Court: Appellate Court of Illinois; July 17, 1996; Illinois; State Appellate Court
Justice Hutchinson delivered the court's opinion regarding an appeal from an order issued by the Illinois Commerce Commission (Commission) concerning Illinois Bell Telephone Company's (Bell) rate regulation. Bell filed a petition to regulate rates for noncompetitive services, leading to a complaint from the Citizens Utility Board (CUB) seeking an investigation and reduction of Bell's rates. The Attorney General (AG), AT&T, and MCI intervened in the proceedings, which were consolidated by the Commission.
CUB raised multiple issues challenging the Commission's order, including claims that the Commission failed to incorporate a proper price index, allowed Bell to earn monopoly profits contrary to the Public Utilities Act, and improperly delegated legislative authority. CUB also asserted that the Commission violated regulatory provisions by granting Bell excessive pricing flexibility, incorrectly adopted Bell's revenue reductions based on selective evidence, and deregulated depreciation rates without proper justification. Additional concerns included the Commission's failure to apply relevant statutes, modify Bell's capital structure to manage costs, and enforce burden of proof standards.
Conversely, Bell contended that the Commission acted arbitrarily by making certain adjustments to the price-cap index and imputing revenue based on unsubstantiated assumptions. Bell also criticized the Commission for its approach to determining fair rates of return, disallowing depreciation expenses, and excluding discretionary services from rate calculations. The court consolidated the appeals of all involved parties for review.
AT&T argues that the Commission erred by ordering rate reductions in bands B, C, and D, which could disadvantage competitors like Bell, and alternatively suggests the Commission should have mandated across-the-board rate reductions for Bell’s switched access services. MCI contends that the Commission violated section 13—506.1 by granting Bell price flexibility for noncompetitive services without adequate evidence, failing to require intra-MSA equal access and presubscription as a quid pro quo for reduced regulation, and incorrectly regulating Bell’s noncompetitive services given its local monopoly status. MCI also asserts that the Commission improperly reduced Bell's local usage rates below imputed costs without adjusting carrier access rates accordingly.
The document highlights the appellants' failure to provide a complete table of contents for the record on appeal as mandated by Rule 342(a), which specifies the requirement for a detailed index of documents and witness testimonies. The absence of this table is particularly concerning due to the voluminous nature of the record, comprising seven crates and thousands of pages. The appeal warns that future non-compliance with Rule 342(a) may lead to dismissal of appeals.
Section 13—506.1 allows the Commission to adopt alternative regulatory methods for noncompetitive telecommunications services, moving away from the traditional rate of return (ROR) regulation, which involves setting rates to achieve a reasonable return on equity. The document references a previous case where the Commission's attempt to implement an alternative regulatory plan was overturned on appeal as exceeding its authority.
Section 13—506.1 expands the Illinois Commission's authority to implement alternative forms of regulation for noncompetitive telecommunications services, allowing for methods like price regulation and earnings sharing to establish just and reasonable rates. Both telecommunications carriers and the Commission can initiate plans, which must be evaluated based on public policy goals and several criteria, including reducing regulatory delays and promoting innovation and efficiency. The Commission can only implement a plan after a hearing, confirming it serves the public interest, produces reasonable rates, adapts to technological changes, and maintains service quality without disadvantaging any customer class. Safeguards include capping basic residential service rates for the first three years, requiring annual compliance reports, allowing for plan rescission based on allegations of unfair rates, and ensuring preexisting protections against discriminatory rates remain intact. The legislature aims to transition the telecommunications industry from a regulated monopoly to a competitive market, emphasizing the necessity of affordable telecommunications services. Article 13 of the Act, which governs this regulation, is set to repeal on July 1, 1999, necessitating the implementation of market mechanisms to maintain service availability and affordability. The State of Illinois prioritizes allowing competition to replace certain regulatory aspects, as long as consumer protection is upheld.
Section 13—506.1 facilitates the transition of the telecommunications industry from monopoly to a competitive market. Although Bell's alternative regulatory plan operates under this section, it remains relevant to traditional rate of return (ROR) regulation issues. Bell's proposal is classified as 'pure price' or 'price cap' regulation, necessitating that Bell demonstrate the reasonableness of existing rates at the plan's inception. To support its case, Bell submitted conventional evidence related to cost of capital and general rate cases. The Citizens Utility Board (CUB) has challenged the appropriateness of Bell's pre-plan rates and is seeking a $209 million rate reduction.
Under Bell's proposed price-cap regulation, an initial 'going-in' rate is set using ROR regulation, with a price index dictating allowable rate increases. This price-cap index is composed of three elements: (1) general inflation, (2) Bell’s productivity growth and input price changes, and (3) service quality metrics. The index is calculated by adjusting the inflation rate with Bell's historical productivity changes and the service quality component, establishing the percentage by which rates may be increased.
Bell categorizes its customers into four 'baskets': residential, business, carrier, and other. Each basket has distinct pricing rules, allowing annual increases up to the price-cap index plus 5%, provided offsets are made for any excess increases within the basket. Importantly, the plan does not regulate or monitor Bell's earnings, granting the company management autonomy within the constraints of the price-cap index. Bell can also determine its depreciation rates, assuming typical business risks and benefits.
The Commission conducted an extensive review, with significant evidence and testimony from over 20 intervenors, spanning nearly two years from Bell's petition filing to the Commission's order. Ultimately, the order accepted a modified version of Bell's plan, which was based on a one-year data period from September 1, 1991, to August 31, 1992, to establish the revenues and expenses for determining the going-in rates.
Bell's intrastate net original cost rate base for its telephone plant in Illinois was determined to be $2.917 billion, reflecting downward adjustments from its proposed rate base of $3.122 billion, including $48.794 million in total adjustments. This amount comprised $1.3 million for depreciation expenses linked to vacancy levels of Bell-owned facilities. The Commission also assessed Bell's operating income at $281.188 million, incorporating adjustments to Bell's reported revenues and expenses, notably a $51 million increase in revenue attributed to potential earnings from more effective negotiations with the Yellow Pages publisher.
The Commission's price-cap index, diverging from Bell's proposal, considered factors such as overall economic inflation, Bell's productivity growth and input prices, a consumer productivity dividend, service quality, and other external changes. The initial price-cap index was set at '100.00', with annual updates based on a defined formula that includes inflation adjustments and performance metrics. The Commission selected the gross domestic product price index (GDPPI) as the inflation measure, a choice supported by expert witnesses from both sides. It was noted that the GDPPI must be periodically adjusted to reflect economic shifts, and Bell is required to disclose any updates to GDPPI weights in its annual filings, as calculated by the U.S. Department of Commerce.
Growth rates of productivity and input prices in the telecommunications industry, particularly for Bell, have historically diverged from those in the broader economy. The Commission noted that the telephone industry has experienced lower input price growth and higher productivity growth, leading to lower output price growth in comparison to the overall economy. To account for this disparity, the Commission adjusted the Gross Domestic Product Price Index (GDPPI), reducing it by 2% to reflect Bell's input price differential. From 1984 to 1991, while the GDPPI grew at 3.7% annually, Bell's input prices grew at a rate 2.5% slower than the economy-wide input prices, which was attributed in part to structural changes following the AT&T divestiture. However, the Commission adjusted the input price growth reduction from 2.5% to 2% due to the influence of recent tax law changes.
Additionally, the GDPPI was reduced by 1.3% to account for Bell's superior productivity growth, measured through total factor productivity (TFP). The Commission accepted a differential TFP of 1.3%, reflecting Bell's historic productivity advantage. The methodologies used for these adjustments aligned with practices observed by the Federal Communications Commission (FCC). To benefit consumers, the Commission incorporated a 1% consumer productivity dividend, ensuring that ratepayers would receive advantages from efficiency improvements stemming from regulatory changes. Bell's argument that its historical productivity would be sufficient for ratepayer benefits was dismissed, as the consumer dividend was designed to guarantee that ratepayers would be the primary beneficiaries of any future productivity enhancements. Testimony indicated that such a dividend could encourage Bell to improve efficiency and recognize the positive impact of incentive regulation on productivity.
The Commission adopted a consumer productivity dividend of 1 to ensure consumers benefit from increased productivity. It retains the ability to adjust the price-cap index for exogenous changes, defined as costs beyond Bell's control that are not reflected in the GDPPI, are quantifiable, and meet a threshold of $3 million or greater. Specific examples and calculation methods for these adjustments are provided. Adjustments can only occur if deemed necessary by the Commission.
The price-cap index includes a service quality adjustment based on eight proposed measurements, with annual evaluations of Bell’s service quality. A score of zero is given for maintained quality, while a decline results in a score of -0.25 per category. If all categories decline, a total downward adjustment of 2 is applied. The overall downward adjustment to the GDPPI, excluding other adjustments, totals 4.3, composed of a 2 input price differential, 1.3 productivity growth differential, and the 1 consumer productivity dividend.
Bell's services are categorized into four baskets: residential, business, carrier, and 'other,' which contains discretionary services. Price increases for these services must not exceed the percentage change in the price-cap index, with a presumption of reasonableness for increases up to that threshold. Bell can raise individual service rates by an additional 2%, provided it offsets this increase with reductions in other services within the same basket. Basic residential service rates are capped for the first five years, covering specified network access and usage rates. A similar five-year cap applies to bands B and C usage services. The overview simplifies the regulatory plan's mechanisms to focus on essential information. Further details will be provided as needed.
The standard of review for orders from the Commission is limited, with factual findings and conclusions presumed true and reasonable, as established by 220 ILCS 5/10—201(d). The burden of proof lies with appellants in any appeal. A Commission order may be reversed if: (A) its findings lack substantial evidence; (B) it exceeds the Commission's jurisdiction; (C) it violates state or federal laws; or (D) the proceedings violated constitutional laws to the appellant's detriment. Substantial evidence is defined as more than a minimal amount, sufficient for a rational mind to support a conclusion, without requiring a preponderance of evidence. The reviewing court cannot reassess the credibility or weight of evidence nor substitute its judgment for that of the Commission. The complexity of evaluating regulatory plans is recognized, emphasizing the Commission’s specialized expertise, which is afforded significant deference. However, the Commission's interpretation of statutory standards does not receive the same level of deference, allowing the reviewing court to affirm, reverse, or remand as necessary.
The discussion begins by outlining the organization of the review, which addresses 28 distinct questions from Bell, CUB, AT&T, and MCI under various substantive headings, rather than addressing each party's contentions in isolation.
CUB contends that section 13—506.1, permitting monopoly profits, is unconstitutional and exceeds the state's police powers, which are intended to protect public health, morals, safety, or welfare. The police power must have a reasonable relationship to the public interest, and due process requires that its exercise is not arbitrary or unreasonable. The legislature has recognized affordable telecommunications services as vital for the health and welfare of Illinois citizens and has determined that competition can replace traditional regulation when consumer protection is maintained.
CUB claims that the original intent of the Act was to prevent public utilities from charging excessive rates and argues that section 13—506.1 undermines this intent. However, it is stated that even if CUB's assertion about the Act's purpose is accurate, it does not render section 13—506.1 unconstitutional under the police power. The police power allows for legislation in the public interest without mandating specific outcomes, meaning that preventing excess profits is not a necessary condition for the exercise of this power. Thus, even if section 13—506.1 deviates from the purported original purpose of the Act, such deviation does not violate the police power.
Section 13—506.1 establishes guidelines for addressing public health, safety, and welfare concerns related to telecommunications services, mandating that rates be 'fair, just, and reasonable.' It requires that any alternative regulatory plan must demonstrate benefits to ratepayers, maintain service quality, and avoid undue prejudice to any customer class. The section reflects a reasonable relationship to the goal of maintaining affordable telecommunications, recognizing the necessity of delegating broad authority to administrative agencies like the Commission to adapt to modern demands.
The excerpt contrasts with the Figura case, where an overly broad legislative approach was deemed unreasonable. In contrast, section 13—506.1 is tailored to avoid unintended consequences while promoting competitive mechanisms over traditional rate-of-return regulation. The argument against vagueness in the delegation of authority is addressed, affirming that the standards provided are sufficiently precise to guide the Commission's discretion. The Act emphasizes the importance of aligning with public policy goals and stipulates seven specific criteria that any regulatory plan must meet to be approved.
Any adopted plan must keep basic residential service rates unchanged for three years from the level in effect 180 days prior to the plan's filing, as stipulated in 220 ILCS 5/13—506.1(c) (West 1994). This provision serves as a legislative safeguard against plans that violate established standards, allowing time for legislative amendments if necessary. The document also notes that certain material is unpublishable under Supreme Court Rule 23.
In the section regarding the capital structure of Bell and Ameritech, the Citizens Utility Board (CUB) claims the Commission did not apply section 9—230 correctly, leading to increased capital costs for ratepayers due to Bell's affiliation with Ameritech. CUB argues that the Commission failed to adjust Bell’s capital structure to prevent excessive costs. The first issue raised is legal—whether a hypothetical capital structure should have been used, as equity typically incurs higher costs than debt. CUB contends that Bell’s capital structure contains excessive equity, advocating for a hypothetical structure with a balanced debt-to-equity ratio, referencing relevant case law to support its argument.
Conversely, the Commission defends its decision to utilize Bell's actual capital structure, asserting it is lawful and reasonable, backed by substantial evidence. The Commission asserts that a hypothetical structure is appropriate only if the actual structure is unreasonable or imprudent. The Commission also addresses the central questions of its obligations under section 9—230 and whether it fulfilled those obligations.
In establishing rates or charges for public utilities, the Commission must exclude any risks or increased capital costs arising from the utility's affiliation with unregulated or nonutility companies. This principle is supported by the Illinois Compiled Statutes (220 ILCS 5/9—230) and has been interpreted in previous cases. In Central Illinois, the court found no violation of this section when the Commission allowed Central Illinois Public Service Company (CIPS) to include temporary cash investments (TCIs) in its capital structure, stating that the inclusion did not affect CIPS's cost of capital. In Citizens Utility Board II, the court analyzed Centel's capital structure and rejected claims of inflated equity impacting costs due to its affiliation with Sprint, emphasizing that the utility must demonstrate the reasonableness of its rate proposals and capital structure. The appellate court directed the Commission to reassess whether Centel's capital structure allowed Sprint to subsidize risky operations and whether it was necessary for service provision. The Commission must also determine if the utility's risk or capital costs increased due to its affiliation with other companies, aiming to uphold legislative intent in statutory interpretation.
In Professional People for the Public Interest v. Illinois Commerce Commission, the court emphasized that the statutory language is crucial for interpreting legislative intent, particularly in section 9—230. The term "any" prohibits the Commission from considering any incremental risk or increased cost of capital when determining a reasonable rate of return (ROR). This mandates that the Commission has no discretion in assessing what part of these increases might be deemed "reasonable" for ratepayers; all increases must be excluded from ROR calculations.
The court ruled that if a utility's risk or capital costs rise due to its affiliation with an unregulated entity, these costs cannot be factored into the ROR. The Commission's previous order was reversed and remanded because it misapplied section 9—230 by only evaluating the reasonableness of a utility’s capital structure without addressing whether the affiliation caused increased risks or costs.
The ruling aligns with prior decisions, such as Central Illinois, which upheld that a utility’s cost of capital should not be influenced by its unregulated parent. Additionally, the court noted that while rates must exclude any incremental risk or cost due to affiliation, simply omitting these factors does not automatically ensure that the rates are just and reasonable. Therefore, the Commission is required to demonstrate that proposed rates are just and reasonable while also confirming that all incremental risks or costs from affiliations have been excluded. The Act stipulates that both findings must be made, and the Commission's failure to do so constituted an error.
The Commission determined that Bell's actual capital structure was reasonable, rejecting claims from CUB regarding substantial evidence presented by its witness James Rothschild and AG witness Stephen G. Hill. CUB alleged that the Commission ignored this evidence, but the Commission discounted their testimonies, instead favoring the evidence from staff witness Jon Summerville and Bell witness Phillips. The distinction between whether the Commission considered substantial evidence and whether its findings were supported by substantial evidence is emphasized, with CUB not contesting the support for the determination but questioning the Commission's adherence to section 9—230. This section mandates that a reasonable rate of return should not include any increased cost of capital. The analysis under section 9—230 is separate from the assessment of the justness and reasonableness of the capital structure, yet findings in one can impact the other. Phillips provided three rationales for the reasonableness of Bell's capital structure: (1) comparison with comparable telecommunications companies, (2) alignment with Standard & Poor's 1992 financial guidelines, and (3) a favorable risk assessment based on Value Line metrics.
Phillips argued that the hypothetical capital structures suggested by Rothschild and Hill contradict industry rating trends, potentially undermining Bell’s financial integrity. He emphasized that altering the previously accepted capital structure would unsettle investors. Summerville supported Phillips, advocating for the use of Bell’s actual capital structure, which he claimed resulted in reasonable rates based on several factors: the embedded cost of long-term debt, short-term debt rates, equity ratios compared to industry projections, risk-adjusted criteria for bond ratings, and Bell's standing among 40 traded telecommunications companies.
The Commission's finding that Bell’s actual capital structure is reasonable is backed by substantial evidence. However, on remand, the Commission must assess whether Bell faces any incremental risk or increased capital costs due to its affiliation with Ameritech. The court clarifies that it will not dictate the methodology for this assessment but emphasizes that the Commission must ensure that no increased risks or costs—intentional or not—are reflected in utility rates, adhering to the legislative intent against such inclusions. If the Commission finds that Bell's costs have risen due to its affiliation with Ameritech, it must quantify this increase and exclude it from Bell’s return on revenue (ROR) calculations. Furthermore, the Commission is allowed to consider additional arguments from the parties and may determine the necessity of further evidence to comply with the requirements of section 9-230.
The Commission has misapplied the legal standard under section 9—230, necessitating a focused examination of issues related solely to this section unless authorized otherwise. If a violation of section 9—230 is found, the Commission will allow additional evidence regarding the reasonableness of Bell’s capital structure, but only if an increase in capital cost or risk due to affiliation is demonstrated. A violation does not automatically require adopting a hypothetical capital structure; the Commission may choose to address increased costs through imputation instead. However, evidence of incremental risk or increased capital costs would compel a reassessment of Bell's actual capital structure's reasonableness.
Due to the errors noted in part XII, the Commission's order is reversed and remanded for further proceedings aligned with these findings. The entire order is reversed because the regulatory plan is interlinked, meaning changes to one aspect could affect the whole. Parties are not permitted to relitigate all previously decided issues and may only raise new arguments with the Commission’s permission. If no increased risk or cost is found, other issues become moot; if an increase is found, further evidence and arguments regarding Bell's capital structure will be permitted, followed by a determination on reopening other issues. The order of the Illinois Commerce Commission is reversed and remanded with specific directions.
