Illinois Bell Telephone Co. v. F.C.C.

• Decision Date: 17 August 1990
• Docket Number: 89-1241,Nos. 88-1175,s. 88-1175
• Citation: 911 F.2d 776
• Parties: ILLINOIS BELL TELEPHONE COMPANY, et al., Petitioners, v. FEDERAL COMMUNICATIONS COMMISSION and United States of America.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 776

911 F.2d 776

286 U.S.App.D.C. 34

ILLINOIS BELL TELEPHONE COMPANY, et al., Petitioners, v. FEDERAL COMMUNICATIONS COMMISSION and United States of America.

Nos. 88-1175, 89-1241.

United States Court of Appeals District of Columbia Circuit.

Argued March 13, 1990.

Decided Aug. 17, 1990.

Alfred Winchell Whittaker, with whom Katherine C. Zeitlin and Floyd S. Keene, for Illinois Bell Telephone Co., et al., William B. Barfield and R. Frost Branon, Jr., for BellSouth Corp., William C. Sullivan, Richard C. Hartgrove, and Patricia J. Nobles, for Southwestern Bell Telephone Co., Martin T. McCue for U.S. Telephone Ass'n, and Dana B. Rasmussen and Robert B. McKenna, for Mountain States Tel. & Tel. Co., et al., were on the joint brief, for petitioners and supporting intervenors in 88-1175 and 89-1241. Melanie S. Fannin, for Southwestern Bell Telephone Co., also entered an appearance, for petitioners and supporting intervenors.

Linda L. Oliver, Atty. for F.C.C., with whom Robert L. Pettit, Gen. Counsel, Daniel M. Armstrong, Associate Gen. Counsel, and John E. Ingle, Deputy Associate Gen. Counsel for FCC, James F. Rill, Asst. Atty. Gen., Catherine G. O'Sullivan and Robert J. Wiggers, Dept. of Justice, were on the brief, for respondents in both cases. Diane S. Killory, Atty. for F.C.C., also entered an appearance, for respondents.

David Casson and L. Marie Guillory were on the brief, for intervenor Nat. Telephone Co-op. Ass'n in No. 89-1241. Denise M. Drialo also entered an appearance, for intervenor Nat. Telephone Co-op. Ass'n.

Jules M. Perlberg, Francine J. Berry, and Marc E. Manly entered appearances, for intervenor AT & T in Nos. 88-1175 and 89-1241.

James R. Young, David K. Young, and Thomas L. Welch entered appearances, for intervenor Bell Atlantic Telephone Co. in Nos. 88-1175 and 89-1241.

J. Richard Devlin, Carolyn C. Hill, and James T. Roche entered appearances, for intervenor United Telephone System Companies in Nos. 88-1175 and 89-1241.

Saul Fisher, Mary McDermott, and Martin J. Silverman entered appearances, for intervenor NYNEX Telephone Co. in Nos. 88-1175 and 89-1241.

Robert L. Barada, Nancy K. McMahon, and Stanley J. Moore entered appearances, for intervenors Pacific Bell and Nevada Bell in No. 88-1175.

Richard McKenna and Gail L. Polivy entered appearances, for intervenor GTE Service Corp. in No. 88-1175.

Martin T. McCue entered an appearance, for intervenor U.S. Telephone Association in No. 89-1241.

John C. Wohlstetter entered an appearance, for intervenor Contel Corp. in No. 89-1241.

Before BUCKLEY, WILLIAMS, and D.H. GINSBURG, Circuit Judges.

Opinion for the Court filed by Circuit Judge D.H. GINSBURG.

D.H. GINSBURG, Circuit Judge:

The petitioners seek review of an order of the Federal Communications Commission modifying the rules for determining the interstate rate base of so-called dominant telecommunications carriers, viz. all local exchange telephone companies, AT & T, and certain international carriers. The Commission excluded from the rate base certain categories of assets that it deemed not "used and useful" in providing telephone service. The petitioners argue that, as a result, they are deprived of a reasonable return on their investment, and thereby suffer an unconstitutional deprivation of property in violation of the Fifth Amendment to the United States Constitution, and further that the Commission acted in an arbitrary and inconsistent manner in excluding certain costs. We grant the petition for review with respect to certain of the exclusions, and remand for the Commission more adequately to account for those aspects of its decision.

I. BACKGROUND

A regulated utility's rate of return (r), multiplied by its rate base (I), plus its operating costs and taxes (C), determine its revenue requirement (R); thus, I X r + C = R, which it recovers through a rate structure calculated to yield that amount. See generally S. BREYER & R. STEWART, ADMINISTRATIVE LAW & REGULATORY POLICY 224 (2d ed. 1985). The rate of return, which is based upon the utility's embedded cost of debt and estimated cost of equity capital, as calculated by the regulator, is set at the minimum level necessary for the utility to maintain its credit and attract the capital needed to provide service. See United States v. FCC, 707 F.2d 610, 612 (D.C.Cir.1983); see also American Tel. & Tel. Co., 57 F.C.C.2d 960, 960-61, p 2 (1976) (rate of return set at "lowest possible cost consistent with [utility's] overall responsibility to provide modern, efficient service at reasonable rates and to maintain the financial integrity of the enterprise").

In 1977, the Commission elaborated upon the specific principles by which it would determine the interstate rate base component of the formula set out above for the purpose of regulating the interstate services of the unified Bell System. See In re American Tel. & Tel. Co.--Charges for Interstate Telephone Service: Phase II Final Decision and Order, 64 F.C.C.2d 1 (1977) ("Docket 19129 Order"), on recon., 67 F.C.C.2d 1429 (1978) ("Docket 19129 Reconsideration Order"). It decided then to adhere to its long-established principle of including in the rate base only property that is "used and useful" in providing service to ratepayers, i.e., is "necessary to the efficient conduct of a utility's business, presently or within a reasonable future period," Docket 19129 Order at 47, p 111; thus, it rejected AT & T's proposed "balance sheet analysis" approach, under which the rate base would include all investor-supplied capital, id. at 48, p 116, because that "would require ratepayers to pay a return to AT & T's investors on capital which to the ratepayers is non-productive," id. at 49, p 118. Such a requirement would conflict with the principle that the cost of investments should be paid by ratepayers only "insofar as the invested capital is used directly for the benefit of the ratepayer." Id.

In 1987, three years after the breakup of AT & T, the Commission reexamined and revised its rules for calculating the rate base used to determine the interstate revenue requirement of dominant telecommunications carriers. See In re Amendment of Part 65 of the Commission's Rules to Prescribe Components of the Rate Base and Net Income of Dominant Carriers: Report and Order, 3 FCC Rcd 269 (1987) ("Rate Base Order"), on recon., 4 FCC Rcd 1697 (1989) ("Reconsideration Order"). Its objective was to "refine the rate base and net income principles previously established ... and incorporate any new principles necessary to reflect the current telecommunications industry environment." 4 FCC Rcd at 1697, p 2 (footnotes omitted). The Commission decided to retain some previously determined exclusions from the rate base and newly to exclude certain additional elements. The petitioners challenge several aspects of the rules as revised in these rate base orders.

II. ANALYSIS

The petitioners contend first that the new rules deprive telephone companies of a reasonable return on their investment, in violation of the fifth amendment, because they exclude from the rate base certain prudent investments, without increasing the rate of return to compensate for the risk of such disallowance. Second, they argue that the Commission applied the "used and useful" standard in an inconsistent and arbitrary fashion with respect to several particulars.

A. Constitutionality of the End Result

The petitioners maintain that, if the Commission excludes from the rate base investments that are prudent when made although not, by the FCC's lights, "used and useful," while using a rate of return that was set at the "lowest possible" constitutional level and based upon the assumption that all prudent investments would be in the rate base, then the return on the carriers' prudently invested capital will decrease to a confiscatory level. "That is not conjecture; it is arithmetic," they say.

In reply, the Commission relies upon the principle that, in determining whether a ratemaking regulation results in an unconstitutional confiscation, the court is to consider only the "net effect," or "end result," of the ratemaking process. Duquesne Light Co. v. Barasch, 488 U.S. 299, 109 S.Ct. 609, 618-19, 102 L.Ed.2d 646 (1989); FPC v. Hope Natural Gas Co., 320 U.S. 591, 603, 64 S.Ct. 281, 288, 88 L.Ed. 333 (1944); Jersey Central Power & Light Co. v. FERC, 810 F.2d 1168, 1177 (D.C.Cir.1987) (en banc). It contends that, because this proceeding was limited to determining what would be in the rate base (I), without regard to the rate of return (r) thereon, there is no way in which the court can presently determine whether the "end result" (I x r) will be confiscatory in application. Thus, it urges that the petitioners' challenge is not ripe, and will not be ripe until the FCC applies a particular rate of return, in a ratemaking case, to the rate base as it has been determined here. Commission counsel assured the court at oral argument that each dominant carrier will have an opportunity, in a ratemaking proceeding, to seek a risk premium in order to compensate it for the risk that prudent investments will be excluded from its rate base; indeed the argument has already been raised in one pending proceeding, see Refinement of Procedures & Methodologies for Represcribing Interstate Rates of Return for AT & T Communications & Local Exchange Carriers, CC Docket No. 87-463.

We agree with the Commission. Only when the composition of the rate base and the allowable rate of return--multiplicand and multiplier--are viewed in tandem can the court evaluate the product to determine whether it is confiscatory and therefore unconstitutional. This must need be so, because "[i]nconsistencies in one aspect of the methodology," seemingly of constitutional significance when viewed in isolation, "have no constitutional effect if they are compensated by countervailing factors in some other aspect." Duquesne Light, 109 S.Ct. at 619. Thus, the present rulemaking, in which...