Mountain States Tel. & Tel. Co. v. F.C.C.

• Decision Date: 23 July 1991
• Docket Number: No. 89-1421,89-1421
• Citation: 939 F.2d 1035
• Parties: , 124 P.U.R.4th 178 The MOUNTAIN STATES TELEPHONE AND TELEGRAPH COMPANY, et al., Petitioners, v. FEDERAL COMMUNICATIONS COMMISSION and United States of America, Respondents, Pacific Bell and Nevada Bell, Bell Atlantic Telephone Company, et al., New York Telephone Company and New England Telephone and Telegraph Company, North American Telecommunications Association, Bell South Corporation, Southern Bell Telephone Company and Telegraph Company, South Central Bell Telephone Company, American Telephone and Telegraph Company, North American Telecommunications Association, United States Telephone Association, GTE Service Corporation, Intervenors.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 1035

939 F.2d 1035

291 U.S.App.D.C. 207, 124 P.U.R.4th 178

The MOUNTAIN STATES TELEPHONE AND TELEGRAPH COMPANY, et al., Petitioners, v. FEDERAL COMMUNICATIONS COMMISSION and United States of

America, Respondents,

Pacific Bell and Nevada Bell, Bell Atlantic Telephone

Company, et al., New York Telephone Company and New England

Telephone and Telegraph Company, North American

Telecommunications Association, Bell South Corporation,

Southern Bell Telephone Company and Telegraph Company, South

Central Bell Telephone Company, American Telephone and

Telegraph Company, North American Telecommunications

Association, United States Telephone Association, GTE

Service Corporation, Intervenors.

No. 89-1421.

United States Court of Appeals, District of Columbia Circuit.

Argued Oct. 15, 1990.

Decided July 23, 1991.

Robert B. McKenna, for petitioners.

Laurel R. Bergold, Counsel, F.C.C., with whom Robert L. Pettit, General Counsel, and John E. Ingle, Deputy Associate General Counsel, F.C.C., James F. Rill, Asst. Atty. Gen., Catherine G. O'Sullivan and Robert Wiggers, Attorneys, Dept. of Justice, were on the brief, for respondents.

Alfred Winchell Whittaker, with whom Katherine C. Zeitlin and Martin T. McCue, for U.S. Telephone Ass'n, Mark J. Mathis, Thomas L. Welch and David K. Hall, for Bell Atlantic Telephone Companies, Gail L. Polivy, Richard McKenna, for GTE Service Corp., James B. Tuthill, M. Mates and Stanley J. Moore, for Pacific Bell, Nevada Bell, William B. Barfield and R. Frost Branon, for BellSouth Corp., et al., Mary McDermott and Donald W. Boecke, for New England Tele. & Tele. Co., and New York Telephone Co., Liam S. Coonan and James S. Golden for Southwestern Bell Corp. were on the joint brief, for intervenors.

Saul Fisher and Martin J. Silverman also entered appearances for intervenor, New England Tele. & Tele. Co., and New York Telephone Co.

Albert H. Kramer and Robert F. Aldrich entered appearances for intervenor, North American Telecommunications Ass'n.

William C. Sullivan, Patricia J. Nobles and Richard C. Hartgrove also entered appearances for intervenor, Southwestern Bell Telephone Co.

Francine J. Berry and Mark E. Manly entered appearances for intervenor, American Tele. & Tele. Co.

Daniel L. Bart also entered an appearance for intervenor, GTE Service Corp.

Before EDWARDS, D.H. GINSBURG, and SENTELLE, Circuit Judges.

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

D.H. GINSBURG, Circuit Judge:

Several telephone companies petition for review of a Federal Communications Commission decision, known as the USOA Antitrust Costs Order, that places upon them the burden of showing that they should recover from ratepayers the costs of adverse judgments, settlements, and litigation expenses arising from certain types of lawsuits. Because the FCC did not adequately justify the scope of the rule, and did not sufficiently consider its probable effects upon the companies' incentives, we grant the petition and remand the matter for the Commission's further consideration.

I. BACKGROUND

Section 201(b) of the Communications Act of 1934, 47 U.S.C. Sec. 201(b), requires that rates for interstate telephone service be just and reasonable. The FCC tries to enforce that requirement, as do most utility regulators, via so-called "rate of return" regulation: a carrier's rates are deemed just and reasonable if they are set at a level expected to produce no more than its "revenue requirement," that is, its allowable expenses plus a reasonable return on its invested capital. See T. Morgan, J. Harrison, & P. Verkuil, Economic Regulation of Business 223 (1985).

In furtherance of this regulatory scheme, the FCC has "prescribe[d] the forms of ... accounts" for regulated carriers. 47 U.S.C. Sec. 220(a). For the purposes of this proceeding, all one need know of the FCC's Uniform System of Accounts [USOA] is that an expenditure in an account "above the line" may presumptively be included in, and an expenditure allocated to an account "below the line" is presumptively excluded from, the carrier's revenue requirement. See American Telephone and Telegraph, 98 F.C.C.2d 982, 985-86 (1984); Proposed Amendments to Uniform System of Accounts (CC Docket No. 85-64), Notice of Proposed Rulemaking, FCC 85-120 at 1 n. 1 (May 3, 1985).

Historically, the FCC has allowed carriers to record their litigation expenses and damage judgments above the line, see 47 CFR Secs. 31.664, 31.669 (1985), although "[p]enalties and fines paid on account of violations of statutes" were placed below the line, in an account for "nonrecurring transactions that are not customary business activities," see 47 CFR Sec. 31.370 (1985). In 1979, the FCC considered changing these rules, but after nearly four years of consideration concluded that they provided ratepayers with "adequate protection against unreasonable litigation spending." See Litigation Expenses, Notice of Inquiry, 70 F.C.C.2d 1961 (1979); Litigation Expenses, Memorandum Opinion and Order, 92 F.C.C.2d 140, 146-47 (1982).

Shortly thereafter, when an antitrust judgment for almost $277 million was entered against AT & T, see Litton Systems, Inc. v. American Telephone and Telegraph, 700 F.2d 785 (2d Cir.1983); AT & T, 3 FCC Rcd 500, 500 (1988), the Commission revisited the subject. Concluding that "violating a statute should [not] be regarded as a routine part of operating a business," the agency directed AT & T to enter the judgment and related litigation expenses below the line in the account for non-recurring transactions as a fine or penalty. AT & T, 98 F.C.C.2d at 984-85, reconsideration denied, 3 FCC Rcd 500, vacated and remanded, Mountain States Telephone and Telegraph v. FCC, 939 F.2d 1021 (D.C.Cir.1991).

Between the issuance of that order and the order denying its reconsideration, the FCC also initiated the rule-making under review here, announcing that:

The policies and accounting classifications we adopt in this proceeding shall apply broadly to litigation costs, judgments and settlements emanating from alleged civil or criminal violations of any federal law, even though we focus on antitrust cases for the purposes of our analysis. We do not here address judgments and costs arising in the ordinary course of business out of contract disputes, tort liability for accidents, workman's compensation, and the like.

Proposed Amendments to Uniform System of Accounts (CC Docket No. 85-64), Notice of Proposed Rulemaking, FCC 85-120 at 3 (May 3, 1985) (Notice ). Within the realm of federal law, though, it proposed that judgments and settlements be recorded below the line, see id. at 3-5, and requested comments on various possible methods of accounting for litigation expenses, see id. at 5-6.

After receiving comments, in 1987 the FCC adopted new accounting rules for the presumptive treatment of litigation expenses, settlements, and judgments (hereinafter called L, S & J costs) related to violations of federal law, pointing out that these rules did not purport to be "a final determination that judgments or other costs associated with a particular case should or should not be disallowed." Report and Order, 2 FCC Rcd 3241, 3242 (hereinafter USOA Antitrust Costs Order or Order ). Rather, the change meant "that the companies, not the Commission, [would] in the first instance need to provide evidence as to the reasonableness of including the costs which were incurred in connection with alleged violations of law in a revenue requirement that is used to compute charges paid by ratepayers." Id. at 3243.

The Order begins:

In our Notice ... we initiated an inquiry into the manner in which carriers should account for costs incurred in defending, settling and paying judgments in antitrust lawsuits, as well as suits alleging civil or criminal violation of any other federal law. (For convenience, all these types of suits will be referred to [in this Order] as "antitrust cases.")

2 FCC Rcd at 3241. Because the analysis in the Order focuses on antitrust considerations, this terminological equation makes it unclear whether certain references to "antitrust cases" are to be read literally or are instead meant to refer to "all federal cases."

Under the new rules, judgments in all federal statutory cases would henceforth be recorded below the line, id. at 3243-44, because they "result from violation of statutes which establish an important public policy." Id. at 3244. Apparently reverting to a literal use of antitrust terminology, the FCC noted in particular that, although the conduct giving rise to an "antitrust judgment" is "often the result of a corporate strategy that could benefit shareholders[,] ... such conduct rarely, if ever, produces any benefit for ratepayers"; hence, this type of expenditure should not appear above the line unless the carrier can show that the judgment is "the byproduct of activities that benefit ratepayers." Id.

Settlements were also to be recorded below the line. The FCC was not reluctant to apply this rule to a settlement reached after the entry of an initial judgment against the carrier, for example, while an appeal is pending: in such a case a judge or jury has determined that the company violated the law. Id. at 3245. The agency explained, however, that it had decided to place prejudgment settlements below the line as well, in order to avoid giving carriers too great an incentive to settle cases rather than risk an adverse judgment, and to avoid giving plaintiffs an incentive to bring frivolous cases in the hope of coercing a settlement before judgment, i.e., while the carrier presumptively could still pass the cost along to ratepayers. Id. at 3245.

The FCC decided to let carriers continue to record litigation expenses above the line during the pendency of the litigation, because mandating below-the-line accounting would "create[ ] an unfair presumption of impropriety, appear[ ] to violate [the FCC's] neutrality in ongoing private court disputes, and [be]...