Opinion for the Court filed by Circuit Judge BORK.
BORK, Circuit Judge.
Alabama Power Company petitions for review of a determination by the Federal Communications Commission that the pole attachment rates it had been charging Group W Cable, Inc. were higher than the maximum permitted by the Pole Attachment Act, 47 U.S.C. § 224 (1982). Because we find that the Commission did not fairly
It has been the general practice of the cable television industry since its inception to lease space on existing distribution poles owned by electric utilities and telephone companies in order to attach its coaxial cables and related equipment.
47 U.S.C. § 224(b)(1). A rate would be considered just and reasonable if it:
47 U.S.C. § 224(d)(1). It is the task of the Commission, therefore, to ensure that the pole attachment rates charged cable operators do not fall below the statutory minimum — incremental costs — or above the statutory maximum — fully allocated costs.
Following passage of the Pole Attachment Act, the FCC instituted a complaint procedure that "focuses on the upper end of the zone of reasonableness." Brief for Respondents at 6. To calculate fully allocated costs, the Commission has adopted the following formulaic representation of the statutory definition:
Teleprompter Corp. v. Alabama Power Co., Mimeo No. 1808 (released June 29, 1981) ("Bureau Order") at 2, Joint Appendix ("J.A.") at 152; see also 47 C.F.R. § 1.1409 (1984). In practice, however, the Commission first determines the net cost of the pole, then multiplies that amount by a percentage figure that reflects operating expenses (also referred to as "carrying charges"), and then multiplies the product by the percentage of pole space used by the cable operator. See, e.g., Bureau Order at 3, J.A. at 153; Teleprompter Corp. v. Alabama Power Co., File No. PA-81-0014 (released Nov. 3, 1983) ("Commission Order") at 7, J.A. at 297. The formula actually used — identical for all purposes to the one shown above — can therefore be expressed as follows:
The Commission determines the cost of the pole by subtracting the depreciation reserve and the amount attributable to "non-cable-related investment" from the gross investment in pole plant, Brief for Respondents at 7, and the figure for carrying charges encompasses the costs of administration, maintenance, depreciation, taxes, and capital.
In December of 1980, Group W,
Alabama Power filed an application for review of the Bureau Order with the Commission one month later, charging that the Bureau had made several mathematical, conceptual, and legal errors. The Commission granted the application in part, but affirmed the Bureau on several key issues of contention. Commission Order, J.A. at 291. The Commission determined that the maximum allowable annual rate was not $1.13 per pole, as the Bureau had found, but $1.56 per pole, and ordered Group W to remit the excess refunds it had received. Since the maximum allowable rate as determined by the Commission was still lower than the rate that had been contractually agreed upon between Alabama Power and Group W, the contracts between the parties were modified to provide that thereafter the Commission's figure would be the rate charged.
In its petition for review before this court, Alabama Power challenges several aspects of the Commission's calculation of the maximum allowable rate. Specifically, Alabama Power raises the following claims:
The first two claims relate to the determination of net pole investment, and we deal with them in Part III. The latter three claims relate to the determination of carrying
At the outset, we must determine the appropriate standard by which to judge the validity of the Commission's calculation. Alabama Power claims that in attempting to compute fully allocated costs the Commission erred and reached a result that falls well below the statutory maximum. While the Commission contests most of Alabama Power's charges of error,
We cannot agree. In the memorandum opinion we review, the Commission determined that $1.56 per pole was the "maximum rate." Commission Opinion at 7, J.A. at 297. In the papers filed before the Commission, both parties focused exclusively on the question of whether the Bureau had correctly calculated the maximum rate. See Application for Review, J.A. at 161; Opposition to Application for Review, J.A. at 191. Thus, in the proceeding below, the Commission never even attempted to determine Alabama Power's incremental costs. It heard no evidence, and made no findings, bearing on a determination of the statutory minimum rate.
Indeed, a determination of incremental costs would not have been germane. The existing contracts between Alabama Power and Group W provided for a rate of $3.00
In calculating net pole investment, the Commission sought to eliminate all non-cable-related investments. Upon review, we find that the Commission used a clearly erroneous method for computing the non-cable-related investment, and we also find that the Commission improperly excluded the costs of guys and anchors as non-cable-related.
In order to appreciate the methodological error made by the Commission, it is helpful to examine first the calculations presented to it by Group W. Opposition to Application for Review, J.A. at 191, 208. Group W took the figure for gross pole investment, excluding lightning arrestors and grounds, — $175,819,167 — and subtracted from it the figures for depreciation and for non-cable-related investment.
When the Commission made its calculation, it used a percentage figure to eliminate the non-cable-related investment from the gross pole investment. The Commission calculated this percentage (41.43%) by dividing the figure provided by Group W for gross non-cable-related investment ($72,840,638) by the figure provided by Group W for gross pole investment, excluding lightning arrestors and grounds ($175,819,167).
However, the Commission proceeded to apply this percentage figure to gross pole investment including the costs of lightning arrestors and grounds. The error is apparent. The entire cost of lightning arrestors and grounds (minus depreciation) ought to have been included in the figure for net pole investment, but the Commission instead reduced that cost by a percentage figure. Since the costs of lightning arrestors and grounds were conceded by both parties to be wholly cable-related, the Commission erred by discounting the costs through the use of a wholly irrelevant percentage figure.
We believe the Commission made an additional error when it excluded the cost of guys and anchors from the category of capital costs by classifying it as a non-cable-related investment. Guy wires and anchors are used to counteract the stress caused by wind, storms, the turning of corners and the attachment of wires. They keep the pole standing and therefore benefit all its users.
The Commission reasons that so long as Group W provides whatever additional guys and anchors are made necessary by the additional stress created by the cable attachments, it need not reimburse Alabama Power for a proportionate share of the expense already incurred to anchor the pole. That, however, is only a calculation of incremental costs, and is inconsistent with the statutory definition of the maximum rate. The statutory language is quite clear: the maximum rate is calculated by "multiplying the percentage of the total usable space ... which is occupied by the pole attachment by the sum of the operating expenses and actual capital costs of the utility attributable to the entire pole, duct, conduit, or right of way." 47 U.S.C. § 224(d)(1) (emphasis added). The Senate Report is no less precise, and explains that "[t]he term `operating expenses and actual capital costs of the utility,' as used in S.1547, as reported, refers to the costs to the utilities, irrespective of the CATV attachment, of owning and maintaining poles." Senate Report at 19-20 (emphasis added). The expense of providing guys and anchors is clearly a cost necessary to the maintenance of Alabama Power's poles.
To compute carrying charges, the Commission determines the percentage of pole investment devoted to each of five categories of expenses: administration, maintenance, depreciation, taxes, and cost of capital. The percentage figure for carrying charges is simply the sum of these five calculations. Alabama Power disputes the Commission's calculation of administrative expenses, its calculation of taxes, and its calculation of the cost of capital. We deal with each in turn.
In calculating the percentage figure for general and administrative expenses, the Commission divided the sum of four separate accounts — administrative and general salaries, office supplies, administrative expenses transferred credit, and regulatory commission expenses — by net plant investment. Commission Order at 6, J.A. at 296. Alabama Power argues that the Commission ought to have included nine other accounts as well, claiming that these other accounts were just as applicable to the service provided Group W as the four that were included.
The degree to which each of these accounts is cable-related is an issue we need not decide, for the Commission was clearly in error when it chose to use only cable-related accounts in calculating administrative costs. The Commission was seeking to determine the percentage of investment devoted to administrative and general expenses. When that percentage is multiplied by the net pole investment, it will yield a reasonable estimate of the administrative and general expenses incurred in the maintenance of Alabama Power's poles. In order to determine that percentage, the Commission could have divided pole-related administrative expenses by pole-related investment, cable-related administrative expenses by cable-related investment, or total administrative expenses by total plant investment.
The Commission has refused to allow Alabama Power to normalize its tax expenses in establishing cable attachment rates. Instead, the Commission has employed the flow-through method of accounting to calculate fully allocated costs. Alabama Power challenges this policy, and contends that the normalization of tax benefits does not render an otherwise acceptable rate unjust and unreasonable.
This issue of accounting arises whenever a utility defers some of its current tax liabilities. If the deferred taxes are normalized, then the rates are calculated to reflect the full tax liability in the year in which that liability is incurred. Under flow-through, in contrast, the benefit of the deferral is passed on to the ratepayers, and each year's rates reflect only the cost of those taxes actually paid that year by the utility. Advocates of flow-through claim that it serves to ensure that rates reflect only those expenses actually borne by the utility, while opponents argue that only through normalization can expenses be matched to the customer that receives the related services. See Public Systems v. FERC, 709 F.2d 73, 76 (D.C.Cir.1983).
The chief point of general dispute has centered on the question whether normalization provides the utility with a permanent tax savings. As long as the revenues and expenses of a utility continue to grow, the taxes postponed in each year will more than offset the past liabilities that come due. Critics of normalization contend that this continuing offset represents a tax savings which should be reflected in the rates; supporters of normalization argue that the "savings" is illusory, since every liability deferred does in fact become due at the appropriate time.
In the order presently under review, the FCC justified its use of flow-through with a citation to one of its previous orders, Television Cable Service, Inc. v. Monongahela Power Co., 88 F.C.C.2d 56 (1981). Commission Order at 6, J.A. at 296. The analysis given in Monongahela — which appears to be the most complete discussion that the FCC has given this issue as it relates to pole attachments — consists of the following paragraph:
88 F.C.C.2d at 59 (citation omitted).
In a more recent memorandum opinion, however, the Commission rejected as "unsound" a party's contention that normalization results in a permanent tax savings. The Commission noted that "the characterization
The Senate Report that accompanied the Pole Attachment Act expressly authorized, but did not require, the Commission to employ the determinations made by state governments of the appropriate rate of return. Senate Report at 22. Relying on an opinion issued by the Alabama Public Service Commission ("APSC"), the FCC held that Alabama Power was entitled to a rate of return of 9.97%. Alabama Power challenges the use of that figure on the grounds that it had been held invalid under Alabama state law almost a year before the Bureau's decision to use it was affirmed by the Commission. Upon reviewing the various state law determinations, we conclude that Alabama Power's claim is a meritorious one.
The 9.97% figure for Alabama Power's rate of return originated in an opinion issued by the APSC in August of 1980, and was based on a finding of 14% return on equity. One week later, the Supreme Court of Alabama issued its decision in an appeal by Alabama Power of an earlier rate order, Alabama Power Co., APSC Docket No. 17667 (July 19, 1979). Alabama Power Co. v. APSC, 390 So.2d 1017 (Ala.1980). In this opinion, the Alabama Supreme Court found the Commission's decision to allow an 11.7% rate of return to be "arbitrary," id. at 1026, and remanded to the Commission with instructions to "enter an order based on the evidence." Id. at 1027. At the time, Alabama Power had an appeal of the more recent rate order — the one establishing the 9.97% rate of return and based on the 14% return on equity — pending before the Alabama Supreme Court. In March of 1981, in response to the joint request of Alabama Power and the APSC, that appeal was remanded to the APSC and the APSC then issued an order disposing of both the earlier and the more recent rate proceedings. That order granted Alabama Power a more substantial rate increase.
Following the issuance of this order, Alabama Power filed an application with the APSC for an additional rate increase. Its application was denied, Alabama Power Co., APSC Docket No. 18117 (Oct. 16, 1981), and its return on equity — 12.43% — was held adequate by the APSC. This determination was reversed by the Alabama Supreme Court in Alabama Power Co. v. APSC, 422 So.2d 767 (Ala.1982). The Alabama Supreme Court found the 12.43% rate of return on equity to be "confiscatory," id. at 770, and held unanimously that "[u]nder the undisputed evidence in this case and our review of the record a 15% return on equity is the minimum which would not result in confiscation." Id. at 773. The court ruled that "[t]he evidence and the monthly reports submitted ... clearly show that the Company has been suffering confiscation of its property for some time," and remanded to the Commission. Id.
We stress that the Commission is under no obligation to accept the Alabama court's determination of what rates constitute the minimum required to avoid confiscation. Regardless of the findings of the state court, the Commission is free to make its own calculation of what would constitute an adequate rate of return, and we will uphold that calculation as long as it meets the statutory requirements and is not arbitrary or capricious. However, where the Commission seeks to free itself from the necessity of making an independent determination by relying on the rulings of state courts and agencies, it may not, under that procedure, adopt determinations that have been invalidated under state law.
We find, therefore, that the Commission's somewhat casual calculations exhibit at several points the sort of "clear error[s] of judgment," Citizens to Preserve Overton Park v. Volpe, 401 U.S. 402, 416, 91 S.Ct. 814, 824, 28 L.Ed.2d 136 (1971), and absence of "rational connection[s] between the facts found and the choice[s] made," Burlington Truck Lines, Inc. v. United States, 371 U.S. at 168, 83 S.Ct. at 246, that render an order arbitrary and capricious. We vacate the Commission's order and remand to the Commission for further proceedings consistent with this opinion.
It is so ordered.
Id. at 22 (emphasis added). In the context of an adjudication between parties under contract, therefore, a determination that a fee is outside the statutory zone is a prerequisite to rate adjustment by the Commission.