In response to financial stresses in the railroad industry, the Congress passed legislation in 1976 and 1980 that dramatically reduced federal regulation over the industry. As a result of the 1976 and 1980 legislation, most rail traffic in the United States is not subject to the Surface Transportation Board’s (the Board) rate regulation, and fewer large railroads account for most of the industry’s revenue and mileage operated. The Board, established pursuant to the ICC Termination Act of 1995, is a bipartisan, independent, adjudicatory body that is organizationally housed within the Department of Transportation (DOT). The Board is responsible for the economic and rate regulation of freight railroads and certain pipelines, as well as some aspects of motor and water carrier transportation. The Railroad Revitalization and Regulatory Reform Act of 1976 and the Staggers Rail Act of 1980 facilitated changes in the freight railroad industry. These acts provided the railroads with greater flexibility to negotiate freight rates and respond to market conditions. The Staggers Act in particular made it federal policy that freight railroads would rely, where possible, on competition and the demand for services rather than on regulation to establish reasonable rates. As a result of mergers and acquisitions fostered by these statutes, as well as changes in bankruptcies and changes in the definition of a class I railroad, the number of large railroads in the United States has declined substantially from the 63 class I railroads operating in 1976 to nine by 1997. In spite of the reduction in the number of class I freight railroads, these railroads accounted for 91 percent of the industry’s freight revenue and 71 percent of the industry’s mileage operated. In 1997, class I freight railroads originated almost 1.6 billion tons of freight, of which coal, farm products, and chemicals accounted for about 61 percent. The nine class I freight railroads in 1997 were the Burlington Northern and Santa Fe Railway Co.; CSX Transportation; Consolidated Rail Corporation; Grand Trunk Western Railroad, Inc.; Illinois Central Railroad Co.; Kansas City Southern Railway Co.; Norfolk Southern Corp.; Soo Line Railroad Co.; and Union Pacific Railroad Co. Since 1997, additional railroad consolidations have occurred. In July 1998, the Board approved the division of the Consolidated Rail Corporation’s (Conrail) assets between CSX Transportation and Norfolk Southern Railway. This will reduce the number of class I freight railroads to eight in 1999. Also, in July 1998, Canadian National Railway, the Canadian parent of Grand Trunk Western Railroad, Inc., requested the Board’s authorization to acquire Illinois Central Railroad Company. The Board’s proposed schedule provides for a final decision on the proposed acquisition no later than May 25, 1999. Officials from the Federal Railroad Administration (FRA) believe that within the next 5 to 10 years, the remaining class I railroads could be merged into two transcontinental railroads. The ICC Termination Act of 1995 eliminated the ICC and transferred its core rail adjudicative functions and certain non-rail functions to the Board. Among other things, the Board has economic regulatory authority over freight railroads, addressing such matters as the reasonableness of rates, mergers and line acquisitions, line constructions, and line abandonments. Under the statute, the Board is responsible for balancing shipper and railroad interests by assisting railroads in their efforts to earn adequate revenue to cover their costs and provide a reasonable return on capital while ensuring that shippers that depend on one railroad are protected from unreasonably high rates. The 1976 and 1980 acts provided railroads with significant flexibility to negotiate freight rates and respond to market conditions. The 1976 act retained federal rate regulation only for traffic where the railroad dominates the market, that is, it provides service for which there is no effective competition to otherwise control rates. In such cases, the ICC had jurisdiction to determine whether a challenged rate was reasonable and, if unreasonable, to award reparations and prescribe a maximum rate. The Staggers Rail Act built on the reforms of the 1976 act by establishing a threshold under which railroads would not be considered market dominant. The ICC Termination Act transferred this regulatory function to the Board. The Staggers Rail Act permitted railroads to negotiate transportation contracts containing confidential terms and conditions that are beyond the Board’s authority while in effect. As figure 1.1 shows, most rail tonnage in 1997—70 percent—moved under contracts between the railroads and shippers involved and therefore was not subject to the Board’s rate regulation. Shipments exempted from rate regulation accounted for an additional 12 percent of all rail tonnage moved in 1997. The Board is required to exempt any person or class of persons, or a transaction or service, from regulation, where regulation is not needed to carry out congressionally set rail transportation policy and either the transaction or service is of limited scope or regulation is not needed to protect shippers from an abuse of market power. For example, in April 1998, the Board exempted 29 nonferrous recyclable commodity groups from the Board’s regulation. The Board found that trucks play a significant role in the transportation of these commodity groups. Therefore, the Board found that railroads do not possess sufficient market power to abuse shippers. Other exemptions issued for the same reason include those for boxcar traffic, certain agricultural products, and intermodal transportation. The remaining traffic, potentially subject to rate regulation, accounted for 18 percent of rail tonnage in 1997. However, the Board’s jurisdiction over this traffic is further limited because it may only provide rate relief where the revenue-to-variable cost percentage exceeds 180 percent and where there is no effective competition. During the 1970s, the railroad industry was in weak financial condition with a rate of return on net investment of 1.2 percent in 1975, and a return on shareholders’ equity of about 1.9 percent. By contrast, manufacturing companies and utilities earned rates of return in 1975 of about 15 and 12 percent, respectively. The financial community was concerned about the railroads’ long-term viability, since the industry faced cash flow difficulties and marginal credit ratings. The 1976 act required the ICC to develop standards for determining whether railroads’ were earning adequate revenues to cover their operating costs and provide a reasonable return on capital. The act provided that railroads’ revenue should (1) provide a flow of net income plus depreciation adequate to support prudent capital outlays, ensure the repayment of a reasonable level of debt, permit the raising of needed equity capital, and cover the effects of inflation and (2) attract and retain capital in amounts adequate to provide a sound transportation system. Despite the reforms of the 1976 act, in 1980, the Congress found that railroads’ earnings were still insufficient to generate the funds they needed to make improvements to their rail facilities. While the 1976 act required the ICC to develop standards for the adequacy of railroad revenue, the Staggers Rail Act of 1980 required the ICC to determine annually which railroads were earning adequate revenues and to consider revenue adequacy goals when it reviewed the reasonableness of rates. According to Board officials, even today, the profitability of class I railroads is among the lowest of major industries. When two or more railroads seek to consolidate through a merger or common control arrangement, they must obtain the Board’s approval; transactions requiring the Board’s approval are not subject to the antitrust laws or other federal, state, and municipal laws. During a merger proceeding involving two or more class I railroads, the Board is required to consider, among other things, how the merger will affect competition among railroads (either in the affected region or in the national transportation system), railroad employees, the environment, and the adequacy of transportation provided to the public. As part of its regulatory responsibilities, the Board also addresses informal and formal complaints that railroads have failed to provide reasonable rail service to shippers. The Board oversees other rail matters, such as line constructions and abandonments. Railroads that want to either construct a new rail line or abandon an existing one must generally obtain the Board’s approval. Concerned about the potential barriers that shippers face in seeking relief from allegedly unreasonable rail rates, Senators Byron L. Dorgan, Conrad R. Burns, John D. Rockefeller IV, and Pat Roberts asked us to describe (1) the Board’s rate relief complaint process and how it has changed since the ICC Termination Act of 1995 became law, (2) the number and outcome of rate relief cases pending or filed since 1990, and (3) the opinions of shippers as to the barriers they face when bringing rate complaints to the Board and potential changes to the process to reduce these barriers. At their request, we are also providing information on McCarty Farms, Inc. et al. v. Burlington Northern, Inc. In addition, in the spring of 1999, GAO will issue a companion report that will address how freight railroad rates and service have changed since 1990. To describe the rate complaint process and how it has changed since the ICC Termination Act, we reviewed prior GAO reports and the Board’s documents, applicable statutes and regulations, and decisions. We met with Board officials, shippers’ organizations, and the AAR to gain a thorough understanding of the process. We then summarized the rate relief process and obtained comments on our summary from the Board. Board officials provided clarification where necessary, and their comments are included in our report. Our description of the rate relief process is contained in chapter 2. To determine the number and outcome of rate relief cases filed and/or pending since 1990, we obtained the rate complaints either filed with or pending before the Board or its predecessor, the ICC, from January 1, 1990, through December 31, 1998. We compared the number of complaints filed between January 1, 1990, and December 31, 1998, with the number of complaints that shippers filed from 1980 through 1990. We reviewed the complaints to determine, among other things, their nature, the complaint process used in filing them and their outcome.