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If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of ) ) MEDIA GENERAL CABLE OF ) FAIRFAX COUNTY, INC. ) ) ) Petition for Reconsideration ) MEMORANDUM OPINION AND ORDER Adopted: October 20, 1997 Released: October 23, 1997 By the Chief, Cable Services Bureau: I. INTRODUCTION 1. In this Order, we grant in part and deny in part the petition for reconsideration of Media General Cable of Fairfax County, Inc. ("MGC"), filed on February 15, 1995. In its petition, MGC requests review of the Consolidated Order in Media General of Fairfax County, Inc., (Fairfax, VA) in which the Cable Services Bureau denied MGC's consolidated appeal of the local rate orders adopted by the communities of Fairfax County, City of Fairfax, City of Falls Church, Town of Herndon, and Town of Vienna, Virginia ("the Communities"). In their orders, the Communities approved MGC's basic service tier ("BST") rates, but recalculated and reduced MGC's regulated equipment and installations rates. The Communities also ordered MGC to issue refunds or credits to subscribers for those charges collected prior to July 14, 1994 that were in excess of MGC's maximum permitted equipment and installation rates. On March 3, 1995, the Communities filed a joint opposition to MGC's petition. MGC filed a reply on March 13, 1995. II. BACKGROUND 2. The Communications Act establishes a dual structure for regulating the rates of those cable systems that are not subject to effective competition. While the Commission has the jurisdiction to regulate cable programming services tier ("CPST") rates, local franchising authorities have the jurisdiction to regulate the basic service tier ("BST") and associated equipment and installation rates, consistent with Commission regulations and subject to Commission review. The goal expressed in Section 623(b)(1) of the Act is that BST rates be reasonable so that subscribers will be protected from rates "exceed[ing] the rates that would be charged for the basic service tier if such system were subject to effective competition." The Commission developed regulations for establishing and adjusting both BST and CPST rates consistent with this goal. The Commission also developed standards for establishing the rate for the operator's equipment and installation charges "on the basis of actual cost." Once certified to regulate BST and associated equipment rates by the Commission, local franchising authorities could review existing rates or proposed rate increases and, if disapproving a rate in whole or in part, issue a written decision prescribing a reasonable rate and ordering refunds. Any appeals of local rate orders are made to the Commission. Appeals not raising novel or unusual issues are reviewed by the Bureau under delegated authority. 3. In reviewing a local rate order, the Commission will not conduct a de novo review but instead will sustain the franchising authority's decision as long as there is a reasonable basis for that decision. If the Commission reverses a franchising authority's decision, it will not substitute its own decision but instead will remand the issue to the franchising authority with instructions to resolve the case consistent with the Commission's directions. 4. The Commission has concluded that a benchmark approach should serve as the primary method for regulation of both BST and CPST rates. The benchmark methodology is based on an analysis of the rates of operators that are subject to competition. It is intended to produce maximum permitted rates for operators not subject to competition which approximate the rates of operators that are subject to competition. The benchmark methodology has the advantage of protecting subscribers from excessive rates and also keeping the costs of administration and compliance low. FCC Form 393 is the form used by the Commission and by local franchising authorities to determine whether an operator's regulated rates for programming, equipment, and installations were reasonable during the period from September 1, 1993 to May 15, 1994. FCC Form 1200 and FCC Form 1205 are the forms used to determine whether regulated rates for programming, equipment, and installations were reasonable for the period beginning on May 15, 1994. 5. Although the Commission adopted a benchmark mechanism as the primary regulatory mechanism for setting initial regulated rates, it acknowledged that this mechanism might not produce fully compensatory rates in all cases. Where the benchmark mechanism was inadequate, the Commission authorized an operator to choose to establish rates based on the reasonable costs of providing regulated cable service through a cost-of-service proceeding. Until the Commission could adopt accounting and cost allocation requirements for cost-of-service proceedings, the showings were governed by general accounting principles. Subsequently, the Commission adopted cost-of-service standards for application to such operators. 6. Because equipment and installation rates are subject to regulation on an actual cost basis in both benchmark and cost-of-service proceedings, an operator's maximum permitted equipment and installation rates are the same under both methodologies. To justify equipment rates in effect during the period from September 1, 1993 to May 15, 1994, an operator used FCC Form 393, Part III. Thereafter, the operator would use FCC Form 1205, which replaced the equipment-related portion of Form 393. 7. To establish its equipment and installation costs on Part III of Form 393, an operator calculates (1) the capital costs of leased customer equipment; (2) the capital costs associated with service installations and the maintenance of customer equipment; (3) the annual operating expenses for installations and maintenance of equipment; and (4) the average installation charges for the various types of installations which the operator performs. As part of an operator's calculation of its annual capital costs (for both its customer equipment and for items associated with the installation of cable service and the maintenance of customer equipment), the operator must include in Schedules A and C any federal and state income taxes payable by the cable entity. The operator then adds these income tax obligations to its return on investment and its annual depreciation expense in order to determine its total capital costs. The higher an operator's state and federal income tax liability, the higher its annual capital costs and its maximum permitted equipment and installation rates. III. ORIGINAL ORDER 8. In local rate orders, each of the Communities found that MGC's BST rates were reasonable because the rates were less than the maximum permitted rates justified by MGC's cost of service showing. However, each of the local franchising authorities reduced MGC's equipment and installation costs by adjusting MGC's income tax rates to reflect deductible interest not included in MGC's calculations. They then ordered MGC to refund all equipment and installation overcharges collected prior to July 14, 1994. 9. MGC appealed these adjustments to the Bureau arguing that it relied upon the instructions accompanying the Commission's Form 393, which do not specifically require a deduction for interest expenses. The Communities responded that the tax deductibility of interest is obvious. According to the Communities, because MGC did not adjust its income tax figures in Schedules A and C to reflect the deductibility of interest expenses from any state and federal income taxes owing or paid, the amount of income tax included in MGC's equipment and installation rates was inflated, causing its equipment and installation rates to be artificially high. 10. MGC also argued that it should not be required to refund the disputed overcharges because had it been adequately advised as to what was required in the FCC Form 393 equipment and installation calculations it would have increased slightly its BST rates in order to compensate for reduced equipment and installation rates. The Communities opposed this refund offset. They argued that, when MGC adjusted its equipment and installation rates pursuant to the local rate orders on July 14, 1994, it could have, but did not, change its BST rates. In their view, MGC was not entitled to a refund offset for a rate it set voluntarily. 11. The Bureau sustained the Communities' orders, noting that the Commission will sustain a franchising authority's decision as long as there is a reasonable basis for that decision. The Bureau held that given the accepted principle that tax interest is a deductible expense for tax purposes, the Communities' local rate orders were based upon a reasonable interpretation and application of the Commission's rules and forms. The Bureau also found that the Communities had effectively rebutted MC's offset argument. IV. MGC'S PETITION FOR RECONSIDERATION 12. In its petition for reconsideration of the Bureau order, MGC argues that it should have no refund liability for two reasons. According to MGC, we erred in holding that regulators have the discretion to interpret FCC Form 393 as requiring treatment of deductible interest and in allowing that interpretation to stand. MGC also argues that refunds are inappropriate even if the treatment of deductible interest stands, because the aggregate rates it charged for BST and equipment and installation were below the aggregate rates it justified using in its cost of service filing and Form 393 presentation. A. Income Tax Adjustments for Interest Expenses 13. MGC advocates that the methodology for calculations required by the Commission's rate regulations should be uniform nationwide, not a matter of local franchising authority discretion. Further, because FCC Form 393, unlike FCC Form 1205, does not explicitly call for an adjustment to income tax rates to reflect deductible interest, and neither the Commission's instructions for FCC Form 393 nor its video workshops explaining the form address the issue of interest deductibility, MGC properly determined that it should not apply a deductible interest adjustment to its rate of return calculation in Form 393. MGC concludes that it should have no refund liability for completing FCC Form 393 as required by the Commission. Nor should it have refund liability arising from any perceived ambiguities in the form. 14. In opposition, the Communities argue that the instructions for Part III, Schedule A in FCC Form 393 unambiguously require the listing of taxes that the operator is required to pay, and that MGC would only be required to pay taxes on income after all allowable deductions have been taken. Its failure to make adjustments for interest deductions, the Communities assert, resulted in rates that recovered income tax expenses that MGC never actually incurred. 15. We are denying MGC's petition on this issue. Congress granted the local franchising authorities primary responsibility for regulating BST rates and the rates for all equipment and installation costs associated with the BST. In developing regulations to be followed by the local franchising authorities, as required by Section 623(b) of the Communications Act, the Commission could not address all possible aspects of rate regulation and necessarily left some discretion to local governments. That discretion was exercised reasonably here. 16. The Commission has explained previously the scope of review of local franchising authority rate decisions: While we have set out the general rules for regulation, we have not attempted, nor could we address, every detail of the rate regulation process. A certain amount of latitude has been left to franchising authorities. As we stated in the Rate Order [Report and Order and Further Notice of Proposed Rule Making in MM Docked No. 92-266, 8 FCC Rcd 5631 (1993)], we will not review decisions of franchising authorities de novo, but rather will sustain their decisions as long as there is a reasonable basis for those decisions. Id. at 5731. This standard of review will apply as well with respect to franchising authority interpretations of any ambiguities in evaluating the responses or information provided on the FCC Form 393 (and/or FCC Forms 1200/1205) or in a cost-of-service showing. 17. Although the instructions accompanying FCC Form 393 do not specifically discuss adjustments that should be made to income tax figures to reflect the deductibility of certain items, treating interest as a deductible expense and accepting MGC's calculations would not be unreasonable for purposes of computing income tax obligations and is consistent with good accounting practices. The Communities' adjustments recognize that equipment purchases may have been financed by debt as well as by equity, an assumption not challenged by MGC. It was reasonable for the Communities to conclude MGC overstated its liability for the federal and state income taxes included in its equipment and installation rates on FCC Form 393 because it did not reflect the deductibility of interest expenses. 18. We also find unpersuasive MGC's related argument that leaving the treatment of interest deductibility to local franchising authority discretion will lead to conflicting results. Although there is the possibility of disparate local resolution of any question involving interpretation of our rules or forms, no disparity has been presented here that would affect the reasonableness of the result reached by the Communities. B. Refund Offsets 19. MGC asserts that, had it been adequately advised about what was required in the FCC Form 393 equipment and installation calculations, it would have increased its BST rates slightly in order to compensate for the reduced equipment and installation revenue. Because it did not increase its BST rates, MGC argues that any calculation of refund liability through July 14, 1994, the period at issue here, should include an offset of equipment overcharges with BST undercharges. The Communities oppose MGC's position, arguing that a company justifying rates with a cost-of-service showing is not entitled to the offsets allowed for benchmark systems, that offsets apply only if old rates were bundled, and that a BST rate set below the maximum rate permitted in the cost-of-service proceeding becomes the operator's maximum permitted rate for determining refund offsets. The Communities also argue that allowing offsets would amount to a re-pricing of basic service equivalent to retroactive ratemaking, which is generally disapproved in common carrier ratemaking, and also is inconsistent with the decision in MCI Communications Corp. v. FCC ("MCI"), in which offsets were disallowed in a common carrier damages proceeding. 20. On reconsideration, we agree with MGC. In its petition MGC makes clear that, in the calculation of refund liability, it seeks an offset of equipment overcharges with BST undercharges. Refund liability for the initial regulated rates within the local franchising authority's jurisdiction should be determined from aggregated actual and permitted rates for BST and equipment and installation, regardless of whether the permitted BST rate is established by the benchmark or cost-of-service methodology. Although the Communities argue that the cost-of-service methodology is different from the benchmark methodology, our concern in both instances is that subscribers be placed "in the same position they would be had they been subject to 'reasonable' rates," which are determined at the operator's election pursuant to a cost-of-service proceeding or by using the benchmark methodology. Allowing offsets within the basic tier avoids penalizing operators unfamiliar with regulation that, in anticipation of regulation, made a good faith effort to adjust their rates accurately. That reasoning applies whether the operator used the benchmark methodology or the cost of service methodology. Subscribers are not harmed if they have not paid rates in excess of aggregated initial permitted charges. 21. The Communities argue that offsets should be limited to benchmark systems because BST and equipment charges have a mathematically inverse relationship in the benchmark calculations, but this does not distinguish the benchmark methodology from the cost-of-service methodology for refund offset purposes. Benchmark comparisons in FCC Form 393 are based on the operator's combined charges for programming and equipment and installation. Only after the benchmark comparisons have been made are equipment and installation costs unbundled in the calculation and the maximum permitted per channel charge determined. The restructured rates determined in FCC Form 1200 require that the operator's total regulated revenue be computed and then the equipment costs computed in FCC Form 1205 be subtracted before the restructured maximum permitted per channel rates can be determined. Operators using cost-of- service showings to justify their initial rates perform similar calculations to establish the correct unbundled BST and equipment rates. In either case, BST and equipment costs have the same inverse relationship in the calculations. As the amount of an operator's costs allocated to equipment and installation increases, the amount allocated to BST decreases. Conversely, as the amount of costs allocated to equipment and installation decreases, the amount allocated to BST increases in both benchmark and cost-of-service computations. These costs are reflected in the rates. 22. The Communities also argue that because MGC did not change its BST rate in July 1994 when it reduced its equipment and installation rates to comply with the local rate order, this BST rate became the maximum permitted rate for the purpose of determining refunds for the period under consideration here. We disagree. An operator may choose to charge less than the permitted BST rate, and that rate would be reasonable, but doing so does not reduce the maximum rate it would be permitted to charge. The Communities argue that  76.942, which governs refunds ordered by a franchising authority, limits consideration only to rates actually charged. This argument fails to acknowledge the clear intent expressed in the Third Recon. Order that an operator's aggregated actual or "old" BST rates and equipment and installation rates at the time its rates became subject to justification should be compared to the system's aggregated "new" permitted rates in order to determine whether refunds are owed. Although the Communities further argue that this aggregation does not apply if the operator's BST and equipment and installation rates were unbundled from the beginning, the rule is clear that it applies regardless of whether the old rates were bundled or unbundled. Under section 76.942, the operator has refund liability for rates previously paid by subscribers only to the extent that those rates exceed the aggregate maximum permitted rates for equipment and BST and are not otherwise justified by a cost of service showing. The rule on its face applies to benchmark rates, but nothing in the rule limits its application only to benchmark rates. We see no reason why refund liability should not also be determined from aggregate rates when an operator's BST rate is established in a cost-of-service proceeding. 23. On the other hand, once permitted regulated rates have been established, whether through a cost of service showing or by applying the benchmark formulas in FCC Forms 393 and 1200, offsets are no longer appropriate for subsequent rate adjustments. Operators filing an FCC Form 1210 to adjust BST rates for inflation and external costs and FCC Form 1205 to adjust equipment and installation costs have previous experience with our rules. Allowing refund offsets beyond the initial period creates a disincentive to comply with the requirements that equipment and installation charges be set at cost and BST price adjustments be based on inflation and external cost changes unless justified by a cost-of-service showing. Also, allowing operators to set service rates at higher than permitted levels in order to recover lost equipment revenues resulting from equipment being priced below maximum permitted levels would undermine Congressional intent to create a competitive market for cable equipment providers. 24. Finally, the Communities argue that offsets should be denied because denial would comport with common carrier principles disfavoring retroactive ratemaking, a corollary to the filed rate doctrine. In a supplement to their opposition, they analogize cable rate refunds to damage claims brought against telephone companies by their customers and argue that a refund is a form of damages, which cannot be offset under the MCI decision. Neither the filed rate doctrine, the prohibition against retroactive ratemaking, nor the principles underlying sections 206 through 209 of the Communications Act adjudicated in MCI are applicable here. 25. Section 621(c) of the Communications Act, setting out general franchise requirements for local franchising authorities, specifically provides, "Any cable system shall not be subject to regulation as a common carrier or utility by reason of providing cable service." Section 623 of the Communications Act establishes the structure for regulating cable service rates. Under section 623(b), the Commission is required to prescribe regulations for enforcement by local franchising authorities to ensure that rates for the basic cable service tier are reasonable and do not exceed the rates that would be charged for the basic service tier if the cable system were subject to effective competition. Cable services rates are not filed as tariffs and are not subject to the provisions governing common carrier tariffs under federal, state or local law. Although cost-of-service requirements are designed to be consistent with the ratebase and rate-of-return formula traditionally used in public utility regulation, they are implemented in a manner that is simpler and easier to administer than the telephone model and are designed to produce rates that approach as closely as possible those that would evolve in a competitive market. If a local franchising authority finds that cable rates are not reasonable, it can remedy the problem prospectively with rate reductions or rate prescriptions. It can remedy the problem retrospectively through refunds for all subscribers. In addition, section 76.942 of the Commission's rules authorizing local franchising authorities to order refunds specifically provides for refund offsets at the basic level. This further distinguishes the instant proceeding from MCI, which found the offsets for individual ratepayers at issue there to be inconsistent with Commission precedent concerning common carrier rates and the Commission's rate-of-return regime as promulgated for common carriers. We do not believe that the Commission's broad discretion under the statute to establish procedures for reviewing rates and making retroactive adjustments precludes the Commission from allowing refund offsets when reviewing the reasonableness of a local rate order addressing a cable operator's initial BST and equipment and installation rates at the onset of rate regulation. V. ORDERING CLAUSES 26. Accordingly, IT IS ORDERED that the petition for reconsideration filed by Media General Cable of Fairfax County, Inc. regarding the issue of the calculation of Media General Cable of Fairfax County, Inc.'s income tax allowance is DENIED. 27. IT IS FURTHER ORDERED that the petition for reconsideration filed by Media General Cable of Fairfax County, Inc. regarding the issue of the calculation of Media General Cable of Fairfax County, Inc.'s refund liability is GRANTED and IS REMANDED FOR FURTHER CONSIDERATION in accordance with the terms of this Order to the communities of Fairfax County, City of Fairfax, City of Falls Church, Town of Herndon, and Town of Vienna, Virginia. 28. IT IS FURTHER ORDERED that the stay of the Bureau's order, which was granted pending the resolution of this petition, is hereby VACATED. FEDERAL COMMUNICATIONS COMMISSION Meredith J. Jones Chief, Cable Services Bureau