March 20, 1995
BELL ATLANTIC - WASHINGTON, D.C., INC., PETITIONER,
THE PUBLIC SERVICE COMMISSION OF THE DISTRICT OF COLUMBIA, RESPONDENT, AND PEOPLE'S COUNSEL OF THE DISTRICT OF COLUMBIA, INTERVENOR.
On Petition for Review of a Decision of the Public Service Commission.
Before Ferren and Schwelb, Associate Judges, and Belson, Senior Judge.
The opinion of the court was delivered by: Belson
BELSON, Senior Judge: In 1984, Bell Atlantic Corporation (Bell Atlantic) was established as one of the divested Regional Bell Holding Companies following the break up of the American Telephone and Telegraph Co. (AT&T). Bell Atlantic - Washington, D.C., Inc. (BA-DC), formerly the Chesapeake and Potomac Telephone Co. (C&P), is a wholly-owned subsidiary of Bell Atlantic, and provides local telephone service in the District of Columbia. It has petitioned for review of a rate case decision of the Public Service Commission of the District of Columbia, Formal Case No. 926, establishing and reaffirming on reconsideration a revenue requirement and setting new rates for telephone services by BA-DC. *fn1
BA-DC filed an application requesting a rate increase of $35.1 million in March 1993. After an extensive eight-month proceeding, the Commission issued its initial decision, Order No. 10353, authorizing a rate increase of $15.8 million. BA-DC and the Office of the People's Counsel (OPC) applied for reconsideration of that order and, in Order No. 10383, the Commission reaffirmed its earlier decision. BA-DC then petitioned for review by this court.
BA-DC's main argument on appeal is that the Commission's decision to use Bell Atlantic's capital structure for ratemaking purposes, rather than the capital structure of BA-DC was, unreasonable, arbitrary, and capricious and should be reversed. *fn2 Because we conclude that the Commission's findings were based upon substantial evidence and were not unreasonable, arbitrary or capricious, and are satisfied that the Commission adequately explained the reasons for its decision, we affirm.
As we have repeatedly stated, the scope of our review of Commission orders is limited. See, e.g., Chesapeake & Potomac Tel. Co. v. Public Serv. Comm'n, 514 A.2d 1159, 1162-63 (D.C. 1986) (This court's review of a Public Service Commission ratemaking decision "is the narrowest judicial review in the field of administrative law"). The Commission's factual findings are conclusive unless they are "unreasonable, arbitrary or capricious." D.C. Code § 43-906 (1990). "As long as there is substantial evidence to support a reasoned Conclusion of the Commission," this court must affirm. Washington Public Interest Org. v. Public Serv. Comm'n, 446 A.2d 28, 32 (D.C. 1982) (internal quotations and citations omitted). It follows that a party seeking to overturn a Commission order "carries a heavy burden of demonstrating clearly and convincingly a fatal flaw in the action taken" -- simply proposing a valid alternative to the actions taken by the Commission is not enough. Chesapeake & Potomac, supra, 514 A.2d at 1163 (citations omitted). Our deference, of course, has limits, for the Commission has "the burden of showing fully and clearly why it has taken the particular ratemaking action." Washington Gas Light Co. v. Public Serv. Comm'n, 483 A.2d 1164, 1169 (D.C. 1984) (citations omitted); Chesapeake & Potomac, supra, 514 A.2d at 1163.
We preface our Discussion of the Commission's determinations in this case by observing that a regulatory commission faces a difficult task when it is called upon to determine a reasonable rate of return for a regulated utility which, like BA-DC, is wholly owned by a parent holding company. The parent company normally has the ability to control the ratio of debt to equity in the capital structure of its subsidiary. That ratio is important in rate determinations because equity is usually a more expensive form of capital than is debt. If a holding company were to move some of its own equity onto the books of its subsidiary, that would create a basis on which the subsidiary could seek a greater return on regulated operations. For these reasons, a regulatory commission must scrutinize a regulated subsidiary's submission that its capital structure is the same as it would be if the subsidiary were independent.
Prior to the divestiture of AT&T, the Commission historically used AT&T's consolidated capital structure in determining the rate of return of BA-DC, then C&P. See Chesapeake and Potomac Tel. Co., Formal Case No. 798, Order No. 7886, 4 D.C.P.S.C. 267, 311 (October 3, 1983); Chesapeake and Potomac Tel. Co., Formal Case No. 827, Order No. 8300, 6 D.C.P.S.C. 325, 362 (August 9, 1985). *fn3 In its last general rate case, Formal Case No. 850, the Commission decided to use Bell Atlantic's consolidated capital structure instead of BA-DC's actual capital structure for ratemaking purposes. Chesapeake and Potomac Tel. Co., Formal Case No. 850, Order No. 9927, 13 D.C.P.S.C. 67, 79-81 (January 29, 1992); Chesapeake and Potomac Tel. Co., Formal Case No. 850, Order No. 9983, 13 D.C.P.S.C. 346, 358 (March 6, 1992). In making and reconfirming this decision, the Commission expressed its preference for using BA-DC's actual capital structure, but found that BA-DC had failed to provide sufficient evidence to rebut the Commission's findings of actual manipulation of BA-DC's capital structure by Bell Atlantic. Formal Case No. 850, (supra) , 13 D.C.P.S.C. at 79-81.
Specifically, the Commission found in No. 850 that Bell Atlantic's capital structure was the capital structure that actually financed BA-DC because the evidence revealed that Bell Atlantic set debt ratio ranges within which BA-DC was expected to remain; that BA-DC's dividend payout ratios were manipulated in order to increase BA-DC's equity ratio for ratemaking purposes; that BA-DC's equity ratio was significantly higher than Bell Atlantic's even though BA-DC's lower business risk should have produced a lower equity ratio; and that Bell Atlantic could not feasibly operate its non-regulated businesses with the amount of equity remaining after the balance sheets of its subsidiary Bell operating companies were subtracted. Formal Case No. 850, (supra) , 13 D.C.P.S.C. at 79-80. The evidence of manipulation of dividend rates in the prior proceeding was especially strong. It included a letter from the President and CEO of BA-DC to Bell Atlantic asking for permission to defer the third quarter dividend in order to affect BA-DC's debt ratio for purposes of an upcoming rate case.
Relying on essentially the same reasons that it had cited in Case No. 850, the Commission decided in the case before us to use Bell Atlantic's consolidated capital structure (with important adjustments that benefitted BA-DC) for ratemaking purposes instead of using BA-DC's actual capital structure. Order No. 10353, (supra) , at 22. The Commission noted again its continued preference for using BA-DC's actual capital structure; but concluded that BA-DC had failed once again to satisfy its evidentiary burden to justify its use. Id. at 22-25.
The Commission properly placed the burden on BA-DC to prove that Bell Atlantic does not control or manipulate BA-DC's capital structure. The details of BA-DC's financial relationship to Bell Atlantic were crucial to the Commission's determination of which capital structure, the parent's or the subsidiary's, should be used for ratemaking purposes because such information reveals the actual source of BA-DC's day-to-day financing. BA-DC is obviously in the best position to provide the Commission with this important information. Most importantly, the Commission's rulings in Formal Case Nos. 827 and 850 had plainly stated what the Commission expected of BA-DC in this respect, and the latter order had made findings regarding the relationship and interaction between Bell Atlantic and BA-DC which would virtually require the continued use of Bell Atlantic's capital structure unless BA-DC established satisfactory reasons for doing otherwise. *fn4
The Commission's factual findings of actual and potential manipulation were not unreasonable, arbitrary or capricious. *fn5 Most significantly, BA-DC failed to present sufficient evidence to refute Commission's finding in Case No. 850 and the evidence in this case that Bell Atlantic sets debt ratio ranges within which BA-DC is expected to remain. Order No. 10353, (supra) , at 23. We cannot agree with BA-DC's contention that it would actually have to adopt an "admittedly irrational capital structure" to satisfy its evidentiary burden. Rather, as stated in Order No. 10353, (supra) , at 23, BA-DC simply has to provide sufficient evidence that it is free to set its own debt ratios. *fn6 We take the Commission to mean that BA-DC must show that it can and has set a debt ratio which is wholly appropriate to its role as a regulated provider of telephone services, and has in no sense been influenced by its relationship to Bell Atlantic in doing so.
Although there was no evidence of dividend payout manipulation presented in this proceeding as there had been in the last such proceeding, Formal Case No. 850, the Commission did not rely on this factor in deciding which capital structure to use. Order No. 10353, (supra) , at 23 ("If this were the only factor to consider, the Commission would not find the use of the Bell Atlantic capital structure to be appropriate"); Order No. 10383, (supra) , at 9. However, if evidence had been presented of continued dividend payout manipulation, BA-DC would have had the burden of refuting it. *fn7
With respect to the relative amounts of debt and of equity in BA-DC's capital structure compared to that of Bell Atlantic, the record supports the Commission's factual findings. Based on the Commission's findings in this proceeding, the percentage of equity in Bell Atlantic's capital structure continues to be significantly lower than that in BA-DC's capital structure even though BA-DC's business risk remains lower than that of Bell Atlantic. Order No. 10353, (supra) , at 23-24. "This disparity is inconsistent with the general rule that the amount of equity in a company's capital structure is directly related to that company's business risk." Id. at 23. Moreover, evidence presented in the present proceeding revealed that Bell Atlantic's consolidated structure would contain even less equity if the Bell operating companies' balance sheets were removed than was the case when the record was made in Case No. 850. Id. at 24; see text, (supra) , at 5. *fn8
The sum of BA-DC's complaint against the reasonableness of the Commission's action is that by imputing to BA-DC the capital structure of Bell Atlantic, the Commission calculated BA-DC's revenue requirement based on the lower cost of debt rather than the higher cost of equity on 11.6% of BA-DC's equity. *fn9 The Commission has taken the position, for the reasons we have summarized, that circumstances fully justified its imputation of Bell Atlantic's capital structure. It adds that, in any event, the use of Bell Atlantic's structure has a legally insignificant impact on BA-DC's rate of return, reducing it from 9.73%, the figure which would result from use of BA-DC's capital structure, to 9.69%, a difference of only .04%. See Order 10383, (supra) , at 11-12. Citing Chesapeake & Potomac Tel. Co. v. Public Serv. Comm'n, 498 A.2d 1167, 1169 (D.C. 1985), the Commission argues that if the total effect of a rate order is not unjust or unreasonable, a reviewing court should not disturb the order. Id. This principle is applicable here. See Washington Gas Light Co. v. Public Serv. Comm'n, 450 A.2d 1187, 1193 (D.C. 1982) (quoting Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S. Ct. 281, 287, 88 L. Ed. 333 (1944) where the Supreme Court established that "it is the 'total effect' of a rate order, rather than the theory employed, that determines its validity"). While BA-DC argues that the imputation of Bell Atlantic's capital structure leads to a significant reduction in its revenues, it neither relates that asserted loss to its rate of return, nor challenges expressly the Commission's Conclusion regarding rate of return.
Turning to BA-DC's second argument on appeal, we conclude that the Commission acted reasonably in ordering BA-DC to adjust the depreciation expense of its associated equipment for ratemaking purposes. *fn10 BA-DC was following the policy of basing depreciation expense on the lives of analog switches. According to the record, the service lives of such switches are very short. There was also substantial uncontested evidence presented in this proceeding supporting the Commission's finding that digital switches are more accurate than analog switches as indicators of the remaining life of associated equipment. Order 10353, (supra) , at 104-106. For example, although BA-DC wire centers contain both analog and digital switches, BA-DC based its depreciation expense for associated equipment solely on the service life of its analog switches. Id. at 106. However, when OPC presented BA-DC's own data which showed that substantial investment in such associated equipment remained after the retirement of analog switches, BA-DC acknowledged that its overall policy was to transfer associated equipment investment to digital switches after retirement of analog switches. *fn11 Id. Given the evidence presented and its indications of the current status of digital technology, we can not conclude that the Commission's finding was unreasonable, arbitrary or capricious.
Because we conclude that the Commission's factual findings were based upon substantial evidence, and were not unreasonable, arbitrary or capricious, and that the Commission adequately explained the reasons for its decision, we find no error of law requiring reversal. Accordingly, the Commission decision in Formal Case No. 926 is affirmed.