Opinion ID: 2310763
Heading Depth: 1
Heading Rank: 4

Heading: The Constitutionality of the Return-on-Equity Penalty

Text: Lastly, Citizens argues that the return on equity and overall rate of return set by the Board is confiscatory and therefore unconstitutional. In the first part of this argument, Citizens contends that the Board was obligated, but failed, to evaluate the impact that its equity-reduction penalty would have on the ability of Vermont Electric Division (VED), as opposed to the company as a whole, to maintain its financial integrity, attract capital, and compensate investors for risks assumed. This argument fails for at least two reasons. First, the argument is, for the most part, inconsistent with the position Citizens took in the proceedings before the Board. Citizens neither introduced evidence to support any rate-of-return analysis of VED as a stand-alone entity, nor even suggested that such an analysis was required until after the Board rendered its decision. In contending that the return-on-equity penalty urged by the Department was confiscatory, Citizens' expert asked the Board to consider the capital structure of Citizens, not VED. In his testimony, the expert consistently referred to the Company and failed to make any distinction between VED and the company as a whole. Further, in its proposal for a decision, Citizens stated that confiscatory rates are those that would impinge on Citizens' ability to raise capital. (Emphasis added.) As noted, in its initial decision, the Board determined that its return-on-equity penalty would not materially impact the financial security of Citizens as a corporate entity. Citizens briefly suggested in its motion for reconsideration, without elaboration or citation to legal authority, that it is impermissible for the Board to set rates for VED based on the fact that a large penalty was necessary to focus Citizens' attention on VED's problems. Citizens offered no evidence or allegations regarding the actual impact of the penalty on VED, nor did the company request a hearing on that issue. The Board responded by noting that Citizens failed to explain why it was inappropriate to consider the financial impact on the company as a whole, and by concluding that the return-on-equity penalty would not imperil VED's ability to attract capital. Indeed, the Board surmised that the substantial penalty would compel Citizens to address VED's management problems and thereby enhance VED's ability to attract resources from within the company. Based on these facts, we conclude that Citizens effectively waived its argument that the Board erred by considering the financial impact on the company as a whole rather than on VED as a stand-alone entity. See Twenty-Four Vt. Utilities, 159 Vt. at 352-53, 618 A.2d at 1303. Second, even assuming that the argument was adequately raised and briefed before the Board, we find it lacking in merit on this very sparse record. In this case, the Board expressed doubt about Citizens' suggestion that, in certain respects, VED operated as a stand-alone entity. After all, Citizens, not VED, is the entity that attracts outside capital and compensates investors. As the Board indicated in its reconsideration order, VED attracts capital only in the intracorporate arena, and thus the return-on-equity penalty should encourage the company to direct more resources to VED. Further, the Board found that the numerous transgressions identified in this proceeding resulted from mismanagement both in Vermont and in out-of-state headquarters, and that Citizens' officers and its corporate structure were responsible for the pattern of misbehavior that prompted the Board's imposition of substantial penalties. The only case cited by Citizens in support of its argument that the Board should not have considered the financial impact of its rates on the company as a whole is an 1898 United States Supreme Court case that did not concern a rate-of-return penalty arising from a utility's imprudence or mismanagement. See Smyth v. Ames, 169 U.S. 466, 541, 18 S.Ct. 418, 42 L.Ed. 819 (1898) (The State cannot justify unreasonably low rates for domestic transportation, considered alone, upon the ground that the carrier is earning large profits on its interstate business, over which, so far as rates are concerned, the State has no control.). As discussed above, modern courts and commentators generally agree that regulatory agencies may impose rates that punish managerial inefficiency and provide an incentive for improvement. See, e.g., Mountain Fuel Supply, 861 P.2d at 427 (regulatory commission may reduce rate of return as method to prompt utility to correct mismanagement and inefficiency without offending standard established by Supreme Court); Bonbright, et al., supra, at 205 (in determining fair rate of return, regulatory commissions may consider effect rates will have not only on allowing public utility to secure capital to provide service but also on stimulating managerial efficiency). Here, the Board found that its return-on-equity penalty was absolutely necessary to focus the company's attention on its operational deficiencies and to prevent a recurrence of past problems. In the second part of its constitutional argument, Citizens contends that the Board violated the standard set forth in Supreme Court cases by imposing a return on equity below any range of reasonableness. We conclude that Citizens has failed to meet its burden of demonstrating that the rates imposed by the Board are so low as to be confiscatory and thus unconstitutional. The fundamental considerations in determining just and reasonable rates were set forth by the United States Supreme Court nearly eighty years ago: A public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs for the convenience of the public equal to that generally being made at the same time and in the same general part of the country on investments in other business undertakings which are attended by corresponding risks and uncertainties; but it has no constitutional right to profits such as are realized or anticipated in highly profitable enterprises or speculative ventures. The return should be reasonably sufficient to assure confidence in the financial soundness of the utility and should be adequate, under efficient and economical management, to maintain and support its credit and enable it to raise the money necessary for the proper discharge of its public duties. Bluefield Water Works & Improvement Co. v. Public Serv. Comm'n, 262 U.S. 679, 692-93, 43 S.Ct. 675, 67 L.Ed. 1176 (1923) (emphasis added); see In re Village of Hardwick Elec. Dep't, 143 Vt. 437, 442, 466 A.2d 1180, 1182 (1983) (quoting and following Bluefield standard). Bluefield, however, did not concern a review of rates reduced for imprudence or mismanagement. Commentators and courts have acknowledged since Bluefield that a utility is not entitled to the same rate of return irrespective of the efficiency of the utility's management or the adequacy of its service. See R. Pierce & E. Gellhorn, Regulated Industries 134-35 (3d ed. 1994) (The phrase `under efficient and economical management' [in Bluefield ] is an important qualification. If an agency finds that a firm is not being managed efficiently and economically, it can lower the firm's allowed rate of return below the level otherwise required to meet the comparable risk test.); C. Philips, The Regulation of Public Utilities 553 (1993) (there is no such thing as a reasonable rate for service that is deficient); see also D.C. Transit Sys., Inc. v. Washington Metro. Area Transit Comm'n, 466 F.2d 394, 420-21 (D.C.Cir.1972) ( Bluefield addressed adequacy of return `under efficient and economical management') (citing Bluefield, 262 U.S. at 693, 43 S.Ct. 675); Arlington Selectmen, 136 Vt. at 498, 394 A.2d at 1131 (we have accepted [the] general proposition ... that poor service can justify lower rates); New England Tel. & Tel. Co., 115 Vt. at 513, 66 A.2d at 147 (A utility must be efficiently and economically managed and operated as a condition to the exercise of its right to impose rates adequate to cover the full cost of service and thus satisfy the investor requirement.); In re General Tel. Co., 98 N.M. 749, 652 P.2d 1200, 1209 (1982) (regulatory commission may consider in rate proceeding quality or inadequacy of service in determining what is just and reasonable rate of return to utility); National Utilities, Inc. v. Pennsylvania Pub. Util. Comm'n, 709 A.2d 972, 979 (Pa.Cmwlth.Ct. 1998) (Fifth and Fourteenth Amendments are not violated when public utility is denied rate increase for failing to provide adequate service to public, even if result is rate of return less than utility would otherwise be entitled to receive). In arriving at a determination of just and reasonable rates, the regulatory agency is required to balance both investor and consumer interests. See Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 603, 64 S.Ct. 281, 88 L.Ed. 333 (1944); Village of Hardwick Elec. Dep't, 143 Vt. at 443, 466 A.2d at 1183; In re Public Serv. Co. of N.H., 130 N.H. 265, 539 A.2d 263, 268 (1988) (constitution requires only that regulatory body engage in rational process of balancing consumer and investor interests). Of course, a fair return to investors is not necessarily fair to consumers. New England Tel. & Tel. Co., 115 Vt. at 513, 66 A.2d at 147; see Federal Power Comm'n v. Natural Gas Pipeline Co., 315 U.S. 575, 607, 62 S.Ct. 736, 86 L.Ed. 1037 (1942) (Black, Douglas and Murphy, JJ., concurring) (The consumer interest cannot be disregarded in determining what is a `just and reasonable' rate. Conceivably, a return to the company of the cost of the service might not be `just and reasonable' to the public.); Pennsylvania Elec. Co. v. Pennsylvania Pub. Util. Comm'n, 509 Pa. 324, 502 A.2d 130, 134 (1985) (legitimate areas of concern noted in Hope are appropriate factors to be weighed in balancing consumer and investor interests, but are not, in themselves, controlling); El Paso Elec. Co. v. Public Util. Comm'n, 917 S.W.2d 846, 862 (Tex.Ct.App.1995) (end result of balance of consumer and investor interests does not insure that utility will produce net revenues). Ratemaking necessarily encompasses an evaluation of the efficiency of the public utility's operations, the adequacy of its service, and the competency of its management. In re Valley Road Sewerage Co., 285 N.J.Super. 202, 666 A.2d 992, 996 (App.Div.1995). Each of these factors must be considered when determining whether rates are just and reasonable under constitutional and statutory standards. See id. at 995-96. Hence, rate levels are not offensive to constitutional and statutory standards merely because they fix returns at a lower scale for inefficient operators. Id. at 995; see D.C. Transit Sys., Inc., 466 F.2d at 419 (utility's fulfillment of its service commitments is sine qua non to constitutional protection under confiscation principles; inefficiency and inferior service deserve less return than would normally be forthcoming). Accordingly, we reject Citizens' suggestion that it is entitled to a certain level of return no matter how egregious its mismanagement or inadequate its service. See Valley Road Sewerage, 666 A.2d at 996. If we were to accept this notion, it would, in effect, permit Citizens to disregard its public obligations and yet insist upon rates that guarantee its continued financial integrity. See D.C. Transit Sys., Inc., 466 F.2d at 422. As demonstrated by the case law cited above, the constitution does not compel such a result. See id. at 423 (constitution neither guarantees public utility immunity from loss occasioned by mismanagement, nor bars regulatory agency from taking adequate steps to protect public from such mismanagement, even if short-term effect is temporary loss to utility); State ex rel. Utilities Comm'n, 208 S.E.2d at 687 (commission is not required to fix rates without regard to quality of service, thereby guaranteeing fair rate of return to complacent monopoly that persists in rendering mediocre service and defying commission orders). On appeal, Citizens has the heavy burden of demonstrating that the rates imposed by the Board are unjust and unreasonable. Hope, 320 U.S. at 602, 64 S.Ct. 281; see Jersey Cent. Power & Light Co. v. F.E.R.C., 810 F.2d 1168, 1175-76 (D.C.Cir.1987) (under deferential standard established in Hope, the courts cannot intervene in the absence of a clear showing that the limits of due process have been overstepped). Our role in reviewing Board orders is not to reweigh the Board's balancing of consumer and investor interests in setting rates, but rather to assure ourselves that the Board has given reasoned consideration to both of those interests, and to consider whether, given those interests, the end result of the rate order is within a zone of reasonableness. In re Permian Basin Area Rate Cases, 390 U.S. 747, 791-92, 88 S.Ct. 1344, 20 L.Ed.2d 312 (1968); Hope, 320 U.S. at 603, 64 S.Ct. 281; see Jersey Cent., 810 F.2d at 1191-92 (Starr, J., concurring) (constitution requires only that end result reflect reasonable balancing of interests of investors and ratepayers). Barring a showing that, given all of the circumstances, the Board's order results in unjust rates, we defer to the Board's decision because it calls for a highly expert judgment that requires the balancing of considerations that cannot be cast into a legalistic formula and thus are better left entrusted to the regulatory agency. Natural Gas Pipeline Co., 315 U.S. at 607, 62 S.Ct. 736 (Black, Douglas and Murphy, JJ., concurring); see Bonbright, et al., supra, at 317 (it is generally accepted that commissions may apply their own judgment under deferential test established in Hope and its progeny). `If the total effect of the rate order cannot be said to be unreasonable, judicial inquiry... is at an end.' Duquesne Light Co. v. Barasch, 488 U.S. 299, 310, 109 S.Ct. 609, 102 L.Ed.2d 646 (1989) (quoting Hope, 320 U.S. at 602, 64 S.Ct. 281). We stress that other than claiming broadly that the rate-of-return reduction is confiscatory and therefore unconstitutional, Citizens has made virtually no record to support its argument. Thus, it has failed to recognize, let alone satisfy, its heavy burden. Cf. US West, 949 P.2d at 1359 (utility made no showing that commission's rate decision fell outside zone of reasonableness). Its only support for the argument that the Board's return-on-equity penalty results in unjust and unreasonable rates is: (1) the reduced return on equity imposed by the Board limited the company, at least temporarily, to the same return obtained by holders of passbook savings and certificate-of-deposit accounts, one of the alternative justifications cited by the Board; (2) the penalties imposed in this case are more severe than those imposed in a number of out-of-state decisions involving completely different facts; and (3) an affidavit, submitted to the Board as part of the company's motion for reconsideration, in which a company accountant states that the Board's return-on-equity penalty will result in reduced revenues of approximately $1.5 million annually. Neither the citations to distinguishable case law, nor the single statement in the affidavit, nor the bald assertion that it was plainly inappropriate for the Board to restrict its rate of return to the return generated by passbook savings accounts  either considered separately or together  come close to satisfying the standard under which we may overturn rate decisions. In justifying its failure to make a record to support its argument, Citizens returns to its claim, rejected above, that it was denied proper notice that such a heavy penalty was contemplated by the Board. Even if we were to accept that claim, however, it would not explain Citizens' failure to proffer any evidence before the Board, in connection with its motion for reconsideration, to show the effect of the rate-of-return order on the company or its Vermont Electric Division. Cf. Twenty-Four Vermont Utilities, 159 Vt. at 352, 618 A.2d at 1303 (utility waived issue by failing to raise it before Board and include it in post-judgment motion). Nor would it explain Citizens' failure to seek an additional hearing to put on additional evidence concerning that effect of the rate order. In short, Citizens has utterly failed to meet its heavy burden of demonstrating that the Board's rate decision is so plainly unreasonable as to be confiscatory and therefore unconstitutional. The decisions of the Public Service Board dated June 16, 1997 and August 28, 1997 are affirmed.