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09/07/78 MASSACHUSETTS ELECTRIC COMPANY v.

September 7, 1978

MASSACHUSETTS ELECTRIC COMPANY
v.
DEPARTMENT OF PUBLIC UTILITIES



Suffolk. Civil action commenced in the Supreme Judicial Court for the County of Suffolk on January 10, 1977. The case was reported by Liacos, J.

Hennessey, C.j., Quirico, Kaplan, Wilkins, & Abrams, JJ.

SYLLABUS BY THE COURT

Public Utilities, Regulation. State Administrative Procedure Act. Practice, Civil, Review of order of department of public utilities. Due Process of Law, Public utilities.

The opinion of the court was delivered by: Abrams

With respect to ascertainment of the cost of equity in determining rates to be charged by an electric company, one of four wholly owned electric operating subsidiaries of a holding company and the appellant in a rate proceeding in 1976 under G. L. c. 25, § 5, this court affirmed the decision of the Department of Public Utilities, that the 12% cost of equity established for the appellant in a 1975 rate proceeding should be maintained, and held that the 12% return on equity was not shown to be confiscatory, notwithstanding testimony of experts for the appellant, which restricted its activities to retail distribution, that the holding company's cost of equity should serve as a proxy for the appellant in order to apply the "comparable earnings" test and the "capital attraction" standard of other utilities; evidence was lacking of the earnings performance of the subsidiaries, each of which was regulated by a different agency, and of an alternative method to the proxy approach. [297-298]

With respect to ascertainment of the cost of equity in determining rates to be charged by an electric company, one of four wholly owned electric operating subsidiaries of a holding company and the appellant in a rate proceeding in 1976, the decision of the Department of Public Utilities that the 12% cost of equity established for the appellant in a 1975 rate proceeding should be maintained, rejecting appellant's argument that use of the company's actual capital structure was erroneous and that the only method of ascertaining its cost of equity was to use the cost of equity of the holding company as a proxy, was warranted by findings made by the Department supported by substantial evidence and by its statement of reasons for the decision, particularly its Discussion concerning the different degrees of risk among the holding company's subsidiaries; the decision did not constitute an abuse of discretion, and was not based on legal error. [298-308]

The mere fact that the rate of return on equity allowed to an electric company by the Department of Public Utilities did not result in maintenance of the market price of the company's stock above book value did not render the rate allowed confiscatory [308-309]; nor was the rate rendered confiscatory by reason of the Department's failure to incorporate an attrition adjustment, allegedly needed due to inflation, where the company did not demonstrate that its failure to earn the allowed rate was the result of the Department's decisions or that the gap between the allowed return and the earned return was due to increased construction costs [309-310]; in the circumstances it was appropriate for the Department to maintain the rate of return on the company's equity which it had established in an earlier proceeding [311].

The burden of demonstrating unconstitutional discrimination on the part of the Department of Public Utilities, in setting a rate of return on equity of an electric company which was the lowest return allowed by the Department to any electric utility in over a year, was not satisfied where the company did not attempt affirmatively to show that no factual situation conceivable supported the reasonableness of the differential treatment of like entities [311-312]; the department's reasons for its decision were supported by substantial evidence, and warranted its Conclusion on the company's return on equity, and the department's failure to explain why it reached different Conclusions concerning cost of equity in other electric utility cases was not arbitrary and capricious [312].

Massachusetts Electric Company (Mass. Electric) appeals under G. L. c. 25, § 5, from the November 30, 1976, decision, order, and rulings of the Department of Public Utilities (Department) in a rate proceeding, D.P.U. 18599. The Department approved rates designed to produce additional revenue of $15,372,000, but decided to maintain the 12% cost of equity which it had set for Mass. Electric in its previous rate proceeding, D.P.U. 18204, which was decided on October 31, 1975. A single Justice of this court has reserved and reported the case for decision.

This appeal deals solely with the correctness of the Department's determination concerning the cost of equity. Mass. Electric argues (1) that, because it is a wholly owned subsidiary of the New England Electric System (NEES), the Department's refusal to use NEES as a proxy for Mass. Electric in determining the cost of equity resulted in a confiscatory rate of return on equity and was erroneous under the standards set forth in the State Administrative Procedure Act (APA), G. L. c. 30A, § 14 (7); (2) that the 12% rate of return on common equity is itself confiscatory because it would result in forced dilution of the equity of existing stockholders and because it did not reflect an attrition adjustment; and (3) that in allowing 12% as the cost of equity the Department discriminated against Mass. Electric in violation of constitutional and statutory standards. We affirm the decision of the Department and hold that (1) the rejection of the proxy approach did not result in a confiscatory cost of equity and that it was not erroneous under the APA; (2) Mass. Electric has not demonstrated that either dilution or attrition will occur as a result of the allowance of a 12% cost of equity; and (3) Mass. Electric has not shown unlawful discrimination.

I. History of Proceedings.

In D.P.U. 18204 the Department allowed Mass. Electric a 12% cost of equity. In that proceeding Mass. Electric also argued that the use of NEES as a proxy was the appropriate method by which to determine the cost of equity for Mass. Electric, and that all the experts who testified concerning cost of equity based their determinations on the cost of equity to NEES. However, evidence concerning the earnings performance of the subsidiaries of NEES was also presented. The Department rejected the proxy approach, noting in particular that Mass. Electric had earned a higher return on NEES's investment than had the other subsidiaries of NEES, and found on the basis of the evidence before it that 12% was a reasonable rate of return on common equity.

Mass. Electric chose not to appeal that decision. Almost three months later, in D.P.U. 18599, it filed a proposed schedule of rates and charges designed to raise retail rates by $18,955,000 *fn1 effective February 1, 1976. The Department suspended the proposed rates until December 1, 1976.

Hearings on the proposed rates began on August 16, 1976, covered seventeen days thereafter, and ended on October 13, 1976. The interveners were a group of customers of Mass. Electric, the Attorney General, and the Massachusetts Consumers' Council.

The four witnesses who testified for Mass. Electric concerning the cost of equity based their determinations on the premise that NEES should serve as a proxy for Mass. Electric in setting a cost of equity figure. The return on equity which they found to be necessary as a result of using the proxy method ranged from 14% to 14.9%. None of their testimony offered an alternative to the proxy approach. In addition, none of it responded specifically to the reasons given by the Department for rejecting the proxy method in D.P.U. 18204, and no evidence concerning the earnings performance of the NEES subsidiaries, data which the Department found highly relevant in D.P.U. 18204, was presented. The expert who testified for the public agency interveners also relied on NEES as a proxy for determining cost of equity. However, he adjusted downward the figure he derived using NEES as a proxy, to reflect the fact that NEES had debt funds as well as equity funds available to finance Mass. Electric's equity requirements; he recommended a rate of return on equity of 10.52% for Mass. Electric.

The Department, consistent with its prior decision, rejected the use of the proxy method because of the absence of evidence, especially evidence of the earnings performance of the NEES subsidiaries, to justify a change from its earlier decision and also because of additional reasons discussed (infra). The Department concluded that Mass. Electric had not presented sufficient evidence to warrant a change in the cost of equity which has previously been established, and it therefore determined to maintain the 12% figure in effect.

II. Method of Determining Cost of Equity.

A. Confiscation.

Mass. Electric first argues that the Department's rejection of the use of NEES as a proxy for Mass. Electric in determining the cost of equity resulted in the setting of a confiscatory rate of return on equity. *fn2 The heart of its contention is that using NEES as a proxy is the only way in which Mass. Electric's cost of equity can be determined.

Confiscation results when a ratemaking decision deprives a utility of the opportunity to earn a fair and reasonable return on its investment. Boston Edison Co. v. Department of Pub. Utils., 375 Mass. 1, 10 (1978). 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 Boston Edison Co. v. Department of Pub. Utils., supra at 10, and cases cited. A utility which alleges that the Department has set confiscatory or otherwise unlawful rates has the burden of proving these allegations. Fryer v. Department of Pub. Utils., 374 Mass. 685, 690 (1978). Fitchburg Gas & Elec. Light Co. v. Department of Pub. ...


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