Opinion ID: 2215827
Heading Depth: 1
Heading Rank: 3

Heading: claims of confiscation.

Text: Boston Edison advances two theories of confiscation. It first alleges that the rate of return allowed by the Department in 18515 was unreasonably low, thereby depriving the Company of the opportunity to earn a fair return on its investment in violation of arts. 1, 10, and 12 of the Declaration of Rights of the Constitution of the Commonwealth and the Fourteenth Amendment to the Constitution of the United States. Clearly this allegation entitles the Company to independent review as to both law and fact. However, Boston Edison seeks to have the court employ this same degree of scrutiny in reviewing each of the many cost-of-service adjustments subsidiary to the Department's final decision in 18515. For this reason, apparently, the Company alleges a second theory of confiscation  confiscation by adjustment. The Company contends that, even if the allowed rate of return was not confiscatory, the numerous adjustments to cost of service ensured that the Company could never earn the return to which the Department found it was entitled. We do not consider whether these allegations even give rise to a claim of confiscation because we conclude instead that Boston Edison failed to meet its burden of proving confiscation on either theory. Confiscation occurs when the Department's ratemaking decision deprives a utility of the opportunity to realize a fair and reasonable return on its investment. Boston Gas Co. v. Department of Pub. Utils., 368 Mass. 780, 789-790 (1975). A return is fair and reasonable if it covers utility operating expenses, debt service, and dividends, if it compensates investors for the risks of investment, and if it is sufficient to attract capital and assure confidence in the enterprise's financial integrity. Fitchburg Gas & Elec. Light Co. v. Department of Pub. Utils., 371 Mass. 881, 884 (1977). See Permian Basin Area Rate Cases, 390 U.S. 747, 792 (1968); Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 603 (1944); Bluefield Water Works & Improvement Co. v. Public Serv. Comm'n of W. Va., 262 U.S. 679, 690 (1923). Yet, it is not enough for a utility merely to allege confiscation in the hope that this court will disagree with the particulars of a complex decision and will supplant it with another more to the Company's liking. This court will not interfere with the exercise of the ratemaking power unless confiscation is clearly established on the record before us. See New England Tel. & Tel. Co. v. Department of Pub. Utils., 327 Mass. 81, 85-86 (1951); St. Joseph Stock Yards Co. v. United States, 298 U.S. 38, 53 (1936). Cf. Fitchburg Gas & Elec. Light Co. v. Department of Pub. Utils., supra at 885. In the instant case, we are not persuaded that Boston Edison will suffer confiscation. As in previous rate proceedings, the Department adopted and applied the cost of capital method of determining the fair rate of return on the Company's rate base. No issue is now presented as to the cost of debt capital or as to the capital structure of the Company. The Company maintains, however, that the 13% return allowed on common stock seriously understated the Company's cost of equity capital and that, as a result, the composite rate of return allowed by the Department  9.49%  was confiscatory or otherwise contrary to law. There is no dispute that the return on equity capital must at least equal `the amount which the company would have to pay in order to hire its equity capital under current conditions.' New England Tel. & Tel. Co. v. Department of Pub. Utils., 327 Mass. 81, 88 (1951). We have recognized, however, that fixing the fair rate of return is a matter of judgment, not a mechanical exercise. New England Tel. & Tel. Co. v. Department of Pub. Utils., 360 Mass. 443, 474 (1971). The rate of return is not an immutable number, but rather one chosen from a range of reasonable rates and determined by the Department to be appropriate under the circumstances. Id. The question before us as to equity capital is whether the 13% figure was above the line of confiscation. Having reviewed the record, we hold that the Department's cost of equity determination is not confiscatory or otherwise illegal. Five witnesses testified as to the rate of return, and their estimates as to the cost of equity ranged from 11.2% to 15.5%. Each of these experts presented a sophisticated analysis that gave the outward appearance of objectivity, but, on closer scrutiny, it is apparent that the method applied by each contained inconsistencies. Each provided an opinion which a reasonable mind might accept as adequate to support a conclusion, see G.L.c. 30A, § 1 (6), but each based his analysis on assumptions that were controversial in themselves. The Department did not base its decision on the testimony of any one witness. Rather, the Department's written decision evaluates the strengths and weaknesses of each witness's testimony, culling from the mass of evidence those elements which, we agree, are worthy of weight. In so doing, the Department based its cost of equity judgment on a reasoned composite of all the evidence. That is a process which this court has strongly encouraged. See Wannacomet Water Co. v. Department of Pub. Utils., 346 Mass. 453, 465-471 (1963). Compare Boston Gas Co. v. Department of Pub. Utils., 368 Mass. 780, 804 (1975), with New England Tel. & Tel. Co. v. Department of Pub. Utils., 360 Mass 443, 474-475 (1971). [T]he return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks. Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 603 (1944). See Fitchburg Gas & Elec. Light Co. v. Department of Pub. Utils., 371 Mass. 881, 884 (1977); Permian Basin Area Rate Cases, 390 U.S. 747, 792 (1968). Clearly, the 13% return on equity satisfied this standard. The Company's witness Benore arrived at 15.5% as his estimate of the cost of equity by comparing the potential return on the Company's shares with the return on industrials shares generally. This comparison is of minimal value because of the dissimilarity of the risks facing public utilities and those facing industrials. See J. Bauer, Updating Public Utility Regulation: Assuring Fair Rates and Fair Returns 107 (1966); Note, An Earnings-Price Approach to Fair Rate of Return in Regulated Industries, 20 Stan. L. Rev. 287, 289 (1968). The dissimilarity between utility and industrials shares is further demonstrated by recent history, since, according to the Company's own evidence, the two groups of securities have not been even roughly comparable since 1965. [3] However, the record contains evidence allowing a comparison of Boston Edison's financial condition to that of fifteen other similarly situated public utilities. These figures were current at the time of the Department's decision, and they show that with a 13% return on equity, Boston Edison enjoyed returns commensurate with the returns earned by similar utilities. [4] The Company ranked at or near the bottom of the sample in several indicators of equity return [5] yet Boston Edison's stock yielded higher dividends than any other stock in the sample. More importantly, the Company's earnings per share were 10.54% of market price, using test year 1975 earnings and the year-end price. Equivalent figures for comparable utilities ranged from 8.84% to 15.24%, and Boston Edison's allowed yield of 13% was the sixth highest of the sixteen. The record as a whole does not sustain a claim of confiscation based on a comparison between Boston Edison and other public utilities. In addition to being commensurate with the returns allowed comparable companies facing comparable risks, the return on equity should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital. Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 603 (1944). See Fitchburg Gas & Elec. Light Co. v. Department of Pub. Utils., 371 Mass. 881, 884 (1977). Boston Edison failed to establish confiscation measured by this standard, as well. A poll introduced by the Company indicated that one out of every eight financial institutions would be attracted, at a 13% return, to the common stock of a public utility whose A-rated bonds were selling to yield 10%. Boston Edison's bonds are one step lower than A-rated, but the strong improvement in money market conditions between the time these investors were polled and the time of the Department's decision in 18515 caused the Department to conclude that a 13% return on equity would be sufficient to attract capital and maintain investor confidence. We agree. Although the Company's bonds are not A-rated, the record shows that at the time of the Department's decision, bonds of a grade comparable to those of the Company had recently sold to yield 11.75%. This evidence cuts both ways. It shows a reluctance on the part of some investors to buy Boston Edison bonds, while the Company's return on equity is 13%, unless they receive a greater return than 10%. Nevertheless, it also shows quite clearly that, with a 13% return on equity, there were enough investors in the market willing to buy Boston Edison bonds if the Company were to pay a return slightly higher than that on which investors polled had previously premised their vote of confidence. Moreover, the financial market in which the Company operates improved substantially over the course of the 18515 proceedings. The Attorney General argues persuasively that this trend continued up to the time of oral argument in this case. At the beginning of test year 1975, the prime interest rate was 10.25%; by the close of the 18515 proceedings in May, 1976, the rate had dropped to 6.75%. As the Company's senior vice president testified, this drop in the interest rate, together with the general improvement in the stock market, has had a restorative effect on the value of the Company's stock: toward the end of 1974, the price of Boston Edison stock ranged from $15 to $17 a share; by the end of test year 1975, the price had risen to $22 a share; by the end of the 18515 proceedings, the stock was selling at $24.50 a share. [6] Clearly, there is an improving market for the Company's outstanding shares, and Boston Edison cannot claim confiscation based on lack of investor confidence. The principal factor causing Boston Edison's witnesses to advocate a 15% return on equity was the Company's belief that the capital attraction standard of the Hope Natural case [7] requires the Department to allow a return on equity sufficient to maintain the market price of the Company's stock at a level slightly higher than the stock's book value. The Department concedes that the 13% return allowed in 18515 will not accomplish this result, and it also recognizes that, in a proper case, a market price lower than book value provides some evidence of confiscation. See, e.g., New England Tel. & Tel. Co. v. Department of Pub. Utils., 371 Mass. 67, 76 (1976). The per se rule advocated by the Company finds no support in our cases, and we are not inclined to adopt it now. Experience has shown that, in making a determination as elusive as estimating the cost of equity capital, mathematical formulas and rules of thumb are obsolete. 1 A.J.G. Priest, Principles of Public Utility Regulation 196 (1969). The Company's principal argument here is that, if it issues new shares, their cost to the new buyers must equal the book value of existing stock in order to avoid diluting the equity of existing shareholders in the corporation. In order to accomplish this, the Company argues, the rate of return must be sufficient (1) to cover the cost of issuing the additional shares, (2) to absorb the drop in market price caused, apparently, by the temporary glut of Boston Edison shares, and (3) to then maintain a market price equal to the book value of shares previously outstanding. Boston Edison asserts that, in order to complete the massive construction program it has undertaken, the Company may decide to issue additional stock. It further asserts that, if it must issue stock at a price lower than book value, it will dilute the equity of existing shareholders and that, as a result, investors will not be attracted to Boston Edison stock at any price. The Company cites no case in which this has occurred, and we know of none. The Department, of course, must set the rate of return high enough to preserve the financial integrity of the Company, but there was no showing in 18515 that the Company has been unable to attract capital in the past or that to issue common stock under present circumstances would jeopardize the Company's ability to attract capital in the future. The record contains speculation to that effect, but nothing more. [8] This is not a case in which the utility has a demonstrable inability to attract capital and where investors face a risk of continual dilution even as the utility finances its normal operations. In such a case, the utility might fairly allege that the dilution is attributable to State action, and this court has recognized that  as a prima facie matter, at least  forced dilution is confiscation. New England Tel. & Tel. Co. v. Department of Pub. Utils., 371 Mass. 67, 76 (1976). See New England Tel. & Tel. Co. v. Department of Pub. Utils., 360 Mass. 443, 477 (1971). In this case, however, Boston Edison's need for additional capital stems from a special project  a construction program of limited duration and unprecedented size. We cannot say as matter of law that the Constitution requires ratepayers to sustain the price of Boston Edison's stock above book value except to the extent absolutely necessary to maintain sufficient investor confidence to allow the business to continue as usual. Ultimately, it is investor confidence, not dilution considered by itself, that is the constitutionally significant criterion. The due process clause has been applied to prevent governmental destruction of existing economic values. It has not and cannot be applied to insure values or to restore values that have been lost by the operation of economic forces. Market St. Ry. v. Railroad Comm'n of Cal., 324 U.S. 548, 567 (1945). We are not persuaded that a market price lower than book value necessarily indicates a lack of opportunity to earn a fair return on equity. The record supports a conclusion to the contrary, namely, that investors are more interested in the return on the market price they pay than in the current book value of their stock. We find that the 13% cost of equity figure set by the Department is above the line of confiscation. The Company also argues that the determination is unsupported by substantial evidence, but we find substantial evidence to support any cost of equity judgment between 11.2% and 15.5%. Robinson argues that the 13% figure is so high as to be confiscatory of the ratepayers, but we disagree. The figure set by the Department falls within the range of permissible judgment. Boston Edison's failure to establish the indicia of confiscation is equally fatal to the claim that it has suffered confiscation by adjustment. The Company's only argument addressing the merits of this second claim is that the Department arbitrarily increased the Company's test year revenues and decreased its test year expense figures. As will be seen in the cost-of-service discussion, infra, the Department's adjustments were not arbitrary and, with three exceptions which we address, the adjustments of which the Company complains were not unlawful.