Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-09-01202/USCOURTS-caDC-09-01202-0/pdf.json

Parties Involved:
AEP Texas North Company
Petitioner
BNSF Railway Company
Intervenor for Respondent
Surface Transportation Board
Respondent
United States of America
Respondent

Document Text:

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued March 19, 2010 Decided June 18, 2010

No. 09-1202

AEP TEXAS NORTH COMPANY,

PETITIONER

v.

SURFACE TRANSPORTATION BOARD AND UNITED STATES OF

AMERICA,

RESPONDENTS

BNSF RAILWAY COMPANY,

INTERVENOR

On Petition for Review of an Order 

of the Surface Transportation Board

William L. Slover argued the cause for petitioner. With him

on the briefs were Kelvin J. Dowd, Robert D. Rosenberg, and

Andrew B. Kolesar III.

James A. Read, Attorney, Surface Transportation Board,

argued the cause for respondents. With him on the brief were

Robert B. Nicholson and John P. Fonte, Attorneys, U.S.

Department of Justice, Ellen D. Hanson, General Counsel,

Surface Transportation Board, Craig M. Keats, Deputy General

Counsel, and Thomas J. Stilling, Attorney.

USCA Case #09-1202 Document #1250680 Filed: 06/18/2010 Page 1 of 21
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Samuel M. Sipe Jr., Anthony J. LaRocca, and Richard E.

Weicher were on the brief for intervenor BNSF Railway

Company in support of respondent. Kathryn J. Gainey entered

an appearance.

Before: SENTELLE, Chief Judge, HENDERSON and BROWN,

Circuit Judges.

Opinion for the Court filed by Chief Judge SENTELLE.

SENTELLE, Chief Judge: AEP Texas (AEPT), an electric

utility company, uses railroads owned by BNSF Railway

Company (BNSF) to transport coal from mines in Wyoming to

an electric generating station in Texas. BNSF exerts market

dominance over the route used for this coal transportation,

which renders the rates charged subject to review by the Surface

Transportation Board (the Board). Under this authority, the

Board has set a reasonable maximum rate for the transportation

service since 1996. See W. Tex. Util. Co. v. Burlington N. R.R.

Co., 1 S.T.B. 638 (1996). In calculating a reasonable maximum

rate, the Board considers, among other variables, the cost of

equity capital, approximating a reasonable rate of return for

railroad investors. AEPT petitioned the Board for a change in

methodology in the calculation of the cost of equity capital. 

While the Board entered some changes, it denied a portion of the

petition requesting a recomputation of that variable for the years

1998–2005. AEPT now petitions for review of that decision of

the Board. We deny the petition with respect to the Board’s

decision not to recalculate that variable with respect to the years

1998–2004. However, as to the 2005 calculation, we hold that

the Board failed adequately to explain its decision. We therefore

vacate the Board’s decision with respect to the 2005 calculation

and remand for further consideration.

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I. Background

AEPT is an electric utility generating and transmitting

electricity to consumers in central and west Texas. To ship coal

from Wyoming mines to its electric generating station near

Vernon, Texas, AEPT uses railways owned by BNSF. Because

there is “an absence of effective competition from other rail

carriers or modes of transportation for the transportation” of coal

on that route, BNSF is said to exert “market dominance” over

AEPT’s shipments. See 49 U.S.C. § 10707(a). Therefore, the

rates BNSF charges on that route are subject to review by the

Surface Transportation Board under § 10707(b), (c). 

If the Board determines a railroad has market dominance,

it can establish a reasonable maximum rate the railroad may

charge for the transportation. § 10707(c). The Board calculates

the reasonable maximum rate using a “constrained market

pricing” methodology set forth in the Coal Rate Guidelines, 1

I.C.C.2d 520 (1985). To evaluate the rate for a specific route

under this methodology, the Board posits a hypothetical railroad

serving a subset of a real railroad’s network. The hypothetical

railroad, called a Stand Alone Railroad (SARR), operates the

route used by the relevant shipper and is presumed to operate at

optimal efficiency. The Board calculates the Stand Alone Cost

for the SARR, which represents the cost of running the

hypothetical railroad and includes a reasonable rate of return on

investment. The return on investment is the rate of return “that

shareholders require to compensate them for the use of their

capital.” Methodology to be Employed in Determining the

Railroad Industry’s Cost of Capital, STB Ex Parte No. 664,

2008 WL 162591, at *1 (Jan. 17, 2008) (“Methodology to be

Employed—2008”). This rate of return is referred to as the “cost

of equity capital,” or the “cost of equity.” The SARR’s Stand

Alone Cost determines the maximum rate the railroad may

charge all the shippers using the routes in the SARR. See BNSF

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Ry. Co. v. STB, 526 F.3d 770, 777 (D.C. Cir. 2008). This

method ensures that no shipper subsidizes another; “though

some bear a higher share of fixed costs than others, they still pay

no more than what they would for a facility designed to serve

only them.” Burlington N. R.R. Co. v. ICC, 985 F.2d 589, 596

(D.C. Cir. 1993).

The Board annually recalculates the industry-wide cost of

capital. This cost of capital is used in various regulatory

capacities, including calculating reasonable maximum rates for

railroads with market dominance. The published cost of capital

includes both the cost of equity capital and the cost of debt

capital. Because the interest rates on borrowed money are easily

observable, the cost of debt capital rarely becomes the subject of

debate. The cost of equity capital, however, is not directly

observable, which forces the Board “to rely on complex finance

models to estimate that component of the cost of capital.” 

Methodology to be Employed—2008, 2008 WL 162591, at *1.

Since 1996, the Board has used the Stand Alone Cost

method to set the rates BNSF may charge AEPT1

 for use of the

Wyoming to Texas railways. W. Tex. Util. Co. v. Burlington N.

R.R. Co., 1 S.T.B. 638 (1996), aff’d sub nom. Burlington N. 

R.R. Co. v. STB, 114 F.3d 206, 209 (1997). As dictated by the

Coal Rate Guidelines, the Board determines the Stand Alone

Cost for the route AEPT uses by calculating, among other

things, the cost of capital for the relevant SARR, called the

Texas & Northern Railroad (TNR). However, because SARRs

are hypothetical, the Board rarely has enough data to estimate an

individualized cost of capital for a specific SARR each year. 

Therefore, for most of its Stand Alone Cost determinations,

1

At the time, the complaining shipper was actually AEPT’s

predecessor, West Texas Utilities Company. For convenience,

however, we refer to the company as AEPT for all time periods.

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including the ones at issue in this case, the Board uses the

estimated cost of capital it publishes each year for the whole

railroad industry. 

Obviously, the calculation of the industry-wide cost of

equity capital is a significant factor in the determination of

reasonable rates, as the cost of equity is a large component of

the overall cost of a railroad. See Railroad Cost of

Capital—2008, STB Ex Parte No. 558 (Sub No. 12), 2009 WL

3052742, at *10 (Sept. 25, 2009). But the cost of equity also has

recursive implications. The Board averages each year’s cost of

equity into an historical cost of capital. The average historical

cost then affects the Board’s forecast of growth, which in turn

affects the cost of equity in future years. 

Because the methodology employed to estimate the cost of

equity can substantially affect the rates a railroad can charge,

and because the cost of equity is difficult to estimate, the

Board’s choice of methodology has provoked controversy for

over a decade. During the Board’s 1997 proceedings for

calculating industry-wide cost of capital, a trade association of

coal shippers called the Western Coal Traffic League (WCTL)

argued that the Board’s methodology for calculating the cost of

equity capital overestimated actual costs. See Railroad Cost of

Capital—1997, 3 S.T.B. 176, 177 n.1 (July 9, 1998). However,

WCTL did not present any alternative calculations of its own. 

Therefore, the Board decided to retain its existing methodology. 

That methodology was a single-stage discounted cash flow

(DCF) model, which the Board had been using since its first

annual cost of capital calculation in 1981. Under the DCF

method, the cost of equity is calculated as the discount rate that

makes the present value of the expected returns on a stock,

including dividends and price appreciation, equal to the current

market value of the stock. See, e.g., Railroad Cost of

Capital—1987, 4 I.C.C.2d 621, 625, 626 (1988); Railroad Cost

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of Capital—2004, STB Ex Parte No. 558 (Sub No. 8), 2005 WL

1534327 (June 21, 2005). In short, the DCF model computes

the cost of equity through a relatively straightforward

manipulation of stock predictions.

In 2005, WCTL again complained about the DCF method

in the industry-wide proceedings, and proposed that the Board

use a capital asset pricing model (CAPM) instead. See Railroad

Cost of Capital—2005, 2006 WL 2692729, at *4 (Sept. 15,

2006). Under CAPM, the cost of equity is equal to the risk-free

rate of return (for example, the rate of return one could expect

from a 20-year Treasury bond) plus a premium associated with

a particular investment. That premium is derived through an

ordinary least-squares regression calculation that takes into

account the overall rate of return on the stock market, systematic

and non-diversifiable risk, and the historical rate of return for a

class of stocks (here, railroad stocks). Methodology to be

Employed—2008, 2008 WL 162591, at *6–8.

Citing a sparse record, the Board decided not to change its

cost of capital methodology for 2005. See Railroad Cost of

Capital—2005 at *5–6. It did, however, start a separate

rulemaking proceeding to determine, among other things,

whether switching from DCF to a new method was warranted. 

Methodology to be Employed in Determining the Railroad

Industry’s Cost of Capital, 2006 WL 2692727 (Sept. 15, 2006)

(“Methodology to be Employed—2006”). After a notice and

comment period in which various interested parties including

WCTL, BNSF, and AEPT participated, the Board adopted

CAPM for calculating cost of equity capital for 2006 and 2007. 

Methodology to be Employed—2008, 2008 WL 162591, at *1;

see also AEP Tex. N. Co. v. BNSF Ry. Co., STB No. 41191 (Sub

No. 1), 2007 WL 2680223 (Sept. 7, 2007), at *4 (“AEP Texas

and BNSF were among the interested parties that filed”

comments). For its 2008 calculation, the Board decided to

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calculate the cost of equity by using both CAPM and an updated

DCF model and averaging the outputs of the two methods. Use

of a Multi-Stage Discounted Cash Flow Model in Determining

the Railroad Industry’s Cost of Capital, 2009 WL 197991, at *1

(Jan. 23, 2009). 

While the Board proceeded with its rulemaking, WCTL

filed a petition to this court arguing the Board’s use of the DCF

model for its 2005 calculation was arbitrary and capricious

under the Administrative Procedure Act, 5 U.S.C. § 706(2)(A). 

Just before oral argument, the Board released its decision to use

CAPM for 2006, and in oral argument counsel for the Board

conceded that the DCF methodology was flawed. However, the

Board also argued that, because of its recent decision to change

the methodology for future years, the proper way to resolve the

issue of whether to use CAPM for prior years’ calculations

would be through administrative proceedings reopening past

years’ decisions. The administrative proceedings could either

address the industry-wide proceedings in 2005 and prior years,

or deal with individual rate cases. If there was enough evidence

to establish that using DCF in prior years was material error, the

Board would retroactively adjust the calculations. This court

therefore denied the petition before it, stating that the 2005 cost

of capital decision was “now ripe for review pursuant to a

petition to reopen under 49 U.S.C. § 722(c).” W. Coal Traffic

League v. STB, 264 F. App’x 7, 8–9 (D.C. Cir. 2008). That

provision allows any interested person to petition to reopen an

STB decision where there is “material error, new evidence, or

substantially changed circumstances.” 49 U.S.C. § 722(c). 

However, neither WCTL nor any other party petitioned to

reopen the 2005 industry-wide cost of capital decision.

While WCTL was challenging the industry-wide cost of

capital calculations, AEPT was engaged for several years in its

own rate case before the Board, challenging the reasonableness

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of the rates set by the Board for the TNR railroad. AEPT

argued, among other things, that the DCF-derived cost of equity

calculations were flawed, and particularly disputed the 2005

figure once the Board published it. See AEP Tex. N. Co. v.

BNSF Ry. Co., STB Docket No. 41191, 2007 WL 2680223, at

*86 (Sept. 7, 2007). In 2006, the Board held the proceeding in

abeyance while it resolved the industry-wide rulemaking. Major

Issues in Rail Rate Cases, STB Ex Parte No. 657 (Sub No. 1),

2006 WL 513502, at *2 (Feb. 27, 2006). In 2007, the Board

decided, inter alia, that the DCF-derived cost of equity estimates

were reasonable. AEP Tex. N. Co. v. BNSF Ry. Co., STB

Docket No. 41191, 2007 WL 2680223, at *19–20 (Sept. 7,

2007). 

In 2008, AEPT petitioned for reconsideration pursuant to 49

U.S.C. § 722(c) on various issues. The Board reopened the case

only with respect to the cost of equity. AEP Tex. N. Co. v. BNSF

Ry. Co., STB Docket No. 41191, 2008 WL 2216062, at *7–9

(May 27, 2008). In the reopened case, AEPT argued that the

rates for the years 2000 to 2005 should be recalculated using

CAPM. AEPT also requested that the Board either recalculate,

using CAPM, the historical cost of capital figures used to

forecast growth, or discard altogether the 1998 to 2005 numbers

in the historical average. See Opening Fourth Supplemental

Evidence of Complainant AEP Texas North Company in

Response to the Board’s Decision on Reconsideration 15, 31

tbl.4 (Aug. 8, 2008) (“Opening Fourth Supp. Evid.”); AEP Tex.

N. Co. v. BNSF Ry. Co., STB Docket No. 41191, at 11 (May 15,

2009) (“2009 Decision”).

In May 2009, the Board denied AEPT’s petition for

reconsideration, rejecting the use of CAPM for any of the years

from 2000 to 2005. 2009 Decision at 4, 10. The Board also

declined to change or excise the 1998 to 2005 DCF calculations

in its historical cost of capital average. Id. at 11. In its decision,

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the Board concluded that “it would be poor public policy to

depart from the previously published figures” for two reasons,

id. at 8. First, the railroad industry and its investors relied on the

published figures. Changing the calculations retroactively

would undermine those expectations as well as erode confidence

in future cost of capital calculations. Id. Second, the Board

concluded that the DCF calculations were reasonable. Even

though CAPM is now the industry norm, the DCF method

produced numbers “easily within the range produced by [] other

finance models” in every year but 2005. Id. at 10 (citing id. at

Chart 1). And as for the 2005 number, “the figure does not vary

significantly more than other models that produce the highest or

lowest estimate in a given year.” Id.

AEPT petitions this court under the Administrative

Procedure Act.

II. Standard of Review

AEPT brings its petition under 5 U.S.C. § 706(2)(A), which

requires courts to set aside an agency decision if it is “arbitrary,

capricious, an abuse of discretion, or otherwise not in

accordance with law.” This standard requires a “rational

connection between the facts found and the choice made.”

Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co.,

463 U.S. 29, 43 (1983) (“State Farm”) (quoting Burlington

Truck Lines, Inc. v. United States, 371 U.S. 156, 168 (1962)). 

This court must vacate the Board’s denial of AEPT’s petition if

the Board made “a clear error of judgment” or if it “entirely

failed to consider an important aspect of the problem.” Id.

(quotation marks omitted). However, because the Board acts

“at the zenith of its powers” when it sets rail rates, Burlington N.

R.R. Co. v. STB, 114 F.3d 206, 210 (D.C. Cir. 1997) (quoting

Am. Trucking Ass’ns v. United States, 627 F.2d 1313, 1320

(D.C. Cir. 1980)) (internal quotation mark omitted), we

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recognize that the Board is “entitled to particular deference.” Id.

 As long as the Board “has rationally set forth the grounds on

which it acted, . . . this court may not substitute its judgment for

that of the agency.” BNSF Ry. Co. v. STB, 453 F.3d 473, 480

(D.C. Cir. 2006) (quoting McCarty Farms v. STB, 158 F.3d

1294, 1301 (D.C. Cir. 1998)).

In addition, the history of the cost of equity methodology

debate presents a concern about what standard the Board was

required to apply in its decisionmaking process. Because AEPT

requests that the Board recalculate past years’ rates with the

methodology adopted in the industry-wide proceedings in 2006

and 2007, both the Board and AEPT discuss the issue in terms

of retroactive application of a new rule. See 2009 Decision at 7. 

In its decision denying AEPT’s petition, the Board therefore

analyzed AEPT’s petition using a balancing test similar to one

created by this court to evaluate whether a change in

methodology can be given retroactive effect. Citing Williams

Natural Gas Co. v. FERC, 3 F.3d 1544 (D.C. Cir. 1993), the

Board decided to “conduct the kind of balancing test described

by the court in Williams Natural Gas.” 2009 Decision at 8. 

However, the Board did not apply the actual analysis outlined by

that case, which was a five factor test originally set forth in

Retail, Wholesale & Department Store Union v. NLRB, 466 F.2d

380, 390 (D.C. Cir. 1972). See Williams Natural Gas, 3 F.3d at

1553–54. Instead, the Board created its own two factor analysis,

weighing “the degree of reliance by the railroad industry on our

prior findings, and whether the prior findings appear to be

within the bounds of reasonable predictions for the industry’s

cost of equity.” 2009 Decision at 8. 

 In its petition to this court, AEPT argues the Board

misapplied the retroactivity analysis. AEPT quotes

Consolidated Edison Co. v. FERC, 315 F.3d 316 (D.C. Cir.

2003), to posit that the Board should have looked not at

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industry’s reliance on the DCF model and the reasonableness of

said methodology, but only at whether “the parties before the

agency are given notice and an opportunity to offer evidence

bearing on the new standard, and the affected parties have not

detrimentally relied on the established legal regime.” Id. at 323.

(internal citation omitted). But in trying to cabin the Board’s

analysis within that case’s framework, AEPT overestimates the

similarity between this case and Consolidated Edison. 

Consolidated Edison addressed whether any legal principle

mandates retroactive application to pending cases of a new

policy statement not given the force of law. 315 F.3d at 319. 

In Williams Natural Gas, we considered whether “a rule

announced in an agency adjudication may be given retroactive

effect.” 3 F.3d at 1553 (emphasis added). In this case, the

Board created a new rule through a full notice and comment

legislative rulemaking under 5 U.S.C. § 553. As neither

Consolidated Edison nor Williams Natural Gas is on point, the

Board was certainly not bound to employ the factors outlined in

either of the cases.

It is also worth noting that AEPT does not request a truly

retroactive application of the new rule. The promulgated rule

establishing CAPM for the 2006 and 2007 industry-wide

proceedings did not disturb the industry-wide calculations for

prior years, and in this case the Board did not reopen those

industry-wide calculations. Rather, the Board revisited whether,

in light of “material error, new evidence, or substantially

changed circumstances,” 49 U.S.C. § 722(c), the Board should

recalculate the maximum rate BNSF was allowed to charge

AEPT from 2000 to 2005. AEPT’s petition did not request a

retroactive application of the new rule, but rather argued that the

new rule revealed that using the old method was a mistake.

In sum, this court must simply determine whether the

Board’s evaluation withstands the arbitrary and capricious

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standard outlined by 5 U.S.C. § 706(2)(A). Because this court’s

precedents on retroactivity do not dictate the Board’s approach,

the use of “the kind of balancing test described by the court in

Williams Natural Gas,” 2009 Decision at 8, neither forecloses

nor guarantees that the Board’s decision satisfies those

requirements.

III. Analysis

AEPT argues the Board’s decision must be overturned

because it is inconsistent with the Board’s prior representations

to this court about how the Board would reassess the DCFderived cost of equity estimates. While incompatibility of an

agency’s action with the agency’s prior representations to this

court might be evidence of arbitrary and capricious

decisionmaking, the Board did not act inconsistently in this

instance. Before this court in Western Coal Traffic League v.

STB, 264 F. App’x 7 (D.C. Cir. 2008), the Board did represent

that the use of the DCF methodology in the industry-wide

determination for 2005 did not establish that AEPT necessarily

would have to submit to the DCF-derived number. In its brief

to this court in that case, the Board explained that AEPT could

seek reopening of its then-pending rate case under 49 U.S.C. §

722(c) if AEPT believed the Board’s final rule switching to

CAPM materially affected the outcome of AEPT’s rate case.

And at oral argument, the Board conceded that CAPM was a

better method, but urged the court to allow the Board to address

the issue first through § 722(c) proceedings. When AEPT filed

its petition for reconsideration, the Board did exactly what it

said it would: address the issue. The Board simply arrived at a

result AEPT did not like. But a promise to allow AEPT to avail

itself of the reconsideration process is not the same as a promise

to change the prior years’ rates. The Board has not acted

inconsistently with its prior representations to this court.

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Therefore, any evidence of arbitrary and capricious

decisionmaking must come from the 2009 Decision itself. As

described above, the Board divided its analysis into two major

sections: reliance by the industry on the previously-published

figures and the reasonableness of the DCF-derived cost of equity

estimates. On the first factor, reliance, the Board concluded that

“there has been significant investment-backed reliance by the

railroad industry on our prior cost-of-capital findings.” 2009

Decision at 8. AEPT argues this was an improper conclusion

because the decision looks at reliance by industry investors in

general, not by BNSF in particular. In addition, AEPT points

out that the Board’s conclusion seemingly contradicts prior

decisions by the Board that say CAPM “dominates the private

sector” and is the “industry norm.” Methodology to be

Employed in Determining the Railroad Industry’s Cost of

Capital, STB Ex Parte No. 664, 2007 WL 2363415, at *4, *5

(Aug. 20, 2007) (“Methodology to be Employed—2007”). How,

argues AEPT, could the industry have relied on the DCF

numbers when the industry was using CAPM? Finally, AEPT

argues that even if investors did rely on the Board’s use of DCF,

there is no evidence such reliance was reasonable. At least by

2005, BNSF and other railroads knew the DCF methodology

was being seriously challenged by WCTL in the industry-wide

proceedings and by AEPT in its individual rate case.

AEPT’s complaint that the Board looked to the industry

rather than BNSF does not undermine the Board’s analysis,

especially because AEPT did not present any information to the

Board to suggest that BNSF, a large and prominent carrier,

operates differently from the industry as a whole. The Board did

not make BNSF-specific conclusions, but it did extrapolate from

what it knew about investors generally to the case at hand. 2009

Decision at 8. Noting that BNSF itself makes significant capital

investments—over $9 billion between 2004 and 2007—the

Board pointed out that “[r]ailroads and investors . . . make

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investment decisions based in part on” the published cost of

capital figures. Id. “If we change that figure retroactively here,

we not only undermine settled expectations but we erode

investor confidence in future cost-of-capital findings.” Id.

(emphasis in original). Because investors might not invest

sufficiently in railroads if they have no confidence in the

stability of the Board’s cost of capital figures, the Board decided

to “set aside our cost-of-capital findings only if the prior

published findings are shown to clearly fall outside a reasonable

range.” Id. at 9. It was reasonable for the Board to use its

general understanding about railroad investors in making its

decision in this case concerning two specific parties. 

Nor does the Board’s conclusion that railroads and investors

relied on the DCF-derived numbers conflict with the Board’s

published acknowledgment that CAPM has become the industry

standard. Railroads like BNSF could rely on the Board’s use of

DCF to model cost of equity even if they used CAPM internally. 

A simple hypothetical illustrates this point: If investors

concluded, using CAPM, that it would cost $1 million to run a

railroad, including the cost of equity, but knew the Board would

allow rates charging up to $1.5 million because of the DCF

calculation, of course they would rely on the Board’s published

figures in deciding whether to invest in the railroad—and decide

that it was a very good deal indeed. The fact that one method is

the industry standard does not mean the industry cannot rely on

the Board’s use of a different method.

AEPT’s final argument about the Board’s analysis of

BNSF’s reliance is more persuasive. The Board’s discussion of

reliance makes no distinction between reliance in one year

versus any other. But the circumstances surrounding the 2005

cost of capital determination are different from other years. In

its 2005 cost of capital determination retaining DCF-derived

figures, the Board explained it was instituting a separate

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proceeding to review the cost of equity methodology. Railroad

Cost of Capital—2005 at *5. Meanwhile, WCTL petitioned this

court for review of the 2005 calculation, and during oral

argument the Board itself represented it might be appropriate to

reconsider at least the 2005 figures. WCTL v. STB, No. 07-1064,

Oral Argument Tr. at 10, 15. AEPT brought evidence of all of

these circumstances before the Board in the 49 U.S.C. § 722(c)

proceeding. See Opening Fourth Supp. Evid. at 7–8. But in the

2009 Decision, the Board completely failed to address the

unique circumstances of the 2005 cost of capital determination. 

The Board did not consider whether railroads and investors

actually or reasonably could have relied on the permanence of

the 2005 cost of capital determination when it was undermined

by shippers in litigation and even by the Board itself. By relying

only on generalized conclusions about how industry players rely

on cost of capital determinations, the Board “entirely failed to

consider an important aspect of the problem,” making its

assessment of reliance for the year 2005 arbitrary and

capricious. State Farm, 463 U.S. at 43. 

The Board’s second consideration, the reasonableness of the

DCF calculations, also included flaws, especially with respect

to the 2005 figure. The Board began its analysis by addressing

generally the arguments AEPT made in the reopened case about

the superiority of CAPM over DCF. AEPT’s evidence broadly

stated that CAPM is more accurate than DCF, that in the

Methodology to be Employed—2008 decision the Board itself

had concluded that DCF overstated the cost of equity, and that

applying CAPM would be consistent with the Board’s decision

to use CAPM in future years. Opening Fourth Supp. Evid. at

15-21. The Board responded by acknowledging that “CAPM is

a more modern and better accepted method for estimating the

cost of equity than the single-stage DCF model.” 2009 Decision

at 9. However, the Board explained, old calculations are not

invalidated just because methods improve—the Board’s switch

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in 2006 to CAPM for the cost of equity calculation did not

invalidate the use of DCF in prior years, just as the Board’s

decision to use a blended CAPM/DCF approach in 2008 did not

invalidate the use of CAPM alone in 2006 and 2007. Id. AEPT

argues that the Board did not consider changed circumstances or

new evidence as it should have under 49 U.S.C. § 722(c), but

these statements by the Board in its decision are evidence of the

Board’s consideration. The fact that the Board did not agree that

the changed circumstances warranted changing prior years’

calculations does not by itself mean the Board acted arbitrarily

or capriciously or failed to consider seriously AEPT’s evidence.

However, the rest of the Board’s analysis of reasonableness

stands on less solid ground. In its discussion, the Board relied

heavily on a chart it created comparing the cost of equity

estimates for the years 1994 to 2007 derived by five different

methodologies: the Board’s calculations (a DCF model through

2005, then CAPM in 2006 and 2007); CAPM; and three

commercially produced methodologies published by

Ibbotson/Morningstar, including a single-stage DCF model, a

multi-stage DCF model, and a model called “3-Factor FamaFrench.” 2009 Decision at 9 n.25, 10 & Chart 1. The chart

reveals the fluctuating estimates produced by each methodology,

and demonstrates the large variation possible in outcomes. In

some years all five methodologies produce similar costs of

equity, while in other years they vary greatly, but no method

consistently produces either the highest or lowest estimates. 

Each methodology sometimes produced estimates on the higher

end of that year’s range, and sometimes produced estimates on

the lower end of that year’s range. 

Referencing the chart, the Board concluded “that various

reasonable and commercially available financial models produce

a range of estimates for the cost of equity. . . . Simply because

one estimate is the highest or lowest in a given year does not

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mean that it is invalid or even the least accurate.” Id. at 10. 

Certainly this is true, but it only establishes that one cannot

determine if the Board’s figures were invalid just by comparing

them to the four other models’ figures. It is problematic, then,

that the Board apparently decided that such a comparison was all

that was necessary to conclude its estimates were reasonable: 

The chart also reveals that the Board’s prior determinations

provide a reasonable estimate of the cost of equity for the

hypothetical SARR posited in this case. For every year

except 2005, the Board’s estimate falls easily within the

range produced by the other finance models. . . . Yet even

then [in 2005], the figure does not vary significantly more

than other models that produce the highest or lowest

estimate in a given year. Thus, we do not regard the

increase as sufficiently large to justify setting aside the

industry’s expectation that we would use that finding as the

target rate of return for that year. 

Id.

The Board’s analysis contains serious flaws. First, the

record before the Board included no information about any of

the four methods the Board used as comparisons to its own

published cost of equity figures. Instead, it appears that the

Board chose to use the Ibbotson/Morningstar models of its own

accord, saying that though “the Morningstar cost-of-equity

estimates were not submitted by either party in this proceeding,

we take official notice of these publicly available cost-of-equity

estimates for the railroad industry.” Id. at 9 n.25. But by

choosing to use estimates not in the record, the Board foreclosed

any opportunity for AEPT to refute the validity or usefulness of

those models, or to offer counterexamples of other

methodologies. In addition, the Board never explained why

those methods were chosen or how they work, or even whether

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they are a representative sample of the types of methodologies

used by the railroad industry or its investors. And the Board

never explained why in some years the Morningstar single-stage

DCF model and the Board’s single-stage DCF model produce

such different cost of equity figures. 

Most problematic, however, is the Board’s use of the chart

to justify its 2005 calculation. The block quote above represents

the entirety of the Board’s analysis about that year. The Board

concluded that the 2005 calculation “does not vary significantly

more than other models,” but gives no information about how it

arrived at this conclusion. As far as can be ascertained from the

decision, the Board’s analysis consisted of nothing more than an

estimation measured by a cursory glance at the graph. Even in

its briefing to this court, the Board employed a perfunctory

analysis, largely resting its argument about reasonableness on

the assertion that “a review of the chart shows visually [that] the

Board’s 2005 DCF figure is not out of line” with the estimates

produced by the other methodologies. Resp. Br. at 40.

Before this court, AEPT attempted to discredit the Board’s

2005 figure by deriving the arithmetic mean, standard deviation,

and 90% confidence interval of the five figures included in the

Board’s graph, and showing that the Board’s figure falls outside

the confidence interval. The Board counters with the fact that

the 2005 CAPM calculation in its graph also falls outside the

confidence interval—although we note that the CAPM figure the

Board criticizes must stem from a different CAPM model than

the one actually employed by the Board in 2006 and 2007, as the

Board’s published figures for 2006–2007 differ from the data

captioned as “CAPM” for those years. The Board also claims

that other statistical tests better suited to small sample sizes

indicate that the Board’s 2005 figure was not outside a

reasonable range.

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We will not attempt to decide the merits of the

methodologies. To paraphrase this court’s admonishment to

parties in a slightly different context, we do not sit as a panel of

statisticians, but as a panel of generalist judges. See City of LA

v. U.S. Dep’t of Transp., 165 F.3d 972, 977 (D.C. Cir. 1999)

(“[W]e do not sit as a panel of referees on a professional

economics journal . . . .”). We do note, however, that these

arguments encapsulate exactly the kind of analysis in which the

Board should have engaged before concluding that its 2005

calculation did “not vary significantly more” than other methods

in other years. We recognize the difficulty of determining

whether a model produces estimates so inaccurate as to be

invalid, especially for a value as elusive as the cost of equity. 

But that does not mean the Board was free to choose methods

for comparison without opportunity for comment by the parties

and without any apparent rigor in its analysis. The Board’s

particularly cursory analysis of the 2005 cost of equity estimates

constitutes arbitrary and capricious decisionmaking.

This leaves one final issue: whether the Board acted

arbitrarily or capriciously when it decided not to recalculate its

historical cost of equity average used to forecast growth. The

Board declined to restate the past years’ cost of equity estimates

using CAPM or to use only the published 2006 and 2007

estimates in its historical average. Instead, the Board elected to

maintain its normal practice of using the average of the

historical cost of capital figures starting with the construction

start date of the SARR. 2009 Decision at 11. In so deciding, the

Board cited two reasons. First, because the Board concluded

there was “no basis to restate the 2005 estimate” to readjust

BNSF’s actual rates for those years, the Board saw no reason to

restate the estimates for the purpose of forecasting. Id. Second,

averaging all historical figures reduces the impact that any one

year’s aberrant estimate would have on the overall forecast. 

Using the DCF-derived estimates in the forecasts rather than

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using only the 2006 and 2007 numbers decreases the chance that

the forecast will be skewed if the 2006 and 2007 calculations

produced flawed estimates. 

These are reasonable justifications by themselves, and we

hold that the Board’s decision is valid insofar as it declines to

throw out all years’ estimates except those for 2006 and 2007. 

We also hold the Board’s decision to be adequate with respect

to the years prior to 2005. But the Board also explicitly

depended on its prior conclusions about the industry’s reliance

on and the reasonableness of the 2005 estimate. Because those

conclusions were arbitrary and capricious, the Board must

reassess its use of the 2005 DCF-derived figure for historical

averaging. If on remand the Board is swayed by AEPT’s

evidence with regard to the 2005 estimate for use in calculating

that year’s maximum rate, we see no reason why the Board

would not also be swayed to adjust the 2005 estimate it uses in

the cost of equity forecasts for the TNR.

IV. Conclusion

In its introduction to its analysis of the continued validity of

the DCF-derived costs of equity, the Board explained that “the

exact cost of equity in a given year remains an essentially

unknowable number and any method we adopt will produce only

an estimate.” 2009 Decision at 7. We recognize that truth, but

even an imperfect estimate must be justified to satisfy 5 U.S.C.

§ 706(2)(A). We hold that, with respect to all years but 2005,

the Board met that standard because the decision exhibits a

“rational connection between the facts found and the choice

made.” State Farm, 463 U.S. at 43 (quotation omitted). 

However, the Board failed to address the concerns raised

regarding the 2005 cost of equity. Because this constitutes a

failure “to consider an important aspect of the problem,” id., we

vacate the decision and remand to the Board to reassess its

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decisionmaking for the 2005 cost of equity estimate.

So ordered.

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