V. Shared and Common Cost Mark-up

AT&T contends the current 21% shared and common cost, or "overhead," markup included in SBC-CA's permanent UNE rates is illegal based on a recent decision of the Ninth Circuit Court of Appeals remanding the Commission's markup calculation. The Ninth Circuit found that the Commission improperly implemented the methodology calculating the shared and common cost markup by attributing some common costs to wholesale operations that should have been attributed to retail operations. (AT&T v. Pacific Bell, 375 F.3d 894.) For this reason, AT&T maintains the markup must either be removed or corrected before true-up payments are made, and this adjustment of the markup should apply from the date the Commission first applied the 21% markup, i.e. November 19, 1999. Moreover, AT&T asserts the Commission has the authority to order retroactive adjustments of the markup, even though the Commission declined to exercise its discretion to order retroactive adjustments in response to an earlier remand of the markup calculation. (See D.02-09-049, p. 25.) In AT&T's view, the current situation can be distinguished from the earlier markup remand where the Commission declined any retroactive adjustment as not promoting competition and not worth the administrative burden given offsetting impacts of the adjustment.⁷ (Id., pp. 25-27.)

Finally, AT&T argues that because it must pass the true-up on to its customers, requiring it to pay an inflated true-up payment now based on what it considers an illegal 21% markup, only to reduce the payment later once the markup is corrected, will unnecessarily burden its customers. AT&T provides what it claims is a straightforward correction of the markup calculation based on the Ninth Circuit's decision and the calculations supporting D.98-02-106, where the components of the markup calculation were first derived. According to AT&T, these corrections result in a revised markup of 10%.

Covad, MCI, MPower, RCN, and TURN/ORA echo the views of AT&T that the Commission should include an adjustment to the markup as part of all carriers' true-up payments. MPower and RCN contend it will not cause financial hardship for SBC-CA to wait for its true-up payments until the Commission can calculate the correct markup. Therefore, they recommend the Commission order carriers to pay 50% of their true-up payments at this time, and the remaining 50% once the markup is reconsidered. Similarly, TURN/ORA question why the Commission would require CLCs to pay a true-up amount that includes a 21% markup the Ninth Circuit has found to be unlawful. Further, they note that any adjustment to the true-up amount to lower the shared and common cost markup would not have a material impact on SBC-CA's revenues, whereas payment of an unlawfully high markup would hamper competitive investment by CLCs.

SBC-CA opposes any adjustment to or deferral of the mark-up as part of the current true-up payments. According to SBC-CA, the 21% markup included in true-up payments is legal and unaffected by the Ninth Circuit's remand order because the remand did not issue until November 2004, after the September 2004 issuance of D.04-09-063 ordering true-up payments. Even now, the case is remanded to the district court and it is unclear if the district court will further remand the matter to the Commission. SBC-CA contends it is premature and speculative to conclude the Commission would actually change the markup percentage and apply any change retroactively. In SBC-CA's view, deferring the markup payment until a future date only creates yet another true-up and prolonged uncertainty.

Further, SBC-CA contends AT&T's latest proposed markup revisions, which result in a 10% markup proposal, are contrary to positions it has taken earlier before the Commission. Therefore, based on the doctrine of judicial estoppel, AT&T is prevented from now changing its position on the correct way for the Commission to calculate the markup. Specifically, SBC-CA asserts that since AT&T previously identified a maximum of $163 million in retail costs that should be removed from the numerator of the markup calculation, it cannot now advocate removal of retailing costs that are close to four times this amount.

Even if the matter is eventually remanded to the Commission, and the Commission decides to modify its mark-up calculation, SBC-CA maintains the Commission can only adjust the markup prospectively. Specifically, in D.02-09-049, the Commission revised the markup from 19% to 21% but declined to order this revision retroactively, noting it would create uncertainty in the struggling telecommunications sector and be inconsistent with Public Utilities Code Section 709. (D.02-09-049, p. 26.) In addition, SBC-CA argues that retroactive rate adjustments are typically unlawful, or at a minimum, highly disfavored, because they disrupt parties' settled expectations of transactions that are already complete. (SBC-CA, 12/8/04, p. 19.)

Discussion: It is undisputed that the Ninth Circuit has remanded to the District Court the issue of how the Commission has calculated the markup. While AT&T and other carriers view this remand as proof that the current 21% markup incorporated into rates is excessive and unlawful, SBC-CA asks us to ignore that the court found error in the 21% markup because the court's mandate issued after the decision ordering the true-up. In SBC-CA's view, we should continue to apply the 21% markup to UNE costs until ordered by the District Court to modify the markup, and even then, only prospectively. We find it unreasonable to ignore the Ninth Circuit's remand order, and essentially pretend it has not issued.⁸ Clearly, the court has found the calculations supporting the 21% markup unlawful and if we ignore this fact now, we only face dealing with the issue later rather than sooner. Even if the District Court handles the remand itself without involving the Commission, the result of any action by the District Court will undoubtedly require Commission action to trickle down into UNE rates.

Thus, the issue we now face is whether to modify the markup immediately as part of the true-up payments, or order preliminary true-up payments while we review the markup elsewhere. While it is appealing to immediately modify the markup and settle this matter after five years of litigation, we cannot do so based on the cursory showing presented by AT&T. We agree with SBC-CA that aspects of AT&T's newest calculations are significantly different than positions it has taken in prior pleadings before this Commission and we cannot accept them without further scrutiny. AT&T has argued over several years in the original OANAD proceeding and its rehearing, and then in District Court, for removal of $163 million in retail costs. Its now asks for a new approach involving removal of approximately four times that amount. SBC-CA, on the other hand, does not present any new markup calculations given its adamant insistence that the markup should remain at 21%.

While we agree with SBC-CA that it is premature to recalculate the markup as AT&T has proposed, we also agree with AT&T that it is unreasonable to demand carriers pay the full 21% markup when the Ninth Circuit has found it in error and there is uncertainty as to whether the 21% will be modified upon remand. It is more reasonable to order payment of a lesser amount and finalize true-up payments after markup remand issues are resolved. We are loath to the idea of yet another true-up, but our options are slim. We will order payment of the majority of the true-up at this time and take care of remaining markup issues in A.04-03-013 (the 2004 SBC-CA UNE Reexamination proceeding), where carriers specifically requested review of the markup percent. We will direct the assigned ALJ to issue a ruling in A.04-03-013 setting an expedited schedule for review of the markup so as to fully comply with the remand order and to bring quick finality to this long debated topic.

Therefore, we direct carriers to make their true-up payments for the period from May 2002 to September 2004, subject to the payment terms described earlier in this order, and to incorporate a 10% rather than a 21% markup. In other words, carriers should calculate their true-up payments assuming that the permanent UNE rates include a markup of only 10%. We emphasize that the 10% markup figure we adopt today for true-up purposes should not be confused with the 10% proposed by AT&T. It is mere coincidence that these numbers are the same. We decline to endorse or adopt AT&T's calculations, preferring to save them for review in A.04-03-013. Rather, we choose a 10% markup because it is approximately half the current 21% rate, it is similar to the 9% markup Verizon now proposes in the Verizon UNE phase of Rulemaking 93-04-003, and the markup is unlikely to be lower than this amount. If we ultimately adopt a higher markup percent in A.04-03-013, carriers can pay the rest to SBC-CA. As TURN/ORA point out, SBC-CA will not be materially impacted if it has to wait for a small portion of its true-up, whereas overpayment could hamper competitive investment by CLCs.

A final determination of the markup percentage will be made in A.04-03-013. If the matter is remanded by the District Court to the Commission, we will set a new markup percent in A.04-03-013 and a further order in that proceeding will resolve the final true-up payments based on a corrected markup percentage. In that proceeding, we will also address what markup should apply prospectively and whether retroactive adjustment of the markup to November 1999 is appropriate. If the matter is not remanded to the Commission or the Commission determines in A.04-03-013 that the markup percent should remain at 21%, a further order in A.04-03-013 will direct carriers to pay the remaining balance to SBC-CA for the difference between a 10% and 21% markup. We find this approach more reasonable than the proposals of RCN and MPower to pay half the true-up obligation now and half after markup issues are settled. There is no reason to withhold 50% of the entire true-up payment when a much smaller amount is in question.

Through our action today to order true-up payments with a 10% markup, we clearly disagree with SBC-CA's position that any adjustment to the markup can only be prospective. Instead, consistent with the earlier markup remand we resolved in D.02-09-049, we find that when faced with a remand, the Commission has the discretion to correct a ratemaking error retroactively. Indeed, this is exactly what SBC-CA argued in previous pleadings in this proceeding when AT&T and MCI opposed a retroactive change to the markup in response to the previous remand order.⁹ In D.02-09-049, we noted that:

[SBC-CA] disagrees that a retroactive adjustment to UNE rates would constitute "retroactive ratemaking." Rather, [SBC-CA] 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).) (D.02-09-049, mimeo. at 24.)

In that same order, the Commission concluded that SBC-CA was correct, the Commission has authority to order retroactive rate adjustments in response to a remand order, and in support the Commission cited the following passage from a D.C. Circuit order:

"[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." (Exxon Company, USA v. FERC, 182 F.3d 30, 49 (D.C. Cir. 1999), as cited in D.02-09-049, mimeo. at 24-25.)

The Commission also noted support for its conclusion that retroactivity is within its discretion by citing the following D.C. Circuit Court passage:

"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." (Verizon Telephone Cos. v. FCC, 269 F.3d 1098,1111 (D.C. Cir. 2001), as cited in D.02-09-049, p. 25.)

In D.02-09-049, the Commission chose not to implement a retroactive markup correction, reasoning it was not warranted given offsetting rate impacts and the administrative burden involved, and finding that a retroactive markup increase could hurt competitive carriers. Given our previous conclusion that the Commission has discretion to retroactively adjust rates in response to a remand order, we will incorporate a markup change as part of the interim rate true-up, from May 2002 to September 2004, because the parties anticipated a rate change, and because leaving a 21% markup in place, which the Ninth Circuit has found unlawful and is likely to modify on remand or order the Commission to modify, could impair competition. We find that consistent with the Commission's actions in D.02-09-049 to remove barriers to open and competitive markets, the Commission can exercise discretion on the issue of retroactivity when faced with a legal error in a prior rate. SBC-CA's UNE rates have been interim since May 2002, and parties expected a true-up. In sum, the circumstances surrounding this remand allow adjustment of the markup percentage back to the date when interim rates went into effect, subject to correction when a markup percentage is finalized in A.04-03-013. We will not prejudge in this order whether to apply a markup revision retroactively to November 1999.