Opinion ID: 1541219
Heading Depth: 2
Heading Rank: 1

Heading: Historical Relationship to Ratemaking

Text: The FPC initially promulgated uniform accounting systems in 1937 and 1940 for electric utility and natural gas companies, respectively. See Kripke, A Case Study in the Relationship of Law and Accounting: Uniform Accounts 100.5 and 107, 57 Harv.L. Rev. 433, 435 (1944). It did so out of a concern about the difficulty of determining the true value of utility properties allowed to comprise the rate base. During the 1920s, a period of rapid turnover and consolidation of ownership, regulatory commissions were confronted by accelerating inflation of book costs as utility properties continually changed handssometimes at arm's length but often in transactions between affiliates at prices designed to maximize the share at the top of the corporate pyramid. See Duke Power Co. v. Federal Power Comm'n, 130 U.S.App.D.C. 389, 393, 401 F.2d 930, 934 (1968). In many cases, therefore, the purchase pricesand, consequently, the rate basesfor utility properties were derived from book values reflecting the capitalization of hopes (more commonly characterized as water). Accordingly, corresponding to an approach taken by the Federal Communications Commission (FCC) a few years earlier in 1935, the FPC's new system divided utility property book values into three categories: (1) the original cost of the property to the first company that devoted it to public service; (2) an acquisition adjustment account reflecting the difference between the utility's own acquisition cost and the depreciated original cost of the property; and (3) any further appreciation reflected in writeups by the company over the sum of the first two categories. Kripke, supra at 436. At the time these accounting rules were promulgated, utility companies were entitled to a financial return (called fair value) computed on a rate base utilizing reproduction costs, which commonly combined all three of the FPC categories. See, e. g., The Minnesota Rate Cases, 230 U.S. 352, 454-55, 33 S.Ct. 729, 57 L.Ed. 1511 (1913); Willcox v. Consolidated Gas Co., 212 U.S. 19, 41, 52, 29 S.Ct. 192, 53 L.Ed. 382 (1909); Smyth v. Ames, 169 U.S. 466, 546-47, 18 S.Ct. 418, 42 L.Ed. 819 (1898). Justice Brandeis, however, dissenting in Southwestern Bell Tel. Co. v. Public Serv. Com'n, 262 U.S. 276, 289, 43 S.Ct. 544, 67 L.Ed. 981 (1923), had attacked the reproduction cost approach, arguing that investors should be entitled only to a return on the capital prudently invested in the enterprise, not on the appreciating value of the property acquired. Utility companies understandably feared, therefore, that the FPC's uniform accounting system, by segregating cost data, presaged an effort to contract each utility's rate base from reproduction costs to original cost. The regulatory agencies sought to avoid judicial scrutiny of their new accounting systems by insisting that these systems would not be considered conclusive for ratemaking purposes. The Supreme Court accepted such assurances, holding in American Tel. & Tel. Co. v. United States, 299 U.S. 232, 57 S.Ct. 170, 81 L.Ed. 142 (1936), that FCC accounting did not violate due process because it merely was a system of notation, without substantive significance. [7] In reaching this conclusion, however, the Court was not oblivious to the powerful influence that the regulatory commissions' accounting systems inevitably would have on ratemaking. In fact, two years before the American Tel. & Tel. Co. decision, the Court already had recognized the significance of the accounting system for the rate structure. In Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151, 54 S.Ct. 658, 78 L.Ed. 1182 (1934), the Court had held that annual depreciation charges were properly limited to computations based on original cost rather than reproduction cost. Greater charges for depreciation, the Court had said, would be tantamount to capital contributions. Id. at 169, 54 S.Ct. 658. By the 1940s, the Supreme Court was ready to allow federal regulatory agencies to utilize the new accounting systems, as the utility companies had feared, to abandon the fair value doctrine of ratemaking. In the spirit of Justice Brandeis' dissent in Southwestern Bell Tel. Co., supra, the Supreme Court held that utility investorswhile entitled to a fair rate of return on the historical cost attributable to their capital investmenthave no constitutional entitlement to a return on the increased value, if any, represented by reproduction cost over original cost. Federal Power Comm'n v. Hope Natural Gas Co., supra ; Federal Power Comm'n v. Natural Gas Pipeline Co., supra . Consequently, the FPC and state regulatory commissions received for the first time a green light for rate orders based solely on historical costs. These cases, however, went further than mere justification of historical cost-based rates. Their principal significance lies in two broader departures from previous holdings: (1) the Court shifted away from a focus on particular property values and rates of return to a more general, limited concern about the financial integrity of the company whose rates are being regulated. Federal Power Comm'n v. Hope Natural Gas Co., supra, 320 U.S. at 603, 64 S.Ct. 281, 288, and (2) the Court emphasized granting considerable deference to the expertise of a regulatory commission in arriving at a proper ratemaking judgment. As a constitutional matter, according to three concurring Justices, [i]rrespective of what the return may be on fair value, if the rate permits the company to operate successfully and to attract capital all questions as to just and reasonable are at an end so far as investor interest is concerned. Various routes to that end may be worked out by the expert administrators charged with the duty of regulation. It is not the function of the courts to prescribe what formula should be used. The fact that one may be fair to investors does not mean that another would be unfair. The decision in each case must turn on considerations of justness and fairness which cannot be cast into a legalistic formula. The rate of return to be allowed in any given case calls for a highly expert judgment. That judgment has been entrusted to the Commission. There it should rest. [ Federal Power Comm'n v. Natural Gas Pipeline Co., supra, 315 U.S. at 607, 62 S.Ct. at 753 (Black, Douglas, and Murphy, JJ., concurring).] The Supreme Court therefore, by the early 1940s, had shifted the utility investor's constitutional right from a just and reasonable rate of return based on current fair value of particular assets to a rate of return on an original cost rate base, with the particular rate being justified by the regulatory commission's expert view of the company's needs. A commission need only assure the financial integrity of the enterprise, including an ability to attract capital and compensate its investors for the risk assumed, even though the approved rate may produce only a meager return on the so-called `fair value' rate base. Federal Power Comm'n v. Hope Natural Gas Co., supra, 320 U.S. at 605, 64 S.Ct. at 289. In facilitating this transition from the fair value to the financial integrity approach, the Uniform System of Accounts did not become a sacred premise for ratemaking. Although the System had provided the mechanism for accomplishing a rejection of the fair value doctrine, it was clear all along, as enunciated in American Tel. & Tel. Co., supra, that accounting decisions, as such, could not be considered determinative for ratemaking itself. See United States v. New York Telephone Co., 326 U.S. 638, 653, 66 S.Ct. 393, 90 L.Ed. 371 (1946); Colorado Interstate Gas Co. v. Federal Power Comm'n, 324 U.S. 581, 608, 65 S.Ct. 829, 89 L.Ed. 1206 (1945); Northwestern Electric Co. v. Federal Power Comm'n, 321 U.S. 119, 125, 64 S.Ct. 451, 88 L.Ed. 596 (1944); American Power & Light Co. v. Securities and Exchange Comm'n, 158 F.2d 771 (1st Cir. 1946), cert. denied, 331 U.S. 827, 67 S.Ct. 1348, 91 L.Ed. 1842 (1947). In our own jurisdiction, for example, there is significant precedent demonstrating that circumstances will dictate ratemaking judgments independent of the uniform accounting system. For example, in Re D.C. Transit System, Inc., 30 P.U.R.3d 405, aff'd, 110 U.S.App.D.C. 241, 292 F.2d 734 (1961), the Commission's predecessor, the District of Columbia Public Utilities Commission (PUC), abandoned the normal accounting treatment when D.C. Transit System, Inc. sold its Fourth Street shops and Southern carhouse to the Redevelopment Land Agency. If the $1.921 million of the sales proceeds attributable to depreciable property had been credited to the depreciation reserve, as required by the Uniform System of Accounts, that reserve would have swollen to 180% of the original cost of the properties. The PUC accordingly deviated from the accounting rules by allowing the company to credit to earned surplus the amount by which the proceeds attributable to the depreciable property exceeded the original cost. [8] The PUC noted: While fully cognizant of the desirability of adhering to the Uniform System of Accounts under normal conditions, we have never recognized the Uniform System of Accounts as an inflexible code from which departures in special or unusual circumstances would not be permitted when authorized by the commission. [ Id. at 410.] See Democratic Central Committee I, supra 158 U.S.App.D.C. at 40-41, 485 F.2d at 819-20. There have been instances where the FPC, too, has rejected strict application of the uniform accounting rules in ratemaking proceedings. Manufacturers Light & Heat Co., 44 F.P.C. 314, 321-25, rehearing denied, 44 F.P.C. 1138 (1970) (contrary to uniform accounting rules, FPC granted above the line recognition of gains and losses in company's reacquisition of debt securities); United Gas Pipe Line Co., 31 F.P.C. 1180, 1189 (1964) (contrary to uniform accounting rules, FPC allowed above the line treatment of reasonable charitable contributions as an operating expense). It thus appears that there is no mandatory relationship between the Uniform System of Accounts and the Commission's ratemaking. We must therefore examine the details of the System to determine whether the Commission's per se reliance on it for ratemaking, as a matter of expert judgment, would appear, nonetheless, to be sound.