Opinion ID: 2329066
Heading Depth: 1
Heading Rank: 2

Heading: Jurisdictional Separations

Text: The Communications Act, enacted by Congress in 1934, gave the Federal Communications Commission (the FCC) authority to regulate interstate and foreign commerce in wire and radio communication, 47 U.S.C. § 151 (1991); while expressly denying the FCC jurisdiction with respect to ... intrastate communications service. 47 U.S.C. § 152(b) (1991); see also Louisiana Public Service Comm'n v. FCC, 476 U.S. 355, 360, 106 S.Ct. 1890, 1894, 90 L.Ed.2d 369 (1986). Authority to regulate intrastate services remained with the several states. Crockett Tel. Co. v. FCC, 963 F.2d 1564, 1566 (D.C.Cir.1992); see also 47 U.S.C. § 221(b) (1991). To implement this scheme of dual regulation, a utility's revenues, investment, and expenses must be apportioned between the interstate and intrastate jurisdictions. Mid-Plains Tel. Co., 5 F.C.C.R. 7050, 7050 (1990), aff'd sub nom., Crockett Tel. Co. v. FCC, 963 F.2d 1564 (D.C.Cir.1992). This process of apportionment is known as jurisdictional separation. Crockett Tel. Co. v. FCC, 963 F.2d at 1566. Congress authorized the FCC to determine what property of a telephone company is used to provide interstate services. 47 U.S.C. §§ 221(c) (1991). However, while the [Communications] Act would seem to divide the world of domestic telephone service neatly into two hemispheres  one comprised of interstate service, over which the FCC would have plenary authority, and the other made up of intrastate service, over which the States would retain exclusive jurisdiction  in practice, the realities of technology and economics belie such a clean parceling of responsibility. Louisiana Public Service Comm'n v. FCC, 476 U.S. at 360, 106 S.Ct. at 1894. In reality, virtually all of the telephone equipment and plant used to provide intrastate service is also used to provide interstate services. Id. Despite the difficulties with which the separations process is fraught, [t]he separation of the intrastate and interstate property, revenues and expenses of the company is important not simply as a theoretical allocation... [i]t is essential to the appropriate recognition of the competent governmental authority in each field of regulation. Smith v. Illinois Bell Tel. Co., 282 U.S. 133, 148, 51 S.Ct. 65, 68, 75 L.Ed. 255 (1930). Failure by the Commission to make properly such jurisdictional separations may constitute reversible error, NET 1982, 448 A.2d at 298 (reversing commission's allocation of foreign exchange plant costs to the interstate jurisdiction contrary to the FCC's practice); but because of `the difficulty in making an exact apportionment of the property ... extreme nicety is not required.' Crockett Tel. Co. v. FCC, 963 F.2d at 1566 (quoting Smith v. Illinois Bell, 282 U.S. at 150, 51 S.Ct. at 69).
Prior to divestiture, [6] the FCC did not adopt a formal jurisdictional separations procedure. Mid-Plains Tel. Co., 5 F.C.C.R. at 7050. Instead, the FCC allowed AT & T to use a cost allocation plan outlined in the Separations Manual, issued by the National Association of Regulatory Utility Commissioners (NARUC) in 1974, to determine each associated Bell Operating Company's costs of providing interstate service. Id. In 1983, the FCC codified the cost-based approach outlined in the Separations Manual as Part 36 of its rules, 47 C.F.R. §§ 36.1-36.741 (1992). Id. The FCC allowed AT & T to distribute its revenues to the smaller independent telephone companies, not by the Separations Manual, but instead by a system of settlements based on negotiated formulas which eventually became known as average schedules. Mid-Plains Tel. Co., 5 F.C.C.R. at 7050. These average schedules adopted generalized industry data to reflect the cost of a hypothetical exchange company. National Assoc. of Regulatory Util. Comm'nrs v. FCC, 737 F.2d 1095, 1127 (D.C.Cir.1984), cert. denied, 469 U.S. 1227, 105 S.Ct. 1224, 84 L.Ed.2d 364 (1985) (hereinafter NARUC v. FCC ). After divestiture and the codification of the Separations Manual, the FCC continued to allow small independent telephone companies, including Pine Tree, to estimate some or all of their costs through use of an `average schedule.' Id. The FCC's purpose in continuing the existing average schedule system was to avoid imposing the burden of developing cost information upon companies that may be too small to meet that burden. [7] Mid-Plains Tel. Co., 5 F.C.C.R. at 7051; see also Separations of Costs of Regulated Tel. Service from Costs of Nonregulated Activities, 2 F.C.C.R. 6283, 6316 n. 218 (1987) (Use of an average schedule eliminates the necessity of conducting expensive and burdensome cost studies.).
The FCC's average schedules, like its Part 36 cost-based separations method, label a certain portion of a telephone company's costs as interstate costs. Therefore, some state regulators simply subtract these interstate costs from the company's total costs and treat the residuum as intrastate costs. Crockett, 963 F.2d at 1567. This intrastate ratemaking method is known as residual or total company ratemaking. Id. The residual ratemaking process, in the context of an average schedule company, has been described as follows: [First] the commission determines a reasonable level of expense and a reasonable return on the net investment rate base for the total company. The commission then deducts the amount of average schedule payments from the total company revenue requirement to determine the intrastate portion of the total company revenue requirement. Intrastate rates are then established to recover this residual amount. Peoples Tel. Co., 100 P.U.R.4th 272, 275-76 (Wisc.P.S.C.1989). In other words, state regulators using residual ratemaking assume that the intrastate revenue requirement is equal to the company's total revenue requirement less revenues deemed by the average schedules to be interstate. Id. In the case at bar, Pine Tree attempted to use a jurisdictional cost-separations study to calculate its intrastate revenue requirement. [8] The commission rejected that approach and decided to use residual ratemaking, holding: Pine Tree's interstate cost allocation is determined by the amount of revenue it receives pursuant to its interstate average schedules. This amount is then deducted from the Company's total revenue requirement to determine its intrastate revenue requirement. The commission reasoned that using residual ratemaking will guarantee 100% recovery, no more, no less. [9] Pine Tree first argues that the commission's approach violates the Supremacy Clause of the United States Constitution. See U.S. Const. art. VI. The Supremacy Clause provides Congress and federal agencies, acting within the scope of their congressionally delegated authority, the power to preempt state regulation. Louisiana Public Service Comm'n v. FCC, 476 U.S. at 368-69, 106 S.Ct. at 1898-99. The FCC has specifically declined to preempt the use, by State regulators, of residual ratemaking with average schedule companies. See Mid-Plains Tel. Co., 5 F.C.C.R. at 7054 (holding that [state regulator's] use of residual ratemaking for determining a telephone company's intrastate revenue requirements does not contravene the Communications Act or any rule of this Commission.). The Court of Appeals for the District of Columbia Circuit affirmed the FCC's decision, concluding: [Use of an] average schedule interstate cost calculation, in conjunction with residual intrastate calculation, does not violate the Communications Act. The power of the state to employ the residual method is not preempted by federal regulation. Crockett, 963 F.2d at 1574. We, therefore, reject Pine Tree's assertion that the commission's use of a residual ratemaking methodology violated the Supremacy Clause. Second, Pine Tree asserts that the commission's use of residual ratemaking results in an unconstitutional taking because the commission's actions take revenue earned from Federal operations and use that money to subsidize State callers. In support of its position, Pine Tree points in particular to the commission's application of an overall rate of return of 10.586% to Pine Tree's interstate as well as its intrastate revenues. [10] Pine Tree asserts that this, at the very least, deprives the company of the interstate return requirement of 12%. [11] The commission apparently decided not to adjust Pine Tree's rate of return to reflect any differences in the interstate and intrastate return requirement. Pine Tree correctly points out that the United States Supreme Court has analyzed regulatory action under the takings clause of the Fifth and Fourteenth Amendments. See Duquesne Light Co. v. Barasch, 488 U.S. 299, 306-10, 109 S.Ct. 609, 615-17, 102 L.Ed.2d 646 (1989) (upholding state statute excluding utility plant not yet in use from a utility's rate base finding no unconstitutional talking of utility's property). The Court held that the Constitution protects utilities from being limited to a charge for their property ... which is so `unjust' as to be confiscatory. Id. 488 U.S. at 307, 109 S.Ct. at 615. The Court continued, [i]f the rate [set by the Commission] does not afford sufficient compensation, the State has taken the use of utility property without paying just compensation and so violated the Fifth and Fourteenth Amendments. Id. 488 U.S. at 308, 109 S.Ct. at 616. Because Pine Tree does not argue that the rates set by the commission are confiscatory, but instead argues that the commission is subsidizing intrastate activities with revenues from interstate activities, its challenge to the commission's setting an overall rate of return is also better analyzed as a federal preemption question as was the commission's decision to use residual ratemaking in general. In its order upholding the use of residual ratemaking for average schedule companies, the FCC implicitly allowed State regulators to apply an overall rate of return even if that rate of return differs from the federal rate. In that proceeding, Mid-Plains Telephone Company challenged an order by the Wisconsin Public Service Commission in which the Wisconsin Commission, using residual ratemaking, applied an overall rate of return different from the federal rate. Mid-Plains Tel. Inc., No. 3650-DR-100, 3650-TR-100, 3650-TI-101, slip op. at 14, 18 (Wisc.P.S.C.1989). The FCC concluded that the Wisconsin Commission's use of residual ratemaking does not contravene the Communications Act or any rule of [the FCC], Mid-Plains Tel. Co., 5 F.C.C.R. at 7054. This conclusion demonstrates the FCC's implicit approval of the Wisconsin Commission's use of an overall rate of return. Moreover, if Pine Tree had wanted to ensure that it recovered the federal rate of return, it could have elected to follow the cost-based separations method of Part 36 rather than the average schedule approach. We also reject Pine Tree's contention that the commission's decision improperly deprives the company of incentive earnings from the Federal average schedule method. The FCC has stated that the economic incentive of retain[ing] the benefits that accrue from increases in productivity and reductions in expenditures is a rationale underlying the use of average schedules. Policy and Rules Concerning Rates for Dominant Carriers, 5 F.C.C.R. 6786, 6820 (1990). Nevertheless, the FCC rejected the argument that the use of residual ratemaking by state regulators, i.e., allowing companies to recover only 100% of their costs, was contrary to FCC policy stating: [I]t has always been our view as a matter of public policy that it would be inequitable for a company to recover more than its total costs. In fact, this Commission has previously declared that [n]o company has a legal or equitable right to obtain more than its full costs. Mid-Plains Tel. Co., 5 F.C.C.R. at 7054 (quoting MTS and WATS Market Structure Average Schedule Companies, 103 F.C.C.2d 1017, 1027 (1986)). Although the FCC's refusal to preempt use of residual ratemaking may appear inconsistent with its stated goal of allowing a utility to retain benefits that accrue from average schedule treatment, the FCC's decision was upheld by the Court of Appeals for the District of Columbia in Crockett, 963 F.2d at 1571-72, 1574 (specifically rejecting the inconsistency argument). Finally, Pine Tree, citing Maine Water Co. v. Public Util. Comm'n, 482 A.2d 443, 456-57 (Me.1984), asserts that the commission's approach use[s] revenues generated from interstate customers to benefit intrastate customers violat[ing] the State's prohibition against cross-subsidization. In Maine Water Co., we acknowledged that a fundamental objective of ratemaking is to avoid cross-subsidization so that one class of customers is neither burdened by the losses from other service nor benefitted from its profits. Id. at 456. In Maine Water Co., we struck down an attempt by the Commission to effect a dollar-for-dollar `flowthrough' of gains realized by Maine Water Company in selling [another of its] division[s]. Millinocket Water Co. v. Public Util. Comm'n, 515 A.2d 749, 753 (Me.1986). We distinguished the commission's actions in Millinocket Water from those in Maine Water because in Millinocket Water, the commission was using a Company's parent as proxy for determining [the] cost of equity and did not attempt to effectuate a flowthrough. Millinocket Water, 515 A.2d at 753. The commission's actions in the case before us can be similarly distinguished from Maine Water; here, the commission relied on average schedules as a proxy to determine Pine Tree's interstate costs and did not attempt to effect a flow-through of gains from Pine Tree's interstate activities to subsidize its intrastate activities.
Local exchange carriers, like Pine Tree, can generate revenue by charging interstate carriers for sending bills to customers and performing collection services usually to customers within its own service territory. Pine Tree provides these billing and collection services to AT & T. During the test year, 1990, AT & T paid Pine Tree $96,418 for these services. Pine Tree's president, Timothy Hutchinson, testified that the company's expenses in providing this service were about eight or nine thousand dollars. Pine Tree argues that the commission impermissibly included Pine Tree's interstate billing and collection revenues in Pine Tree's total revenues. Pine Tree argues that any regulation of these services is outside the commission's jurisdiction. The commission asserts that the FCC has not preempted state regulation of interstate billing and collection services and that since ... the billing and collection revenues are still to be regulated for jurisdictional separations purposes, this commission has no other alternative under the paradigm of residual ratemaking than to include those revenues as part of Pine Tree's total interstate revenue and hence its interstate costs for intrastate ratemaking purposes. The commission continues, [a]ny other method of regulation would not ensure that Pine Tree does not receive any more or less than 100% of its total company revenue requirement. We closely analyze FCC precedent in order to decide this issue. In 1986, the FCC concluded that carrier billing or collection for the offering of another unaffiliated carrier is not a communications service for the purposes of Title II of the Communications Act. Detariffing of Billing & Collection Services, 102 F.C.C.2d 1150, 1168 (1986). The FCC also declined to exercise its authority to regulate such services pursuant to Title I of the Communications Act. Id. at 1170. The FCC continued: [W]e have concluded that we should give preemptive effect to our decision with respect to [local exchange carrier] billing and collection for interstate services of interexchange carriers. State rate regulation of such billing and collection services is not required.... Therefore, we have decided to preclude such regulation. Id. at 1177 (emphasis added). The FCC added, the deregulation of billing and collection services should not shift costs between the state and interstate jurisdictions... [but] merely removes some interstate costs from the regulated arena. Id. at 1175. In 1987, however, the FCC added, we did not preempt all state regulation of billing and collection service. Separation of Costs of Regulated Telephone Service from Costs of Nonregulated Activities, 2 F.C.C.R. 1298, 1309 (February 1987) (emphasis added) (hereinafter Separations I ). In a footnote, the FCC explained these remarks as follows: While we preempted state regulation of [local exchange carrier] billing and collection for interstate service of interexchange carriers ... we did not preempt regulation of billing and collection services for intrastate services. Id. at 1350 n. 152 (citation omitted) (emphasis added). In 1987, the FCC established a method of separating regulated and nonregulated activities. See id. at 1299. Under that scheme, a company would generally first separate its regulated from its nonregulated activities, [12] and then only the regulated activities would proceed to the jurisdictional separation phase. Separation of Costs of Regulated Tel. Service from Costs of Nonregulated Activities, 2 F.C.C.R. 6283, 6300 (October 1987) (hereinafter Separations II ). The FCC has determined that billing and collection activities are deregulated activities in the interstate jurisdiction but has allowed regulation in the intrastate jurisdiction; and because of this, unlike those services that are preemptively deregulated in both interstate and intrastate jurisdictions, billing and collection services remain subject to the jurisdictional separation process. Separations I, 2 F.C.C.R. at 1309 ([W]e did not preempt all state regulation of [intrastate] billing and collection service... [therefore] [w]e believe that billing and collection activities should continue to be accorded regulated accounting treatment.); see also 47 C.F.R. § 32.23 (1992). Because Pine Tree's revenues from interstate billing and collection services are not separated from its regulated activities prior to jurisdictional separations and because Pine Tree chose to use average schedules rather than a cost-based jurisdictional separation, the commission did not err by including Pine Tree's interstate billing and collection revenues in Pine Tree's total revenues for residual ratemaking purposes. [13] Moreover, even if the commission had committed error by including these costs, such error would be harmless because Pine Tree did not supply adequate evidence on which the commission could exclude expenses of interstate billing and collection services. Hutchinson testified that he estimated the companies expenses for billing and collection services based on Pine Tree's costs of printing bills and an estimate by Pine Tree staff as to time spent answering questions on interstate bills. Contrary to Pine Tree's assertion during oral argument that its cost separation study, excluded by the commission, contained an accurate separation of interstate billing and collection services expenses, that study did not do so. According to 47 C.F.R. §§ 36.378 (1992), account number 6623, customer services, should be broken into three separate categories: (1) message processing expenses, (2) carrier access charge billing and collection expenses, and (3) other billing and collecting expenses. The expenses identified in the other billing and collecting expenses category are then further segregated according to 47 C.F.R. § 36.380 (1992). The study commissioned by Pine Tree did not segregate expenses to this extent; and, in fact, simply included one lump sum for all customer services expenses. [14]