VII. Sharing

A. RTC

RTC requested that the sharing mechanism be suspended because it is unnecessary in today's competitive market. RTC also pointed out that D.98-10-026 suspended sharing for Pacific and Verizon. RTC referred to the following language in D.98-10-026.

"...we must now, at a minimum, suspend sharing, with the objective of elimination during the next NRF review (if conditions continue to warrant its elimination). Dramatic changes are underway as a result of passage of the Telecommunications Act of 1996, our opening of local exchange markets to facilities-based and resale competition, our authorizing CPCNs for over 150 CLCs, our authorizing over 100 interconnection agreements, and as CMA points out, rapid changes in technology . . [¶] We are convinced by parties advocating the elimination of sharing that sharing can distort operating and investment decisions. Sharing changes the forecast of present and future cash flows, and introduces greater uncertainty into the present and future stream of revenues, thereby changing the analysis without sharing. . . [¶] While distortions to operating decisions are a vital concern, distortions to investment decisions are perhaps the most costly efficiency consequence of continued sharing, due to the long term effect of delaying or rejecting otherwise cost-effective investments. . . . [¶] Moreover, sharing is asymmetric. That is, potential competitors . . . make operating and investment decisions without profit constraints. . . . It is imperative . . . that all firms . . . face the same financial analysis as they make operating and investment decisions. It is imperative that our policies not skew the playing field for or against any potential player, including [ILECs]. To do otherwise compromises the efficiency of the competitive process itself."

RTC stated that its experience under NRF provides no evidence contrary to the facts that led to the Commission's conclusion in D.98-10-026. RTC stated that it was not ordered to submit recommendations on market-based and related rates of return in this proceeding. RTC also stated it did not make such a request because the rates of return would be irrelevant if sharing is suspended and eventually eliminated.

B. ORA

ORA recommends that sharing should be retained for the following reasons:

· The sharing mechanism has not deterred RTC from increasing its capital investment.

· Retention of sharing will not result in asymmetrical treatment between RTC and its competitors.

· There is no real competition in RTC's service area.

· RTC's ratepayers have not received financial benefits from NRF.

· RTC's cross-subsidization of its affiliates and other anticompetitive behavior warrant retention of sharing.

ORA alleges that according to RTC's own testimony, RTC has and is making significant investments in technology. Therefore, sharing is not a disincentive to capital investment.

ORA states that sharing only applies to Category 1 and Category 2 services. These are services that are either monopoly services or services that are not fully competitive. Sharing does not apply to Category 3 services which are competitive. Therefore, sharing does not result in asymmetrical treatment between RTC and its competitors because it does not apply to those services where full competition exists.

ORA asserts that RTC's number of access lines, number of customers, local usage minutes and net income have increased under NRF. Competitors only own 1.7% of RTC's total access lines. Therefore, ORA asserts that RTC has no real competition in its service territory.

ORA states that Pacific's and Verizon's ratepayers received benefits in the form of lower rates because the productivity factors were greater than inflation. On the other hand, even though RTC's productivity factor has been greater than inflation, RTC's ratepayers have received no benefits because price indexing has been suspended. In addition, Verizon's customers benefited from sharing whereas RTC's customers have received no refunds under sharing.

ORA represents that the audit results demonstrate that RTC has engaged in cross-subsidization of its affiliates by improperly allocating costs to and revenues away from RTC. This cross-subsidization of its affiliates is anticompetitive because it allows the affiliate to provide services below actual costs. ORA contends that this cross-subsidization has harmed ratepayers because ratepayers were deprived of sharable earnings and there is a higher likelihood that RTC will ask the Commission for revenue increases by claiming financial difficulties.

ORA also points out that the Commission has retained sharing for Citizens Telecommunications Company of California, Inc.

C. Discussion

1. Retention of Sharing Mechanism

We conclude that the current sharing mechanism should be retained for RTC. The foregoing discussion of the audit results has demonstrated that RTC has shifted to its regulated operations a significant amount of costs that should have been attributed to non-regulated operations. The audit results show that RTC has effectively cross-subsidized its affiliates at the expense of the reported earnings of RTC. Such cross-subsidization directly contravenes the pro-competitive policies of this Commission as it unfairly disadvantages the firms which must compete against RTC's affiliates and lack the funding source of monopoly or near-monopoly services. The foregoing further demonstrates that cross-subsidization by RTC depressed RTC's earnings so significantly as to prevent sharing that otherwise would have occurred absent the cross-subsidization. By applying the sharing mechanism to RTC's corrected earnings for 1998 and 1999, shareholders will be denied a measure of the benefits from the improper cross-subsidization of RTC's affiliates. In addition, sharing will allow ratepayers to gain some of the benefits from costs for RTC that should have been lower had they been properly recorded and allocated.

Under these circumstances, we find that the sharing mechanism should continue to apply to RTC. In light of the documented cross-subsidization that occurred in the period 1997 through 1999, we cannot assume that similar cross-subsidization will not occur in subsequent years. As it has operated here, in future years, the sharing mechanism will serve to limit the benefits that shareholders may reap from any improper cost-shifting we may detect. Combined with effective auditing of RTC's books and records, sharing can serve as an important disincentive to cross-subsidization. ⁴

In addition, we agree with ORA that RTC's experience under NRF is distinguishable from that of Pacific Bell and Verizon. Unlike customers of those two large LECs, RTC's customers have never experienced rate reductions from the inflation minus productivity portion of the NRF formula. Efficiency gains that RTC has enjoyed under NRF are thus not shared with ratepayers in the form of reductions to Category I rates and Category II rate caps. In light of the continued suspension of the NRF indexing mechanism,⁵ the sharing mechanism is an important means by which we can allow ratepayers at least an opportunity to gain some tangible benefits from NRF regulation. We note that California's other similarly situated mid-sized LEC, Citizens, has agreed to retain sharing as part of a negotiated settlement.

Moreover, although RTC asserts that the sharing mechanism can have an adverse impact on innovation and new investment, the record does not show that the current sharing mechanism has had that effect on RTC. Under the sharing mechanism, RTC has undertaken a variety of major investment initiatives. Through its Avalanche project, RTC has upgraded transmission quality to permit faster communications speeds over switched telephone lines. In addition, RTC has deployed DSL service and ATM service in order to provide increased bandwidth for its residential and business customers. These upgrades and new services have required substantial levels of capital investment. RTC claims to be a technologically advanced local telephone company whose advanced capabilities rival those of the largest local carriers. The record does not provide any reason to challenge this assertion.

Finally, we reject RTC's claim that the sharing mechanism places the company at a competitive disadvantage. As ORA points out, the sharing mechanism does not apply to any of Roseville's Category III services and therefore can have no effect on services for which RTC lacks significant market power. The services to which the sharing mechanism applies, Category I and II services, are by definition services over which RTC has significant market power. The sharing mechanism serves as a check to prevent excessive exploitation of that market power. In short, sharing only affects services for which competition is either weak or non-existent. Roseville does not identify any competitive harm that it has suffered as a result of the sharing mechanism.⁶

2. Refund of Sharable Earnings

Since sharing should have occurred in 1998, ratepayers should be made whole for the shareable earnings they did not receive. Therefore, we will require RTC to amend its 1999 shareable earnings filing to reflect the adjustments included herein. RTC shall add to the 1999 sharable earnings $419,505 that should have been shared in 1998 plus interest calculated in accordance with Ordering Paragraph 16 of D.89-10-031.

The 1999 sharable earnings calculation in this decision is based on 1999 recorded data with one exception. Audit Calculation 32 - Residual Costs Attributable to Non-Regulated Operations is based on partial year data. Therefore, RTC may use full year data for Audit Calculation 32 in its amendment.

In order to ensure that this decision is properly implemented, we will allow ORA additional time to review the amended 1999 shareable earnings filing. Therefore, we will require RTC to provide ORA with an advanced copy of its amended filing, including complete workpapers, 30 days before it is filed. ORA and other parties will then have the opportunity to provide comments on the filing as provided for in General Order 96-A.