V. Retroactive Adjustment

Parties' Positions

Joint Applicants oppose the concept of any retroactive adjustment to the shared and common cost markup, stating that this would entail not only abysmal public policy leading to "crippling uncertainty" in competitive telecommunications markets, but also retroactive ratemaking in which the Commission is not authorized to engage.²⁰ Further, Joint Applicants argue that a retroactive adjustment to rates in light of the Remand Order would be inequitable given that other UNE rate changes have not been made retroactively, even where the Commission's has found that UNE rates were inflated.

Likewise, XO urges the Commission not to apply any changes to the markup calculation retroactively because a retroactive adjustment would have a devastating impact on the development of local exchange competition in California. Similar to Joint Applicants, XO considers the idea of a retroactive correction poor public policy because it would jeopardize future reliance on Commission orders. Allegiance echoes the comments of Joint Applicants and XO that any adjustment should apply prospectively only.

Pacific suggests that any UNE price adjustments based on the Remand Order should be implemented prospectively for now, and that the question of whether UNE prices should be revised retroactively can be addressed later. Pacific disagrees that a retroactive adjustment to UNE rates would constitute "retroactive ratemaking." Rather, Pacific maintains that the Commission, pursuant to federal law, has the authority to "undo what is wrongfully done by virtue of its order," even where its statutory authority to fix rates is "prospective only." (United Gas Improvement Co. v. Callery Properties, Inc., 382 U.S. 223, 229-30 (1965). According to Pacific, the Commission has the authority to implement a retroactive adjustment when its rates are judicially reversed. (See Natural Gas Clearinghouse v. FERC, 965 F.2d 1066, 1073-4 (D.C. Cir. 1992).

Discussion

We agree with Pacific that the Commission has the authority to order retroactive rate adjustments in responding to the Court's Remand Order. In United Gas, the Supreme Court upheld FERC-ordered²¹ refunds that FERC approved on remand of a rate order that had been overturned by a reviewing court. The Supreme Court made clear that FERC had the authority to order such refunds without violating the rule against retroactive ratemaking, and it also found that FERC's exercise of such authority was a matter of discretion.

Several years later, in Exxon Company, USA v. FERC, 182 F.3d 30 (D.C. Cir. 1999), the D.C. Circuit stated that while "FERC does have a measure of discretion in determining when and if a rate should apply retroactively, ... such discretion is not without its limits." (Id. at 49.) The court explained that:

"[t]here is ... a strong equitable presumption in favor of retroactivity that would make the parties whole. As we have stated, "when the Commission commits legal error, the proper remedy is one that puts the parties in the position they would have been in had the error not been made. CPUC, 988 F.2d at 168."

At the same time, the Exxon court made clear that the agency could consider equitable factors in determining whether to apply a rate retroactively. "This is not to say that FERC must do so in every case if the other considerations properly within its ambit counsel otherwise." (Id.)

The D.C. Circuit reiterated the principles in the above cases most recently in Verizon Telephone Cos. v. FCC, 269 F.3d 1098 (D.C. Cir. 2001). Among other things, the court reiterated that an agency's decision to make retroactive adjustments in the wake of a court order was a matter of discretion. "We have previously held that administrative agencies have greater discretion to impose their rulings retroactively when they do so in response to judicial review, that is, when the purpose of retroactive application is to rectify legal mistakes identified by a federal court." (Id., at 1111.)

Given the foregoing, we will exercise our discretion in this case to not retroactively adjust rates in response to the Remand Order. Although we are aware of the strong equitable presumption in favor of retroactivity that would make the parties whole, we find that there are equitable considerations that militate against making retroactive adjustments to UNE rates at this time. First, we note the recent spate of bankruptcies in the telecommunications sector that have placed many of the competitive carriers that would be impacted by a retroactive UNE rate adjustment into bankruptcy proceedings. It is reasonable to conclude that any carriers currently under bankruptcy protection would have difficulty making any back payments to Pacific for monies owed retroactively to 1999 when the 19% markup was originally adopted.

Second, we agree with those who have commented that it would be bad public policy to inject further uncertainty into the competitive telecommunications sector by leaving the question of retroactive rate adjustments to a future date, or by ordering retroactive UNE rate payments at this time. We base this opinion on the current and well-documented negative market conditions affecting the sector. To leave the issue open, as Pacific suggests, would be even worse than ordering retroactive adjustments because the uncertainty alone would likely undermine the ability of these emerging competitors to gain access to needed investment capital. We cannot in good conscience order a retroactive adjustment, or leave the question open, because of the harm this would cause to the competitive telecommunications sector. This is consistent with our duty under Section 709 of the Public Utilities Code to encourage the development and deployment of new telecommunications technologies, promote economic growth and job creation, and to remove barriers to open and competitive telecommunications markets.

Third, we agree with Joint Applicants that it would be illogical to order retroactive payments to Pacific to cover the increase in the markup when the Commission found earlier this year that certain UNE rates were too high and it ordered downward adjustments to these rates. In D.02-05-042, the Commission found that UNE loop and switching rates were too high and it lowered them. In addition, the Commission has now expanded its review of UNE loop and switching rates to include other UNEs as well based on a preliminary showing that these rates may be above cost. The rates under review form the majority of UNEs purchased by interconnecting carriers. A retroactive adjustment to raise the markup would be contrary to the Commission's conclusions regarding the price of these UNEs relative to their cost.

Finally, since we have found in today's order that the markup should be increased while at the same time finding that recurring prices should be decreased, these changes largely offset each other and the administrative burden of making these offsetting changes retroactively outweighs the benefit. With the two offsetting changes, any adjustments would probably balance out to a great extent. Indeed, the net effect of the changes might prove to mean payments by Pacific back to competitors. We do not believe that it would be a good use of resources to track the net effect of all of these changes retroactively, especially given the degree to which the changes offset each other.

Therefore, the adjustments to the markup calculation and to UNE recurring prices that we make by this order should apply prospectively from the effective date of this order. We will exercise our discretion and not require any retroactive adjustments.

In addition, we will stay implementation of the increase to the markup pending resolution of the decreases to UNE recurring prices that are discussed above. We would prefer that both of these rate changes go into effect simultaneously. Hence, although both rate changes will apply as of today's date, they will not be implemented until the actual change to the recurring prices has been determined based on additional filings ordered herein.