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The Ponderosa Telephone Co v. Public Utilities Commission

July 5, 2011


(CPUC Decision Nos. 10-06-029 & 10-10-036) ORIGINAL PROCEEDING; petition for writ of review.

The opinion of the court was delivered by: Levy, Acting P.J.



In this original proceeding, and the two companion proceedings (F061259, F061306), 11 rural telephone companies challenge California's Public Utilities Commission (Commission) Decision No. 10-06-029, as modified by Decision No. 10-10-036 (Decision). The Decision allocates the proceeds from the redemption of Rural Telephone Bank (RTB) stock to the telephone companies' ratepayers. The subject stock was issued by the RTB in one of two ways. First, as a condition of receiving a loan from the RTB, a rural telephone company was required to purchase an amount of stock equal to 5 percent of the loan proceeds. Second, if the total interest received by the RTB from its borrowers exceeded its expenses and reserve requirements, the RTB issued patronage refunds to the rural telephone companies in the form of additional shares of stock. When the RTB was dissolved, this stock was redeemed for par value. This court issued a writ of review to consider the Decision.

Petitioner, The Ponderosa Telephone Co. (Ponderosa), contends that it owned the RTB shares. Accordingly, Ponderosa argues, the Commission's action in allocating the share proceeds to the ratepayers constituted an unlawful taking of Ponderosa's property, resulted in improper retroactive ratemaking, and was contrary to the Commission's own rules. Ponderosa further asserts that it was denied due process and that the Decision is not supported by either substantial evidence or adequate findings.

As discussed below, the Commission erred in allocating both the purchased share proceeds and the patronage share proceeds to the ratepayers. Therefore, the Decision will be annulled.


1. Ratemaking principles and procedures.

Ponderosa provides telephone service in rural areas of three counties and is subject to the Commission's regulatory authority. The Commission periodically establishes the rates Ponderosa charges for telephone service in general rate case proceedings using a cost-of-service or rate-of-return model. Under this structure, the Commission examines the company's costs in a test year and determines the company's revenue requirement during that test year.

The Commission examines several cost components in calculating a utility company's revenue requirement. The Commission begins by determining the value of the assets that the company has invested in to provide utility service. Property or portions thereof that are unproductive for public utility purposes are excluded. This figure is known as the "rate base."

To invest in rate base assets, a utility company raises funds by either issuing debt or selling equity. Costs are associated with each method. The company either has to pay interest to creditors on borrowed funds or pay a portion of profits or dividends to equity investors, i.e., shareholders. This cost is known as the cost of capital. The cost of capital, also known as the rate of return, multiplied by the rate base is one component of the utility company's revenue requirement.

Utility companies usually use a mix of debt financing and equity as a source of funds for their regulated activities. The reason is that, while debt is cheaper to obtain, it increases financial risks to the shareholders. Interest must be paid to creditors regardless of how the company is doing financially. On the other hand, shareholders expect an annual return that is usually greater than the cost of debt. Accordingly, companies attempt to find a middle ground between all equity financing and all debt financing.

The Commission determines a utility company's cost of capital in a three-step process. The Commission first adopts a reasonable capital structure, i.e., the proportion of debt to equity that a utility company should use to finance its capital needs. Next, the Commission calculates the company's cost of debt, based on the actual cost of the company's outstanding debt during the most recent period. Third, the Commission determines the appropriate return on the equity component of the utility company's capital by examining returns for businesses with comparable risks. Applying the resulting figures to the adopted capital structure produces the weighted cost of capital. This weighted cost of capital becomes the utility company's authorized rate of return on rate base. Alternatively, the Commission may simply apply an overall rate of return without regard to a specific capital structure.

As noted above, the Commission determines the utility company's rate base and multiplies that number by the authorized rate of return. This figure is then added to the company's operating expenses and tax costs. The sum is the company's revenue requirement, i.e., the amount needed to cover the company's costs and provide a reasonable return on its investments.

The Commission sets rates that are designed to enable a telephone company to generate sufficient revenue to meet the revenue requirement. In rural areas the cost of providing service is high. Nevertheless, the Commission limits rates for rural customers to 150 percent of urban area rates. To make up the difference between the permitted rural rates and the actual cost of service, eligible telephone companies receive subsidies from the California High Cost Fund A. Surcharges assessed against all California telephone customers provide these funds.

2. The Rural Telephone Bank.

In 1971, Congress created the RTB, the purpose of which was to make capital available to rural telephone providers at reasonable costs for investment in infrastructure. RTB's initial cash infusion of $600 million was provided by the federal government. In exchange, the RTB issued Class A stock to the Administrator of the Rural Utilities Service.

A second form of financing for the RTB was Class B stock. As a condition of obtaining a loan, RTB customers were required to purchase Class B stock in an amount equal to 5 percent of the RTB loan. These customers could either purchase this stock with cash or borrow additional money from the RTB to finance the stock purchase. Class B shares had a par value of $1. However, these shares were not transferable and paid no dividends.

RTB borrowers were also eligible to receive what the RTB called "patronage refunds" in the form of Class B stock. These patronage shares were a partial rebate of the interest paid to the RTB and were distributed when the RTB determined that the interest it had received from its borrowers exceeded its costs. A company's patronage refund was based solely on the dollar amount of interest it paid, not the number of Class B shares it held. Again, being Class B shares, the patronage stock could not be transferred and paid no dividends.

The RTB also issued Class C stock. Class C stock had a par value of $1,000 and paid dividends. This stock could be acquired in one of two ways. RTB customers could either make discretionary purchases of Class C shares or could convert Class B shares to Class C shares at any time after the RTB loan that necessitated the purchase of the Class B shares had been repaid.

In 2005, the RTB board, with congressional approval, dissolved the RTB and initiated the stock redemption process. Beginning in 2006, all Class B and Class C shares were redeemed at par value, i.e., $1 per share and $1,000 per share respectively. In November 2007, the RTB distributed its remaining funds ...

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