' principal business is electric power. It is
also active in natural gas production, real estate, and investment
management businesses.(3)
Within the DRI corporate structure, the non-utility subsidiaries are
involved in both energy related and non-energy related businesses. These
subsidiaries have included Dominion Energy, Inc. (DEI), Dominion Lands, Inc.
(DLI), and Dominion Capital, Inc. (DCI).(4) DEI was formed in 1987 to pursue
independent power production and to acquire and develop natural gas reserves.
DLI, also formed in 1987, is a real estate company which owns and
(2) This issue was addressed by The Liberty Consulting Group Report
for the State of New Jersey Board of Regulatory Commissioners,
December 1992, pp. III-15 - III-21.
(3) Response to Interrogatories and Requests (IR) #218.
(4) Dominion Lands became a subsidiary of Dominion Capital during 1994.
2
<PAGE>
operates properties, mainly in Virginia, for future development or sale. DCI
was formed in 1985 to manage the investments of Dominion Resources. Each of
these subsidiaries, in turn, has numerous subsidiaries of their own.
Is there a benefit derived from the credit standing of the energy utility,
Virginia Power, when the DRI non-utility subsidiaries obtain financing? As
discussed below, the answer to this question is yes. Creditors providing debt
for non-utility subsidiaries look to the parent company, DRI, and also to
Virginia Power, the primary asset and source of cash flow of DRI. The utility
is the only subsidiary which has significant credit history and market
presence. Because of Virginia Power's solid credit history, the non-utility
subsidiaries typically receive more favorable borrowing rates and/or terms
from lenders. If these same non-utility subsidiaries were to act as stand
alone companies and start a business from base zero, the interest rate or
effective yield on credit would most likely be less favorable.
In order to determine whether or not credit support is being provided
to the non-utility subsidiaries by Virginia Power, it is necessary to identify
and carefully examine all non-utility financing arrangements. If credit support
is found to exist, then its value should be determined. This task can be
quite involved, and consequently, is beyond the scope of this study. However,
different sources of financing are discussed below to demonstrate that credit
support does, in fact, exist and it has a dollar value.(5) It should be noted
that credit support can exist with or without the existence of actual
guarantee or other credit support agreements.
Commercial banks are one source of financing for DRI's non-utility
subsidiaries. Based on conversations with commercial bankers, two issues to
examine when assessing the creditworthiness of a non-utility subsidiary are
(1) stand alone or project specific factor and
(5) The accompanying Liberty Consulting Group report also discusses
non-utility financing and provides an overview of some of the
arrangements.
3
<PAGE>
(2) impacting factor. The stand alone factor examines the non-utility
subsidiary from a single business entity perspective and not as part of a
diversified holding company structure. Included in the stand alone factor
is the examination of the specific risks of the capital project or
investment. The project's investment risk is a critical factor in the decision
for assigning a specific credit rating to the non-utility subsidiary. Some
projects are clearly more risky than others and, therefore, these projects
have a less favorable credit rating.
The impacting factor focuses on the impact that the utility, Virginia
Power, has on the credit rating of the non-utility subsidiaries of DRI. The
non-utility subsidiaries are examined as part of the diversified utility
holding company structure and not purely as stand alone entities. Assessing
this impacting factor includes examining the cash flows associated with DRI,
and DRI receives significant cash flow from Virginia Power in the form of
dividends. (Cash flow analysis is addressed in Section II.B.) The impacting
factor can also be altered in magnitude through the use of credit support
agreements.
Commercial bankers typically use a rating scale of one to ten when
assessing the risk of a credit facility. Grade one is a risk free investment,
and grade ten is a "junk", or highly risky, investment. The preferred
investment grade categories are generally one through four. A relevant
question that arises is: How much is the impacting factor worth when
moving within the preferred investment grade categories of one through four?
Commercial bankers have different opinions on the value of the impacting
factor, and understandably, they are reluctant to cite a firm basis point value
for the various ratings. However, they do agree that there is some quantitative
value, and they estimate that the impacting factor may be worth at least
one-half to one investment grade, assuming the credit is first judged as
investment grade on a stand alone basis. Presumably, the impacting factor
would be more critical, possibly requiring execution of a support agreement,
if the credit is judged as non-investment grade on a stand alone basis.
Therefore, it is reasonable to conclude that the basis point or interest rate
differential associated with the impacting factor has a variable value.
4
<PAGE>
The fact that DRI has executed a number of credit support agreements to
secure financing for its non-utility subsidiaries could increase the value of
the impacting factor. These agreements require DRI to maintain the financial
condition of DCI, DLI and DEI through minimum net worth requirements, among
other things.
The stand alone and impacting factors are important in establishing a
framework to estimate a numerical value for the credit support provided by
the utility to the non-utility subsidiaries. The general framework to quantify
the value of the credit support is presented in Exhibit II-A-1. The individual
components of the general framework include the year, dollar amounts of credit,
basis point differential associated with the impacting factor, and credit
support value. To determine the value of credit support, the dollar amount of
credit would be multiplied by the basis point differential.
The dollar amounts of credit in this schedule represent non-utility
credit facilities for which DRI has executed a credit support agreement, and
one DCI facility which is not directly tied to a DRI a support agreement.
This exhibit shows a rising trend overall in direct credit support provided
by DRI to the non-utility subsidiaries since 1986. Because Virginia Power
is DRI's primary source of cash flow, it is Virginia Power that is indirectly
enabling DRI to execute these agreements. This exhibit does not include
numerous project loans which may not benefit directly from a support agreement
but which may, nevertheless, derive indirect support from DRI, and therefore,
from Virginia Power. Even using a conservative estimate of 10 basis points
for the value of the impacting factor associated with investment grade
credit facilities, the value of past credit support has been in the
millions of dollars.
The Interim Report filed on December 1, 1994, stated that DRI's lenders
had been asked to provide a value of credit support. The following question
was asked:
Please contact your financial lender(s) and find out what interest
rate or basis point reductions the non-utility subsidiaries have
received on their debt or credit issuances due to DRI's financial
strength from Virginia Power.
5
<PAGE>
DRI responded to this question, stating:
When renegotiating credit agreements for its non-utility
subsidiaries, DRI is extremely careful to make sure that the lender
understands that there is ABSOLUTELY NO credit support from
Virginia Power. Virginia Power is not a party to any of the credit
agreements and, therefore, has no obligations, financial or
otherwise, under any agreement. To pose the question to lenders as
requested would imply that we expect a "discount" on the credit
facility because of Virginia Power's financial strength. Such an
implication would be in direct conflict with the representation
made to the lenders when securing the credit.(6) (Emphasis provided
by DRI.)
DRI clearly has a different view than commercial bankers regarding the value
of the impacting factor derived from Virginia Power. While the above response
may provide one legal perspective on the issue of credit support, it ignores
important aspects of credit analysis and addresses the issue too narrowly.
DRI's commercial paper program is another source of financing for
non-utility subsidiaries which derives credit support from Virginia Power. In
the past, the commercial paper program used jointly by DRI and Virginia Power
was approximately $400 million. During 1992, this joint commercial paper was
split, and Virginia Power now issues its own commercial paper. However, DRI
continues to secure joint bank lines of credit to support both the utility
and non-utility commercial paper programs. The use of joint bank lines of
credit is under review in Case No. PUF940031, which deals with the ICA.
The rating agencies openly recognize DRI's reliance on Virginia Power for
credit support. In rating DRI's commercial paper, Standard & Poor's Corporation
has stated, "Credit support for Dominion Resources' ratings is mainly
derived from its primary unit, Virginia Electric & Power, which provides 96%
of total gross operating cash flow for the consolidated concern."(7)
(6) IR#253.
(7) Standard & Poor's GLOBAL SECTOR REVIEW, July 1994, pp. 32-33.
6
<PAGE>
The impacting factor described previously plays a role in the
rating of DRI's commercial paper. Standard & Poor's recently affirmed
the ratings of both DRI's and Virginia Power's commercial paper. DRI's
rating is an "A-2" and Virginia Power's is an "A-1." As stated earlier,
the credit rating of DRI's commercial paper is significantly impacted by
Virginia Power. Exhibit II-A-2 is a document from Standard & Poor's
which identifies the rating criteria and other policies concerning a
commercial paper program.
As previously stated, it is not feasible at this time to estimate a
precise basis point figure for the value of credit support to
non-utility activities. This topic requires significant additional study
and, consequently, it is beyond the scope of this analysis. However, it
is recommended that the Commission pursue a comprehensive quantification
of the value of credit support.
The following conclusions are presented concerning credit support
issues. First, there is economic value and benefit associated with the
credit support from Virginia Power to the non-utility subsidiaries of
DRI. Second, Virginia Power's creditworthiness has an impact on DRI's
commercial paper rating. Third, virtually all of the non-utility debt
derives a benefit from the non-utility subsidiaries' association with
DRI and Virginia Power. Fourth, quantification of the specific values of
credit support provided by Virginia Power is beyond the scope of this
study and needs additional analysis. Fifth, the comprehensive historic
value of the credit support could be in the millions of dollars.
B. Sources and Uses of Funds
An examination of a company's sources and uses of funds will show
its cash flows generated during a specific period. It can also help
clarify what effect operations have had on a company's cash position and
its subsequent ability to meet financial obligations.
7
<PAGE>
Specifically, in the case of a diversified holding company, a sources
and uses analysis can be helpful in demonstrating where its funds
originated and where, according to management's discretion, they were
allocated.
This subsection will address some of the important cash flows,
including capital flows, between DRI and its subsidiaries, both utility
and non-utility. These cash flows include dividend payments to DRI from
its subsidiaries, equity additions and contributions from retained
earnings and stock issues, depreciation, and deferred taxes. Moreover,
this section will examine the impact that these capital flows have had
on Virginia Power's capital structure. A limited examination of DRI's
capital allocation policies and its impact on Virginia Power will be
presented. Specifically, this section is organization into the following
subsections:
(1) Virginia Power's Capitalization of DRI;
(2) Sources of Dividends Paid to DRI;
(3) DRI's Capital Allocation Policies and Its
Impact on Virginia Power;
(4) Use of Virginia Power Depreciation-Generated Funds;
(5) Virginia Power-Capital Structure; and
(6) Conclusions.
VIRGINIA POWER'S CAPITALIZATION OF DRI
DRI was capitalized under a Plan of Exchange which was consummated
on May 19, 1983. Under this Plan of Exchange, DRI acquired all of the
issued and outstanding common stock of Virginia Power. DRI was
originally formed to facilitate diversification activities and financing
flexibility.
Since DRI's inception, there have been consistent cash flows
between Virginia Power and DRI. Exhibit II-B-1 is a schedule of all
dividends paid by Virginia Power to DRI, as well as all equity
contributions from DRI to Virginia Power. Equity contributions have
historically been made in December of each year. There were no noncash
distributions between DRI and Virginia Power in the year of DRI's
origination, nor in any subsequent years.(8)
(8) Response to IR#175.
8
<PAGE>
Although Virginia Power's dividend requirement has steadily
increased over the twelve year period, these dividend payouts appear to
be reasonable relative to the electric utility industry, except for
1994, as discussed below.
SOURCES OF DIVIDENDS PAID TO DRI
Exhibit II-B-2 shows dividends paid by each DRI subsidiary from
1983 through 1994. Dominion Capital was established in 1985, and it
began paying dividends in 1986. Dominion Energy was established in 1987,
and it began paying dividends in that year. Dominion Lands, also
established in 1987, began paying dividends in that year. Dominion Lands
became part of Dominion Capital in 1994. Therefore, dividends paid by
Dominion Lands were added to those of Dominion Capital for 1994.
Although the dividend payout ratios for Virginia Power are
significantly different than those of DRI's non-utility subsidiaries,
there is no indication at this time that Virginia Power and its
ratepayers have been unduly burdened. However, Virginia Power's dividend
payout ratio reached a disturbingly high level of 98% in 1994.
Excessively high dividend payout ratios by Virginia Power to DRI could
result in a credit downgrade for Virginia Power and related higher cost
of capital. Since Dominion Capital and Dominion Energy are relatively
new entities, their respective levels of net income are relatively low
compared to that of Virginia Power. Consequently, one would expect that
their dividend requirements are lower and less consistent as compared to
Virginia Power. However, it is important in the future to monitor
dividend policies and payments of the non-utility subsidiaries for their
potential adverse impact on DRI's consolidated dividend policy. At the
present time, DRI's dividend policy is consistent with that of an income
stock (versus growth stock). Diversification into other lines of
business could affect the consistency of DRI's dividend policy.
9
<PAGE>
DRI'S CAPITAL ALLOCATION POLICIES AND ITS IMPACT ON VIRGINIA POWER
Exhibit II-B-3 is a schedule of DRI's allocation of equity to its
subsidiaries. Exhibit II-B-4 shows the same information as a percentage
of total equity additions. Until 1985, Virginia Natural Gas was
wholly-owned by Virginia Power and consequently did not receive equity
contributions directly from DRI. Between 1985 and 1990, VNG was a
wholly-owned subsidiary of DRI. Then, in 1990, DRI divested itself of
Virginia Natural Gas.
As presented in Exhibit II-B-4, non-utility activities received a
greater percentage than Virginia Power of DRI's total equity additions
during five of the ten years from 1985-1994. Virginia Power received the
greater amount in the remaining five years. During two of those five
years, the non-utility activities received no additions at all.
Analysis of the data in Exhibits II-B-3 and II-B-4 does not give
any significant indication that Virginia Power has been unduly harmed or
burdened by DRI's allocation of equity additions. A comparison of DRI's
equity additions to each of its subsidiaries does not indicate that
Virginia Power has suffered any significant financial drain due to DRI's
non-utility operations. In 1985, 1986 and 1988, however, a comparatively
large amount of equity was allocated to the non-utility subsidiaries.
During the same period of time, Virginia Power's equity ratio was
suffering and the rating agencies were expressing concern about Virginia
Power's high debt level. DRI subsequently began investing more equity to
raise Virginia Power's common equity ratio. Although the capital
structure was ultimately restored to a reasonable level, under emphasis
on DRI's investment in non-utility subsidiaries could have potentially
harmed the utility's financial integrity.
It should be noted that this analysis can only consider DRI's past
performance. It is unreasonable to speculate on what DRI's future
decisions will be. The potential for future problems, however, will be
discussed in Section III.
10
<PAGE>
Virginia Power currently has a $200 million commercial paper
program, which is rated A-1/P-1 by Standard & Poor's and Moody's,
respectively. In combination with the selling of accounts receivable,
the commercial paper program is used to satisfy most of Virginia Power's
short-term requirements. (See Exhibit II-B-8.) An additional source of
short-term funds is the Intercompany Credit Agreement (ICA) with DRI.
Through the ICA, Virginia Power has access to $300 million, reduced by
the aggregate amount of Virginia Power commercial paper then
outstanding, as outlined in the ICA between Virginia Power and DRI.
Short-term borrowing requirements for the non-utility subsidiaries
are also met through DRI's Intercompany Credit Agreements. Each of these
agreements is between the subsidiaries and DRI specifically. The primary
source of funding for all of the ICAs is the DRI commercial paper
program which is rated A-2/P-2.
One significant aspect of DRI's capital allocation policies
concerning Virginia Power centers around Virginia Power's efforts to
keep its capital structure in a reasonable range that allows the utility
to obtain capital on favorable terms. Virginia Power's target common
equity capitalization ratio range is currently between 42% and 45%, and
this target is reasonable considering changing risk factors.
Virginia Power's maintenance of a healthy capital structure is
desirable from both an investment perspective and a public interest
perspective. Access to capital markets is critical for capital intensive
firms, such as Virginia Power. One of Virginia Power's primary concerns
should continue to be the maintenance of a reasonable capital structure
that supports at least an "A" bond rating.
It is significant to realize that equity contributions are
generated from DRI, and Virginia Power's sole access to common equity
capital is through DRI. While Virginia Power has gained some
independence from DRI by way of having its own commercial paper program,
DRI's policies regarding its non-utility subsidiaries clearly have an
impact on Virginia Power's cost of capital. Regardless of efforts to
keep Virginia Power and non-utility
11
<PAGE>
businesses separate under the umbrella of DRI, certain aspects of
business cannot be completely segregated. Therefore, it is important to
monitor closely DRI's investment policies regarding non-utility
subsidiaries.
USE OF VIRGINIA POWER DEPRECIATION-GENERATED FUNDS
Depreciation is a key factor in the annual capitalization
requirements of Virginia Power. (See Exhibit II-B-5 and Exhibit II-B-6.)
Virginia Power's operations have generated large amounts of cash based
on depreciation and deferred taxes. (See Exhibit II-B-7.) Depreciation,
as a source of funds, has generated on average $363 million per year
from 1983 - 1993. Capital flows from Virginia Power to DRI currently
consist primarily of dividends. Assuming that net income (cash)
available for common dividends is paid out first when dividends are
paid, the inclusion of any funds generated by Virginia Power's
depreciation in the dividend payment to DRI would occur only when the
dividends paid out exceed the net income available for common dividends.
From 1983 to 1994, net income has been sufficient to cover all common
stock dividend payments to DRI, and depreciation-generated funds have
not been used for this purpose. However, it continues to be important to
closely monitor DRI's and Virginia Power's capital allocation and
depreciation policies to assure that DRI's activities do not adversely
impact Virginia Power's financial stability.
VIRGINIA POWER - CAPITAL STRUCTURE
Virginia Power's target capital structure has changed during the
period from 1983 to 1993 to coincide with debt rating agency
requirements. For each year since DRI's formation, Virginia Power's
capital structure has been set in order to sustain the company's solid
"A" debt rating.(9) Exhibit II-B-9 shows Virginia Power's actual
capitalization and capitalization
(9) Response to IR#179. Please note that Virginia Power's senior
debt rating downgraded from "A+" to "A" in November 1991.
12
<PAGE>
ratios from 1983 to 1993. Note that the company's debt levels have
decreased over the period, which is in accordance with changing debt
rating requirements in order to maintain the desired "A" debt rating.
In 1984 Virginia Power's common equity ratio of 36.24% was adequate
to earn it an "A+" rating. Today, however, a common equity ratio that
low would be unable to support anything higher than a "BBB" rating.
Consequently, for each year following DRI's origination, capital
structure targets were set to maintain a solid "A" debt rating based on
rating agency requirements in each time period.(10) However, during the
late 1980's, Virginia Power's equity ratio was low compared to Standard
& Poor's benchmark range.
During the past ten years, business risks for electric utilities
have increased because of various factors including competitive
pressures, nuclear power issues, and diversification activities. Major
bond rating agencies, such as Standard & Poor's, have imposed more
rigorous rating standards or benchmarks, including pretax interest
coverage ratios and debt ratios, in order to maintain a solid "A" debt
rating.(11) In Section III of this report, increasing business risks in
the electric utility industry are discussed.
CONCLUSIONS
There is no significant evidence at this time that the level of
funds received by DRI from Virginia Power has adversely affected the
utility. For the most part, dividend requirements by DRI of Virginia
Power on allocated equity have been appropriate during the 1983-1993
period.(12) However, Virginia Power's dividend payout ratio reached a
disturbingly high level of 98% in 1994. Dividend policy clearly needs to
be carefully monitored.
(10) Response to IR#179.
(11) Selective credit reports issued by Standard & Poor's during
the past ten years.
(12) Please see the accompanying Liberty Consulting Group report for a
discussion of problems associated with DRI's dividend policy on
its unallocated equity.
13
<PAGE>
Moreover, equity allocations by DRI do not appear to have been
disproportionately allocated to non-utility subsidiaries over the period
of study. However, there was a period in the mid-to-late 1980's when
Virginia Power's equity ratio approached levels which could have been
cause for concern.
It will be important to closely monitor the investment policies of
DRI in the future with regard to its non-utility subsidiaries. While no
significant actions by DRI with negative implications for the utility
have been discovered regarding primary sources and uses of cash, these
activities can clearly impact the utility and should be monitored
carefully in the future.
14
<PAGE>
III. CHANGING BUSINESS RISKS IN THE ELECTRIC UTILITY INDUSTRY
A. Industry Issues
Business risk is defined as variability in earnings before interest
and taxes (EBIT). Business risk exists for the firm even if the firm has
zero debt or financial risk. Total investment risk equals business risk
plus financial risk.
During the past ten years, business risks facing electric utilities
have generally increased because of various factors including
competitive pressures, nuclear power issues, and diversification
activities.(13) Regulators, investors, and ratepayers clearly need to be
aware of and need to address changing business risks.
Concerning competitive pressures, the Energy Policy Act of 1992
recognized the role of market forces in developing a competitive
wholesale market for electricity and changed the rules concerning
generating capacity and transmission access for the electric utility
industry. Exempt wholesale generators (EWGs) are not limited by the
restrictions of the Public Utility Holding Company Act of 1935 (PUHCA),
and EWGs can compete with utilities and non-utility generators in the
power market. Wholesale access to transmission systems can be ordered by
the Federal Energy Regulatory Commission (FERC). State regulatory
commissions have authority concerning retail access. Bypass threats and
stranded investments are growing concerns for electric utilities and
have direct impacts on business risk.
Nuclear power issues have also contributed to business risks faced
by electric utilities. First, there have been significant financial
disallowances by some state regulatory commissions of costs related to
the construction of nuclear power plants. Second, there have been
increasing concerns relative to the cost of nuclear decommissioning and
the technology for nuclear decommissioning. Third, safety and
environmental issues relating to the operations of nuclear power plants
continue to be raised.
(13) See Gregory B. Enholm and J. Robert Malko, ELECTRIC UTILITIES
MOVING INTO THE 21ST CENTURY, published by Public Utilities
Report, Inc., Arlington, Virginia, 1994.
15
<PAGE>
Actual and potential negative effects associated with
diversification activities on the financial condition of electric
utilities have also contributed to increasing business risks in the
electric utility industry.(14) Financial difficulties associated with
diversification activities can negatively impact the cost and quality of
service provided by the electric utility.
B. Holding Company Profiles
In this subsection, four electric utility holding company profiles
are presented. These profiles illustrate some recent actual problems and
failures associate with diversification activities.
PINNACLE WEST CAPITAL CORPORATION
Pinnacle West Capital Corporation (PNW) is an exempt holding
company under the PUHCA. Its principal subsidiary is Arizona Public
Service (APS), an electric utility. One of PNW's other subsidiaries was
MeraBank, an Arizona-based savings and loan which was purchased for
$426 million in 1986 by PNW. MeraBank ran into financial difficulties
that in 1988 depressed PNW's earnings by $1.46 per share. In July 1988,
MeraBank stopped operating, and PNW took a $182 million write-off in
real estate losses and loss reserves. The company reduced its common
dividend 43% to $1.60 from $2.80 in 1988 and then omitted the remaining
$1.60 in 1989. PNW also took a $7.80 per share write-down in 1989 due to
the MeraBank failure. During this period, PNW infused $465 million into
the bank to try to cover losses. PNW was eventually relieved from
further obligations by Federal regulators. In 1990, Arizona regulators
petitioned the SEC to revoke PNW's exemption from PUHCA regulation.
The effective and timely use of an asset cap would have reduced the
intensity of these financial failures and protected the utility
ratepayer by limiting the actual size of the
(14) J. Robert Malko and Philip R. Swensen, "Corporate Restructuring
In The Electric Utility Industry: Some Thoughts," presented at
TWENTY-THIRD ANNUAL CONFERENCE, sponsored by the Institute of
Public Utilities at Michigan State University, held at
Williamsburg, Virginia, December 1991.
16
<PAGE>
diversification program. The Arizona Corporation Commission did use a
dividend payment restriction on the utility because of financial losses
associated with diversification by the holding company. This restriction
limited the utility's dividend to PNW to $170 million annually for a two
year period beginning December 6, 1991. The restriction was lifted in
December of 1993. The regulatory tools of an asset cap and dividend
restriction are discussed in Section IV.
SCECORP
SCEcorp is an exempt holding company under the PUHCA. Its principal
subsidiary is Southern California Edison (Edison). In September 1990,
the California Commission disallowed recovery of $48 million of Edison's
payments during 1985-87 to five cogeneration and eight geothermal power
projects which re up to 50% owned by Mission Energy, a subsidiary of
SCEcorp.
In November 1991, an agreement was reached where Edison's customers
would benefit from a one-time $120 million reduction in rates and a
reduction in the amount charged for energy purchased from energy
entities affiliated with Edison. Total savings were estimated at
approximately $250 million. Based on the agreement, Edison provided an
additional $74 million in reserves to cover the cost of the settlement.
The effective and timely use of a comprehensive affiliated interest
statute would have reduced the intensity of these financial problems and
protected the utility ratepayer. The Virginia Commission is fortunate to
have relatively strong authority through its affiliated interest
statutes. In addition, the Virginia Commission has discouraged power
purchases from affiliated non-utility generating companies.
17
<PAGE>
FPL GROUP, INC.
FPL Group is an exempt holding company whose principal subsidiary
is an energy utility, Florida Power and Light (FP&L). In October 1990,
following substantial losses by its non-utility subsidiaries, FPL Group
announced write-downs totaling $752 million, and subsequently reduced
its dividend growth by half to 1.7% from 3.5% in May 1991.
Another significant action related to dividend policy occurred in
May 1994, when FPL Group reduced its dividends by 32%. The holding
company took this action in an effort to redirect its efforts concerning
FP&L and two other subsidiary areas.
In 1985, FPL Group acquired Colonial Penn Insurance Company located
in Pennsylvania for $565 million. Before that time, one of Colonial
Penn's biggest customers had been the American Association of Retired
Persons (AARP). However, subsequent to Colonial Penn's acquisition by
FPL, AARP stopped insuring through Colonial Penn. This action was a
major setback to Colonial Penn resulting in it being offered for sale.
Despite FPL Group's purchase and efforts to turn the company around,
Colonial Penn lost money. In April 1991, FPL Group sold Colonial Penn
for $150 million. FPL Group's total losses from the Colonial Penn
investment were $686 million.
FPL Group also took a write-down of $63 million for its cable
business and other real estate holdings in 1990. The company sold its
cable business during 1995. Although these non-utility write-downs did
not directly affect the electric utility, they depressed FPL Group's
stock price.
The effective and timely use of both strategic planning and an
asset cap would have reduced the intensity of these financial problems.
These regulatory tools are discussed in Section IV.
18
<PAGE>
HAWAIIAN ELECTRIC INDUSTRIES (HEI)
During September 1982, the Hawaii Public Utilities Commission (PUC)
approved the formation of Hawaiian Electric Industries (HEI), a holding
company, by the Hawaiian Electric Company (HECO), an electric utility.(15)
As part of the approval process, the Hawaii PUC imposed 24 conditions,
dealing with accounting, financial and management issues, to provide
guidelines for diversification activities by HEI. At the end of 1993,
non-utility assets totaled approximately $2.8 billion for HEI, and there
was approximately a $72 million equity investment in these assets.(16)
Electric utility assets for HEI totaled approximately $1.9 billion.
During 1987, HEI acquired the Hawaiian Insurance Group (HIG). This
non-utility subsidiary provided property and casualty insurance for
commercial and personal lines. HEI's investment in HIG was completely
written off in 1992 because of significant insurance claims of
approximately $300 million associated with Hurricane Iniki and $140
million in claims associated with normal operations.
During the 1990-1991 period, there were also conflicts of interests
among HECO's liability insurance claims and HIG regarding whether a HECO
insurance claim relating to damages caused by an outage were covered by
its HIG insurance. In resolving this dispute between the sister
subsidiaries, there was a need to employ outside independent counsel.
The effective and timely use of both strategic planning and an
asset cap probably would have reduced the intensity of these financial
problems. Again, with respect to issues relating to transactions
between the utility and its affiliates, Virginia's affiliated interest
statutes are relatively strong.
(15) For recent analysis concerning diversification activities
relating to HEI, see Review of the RELATIONSHIPS BETWEEN
HAWAIIAN ELECTRIC INDUSTRIES AND HAWAIIAN ELECTRIC COMPANY,
submitted to the Hawaii PUC, prepared by Dennis Thomas and
Associated, January 1995.
(16) Ibid, p.32.
19
<PAGE>
C. Regulatory Tools and Financial Agency Problems
Regulatory tools, such as those described in the company profiles,
can reduce the severity of financial agency problems which can arise
between utility stockholders and utility bondholders, between management
and investors, AND between utility stockholders and utility
ratepayers.(17) A financial agency problem is defined as a situation
that develops when a strategy or action pursed by the management of a
business firm benefits one group, such as stockholders, but harms
another group, such as bondholders. Financial agency problems can
clearly result in monetary losses to investors which have the potential
to adversely affect the utility's financial integrity. Specifically,
divided payout ratios in excess of 100% and higher debt ratios in the
electric utility capital structure caused by investments in
diversification activities could be harmful to electric utility
ratepayers and bondholders. However, these financial activities could
be helpful to the electric utility stockholder(s), which could be either
a parent holding company or a group of investors. Financial agency
problems associated with electric utility diversification can clearly
increase the investment risk of the utility.
Major bond rating agencies have recognized and reacted to the
increasing and changing business risks in the electric utility industry
during the past ten years. Specifically, Standard & Poor's has imposed
more rigorous rating standards or benchmarks, including pretax interest
coverage ratios and debt ratios, for maintaining a solid "A" debt rating
- - an important financial goal of Virginia Power. Exhibit III-1 clearly
shows the higher or stronger standard for a single "A" bond rating for
an electric utility during the past five years.
Increasing business risks facing the electric utility industry
during the 1990s are causing state regulatory commissions to re-examine
regulatory tools and guidelines in order to protect
(17) J. Robert Malko, Richard Williams, and George Hermina,
"Electric Utility Diversification: Activities In Some Eastern
States," appears in THE KENTUCKY JOURNAL OF ECONOMICS AND
BUSINESS, Vol.7, September 1987.
20
<PAGE>
the public interest, including the interests of utility ratepayers.(18)
Specific regulatory guidelines and tools are proposed to the Virginia
Commission in the next major section of this Final Report concerning the
financial insulation of Virginia Power. These proposed regulatory tools
address some of the issues and problems associated with increasing
business risk facing Virginia Power, including risks associated with
DRI's diversification activities.
(18) See Gregory B. Enholm and J. Robert Malko, ELECTRIC UTILITIES
MOVING INTO THE 21ST CENTURY, published by public utilities Report,
Inc., Arlington, Virginia, 1994. See also Gregory B. Enholm and J.
Robert Malko, "Changing the Rules: The Pros and Cons of Incentive
and Performance Based Regulations," presented at the NARUC 106th
Annual Convention and Regulatory Symposium, Reno, Nevada, November,
1994.
21
<PAGE>
IV. FINANCIAL INSULATION OF VIRGINIA POWER
A. Financial Integrity
Investors who own securities (debt or stock) in a regulated
utility expect to earn a fair return on their investment. If a utility
does not have adequate earnings, investors will be reluctant to provide
additional investment capital. If a utility cannot attract sufficient
investment capital, the utility cannot provide reliable and adequate
service to its customers. The U.S. Supreme Court has established legal
guidelines for the setting of a utility's return on capital. In
BLUEFIELD WATER WORKS VS. PUBLIC SERVICE COMMISSION OF WEST VIRGINIA,
262 U.S. 679 (1923), the Court stated:
A public utility is entitled to such rates as will permit it to
earn a return on the value of the property which it employs for the
convenience of the public equal to that generally being made at the
same time and in the same general part of the country on
investments in other business undertakings which are attended by
corresponding risks and uncertainties; but it has no constitutional
right to profits such as are realized or anticipated in highly
profitable enterprises or speculative ventures. The return should
be reasonably sufficient to assure confidence in the financial
soundness of the utility and should be adequate, under efficient
and economical management, to maintain and support its credit and
enable it to raise the money necessary for the proper discharge of
its public duties. A rate of return may be reasonable at one time
and become too high or too low by changes affecting opportunities
for investment, the money market and business conditions generally.
In HOPE NATURAL GAS VS. FEDERAL POWER COMMISSION, 320 U.S. 591, (1944),
the Court stated:
The return of the equity owner should be commensurate with the
returns on investments in other enterprises having corresponding
risks. That return, moreover, should be sufficient to assure
confidence in the financial integrity of the enterprise so as to
maintain its credit and to attract capital. Id. at 603.
Financial integrity of a regulated utility clearly relates to its
ability to maintain a reasonable credit rating and to attract needed
capital on reasonable terms. Based on discussions with financial staff
at DRI and Virginia Power, the officials clearly specified that
22
<PAGE>
the near-term future policy, present policy and recent past policy of
DRI and Virginia Power is to maintain a solid "A" bond rating for debt
associated with Virginia Power. Analysis in this report concerning
financial insulation of Virginia Power recognizes and is sensitive to:
(1) the financial integrity objective, and (2) risks to Virginia Power's
ratepayers associated with diversification activities.
In the following subsections, specific regulatory and financial
guidelines and tools are presented and proposed in order to help the
Virginia Commission address some of the issues and problems associated
with increasing business risks in the electric utility industry AND to
help insulate Virginia Power from risks associated with the diversified
activities of DRI. Although there is no significant evidence, based on
this analysis, that the level of funds received by DRI from Virginia
Power has adversely impacted the utility, the size of non-utility
diversification activities has clearly continued to grow for DRI during
the past 10 years. (The magnitude of increase in non-utility activity
will be identified later in this section.) An important component of
effective insulation of the electric utility business from risks
associated with diversified activities and related financial agency
problems, involving management, utility investors, and utility
ratepayers, is the development and implementation of defined regulatory
guidelines or frameworks.(19)
One point of clarification needs to be made regarding data used in
this section of the report. As stated on page 27 of the Interim Report,
some inconsistencies were observed between IR #211A and IR #177 on the
quantitative financial information provided by DRI and Virginia Power on
dividend payout ratios. Concerning this matter, Virginia Power provided
clarification in response to IR#329. For this report, dividend payout
ratio analysis of Virginia Power is conducted using data provided from
IR #211A because of consideration of the timing of obtaining
information.
(19) J. Robert Malko, Richard Williams, and George Hermina,
"Electric Utility Diversification: Activities In Some Eastern
States," appears in THE KENTUCKY JOURNAL OF ECONOMICS AND
BUSINESS, Vol.7, September 1987.
23
<PAGE>
In response to IR #291, Virginia Power provided an explanation
regarding the inconsistencies observed in the capitalization numbers
previously provided in IR #212B and IR #179. For this report, capital
structure analysis of Virginia Power uses data provided from IR #179, as
opposed to IR #212B, because of consideration of completeness of
information.
B. Dividend Policy
In this subsection of the report, both quantitative analysis and
policy analysis concerning Virginia Power's dividend policy and dividend
payments to DRI are presented.
QUANTITATIVE ANALYSIS
Exhibit IV-B-1 indicates that the common dividends paid by DRI have
grown from $197.8 million in 1983 to $434.7 million in 1994. Exhibit
IV-B-3 shows that the dividend payout ratio was 74.37 percent in 1983
and 90.9 percent in 1994. During the 1983-1994 period, the dividend
payout ratio for DRI peaked in 1994.
Exhibit IV-B-4 shows yearly common dividends paid by Virginia Power
to DRI from 1980-1994. Virginia Power paid common dividends of $133.0
million in 1980, and $395.5 million in 1994. Exhibit IV-B-6 plots the
dividend payout ratio of Virginia Power. The dividend payout ratio for
Virginia Power was 72.16 percent in 1980, rising to 98 percent in 1994.
During this period, Virginia Power's dividend payout ratio reached a low
of 66.96 percent in 1986.
Exhibit IV-B-7 presents the comparative analysis of Virginia
Power's dividend payout ratios with those of four comparable companies
that include: Atlantic Energy, Carolina Power & Light, Delmarva Power &
Light and Pennsylvania Power & Light. The four comparable companies were
selected based on considerations of financial and operating
characteristics relative to those of Virginia Power, which is clearly
the most substantial asset of DRI.
24
<PAGE>
Virginia Power's dividend payout ratios for years 1983 through 1993
are found to be reasonably consistent with those of the comparable
companies.(20) However, Virginia Power's 1994 dividend payout ratio was
disturbingly high.
POLICY ANALYSIS
The level of dividend payments by Virginia Power and DRI, while
sizable, are consistent with the income stock feature of both Virginia
Power and DRI. This study concludes that no unreasonably high dividends
have been paid-out by Virginia Power to DRI during the period,
1983-1993. However, the dividend payout ratio reached a disturbingly
high level of 98 percent in 1994. It is reasonable and prudent for the
Virginia Commission to have regulatory authority to implement a dividend
payout ratio restriction on Virginia Power in order to insulate
effectively the electric utility from potential adverse risks of
diversified activities.
If DRI's non-utility activities incur significant losses, and these
financial losses cause Virginia Power's dividend payout ratio to exceed
100%, then the financial integrity of Virginia Power could be harmed by
suffering weakened cash flow, a potential downgrade in bond rating, and
an increase in its cost of capital.(21) A downgrade of Virginia Power's
bond rating would be harmful to bondholders and ratepayers of Virginia
Power. Considering the increasing business risk facing the electric
industry, it is prudent for an electric utility to reduce its financial
risk and have a healthier common equity ratio. One means of achieving
this goal is a reduction in dividend payout to the holding company.
Therefore, a dividend payout ratio restriction is a regulatory tool that
can also help maintain a healthy utility capital structure.
(20) The relatively high dividend payout ratio in 1988 for Carolina
Power & Light was caused by unrecoverable costs associated with
power plants. Also, the comparatively high dividend payout ratio
for Delmarva Power & Light in 1990 was caused by losses associated
with non-utility activities.
(21) In MOODY'S BOND SURVEY dated October 31, 1994 Moody's clearly
listed diversification activities by DRI as a factor contributing
to risk in Virginia Power's credit profile.
25
<PAGE>
A specific dividend payout ratio restriction of 90% (dividend / net
income) per annual time period is recommended. Since the formation of
DRI, Virginia Power did not exceed this limit until 1994. Virginia Power
should have the flexibility of formally requesting, in a timely manner,
the Commission to increase the specific percentage payout ratio
restriction above 90% for any specific time period. On the other hand,
the Commission should have the flexibility to lower the dividend payout
restriction below 90% depending on financial and economic conditions.
Effective financial forecasting will clearly supplement this process.
The proposed tool of a dividend payout ratio restriction on Virginia
Power is consistent with the goals of effectively insulating Virginia
Power, including its ratepayers, from adverse risks of diversification
and protecting the financial integrity of Virginia Power during periods
of changing business risks.(22) It is also interesting to note that the
Virginia Power Board passed a resolution in January of 1995 containing a
variant of a dividend payout ratio restriction for planning
purposes.(23)
C. Capital Structure Policy
In this subsection of the report, both quantitative analysis and
policy analysis concerning Virginia Power's capital structure policy are
presented.
QUANTITATIVE ANALYSIS
Exhibit IV-C-2 shows that total debt constituted 54.68 percent of
the total capital of Virginia Power in 1983 and declined to 46.43
percent in 1993. Exhibit IV-C-1 plots the yearly dollar amounts of total
debt, preferred stock and common equity of Virginia Power. Total debt
increased in absolute dollars from $3.3 billion in 1983 to $4.1 billion
in 1993.
(22) In a publication issued by Merrill Lynch dated October 25, 1994,
Merrill Lynch analysts indicated disappointment in the size of
dividend growth by DRI and stated that DRI stock was over-valued.
This report is an example of the importance investment analysts
place on utility dividends. Poor financial performance by the
non-utility subsidiaries could cause pressure for higher dividend
payouts on Virginia Power.
(23) See IR #327.
26
<PAGE>
Virginia Power's common equity ratio increased from 35.38 percent
in 1983 to 44.37 percent in 1993. The level of common equity increased
from $2.1 billion in 1983 to $4.0 billion in 1993. The preferred stock
increased from $611 million in 1983 to $819 million in 1993. However,
the preferred stock ratio declined slightly from 10.05 percent in 1983
to 9.20 percent in 1993.
Exhibits IV-C-3, IV-C-4 and IV-C-5 present the comparative analysis
of preferred stock, long-term debt and common equity of Virginia Power
with those of Atlantic Energy, Carolina Power & Light, Delmarva Power &
Light and Pennsylvania Power & Light. Virginia Power's proportion of
preferred stock has been reasonably consistent with those of the
comparable companies during the period 1983 through 1993. The proportion
of long-term debt in the capital structure for Virginia Power was higher
than that of the comparable companies in years 1983 through 1989.
However, it is important to note that during this period, Virginia
Power's short-term debt (ICA borrowings) was reported as long-term debt.
In subsequent years from 1990 through 1993, the proportion of
long-term debt in the capital structure for Virginia Power has been
reasonably consistent with those of the comparable companies. Similarly,
the component of common equity in the capital structure was lower than
the comparable companies in years 1983 through 1988. In the subsequent
years from 1989 through 1993, however, it has been reasonably consistent
with the comparable companies.
POLICY ANALYSIS
In order to maintain financial integrity and an appropriate bond
rating, Virginia Power needs to maintain a balanced capital structure.
As previously discussed, Virginia Power has attempted to maintain a
balanced capital structure in order to support a solid "A" bond rating
during the period 1983-1993.
27
<PAGE>
Considering the increasing business risk and uncertainty in the
electric utility industry, it is reasonable and prudent for the Virginia
Commission to have the regulatory authority to implement a common equity
ratio floor. The Public Service Commission of Wisconsin has recognized
the importance of AND has applied the tool of the equity floor to energy
utilities that are part of diversified holding companies.(24) A common
equity floor for Virginia Power is consistent with the goals of
effectively insulating Virginia Power, including its ratepayers, from
adverse risks of diversification and protecting the financial integrity
of Virginia Power during changing business risks.
A specific common equity ratio floor of 150 basis points below the
most recent common equity ratio authorized by the Commission for
Virginia Power is recommended, and should provide reasonable financial
flexibility to the utility. The resulting capital structure should be
reasonable and should help the utility maintain its financial integrity.
A 12-month or 13-month average could be used in computing the effective
common equity ratio for Virginia Power. Virginia Power would have the
flexibility of requesting the Commission to lower the common equity
ratio floor for any specific time period. Regulatory policy concerning
utility capital structure should be coordinated with regulatory policy
concerning utility dividends. The tool of a common equity ratio floor,
as opposed to the tool of the dividend payout restriction, is a more
flexible means of regulating financial policy of the utility.
D. Cost of Capital
Exhibit IV-D-1 plots the cost of short-term debt, long-term debt,
preferred stock, common equity and the weighted average cost of capital
for Virginia Power. The cost of short-term debt has fluctuated widely,
reaching 19.9 percent in 1980 and falling to 3.14 percent in 1993.
(24) J. Robert Malko and George R. Edgar, "Energy Utility
Diversification: Its Status in Wisconsin", PUBLIC UTILITIES
FORTNIGHTLY, August 7, 1986, pp. 20-24.
28
<PAGE>
The cost of long-term debt was 8.54 percent in 1980 and 7.67
percent in 1993. The cost of preferred stock was 8.51 percent in 1980
and 4.88 percent in 1993. Similarly, the allowed return on common equity
was 15.5 percent in 1980 and 11.4 percent in 1993. The weighted average
cost of capital was reported to be 11.21 percent in 1980 and 9.092
percent in 1993.
Exhibits IV-D-2, IV-D-3, and IV-D-4 compare Virginia Power's cost
of long-term debt, preferred stock and the allowed return on common
equity at year-end to the comparable companies for years 1983 through
1993. Please note that in this analysis, adjustments for possible
financial regulatory or accounting differences in arriving at the cost
of long-term debt and the cost of preferred stock associated with
Virginia Power and the four comparable companies have not been made in
this analysis. With this caveat, the cost of long-term debt for Virginia
Power is reasonably consistent with that of the comparable companies for
the defined time period. The cost of preferred stock for years 1983
through 1990 is also reasonably consistent with those of the comparable
companies. Moreover, in years 1992 and 1993, the cost of preferred stock
for Virginia Power has been the lowest among the comparable companies.
Similarly, the allowed rate of return on common equity for Virginia
Power has been reasonably consistent with the comparable companies for
years 1983 through 1991.(25) Moreover, in the years 1992 and 1993, the
allowed rate of return on common equity has been the lowest for Virginia
Power relative to the comparable companies. However, the frequency of
formal rate cases varies by utility. Please also note that it is the
policy of the Virginia Commission is to authorize return on common
equity as a range, typically covering one hundred basis points.
(25) One exception is Pennsylvania Power & Light during the years
1987-1993. That company's authorized return has remained at 15.5%
because it did not request a rate increase during the period.
However, the allowed return on equity for this energy utility is a
contested issue in a pending rate case.
29
<PAGE>
E. Financial Forecasting
In an era of increasing risk and uncertainty in the energy utility
industry, prudent and reasonable regulatory strategic planning can
reduce foreseeable risk and uncertainty AND serve the public
interest.(26) The NARUC Ad Hoc Committee on Utility Diversification,
comprised of ten state regulators from different sections of the United
States, made the following recommendation concerning strategic planning
on page 82 of its final report, 1982 REPORT OF THE AD HOC COMMITTEE ON
UTILITY DIVERSIFICATION, issued in October 1982:
Each regulatory commission should establish a regulatory strategic
planning capability. Many utilities have established or intend to
establish a corporate strategic planning capability. Utility
executives are realizing that the economics underlying utility
operations have changed. Hence, management will need a capability
to assess options. Regulators should no longer assume that
previously successful regulatory procedures and institutional
structures can be viable in the future without modification.
The Public Service Commission of Wisconsin (PSCW) has recognized
the importance of applying regulatory strategic planning to energy
utility financial issues. In the October 1984 rate order (DN6680-UR-14)
issued by the PSCW for Wisconsin Power & Light Company, the importance
of applying regulatory strategic planning to energy utility financial
issues has been recognized. The PSCW stated at page 26 of that order:
Strategic planning is and will continue to be an essential factor
in allowing both regulatory commissions and regulated utilities to
meet the challenges of rapid economic and technological change
which occurred in the decade of the 1970's and will continue
through the 1980's. The Wisconsin Commission needs the capability
and related information to analyze long-term financial issues. In
the next rate case filing, Wisconsin Power and Light Company will
be required to include 10-year forecasts of its major financial
variables including sources and uses of funds, capitalization
ratios, and external financing. These forecasts should be developed
using alternative assumptions.
During the mid-1980s, similar rate orders were issued by the PSCW
for other major electric utilities. These financial forecasts have been
presented as part of testimony in annual
(26) See J. Robert Malko, "Regulatory Strategic Planning and Electric
Utilities," presented at the NARUC Annual Convention and
Regulatory Symposium, New York City, November 1985.
30
<PAGE>
rate case proceedings, and appropriate financial issues have been
examined. In addressing diversification issues and activities related to
energy utilities, the PSCW has effectively used 5-year and 10-year
financial forecasts.(27)
Considering the increasing business risk in the electric utility
industry AND the need to insulate the utility from risks associated with
diversification by a parent holding company, it is reasonable and prudent
for the Virginia State Corporation Commission to implement the regulatory
tool of financial forecasting in regular energy utility rate cases.
These financial forecasts would be developed and presented, using
alternative financial and economic assumptions, by the utility (Virginia
Power) in rate cases in order to examine how the utility plans to
address its changing business risks. By examining the utility's
financial forecasts within the framework of a rate case setting, the
Commission and its Staff can relate important financial issues to the
financial forecast AND can monitor the degree of reasonable accuracy of
the financial forecasting model. The proposed tool of mandatory
financial forecasts using 5-year and/or 10-year time periods for energy
utilities to file as part of regular rate cases is consistent with the
goals of effectively insulating Virginia Power, including its
ratepayers, from adverse risks of diversification AND protecting the
financial integrity of Virginia Power during conditions of increasing
business risk. The Virginia State Corporation Commission currently
requires 10-year or 20-year electric utility forecasts in alternative
years.
Exhibit IV-E-1 presents the financial accounts and variables that
are currently forecasted and analyzed in alternative years. This
framework serves as a useful benchmark for the presentation of a 5-year
or 10-year financial forecast by the utility in rate cases.(28)
(27) J. Robert Malko and George R. Edgar, "Energy Utility
Diversification: Its Status in Wisconsin," PUBLIC UTILITIES
FORTNIGHTLY, August 7, 1986, pp. 20-24.
(28) The proposed 5-year or 10-year forecast should consider appropriate
U.S. Securities and Exchange Commission guidelines and
restrictions.
31
<PAGE>
F. Size of Diversification Activities Relative to Virginia Power
In this subsection of the report, both quantitative analysis and
policy analysis concerning the relative size of DRI's diversification
activities are presented.
QUANTITATIVE ANALYSIS
DRI's assets increased from $7.7 billion in 1983 to $13.6 billion
in 1994.(29) DRI's earnings have also increased from $266.0 million
to $478.2 million in 1994.
Exhibit IV-F-1 illustrates the magnitude of non-utility diversification.
Exhibit IV-F-4 tabulates income and assets of non-utility subsidiaries of and
also presents the combined income and combined assets of the non-utility
subsidiaries. The non-utility subsidiaries total income increased from
$1.3 million in 1985 to $53.1 million in 1993. The total non-utility assets
of DRI were $345.2 million in 1985 and $1.68 billion in 1993. The non-utility
income comprised 0.37 percent of total DRI income in 1985, and 10.3 percent
in 1993. However, in the years 1991 and 1992, the non-utility subsidiaries
contributed only 2.83 percent and 3.95 percent of total DRI income, but
constituted 8.2 percent and 9.8 percent of total assets of DRI during that
time period. The non-utility subsidiaries of DRI comprised 4.2 percent of
total assets of DRI in 1985 and 12.6 percent in 1993.
Exhibit IV-F-2 compares total assets of non-utility subsidiaries of
DRI with total capitalization of Virginia Power. The ratios of the total
assets of non-utility subsidiaries of DRI to the total capitalization of
Virginia Power are also presented in this exhibit. This ratio was 5.17
percent in 1985 and increased to 18.80 percent in 1993.
The empirical information clearly shows that DRI's diversification
activities have increased absolutely and relatively during the past 10 years.
(29) Financial information for 1994 is from the 1994 DRI 10-K.
32
<PAGE>
POLICY ANALYSIS
A holding company structure, such as DRI's, clearly provides the
corporation with the financial flexibility, such as direct equity
issuance for diversification, for starting-up various new businesses
and/or acquiring existing major businesses.(30) From a public interest
perspective, there is concern that significant levels of diversification
by the parent holding company could increase risks to the energy utility
and to the utility ratepayer because the energy utility would no longer
be the primary or relatively substantial component of the diversified
corporation, and there would be an increase in the level and complexity
of financial and accounting transactions involving the energy
utility.(31)
The concept of an asset cap has been developed in order to address
concerns of size of diversification activities, and related financial
agency problems. The cap is a function of the size of assets of the
energy utility. For example, if the energy utility has total assets of
one billion dollars, and the asset cap is set at 30%, then the
diversified parent holding company would be limited to $300 million of
assets in diversification activities. The Public Service Commission of
Wisconsin has recognized the importance of AND has applied the tool of
the asset cap on diversified activities of energy utility holding
companies in order to insure that the utility is the dominant financial
component of the holding company.(32)
Considering the increasing business risks in the electric utility
industry and risks associated with diversification by a parent holding
company, it is reasonable and prudent for the Virginia Commission, under
appropriate circumstances, to consider the implementation of
(30) J. Robert Malko, Richard Williams, and George Hermina, "Electric
Utility Diversification: Activities in Some Eastern States,"
appears in THE KENTUCKY JOURNAL OF ECONOMICS AND BUSINESS, Vol. 7,
September 1987 issue.
(31) In Moody's Bond Survey dated October 31, 1994, Moody's clearly
listed diversification as a factor contributing to risk in Virginia
Power's credit profile.
(32) J. Robert Malko and George R. Edgar, "Energy Utility
Diversification: Its Status in Wisconsin," PUBLIC UTILITIES
FORTNIGHTLY, August 7, 1986, pp. 20-24.
33
<PAGE>
an asset cap. Factors to consider would be the nature of the diversified
activities and an assessment of the potential impact upon the utility.
Based on consideration of the current size of DRI's diversification
program and changing business risk in the electric utility industry, an
asset cap of 25% of Virginia Power's total assets is reasonable as an
upper limit for DRI's non-utility diversification asset at the present
time. Based on Virginia Power's 1994 assets of $11.6 billion, as asset
cap of approximately $3 billion would result. This compares to
approximately $2 billion of DRI non-utility diversification assets
currently. DRI would have the flexibility to request the Commission to
increase the size of this asset cap for non-utility diversification
activities. The proposed tool of an asset cap is consistent with the
goals of effectively insulating Virginia Power, including its
ratepayers, from adverse risks of diversification and protecting the
financial integrity of Virginia Power during periods of increasing
business risk.
G. Stock Price Changes
Exhibit IV-G-1 presents Friday close stock prices from December 31,
1993 through December 30, 1994 for Atlantic Energy, Carolina Power &
Light, Delmarva Power & Light, Dominion Resources, Inc. and Pennsylvania
Power & Light. Exhibit IV-G-2 presents the total dollar figures of
Friday close stock prices for the same companies. DRI's stock prices
ranged between $45.38 and $34.88 during the period of December 31, 1993
through December 30, 1994. Exhibit IV-G-1 shows that during this period,
DRI's stock price started at a high on December 31, 1993 and
subsequently declined during 1994. Based on Analysis of Exhibits IV-G-1
and IV-G-2, the comparable companies' stock price have acted in similar
fashion to DRI's stock price fluctuations.
Exhibit IV-G-3 plots the weekly price changes for DRI and the four
comparable companies during January 7, 1994 through December 30, 1994.
Moreover, Exhibit IV-G-4 presents the dollar figures of stock price
changes for these companies. The purpose of these
34
<PAGE>
exhibits is to examine the trends in stock price CHANGES and to identify
the related time periods. This analysis indicates that the changes in
DRI's stock price have been reasonably consistent with stock price
changes associated with the comparable companies during 1994. However,
it is noteworthy to mention that DRI experienced the largest dollar
amount and related percentage amount of stock price decline during a one
week period, relative to that of the four comparable companies.
Specifically, this relatively significant dollar decline in DRI's stock
price occurred during the latter part of June 1994.
There are many economic and financial factors, such as interest
rates changes and specific business risks, that cause stock price
fluctuation. This report only indicates that DRI's stock experienced a
larger one week dollar decrease than that of the selected comparable
companies during the period of analysis. (See Exhibit IV-G-4.) However,
the percentage decrease in total common stock price for DRI during the
entire 1994 time period is reasonably consistent with that of the four
comparable companies. (See Exhibit IV-G-5.)
This report makes no conclusions or inferences as to specific
causes of why DRI's stock price declined. However, DRI's stock price
activity should be monitored in the future.
35
<PAGE>
V. COMMISSION STAFFING NEEDS
There are clearly increased duties and responsibilities for the
Commission Staff in monitoring and analyzing the accounting, economic,
engineering, financial, and legal issues and activities related to
energy utilities, such as Virginia Power, that are part of complex and
diversified corporate structures, such as DRI. Therefore, it is
reasonable and prudent for the Commission or another appropriate
Virginia governmental body to have the authority to assess a special fee
on the stockholders of the diversified corporate structure, such as DRI,
to fund potentially needed additional Commission Staff positions. These
additional staff positions could prepare annual reports and present
expert testimony in appropriate proceedings concerning issues and
activities relating to diversified energy utility corporate structures
in order to effectively protect the public interest.
VI. CONCLUSIONS AND RECOMMENDATIONS
(1) There are several conclusions regarding credit support issues.
First, there is economic value and benefit associated with the credit
support from Virginia Power to the non-utility subsidiaries of DRI.
Second, Virginia Power's creditworthiness has an impact on DRI's
commercial paper rating. Third, virtually all of the non-utility debt
derives a benefit from the non-utility subsidiaries' association with
DRI and Virginia Power. Fourth, quantification of the specific values of
credit support provided by Virginia Power is beyond the scope of this
study and needs additional analysis. Fifth, the comprehensive historic
value of the credit support could easily be in the millions of dollars.
(2) The primary conclusion concerning sources and uses of funds is that
there is no significant evidence that the level of funds received by DRI
from Virginia Power have adversely affected the utility. Dividend payout
ratios have been reasonable for the 1983-1993 period. However, Virginia
Power's dividend payout ratio reached a disturbingly high level of 98
percent in 1994. Equity allocations of DRI do not appear to have been
disproportionately allocated to non-utility subsidiaries over the entire
period of study.
36
<PAGE>
It will be important to closely monitor the investment policies of
DRI in the future regarding its non-utility subsidiaries. While no
significant inappropriate actions have been identified regarding sources
and uses of cash, including capital and depreciation, the potential
exists for problems, and DRI's activities should be carefully monitored
in the future.
(3) During the past ten years, business risks facing electric utilities
have generally increased because of various factors, including
competitive pressures, nuclear power issues, and diversification
activities. Major bond rating agencies have recognized and reacted to
these increasing business risks by imposing more rigorous standards.
Utilities, such as Virginia Power, have, in turn, targeted their capital
structure ratios to meet these changing benchmarks.
(4) Financial variables, such as dividend payout ratios, capital
structure ratios, and the cost of capital, appear to be reasonable for
Virginia Power since the formation of DRI in 1983 through 1993. However,
as mentioned above, Virginia Power's 1994 dividend payout ratio was
disturbingly high. In addition, the relative and absolute size of
non-utility diversification activities has clearly continued to grow for
DRI during the past 10 years and now comprises a significant component
of the holding company's assets.
(5) DRI experienced the largest stock price decline during a one week
period in June of 1994, relative to that of four companies comparable to
Virginia Power, which is DRI's most substantial asset. This relatively
significant decline in DRI's stock price occurred during the latter part
of June 1994. However, this analysis indicates that changes in DRI's
stock price have been reasonably consistent with stock price changes
associated with the four companies during 1994. There are many economic
and financial factors, such as interest rate changes and specific
business risks, that cause stock price fluctuations. Moreover, this
report makes no conclusions or inferences as to specific causes of why
DRI's stock price declined. However, DRI's stock price activity should
be monitored in the future.
37
<PAGE>
(6) The Commission should consider the following regulatory tools to
assist Virginia Power in addressing some of the issues and problems
associated with increasing business risks in the electric utility
industry AND to effectively insulate Virginia Power and its ratepayers
from adverse risks and related financial agency problems of
diversification:
(i) dividend payout ratio restriction,
(ii) common equity ratio floor,
(iii) 5-year and 10-year financial forecast; and
(iv) asset cap for diversification activities.
Appropriate specific values for these regulatory tools are clearly a
function of financial and economic conditions.
(7) The Commission should consider assessing a fee on the stockholders
of the diversified corporate structure or parent holding company, such
as DRI, to fund necessary additional Commission Staff positions to
monitor and analyze issues and activities relating to energy utilities
that are part of diversified corporate structures.
In summary, DRI should remember that it is primarily an electric
utility that was allowed to diversify. The regulatory tools and
guidelines proposed in this report would help effectively insulate
Virginia Power, including its ratepayers and its debt and preferred
stock investors, from adverse risks and related agency problems
associated with diversification.
38
<PAGE>
Exhibit I
Financial Issues Related To Utility Diversification
A Public Policy Perspective
Financing Financial
DRI's Agency Issues
Diversification and Problems
Regulatory Financial Insulation
Response of Virginia Power
<PAGE>
EXHIBIT II-A-1
CREDIT SUPPORT VALUE
FRAMEWORK FOR ANALYSIS
Basis Point
Differential Credit Support
Year Dollar Amount of Credit* (Variable Value) Value
1986 254,000,000
1987 232,700,000
1988 519,400,000
1989 564,400,000
1990 604,400,000
1991 544,800,000
1992 559,800,000
1993 803,500,000
1994 758,800,000
Source: Response to IR #324 and IR #334
* Dollar amounts represent maximum borrowing capacity of non-utility debt
instruments for which DRI has executed a support agreement, and a $7.8
million DCI credit facility in 1993 and 1994 which is not directly
associated with a credit support agreement.
<PAGE>
COMMERCIAL PAPER
Commercial paper consists of unsecured promissory notes issued to raise
short-term funds. Typically, only companies of unquestionable credit standing
can sell their paper in the money market, although there had been some growth
in issuance of lesser quality, unrated paper prior to the junk bond market
collapse late in 1989. (Issuance of commercial paper backed by letters of
credit (LOC) from first-tier banks had become quite popular. Credit quality of
such paper rests entirely on the transaction's legal structure and the bank's
creditworthiness. As long as the LOC is structured correctly, credit quality
of the direct obligor can be ignored. Legal issues regarding LOC backing are
not covered here.)
RATING CRITERIA
Evaluation of an issuer's commercial paper (CP) reflects S&P's opinion of the
issuer's fundamental credit quality. The analytical approach is virtually
identical to the one followed in assigning a bond rating, and there is a
strong link between the short-term and long-term rating systems (see chart).
[CORRELATION OF CP RATINGS WITH BOND RATINGS chart goes here]
In effect, the minimum credit quality associated with the 'A-1-'CP
rating is the equivalent of an "A"- bond rating. Similarly, for CP to be
rated 'A-1', the bond rating would need to be at least 'A-', (In fact,
the 'A-/A-1' combination is rare. Typically, 'A-1' CP ratings are
associated with 'A+' and 'A' bond ratings.) Conversely, knowing the bond
rating will not determine a CP rating, considering the overlap in rating
categories. However, the range of possibilities is always narrow. To the
extent that one of two CP ratings might be assigned at a given level of
long-term credit quality (e.g., at the "A" level), several criteria
apply to make that determination.
Overall strength of the credit within the rating category is the first
consideration. For example, a marginal 'A' credit likely would have its CP
rated 'A-2'; a solid 'A' would almost automatically receive an 'A-1'.
Next come liquidity considerations, which receive greater emphasis in CP
ratings than in bond ratings. The purpose and pattern of commercial paper
usage are rating elements. For example, if commercial paper is used only to
finance seasonal working-capital requirements, that could contribute to a
higher rating. The rating benefits because the assets liquidate in a
predictable way and enable repayment of the CP.
Finally, the CP rating perspective sometimes focuses more intensely on the
nearer term. The time horizon for a CP rating extends well beyond the typical
30-day life of a CP note, the 270-day maximum maturity for the most common
type of CP, or even the one-year tenor used to distinguish between short-term
and long-term ratings. Thus, CP ratings are likely to endure over time, rather
than change frequently. Nonetheless, occasionally, the near-term outlook is
distinct from long-term prospects. For example, there are companies with
substantial liquidity, providing protection in the near or intermediate term,
but which also have less than stellar profitability, a long-term factor.
Similarly, companies with relatively large cash holdings that may be used to
fund acquisitions in the future fit in this category.
The distinction, in reverse, often applies after an issuer makes a major
acquisition. S&P's confidence that the firm can restore financial health over
the long term is factored into its bond ratings, while financial stress that
dominates the near term may lead to a relatively low CP rating. Use of
different time horizons as the basis for long and short-term ratings implies
that either one or the other rating will change with time.
BACK-UP POLICIES
In the past, a key purpose of S&P's requiring bank-line backup was to ensure
that an issuer would be able to meet its obligations in the event of a
disruption to the financial markets that might inhibit the normal rollover of
commer-
Note: This document was provided by professional staff at Standard & Poor's
Corporation.
<PAGE>
cial paper, even while the issuer's own financial condition remained strong.
However, the growth of the CP market prompted a reevaluation. It is S&P's
current judgment that the protection afforded by back-up facilities could not
be relied on with a high degree of confidence in the event of widespread
disruption of the commercial paper markets. A general disruption of commercial
paper markets would be a highly volatile scenario, under which most bank lines
would represent unreliable claims on whatever cash would be made available
through the banking system to support the market. S&P neither anticipates that
such a scenario is likely to develop, nor assumes that it never will.
S&P continues to emphasize bank-line availability as an important
buttress to liquidity, but only in the context of normal market
conditions. The change in S&P's commercial paper back-up policy shifts
the focus away from market disruption, while confirming the utility of
bank facilities in supporting operations of any entity that incurs
short-term obligations in the normal course of business.
A substantial level of liquidity-in the form of bank facilities or
readily available liquid resources-is prudent for virtually all issuers
and will continue to be necessary to support an investment-grade rating
on both commercial paper and long-term debt. From time to time, there
will be developments-e.g., bad business conditions, a lawsuit,
management changes, a rating change-affecting a single company or group
of companies, which may make CP investors nervous and unwilling to roll
over the issuer's paper, even though the issuer remains creditworthy.
Prearranged bank facilities are often essential in protecting against
the risk of default under these circumstances.
Industrial and utility issuers typically provide 100% backup-excess liquid
assets or bank facilities-for paper outstanding. However, companies with the
highest credit quality can provide a lower percentage of coverage. Issuers
rated 'A-1'need not prearrange 100% coverage because they should be able to
raise funds quickly even if some adversities develop. The exact amount is
determined by the issuer's overall credit strength and its access to capital
markets. Some 'AAA' issuers may have as little as 50% backup.
Importantly, backup must be sufficient to provide the appropriate level of
coverage for other maturing short-term debt, not just commercial paper. Backup
for 100% of rated commercial paper is meaningless if other debt maturities-for
which there is no backup-coincide with those of commercial paper. Thus, the
scope of backup must extend to Eurocommercial paper, master notes, syndicated
bank notes, and other similar confidence-sensitive obligations.
QUALITY OF BACK-UP FACILITIES
Banks offer various types of credit facilities that differ widely regarding
the degree of the bank's commitment to advance cash under all circumstances.
Ever weaker forms of commitment, which are less costly to issuers, have become
common in recent years and provide banks still greater flexibility to redirect
credit at their own discretion.
At the very least, S&P expects that all back-up lines be in place and
confirmed in writing. "Preapproved" lines or orally committed lines are viewed
as insufficient. S&P also is particularly skeptical about reliance on
"money-market" lines or similar arrangements which are little more than an
invitation to do business at some future date. Payment for the lines-whether
by fee or balances-generally creates some degree of moral commitment on the
part of the bank. Whether a facility is specifically designated for CP backup
is of little significance.
There is no distinction to be made between a 364-day and 365-day facility.
However, it is obviously critical that the facility at all times extends
beyond the longest maturity of the paper it is backing. A prudent company will
arrange for the continuation of its banking facilities well in advance of
their lapsing.
The weaker the credit, the greater the need for more reliable forms of
liquidity. Issuers rated 'A-1+' have superior access to capital because
of their strong credit profiles; one assumes that banks would not
hesitate in honoring lines of credit to such borrowers. By contrast, S&P
considers it prudent for 'A-1' and 'A-2'-and certainly 'A-3'-CP issuers
to have a substantial portion of their banking facilities contractually
committed in the form of a revolving credit. These revolvers should
provide same-day availability of funds.
As a general guideline, an 'A-1' should have sufficient revolving credit
capacity to provide for the next 10 days' maturities of outstanding paper. In
the case of 'A-2' and 'A-3' issuers, revolvers should cover at least 15 days
of maturing paper. Usually, for 'A-2' and 'A-3' issuers, this would translate
into backup of 50% of total outstandings with revolving credits. The rest of
the backup should be with other committed facilities, such as compensated
lines. Stronger backup may be required in some cases to provide additional
protection against potential roll-over problems caused by declining market
confidence in the issuer.
S&P recognizes that even revolving credit agreements, which usually represent
the strongest commitment a bank can make, often include "material adverse
change" clauses, allowing the bank to withdraw under certain circumstances.
While inclusion of an escape clause weakens the commitment, S&P does not
consider it critical-or realistic-for most borrowers to negotiate removal of
"material adverse change" clauses.
It is important to note that even the strongest form of backup-a
revolver with no "material adverse change" clause-does not enhance the
underlying credit and does not lead to a higher rating than indicated by
the company's own creditworthiness. Credit enhancement can be
accomplished only through LOC or another instrument that unconditionally
transfers the debt obligation to higher-rated entity.
Banks providing issuers with facilities for backup liquidity should
themselves be sound institutions with the capacity to lend funds as
committed. A bank's credit rating can serve as a guide as to its
soundness: Possession of an investment-grade rating should indicate
sufficient financial strength for the purpose of providing a commercial
paper issuer with a reliable source of funding.
S&P criteria do not require that the bank's credit rating equal the
issuer's rating. Nor do they require that the bank's credit rating be
'AA', 'A', 'A-1', or even 'A-2' to be included in the lineup of banks
supporting an issuer's liquidity. There is no reason to presume that any
potential difficulties for the bank would coincide with the period
during which the issuer would look to it for support. Moreover, higher
credit quality of the bank does not translate into an inclination to add
assets at a given point in time or to lend to a given borrower.
Nonetheless, S&P would look askance at situations where most of a
company's banks were only marginally investment grade. That would
indicate an imprudent reliance on banks which might deteriorate to weak,
noninvestment grade status.
Dependence on just one or very few banks is also viewed as an unwarranted
risk. Apart from the potential that the bank will not have adequate capacity
to lend, there is the chance that it will not be willing to lend to this
issuer. Having several banks diversifies the risk that any bank will lose
confidence in this borrower and hesitate to provide funds.
Concentration of banking facilities also tends to increase the dollar amount
of an individual bank's participation. As the dollar amount of the exposure
becomes very large, the bank may be more reluctant to step up to its
commitment. In addition, the potential requirement of higher-level
authorizations at the bank could create logistical problems with respect to
expeditious access to funds for the issuer.
Diversification is desirable up to a point: a company must not spread its
banking business so thinly that it lacks a substantial relationship with any
of its banks. In the end, it is a solid business relationship with a bank that
is the key to whether the bank will stand by its client. Standardized criteria
cannot capture or assess the strength of such relationships. S&P is
interested, though, in any evidence-subjective as it may be-that might
demonstrate the strength of an issuer's banking relationships. For example,
the nature of credit and noncredit services provided by the bank and the
length of the business relationship after can provide some insight.
GUIDELINES FOR U.S INDUSTRIALS AND UTILITIES
Contractual Total Bank
Commitment Commitment
Or Cash Or Cash
A-1-AAA 50%
A-1-AA 75%
A-1 10 Days 100%
A-2 15 Days 100%
A-3 15 Days 100%
<PAGE>
EXHIBIT II-B-1
CAPITAL FLOWS BETWEEN VIRGINIA POWER AND DRI FROM 1983 THROUGH 1994
($000)
<TABLE>
<CAPTION>
DIVIDEND
DRI EQUITY VIRGINIA POWER PAYOUT
YEAR CONTRIBUTION DIVIDEND RATIO
<S> <C> <C> <C>
1983 $ 70,428 $202,453 71%
1984 $100,094 $223,060 72%
1985 $ 54,852 $247,865 73%
1986 $ 57,482 $230,632 68%
1987 $ 79,990 $272,284 67%
1988 $ 34,994 $289,101 71%
1989 $100,000 $303,000 81%
1990 $200,000 $326,900 83%
1991 $150,000 $346,900 80%
1992 $ 75,000 $369,800 87%
1993 $ 50,000 $378,900 81%
1994 $ 75,000 $395,548 98%
</TABLE>
Source: Response to IR #174. Dividend payout ratios came from IR #177 and are
from information in the restated column, and Virginia Power's report to
Virginia SCC, Feb 27, 1995, Case No. PUF940032.
<PAGE>
EXHIBIT II-B-2
DIVIDENDS PAID TO DRI BY EACH SUBSIDIARY
($000)
<TABLE>
<CAPTION>
DOMINION CAPITAL DOMINION LANDS DOMINION ENERGY VIRGINIA POWER
COMMON COMMON COMMON COMMON
DIVIDENDS PAYOUT DIVIDENDS PAYOUT DIVIDENDS PAYOUT DIVIDENDS PAYOUT
YEAR PAID RATIO PAID RATIO PAID RATIO PAID RATIO
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1983 0.00 0.00 0.00 0.00 0.00 0.00 $202,453 76%
1984 0.00 0.00 0.00 0.00 0.00 0.00 $223,060 77%
1985 0.00 0.00 0.00 0.00 0.00 0.00 $247,865 78%
1986 $ 3,866 39.03 % 0.00 0.00 0.00 0.00 $258,834 69%
1987 $ 6,341 39.91 % $ 1,098 338.89% $ 82 NMF $272,284 67%
1988 $ 5,669 41.48 % $ 1,897 63.53 % $ 2,838 37.50 % $289,101 71%
1989 $ 5,862 39.54 % $ 2,076 556.57% $ 5,934 40.86 % $302,994 81%
1990 $ 5,410 24.16 % $ 1,860 186.19% $ 6,599 51.68 % $326,862 83%
1991 $ 7,205 169.77% $ 1,815 206.02% $ 7,254 62.94 % $346,900 80%
1992 $ 7,957 72.99 % $ 1,742 NMF $ 8,016 84.73 % $369,800 87%
1993 $ 9,550 34.10 % $ 1,974 NMF $21,435 72.41 % $378,900 81%
1994 $13,075 69.24 % * NMF $26,392 44.26 % $395,548 98%
</TABLE>
Source: Response to IR #177. Dividend payout ratios are from the reported
column.
NMF-No meaningful figure. Earnings in these years were negative.
* Dominion Lands became a subsidiary of Dominion Capital in 1994. The following
Dominion Lands data is reflected in the Dominion Capital's 1994 figures:
dividends of $1,228,000, balance for common of ($3,842,000).
<PAGE>
EXHIBIT II-B-3
DOMINION RESOURCES' ALLOCATION OF EQUITY
(MILLIONS)
<TABLE>
<CAPTION>
EQUITY EQUITY
ALLOCATED ALLOCATED EQUITY
TO TO ALLOCATED TO TOTAL
VIRGINIA VIRGINIA NON-UTILITY RETAINED/ EQUITY
YEAR POWER NATURAL GAS SUBSIDIARIES (CARRYOVER) ADDITIONS
<S> <C> <C> <C> <C> <C>
1983 $ 70.40 $ 0.00 $ 0.00 $ 3.50 $ 73.90
1984 $100.10 $ 0.00 $ 0.00 $ 3.90 $ 104.00
1985 $ 54.90 $ 0.00 $ 40.00 $ 20.90 $ 115.80
1986 $ 57.50 $ 7.50 $ 43.80 $ 14.60 $ 123.40
1987 $ 80.00 $ 4.50 $ 17.50 $ (6.10) $ 95.90
1988 $ 35.00 $ 5.50 $ 59.50 $ (6.70) $ 93.30
1989 $100.00 $ 0.00 $ 0.00 $ 8.80 $ 108.80
1990 $200.00 $ 0.00 $ 0.00 $ (8.70) $ 191.30
1991 $150.00 $ 0.00 $ 0.00 $(13.70) $ 136.30
1992 $ 75.00 $ 0.00 $ 135.00 $(17.40) $ 192.60
1993 $ 50.00 $ 0.00 $ 35.00 $111.60 $ 196.60
1994 $ 75.00 $ 0.00 $ 4.90 $ 87.10 $ 167.00
</TABLE>
Source: Response to IR #180. Also, 1994 numbers provided by Virginia
Power report to the VSCC, dated February 27, 1995, Case No. PUF940032.
<PAGE>
EXHIBIT II-B-4
DOMINION RESOURCES' ALLOCATION OF EQUITY
AS A PERCENT OF TOTAL EQUITY ADDITIONS
<TABLE>
<CAPTION>
% OF EQUITY
% OF EQUITY % OF EQUITY ALLOCATED
ALLOCATED ALLOCATED TO
TO VIRGINIA TO VIRGINIA NON-UTILITY RETAINED/ TOTAL
YEAR POWER NATURAL GAS SUBSIDIARIES (CARRYOVER) PERCENT
<S> <C> <C> <C> <C> <C>
1983 95% 0.00 0.00 5% 100%
1984 96% 0.00 0.00 4% 100%
1985 47% 0.00 35% 18% 100%
1986 47% 6% 35% 12% 100%
1987 83% 5% 18% -6% 100%
1988 38% 6% 64% -7% 100%
1989 92% 0.00 0.00 8% 100%
1990 105% 0.00 0.00 -5% 100%
1991 110% 0.00 0.00 -10% 100%
1992 39% 0.00 70% -9% 100%
1993 25% 0.00 18% 57% 100%
1994 45% 0.00 3% 52% 100%
</TABLE>
Source: Response to IR #180. Also, 1994 numbers provided by Virginia
Power report to the VSCC, dated February 27, 1995, Case No. PUF940032.
<PAGE>
EXHIBIT II-B-5
VIRGINIA POWER'S CAPITALIZATION AND DEPRECIATION
($ MILLIONS)
<TABLE>
<CAPTION>
TOTAL
ASSET CAPITALIZATION DEPRECIATION
YEAR ASSETS GROWTH CAPITALIZATION GROWTH SOURCES
<S> <C> <C> <C> <C> <C>
1982 NA NA NA NA NA
1983 NA NA $6,082 NA $ 450
1984 NA NA 6,438 $356 275
1985 NA NA 6,674 236 404
1986 $ 8,595 NA 6,944 270 404
1987 9,256 $ 661 7,445 502 404
1988 9,495 239 7,665 220 262
1989 10,086 591 8,202 537 334
1990 10,105 19 8,345 143 290
1991 10,205 100 8,485 140 348
1992 11,317 1,112 8,681 196 455
1993 11,521 204 8,907 226 370
1994 11,648 127 NA NA NA
Total 3,995
Average 363
</TABLE>
Source: Response to IR #5, 5th set, for Total Asset figures for 1986 through
1993. Response to IR #179 for Capitalization and Capitalization Growth figures.
Also Total Depreciation Sources is defined as total depreciation plus total
deferred tax expense as indicated in response to IR #331.
<PAGE>
EXHIBIT II-B-6
VIRGINIA POWER'S CAPITALIZATION AND DEPRECIATION PERCENTAGES
<TABLE>
<CAPTION>
DEPRECIATION AS A % OF DEPRECIATION AS A % OF
YEAR ASSET GROWTH CAPITALIZATION GROWTH
<S> <C> <C>
1982 NA NA
1983 NA NA
1984 NA 77%
1985 NA 171%
1986 NA 150%
1987 61% 80%
1988 110% 119%
1989 57% 62%
1990 1526% 203%
1991 348% 249%
1992 41% 232%
1993 181% 164%
1994 NA NA
</TABLE>
Source: The percentages in this exhibit are calculated from Exhibit II-B-5.
Exhibit II-B-5's numbers are based on response to IR #5, 5th set, and IR #179.
Also, Total Depreciation Sources is defined as total depreciation and total
deferred tax expense as indicated in response to IR #331.
<PAGE>
EXHIBIT II-B-7
VIRGINIA POWER'S USES OF DEPRECIATION
($000)
<TABLE>
<CAPTION>
1983 1984 1985 1986 1987 1988 1989 1990 1991 1992
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(1) $434,508 393,009 1,593,964 371,852 949,568 574,558 769,343 773,128 595,432 552,767
Plant Additions
(2) $204,064 211,639 231,454 270,852 290,046 300,118 322,583 349,835 368,781 383,120
Depreciation
(3) $246,207 63,206 172,047 132,776 113,632 (38,113) 11,079 (59,895) (20,385) 71,446
Net Deferred Tax
Expense
(4)=(2)+(3) $450,271 274,848 403,500 403,628 403,678 262,005 333,662 289,941 348,396 454,585
Total Dep'n Sources
(5) -- -- -- -- -- -- -- -- -- --
Other Sources
(6)=(4)+(1) 103.63% 69.93% 25.31% 108.55% 42.51% 45.60% 43.37% 37.50% 58.51% 82.23%
Dep. as % of
Additions
</TABLE>
<TABLE>
<CAPTION>
1993
<S> <C>
(1) 576,336
Plant Additions
(2) 394,913
Depreciation
(3) (25,272)
Net Deferred Tax
Expense
(4)=(2)+(3) 369,641
Total Dep'n Sources
(5) --
Other Sources
(6)=(4)+(1) 64.14%
Dep. as % of
Additions
</TABLE>
Source: Response to IR #331.
Note: 1994 numbers are not available.
<PAGE>
Exhibit II-B-8
Short Term Funding Requirements
Average Daily Outstanding
(Thousands of Dollars)
<TABLE>
<CAPTION>
Commercial Poll. Control Real Estate Accts. Rec. Intercompany Percent
Year Paper Master Notes Notes Notes Sales From DRI Total from DRI
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1983 $75,131 $12,679 $ 8,947 $ 0 $ 0 $ 0 $ 96,757 0.00%
1984 2,482 0 10,147 0 0 80,550* 93,179 86.45%
1985 0 0 2,996 0 0 166,075* 169,071 98.23%
1986 0 0 8,767 0 0 113,642 122,409 92.84%
1987 0 0 661 0 0 56,828 57,489 98.85%
1988 0 0 0 0 0 16,832 16,834 99.99%
1989 0 0 0 525 0 84,872 85,397 99.39%
1990 0 0 0 0 7,397 26,315 33,712 78.06%
1991 0 0 0 0 119,686 26,831 146,517 18.31%
1992 26,154 0 0 0 194,467 826 221,447 0.37%
1993 35,203 0 0 0 111,918 0 147,121 0.00%
1994 39,642 0 0 0 115,753 0 155,395 0.00%
</TABLE>
Source: IR # 320
* Year end amounts outstanding. Average daily balances were not available.
<PAGE>
Exhibit II-B-9
Virginia Electric and Power Company
Actual Capitalization & Ratios
1983-1993
(Thousands of Dollars)
<TABLE>
<CAPTION>
Debt 1983 1984 1985 1986 1987 1988 1989 1990 1991
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Long-Term Debt $2,846,036 3,146,532 2,995,743 3,505,345 3,631,263 3,695,545 3,977,649 3,817,403 3,818,031
Due Within One Year 213,000 112,158 376,905 43,783 137,580 96,539 134,693 127,575 63,625
Short-Term Debt 63,542 500 11,200 500 42,304 35,640 39,295 118,587 104,907
Capital Leases 147,354 173,039 121,597 135,712 49,516 43,350 34,667 32,685 31,683
Cap leases -- Current 55,359 47,240 55,477 44,459 6,144 6,301 6,869 6,050 2,424
Total Debt 3,325,291 3,479,469 3,560,922 3,729,799 3,866,807 3,877,375 4,193,173 4,102,300 4,020,670
Preferred Stock
Mandatory Redemption 311,260 322,377 308,494 337,310 371,027 349,743 318,652 296,718 270,135
Optional Redemption 289,014 289,014 289,014 194,014 319,014 394,014 469,014 469,014 469,014
Preference Stock
Due Within One Year 10,683 13,883 13,883 13,083 13,083 18,083 25,283 18,083 26,583
Total Preferred
Stock 610,957 625,274 611,391 544,407 703,124 761,840 812,949 783,815 765,732
Common Equity 2,145,645 2,332,888 2,501,430 2,669,318 2,875,449 3,025,672 3,196,097 3,459,338 3,698,430
Total Capitalization 6,081,893 6,437,631 6,673,743 6,943,524 7,445,380 7,664,887 8,202,219 8,345,453 8,484,832
Capitalization Ratios
Debt 54.68% 54.05% 53.36% 53.72% 51.94% 50.59% 51.12% 49.16% 47.39%
Preferred 10.05% 9.71% 9.16% 7.84% 9.44% 9.94% 9.91% 9.39% 9.02%
Common Equity 35.28% 36.24% 37.48% 38.44% 38.62% 39.47% 38.97% 41.45% 43.59%
</TABLE>
<TABLE>
<CAPTION>
Debt 1992 1993
<S> <C> <C>
Long-Term Debt 3,800,190 3,899,908
Due Within One Year 136,735 165,750
Short-Term Debt 49,500 43,000
Capital Leases 29,108 27,179
Cap leases -- Current 2,626 0
Total Debt 4,018,159 4,135,837
Preferred Stock
Mandatory Redemption 260,242 224,000
Optional Redemption 569,014 594,014
Preference Stock
Due Within One Year 16,300 1,500
Total Preferred
Stock 845,556 819,514
Common Equity 3,817,112 3,952,020
Total Capitalization 8,680,827 8,907,371
Capitalization Ratios
Debt 46.29% 46.43%
Preferred 9.74% 9.20%
Common Equity 43.97% 44.37%
</TABLE>
Source: IR # 179
<PAGE>
Exhibit III-1
Changing Debt Rating Benchmarks by Standard & Poor's for a "Single A"
Bond Rating for an Electric Utility, Selective Years 1988 - 1993
<TABLE>
<CAPTION>
Pretax Interest
Year Coverage Total Debt + Total Capital
<S> <C> <C>
1988 2.00 - 3.25x 52 - 60%
1989 2.00 - 3.25x 52 - 60%
1990 2.50 - 4.00x 44 - 54%
1991 2.50 - 4.00x 44 - 54%
1992 2.50 - 4.00x 44 - 54%
1993 2.75 - 4.50x 41 - 52%
</TABLE>
Source: Selected Credit Review reports issued by Standard & Poor's, 1988-1993.
EXHIBIT IV-B-1 Dominion Resources, Inc.
Dividend Policy-Common Dividend Paid
Dominion Resources, Inc.
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Common
Dividends
Paid 197,825 220,215 244,065 265,600 284,300 301,800 320,500 340,700 362,200 386,900 411,200 434,700
(thousands of $)
</TABLE>
EXHIBIT IV-B-2 Dominion Resources, Inc.
Dividend Policy-Balance Available for Common
Dominion Resources, Inc.
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Available for
Common 266,017 293,265 319,807 379,800 430,500 438,400 410,700 445,700 459,900 444,500 516,600 478,200
(thousands of $)
</TABLE>
EXHIBIT IV-B-3 Dominion Resources, Inc.
Dividend Policy-Dividend Payout Ratio (%)
Dominion Resources, Inc.
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Dividend
Payout
Ratio (%) 74.37 75.09 76.32 69.93 66.04 68.84 78.04 76.44 78.76 87.04 79.6 90.9
</TABLE>
EXHIBIT IV-B-4 Virginia Electric & Power Company
Dividend Policy-Common Dividends Paid
Virginia Electric & Power Company
<TABLE>
Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Virginia
Power
Common
Dividends
Paid 133,005 144,937 172,791 202,453 223,060 247,865 258,834 272,284 289,101 302,994 326,862 346,893 369,803 378,940 395,548
(thousands
of $)
</TABLE>
EXHIBIT IV-B-5, Virginia Electric & Power Company
Dividend Policy-Balance Available for Common As Reported
<TABLE>
Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Available for
Common 184,329 180,614 221,598 265,527 291,118 318,623 374,756 406,660 407,011 375,240 392,164 435,914 423,809 466,906 404,870
(thousands
of $)
</TABLE>
EXHIBIT IV-B-6 Virginia Electric & Power Company
Dividend Policy-Dividend Payout Ratio (%)
<TABLE>
Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Dividend
Payout
Ratio 72.16 80.25 77.97 76.25 76.62 77.79 69.07 66.96 71.03 80.75 83.35 79.58 87.26 81.16 97.70
(percent)
</TABLE>
EXHIBIT IV-B-7 Analysis with Comparable Companies
Dividend Policy-Payout Ratio (%)
Payout Ratio (%)
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VEPCO 76.25% 76.62% 77.79% 69.07% 66.96% 71.03% 80.75% 83.35% 79.58% 87.26% 81.16%
Atlantic 65.00% 76.00% 99.00% 87.00% 66.00% 75.00% 75.00% 97.00% 85.00% 90.00% 85.00%
CPL 101.70% 63.50% 65.20% 65.90% 70.80% 136.30% 68.10% 67.70% 67.60% 67.60% 78.80%
Delmarva 69.00% 70.00% 70.00% 70.00% 89.00% 86.00% 84.00% 257.00% 91.00% 91.00% 88.00%
PPL 79.00% 80.00% 96.00% 83.00% 81.00% 74.00% 71.00% 76.00% 77.00% 79.00% 80.00%
</TABLE>
Source: VEPCO: IR #211A; Atlantic: Financial & Statistical Review;
CPL: Financial & Statistical Review; Delmarva: Financial and
Statistical Review; PPL: Statistical Review
EXHIBIT IV-C-1 Virginia Electric & Power Company
Capital Structure
Virginia Electric & Power Company
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
(THOUSANDS OF DOLLAR)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Total Debt
Equi. 3,325,291 3,479,469 3,560,922 3,729,799 3,866,807 3,877,375 4,193,173 4,102,300 4,020,670 4,018,159 4,135,837
Preferred
Stock 610,957 625,274 611,391 544,407 703,124 761,840 812,949 783,815 765,732 845,556 819,514
Common
Equity 2,145,645 2,332,888 2,501,430 2,669,318 2,875,449 3,025,672 3,196,097 3,459,338 3,698,430 3,817,112 3,952,020
</TABLE>
EXHIBIT IV-C-2 Virginia Electric & Power Company
Capital Structure-Percentage of Total Capital
Virginia Electric & Power Company
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Total Debt Equi. 54.68% 54.05% 53.36% 53.72% 51.94% 50.59% 51.12% 49.16% 47.39% 46.29% 46.43%
Preferred Stock 10.05% 9.71% 9.16% 7.84% 9.44% 9.94% 9.91% 9.39% 9.02% 9.74% 9.20%
Common Equity 35.28% 36.24% 37.48% 38.44% 38.62% 39.47% 38.97% 41.45% 43.59% 43.97% 44.37%
</TABLE>
EXHIBIT IV-C-3 Analysis with Comparable Companies
Capital Structure-Preferred Stock (%)
Preferred Stock (%)
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VEPCO 10.05% 9.71% 9.16% 7.84% 9.44% 9.94% 9.91% 9.39% 9.02% 9.74% 9.20%
ATE 11.00% 10.00% 8.00% 7.00% 6.00% 11.00% 9.00% 12.00% 15.00% 14.00% 11.77%
CPL 12.70% 12.40% 10.50% 8.70% 7.60% 7.10% 6.60% 6.50% 5.00% 2.70% 2.70%
Delmarva 12.59% 12.13% 8.45% 7.89% 7.73% 7.37% 9.10% 8.80% 8.18% 9.97% 9.16%
PPL 18.20% 17.50% 16.80% 12.90% 13.70% 12.50% 11.80% 11.60% 10.90% 9.09% 9.00%
</TABLE>
Source: VEPCO: IR #179; Atlantic: Financial & Statistical Review;
CPL: Financial & Statistical Review; Delmarva: Financial and
Statistical Review; PPL: Statistical Review
<PAGE>
EXHIBIT IV-C-4 Analysis with Comparable Companies
Capital Structure-Long-Term Debt (%)
Long-term Debt (%)
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VEPCO 54.68% 54.05% 53.36% 53.72% 51.94% 50.59% 51.12% 49.16% 47.39% 46.29% 46.43%
ATE 45.00% 45.00% 48.00% 49.00% 49.00% 43.00% 46.00% 43.00% 38.00% 39.00% 42.19%
CPL 48.70% 49.10% 49.70% 48.30% 47.50% 49.80% 47.70% 50.20% 50.70% 50.00% 48.20%
Delmarva 46.33% 45.05% 48.68% 48.98% 48.66% 44.68% 43.99% 47.87% 46.30% 44.56% 41.56%
PPL 47.70% 48.30% 48.50% 52.10% 49.00% 49.10% 48.80% 46.50% 47.10% 47.40% 47.60%
</TABLE>
Source: VEPCO: IR #179; Atlantic: Financial & Statistical Review;
CPL: Financial & Statistical Review; Delmarva: Financial
and Statistical Review; PPL: Statistical Review
EXHIBIT IV-C-5 Analysis with Comparable Companies
Capital Structure-Common Equity (%)
Common Equity (%)
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VEPCO 35.28% 36.24% 37.48% 38.44% 38.62% 39.47% 38.97% 41.45% 43.59% 43.97% 44.37%
ATE 44.00% 45.00% 44.00% 44.00% 45.00% 46.00% 45.00% 47.00% 47.00% 47.00% 46.04%
CPL 38.60% 38.50% 39.80% 43.00% 44.90% 43.10% 45.70% 43.30% 44.30% 47.30% 49.10%
Delmarva 41.08% 42.82% 42.86% 43.14% 43.17% 42.72% 42.63% 39.67% 42.37% 42.16% 47.01%
PPL 34.10% 34.20% 34.70% 35.00% 37.30% 38.40% 39.40% 41.90% 42.00% 42.70% 43.40%
</TABLE>
Source: VEPCO: IR #179; Atlantic: Financial & Statistical Review;
CPL: Financial & Statistical Review; Delmarva: Financial
and Statistical Review; PPL: Statistical Review
<PAGE>
EXHIBIT IV-D-1 Virginia Electric & Power Company
Cost of Capital
Virginia Electric & Power Company
<TABLE>
* * * * * * * *
Year Cost 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Short-Term Debt (%) 19.9 13 11.86 10.52 3.197 3.14
Long-Term Debt (%) 8.54 8.81 9.04 8.82 8.99 8.74 8.35 8.417 8.689 8.857 8.662 8.429 7.889 7.676
Preferred Stock (%) 8.51 8.51 8.51 8.16 8.25 8.25 7.92 7.485 7.57 7.75 6.869 6.43 5.2 4.882
Common Equity (%) 16.5 16.5 15 15 15 14.5 14.5 13.25 13.25 13.25 13 12.25 11.4 11.4
Weighted Average (%) 11.21 11.15 10.49 10.41 10.45 10.14 9.75 10.23 10.407 10.491 10.315 10.292 9.195 9.092
</TABLE>
* For the years 1984-1991, short-term debt needs were met with the Intercompany
Credit Agreement, which is included in long-term debt in those years.
<PAGE>
EXHIBIT IV-D-2 Analysis with Comparable Companies
Cost of Capital - Long-Term Debt (%)
Long-term Debt (%)
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VEPCO 8.82% 8.99% 8.74% 8.35% 8.42% 8.69% 8.86% 8.66% 8.43% 7.89% 7.68%
ATE 9.19% 9.24% 9.61% 8.89% 8.99% 9.09% 9.20% 9.15% 8.85% 8.82% 8.38%
CPL 9.57% 9.57% 9.53% 9.05% 8.93% 8.78% 8.63% 8.63% 8.04% 7.36% 6.85%
Delmarva 8.08% 8.25% 8.48% 8.25% 8.23% 8.63% 8.62% 8.64% 8.16% 7.69% 7.24%
PPL 10.98% 11.11% 11.23% 10.53% 10.31% 10.15% 9.80% 9.69% 9.72% 9.36% 8.63%
</TABLE>
Source: VEPCO: IR #213 & IR 330; Atlantic: Financial & Statistical Review;
CPL: Financial & Statistical Review; Delmarva: Financial
and Statistical Review; PPL: Statistical Review
<PAGE>
EXHIBIT IV-D-3 Analysis with Comparable Companies
Cost of Capital - Preferred Stock (%)
Preferred Stock (%)
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VEPCO 8.16% 8.25% 8.25% 7.92% 7.49% 7.57% 7.75% 6.87% 6.43% 5.20% 4.88%
ATE 7.46% 7.42% 7.24% 6.95% 6.72% 7.54% 7.47% 7.70% 7.75% 7.74% 7.84%
CPL 8.96% 9.25% 9.26% 8.89% 8.75% 8.75% 8.72% 8.66% 8.68% 8.41% 8.33%
Delmarva 8.29% 8.28% 7.00% 6.23% 6.60% 6.49% 6.51% 6.42% 5.87% 5.80% 5.46%
PPL 9.66% 9.94% 10.02% 8.33% 7.77% 7.66% 7.62% 7.54% 7.51% 7.36% 6.30%
</TABLE>
Source: VEPCO: IR #211A, IR #330; Atlantic: Financial & Statistical Review;
CPL: Financial & Statistical Review; Delmarva: Financial
and Statistical Review; PPL: Statistical Review
<PAGE>
EXHIBIT IV-D-4 Analysis with Comparable Companies
Cost of Capital - Allowed Return on Equity (%) - At Year End
Allowed Return on Equity
<TABLE>
Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VEPCO 15.00% 15.00% 14.50% 14.50% 13.25% 13.25% 13.25% 13.00% 12.25% 11.40% 11.40%
ATE 15.00% 14.30% 14.30% 14.10% 14.10% 14.10% 14.10% 14.10% 12.50% 12.50% 12.50%
CPL 14.50% 16.25% 15.25% 15.25% 12.63% 12.75% 12.75% 12.75% 12.75% 12.75% 12.75%
Delmarva 15.10% 15.10% 14.86% 14.86% 12.50% 12.50% 12.50% 12.50% 12.50% 12.50% 12.50%
PPL 15.50% 15.50% 15.50% 15.50% 15.50% 15.50% 15.50% 15.50% 15.50% 15.50% 15.50%
</TABLE>
Source: VEPCO: IR #212, IR #213 & IR #330; Atlantic: Financial &
Statistical Review; CPL: Financial & Statistical Review;
Delmarva: Financial and Statistical Review; PPL: Statistical
Review
Note: VEPCO Allowed ROE Range: 1983-84: 15-15.5%; 1985-86: 14-15%;
1987-90: 12.5-13/5%; 1991: 11.5-12.5%; 1992-93: 10.5-11.5%.
<PAGE>
EXHIBIT IV - E - 1
COMPANY NAME:__________________ Page S-1
RATE OF RETURN STATEMENT - TOTAL COMPANY, ELECTRIC ONLY
<TABLE>
ACTUAL PROJECTED
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2002 2003
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
I. Total Operating Revenues
II. Operating Expenses and Taxes
a. O&M, excluding fuel
b. Fuel
c. Depreciation
d. Taxes
e. Other
f. Total
III. Net Operating Revenues
IV. Add (Deduct) from Net
Operating Revenues
a. AFUDC
B. Other
V. Net Operating Income
</TABLE>
Page 1 of 4
<PAGE>
EXHIBIT IV - E - 1
COMPANY NAME:__________________ Page S-2
RATE OF RETURN STATEMENT - TOTAL COMPANY, ELECTRIC ONLY (continued)
<TABLE>
ACTUAL PROJECTED
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
VI. Rate Base
a. Electric Plant in Service
b. Less: Accumulated
Depreciation
c. Net Plant
d. CWIP and AFUDC
e. Working Capital
f. Other Items (Net)
g. Total Rate Base
VII. Rate of Return on Rate Base
VIII. Rate of Return on Common
Equity
IX. Projected Capital Structure
a. Debt (%)
b. Common Equity (%)
c. Preferred Stock (%)
</TABLE>
Page 2 of 4
<PAGE>
EXHIBIT IV - E - 1
COMPANY NAME:__________________ Page S-3
STATEMENT OF SOURCES OF FUNDS FOR CONSTRUCTION EXPENDITURES
<TABLE>
ACTUAL PROJECTED
1990 1991 1992 1993 1994 1995 1996-1997 1998-2003
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sources of Funds
Income Before Interest
Items Not Requiring (Providing
Funds:
Depreciation & Amortization
AFUDC
All Other
Funds From Operations
Less:
Interest Expense
Preferred Dividends
Common Dividends
Funds From Financing:
Long Term Debt (Net Proceeds)
Preferred Stock
Common Stock
Other, including S.T. debt
</TABLE>
Page 3 of 4
<PAGE>
EXHIBIT IV - E - 1
COMPANY NAME:__________________ Page S-4
STATEMENT OF SOURCES OF FUNDS FOR CONSTRUCTION EXPENDITURES (continued)
<TABLE>
ACTUAL PROJECTED
1991 1992 1993 1994 1995 1996 1997-1998 1999-2002
<S> <C> <C> <C> <C> <C> <C> <C> <C>
SOURCES OF FUNDS (Continued)
Less Retirements of Securities
Long Term Debt
Preferred Stock
Common Stock
Other (Specify)
Net Funds From Financing
Other Sources (Uses)
Change in Working Capital
Other, Net
TOTAL SOURCES OF FUNDS
TOTAL CONSTRUCTION EXPENDITURES
(excluding AFUDC)
</TABLE>
Page 4 of 4
<PAGE>
EXHIBIT IV-F-1 Dominion Resources, Inc.
DRI Non-Utility Diversification
Dominion Resources, Inc.
Non-Utility Subsidiaries Dominion Resources Non-Uti./DRI Cons.
TOTAL TOTAL Consolidated
Year INCOME ASSETS Income Assets Income Assets
(in million dollars) (in million dollars)
1983 0.000 0.000 266.000 7,691.600 0.000% 0.000%
1984 0.000 0.000 297.000 8,097.800 0.000% 0.000%
1985 1.258 345.210 341.000 8,292.300 0.369% 4.163%
1986 9.428 397.808 385.200 9,063.700 2.448% 4.389%
1987 15.060 462.070 430.500 9,864.700 3.498% 4.684%
1988 24.222 590.899 438.400 10,282.300 5.525% 5.747%
1989 29.719 727.576 410.700 11,033.500 7.236% 6.594%
1990 36.192 826.246 445.700 10,990.900 8.120% 7.518%
1991 13.031 927.707 459.900 11,201.400 2.833% 8.282%
1992 17.559 1,237.677 444.500 12,615.100 3.950% 9.811%
1993 53.133 1,681.546 516.600 13,349.500 10.285% 12.596%
<PAGE>
EXHIBIT IV-F-2 Virginia Electric & Power Company
DRI Non-Utility Diversification and VEPCO's Total Capitalization
Virginia Electric & Power Company
VEPCO Non-utility Non-Utility Total Assets/
Year Total Capitalization Total Assets of DRI VEPCO Total Capitalization
(in thousands of dollars)
1985 6,673,743 345,210 5.17%
1986 6,943,524 397,808 5.73%
1987 7,445,380 462,070 6.21%
1988 7,664,887 590,899 7.71%
1989 8,202,219 727,576 8.87%
1990 8,345,453 826,246 9.90%
1991 8,484,832 927,707 10.93%
1992 8,680,827 1,237,677 14.26%
1993 8,907,371 1,681,546 18.88%
<PAGE>
EXHIBIT IV-F-3
DOMINION RESOURCES, INC.
CONSOLIDATED STATEMENT
(MILLIONS OF DOLLARS)
<TABLE>
1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
< s> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets 7,691.60 8,097.80 8,292.30 9,063.70 9,864.70 10,282.30 11,033.50 10,990.90 11,201.40 12,615.10 13,349.50
Earnings 266.00 297.00 341.00 385.20 430.50 438.40 410.70 445.70 459.90 444.50 516.60
Int. Payments 271.20 261.50 270.20 331.10 340.80 358.70 407.30 426.80 414.30 373.70 373.50
Debt 2,846.00 3,066.00 2,857.00 3,482.70 3,980.70 4,164.40 4,540.60 4,395.60 4,393.30 4,404.10 4,750.50
</TABLE>
Source: First Supplemental Responses to the 9th Set, Part II, IR #213 and
IR #214 B
<PAGE>
EXHIBIT IV-F-4
DOMINION RESOURCES, INC.
INCOME AND ASSETS OF NON-UTILITY SUBSIDIARIES OF DRI
(THOUSANDS OF DOLLARS)
<TABLE>
DCI DCI DLI DLI DEI DEI TOTAL TOTAL
Year Income Assets Income Assets Income Assets INCOME ASSETS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1985 1,258 345,210 0 0 0 0 1,258 345,210
1986 9,428 379,686 0 17,908 0 214 9,428 397,808
1987 15,964 432,941 249 19,562 (1,153) 9,567 15,060 462,070
1988 13,667 393,189 2,986 36,413 7,569 161,297 24,222 590,899
1989 14,825 447,368 373 43,870 14,521 236,338 29,719 727,576
1990 22,425 509,858 999 66,285 12,768 250,103 36,192 826,246
1991 614 508,248 891 120,363 11,526 299,096 13,031 927,707
1992 10,901 541,670 (320) 141,000 6,978 555,007 17,559 1,237,677
1993 26,124 604,741 (5,552) 138,689 32,561 938,116 53,133 1,681,546
</TABLE>
Source: First Supplemental Responses to the 9th Set, Part II, IR #214 B
<PAGE>
EXHIBIT IV-G-2 Analysis with Comparable Companies
Stock Price (Friday Close) Analysis
Date ATE CPL Delmarva DRI PPL
31-Dec-93 $21.750 $30.125 $23.625 $45.375 $27.000
07-Jan-94 $21.375 $28.875 $22.875 $44.875 $26.500
14-Jan-94 $21.250 $28.625 $22.375 $43.750 $26.250
21-Jan-94 $20.875 $28.000 $22.000 $43.000 $25.500
28-Jan-94 $21.375 $29.125 $22.375 $43.375 $25.625
04-Feb-94 $20.500 $28.000 $21.250 $42.375 $24.375
11-Feb-94 $20.500 $28.000 $21.250 $42.000 $24.500
18-Feb-94 $20.375 $27.125 $20.750 $40.875 $23.500
25-Feb-94 $20.250 $26.875 $20.875 $40.625 $24.125
04-Mar-94 $20.875 $27.375 $21.125 $41.125 $23.625
11-Mar-94 $21.000 $27.500 $21.000 $41.125 $23.500
18-Mar-94 $20.750 $27.000 $21.750 $41.000 $23.500
25-Mar-94 $20.375 $26.750 $21.125 $40.750 $23.625
31-Mar-94 $20.250 $25.625 $20.625 $40.000 $23.000
08-Apr-94 $20.125 $25.500 $20.500 $40.125 $23.500
15-Apr-94 $20.125 $25.125 $20.125 $40.250 $23.375
22-Apr-94 $21.250 $26.000 $20.750 $41.750 $24.875
29-Apr-94 $21.250 $26.625 $21.000 $42.250 $24.625
06-May-94 $20.250 $24.750 $19.875 $40.750 $23.375
13-May-94 $18.500 $23.875 $18.250 $39.000 $22.250
20-May-94 $18.000 $24.500 $18.125 $40.125 $22.500
27-May-94 $18.375 $24.625 $18.625 $39.750 $22.500
03-Jun-94 $18.250 $24.750 $18.500 $39.750 $21.875
10-Jun-94 $18.500 $24.375 $18.500 $39.875 $21.125
17-Jun-94 $17.500 $24.000 $18.125 $38.875 $20.500
24-Jun-94 $16.625 $23.000 $17.750 $36.250 $20.000
01-Jul-94 $17.250 $23.375 $18.250 $36.625 $19.750
08-Jul-94 $17.875 $23.625 $17.875 $36.250 $20.250
15-Jul-94 $18.500 $24.875 $18.250 $36.500 $20.375
22-Jul-94 $18.750 $24.875 $18.500 $35.875 $20.625
29-Jul-94 $19.000 $26.625 $18.875 $36.375 $20.500
05-Aug-94 $19.000 $26.625 $19.125 $37.250 $21.500
12-Aug-94 $18.375 $26.125 $18.750 $37.250 $20.625
19-Aug-94 $18.250 $26.000 $18.500 $37.875 $20.500
26-Aug-94 $17.250 $26.625 $18.750 $37.625 $20.875
02-Sep-94 $17.250 $25.750 $18.500 $36.375 $20.250
09-Sep-94 $16.875 $25.250 $18.000 $36.250 $19.750
16-Sep-94 $16.375 $25.125 $18.250 $34.875 $19.625
23-Sep-94 $16.250 $25.375 $18.250 $35.875 $19.500
30-Sep-94 $16.375 $26.250 $18.750 $37.250 $20.000
07-Oct-94 $16.125 $25.875 $18.500 $37.000 $19.875
14-Oct-94 $17.000 $26.375 $18.875 $37.625 $19.875
21-Oct-94 $16.500 $25.875 $18.750 $37.750 $19.875
28-Oct-94 $16.625 $26.500 $18.625 $37.250 $19.625
04-Nov-94 $17.000 $25.875 $19.000 $36.250 $19.500
11-Nov-94 $16.750 $25.750 $18.250 $35.375 $19.250
18-Nov-94 $16.875 $25.250 $18.000 $35.750 $19.000
25-Nov-94 $17.625 $26.250 $18.625 $36.750 $20.625
02-Dec-94 $17.875 $26.500 $18.375 $36.875 $19.875
09-Dec-94 $17.875 $27.375 $18.125 $37.375 $19.625
16-Dec-94 $17.875 $28.000 $18.750 $36.875 $19.750
23-Dec-94 $17.750 $26.625 $18.250 $36.250 $19.375
30-Dec-94 $17.625 $26.625 $18.141 $36.000 $19.000
<PAGE>
EXHIBIT IV-G-4 Analysis with Comparable Companies
Weekly Stock Price Changes Analysis
Date ATE CPL Delmarva DRI PPL
07-Jan-94 ($0.375) ($1.250) ($0.750) ($0.500) ($0.500)
14-Jan-94 ($0.125) ($0.250) ($0.500) ($1.125) ($0.250)
21-Jan-94 ($0.375) ($0.625) ($0.375) ($0.750) ($0.750)
28-Jan-94 $0.500 $1.125 $0.375 $0.375 $0.125
04-Feb-94 ($0.875) ($1.125) ($1.125) ($1.000) ($1.250)
11-Feb-94 $0.000 $0.000 $0.000 ($0.375) $0.125
18-Feb-94 ($0.125) ($0.875) ($0.500) ($1.125) ($1.000)
25-Feb-94 ($0.125) ($0.250) $0.125 ($0.250) $0.625
04-Mar-94 $0.625 $0.500 $0.250 $0.500 ($0.500)
11-Mar-94 $0.125 $0.125 ($0.125) $0.000 ($0.125)
18-Mar-94 ($0.250) ($0.500) $0.750 ($0.125) $0.000
25-Mar-94 ($0.375) ($0.250) ($0.625) ($0.250) $0.125
31-Mar-94 ($0.125) ($1.125) ($0.500) ($0.750) ($0.625)
08-Apr-94 ($0.125) ($0.125) ($0.125) $0.125 $0.500
15-Apr-94 $0.000 ($0.375) ($0.375) $0.125 ($0.125)
22-Apr-94 $1.125 $0.875 $0.625 $1.500 $1.500
29-Apr-94 $0.000 $0.625 $0.250 $0.500 ($0.250)
06-May-94 ($1.000) ($1.875) ($1.125) ($1.500) ($1.250)
13-May-94 ($1.750) ($0.875) ($1.625) ($1.750) ($1.125)
20-May-94 ($0.500) $0.625 ($0.125) $1.125 $0.250
27-May-94 $0.375 $0.125 $0.500 ($0.375) $0.000
03-Jun-94 ($0.125) $0.125 ($0.125) $0.000 ($0.625)
10-Jun-94 $0.250 ($0.375) $0.000 $0.125 ($0.750)
17-Jun-94 ($1.000) ($0.375) ($0.375) ($1.000) ($0.625)
24-Jun-94 ($0.875) ($1.000) ($0.375) ($2.625) ($0.500)
01-Jul-94 $0.625 $0.375 $0.500 $0.375 ($0.250)
08-Jul-94 $0.625 $0.250 ($0.375) ($0.375) $0.500
15-Jul-94 $0.625 $1.250 $0.375 $0.250 $0.125
22-Jul-94 $0.250 $0.000 $0.250 ($0.625) $0.250
29-Jul-94 $0.250 $1.750 $0.375 $0.500 ($0.125)
05-Aug-94 $0.000 $0.000 $0.250 $0.875 $1.000
12-Aug-94 ($0.625) ($0.500) ($0.375) $0.000 ($0.875)
19-Aug-94 ($0.125) ($0.125) ($0.250) $0.625 ($0.125)
26-Aug-94 ($1.000) $0.625 $0.250 ($0.250) $0.375
02-Sep-94 $0.000 ($0.875) ($0.250) ($1.250) ($0.625)
09-Sep-94 ($0.375) ($0.500) ($0.500) ($0.125) ($0.500)
16-Sep-94 ($0.500) ($0.125) $0.250 ($1.375) ($0.125)
23-Sep-94 ($0.125) $0.250 $0.000 $1.000 ($0.125)
30-Sep-94 $0.125 $0.875 $0.500 $1.375 $0.500
07-Oct-94 ($0.250) ($0.375) ($0.250) ($0.250) ($0.125)
14-Oct-94 $0.875 $0.500 $0.375 $0.625 $0.000
21-Oct-94 ($0.500) ($0.500) ($0.125) $0.125 $0.000
28-Oct-94 $0.125 $0.625 ($0.125) ($0.500) ($0.250)
04-Nov-94 $0.375 ($0.625) $0.375 ($1.000) ($0.125)
11-Nov-94 ($0.250) ($0.125) ($0.750) ($0.875) ($0.250)
18-Nov-94 $0.125 ($0.500) ($0.250) $0.375 ($0.250)
25-Nov-94 $0.750 $1.000 $0.625 $1.000 $1.625
02-Dec-94 $0.250 $0.250 ($0.250) $0.125 ($0.750)
09-Dec-94 $0.000 $0.875 ($0.250) $0.500 ($0.250)
16-Dec-94 $0.000 $0.625 $0.625 ($0.500) $0.125
23-Dec-94 ($0.125) ($1.375) ($0.500) ($0.625) ($0.375)
30-Dec-94 ($0.125) $0.000 ($0.109) ($0.250) ($0.375)
Source: Author's Computations
<PAGE>
EXHIBIT IV-G-5
Analysis With Comparable Companies
Annual Stock Price Percentage Change Analysis
Date ATE CPL Delmarva DRI PPL
31-Dec-93 $21.750 $30.125 $23.625 $45.375 $27.000
30-Dec-94 $17.625 $26.625 $18.141 $36.000 $19.000
Total 1994
Percentage Change (18.97%) (11.62%) (23.21%) (20.66%) (29.63%)
Source: Based on Exhibit IV-G-2.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
DOMINION RESOURCES, INC.
Registrant
/s/ L. R. Robertson
L. R. Robertson
Senior Vice President
(Chief Financial Officer)
Date: April 17, 1995
