# Opposition — Western Coal Traffic League v. United States

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Opposition
- **Published:** January 1, 1983
- **Citation:** 462 U.S. 1110

## Text

No. 82-1369

——

Iu the Supreme Cowt of the United States

OCTOBER TERM, 1982

WESTERN COAL TRAFFIC LEAGUE, ET AL., PETITIONERS
VU:

UNITED STATES OF AMERICA, ET AL.

ON PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

BRIEF FOR THE FEDERAL RESPONDENTS
IN OPPOSITION

REX E. LEE
Solicitor General
Department of Justice
Washington, D.C. 20530
(202) 633-2217
JOHN BROADLEY
General Counsel

LAWRENCE H. RICHMOND

Deputy Associate General Counsel
ERNEST B. ABBOTT

Attorney

Interstate Commerce Commission
Washington, D.C, 20480

——- -—-— -— —— —-- ~~ —— ——————

QUESTIONS PRESENTED

1. Whether the Interstate Commerce Commission’s
adoption, as the standard for railroad revenue ade-
quacy, of a rate of return on net investment equal to
the current cost of capital was consistent with 49
U.S.C, 10704(a) (2) and constituted a reasonable ex-
ercise of discretion.

2. Whether the Commission’s definitions of cost of
capital and net investment base were arbitrary and
capricious.

(1)

TABLE OF CONTENTS

Page
Opinions below spect cahcuaes ae 1
Jurisdiction ; . ideeeatat 1
Statement . . 2
REESE EE eR OS I eA TI SR SITET EN eas %
Conclusion 22
TABLE OF AUTHORITIES
Cases:
Adequacy of Railroad Revenue, 361 1.C.C, 79, 362
L.C.C, 198, petition for reopening denied, 362
1.C.C, 794 (Ex Parte No, 3538) 3,4, 11, 13, 15-16
Atchison T. & S.F. R, Co. v. Wichita Board of
Trade, 412 U.S, 800 15-16
Chesapeake & Ohio Ry., Docket No, 38793, petition
for review (served Mar. 18, 1982), appeal dock-
eted, No, 82-3122 (3d Cir.), Wheeling Pittsburgh
Steel Co. v. ICC : : 10
Cleveland-Cliffs Iron Co. Vv, ICC, 664 F.2d 568 ..... 20
Establishment of Adequate Railroad Revenue
Levels, 858 1.C.C, 844, modified, 359 I.C.C, 270
(Ex Parte No, 338) ae HH Be eS
Iowa Public Service Co. v. ICC, 643 F.2d 542 20
San Antonio v. United States, 631 F.2d 831, modi-
fied, 655 F.2d 1341, rev'd on other grounds
sub nom, Burlington Northern, Ine. v. United
States, No, 81-1008 (Dec, 13, 1980) . 13, 20
Standards for Railroad Revenue Adequacy, 364
L.C.C, 803 (Fx Parte No, 393) rite 6, 8
Ex parte, No, 347 (Sub-No, 1), Coal Rate Guide-
lines—Nationwide, 364 1.C.C, 360 . 10, 20

Ex parte, No, 393 (Sub-No, 1), Standard for Rail-
road Revenue Adequacy (Mar, 9, 1983) . 17, 19, 21

Statutes:

Act of Oct, 17, 1978, Pub. L, No, 95-473, 92 Stat.
1337 2

(111)

IV
Statutes :—Continued Page
Economic Recovery Tax Act of 1981, Pub. L. No.
97-34, 95 Stat. 172 a 21
Milwaukee Railroad Restructuring Act, Pub. L.
No, 96-101, 93 Stat. 736 . 4

Railroad Revitalization and Regulatory Reform
Act of 1976, Pub. L. No, 94-210, 90 Stat, 31

(49 U.S.C. (& Supp. IV) et seq.) 2
Section 101(a), 90 Stat, 33 9
Section 202 (b) and (e), 90 Stat. 25, 36-38 2
49 U.S.C. (Supp. 1V), 10101a, note 5
49 U.S.C. (Supp. IV) 10701a(a) (3) 5
49 U.S.C. (Supp. IV) 10701a(b) (3) 9
49 U.S.C. (Supp. [V) 10704(a) 12,17
49 U.S.C. (Supp. IV) 10704(a) (2) 2, 11, 13, 18
49 U.S.C. (Supp. IV) 10704(a) (2) (A) 7,18
49 U.S.C. (Supp. IV) 10704(a) (2) (B) 11,17
49 U.S.C. (Supp. 1V) 10704(a) (3) and (4) 5
49 U.S.C. (Supp. IV) 10705a(a) and (b) 5
49 U.S.C. (Supp. 1V) 10707a(d) (3) and (e) 5

Rock Island Transition and Employee Assistance
Act, Pub, L. No, 96-254, 94 Stat. 399 4
Stagwers Rail Act of 1980, Pub, L. No, 96-448,

94 Stat. 1895 8 4
Section 2, 94 Stat. 1896 11
Section 3, 94 Stat. 1897 5,9
Section 201(a), 94 Stat. 1898 5
Section 203(a), 94 Stat. 1901 5
Section 205, 94 Stat. 1905 5
Section 205(b) (2), 94 Stat. 1906 h
Section 217(a) (1), 94 Stat. 1917 5

AM TS.C, Mal) 2
Miscellaneous:

Ex parte, No, 392, Standards for Railroad Revenue
Adequacy (Notice), 45 Fed. Reg. (1980) :

p. 80150-80155 5-6
p. 80151-80152 6
p. 80152 19

H.R. Rep. No. 95-1395, 95th Cong., 2d Sess,
(1978) . era -

Sk Se ee

Miscellaneous—Continued Page
H.R. Rep. No. 96-1430, 96th Cong., 2d Sess.

ce 5

S. Rep. No. 94-499, 94th Cong., 2d Sess. (1975). 13

S. Rep. No. 94-595, 94th Cong., 2d Sess. (1976). 2

U.S. Railway Ass’n, Conrail at the Crossroads:
The Future of Rail Service in the Northeast
| Nee AE ape paateanhs 4

Iu the Supreme Court of the United States

OCTOBER TERM, 1982

No. 82-1369
WESTERN COAL TRAFFIC LEAGUE, ET AL., PETITIONERS
Ge

UNITED STATES OF AMERICA, ET AL.

ON PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

BRIEF FOR THE FEDERAL RESPONDENTS
IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. la-
35a) is reported at 691 F.2d 1104. The decision of
the Interstate Commerce Commission (Pet. App. 1b-
24b) is reported at 364 I.C.C. 803.

JURISDICTION

The judgment of the court of appeals was entered
on October 19, 1982 (Pet. App. 1d-2d), and petitions
for rehearine were denied on November 15, 1982

(1)

2

(Pet. App. le-2c). The petition for a writ of cer-
tiorari was filed on February 14, 1983. The jurisdic-
tion of this Court is invoked under 28 U.S.C. 1254/1).

STATEMENT

1. Congress enacted the Railroad Revitalization
and Regulatory Reform Act of 1976, Pub. L. No. 94-
210, 90 Stat. 31 (the “4R Act’’), in the face of a sea
of bankruptcies involving most railroads serving the
northeastern United States. Intervention by the In-
terstate Commerce Commission into railroad rate-
making was perceived as a major contributor to the
carriers’ weakened financial position, and Congress
sought to restore stability by reducing regulatory re-
straints on rail carrier pricing decisions. See S. Rep.
No. 94-595, 94th Cong., 2d Sess. 124 (1976). Thus,
the 4R Act substantially limited the power of the
Commission to find rates unreasonably high or low,
and restricted the Commission’s power to suspend
rate changes. 4R Act, Section 202(b) and (e), 90
Stat. 35, 36-38.

The 4R Act also directed the Commission to de-
velop and promulgate reasonable standards for the
establishment of adequate railroad revenue levels,
and then to make “an adequate and continuing effort
to assist those [rail] carriers in attaining [the] rev-
enue levels prescribed * * *.” 4R Act, Section 205, 49
U.S.C. (Supp. IV) 10704(a)(2) * * *.' The Act

' The provision enacted by the 4R Act was originally codi-
fied at 49 U.S.C. 15a(4). That provision was restated with-
out substantive change as 49 U.S.C. (Supp. IV) 10704 (a) (2)
by the Act of Oct. 17, 1978, Pub. L. No. 95-473, 92 Stat. 1337.
See H.R. Rep. No. 95-1395, 95th Cong., 2d Sess. 70, 72 (1978).
The excerpt quoted above is from the restated provision as it
appears in 49 U.S.C. (Supp. IV) 10704 (a) (2).

carefully specified that the revenue levels established
by the Commission as adequate must be sufficient to
“support prudent capital outlays, assure the repay-
ment of a reasonable level of debt, permit the rais-
ing of needed equity capital, *~ * * cover the effects
of inflation * * * [and] attract and retain capital in
amounts adequate to provide a sound transportation
system in the United States.” /bid. Congress did not,
however, give carriers whose revenues were deter-
mined to be inadequate any regulatory freedoms un-
available to “revenue adequate” carriers, or specify
how the Commission was to use its revenue adequacy
findings in individual rate proceedings.

Pursuant to the 4R Act, the Commission began an
extensive rulemaking proceeding to devise standards
of revenue adequacy. /stablishment of Adequate
Railroad Revenue Levels, 358 1.C.C. 844, modified,
359 1.C.C. 270 (1978) (Kx Parte No. 338). Upon
promulgation of generic standards, the Commission
conducted a proceeding to make revenue adequacy
determinations for individual railroads. See Ade-
quacy of Railroad Revenue, 361 L.C.C. 79 (1978),
and 362 I.C.C. 198 (1979), petition for reopening
denied, 262 1.C.C. 794 (1980) (Ex Parte No. 353).

Rather than adopting a single standard of revenue
adequacy in these proceedings, the Commission de-
fined a range between a minimum and a maximum
standard. The minimum standard was determined
by using the “flow of funds” approach, advocated by
shipper groups (including several of the petition-
ers herein). This method was designed to measure
the revenues required to (1) pay all operating ex-
penses and contractual debt obligations, and (2) pro-
vide enough equity capital from retained earnings to
permit financing of all necessary future investments
at the current cost of capital for debt and equity. Ex

4

Parte No, 338, supra, 358 LC.C, at 859-860; Ex Parte
No. 353, supra, 362 1.C.C, at 204, 227-242. The maxi-
mum standard for revenue adequacy was defined as
the “fair return level”—i.e., a rate of return equal
to the cost of capital multiplied by the net invest-
ment base. Kw Parte No, 338, supra, 358 LC.C, at
896; 359 LC.C. at 273; Ex Parte No, 353, supra, 362
L.C.C, at 223-224. In addition, the Commission pro-
posed to give weight to a number of financial indi-
cators in determining the revenue adequacy of indi-
vidual carriers; where a carrier’s revenues fell
within the range, these indicators would be used in
making a judgment regarding revenue adequacy, 358
LC.C. at 858-860."

The railroad industry continued to struggle finan-
cially despite the 4R Act reforms, prompting Con-
gress to enact the Staggers Rail Act of 1980,’ Pub. L.
No, 96-448, 94 Stat. 1895 (“Staggers Act”). The

* Using these standards, the Commission found 15 carriers
with rates of return ranging from 4.02 to 11.70 percent to be
revenue adequate, and 23 carriers with rates of return rang-
ing from —40, to 4.65°7 to be revenue inadequate, 362 1.C.C.
at 297-341.

"For example, during this period, two major midwestern
rail carriers—the Chicago, Rock Island & Pacific Railroad and
the Chicajyro, Milwaukee, St. Paul and Pacific Railroad—not
only declared bankruptcy, but ceased providing service over
the major parts of their systems, forcing congressional inter-
vention, See Rock Island Transition and Employee Assistance
Act, Pub, L. No, 96-254, 94 Stat. 399; Milwaukee Railroad
Restructuring Act, Pub, L. No, 96-101, 93 Stat. 736. Two
other major carriers—Consolidated Reil Corporation and the
Delaware & Hudson Railroad—required major government
subsidies. U.S. Railway Ass'n, Conrail at the Crossroads:
The Future of Rail Service in the Northeast 2, 39 (1981).
See also the Commission's initial revenue adequacy determina-
tions in Ex Parte No, 353, 362 1.C.C. at 257.

5

express purpose of the new legislation was “to pro-
vide for the restoration, maintenance, and improve-
ment of the physical facilities and financial stability
of the rail system of the United States.” Section 3,
94 Stat. 1897, 49 U.S.C. (Supp. IV) 10101a, note.
This financial and physical improvement was to be
accomplished primarily through further limiting of
federal regulation of railroad ratemaking and
through encouraging the earnings levels necessary to
attract needed capital. H.R. Rep. No. 96-1430, 96th
Cong., 2d Sess, 79-80 (1980).

In the Staggers Act, the Commission once more
was directed to complete a proceeding—this time
within 180 days—to establish standards of revenue
adequacy and to determine which railroads were
meeting those standards. Section 205(b)(2), 49
U.S.C, (Supp. IV) 10704(a) (3) and (4). Addi-
tional such proceedings were to be conducted in sub-
sequent years. The Staggers Act also directed the
Commission to consider revenue adequacy in any pro-
ceeding involving the reasonableness of a railroad
rate. Section 201(a), 49 U.S.C. (Supp. IV) 10701a
(a) (3). Only railroads not earning adequate rev-
enues would have the right, after 1984, to increase
rates by 4% per year without those increases being
subject to suspension (Section 205(a), 49 U.S.C.
(Supp. IV) 10707a(d) (3) and (e)), and only rail-
roads not earning adequate revenues would have the
right to impose surcharges on all traffic moving under
joint rates (Section 217(a) (1), 49 U.S.C. (Supp. IV)
10705a(a) and (b)). Under this statutory scheme,
then, a finding of revenue adequacy would narrow the
ratemaking flexibility of the carrier involved.

2. a. Faced with these congressional directives,
the Comniission instituted the proceeding that is the
subject of the instant petition. Ka Parte No, 398,

6

Standards for Railroad Revenue Adequacy, 45 Fed.
Reg. 80150-80155 (1980). The Commission proposed
that, in light of the emphasis of the Staggers Act on
revenue adequacy, the then-existing standards should
be replaced. Under the proposed standards, revenues
would be deemed adequate if a railroad earned a rate
of return on investi ent equal to the current cost of
capital, and if the railroad achieved certain financial
ratios consistent with a sound financial condition. The
Commission proposed to withdraw the “funds-flow”
standard. 45 Fed, Reg. 80151-80152 (1980).

After consideration of voluminous comments filed
by railroad and shipper interests, the Conimission
promulgated its current revenue adequacy standards.
Standards for Railroad Revenue Adequacy, 364 LC.C,
803 (1981) (Pet. App. 1b-24b) (“He Parte No.
393”). The Commission found (Pet. App. 7b-8b)
that the most appropriate standard for determining
if a railroad has adequate revenues is whether it re-
ceives a rate of return equal to the current cost of
capital. This rate of return was deemed the minimum
rate of return that would allow railroads to obtain
investment funds, because, in the Commission’s
judgment, “investments earning less than the cost of
capital will, in general, not maintain existing fund-
ing nor obtain new funding” (id. at 8b).

The Commission also stressed that a rate of re-
turn equal to the current cost of capital would sat-
isfy all of the statutory criteria, because it would give
carriers a “ ‘flow of net income sufficient to support
prudent capital outlays, assure the repayment of a
reasonable level of debt, permit the raising of needed
equity capital, cover the effect of inflation’ and other-
wise meet the requirements of the statute” (Pet.

7

App. 8b, quoting 49 U.S.C. (Supp. IV) 10704(a) (2)
(A)).

b. Having adopted this standard for determining
revenue adequacy, the Commission next defined the
relevant cost of capital as a weighted average of the
current cost of debt and equity. The Commission re-
jected the shippers’ contentions that the embedded
cost of debt, reflecting the historical cost of prior in-
vestment, should be used. The Commission explained,
repeating the analysis provided in the Notice of Pro-
posed Rulemaking (Pet. App. 13b):

A sound transportation system should return the
cost of capital to investors and reflect that cost
of capital in prices paid by users. These are
forward-looking concepts. The year and the rate
at which past debt was raised are not sevelant
for these purposes. The more relevant consider-
ation is the cost to the railroad of raising (or
not losing) capital for current and future
investment.

The Commission did not exclude unused and non-
useful assets from the initial calculation of the net
investment base, finding that to do so would be im-
practical in the 180-day period available to complete
the initial proceeding and that only minimal distor-
tions would result in any event (Pet. App. 10b). The
Commission also determined that reserves for de-
ferred taxes that would have been due had the rail-
roads not used the accelerated rather than straight-
line depreciation method for tax purposes should not
be subtracted from the investment base.

3. The court of appeals affirmed the Commission’s
decision in all respects.‘ The court held that the “over-

4A cross-petition filed by several railroads, objecting to
the Commission’s statement that it would, in 4 future pro-

p¢leum™

8

all policy pursued by the agency [in adopting a single
rate-of-return standard] is entirely consistent with
Congressional directives,” and that the “[r]easons for
departure from the ICC’s prior position with respect
to use of financial ratios and flow of funds analysis,
and for refraining from incorporating productivity
standards * * *, have been carefully explained” (Pet.
App. 26a). The court further concluded that the
agency’s use of the current (rather than embedded)
cost of debt was consistent with the statute (id. at
28a-29a), and that the agency had adequately ex-
plained the inclusion of both unused and unuseful
assets and the reserve for deferred taxes in the in-
vestment base (id. at 3la, 38a).

ARGUMENT

The court of appeals correctly determined that the
Commission’s revenue adequacy standards are con-
sistent with the statutory scheme and supported by
the Commission’s analysis. The decision conflicts with
no decision of this Court or of any court of appeals,
and does not warrant further review.

1. Petitioners urge (Pet. 9-13) that the revenue
adequacy standards adopted in Ew Purte No, 393
raise important questions concerning the Commis-
sion’s regulation of rail rates, because, in petitioners’
view, the standards deprive captive rail shippers of
the maximum rate protections provided in the Inter-
state Commerce Act. This arguinent confuses the dis-
tinct issues of defining revenue adequacy, on the one
hand, and utilizing the concept of revenue adequacy
in ratemaking decisions, on the other. Only the Com-

ceeding, consider excluding ‘unused and nonuseful assets”
from the investment base, was denied as not ripe for judicial
review (Pet. App. 33a-34a).

9

mission’s definition of revenue adequacy is at issue in
this case.

The purpose of both the 4R Act and the Staggers
Act was to help rehabilitate and maintain the physical
facilities of the railroad industry and to restore its
financial integrity. 4R Act, Section 101(a), Pub. L.
No. 94-210, 90 Stat. 33; Staggers Act, Section 4, Pub.
L. No. 96-448, 94 Stat. 1897. Thus, because revenue
adequacy findings must be considered in rate proceed-
ings and can limit a carrier’s access to several Stag-
gers Act reforms, revenue adequacy must be carefully
defined to ensure that no carrier is labeled revenue
adequate unless its revenues are “adequate” for the
purposes Congress sought to achieve: the obtaining of
long-term financing for the rehabilitation and mainte-
nance of that carrier’s physical plant.

Contrary to petitioners’ contention, however, the
Commission’s definition of revenue adequacy does not
have the effect of “depriving captive rail shippers of
the maximum rate protections which Congress in-
tended them to have” (Pet. 9). Individual rates, or
methods that may be used to determine individual
rates, are not at issue here. Although the Commis-
sion is required to “consider” revenue adequacy in
individual rate cases (49 U.S.C. (Supp. IV) 10701a
(b) (3) ), the Commission’s decision in this case does
not determine or even discuss what form that con-
sideration might take. Accordingly, the decision be-
low does not preclude shippers from seeking relief
from unreasonable rates charged by carriers even if
those carriers are determined to be revenue inade-
quate. Indeed, both the Commission and the court of
appeals stressed that “a revenue adequacy determina-
tion is no guarantee that any carrier will attain any
level of revenue” (Pet. App. 6b, 7b, 27a).

10

Petitioners apparently believe that the Commission
has given undue weight to carrier revenue needs in
the concededly “few” individual rate cases decided
after the Commission rendered the decision at issue
here. They point (Pet. 11) to several individual rate
cases in which revenue inadequacy was considered.’
Petitioners’ argument regarding the methods used
in individual rate cases has no relevance here. None
of these cases is now before the Court, and petitioners’
objections with respect to them may be raised in ac-
tions seeking judicial review in those cases. This case,
as we have said, concerns only the Commission’s defi-
nition of revenue adequacy.”

Petitioners also contend (Pet. 13) that the standard
adopted by the Commission must be erroneous because
it results in a finding of revenue inadequacy for many
railroads and, hence, no “meaningful distinction” is
made between financially strong and weak railroads.

5 All but one of these cases involved carriers whose revenues
were inadequate under both the new standards adopted by the
Commission in the instant proceedings and the old standards.
The exception is the Chesapeake & Ohio Ry., Docket No. 38793,
petition for review of a decision of the Public Service Comm'n
of West Virginia (served Mar. 18, 1982), appeal docketed,
No. 82-3122 (3d Cir.), Wheeling Pittsburgh Steel Co. v. ICC.

6 Similarly, the Commission’s proposed guidelines for taking
revenue adequacy into account in ratemaking proceedings, set
forth in a notice in Ex Parte No. 347 (Sub-No. 1), Coal Rate
Guidelines—Nationwide (served Feb. 24, 1983), discussed
in the Brief Amicus Curiae filed by the Consumer Owned
Power Coalition (at 18-22), may be contested in an action
challenging those guidelines if they are finally adopted by the
Commission or in an action contesting individual rates deter-
mined by reference to the proposed or final guidelines. Those
guidelines do not furnish a basis for reviewing the revenue
adequacy standards themselves in this case.

11

The purpose of the Staggers Act, however, was not
to require the Commission to determine which car-
riers have more adequate or less adequate revenues
on a relative basis. Rather, it required the Commis-
sion to define revenue adequacy at levels sufficient to
“attract and retain capital in amounts adequate to
provide a sound transportation system.” 49 U.S.C.
(Supp. IV) 10704(a)(2)(B). Further, Congress
made explicit findings in the Staggers Act that earn-
ings of the railroad industry as a whole were “insuf-
ficient to generate funds for necessary capital im-
provements” and that “by 1985, there will be a capi-
tal shortfall within the railroad industry of between
$16,000,000,000 and $20,000,000,000.” Staggers Act,
Section 2, 94 Stat. 1896. Given these findings, Con-
gress could not have anticipated that the Commission
would find large numbers of carriers to be revenue
adequate, See Pet. App. 15b-16b.’

2. The court of appeals correctly rejected peti-
tioners’ contention (Pet, 14-18) that 49 U.S.C. (Supp.
IV) 10704(a) (2) “expressly precluded” the Commis-
sion from adopting return on investment as the sole
measure of revenue adequacy. As its terms make
clear, 49 U.S.C. (Supp. IV) 10704(a) (2) does not re-
quire the Commission either to adopt or to avoid any
particular method for determining revenue adequacy.
Rather, the statute lists several performance tests for

7 Petitioners cite (Pet. 13) the Burlington Northern Rail-
road (BN) as an example of a strong railroad that should be
considered revenue adequate, because it had the resources
recently to acquire control of E] Paso Natural Gas Company.
Contrary to petitioners’ contention, however, BN’s decision
to invest internally generated funds outside the rail industry
in fact does not speak well for the profitability of BN’s rail
operations. Moreover, BN was considered revenue inadequate
even under the old standards that petitioners now seek to have
reinstated. See Ex Parte No. 358, supra, 362 1.C.C. at 303.

12

carrier revenue adequacy, and requires the Commis-
sion to design standards that would enable railroads
to satisfy those tests. Thus, Section 10704(a) pro-
vides:

The Commission shall maintain and revise as nec-
essary standards and procedures for establishing
revenue levels for rail carriers “ “ © that are
adequate, under honest, economical, and efficient
management, to cover tctal operating expenses,
including depreciation and obsolescence, plus a
reasonable and economic profit or return (or
both) on capital employed in the business.

Further, the revenue levels established by the Com-
mission must—

(A) provide a flow of net income plus deprecia-
tion adequate to support prudent capital outlays,
assure the repayment of a reasonable level of
debt, permit the raising of needed equity capital,
and cover the effects of inflation; and (B) attract
and retain capital in amounts adequate to pro-
vide a sound transportation system in the United
States.

The Commission found that a rate of return on in-
vestment equal to the current cost of capital would
satisfy all of these performance criteria (Pet. App.
7b-9b). The Commission credited the testimony of a
witness in the proceedings, Professor Baumol, that
any decision which precluded a compensatory return
on a railroad’s cost of capital would result in dis-
investment from the railroad industry, because in-
vestors would choose to invest their funds elsewhere
at a higher rate of return (Pet. App. 7b-8b). Such
disinvestment in turn would lead to deterioration of
plant and equipment, avoidance of replacement of
equipment, neglect of opportunities for moderniza-

13

tion, and withdrawal of railroad services valued by
customers. In contrast, the Commission concluded
that the rate-of-return standard would prevent these
results, and thus was entirely consistent with con-
gressional directives."

Petitioners contend (Pet. 17), however, that the
Commission did not explain its departure from its
prior position, expressed in Ew Parte No, 338, that it
would look to factors beyond the rate of return in
determining revenue adequacy. See Ex Parte No, 338,
supra, 358 I.C.C. at 858-860; Ex Parte No. 358,
supra, 362 I.C.C. at 216. This contention is without

*Contrary to petitioners’ contention (Pet. 16-17), the
opinion of the District of Columbia Circuit in San Antonio
v. United States, 631 F.2d 831, 850 n.104 (D.C. Cir. 1980),
modified, 655 F.2d 1341 (1981), rev’d on other grounds sub
nom. Burlington Northern, Inc. v. United States, No, 81-1008
(Dec. 13, 1982), supports rather than undermines the Com-
mission’s and court of appeals’ decision. The court there
stated that although 49 U.S.C. (Supp. IV) 10704(a) (2) re-
veals that revenue levels must provide net income adequate to
support prudent capital outlays, assure the repayment of a
reasonable level of debt, and permit the raising of needed
equity capital, “that language specifies not at all the exact
methodology that the Commission shall use in accomplishing
the mandate.” 631 F.2d at 850 n.104. The court likewise re-
jected the city’s reliance upon the same Senate Report relied
upon by petitioners herein (Pet. 15, quoting S. Rep. No. 94-
499, 94th Cong., 2d Sess. 51-52 (1975) ); it noted that although
the Report indicates that the Commission should not focus
solely on rate-of-return analysis and should adopt a prospec-
tive view of revenue needs, the Report does not prescribe the
specific standards by which to determine the adequacy of
revenue levels. 631 F.2d at 850 n.104. Here, the Commission
did not focus solely on rate of return. It explicitly considered
the other statutory criteria of adequacy and determined that
a rate-of-return standard would assure sufficient income to
meet those criteria (Pet. App. 86-96).

14

merit. The Commission explained that in Ex Parte
No. 338 and Ex Parte No. 353, it had established a
range of revenue adequacy, with a high value to be
determined by looking to the cost of capital and a low
value to be determined by using a flow of funds model.
The Commission stated that flow of funds determina-
tions “represent minimum target levels to be
achieved” and “are appropriate as indicators only of
the short-term viability of railroads” (Pet. App. 6b
(emphasis added) ). These indicators, the Commis-
sion explained, were “never intended to define a long-
term level of adequate revenue” (id. at 5b), and “are
especially inappropriate as measures to limit rail pric-
ing flexibility which is one of the roles the [Staggers]
Rail Act accords revenue adequacy findings” (id. at
6b). The Commission continued (ibid.) :

If we adopted the Ex Parte No. 353 minimum or
short-term standard for use here, we would likely
in the next few years find ourselves denying a
railroad the pricing flexibility necessary to ob-
tain long-term revenue adequacy simply because
that railroad was making some progress toward
achieving that goal. In short, we would be as-
signing the railroads the Sisyphean task of work-
ing toward revenue adequacy, and every time it
came close robbing it of the very means it had
used to get there. We do not believe this is de-
sirable nor do we believe it was intended by
Congress. Thus, our adoption of a rate of return
standard is not a radical departure from our
previous standards. Ex Parte No. 353 clearly
accepted rate of return as a proper standard for
ascertaining if a railroad has actually earned
adequate revenues, In adopting such a standard
here, we are only adapting our earlier findings
to the mandate and policy of the [Staggers] Rail
Act.

15

Finally, the Commission stressed that a finding of
revenue inadequacy does not give a railroad license
to set rates at unreasonable levels, because “revenue
need is not the only factor to be considered when the
reasonableness of a rate is determined” (id. at 7b).
As a result, “the computation of an adequate revenue
level for the carrier does not represent a guarantee
that the carrier will attain such a revenue level”
(ibid.).

The court of appeals held that the “[rJeasons for
departure from the ICC’s prior position with respect
to use of financial ratios and flow of funds analysis
* * * have been carefully explained” (Pet. App. 26a).”
The Commission therefore satisfied its responsibility
to explain its change of policy. Cf. Atchison T. &

® Petitioners contend (Pet. 17) that the Commission had
taken the position in its decisions in Ex Parte No, 338 and
Ex Parte No, 353 that 49 U.S.C. (Supp. IV) 10704 (a) (2) pro-
hibited the Commission from adopting a single standard of
revenue adequacy and that the Commission therefore erred in
not explaining why its legal position on this question of statu-
tory construction had changed. However, as a reference to the
pages of the Commission’s decisions relied upon by petitioners
makes clear, the Commission did not rest its decisions on a
conclusion that the statute precluded it from settling on one
measure of revenue adequacy; it simply described why it de-
termined that consideration of other factors was appropriate.
See 358 I.C.C. at 858-859; 362 I.C.C. at 216. The Notice of
Proposed Rulemaking in Ex Parte No. 328 did state that what
is now Section 10704(a) (2) does not envision that rate of re-
turn will be the sole factor to be considered in judging revenue
adequacy. See 358 1.C.C. at 904. But the Commission did not
take a contrary view here; it considered the other statutory
factors and determined that they would be satisfied by using
rate of return as a measure of the revenues that would be
necessary to accomplish the statutory purpose.

16

S.F. R. v. Wichita Board of Trade, 412 U.S. 800, 808-
809 (1973) (plurality opinion of Marshall, J.).

3. Petitioners object (Pet. 19-20) because the
Commission included “unused and non-useful” assets
in the net investment base. This objection is insub-
stantial, especially in this case. Throughout these
proceedings the Commission actually has agreed that
it should seek to eliminate unused and unuseful assets
from the investment base when it is feasible to do so.
But the Commission also recognized that the identifi-
cation of unused and unuseful assets is a complex and
controversial task that could not be performed within
the 180-day period allowed by Congress for comple-
tion of the initial revenue adequacy determination
(ibid.). Further, the Commission found that includ-
ing unused and unuseful assets in the initial invest-
ment base would cause only a “minor distortion,”
because these assets amount to significantly less than
1% of total net investment and because the rail-
roads with the highest percentage of unused and
unuseful assets are the least profitable and therefore
are the least likely to be found revenue adequate in
any event (id. at 10b). The court of appeals found
evidence in the record to support these findings, and
on this basis correctly concluded that “no adjustment
to the book values of the investment base [to reflect
unused and unuseful assets] was necessary at this

10 Petitioners attempt to show the significance of this issue
by referring (Pet. 20 n.14) to a railroad witness’ estimate
that there are $225 million in unused and unuseful property.
This figure was derived using the generous and questionable
assumption that the book value per mile of unuseful property
is equal to the average book value per mile of all railroad
property. Even so, this estimated total amounted to only
.79% of railroad net investment.

17

time, because no likelihood of substantial over-valua-
tion was established” (id. at 3la).

This issue may soon be mooted in any event, be-
cause the Commission recently proposed a number of
substantial changes to improve the accuracy of its
initial revenue adequacy standards. One of these pro-
posals is “Elimination of Assets that are not used and
useful from the investment base.” Ex Parte No. 393
(Sub-No. 1), Standard for Railroad Revenue Ade-
quacy (Mar. 9, 1983), slip op. 2. In these circum-
stances, the Commission’s inclusion of these assets
presents no issue warranting this Court’s review.

4. Petitioners attack (Pet. at 20-21) the Commis-
sion’s decision to use the current cost of debt, rather
than the embedded cost of debt, in computing the ade-
quate rate of return on carrier net. investment. Peti-
tioners claim that the Commission’s approach over-
states debt costs because, at the present time, the cur-
rent cost of debt substantially exceeds the carrier’s
contractual interest and principal repayment require-
ments.

Contrary to the premises underlying petitioners’
contention, however, “revenue adequacy” for purposes
of 49 U.S.C. (Supp. IV) 10704(a) is a long-run and
forward-looking concept. The Commission must es-
tablish revenue levels adequate to “attract and retain
capital in amounts adequate to provide a sound trans-
portation system” in the future (49 U.S.C. (Supp.
IV) 10704(a)(2)(B)), rather than merely measure
the historical profitability of a carrier or that car-
rier’s ability to repay the debt associated with past
investments. Moreover, as the Commission found
(Pet. App. 13b), if a railroad attempts to raise capi-
tal today, either to rebuild worn-out facilities or to
expand existing facilities, it must compete for scarce
investment funds. To do so, it must offer a rate of

18

return equal to the cost of capital, where the cost of
capital is the weighted average of the current cost of
debt and the current cost of equity capital. Con-
versely, and as noted by the court of appeals, “[ijf
the railroads could not gain a rate of return on invest-
ment represented by old debt in excess of the old in-
terest rates on such debt, they would be unlikely to
attract new equity capital, and their shareholders
would insist on investment of internally generated
funds outside the rail industry” (id. at 28a).

The Commission’s choice of the current cost of capi-
tal also cannot be divorced from its choice of an origi-
nal cost investment base or its obligation to promul-
gate standards that “cover the effects of inflation.”
49 U.S.C. (Supp. IV) 10704(a)(2)(A). The Com-
mission was aware that the current and embedded
cost of debt differ largely because the inflation rates
anticipated by current and past investors differ.”
Similarly, the Commission was aware that, in times
of inflation, historical cost accounting systems using
actual “embedded” costs fail to reflect the impact of
changing prices on asset values and expenses. As a
result, such systems tend to understate operating ex-
penses (especially depreciation) and result in the re-
porting of illusory profits.’* In the instant proceeding,

“The nominal cost of capital is the sum of the real cost
of capital and the expected rate of inflation” (Pet. App. 12b).

% The Commission recently elaborated:

Historical cost depreciation is viewed as a systematic
method for allocating asset costs over useful lives, How-
ever, during periods of inflation, this cost does not re-
flect the economic cost consumed. Thus, while reported
earnings of a company often increase during periods of
inflation, the increases are not necessarily real. To main-
tain operating capability, for example, a railroad must

19

the Commission was forced to use an original cost
valuation of the investment base because replacement
data were unavailable (Pet. App. 17b). The Commis-
sion then selected the current nominal cost of capital
as the proper rate of return standard, noting wide
acceptance for the proposition that “the nominal cost
of capital must be applied to an original cost-based
asset valuation if the railroads are to be compensated
for inflation” (id. at 12b); see Ex Parte No. 398
(Notice), 45 Fed, Reg. 80152 (1980). This was a
rational respynse to the general problem of properly
accountine for inflation.”

5. Finally, petitioners argue (Pet. 22-24) that the
Commission should have excluded deferred taxes from
the railroad’s net investment base and that the court
of appeals created a conflict among the circuits when
it affirmed the Commission’s treatment of deferred
taxes,

Contrary to petitioners’ contention, however, there
is no conflict among the circuits regarding the validity
of the Commission’s current position. Each of the

continually replace productive assets at present costs, In
periods of inflation, each replacement of an asset is more
costly than its predecessor, Business continuity is not
assured, therefore, merely because current revenues ex-
ceed past costs. While sales, earnings and dividends in-
crease during inflationary periods, those increases do not
necessarily represent gains in net worth in real terms.

Er Parte No, 893 (Sub-No. 1) (Mar. 9, 1983), slip op. 7 (foot-
note omitted).

' The Commission reopened the entire issue of inflation
accounting, including the choice of cost of capital and invest-
ment hase, in Ex Parte No. 398 (Sub-No, 1), supra. The
Commission there proposed to withdraw the standards now
under review and to replace them with a current cost valua-
tion of the railroads’ investment base and a “real” (adjusted
for inflation) cost of capital rate of return.

20

three cases cited by petitioners ' arose at a time when
the Commission’s revenue adequacy policy, as ex-
pressed in Ex Parte No. 338, supra, 358 LC.C, at
889-894, required deduction of the deferred tax ac-
count from the net investment base. In each of the
cited cases, the Commission apparently had failed to
follow its own policy, and the courts simply re-
manded the cases to the Commission to “clarify
whether this [deferred tax] adjustment was indeed
appropriate and in fact performed.” See, e.g., Cleve-
land-Cliffs Iron Co. v. ICC, 664 F.2d 568, 586 (1981)."”
In a notice issued in Ex Parte No, 347 (Sub-No. 1),
Coal Rate Guidelines—Nationwide, 364 1.C.C, 360,
371 (1980), however, the Commission suggested that
its Ex Parte No. 338 policy should be changed, be-
cause it substantially reduced the incentive of rail-
roads to undertake railroad investments, and thus
thwarted “the intent of Congress in passing the Reve-
nue Acts of 1954 and 1962, to provide business enter-
prise with tax benefits as a means of spurring capital
spending.”

The Commission adopted this reasoning in the in-
stant proceeding, finding that “[i]f we exclude in-

4 San Antonio Vv. United States, supra, 621 F.2d at 847;
Iowa Public Service Co. v. ICC, 643 F.2d 542, 546-547 (8th
Cir. 1981); and Cleveland-Cliffs Iron Co. v. ICC, 664 F.2d
568, 586 (6th Cir. 1981).

In San Antonio v. United States, the court of appeals ex-
pressed the view that under principles expressed in certain
public utility rate cases, the deferred tax account should be
deducted from the net investment base once normalization of
taxes is elected. 631 F.2d at 847. As the court itself noted
(ibid.), however, the Commission’s policy at that time was to
deduct deferred taxes, and the Commission had simply failed
to follow that policy in the case under review. The D.C. court
therefore had no occasion to review the Commission's revised
policy, at issue in this case.

= |

21

ternally generated funds, whether stemming from ae-
celerated depreciation or any other railroad activity,
from the investment base, the effect will be to estab-
lish a rate of return below the cost of capital’? and
“result in incentives to railroads to invest these funds
in nonrail operations” (Pet. App. 11b). Against this
background, the Commission adopted its new policy
of including deferred taxes in the net investment
base, accompanied by a careful explanation of its
change from the prior policy.’* The court of appeals
correctly recognized that the cases decided under the
Commission’s old policy no longer apply (Pet. App.
33a & n.8), and found the Commission’s new policy
“rationally supported” and “consistent with the Con-
gressional directive” (ibid.). The court of appeals’
decision affirming the Commission’s treatment of the
deferred tax acount—the first decision addressing the
Commission’s new policy—does not warrant review
by this Court."

16 Petitioners claim the Commission’s treatment of deferred
taxes is inequitable because it permits the railroads to earn a
return on investment capital “provided by the ratepayers”
(Pet. 24) and not by railroad investors. The deferred tax
account is not contributed by the ratepayers, however; if
contributed by anyone, it is by the federal government,
through authorization of accelerated depreciation for tax
purposes. The Commission determined that its treatment of
deferred taxes was consistent with the congressional purpose
underlying accelerated depreciation of encouraging capital
spending—a policy that also is consistent with the goals of the
4R and Staggers Acts.

17 The Commission is again considering how tax benefits
should be treated in computing revenue adequacy in order to
reflect the impact of the Economic Recovery Tax Act of 1981,
Pub. L. No. 97-34, 95 Stat. 172. See Ex Parte 393 (Sub-No. 1),
supra, slip op. 18.

22

CONCLUSION

The petition for a writ of certiorari should be
denied.

Respectfully submitted.

Rex E. LEE
Solicitor General
JOHN BROADLEY
General Counsel

LAWRENCE H. RICHMOND
Deputy Associate General Counsel

ERNEST B. ABBOTT
Attorney

tr oU. 8. GOVERNMENT PRINTING Office 1669 408744 1944

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385010_0472%3A2. Public record. Not legal advice.