Verizon Telephone Companies v. F.C.C.

Decision Date20 June 2006
Docket NumberNo. 04-1332.,No. 04-1331.,04-1331.,04-1332.
Citation453 F.3d 487
PartiesVERIZON TELEPHONE COMPANIES, et al., Petitioners v. FEDERAL COMMUNICATIONS COMMISSION and United States of America, Respondents AT & T Corporation, Intervenor.
CourtU.S. Court of Appeals — District of Columbia Circuit

Sean A. Lev argued the cause for petitioners. With him on the briefs were Michael K. Kellogg, Mark L. Evans, Scott H. Angstreich, Michael E. Glover, Edward Shakin, James G. Harralson, and Bennett L. Ross. Richard M. Sbaratta entered an appearance.

Richard K. Welch, Counsel, Federal Communications Commission, argued the cause for respondents. With him on the brief were R. Hewitt Pate, III, Assistant Attorney General, U.S. Department of Justice, Robert J. Wiggers and Robert B. Nicholson, Attorneys, and John E. Ingle, Deputy Associate General Counsel, and Laurel R. Bergold, Counsel. John A. Rogovin and Samuel L. Feder, Counsel, entered appearances.

Judy Sello, David W. Carpenter, and David L. Lawson were on the brief for intervenor AT & T Corporation. James P. Young entered an appearance.

Before: GINSBURG, Chief Judge, and ROGERS and GRIFFITH, Circuit Judges.

Opinion for the Court filed by Circuit Judge GRIFFITH.

GRIFFITH, Circuit Judge.

This matter involves the use of an accounting rule, "add-back," in a complex area of regulation addressing the rates charged by local telephone exchange carriers for access to their networks. Its resolution, however, is relatively straightforward because, at its core, petitioners' challenge cannot overcome the broad delegation of power Congress has given the Federal Communications Commission ("FCC" or "Commission") to suspend petitioners' rates and determine whether they are "just and reasonable." Petitioners contend that the FCC unreasonably required their 1993 and 1994 tariffs to comply with the add-back rule years after those tariffs were filed. But Congress has expressly authorized the FCC to do what petitioners urge it cannot: suspend petitioners' tariffs upon their filing, subject petitioners to an accounting order to track revenue earned under the tariffs, and determine at a later date whether petitioners' tariffs contain "just and reasonable" rates. 47 U.S.C. § 204(a)(1). We conclude that the Commission reasonably applied its "quasi-legislative authority," see Global NAPs, Inc. v. FCC, 247 F.3d 252, 259 (D.C.Cir.2001), under 47 U.S.C. § 204(a)(1) in rejecting petitioners' suspended tariffs for failing to apply addback.

I.

Significant background is needed to understand the issue before us. Prior to September 1990, local telephone companies (local exchange carriers or "LECs") were subject to "rate-of-return" regulation in setting prices for interstate carriers to access their local telephone networks. 1993 Annual Access Tariff Filings; 1994 Annual Access Tariff Filings, 19 F.C.C.R. 14,949, 14,949 ¶ 2, 2004 WL 1713893 (2004) (the "Tariff Order"). As we explained in National Rural Telecom Ass'n v. FCC, 988 F.2d 174 (D.C.Cir.1993),

[r]ate-of-return regulation is based directly on cost. Firms so regulated can charge rates no higher than necessary to obtain sufficient revenue to cover their costs and achieve a fair return on equity. As one virtue of perfect competition is that it drives prices down to cost, rate-of-return regulation seems on its face a promising way to regulate natural monopolies, in principle roughly duplicating the benefits of competition.

Id. at 177-78 (quotation marks and internal citations omitted). Under rate-of-return regulation, if an LEC earned more than was permitted by the regulated rate, the company was required to refund those over-earnings to its ratepayers. Price Cap Regulation of Local Exch. Carriers, 8 F.C.C.R. 4415, 4415 ¶ 5, 1993 WL 757454 (proposed July 6, 1993) ("Add-Back NPRM"). The Commission "required LECs to treat refund payments as adjustments to the period in which the overearnings occurred, rather than to the period in which the refund is paid." Id. "Thus, LECs `added-back' the amount of any refund for prior excess earnings into the total earnings used to compute the rate of return for the current earnings period." Tariff Order, 19 F.C.C.R. at 14,950 ¶ 2. The reason for requiring add-back was simple: for rate-of-return regulation to work, a current earnings period needed to reflect current earnings and not be distorted by refunds paid in the current period for past overcharges. Add-back "provide[d] a clear picture of current earnings for the reporting period" by allowing the Commission to determine "whether an access category being adjusted through a refund is earning above its adjusted maximum rate of return in the monitoring period." Amendment of Part 65, Interstate Rate of Return Prescription, 1 F.C.C.R. 952, 956 ¶ 43 (1986).

"In September 1990, the Commission replaced rate-of-return regulation for the largest LECs with . . . price cap regulation." Tariff Order, 19 F.C.C.R. at 14,950 ¶ 3. Under the price cap regime, "the regulator sets a maximum price, and the firm selects rates at or below the cap. Because cost savings do not trigger reductions in the cap, the firm has a powerful profit incentive to reduce costs." Nat'l Rural Telecom, 988 F.2d at 178. "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." Bell Atl. Tel. Cos. v. FCC, 79 F.3d 1195, 1198 (D.C.Cir.1996). The Commission had to address three basic questions in setting up price cap regulation: (1) what initial price caps should be; (2) how to address inflation in future years; and (3) how to account for the LECs' future efficiency and innovation. The Commission answered the first question by "cho[osing] existing rates," the second question by selecting "an escalator based on general price inflation," and the third by providing for "an annual percentage reduction [to the price caps] for expected savings from innovation and other economies." Nat'l Rural Telecom, 988 F.2d at 178 (citing Policy and Rules Concerning Rates for Dominant Carriers, Second Report and Order, 5 F.C.C.R. 6786, 6792, 6814, 1990 WL 603395 (1990) ("LEC Price Cap Order")). At issue here is this third determination: the percentage reduction applied to price cap indices ("PCIs") annually, known as a productivity factor or "X-factor."

The Commission sought to create a productivity factor that would "generate lower rates for customers while offering LECs a fair opportunity to earn higher profits." LEC Price Cap Order, 5 F.C.C.R. at 6801 ¶ 120. But the Commission believed that it would be "difficult to determine a single, industry-wide productivity offset that will be perfectly accurate for the industry as a whole or for individual LECs or market conditions at a given time." Id. Accordingly, the Commission adopted two mechanisms to prevent an imperfect productivity factor (i.e., one that does not accurately represent efficiency gains or losses) from distorting customer rates or the LECs' profits. Under its "sharing plan" mechanism, the Commission required participating LECs to "share" their earnings above a certain level with their interstate access customers by lowering their price caps in the following year. LEC Price Cap Order, 5 F.C.C.R. at 6801 ¶ 124. Price cap LECs were allowed to choose one of two X-factors, which would dictate how much their rates would be lowered and the extent of their sharing obligation. Specifically,

a price cap LEC opting for an X-factor of 3.3 percent and earning a rate of return above 12.25 percent was required to share half of earnings above 12.25 percent and all earnings above 16.25 percent with its access customers. [LEC Price Cap Order, 5 F.C.C.R. at 6801 ¶ 125.] For LECs that elected a more challenging 4.3 percent X-factor, 50 percent sharing began for rates of return above 13.25 percent, and 100 percent sharing began at rates of return above 17.25 percent. [LEC Price Cap Order, 5 F.C.C.R. at 6787-88 ¶¶ 7-10.]

Tariff Order, 19 F.C.C.R. at 14,951 n. 9.1 Thus, an LEC that selected a 4.3 percent X-factor would initially have to cut rates more than a competitor that selected a 3.3 percent X-factor, but could keep a greater percentage of its earnings. Alternatively, a "low-end adjustment" mechanism "permitted price cap LECs earning less than 10.25 percent in a particular year to adjust their PCIs and rates upward in the following year to a level that would have allowed them to achieve an earnings rate of at least 10.25 percent for the year in which they under-earned." Id. at 14,951 ¶ ¶ 3, 4.

Sharing and low-end adjustments were first applied to the LECs' 1992 access tariffs. Some LECs had to lower their price caps based upon 1991 earnings, while others were permitted to increase price caps for 1992. One year later, those adjustments raised an issue not addressed by the Commission in promulgating its price cap plan: what effect should the adjustments made to 1992 price caps based upon over- or under-earnings from 1991 have in calculating the rates of return for 1992 (and thereby determining the rates to be charged for 1993)? In calculating the rates to be charged for 1993, LECs had to determine whether (1) to "add back" the adjustment made to rates for 1992 in calculating the rate of return for 1992, as occurred prior to price cap regulation or (2) to calculate the rate of return for 1992 without considering the effect of sharing or low-end adjustments made because of earnings from 1991. Perhaps not surprisingly, LECs that could achieve higher rates for 1993 by applying add-back chose to apply add-back, and LECs that could achieve higher rates for 1993 by not applying add-back chose not to apply add-back. Thus, each LEC took the position on add-back that would allow it to maximize its price...

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