Central Tel. Co. v. State Corp. Commission

• Decision Date: 02 March 1979
• Docket Number: No. 781156,781156
• Citation: 219 Va. 863,252 S.E.2d 575
• Parties: , 29 P.U.R.4th 487 CENTRAL TELEPHONE COMPANY of Virginia v. STATE CORPORATION COMMISSION of Virginia. Record
• Court: Virginia Supreme Court

Page 575

252 S.E.2d 575

219 Va. 863, 29 P.U.R.4th 487

CENTRAL TELEPHONE COMPANY of Virginia v. STATE CORPORATION COMMISSION of Virginia.

Record No. 781156.

Supreme Court of Virginia.

March 2, 1979.

Donald W. Glaves, Chicago, Ill., David Meade White, Richmond (White & Wood, P. C., Richmond, Ross, Hardies, O'Keefe, Babcock & Parsons, Chicago, Ill., on brief), for appellant.

Edward L. Flippen, Richmond (Richard D. Rogers, Jr., Lewis S. Minter, Richmond, on brief), for appellee.

Before I'ANSON, C. J., and CARRICO, HARRISON, COCHRAN, HARMAN, POFF and COMPTON, JJ.

HARRISON, Justice.

On June 15, 1977, Central Telephone Company of Virginia and Southern Telephone Company filed with the State Corporation Commission tariff revisions designed to increase their gross annual revenues $4,667,194 and $262,681, respectively. On April 18, 1978, the Commission authorized additional gross revenue to Central in the amount of $1,600,366, effective May 15, 1978. Southern's requested increase was approved. Central has noted an appeal of right from this final order.

Southern Telephone Company is a wholly owned subsidiary of Central Telephone of Virginia (Central). Central is 100% Owned by Central Telephone Company (Centel), which also owns and operates directly, or through subsidiary companies, telephone properties in seven other states. Centel is 100% Owned by Central Telephone and Utilities Corporation, a Kansas corporation, (CTU). The principal officers and organization heads of CTU are also the principal officers and organization heads for Southern, Centel and Central. CTU and most of its subsidiaries purchase telephone related materials and supplies from Central Service Company (Service Company), which was incorporated in 1967, and which is also wholly owned by Centel. CTU owns all of the common stock of two other telephone companies which own and operate properties in Texas and Illinois. CTU also owns and operates electric utility properties in Colorado, and electric, telephone and water properties in Kansas. CTU and its subsidiaries comprise the fourth largest telephone system in the United States. Telephone operations account for approximately 85% Of CTU's total operations.

On February 3, 1976, the Commission approved local service tariffs designed to yield Central a 9% Rate of return on its investment as of May 31, 1975. An audit by the Commission's staff in 1976 revealed that for the year which ended May 31, 1976, the company did not earn a 9% Return and that an additional $2,359,806 in gross annual revenue would be required in order for Central to do so. On October 27, 1976, Central filed an application for an interim increase in local service rates. It sought to impose a temporary surcharge designed to yield the company the deficiency in gross annual revenue which had been found by the Commission's Thereafter, on June 15, 1977, Central and Southern filed with the Commission their applications for a permanent increase in local service rates tariff revisions and proposed that the permanent rates become effective July 15, 1977. However, this date was suspended by the Commission which ordered that public notice be given of the proposed increase in rates. Public hearings on the permanent applications were held on October 19-21, 1977, followed by oral arguments on October 28, 1977. A decision, with Commissioner Bradshaw dissenting, was reached six months later.

staff. This surcharge was to be collected subject to a refund until the Commission could investigate and arrive at a decision on an application for a permanent increase in rates which Central proposed to file. After investigation and a hearing the Commission found on December 22, 1976, that there was a substantial need for temporary relief and entered its order authorizing Central to impose a 9.60% Surcharge, effective January 7, 1977, designed to produce the needed $2,359,806 in additional revenue.

The Commission's staff and Central determined Central's rate base, net operating income and rate of return for the twelve months ending December 31, 1976. The Commission accepted this test period for purposes of evaluating Central's filed tariff revisions. Central's rate base as of December 31, 1976, equaled $142,300,571, and its test period net operating income-adjusted equaled $9,814,041. After accounting adjustments, pro forma adjustments, and intrastate separations, the Commission's staff calculated Central's rate based to equal the sum of $107,913,600 and its test period net operating income-adjusted equaled $8,131,678. Central accepted the staff's adjustments with the exception of a pro forma adjustment to the rate base, hereinafter considered, and the associated expense adjustments.

The Commission, having concluded that Central, a subsidiary of CTU, was a part of an integrated telephone service under unified control, determined that CTU's consolidated capital structure and cost of debt were appropriate to use in determining a fair return to Central. Additionally, the Commission found that Central had purchased materials and supplies from its affiliate, Service Company, at unreasonable prices and therefore made a downward adjustment of approximately $1,870,000 to Central's rate base to reflect the extent of the overpayment by Central to Service Company from 1967-1976.

The Commission found that Central was entitled to a return on common equity of 13% And an overall rate of return of 8.34%, the effect of which was to allow Central an increase in gross revenue in the amount of $1,600,366. Central was directed to eliminate the surcharge, to file rates for local service which would generate the gross annual revenue allowed and to file a plan for refunding the revenue collected under the interim surcharge which was in excess of what would have been collected under the allowed permanent rates.

The Commission's order fixing Central's rates was suspended pending Central's appeal, thus leaving the interim rates in effect under bond. While no appeal was taken by Southern, the Office of the Attorney General, Division of Consumer Counsel, noted an appeal from the Commission's order of April 18, 1978, which raises questions involving Southern, but different from those involved in Central's appeal. See Commonwealth of Virginia, ex rel., etc. v. Central Telephone Company, et als., 252 S.E.2d 586 (Va. Record No. 781175, this day decided.)

Although Central made fifteen separate assignments of error to the Commission's final order, the questions presented on appeal are as follows: (1) Whether in determining a fair rate of return to be allowed Central the Commission may use the consolidated capital structure and consolidated cost of debt of Central's parent corporation, CTU? (2) Whether the Commission was justified in declaring unreasonable and excessive, and excluding from Central's rate base, certain costs incurred by Central since 1967 in purchasing materials and supplies The Commission says that its use of CTU's consolidated capital structure and cost of debt was a matter within its discretion. It maintains that its finding, that an 8.34% Rate of return is just and reasonable, was based upon substantial evidence and that therefore its order should be affirmed. Central disagrees and quotes from this Court's opinion in City of Lynchburg v. Telephone Company, 200 Va. 706, 720, 107 S.E.2d 462, 472 (1959), as follows:

from its affiliate, Service Company? (3) Whether in arriving at Central's rate base the Commission properly excluded certain expenses allocated to Central by CTU following a sale by CTU of gas properties located in Nebraska and South Dakota? and (4) Whether the order of the Commission was retroactive in effect and at variance with its prior orders entered in similar rate cases?

It is only when it is made clear by the evidence that the officers and directors are following a policy (with respect to capital structure) in this regard which unreasonably favors the stockholders at the expense of the consumers that the rate-making tribunal should substitute a capital structure radically different from one fashioned by the officers and directors of the corporation.

While Central's equity is indirectly owned by CTU, Central issues its own debt, which is secured by first mortgage bonds on its property in Virginia. On December 31, 1976, Central's capital structure was comprised of 48.78% Debt and 51.22% Common equity. ¹ Central has no preferred stock. The weighted average interest cost on its outstanding debt as of December 31, 1976, was 7.72%. Central says that historically it has maintained approximately a 50%-50% Debt-equity capital structure, and that for the first time the Commission has ignored Central's own capital structure and cost of debt in arriving at the rate of return Central is entitled to earn on its investment. Central argues that the Commission's use of CTU's capital structure and CTU's cost of debt means the rate of return authorized by the Commission will produce a return on equity of only 11.56%, which, it says, is lower than any witness estimated as the lowest cost of attracting equity capital. It further contends that had the Commission used Central's actual capital structure, actual cost of debt and a return on equity of 13%, Central's overall rate of return would have been 8.98%. ² Central's expert witnesses, testifying on the fair rate of return and the use of a hypothetical capital structure, were Thomas A. Owens, Jr., the Vice President and Chief Financial Officer of CTU and Central, and Dr. Robert S. Stich, a corporate finance/business policy professor at the University of Missouri. Dr. William F. Beazer, an economics professor at the University of Virginia, was the Commission's expert. All witnesses, in arriving at a fair return to Central, used the cost of capital method, whereby the cost of attracting debt and equity capital is determined and then applied to an appropriate capital structure. Owens and Stich testified that...