5. Discussion

Pursuant to Pub. Util. Code § 2107, the Commission is vested with the authority to fine a public utility which violates or fails to comply with any Commission decree or directive between $500 and $20,000 per offense.

In D.10-06-029, the Commission ordered the applicants to show cause why a fine of $20,000 should not be levied on each applicant for each of the following alleged violations:

(A) failure to disclose the substantial revenue from the dissolution of the Rural Telephone Bank in their respective 2006 California High Cost Fund A advice letter filings as required by Decision 91-09-042, and

(B) failure to comply with Rule 1 of the Commission's Rules of Practice and Procedure by filing an application that did not disclose the actual amount at issue and not being forthcoming with relevant information.

The Commission provided for applicants to submit additional evidence and argument on the show cause matters, which applicants did on July 28, 2010. No other party presented additional information.

As set forth below, we have considered the applicants' additional evidence and argument. On the California High Cost Fund A issue, we find that three of the applicants neither sought nor obtained support from Fund A based on the 2006 accounting. These applicants, Happy Valley Telephone Company, Hornitos Telephone Company, and Winterhaven Telephone Company, have presented good cause to justify not levying a fine. Each of the other applicants, however, sought and received substantial funding from Fund A utilizing an accounting that omitted the revenue obtained from the Rural Telephone Bank dissolution.10 These applicants, Calaveras Telephone Company, Cal-Ore Telephone Company, Ducor Telephone Company, Kerman Telephone Company, The Ponderosa Telephone Company, Sierra Telephone Company, Inc., The Siskiyou Telephone Company, and Volcano Telephone Company, have failed to show good cause for not levying a fine, and a fine of $20,000 is imposed on each.

On the Rule 1 Show Cause Order, we find that all applicants failed to disclose the total amount of the stock redemption proceeds in their application and that the amount omitted was material. Each applicant should be fined for this omission.

Five of the applicants, however, disclosed a portion of the stock redemption proceeds, but the other applicants, Happy Valley Telephone Company, Hornitos Telephone Company, Kerman Telephone Company, Sierra Telephone Company, Inc., Volcano Telephone Company, and Winterhaven Telephone Company, joined the application but disclosed no proceeds whatsoever. As noted in D.10-06-029, nearly two years of repeated staff inquiries were necessary to reveal that these applicants, despite having disclosed no proceeds in the application, had actually received over $15 million in Rural Telephone Bank stock redemption proceeds. We find that submitting an application showing no proceeds at all is an aggravating factor and that these applicants should be fined the highest statutory amount, $20,000 each, and the applicants that disclosed some proceeds should be fined $15,000 each.

We analyze the record and applicable law for each of the show cause issues below.

We begin with the role of Rural Telephone Bank stock redemption proceeds in California High Cost Fund A draws. As explained in D.10-06-029, the California High Cost Fund A pays the eligible applicants the difference between their local exchange revenue requirement and the amount that could be recovered from customers with rates set at 150% of urban area rates.11 The Commission annually calculates each applicant's support from the Fund based on actual earnings during the previous year, adjusted for regulatory changes as ordered by the Commission or the Federal Communications Commission and its actual Universal Service Fund12 support amount. The carriers revenue requirement is then subject to a "means test," except for the year following a general rate case, based on seven months actual data annualized, to ensure the rate of return does not exceed 10%. Thus, recorded financial data from 2006 was an important input to calculate support paid to eligible recipients in 2007. As described above, during 2006 the applicants received approximately $28 million in stock redemption proceeds from the Rural Telephone Bank which were not disclosed to the Commission.

Happy Valley Telephone Company, Hornitos Telephone Company, and Winterhaven Telephone Company did not seek any support payments under California High Cost Fund A in 2007 and therefore did not request any funding based on their 2006 Advice Letters.13 Commission rules14 require only applicants seeking California High Cost Fund A support to include at least seven months of recorded data as part of the "means test." Consequently, these three applicants were not required to disclose recorded financial data from public utility operations in their 2006 Advice Letters and were therefore not in violation of D.91-09-042. Accordingly, we find Happy Valley Telephone Company, Hornitos Telephone Company, and Winterhaven Telephone Company have shown good cause not to impose fines for their 2006 High Cost Fund A advice letters.

In contrast, the remaining eight applicants: Calaveras Telephone Company, Cal-Ore Telephone Company, Ducor Telephone Company, Kerman Telephone Company, The Ponderosa Telephone Company, Sierra Telephone Company, Inc., the Siskiyou Telephone Company, and Volcano Telephone Company, have not presented a valid defense against penalties for failing to disclose their Rural Telephone Bank proceeds in their advice letters filed in 2006 for California High Cost Fund A funds.

These applicants contend that they were not required to disclose any Rural Telephone Bank stock redemption in their 2006 California High Cost Fund A advice letters because the Rural Telephone Bank stock was an "unregulated investment" akin to owning shares of Microsoft.15

As demonstrated in D.10-06-029, the Rural Telephone Bank stock is directly related to public utility operations because the loans from which the stock originated are secured by mortgages on public utility property and the proceeds from the loans were used for public utility purposes and included in revenue requirement.16 Public Utilities Code Section 817 specifically precludes mortgaging public utility property for private shareholder purposes. Thus, as a matter of law, Rural Telephone Bank stock cannot be an unregulated investment of the shareholders and must be part of the regulated public utility operations of each applicant. Accordingly, the proceeds from the redemption of this stock were required to have been included in the seven months of recorded financial data shown in each applicant's 2006 advice letter, but were not.

The purpose of the recorded financial data is to conduct a means test and develop a snapshot of the utility's expenses and revenues. Anything that affects the utility's revenue should be included in the means test to give the Commission an accurate financial picture of the utility's past and projected revenue. In this way, the Commission can ensure that the subsidized utilities are not earning above their authorized rate of return.

In their defense, applicants argue that there is not a specific line item in the advice letter form for regulated stock redemption proceeds. The form does contain, however, a "miscellaneous" line item in the revenue report, which provides an obvious place to show the unusual revenue obtained from the Rural Telephone Bank dissolution. Another option would be to add a new line. There is no suggestion, however, that the absence of a labeled line indicates that the Commission authorizes the exclusion of other public utility revenue. The form is intended and seeks to include all utility revenue. Finally, even if the applicants were unsure of exactly where to present the information, they could have asked for Commission staff guidance, either formally or informally. Instead, they opted to omit the millions of dollars of proceeds and failed to present an accurate picture of their finances to the Commission, on which the Commission relied for its decision to distribute public subsidy funds.17

Therefore, we conclude that Calaveras Telephone Company, Cal-Ore Telephone Company, Ducor Telephone Company, Kerman Telephone Company, The Ponderosa Telephone Company, Sierra Telephone Company, Inc., the Siskiyou Telephone Company, and Volcano Telephone Company were required by Commission decision to include the Rural Telephone Bank stock redemption proceeds in their 2006 High Cost Fund A advice letters and that these applicants did not comply with this requirement. As provided in Pub. Util. Code § 2107, any public utility which violates or fails to comply with a Commission decision is subject to a penalty of not less than $500, nor more than $20,000.

In establishing an appropriate fine under § 2107, the Commission considers two general factors: the severity of the offense and the conduct of the utility. In addition, the Commission considers the financial resources of the utility, and the totality of the circumstances related to the violations.18 Commission precedent should also be considered when assessing fines.19

The amount of a fine imposed pursuant to § 2107 must be proportional to the severity of the offense. Here, these applicants obtained substantial amounts of public subsidy funds based on incomplete advice letters which created a false impression of the applicants' actual financial position, upon which the Commission dispensed public funds. As this fact pattern illustrates, disregarding a statutory or Commission directive is accorded a high level of severity because compliance is absolutely necessary to the proper functioning of the regulatory process. 20 These applicants omitted relevant and material financial information and undermined the entire regulatory process by preventing the Commission from adequately performing its duties.

Accordingly, we find that the severity of this violation is of the highest level and the fine amount should also be set at the highest level.

In considering the conduct of the utility, the Commission reviews the utility's efforts to prevent, detect, disclose, and rectify the violation.21 Here, there is no evidence that any applicant made any effort to prevent, detect, or disclose and rectify the violation. A reasonable step for a utility when presented with novel, but significant, revenue which is related to public utility operations, would have been to make an informal inquiry of Commission staff. Such inquiries are routine. Applicants chose not to pursue this readily available avenue and instead concealed the stock redemption proceeds while obtaining millions of dollars in public subsidy payments. We find, therefore, that the conduct of the utility is an aggravating factor on this issue.

The size of the fine should reflect the financial resources of the utility. All of the applicants are small local exchange companies with limited finances. Collectively, however, they received over $31 million. The highest level of fine is required to deter future such conduct, and is consistent with the totality of the circumstances in furtherance of the public interest.22

Precedent also supports a fine at the high end of the spectrum. In D.09-07-021, we fined the utility $10,000 per incident for each violation of a Commission order.23 The utility failed to file four customer-complaint reports ordered by the Commission. We found that since the utility was not a repeat offender in that it had never been before the Commission for a violation of this type, it would be fined $10,000 for each violation. However, we noted that the utility's "conduct clearly undermines the proper functioning of the regulatory process because the Commission cannot identify and correct poor utility customer service without adequate data."24 Here, the applicants' conduct resulted in a multi-million dollar windfall, which requires a higher level of fine to deter future violations.

Upon review, we do not find any mitigating factors which would lessen the violation. As a result, Calaveras Telephone Company, Cal-Ore Telephone Company, Ducor Telephone Company, Kerman Telephone Company, The Ponderosa Telephone Company, Sierra Telephone Company, Inc., the Siskiyou Telephone Company, and Volcano Telephone Company are each fined $20,000 for violating D.91-09-024. This amount shall be payable to the State of California General Fund. This amount is sufficient to deter future violations by the applicants and others.

Rule 1.1 of the Commission's Rules of Practice and Procedure states that any person who transacts business with the Commission agrees to "never mislead the Commission or its staff by an artifice or false statement of law or fact." As set forth below, we find that applicants violated this rule, some applicants more egregiously than others.

In the application, six of the named applicants disclosed no Rural Telephone Bank stock redemption proceeds whatsoever despite seeking, as clearly stated in the caption, a "Ratemaking Determination Regarding Dissolution of the Rural Telephone Bank." After repeated inquiries from Commission staff, these applicants admitted to receiving over $15 million in Rural Telephone Bank stock redemption proceeds.

The other five applicants disclosed that they received some Rural Telephone Bank stock redemption proceeds, but only a fraction of the total. We find that acknowledging and disclosing at least a portion of their Rural Telephone Bank stock redemption proceeds in the initial application is a mitigating factor and that these five applicants should be granted a small reduction in their fines for displaying some degree of candor with the Commission.

We now turn to the arguments presented by all the applicants against a finding that Rule 1 required them to disclose the full amount of their Rural Telephone Bank stock redemption. Applicants first argue that they "plainly" disclosed the "existence and nature of the patronage shares" in footnote 21 of the application.25

That footnote, however, does not indicate that the applicants received over $24 million for this type of stock which, in the context of an application to credit ratepayers with $3,000, is a significant amount. Footnote 21 includes no amounts at all, and does not explain that the stock was obtained as a refund of interest paid by ratepayers on the loans.

Applicants go on to argue that the footnote 21 and "ample public information"26 gave the Commission constructive notice of the patronage stock. We specifically address this argument to disabuse these applicants, and all practitioners before the Commission, of the notion that the doctrine of constructive notice can be relied on to cure deficiencies in applications presented to the Commission.

Constructive notice can be contrasted with actual notice. The California Civil Code defines actual notice as notice "which consists in express information of a fact" and constructive notice as that "which is imputed by law." Cal. Civ. Code § 18. Constructive notice is analogous to "implied actual notice" and "inquiry notice." F. P. Baugh, Inc. v. Little Lake Lumber Company, 297 F.2d 692, 696 (9th Cir. Cal. 1961).

The issue of constructive notice arises in very specific legal disputes, including trademark infringement, tort law, and real property law. When a trademark is registered with the Office of the Federal Register, this is sufficient to give notice to any person subject to or affected by the registration, regardless of whether actual notice is received. 44 U.S.C.S. § 1507. In tort law, constructive notice is used in severe instances where one of the parties knew or should have known about the existence of a dangerous condition. In these cases, constructive notice is inferred when the plaintiff can show that the condition existed for such a period of time and was of such an obvious nature that, with the exercise of due care, the defendant should have discovered the condition and its dangerous nature.27

Property law, on the other hand, utilizes the concept of constructive notice in real estate transactions. Recording a deed is equivalent to putting interested parties on constructive notice such that they can obtain actual notice through a search or inquiry.28

By suggesting constructive notice as a theory to support their omission of relevant material from a document presented to the Commission, the applicants deeply misunderstand Rule 1.1 and their proper role before this Commission. "Any person" who presents a document to the Commission "agrees . . . never to mislead the Commission or its staff." This standard requires all utilities and practitioners before the Commission to present documents, especially applications, with all relevant and material information shown in a clear and understandable manner. The burden is on the applicant to present the information necessary to meet this standard, and such information cannot be "imputed" to the Commission. In short, Rule 1.1 requires "every person" transacting business with the Commission to give actual notice of all relevant and material facts. Accordingly, we find no merit in applicants' constructive notice argument.

Similarly, applicants argue that no Commission decision or resolution directed that "a full accounting of all shares must be provided" with any application and they "believed that the Commission's concern was not with the patronage shares."29 The fact that the majority of the Rural Telephone Bank stock redemption proceeds, $24 million of the total $31 million, arose from patronage refund stock substantially undermines the applicants' argument. The applicants offer no facts supporting their "belief" that the Commission's only ratemaking "concern" was for the far smaller share of the proceeds resulting from loan purchased stock.

As we found in D.10-06-029, applicants are cost-of-service regulated public utilities and Rural Telephone Bank stock obtained with loans secured by public utility property, or interest paid on such loans, and included in regulated revenue requirement is public utility property subject to the ratemaking jurisdiction of this Commission. Applicants have presented no evidence to support their dubious "belief" that this Commission was not concerned with a multi-million dollar revenue windfall related to public utility property.30

Rule 1.1 prohibits any person from misleading the Commission through "an artifice," which Black's Law Dictionary defines as "trick or fraud" implying "craftiness or deceit."31 As analyzed above, the applicants presented an application to this Commission seeking a ratemaking determination regarding the dissolution of the Rural Telephone Bank which omitted any meaningful disclosure of the significant amounts received from the Rural Telephone Bank. This document constituted an artifice within the meaning of Rule 1.1 because it created the false impression that a trivial amount was subject to Commission disposition pursuant to the application. Therefore, we find that all applicants violated Rule 1.1 of the Commission's Rules of Practice and Procedure.

As discussed above, when setting a fine under § 2107, the Commission considers the severity of the offense, the conduct of the utility, the financial resources of the utility, the totality of the circumstances, and Commission precedent.32

As with the High Cost Fund A issue analyzed above, the applicants' offense is severe because misleading representations to the Commission undermine the proper functioning of the regulatory process. The conduct of the utility in preventing, detecting, or disclosing and rectifying the violation is an aggravating factor as, again, there is no evidence that any applicant made any effort to prevent, detect, or disclose and rectify the violation. Due to the amount at issue, $31 million, the highest level of fine is necessary. In D.01-08-019, we fined a utility $10,000 per offense for violating Rule 1 in responses to data requests, with a total of $200,000 assessed against the utility.33 Here, the total amount is substantially less and in line with the applicants' financial status.

As noted above, upon review, we find that Happy Valley Telephone Company, Hornitos Telephone Company, Kerman Telephone Company, Sierra Telephone Company, Inc., Volcano Telephone Company, and Winterhaven Telephone Company, joined the application but disclosed no proceeds whatsoever, despite having received substantial proceeds, and that this is an aggravating factor. These applicants should be fined the highest statutory amount, $20,000 each, for failing to comply with Rule 1.1 of the Commission's Rules of Practice and Procedure by filing an application that failed to disclose all relevant and material information.

The applicants that disclosed a portion of their Rural Telephone Bank stock redemption proceeds - Calaveras Telephone Company, Cal-Ore Telephone Company, Ducor Telephone Company, The Ponderosa Telephone Company, and the Siskiyou Telephone Company - are each fined $15,000 for violating Rule 1.1 of the Commission's Rules of Practice and Procedure by submitting an application that failed to disclose all relevant and material facts.

Each applicant shall pay the above-stated amount to the State of California General Fund within 20 days of the effective date of this order.

In D.10-06-029, the Commission stated that:

The amount credited to the California High Cost Fund A or monthly line charges should immediately include interest calculated at the annualized, financial 90-day commercial paper rate from April 11, 2006, to the refund date(s), and if the Commission determines that disclosure of the stock redemption proceeds was required, then the California High Cost Fund A interest rate of 10% should apply.34

Applicants contend that this interest rate is an impermissible additional penalty that would exceed the $20,000 amount authorized by Pub. Util. Code § 2107.35 Applicants explain that this punitive interest rate was adopted by the Commission in 1998 "for amounts wrongfully withheld by carriers without any possible justification" and not as compensation for the time value of money.36

In D.98-01-023, the Commission adopted the 10% interest rate for payments due from carriers for two of the three telecommunications public policy programs - California High Cost Fund B and California Teleconnect program. This interest rate was subsequently extended to the High Cost Fund A in D.98-06-065. The first decision adopted interest rates applicable to a number of elements of these programs and specifically addressed rates necessary "to make carriers whole for the time value of money" and required carriers to invest High Cost B and Teleconnect held funds in interest-bearing accounts.37 The Commission adopted the 10% interest rates for overdue payments with little discussion, and nowhere in the decision does the Commission indicate any punitive intent. Given that the overarching topic for the entire decision was interest rates, and the detail into which the Commission delved on the topic, it is reasonable to expect that the Commission would have revealed any intent to create a penalty. Consequently, we conclude that the Commission did not intend to impose a penalty on carriers with the 10% interest rate.

In considering whether this interest rate nevertheless constitutes a penalty, we begin with the "interest rate" each applicant charges its ratepayers for the time value of shareholders' invested capital, i.e. the cost of capital. Each applicant includes in its revenue requirement a cost of capital of 10%. The Commission has repeatedly found this to be just and reasonable. Moreover, California telephone companies are authorized to charge up to 18% annual interest on late payments from customers.38 Neither of these interest rates has been found to be punitive.

In conclusion, we find that the long-standing, Commission-adopted 10% interest rate for payments due to the California High Cost Fund A was not intended to be a penalty within the meaning of Section 2107, and is in line with other interest rates charged by the applicants. Consequently, we find no merit to applicants' arguments. Consistent with the 1998 decision, we find that interest should be included on amounts owed to the California High Cost Fund A at the applicable rate of 10% per year. Therefore, no later than 45 days after the effective date of today's decision, these applicants must file a Tier 2 Advice Letter making these changes to their refund obligation and conforming changes to the tariffs.

10 D.10-06-029, mimeo. at 15.

11 See generally Re Alternative Regulatory Framework for Local Exchange Carriers, 41 CPUC2d 326, 330 (D.91-09-042 modifying D.91-05-016).

12 A federal program providing support for rural telephone carriers.

13 July 28, 2010, Response of Happy Valley Telephone Company, Hornitos Telephone Company, and Winterhaven Telephone Company, at 2, and attached testimony of Duane D. Dickson.

14 D.91-09-042, Appendix, Paragraph B.

15 Applicants' Response at 3.

16 D.10-06-029 at 42.

17 Applicants also contend that the Commission's directive to file a ratemaking application for Rural Telephone Bank proceeds impliedly exempts them from complying with the High Cost Fund A requirements. The Commission, however, addresses High Cost Fund A issues via the means test advice letter process and not through a ratemaking application.

18 Rulemaking to Establish Rules for Enforcement of the Standards of Conduct Governing Relationships Between Energy Utilities and Their Affiliates Adopted by the Commission in D.97-12-088, 84 CPUC2d 155, 182-84 (D.98-12-075).

19 Id. at 184.

20 Ibid.

21 Id. 183-184.

22 Ibid.

23 Application of California-American Water Company for Authorization to Increase its Revenues for Water Service in its Monterey District by $24,718,200 or 80.30% in the year 2009; $6,503,900 or 11.72% in the year 2010; and $7,598,300 or 12.25% in the year 2011 Under Current Rate Design and to Increase its Revenues for Water Service in the Toro Service Area of its Monterey District by $354,324 or 114.97% in the year 2009; $25,000 or 3.77% in the year 2010; and $46,500 or 6.76% in the year 2011 Under the Current Rate Design and Current Matters (D.09-07-021), 2009 Cal. PUC LEXIS 346, *120.

24 Id. at *118.

25 Applicants' Response at 8.

26 Id. at 11.

27 Delta Farms Reclamation Dist. v. Superior Court, 33 Cal. 3d 699, 712 (Cal. 1983); Ortega v. Kmart Corp., 26 Cal. 4th 1200, 1203 (Cal. 2001) (plaintiff customer slipped on a puddle of milk, was injured, and had the burden of proof to show that the dangerous condition existed for a sufficient time to support a finding that the store owner had constructive notice of the condition.)

28 Basch v. Tidewater Associated Oil Co., 49 Cal. App. 2d Supp. 743, 748 (Cal. App. Dep't Super. Ct. 1942) (by presuming that all recorded deeds are constructive notice of possession of property, a purchaser is expected to know or ascertain all information that is available from a reasonably diligent inquiry.)

29 Applicants' Response at 10.

30 Applicants similarly offer no evidence for their suggestion that the Commission must affirmatively require a full accounting of all public utility revenue from a cost-of-service regulated utility.

31 Black's Law Dictionary, 6th ed. (1990) at 113.

32 Id. at 184.

33 Order Instituting Rulemaking on the Commission's Own Motion into Competition for Local Exchange Service. (D.01-08-019), 2001 Cal. PUC LEXIS 653, *17.

34 D.10-06-029 at Conclusion of Law 24.

35 Applicants' Response at 15.

36 Id.

37 Rulemaking on the Commission's Own Motion into Universal Service, R.95-01-020/I.95-01-021, 78 CPUC 2d 272 (headnote only) (1998 Cal. PUC LEXIS 97, 12-15).

38 http://www.calphoneinfo.ca.gov/NR/rdonlyres/27DAE2C5-BF27-4F29-AD42-46FE5AB7ED28/3288/late_payments_eng_feb2008.pdf.

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