Opinion ID: 372907
Heading Depth: 2
Heading Rank: 1

Heading: Sustaining Capital and the Method of Evaluation

Text: 26 In June of 1964, the sale of its 10 million shares of common stock at $20 per share netted COMSAT just under 200 million dollars of equity capital. Because of early technological successes with the synchronous satellite concept, and a diplomatic breakthrough as well in the establishment of a multi-member international consortium, 13 COMSAT soon found that it did not require the full 200 million dollars for its INTELSAT (international satellite) operations. As explained above, part of the equity was diverted into COMSAT General. The total amount of equity devoted to INTELSAT, therefore, came to 136 million dollars. It is this sum that COMSAT considers as the foundation of its 1964 rate base. As of 1973, in addition to the value of currently useful equipment, COMSAT wishes to add to the rate base 152 million dollars in return deficiencies: these are sums calculated as representing the difference between the actual rate of return that COMSAT realized between 1964 and 1973 and what COMSAT considers should have been a normal rate of return on its rate base over that period. 27 The question of return deficiencies will be considered in the next subsection. Turning our attention to the 136 million dollars in the original rate base, we observe that the Commission disallowed a 25 million dollar item in the account called sustaining capital. (J.A. 85; 56 FCC2d at 1185). The principal component of this account, which included some reserve for depreciation as well, was a contingency fund set aside from operating capital, out of which COMSAT, as a self-insurer, planned to provide funds in case of launch failure or similar catastrophe. By 1973, the only remaining item of capital left in the sustaining capital account was this catastrophe reserve. 28 The Commission found that COMSAT had inadequately explained why a line of credit could not have been established to provide the requisite financial security for this contingency. (J.A. 42; 56 FCC2d at 1142). Indeed, COMSAT had been issued a line of credit in 1964 (J.A. 58; 56 FCC2d at 1158). Also, the Commission found that it was unrealistic for COMSAT to have presumed that no other funding would be available to it in the event of catastrophe. Even if COMSAT could not feasibly go into the general debt market at the early stages of its corporate career, it could have sought additional financing in the nature of debt from those with the most serious interest in the financial stability of the company: the shareholders, half of whom were common carriers. One possible plan for such financing is discussed in the Commission's opinion. Id. Perhaps most realistic, especially considering COMSAT's continual insistence that it had a crucial governmental mandate (though this was something short of a guarantee), is the potential for COMSAT to have sought an appropriation from the federal government in the rare circumstance of severe technological failure. Finally, the Commission did allow other expenditures to minimize the risk of launch failure and its deleterious impact on COMSAT, and the Commission allowed these to be recouped. (J.A. 42-43; 56 FCC2d at 1142-43). We hold that there is substantial evidence to uphold the Commission's decision not to include this 25 million dollars as sustaining capital in COMSAT's 1973 rate base. 29 The discussion of sustaining capital introduces the essential difference between the method of rate-base calculation suggested by COMSAT, and that adopted by the Commission. The Commission measures a public utility's rate base as the net book cost of plant service, that is, the total value of utility plant devoted to public service, less accrued depreciation. (J.A. 19; 56 FCC2d at 1119). The FCC summarized its rationale for employing this method as follows: 30 It has been concluded that by recognition in the rate base of deferred start-up costs, R&D and failed satellites and launches in addition to property used and useful in providing service, Comsat's rate base could fairly be regarded as conventional. We believe this choice to be in furtherance of recognized regulatory principles; it maintains for the benefit of the public a sense of consistency with other monopoly utility operations providing needed public services. We thus determined not to give rate base treatment to the incorporeal and hypothetical claimed assets which, as proposed, constituted approximately one-half of Comsat's rate base. Rather, in a manner again reflecting established regulatory principles, we determined that to the extent the record justified recognition of elements of risk associated with such items, they should be melded into the determination of Comsat's rate of return allowance. 31 (J.A. 84; 56 FCC2d at 1184). 32 By contrast, COMSAT claims that its rate base should follow the prudent investment theory; that is the term given to the method proposed by the opinion of Justice Brandeis dissenting from opinion (of the majority) in Southwestern Bell Telephone Co. v. Public Service Commission, 262 U.S. 276, 290, 43 S.Ct. 544, 547, 67 L.Ed. 981 (1923): 33 The thing devoted by the investor to the public use is not specific property, tangible and intangible, but capital embarked in the enterprise. Upon the capital so invested the Federal Constitution guarantees to the utility the opportunity to earn a fair return. (footnote: Except that rates may, in no event, be prohibitive, exorbitant, or unduly burdensome to the public. . . .) Thus, it sets the limit to the power of the State to regulate rates. The Constitution does not guarantee to the utility the opportunity to earn a return on the value of all items of property used by the utility, or of any of them. 34 The motivation for Justice Brandeis' opposition to the rate base methodology of reproduction cost, or trended historical cost approved by the majority in Southwestern Bell, was the imprecision of that calculation. By using capital embarked on the enterprise, Justice Brandeis hoped to avoid the variability inherent in estimating such cost elements. The rate base would be ascertained as a fact, not determined as matter of opinion. It would not fluctuate with the market price of labor, or materials, or money. 262 U.S. at 306-307, 43 S.Ct. at 553. The reliance of earlier cases on other methods was to be explained by the fact that before the growth of public commission regulation, it had not always been easily determinable how much capital had been invested in any given company. 262 U.S. at 309, 43 S.Ct. 544. 35 When understood in its context, therefore, Justice Brandeis' opinion advocating his dissenting theory might not have objected to the use of book cost less depreciation as the science of accounting has since standardized the various permissible methods of calculating depreciation. 36 Most important of all in this methodology debate, however, is the fact that the prudent investment approach has Never been adopted by the Supreme Court as the sole method of rate base determination. Southwestern Bell, itself, approved the application of a replacement cost approach. While Justice Brandeis and Holmes concurred in the result, which found the rate of return to be non-compensatory under the circumstances of that case, their opinion was a minority one and was explicitly labeled a dissent from the majority's reasoning. 37 The position that has been taken by the Supreme Court since at least 1944, and reiterated on several subsequent occasions, is that the widest latitude is to be permitted public regulatory commissions in their determination of a rate base. The Court has recognized that any of a large number of rate base theories are acceptable, and requires only that the chosen theory be consistently applied, and result in a reasonable rate of return. The leading case is FPC v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944). The Commission, Beginning with book cost, made certain adjustments not necessary to relate here and found the 'actual legitimate cost' of the plant in interstate service to be (a certain sum). It Deducted accrued depletion and depreciation . . . . And it added (another sum) for future net capital additions . . . . 320 U.S. at 596, 64 S.Ct. at 284-85 (emphasis added). The described method of rate base determination is largely analogous to the one used by the FCC in the present case. 38 In Hope, (t)he Circuit Court of Appeals set aside the order of the Commission for the following reasons. . . . It held that the rate base should reflect the 'present fair value' of the property, that the Commission in determining the 'value' should have considered reproduction cost and trended original cost, and that 'actual legitimate cost' (prudent investment) was not the proper measure of 'fair value' where price levels had changed since the investment. 320 U.S. at 599-600, 64 S.Ct. at 286. 14 It was this reversal that was set aside by the Supreme Court. The Court held that the public regulatory commission was not bound to the use of any single formula or combination of formula(s) in setting a rate base. 320 U.S. at 602, 64 S.Ct. at 287. The determining principle for valuating rate-base schemes announced in Hope is that: 39 Under the statutory standard of just and reasonable it is the result reached not the method employed which is controlling. . . . It is not theory but the impact of the rate order which counts. If the total effect of the rate order cannot be said to be unjust and unreasonable, judicial inquiry under the Act is at an end. The fact that the method employed to reach that result may contain infirmities is not then important. 40 320 U.S. at 602, 64 S.Ct. at 287-88. The Commission's choice in this case of a book-value less depreciation method (the same method, in basic terms, that was approved in Hope ) cannot be upset. 41 In 1968, the Court again embraced this principle of wide choice. In the Permian Basin Area Rate Cases, 390 U.S. 747, 767, 88 S.Ct. 1344, 20 L.Ed.2d 312 (1968), the Court cited Hope with approval, and then went on to emphasize that there was a zone of reasonableness within which any rate determined by a regulatory commission could not be set aside. 15 Permian Basin did introduce greater detail into the obligations of a reviewing court, but none of these in any way compromised the general rule that a wide variety of rate-base determinations (including the one at issue in Hope and in this case) were permissible. The Court held: 42 It follows that the responsibilities of a reviewing court are essentially three. First, it must determine whether the Commission's order, viewed in light of the relevant facts and of the Commission's broad regulatory duties, abused or exceeded its authority. Second, the court must examine the manner in which the Commission has employed the methods of regulation which it has itself selected, and must decide whether each of the order's essential elements is supported by substantial evidence. Third, the court must determine whether the order may reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed, and yet provide appropriate protection to the relevant public interests, both existing and foreseeable. 43 390 U.S. at 792, 88 S.Ct. at 1373. 44 The point to be stressed here is that the Supreme Court leaves entirely up to the Commission the method of regulation to be selected. 16 45 Permian Basin affords no suggestion whatsoever that the choice of rate-base methodology available to a regulatory commission is restricted to the capital embarked in the enterprise or prudent investment standard. Nor has subsequent decision law from the Supreme Court narrowed a Commission's freedom in that regard. On the contrary, the Hope standard has been explicitly reiterated. In FPC v. Memphis Light, Gas & Water Division, 411 U.S. 458, 466, 93 S.Ct. 1723, 36 L.Ed.2d 426 (1973), the Court held that the broad discretion of the Commission delineated in Hope Natural Gas  would apply fully, unless there were evidence in the legislative history of a contrary Congressional intention. Most recently, the Court has stated (T)here is no single cost-recovering rate, but a zone of reasonableness: 'Statutory reasonableness is an abstract quality represented by an area rather than a pinpoint. It allows a substantial spread between what is unreasonable because too low and what is unreasonable because too high.' Montana-Dakota Util. Co. v. Northwestern Pub. Serv. Co., 341 U.S. 246, 251 (71 S.Ct. 692, 695, 95 L.Ed. 912) (1951). FPC v. Conway Corp., 426 U.S. 271, 278, 96 S.Ct. 1999, 2004, 48 L.Ed.2d 626 (1976). 46 We therefore affirm the choice of the rate-based determination method adopted by the Commission. Three particular objections to the composition of that rate-base are raised: that the Commission erred (1) in not including a fund for return deficiencies the amount by which previous earnings had fallen short of COMSAT's concept of the reasonable rate to which it considered itself to be entitled; (2) in its choice of interest rate, in applying the interest during construction method of compensating for certain start-up costs; and (3) in requiring the amortization of laboratory investments out of the rate base over the next five years.