Bell Atlantic Telephone Companies v. F.C.C.

• Citation: 79 F.3d 1195,316 U.S.App. D.C. 395
• Decision Date: 29 March 1996
• Docket Number: 95-1219,95-1258,95-1234,95-1316 and 95-1318,95-1245,Nos. 95-1217,95-1239,s. 95-1217
• Parties: BELL ATLANTIC TELEPHONE COMPANIES, Petitioner, v. FEDERAL COMMUNICATIONS COMMISSION and United States of America, Respondents, Rochester Telephone Corporation, et al., Intervenors.
• Court: United States Courts of Appeals. United States Court of Appeals (District of Columbia)

Page 1195

79 F.3d 1195

316 U.S.App.D.C. 395

BELL ATLANTIC TELEPHONE COMPANIES, Petitioner, v. FEDERAL COMMUNICATIONS COMMISSION and United States of

America, Respondents,

Rochester Telephone Corporation, et al., Intervenors.

Nos. 95-1217, 95-1219, 95-1234, 95-1239, 95-1245, 95-1258,

95-1316 and 95-1318.

United States Court of Appeals, District of Columbia Circuit.

Argued Dec. 19, 1995.

Decided March 29, 1996.

On Petitions for Review of Orders of the Federal Communications Commission.

Mark L. Evans, Washington, DC, argued the cause for petitioners and intervenors challenging the "price cap" rules. With him on the briefs were James R. Young, Michael E. Glover, Edward H. Shakin, Arlington, VA, Robert M. Lynch, San Antonio, TX, Durward D. Dupre, St. Louis, MO, Thomas A. Pajda, St. Louis, MO, Linda Kent, Charles Cosson, Michael J. Shortley, III, Arlington, VA, Lucille M. Mates, John W. Bogy, James L. Wurtz, San Francisco, CA, Margaret E. Garber, Reno, NV, Richard McKenna, Irving, TX, M. Edward Whelan, III, Los Angeles, CA, M. Robert Sutherland, Atlanta, GA, Robert B. McKenna, Denver, CO, Saul Fisher, Bedminster, NJ, Joseph DiBella, White Plains, NY and Rodney L. Joyce, Washington, DC. David J. Gudino, Washington, DC, entered an appearance.

Paul T. Cappuccio, Washington, DC, argued the cause for petitioners and intervenors challenging the "add-back" order. With him on the briefs were Steven G. Bradbury, Lawrence R. Sidman, Washington, DC, Michael S. Pabian, Hoffman Est, IL, M. Robert Sutherland, Atlanta, GA, Robert M. Lynch, San Antonio, TX, Durward D. Dupre, Thomas A. Pajda, St. Louis, MO, James R. Young, Michael E. Glover, Edward H. Shakin and Michael J. Shortley, III, Arlington, VA.

John E. Ingle, Deputy Associate General Counsel, Washington, DC, Federal Communications Commission, argued the cause for respondents. With him on the briefs were William E. Kennard, General Counsel, Daniel M. Armstrong, Associate General Counsel, Laurence N. Bourne, and Carl D. Lawson, Counsel, Anne K. Bingaman, Assistant Attorney General, United States Department of Justice, Robert B. Nicholson and Robert J. Wiggers, Attorneys, Washington, DC.

Gene C. Schaerr, Washington, DC, argued the cause for intervenors in support of respondents. With him on the briefs were Mark C. Rosenblum, Peter H. Jacoby, Basking Ridge, NJ, Frank W. Krogh, Donald J. Elardo, Harold R. Juhnke, Jay C. Keithley and James S. Blaszak, Washington, DC.

E. Edward Bruce, John F. Duffy, Washington, DC, Saul Fisher, Bedminster, NJ, and Joseph DiBella, White Plains, NY, were on the brief in support of respondents on behalf of intervenors New York Telephone Company and New England Telephone and Telegraph Company.

Before: SILBERMAN, BUCKLEY, and RANDOLPH, Circuit Judges.

Opinion for the court filed by Circuit Judge RANDOLPH.

RANDOLPH, Circuit Judge:

Petitioners, a group of local telephone exchange carriers, seek review of two orders of the Federal Communications Commission. These orders--the Performance Review Order ¹ and the Add-Back Order ²--made several changes to the Commission's scheme for regulating prices charged by local telephone companies for interstate access services. We deny the petitions for review because the orders are neither arbitrary nor capricious and have no impermissible retroactive effects.

I

A. Background

In 1990, the Commission implemented a price cap plan for regulating rates charged by local telephone exchange carriers for interstate access services. ³ Under the price cap plan, the carriers' services are grouped into baskets. For each basket, the Commission established a maximum price, called the price cap index. As long as a carrier's tariffed rates remain below the price cap index, its rates go into effect after substantially streamlined review. Price cap regulation is intended to provide better incentives to the carriers than rate of return regulation, because the carriers have an opportunity to earn greater profits if they succeed in reducing costs and becoming more efficient. See generally National Rural Telecom Ass'n v. FCC, 988 F.2d 174 (D.C.Cir.1993).

The price cap rules required annual adjustments to the carriers' price cap indices for inflation and certain "exogenous" changes outside the carriers' control, coupled with a percentage offset for anticipated productivity gains. The productivity offset was necessary because the telecommunications industry had experienced faster productivity growth than the economy generally. As adopted in 1990, the price cap rules required the carriers to use a minimum productivity offset (or "X-factor") of 3.3 percent.

The Commission derived the productivity offset from two studies of historical productivity growth. The first, known as the Frentrup-Uretsky study, concluded that local exchange carrier productivity growth over the post-1984 period had been 3.5 percent annually. LEC Price Cap Order, 5 F.C.C.R. at 6797 pp 83-84. (1984 had been a watershed year, because in that year the Bell System divested its local exchange operations, which created many of the local exchange carriers in their present-day incarnations.) The second study, known as the Spavins-Lande study, examined long term productivity and concluded that productivity growth in the industry had been 2.1 percent annually over the period 1928-1989. Id. at 6797-98 pp 90-95. The Commission decided that both measures of productivity growth were relevant, and used an average of the two numbers (2.8 percent) as the basis for the historical component of the X-factor.

The Commission expected, however, that incentive regulation would result in greater productivity gains than rate of return regulation, and therefore added a 0.5 percent "consumer productivity dividend" to the original X-factor, for a total of 3.3 percent. LEC Price Cap Order, 5 F.C.C.R. at 6799 p 100. No party to the original proceeding challenged either the overall method for determining the productivity offset, or this specific component of that offset. See National Rural Telecom Ass'n v. FCC.

The Commission was concerned that these offsets might not accurately reflect the local exchange carriers' productivity growth. LEC Price Cap Order, 5 F.C.C.R. at 6801 p 120. The Commission feared that if the productivity offset was too low, for example, the annual reduction in the price caps would not keep pace with the local exchange carriers' productivity gains, and therefore consumers would not fully share in the benefits of incentive regulation, and could wind up worse off than they would have been if traditional rate of return regulation had been in effect.

In order to reduce this risk, the Commission adopted as a backstop program the sharing adjustment, the general validity of which is not disputed here. Id. Sharing entails a one-time adjustment to a local exchange carrier's price cap index when its rate of return for the previous year has been abnormally high. ⁴ The Commission reasoned that, in a year in which a local exchange carrier's earnings are particularly high, the carrier's productivity offset will probably have understated that local exchange carrier's actual gains in efficiency. Reconsideration Order, 6 F.C.C.R. at 2684 p 102. Therefore, a correction in the price cap index for future rates is necessary in order to allow consumers to "share" in this additional, unanticipated productivity gain in the succeeding year. The Commission uses a percentage (usually 50 percent) of the local exchange carrier's earnings over a certain threshold as a proxy for determining this additional productivity gain, and requires that the local exchange carrier's price cap index (though not necessarily its rates) be reduced by this amount during the following year.

The Commission established a minimum X-factor of 3.3 percent, but allowed carriers to choose each year between a 3.3 percent offset and a 4.3 percent offset. LEC Price Cap Order, 5 F.C.C.R. at 6787-88 pp 5-8. If a carrier chose the higher 4.3 percent offset its price caps would increase less, but it would be subject to a higher sharing threshold, allowing it to retain more of its earnings. ⁵

The Commission did not envision that sharing would be routine. See id. at 6801 pp 120-21; Performance Review Order, 10 F.C.C.R. at 9051 p 203. In practice, however, sharing became routine: in 1993 alone, the great majority of price cap local exchange carriers were in the sharing zone, including all seven Bell Operating Companies. Id.

B. The Performance Review Order

In the original price cap orders, the Commission stated that it would undertake a thorough "performance review" after the first four years of price cap regulation to evaluate how well the system had worked. LEC Price Cap Order, 5 F.C.C.R. at 6834 pp 385-88. Accordingly, in 1994 the Commission initiated a rulemaking proceeding that produced the Performance Review Order.

The Commission sought comment on what local exchange carrier productivity had been under price caps and what the X-factor should be in the future. In response, United States Telephone Association ("USTA"), on behalf of most local exchange carriers, submitted a study that proposed to determine the productivity factor based on a "total factor productivity" method ("TFP"). According to the USTA study (as revised), local exchange carrier productivity growth had been 2.3 percent. Other parties challenged USTA's proposal, contending that there were serious conceptual and methodological problems with its proposed TFP methodology. See id. at 9014-18 pp 117-26.

MCI also submitted a study based on a correction of what it saw as errors in the Commission's original determination of the X-factor. In 1990, there had been significant controversy about the Commission's decision to include the 1984 data point in the Frentrup-Uretsky study. The 1984 data point was a statistical "outlier," but the Commission had retained it, erring on the side of including all relevant information. MCI argued that the...