# FILED
July 1, 1998 Cecil W. Crowson Appellate Cou rt Clerk 

### IN THE COURT OF APPEALS OF TENN ESSEE

AT NASHVILLE

CONSUMER ADVOCATE DIVISION, ) ) Petitioner/Appellant, ) ) Appeal No. VS. ) 01-A-01-9708-BC-00391 ) TENNESSEE REGULATORY ) Tennessee Regulatory Commi ssion AUTHORITY; NASHVILLE GAS ) No. 96-00977 COMPANY, ) ) Respondents/Appellees. )
APPEALED FROM THE TENNESSEE REGULATORY COMMISSION AT NASHVILLE

JOHN KNOX WALKUP Attorney General & Repor ter L. VINCENT WILLIAMS Assistant Attorney Gener al 425 Fifth Avenue North Nashville, Tennessee 37243 Attorney for Petitioner/Appe llant H. EDWARD PHILLIPS, III Tennessee Regulatory Author ity 460 James Robertson Parkwa y Nashville, Tennessee 37243-0505 Attorney for Respondent/Appell ee Tennessee Regulatory Authority T. G. PAPPAS JOSEPH F. WELBORN III 2700 First American Center Nashville, Tennessee 37238 JERRY W. AMOS P. O. Box 787 Greensboro, North Caroli na 27402 Attorneys for Respondent/Appel lee Nashville Gas C ompany HENRY WALKER 414 Union Street, Suite 1600 Nashville, Tennessee 37219 Attorney for Intervening Appellant Associated Valley Industries

AFFIRMED AND REMAN DED

BEN H. CANTRELL, JUDGE 

## O P I N I O N- 2 - This petition under Rule 12, Tenn. R. App. Proc., to revi ew a rate making order of the Tennessee Regulator y Authority presents a host of procedural and substantive issues. We aff irm the agency order.

I.

On May 31, 1996 Nashville Gas Company (NGC) fil ed a petition before the Tennessee Public Service Commission requesting a general increase in its rates fornatural gas servi ce. The proposed rates would pr oduce an increase of

$9,257,633 in th e comp any’s revenue. The Cons umer Advocate Divis ion (CAD) of the State Attorney General’s office filed a notice of appe arance on June 6, 1996 and Associated Valley Industries(AVI), a coalition of indus trial users of natural gas, enter ed the fray on August 20, 1996.

The Public Service Commis sion was replaced on Jul y 1, 1996 bythe Tennessee Regulatory Authority (TRA), a new agency created by the legislature. By
an administrative ord er, TRA laid down the procedur e by which it w

ould accept jurisdiction of matters previously filed before the Public Service Commission, and the parties successfully navigated the uncharted waters of theTRA to get the case ready for a final hearing on November 13, 1996.

At a scheduled conference on December 1 7, 1996, t he TRA orally approved a general rate increas e for NGC, effective January 1, 1997, that woul d produce approximately $4,400,000 i n new revenue. When afinal order had not been filed by December 31, 1996, NGC began charging the rat es orally approved at the conference on December 17. On Februa ry 19, 1997 TRA filed its writt en order adopting the oral findings of December 17 , 1996. The order allowed th e increased rates “for service r

endered on and after January 1, 1997. ”- 3 - II. The Procedural Issues

a. Was the TRA required to appoint an administrative law judge

or hearing officer to conduct the hearing?

Th e Tennessee Administrative P rocedures Act provides that a conteste d
case hearing shall be conducted (1) in the presence of

the agency members and an adminis trative judge or hearing officer or (2) by an administrative judg e or hearing officer alone. Tenn. Code Ann. § 4-5-301( a). The CAD asserts that the TRA’ s order in this case is void

because the agency did not follow the mandate of this statute.

The TRA, however, is also governed by an elabor ate set ofprocedural statutes. See

Tenn. Co de Ann. § 65-2-101, et seq. Tenn. Code A nn. § 65-2-111 providesthat the TRA may dire ct that co ntested case proc eedings b e heard b y a hearing examiner, and we held i n Jackson Mobilphone Co. v. Tennessee Public Service Comm. , 876 S.W.2d 106 (Tenn. App. 1994), that the TRA’s predecessor, the Public Service Commission, c ould conduct a

contest ed case h earing

itself or appoint
a hearing officer. We think that decision i s still good law and that it applies to the TRA.

b. Did t he TR A staf f con duct its o wn i nves tiga tion and i mpro perl y

con vey ex par te i nfo rma tio n to t he T RA?

The CAD argues that the TRA viol ated two sections of the UAPA in the proceeding b e low: (1) the section prohibiting a person w ho has served as an investigator, prosecut or, or advo cate in a c onteste d case fr om servi ng as an adminis trative judge or hearing officer in the same proceeding, Tenn. Code Ann. § 4- 5-303; and (2) the section prohib it ing ex parte communicati ons during a contested case proceeding, Tenn. Code Ann. § 4-5-304.- 4 - As to the first contention, there is nothing in therecord that supports it. The Regulatory Authority members sat as a unit to h ear the proof i n the hearing be low. We have held that they were entitled to do so. There is no proof that any of them had served as an investigator, prosecutor, or advocate in the same proce eding.

As to the second contention, it is ba sed on the CAD’s suspici on that members of the TRA

staff had

taken pa rt in an

investigatio n of NGC, had prepared
a report for

the Authority, and had, in fact, continued to communicate with NGC and relay that information to the Authority members.

At the begi nning of the hearing the Consumer Adv ocate moved to discover what he described as a r eport from the staff that augmented or boosted the position of one party

or the other. He admitted that he did not know that such a report existed but that he believed it did, because of the past pract ice b efore the Public Service Commission.

The A uthority

chairman moved to deny the motion with the followi ng explanation: I believe th at as a dir ector I ha ve a right to have

privilegedcommu n ication with a member of my staff for the purpose of understanding issu es and an a lyzing the evidence in the many complicat ed proceedings that this Age ncyhas to hear. I reject y our allegation tha

t I hav e abdicated my responsibility as a decision maker. I rely on my staff expertise as the law per mits me to do so. Therefore, I move that your moti on be denied. The Agency members unanimously denied the CAD’s motion.

On this part of the co ntrove rsy we ar e persuaded that the TRA was correct. The TRA deals with high ly complicated data inv olving principles

of finance, accounting, and corporate efficiency; it also deals with the convoluted princi pl es of legislati ve utility regulati on. To expec t the Authority members to fulfil l their duties without the help of a competent and efficient staff defies all logic. And, we ar e- 5 -

convinced, the staff may make recommendations or suggestions as to the merits of the questions before the TRA. Se e Te nn. Code Ann. § 4-5-304(b). Otherwise, all support staff -- law clerks, court clerks , and other specialists -- would be of little service to the person(s) that hir e them. We are satisfied that any report made by the agencystaff based on the record before the TRA w as not subject to the CAD’s moti on to discover it.

The other part of the CAD’s contention is more troubling. It contains an assertion that members of the TRA staff were passi ng alon g to the TRA evidence received from NGC. We would all agree that s uch ex parte communications a r e prohibited. See

Tenn. Code Ann. § 4-5-304(a) and (c).

In support of his contention Consumer Advocate called the manager of the utility rate div

ision who testified that he did an investigation o f NGC under an audit. At that poin t the parties engaged in a g eneral discussion about the Authority’s prior ruling that the staff members’ advice coul d not be discovered. A question about whether his advice was based o n anyt h ing other than the facts in the record was excluded after an off-the-record discussi on, and the witness was as ked only one other question. He answe red “ye s” when asked if he had talk ed with the company or company

officials since the time of the audit. There were no ques tions bearing on the nature of the conversations, or w hether the witness recei ved or disseminated any information pertinent to th e NGC proceeding.

We canno t find on the basis of the evidence in this record tha t th e Agenc yreceived any ex parte communications that wer e prejudicial to the CAD’ s position. We would add only one further point: that administrative agencies should ensure compliance with the Administrative Proce dures Act.

c. Did NGC unlawfully

put its- 6 - new rates into effect on Ja nuary 1, 1997?

The CAD argues that since no written order had been e ntered allowing the rate increase, NGC had no authority to start c

harging the

increased rates, and the TRA’s February ord er amounted t o retroactive rate making.

The TRA has the power to fix just and reasonable rates “ which shall be imposed, obse rved, and followed thereafter” by any public utility . Tenn. Code Ann. § 65-5-201. But th e statutory scheme -- w hich is the same as it w as during the existence of the Public Service Co mmission -- recogniz es that a public utility

may set its own rates, subject to the power given to the TRA to determineif they are just and reasonable. Tenn. Code Ann. § 65-5-203(a). S ee Co nsumer Advocate Division v. Bissell, No. 01-A-01-9601-BC-00049 (Tenn. App., Nashville, Aug. 2 6, 1 996). The increased rates may be suspended for an outside limit of nine m onths while the TRA conducts its investigation , id. , but after six m onths th e utility m ay, upon notice to TRA, place the increased rates into effec t. Ten n. Code Ann. § 65-5-203(b)(1) . The authorit y may

require a bond in the amount of the proposed annual increase. Id.

In this case, NGC filed its petition on May 31, 1996. Because the Public Service Commission was replac ed by th e TRA on July 1, 1996, NGC refiled the petition on July 29, 1996. The CAD ar gues that

the petition, therefore, had not been pending for the six months per iod that would allow

NGC to put the rates into effect.

Under the circumstances of this case, however, we thi nk that argument exaltsform over substance. The TRA had hea rd the proof, and in an open meeting had announced its de cision t o allow part of the rate i ncrease to go into effect on January 1, 1997. While a written order had not been entered, NGC notified the TRA that it would put the approved rates into effect on the date specified in the TRA’s oral decision.- 7 - In our view, the increased rates had been pendin g since May. The hiatus between May and July was caused by a massive overhaul o f th e state regulatorymachinery, and that fact cannot be attri buted to NGC. So, under the statutory scheme, NGC had the power to put the approved rates into effect on January 1, 1997.

In addition, Tenn. Code Ann. § 65-2-112 says “E very final decision or order rendered by the authority in a contested case shall be in w riting, or stated in the record

. . . .” NGC could hav e used the TRA’s oral decisi on as the basis for its action of putting the rates into effect. The d ecision had been “stated in the record” on December

17, 1996. We add this caveat, however. The statute goes on to say that either a written or oral decision “shall contain a s tatement of the findings of fact and conclusionsof law upon whi ch the decis ion of the authority is based .” We do not express an opinion on whether the De cember 17 oral decision compl ies with that mandate. But we do agree that findi ngs of fact and conclusions of law are a nece ssaryrequirement for a meaningful r eview of an administrati ve a gency’s decision

. See Levy v. State Bd. of Examiners for Speech Pathology & Audiology , 553 S.W.2d 909 (Tenn. 1977).

III. The Substantiv e Issues a. Hearsay

The CAD argues

that some ofthe evidence offered by NGC’ s expert on the projected increase in compa ny expense s was based on rank he arsay. We notice, however, that Tenn. Code Ann. § 65-2-109 all ows TRA to admit a nd give prob ative effect to any evidence that w ould be accepted by

reasonably prudent persons in the conduct of their affairs. The same statute relieves the TRA from the rules of evidence that would apply in a court proceedin g.- 8 - The CAD does not

address the question of whether the evidence it calls hearsay is, nevertheless, of the k ind tha t wou ld be relied on by reaso nably prudent p ersons in the conduct of their affairs. NGC argues that the evidence was not hearsay because it was based on the company records that are kept in the ordinary
cou r se of business. See Tenn. R. Evid. 801, 803(6).We need not decide whether the proffered evidence was hearsay because we ar e satisfied that the

evidence was reliable and could be considered by the TRA. The TRA heard the objection s to the evidence and the CAD’s argument that its evidence on the same sub ject shou ld have been received. The TRA chose NGC’s evidence as more reliable. We find no f ault with the TRA’s decisi on on this issue.
b. Advertising

This is an issueon which the briefs of the pri ncipal parties seem to be speaking different languages. The followi ng explanation is the bes t we can glean from the record. In 1984 the Public Service Commission adopted a rule that disallowed as
a recoverable exp ense by a utility any “promotional or politic al advertising.” The prohibition covered

advertising for the pur pose of encouraging any per son to select
or use gas service or additional gas service. It did not cover (among other things) advertisinginformi ng custom ers how to c onserve energy or to reduce pe ak demand forgas, or

advertising promoting the use of energy efficient appliances

. See former Rule 1220-4-5-.45, Tenn. Regis.

In a 1985 proceeding involv ing a rate increase appl ication by NGC, the Commission deviated from the rule and allowed advertising expense s up to .5% of
revenues. In Mar ch o f 1996 the Commission repealed 1220-4- 5-.45 and proposed
a new rule that would allow a utility to recove r “all prudently incu rred expenditures for advertising.”

Apparently the ru le had not mad e it completely th rough the adop tion procedu re when the TRA heard this case below.- 9 - Nevertheless, based o n pr oof of $1,486,000 in external adver tising expenses, $800,000 in marketing personnel payroll and $300,000 in miscellaneous
sa les expenses, the T RA allo wed the recove ry of al l but app roxima tely ha lf o f th e external advertising expe nses . The CA D urged disallowanc e of all the related expensesexcept ap proxi mately $64 7,000 and NGC claims that the TRA erred in reducing the external operating expenses because there was no proof that they were imprudently incurred.

We think the TRA was justified in its conclusion on this issue. Based on th e testimo ny in the record that the advertising expens es were incurred to meet competition, to add new customers on existing mains, and to get existing customers to use more gas, the TRA concluded that the rate payers benef ited from at least part of the externa l advertising.

c. The Long Term Incen tive Plan

The TRA allowed NGC to recover approximatelyone-half of the cost of its Long Term Incentive Plan. The CAD opposes the allowanc e of any ofthis expense on the basis that the pla n encourages executiv es to seek growth thr ough rate increasesinstead of through performance ga ins. According to the CAD, the plan does not promote improved serv ice.

NGC offered evidence, however, that the plan had increased employ ee efficiency and h ad reduced the number of company employees pe r customer in Tennessee. The savings amounted to $7 million annually in

wages and salaries.The
same witness rebutted the CA D witness who testified that the plan encourages employee s to seek ra te increa ses rathe r than imp roved eff iciency.- 10 - None of the parties to the appeal cited any authority gov

erni n g the allowance of incentiv

e payments i n utility

rate cases.Th e proof in cluded some refere nces to cases in other jurisdictions where that state’s utility commissio n ha d allowed either 100% of the incentive payments or some fractio n there of. The
consensus seems to be to look at each plan on a case by case basis and view each plan in the context of the util ity’s total compensation package.

We do not t h ink the TRA erred in the treatment of the long term incentive plan in this

case.

d. Rate of Return

NGC requested a

rate of return on equity in the rang e of 13% to 13.25%. The CAD requestedan 11% rate of return and offered exper t testimony showing

that monthly compound ing of t he com pany’s income would r aise the rate of return to 11.60%. The TRA set a rate of return o f 11.5%.

We fail to see how eithe r side co uld make much of a case on appeal. The TRA’s findings and conclusions are supported by evidence in the record that is both substantial and material. See Tenn. Code Ann. § 4-5-322(h). A proper r ate of return is not apoin t on a scale, Tennessee Cable Televisi on Ass’n v. PSC

, 844 S .W.2d 151 (Tenn. App. 1992), it cover s a fairly broad range,as indicated by the testimony

of the competing expertsin this case. We affirm the TRA’s decision on this point.

We take no position on the issu e of the compounding effect of the company’s receipts. It is a conce pt thatis new to us in utility regulati on, and its merits need to be explored more thoroug hly than they have been in this record.
IV. The Rate Design1 There are threeother bloc ks in the in terruptible ind ustrial cate gory of us ers. Block one appli es to usage of 1-1,500 decat herms per month; block two cov ers the 1,501-4,000 category; and block thre e app lies to the 4 ,001 -9,00 0 cat ego ry. - 11 -

The intervenor, AVI, challenges the part of the TRA’s order that raised the “tailblock” r ate for g as supplied to NGC’s lar gest interruptible cus

tomers. The tailblockrate is the lowest r ate charged per

unit and it appli es to usage of over 9,000 decatherms

per month. 1 NGC’s petitiondid not seek any increas e in the rates falling in this category. The CAD’s proof propo sed that any changes be spread to all customer

classes, but the intervenor sought an overall rate decrease. AVI’s witness testified that industrial rates were set well above costs and should not be increased The TRA’s order increased the tailblock rate from $0.21 per decatherm to $0.228 per decatherm. The TRA said in its order:

After careful consideration of th e te stimony and exhibi ts of th e parties, the Authority finds that the rate increase approved herein should be s pread equally to all customers. It is the intent of the Authority to spread this increase to all ratepayers, i nc ludi ng interruptible Sales customer s, Transportation customers, and Spec ial Contract custom ers , in order to minimize the overall impact of this rate change. In addition, the Authori t y concludes that the residentialcustomer charge should be increased from $6.00 per month to $7.00 per month.

We think

the question of whether to spread the rate increase to all classes of users was withi n the discretion of the TRA. In CF Industries v. Tenn. Pub. Serv. Comm. , 599 S.W.2d 536 (1980), our Supreme Court said:

Specifi cally, there is no requirement i n any rate case that the Commission receiv e and consider cost of service data, or what such data, if in the record, are to be accorded exclusivity. It is self-evident that cost of service is of greatsignificance in the establ ishment of rates but is of lesser value in arr

iving at rate des ign. A fair rate of re turn t o the regulated utility is one thing; the establishment

of rates among various cus tomer classes is quite another. 599 S.W. at 542. * * * Thus, the Public S ervic e Commission in rate making and de sign ca ses is not solely governed by the proof although, of course, there must be an adequate evidentiarypredicate. The Commission, however, is not- 12 - hamstr un g by the naked record. It may consider all relevant circumstances shown by the record, all recognizedtechnical and scientific facts pertinent to the is sue under consideration and may superimpose up on th e entire transaction it s own exper tise, technical competence and specialized knowl edge. Th us focusing upon the issues, the Commiss i on decides that which is just and reasonable. This is the lit m us test -- nothing more, nothing less. 599 S.W. at 543.

We think it would be a

rare case where the court would interfere with a rate increase spread evenly over all classes of users. If the rate des ign is inequitable it was not established

in this proceeding. Ther efore, a request that the rate increase be applied unevenly is, in fact, a request to change the rate design -- on w hich the intervenor would hav

e the burden of proof. A change wo uld have to beshown by a greater amount of proof than appears i n this record.

The TRA’s order is affirmed and the c ause i s remande d to the Tennessee Regula

tory Authority

for enfo rcement. Tax the costs on appeal to the Consumer Advocate Div ision.

____________________________ BEN H. CANTRELL, JUDGE

CONCUR:

_______________________________ HENRY F. TODD, PRESI DING JUDGE MIDDLE SECTION

_____________________________ WILLIAM C. KOCH, JR., JUDGE- 13 -