Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of ) ) MOUNTAIN CABLE COMPANY d/b/a ) File No. CSB-A-0628 ADELPHIA CABLE COMMUNICATIONS ) ) BETTER TV, INC. OF BENNINGTON d/b/a ) ADELPHIA CABLE COMMUNICATIONS ) ) YOUNGS CABLE TV CORP. ) ) Appeal of Local Rate Order of ) the Public Service Board ) State of Vermont ) MEMORANDUM OPINION AND ORDER Adopted: July 20, 1999 Released: July 22, 1999 By the Deputy Chief, Cable Services Bureau: 1. Mountain Cable Company d/b/a Adelphia Cable Communications, Better TV, Inc. of Bennington d/b/a Adelphia Cable Communications, and Youngs Cable TV Corp. (collectively "Adelphia"), the franchised cable operators in various cable communities in the State of Vermont, filed an appeal of the May 3, 1999 Order of the State of Vermont Public Service Board ("Board"), which addressed Adelphia's late fees and network upgrade rate increases scheduled to take effect on August 1, 1998. The Vermont Department of Public Service ("Department") has opposed this appeal. After considering all of the pleadings before us, we grant Adelphia's appeal in part and remand the Order to the Public Service Board for further action. 2. Also before us are Adelphia's May 20, 1999 Emergency Petition for Stay of Enforcement Pending Appeal of Rate Order, which the Department opposed, and the Department's June 3, 1999 Emergency Petition to Dismiss, or, Alternatively, to Stay Appeal of Rate Order, which Adelphia opposed. In light of our action on the merits, both petitions are dismissed as moot. BACKGROUND 3. Under the Commission's rules, rate orders issued by local franchising authorities may be appealed to the Commission. In ruling on an appeal of 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. Therefore, the Commission will reverse a franchising authority's decision only if it determines that the franchising authority acted unreasonably in applying the Commission's rules in rendering its local rate order. 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 decision on appeal. 4. An operator that wants to increase its basic service tier ("BST") rate or include a network upgrade rate add-on in its rate has the burden of demonstrating that the increases are in conformance with the Commission's rules. In determining whether the operator's proposed increases are in conformance with the rules, a franchising authority may direct the operator to provide supporting information. After reviewing an operator's rate forms, and any other additional information submitted, the franchising authority may either approve the operator's requested rate increases or issue a written decision explaining why any or all of the operator's rates are not reasonable. If the franchising authority determines that the operator's proposed rates exceed the maximum permitted rates as determined by the Commission's rules, it may prescribe rates different from the proposed rates provided that it explains why the operator's rates are unreasonable and the prescribed rates are reasonable. Prescribed rates may not be less than the rates permitted under the Commission's rules. A. Late Fees 5. The Board disallowed Adelphia's proposed late fee of $5.00 and ordered refunds of fees collected since July 23, 1998 because the company did not show that the costs imposed by late-paying customers were not already reflected in the benchmark formula rates and did not appropriately determine those costs. The Board viewed these as necessary preconditions for collecting a cost-based late fee. The Board was concerned that authorizing late fees based on cost elements already used in establishing benchmark rates would permit double recovery of those costs. 6. While acknowledging that late fees generally fall outside the scope of the rate regulation provisions of the Communications Act and a local order determining the reasonableness of a particular late fee charge ordinarily will not be subject to Commission review, Adelphia argues that the Board committed reversible error cognizable by the Commission in this case when it concluded that late payment costs are recovered pursuant to the Commission's benchmarks. According to Adelphia, benchmark rates are not cost based, but are determined by comparing the revenues of a cable system subject to rate regulation with the revenues of a competitive cable operator with similar characteristics, such as subscriber size and channel capacity. In addition, the Commission's recognition that late fees are treated like other ancillary charges that were subject to state or local consumer protection laws confirms the Board's error in concluding that benchmark rates recover the costs of late payments. Adelphia argues that the Board's error permeated the Board's review so that, even when the Board considered Adelphia's cost showing, the issue was framed in terms of whether Adelphia had provided proof that it incurred costs not already reflected in the benchmark rates. Thus, Adelphia asks that the Commission reverse the Board's order insofar as it bars Adelphia from establishing any late fee charge and requires refunds of previously collected late fees. Adelphia does not ask for review of the reasonableness of a particular late fee charge. 7. The Department opposes Adelphia's appeal. It disagrees with Adelphia that the Commission can provide a remedy in this case, arguing that the Board's review of Adelphia's late fees lies outside the Commission's statutory jurisdiction and field of special expertise in regulating service and equipment rates pursuant to federal law. According to the Department, the Board's action striking down the late fees traces from Vermont law and is independent of any basis in FCC regulations. While the Board discusses the potential overlap between costs recovered by late fees and costs recovered through rates regulated under Commission rules, the Department argues that the Board does not confine itself to these matters and does not foreclose future consideration of a showing by Adelphia that late fees were appropriate on the basis of issues having nothing to do with those costs that might also be related to Commission-regulated rates. The Department argues that the Commission lacks any statutory mandate to interfere in state-level determinations with respect to charges that are not subject to federal rate regulation, even if the Commission disagrees with the Board's approach to late fees, as long as the state government does not miscalculate the rates that are regulated under the Commission's methodology. 8. The Department also disagrees with Adelphia's analysis of the benchmark method. It argues that the benchmark "method, which was based on existing rates rather than on a detailed cost analysis, was nonetheless intended to `permit a full recovery of the average costs incurred' by cable operators." "Thus, the benchmark rates `are expected to provide adequate recovery of an operator's total revenue requirement needed to cover all capital and operating costs,'" including the costs of billing and collection recognized in the Board Order. The Department argues that the Board could reasonably find that Adelphia failed to show it incurred any costs due to late payments over and above its normal operating costs recovered through the benchmark rate, and the Board has acknowledged that a late fee may be imposed for reasons other than cost recovery. Finally, the Department argues that the Commission has no grounds for reversing or staying the Board's order, even if it chooses to issue an advisory opinion about the relationship between a cable operator's costs of late payment collection and its benchmark rate, because the Board's Order included reasons for rejecting Adelphia's late fee claim independent of the Commission's ratemaking methods. 9. Section 623(b) of the Communications Act directs the Commission to design regulations for BST rates. The Commission has declined to adopt regulations governing late fees, providing, instead, that late fees are within the purview of the franchising authority and are appropriately dealt with through local negotiation or the application of state or local consumer protection and customer service laws. Local or state authorities may regulate the rates of late fees utilizing local or state laws, if these laws permit such regulation. Just as we determined in Falcon Cablevision that we will not rule on the reasonableness of a franchising authority's decision to require a cost justification with respect to late fee charges, we will not rule here on a franchising authority's decision to require a cable operator to show that the costs being recovered through late fees exceed the normal billing and collection costs recovered through its tier rates. B. Form 1235 Network Upgrade Adjustment 1. Background 10. Section 76.922(j) of the Commission's rules allow operators undertaking significant network upgrades to recover the net increase in cost attributable to the upgrade by adding the upgrade costs to the rates permitted under the benchmark and price cap rate methodologies. Operators calculate their upgrade add-on by making an abbreviated cost-of-service filing on FCC Form 1235 and certify that they meet the minimum technical requirements specified in the form. In order to assist operators in projecting cash flows and obtaining capital for the construction of upgraded systems, the Commission allows operators to file FCC Form 1235 for pre-approval using projected upgrade costs at any time before making the upgrade services available to subscribers. The operator may begin charging the rates determined in the pre-approval form in subsections of the system where the rebuild is complete and service is provided to subscribers. When the upgrade is complete, operators using this phased-in approach must refile the form using the actual costs where possible and substituting actual costs for the projected costs in the pre-approval filing. Operators filing Form 1235 have the option of recouping all of their upgrade costs from services other than the BST or may collect costs allocated to the BST from BST subscribers. 11. Adelphia is upgrading its systems in phases and sought State pre-approval of BST rate increases based on the expected future capital investment and technical improvements. The Board denied all of Adelphia's monthly network upgrade adjustment without prejudice to Adelphia's right to renew the issue if it files completed versions of FCC Form 1235 at some future date. The Board required refunds of any upgrade add-ons collected from subscribers after August 1, 1998. The Hearing Officer, whose findings and conclusions were adopted except as modified by the Board, found: Adelphia did not include any offsetting revenue other than advertising revenue in its calculation. The Company did not identify any property, plant, or equipment which may be disposed of as a result of the upgrade, the revenues from which could also be used to reduce the costs recovered from ratepayers. Estimates of projected incremental operating costs and operating or support savings are absent from the filings. The post-upgrade channel line-ups have not yet been developed. There is no rate base adjustment for excess capacity in the upgraded systems. The Company indicated that it did not include any projected operating cost changes or changes in plant-related support expenses "for simplicity in the pre- approval calculation" notwithstanding the clear FCC instructions to do so and the Department's testimony challenging the company's filing as deficient. In reviewing Adelphia's exceptions to the Hearing Officer's findings and conclusions, the Board found that Adelphia's "pre-approval filing was incomplete on its face since it included only projected capital costs (including associated depreciation and financing costs) but did not include offsetting factors explicitly required by Form 1235. Specifically, the Company did not include projections of changes in revenues or operating costs . . . ." The Board added that Adelphia's "pre-approval filings omitted several categories of costs and revenues" from its Form 1235. 12. Adelphia disagrees with the Board's criticisms of its Form 1235 filings and asserts that its pre-approval upgrade adjustment should have been accepted as submitted. Adelphia argues the Board erred when it faulted Adelphia for not projecting any offsetting revenue adjustments in calculating its BST upgrade add-on because its Form 1235 clearly indicated that no new channels are going to be added to the BSTs as a result of the upgrade. It also argues the Board erred in concluding its Form 1235 was defective because it projected that it would incur no net change in its operating or support costs as a result of the upgrade. Finally, assuming arguendo that the Board could reasonably disagree with its revenue and operating cost projections, Adelphia argues the decision to reject all of its upgrade add-on was not reasonable or consistent with Commission precedent holding that a franchising authority cannot reject a rate in its entirety because of a disagreement about specific elements of a rate calculation. 13. The Department opposes Adelphia's appeal. In its view, whether an upgrade is significant is a local question, and Adelphia failed to demonstrate any need for an upgrade add-on to the BST. It argues that Adelphia has failed to show a net increase in costs, taking into account the cost of the upgrade, the operator's gain on the disposition of retired assets, additional revenues due to the implementation of the upgrade, such as anticipated home shopping revenues, and savings in operating costs due to increased efficiencies and improved technology, such as the reduction of amplifier cascaded due to increased use of fiber. It disagrees with Adelphia's position that the Board should have recalculated the rate using the best information available, because so much essential information was missing and the Board is limited to the hearing record when making rate decisions. The Department also argues that Adelphia is not entitled to any upgrade add-on because it will place no new channels on the basic tier, and it disagrees with Adelphia's argument that offsetting factors not directly linked to the basic tier should be ignored. 14. In response to the Department's opposition, Adelphia addressed offsetting gains from the disposition of plant. Adelphia argues that it did not project offsetting gains because the prospect of such gains was too speculative at the time the pre-approval filing was submitted. It states its intention to reflect any gains that do occur in the final Form 1235 filings. 2. Discussion 15. In the case before us, the Board accepted Adelphia's certification that its planned network upgrades meet the minimum technical requirements for an abbreviated cost-of-service showing, and it did not dispute Adelphia's total capital costs estimated in its pre-approval filings on Forms 1235. The dispute is whether the Board erred in disallowing the add-on in its entirety because Adelphia did not show gains from the disposition of property to be replaced in the upgrade and did not show expected revenues and operating cost adjustments. We conclude that the Board did not err in expecting the operator to consider operating cost adjustments and gains in its ratemaking but did err in its treatment of revenues associated with non-BST channels. Because the Board's Order did not allow the operator to recover any upgrade costs as it phased in the upgrade and because the decision to disallow the upgrade add-ons in their entirety was based in part on its conclusion that Adelphia failed to bear its evidentiary burden by failing to include revenues not attributable to the BST, we are remanding the Order for further consideration and are directing Adelphia to file information on estimated gains and operating costs with the Board. 16. A cable operator seeking to recover the costs of a significant upgrade should allocate upgrade costs to the BST and other services in conformance with the Commission's cost allocations rules for cost-of-service showings. The cost assignments and allocations made on the worksheets for FCC Form 1235 are to be made in accordance with section 76.924(f) of the Commission's rules specifying cost allocation requirements. Section 76.924(f)(2) specifies that costs of programming shall be directly assigned or allocated only to the service cost category in which the programming is offered. Section 76.924(f)(6) provides for direct allocation of costs incurred exclusively to support a specific service cost category or the equipment basket wherever possible. Section 76.924(f)(7) allows the operator flexibility in determining specific allocators and allocation schemes that achieve reasonable results when direct allocation is not possible. Wherever possible, common costs for which no allocator has been specified by the Commission are to be allocated based on direct analysis of the origin of the costs. Where this is not possible, common costs shall, if possible, be allocated based on indirect cost-causative linkage to other costs directly assigned or allocated to the service cost categories and equipment basket. Where neither direct nor indirect measures of cost causation can be found, common costs shall be allocated to each service cost category based on the ratio of all other costs directly assigned and attributed to a service cost category over total costs directly or indirectly assigned and directly or indirectly attributable. 17. These cost allocations are reflected in Form 1235, Worksheet A, which is used to compute: the net upgrade rate base; the projected net impact of the upgrade on operating expenses, including plant related operating expenses and plant related support expenses; the interest expense related to the upgrade; and the net revenue and income adjustments related to the upgrade, including cable revenue and other adjustments. Worksheet A shows by service category directly assigned cost elements, allocated cost elements, and the total of directly assigned and allocated cost elements. Costs and revenues assigned or allocated to the BST through this process would be reflected as BST costs and revenues. Costs and revenues for other services or the equipment basket would be reflected as CPST or as "other" costs and revenues. The totals by service cost category from Worksheet A are used in Part II of the form to compute the total upgrade revenue requirement which can be recovered from subscribers for the BST and for any CPSTs. The revenue requirement is computed by adjusting the net upgrade rate base for taxes, net operating expenses, and net revenue and income adjustments. No upgrade revenue requirement is computed on Form 1235 for equipment or premium services. 18. The instructions to Form 1235 also provide that any gains realized from the disposition of property, plant, and equipment used to provide network services are to offset the cost of the capital improvement in the ratemaking process. This offset would be reflected in the net upgrade rate base computed in Worksheet A and carried over to Part II of the form. In opposing Adelphia's appeal, the Department repeats the Hearing Officer's finding that Adelphia "`did not identify property, plant, or equipment that could be disposed of as a result of the upgrade, the revenues from which could also be used to reduce the costs recovered from the ratepayers.'" Adelphia responds only that the prospect of gains from the disposition of plant was too speculative when it submitted its pre-approval filing. It said in its Supplemental Comments to the Board that upgrades for four of the six systems at issue will involve incremental plant only, with existing plant continuing to be used and useful, so anticipated gains from those upgrades will be minimal. For the other two systems at issue, it stated its intention to wait until the rebuilds/upgrades are complete before reflecting any gain from replaced plant in the those rates. 19. Adelphia's position, that it need not address anticipated gains in the pre-approval process, is not supported by the rate form or any Commission rule. In developing its rate regulations, the Commission intended that an operator's initial rates, whether set through the benchmark or cost of service methodologies, should be sufficient to compensate the operator for its investment in property, plant, and equipment used for cable service. When property, plant, or equipment is pulled out of service as part of a major upgrade, subscribers paying for the cost of the upgrade through an upgrade add-on to their rates should not also be expected to continue paying for what is no longer used and useful. For this reason, operators are expected to reduce the costs of the capital improvement by gains realized from the disposition of property, plant, and equipment used before the upgrade. This expectation applies whether the rates to be charged are pre-approval or final rates. Adelphia is concerned that the actual gains from disposing of old plant were not known when it prepared its pre-approval Forms 1235, but neither were the actual capital costs of the upgrade. Where gains are likely because, for example, the operator is replacing old plant, the operator is expected to make a good faith effort to estimate gains that would affect its net costs when developing the pre-approval rates it proposes to charge subscribers, and it can adjust these estimates in its final form. 20. Adelphia argues the Board erred in concluding that its Form 1235 was defective for failing to include projected net changes in operating or support costs. It states it pointed out during the local review process that increases in these expense categories were at least as likely as decreases, but nothing in the record shows that Adelphia gave the franchising authority any estimates or projections to support this view. In an exhibit in the Board proceeding, Adelphia stated it omitted operating and support costs "[f]or simplicity in the pre-approval calculation," and its Supplemental Comments to the Board state it did not include projections. Adelphia explains this omission by arguing that Form 1235 pre-approval filings justifying CPST rates before the Commission frequently show either no change or a net increase in operating and/or support expenses. These filings are not based on data relevant to Adelphia's filings, however, and the Board was not unreasonable in expecting Adelphia to provide its own projections to support its requested BST rates. Whether Adelphia's operating costs will change at all, increase, or decrease will depend on the circumstances of each of the systems at issue and will be affected by matters such as changes in pole attachment costs, real estate taxes, and utility charges as well as by the service and repair costs noted by the Department and other changes in personnel needs resulting from the upgrade. 21. Adelphia also argues that the Board erred in accepting the Hearing Officer's conclusion that Adelphia had violated the Commission's rules by failing to include projected changes in revenues other than CPST advertising revenues in the Form 1235 calculations. The Hearing Officer found that Adelphia had acknowledged in discovery it expected ancillary revenues from the upgrade but had shown only advertising revenue on the CPST in its filings and had not shown offsetting revenues for pay-per view or home shopping commissions. Incorporating the Hearing Officer's findings and conclusions, the Board found that the Company did not include projected revenues changes. Adelphia argues that cable operators are required to project ancillary revenues only to the extent those revenues are specifically attributable to channels added as a result of the upgrade, and states that its Form 1235 filings clearly indicated no new channels would be added to the BST as a result of the upgrade. Thus, it does not expect offsetting advertising or home shopping commissions relevant to the BST. The Department disagrees that offsetting factors not associated with the basic tier should be ignored, arguing that all new revenues from the upgrade must be offset against the upgrade costs. 22. Section 76.924(f)(2) of the Commission's rules specifically provides that programming costs are directly assigned or allocated only to the service cost category in which the programming at issue is offered. Costs of any programming added to the BST as a result of the upgrade are directly allocated to the BST, and the only upgrade related programming revenues allocated to the BST are revenues derived from channels added to the BST as a result of the upgrade. Costs and revenues attributable to programming on other service tiers would be allocated to the tier on which the particular programming is added. While Form 1235 asks for information about projected CPST and other revenues, revenues directly allocated to those categories would not affect the BST rates subject to the Board's jurisdiction and are not subject to the Board's review. Because determining the revenue requirement for the BST does not depend on information about revenues from advertising or home shopping commissions for channels added to the CPST or carried on a premium basis, denying a BST network upgrade add-on for failing to show revenues directly generated by non-BST channels is not reasonable. 23. Finally, Adelphia challenges the Board's decision to disallow all of the upgrade add-on, arguing that, if the Board reasonably disagreed with its revenue and operating cost projections, it should have requested additional information or substituted its judgment for the operator's estimate, using the best information available from public sources. The Department disagrees. It states that the Board is limited in its decision-making to evidence on the record presented during hearings and argues that the Board's decision was reasonable in light of the amount of information missing from Adelphia's submission. While agreeing that local regulators may use the best information available when faced with a gap in a cable operator's calculations, it argues that the Board should not be required to bear Adelphia's evidentiary burden in this case when most of the required information is missing. It also argues the offsets could be significant enough to completely offset the estimated capital costs. It posits that the operator should realize operating cost savings due to increased efficiencies and improved technology, e.g., the reduction of amplifier cascades due to increased use of fiber and the assumed reduction in required service and repair, and can recover the upgrade costs through additional services and revenues. 24. If a cable operator files a facially incomplete rate justification in that it fails to complete the rate form or fails to include supporting information required by the form, the franchising authority should give the operator an opportunity to cure the defect. The franchising authority may also order the cable operator to file supplemental information. If the operator fails to provide the requested information within the required time or fails to provide complete information in good faith, the franchising authority may hold the operator in default and mandate appropriate sanctions as if the operator had failed to submit a response at all. In that case, the franchising authority could enter an order finding the operator's rates unreasonable and mandating appropriate relief, which could include, for example, ordering a prospective rate reduction and a refund based on the best information available at the time. Disapproving a rate in its entirety, or reducing it to zero, because some but not all cost elements are unproven generally is not reasonable, although as the cases cited by the Department point out, disallowing unproven cost elements may be reasonable. 25. We find that the Board's denial of all of Adelphia's upgrade add-on is not supported by the operator's failure to provide revenues from non-BST channels, operating cost savings and gains from the disposition of plant. As discussed above, revenues from non-BST channels would not affect the BST revenue requirement. Although the Department speculates that the savings in operating costs from use of fiber could be significant, it is highly unlikely that operating cost savings, if any, and any gain from disposing of old plant could negate all of the costs of an upgrade meeting the minimum technical standards specified in Form 1235 for a significant upgrade. According to Adelphia's Supplemental Comments to the Board, only two of the systems will be upgraded by replacing rather than incrementally increasing plant. On the other hand, we recognize the Board's dilemma under Vermont law in considering adjustments based on the best information available if it had sought but not received the missing information from Adelphia. According to the Department, Vermont law requires the Board to act only on the record before it, and the record lacked sufficient information for determining adjustments. Although Adelphia argues that some operators filing with the Commission showed no net change in operating costs or a net increase in operating costs, this does not require a finding that Adelphia's upgrades involve similar designs or costs. 26. We are remanding the Board Order for further consideration of the network upgrade add-on consistent with this Memorandum Opinion and Order. To facilitate the Board's review, Adelphia is directed to file its estimates of projected changes in plant related operating and support expenses and its estimates of the gains to be realized from the disposition of property, plant and equipment used prior to the upgrades. This information is to be filed with the Board within 20 days of the release of this Memorandum Opinion and Order. 27. Accordingly, IT IS ORDERED that the Emergency Petition for Stay of Enforcement Pending Appeal of Rate Order filed by Adelphia on May 20, 1999 IS DISMISSED. 28. IT IS FURTHER ORDERED that the Emergency Petition to Dismiss, or Alternatively, to Stay Appeal of Rate Order filed by the Department on June 3, 1999 IS DISMISSED. 29. IT IS FURTHER ORDERED that the Appeal of Rate Order filed by Adelphia on May 25, 1999 IS GRANTED in part and DENIED in part and the matter IS REMANDED to the Vermont Public Service Board for further action consistent with this Memorandum Opinion and Order. 30. IT IS FURTHER ORDERED that, within twenty (20) days of the release of this order, Adelphia MUST SUBMIT to the Vermont Public Service Board its estimates of projected changes in plant related operating and support expenses and its estimates of any gains to be realized from the disposition of property, plant and equipment used prior to the upgrades. 31. This action is taken pursuant to authority delegated by  0.321 of the Commission's rules. 47 C.F.R.  0.321. FEDERAL COMMUNICATIONS COMMISSION William H. Johnson Deputy Chief, Cable Services Bureau