# Brief of Appellants — American Telephone & Telegraph Co. v. United States > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386010_0087%3A06 ## Record - **Collection:** Supreme Court brief - **Document type:** Brief of Appellants - **Published:** January 1, 1936 - **Citation:** 299 U.S. 232 ## Text age Opinion below--.-.-.-.------------------------------------ - 1 Pete 6 oo oo once wee ccec cccescwnsesepeccessscncceene 1 Questions presented - - - - - Sakbbinnd ja cecessbutadianhanetens 2 Statute involved-----.----------------------+------------- 4 ‘ Statement--_---.-.----------------------------------------- ee Argument: I. The limited grounds upon which idaiinaie may attack the order of the Commission----------_.-------- 11 II. The original cost provisions are within the Commis- sion’s statutory authority and they do not infringe _ rights guaranteed by the due process clause of the Fifth Amendment-_-.--.------- hp dknedke eens abies 15 1. The original cost provisions_--_-_-._.------- 15 2. The segregation of amounts represented by ' - account 100.4 into a separate balance-sheet account is not arbitrary_--........_-.---- 21 3. Account 100.4 is not a suspense account------ 26 4. The provision that the Commission may direct that part of the expenditure made to acquire the property of another utility be written off is reasonable and within the Comentanton’s ebattory atethortty ........ cn ccecawcccccene 32 5. Paragraph (C) of account 100.4 is not invalid by reason of the fact that it does not itself - lay down the rules by which the Commis- sion will act in directing the writing off, other disposition, or amortization of amounts | PD Rs htc batinndaesidandencdanwe 40 6. Since the Commission’s order permits amortiza- tion chargeable as an operating expense of amounts in account 100.4, it protects any _ substantive right which appellants may have . to charge depreciation against amounts in Se ace cccccana ease ndis ween “ 45 ‘ 7. The original cost provisions are not invalid by reason of the cost of compliance. ________-_- . 68 ’ III. The provision that the charges to certain accounts shall be just and reasonable and that payments in excess thereof shall be charged as a non-operating expense is not arbitrary or unreasonable------------- ee 55 105168—36——-1 (I) Argument—Continued. IV. The provisions governing classification of physical _ property are not arbitrary or unreasonable ------- V. If certan provisions of the Commissien’s order should he held invalid, the separability of the remaining provisions is an administrative question which this ; See Gee Ge Ge nccesunndacsnsscueauess 68 Condbusiet. ..cccccccccccccccccccccccccccccsccccegeccccce 70 Appendix: ’ Pertinent provisions (other than Sec. 220) of the Communi- CD le GE Fe eo ccc dateccennncesevsccvbesucece 71 : CITATIONS Cases: ' Abrams v. Van Schaick, 293 U. 8. 188. _.........-.-.---- 14 Accounting of New York Telephone Co., 188 I. C. C. 83---- 42 Acquisition of Control of Northwestern Long Distance Tele- phone Ca., 71 1. ©. ©. GBB... cnc ccgpocecccccccce sce 36 Acquisition of Illinois Southern Telephone Co., 1451.C.C. 43. 37, 38 Acquisition of Property by Saratoga & Encampment Valley ee Se 748, eee 42 Addy Co. v. United States, 264 U.S. 239.....-.-....---- 46 Atlanta, Birmingham & Coast R. R. Co. v. United States, EP as Uh Ebbeeschocdcstucecsensestcacond nenesane 42, 61 Chesapeake & Ohio Ry. Co. v. Uniteg States, 5 F. Supp. 7-- 42 Columbus Gas & Fuel Co. v. Public Utilities Commission, 292 Ds Oh Bt nasqesepececescoscesenessasesesenonesssénes 57, 67 Dayton Power & Light Co. v. Public Utilities Commission, Dl Mitt Pi ckdanbiddintihbatnabahinaddithaadanbased 57 Edelman v. Boeing Air Transport, Inc., 289 U. 8. 249____- 14 Intersiate Commerce Commission v. Goodrich Transit Co., I Re eat aed eis 11, 58, 64 Interstate Commerce Commission v. Illinois Central R. R. Co., Eas a Giitenteindnaseddsncdeanassseoueenesaenes ll Kansas City Southern Ry. Co. v. United States, 231 U.8.423.. 11, 12, 23, 33, 58, 4 . Knozville vy. Knoxville Water Co., 212 U. 8. 1__.,-------- Lindheimer v. Illinois Bell Telephone Co., 292 U.8.151_ 23, 34, ps Los Angeles Gas & Electric Corp. v. Railroad Commission, STEED Tl a ahiasethitipiptinbindiiickeaapaatundaabinminaneanniaents Matter of New York Edison Co. v. Maltbie, 244 App. Div. Gey GUE UE Ble Be Mew enccncusscenescosscscda McCardle v. Indianapolis Water Co., 272 U. 8. 400... ___.- New York Central Securities Co. v. United States, 287 U. 8S. Siichindiadatiahtncteavcidanetiantsspeiaabinendesecadimmenibeidninadendhirteihtnéniiiee Norfolk & Western Ry. Co. v. United States, 287 U. 8. 134... - 12, 13, 21, 42, 57, 61, 64 Pacific Tel. & Tel. Co. v. Seattle, 291 U. 8. 300_.......__- Cases—Continued. St. Joseph Stock Yards Co. v. United States, 298 U. 8. @8__- Smith v. Illinois Bell Tel. Co., 282 U. 8. 133___-._______- . Smith v. Interstate Commerce Commission, 245 U.S. 33___- Gegth v. Amea, 160 U. &. 406... 22 ccc ccc ccccccce Steamship Co. v. Emigration Commissioners, 113 U. S. 33_- Telephone and Railroad Depreciation Charges, 177 I. C. C. 351 sessed epi dt Shdcatdgcecansls tied ica maketh dhs tae as aah aa edd a United Retleays Ce Tey Se Gs Ob Be catccocccaaseusa United States v. Atlanta, ene & Coast R. R. Co., 282 United States v. Clyde ra Co., 36 F. (2d) 691__-....___- United States v. Cohen Grocery Co., aoe U. &. Gh.......-.. Wilshire Oil Co., Inc. v. Unfted States, 295 U. S. 100_____- Miscellaneous: . Uniform System of Accounts for Telephone Companies, First Issue, effective January 1, 1913______._._______- Accounting Bulletin No. 11, Interstate Commerce Com- mission, effective July,1, 1916... .................-.- H. Rep. No. 1273, 73d Cong., 2d Sess_________- een Moody’s Public Utilities Manual 1935____..___________- Moody’s Public Utilities Manual 1936____._______._____- Poor’s Public Utilities Manual 1929______._________- haw 48, 52 35 34 47 61 61 62 14 | Inthe Supreme Gourtof the Wnited States OctosEr TERM, 1936 No. 74 / APPELLANTS —" “THe UnItTep States oF AMERICA, FEDERAL COMMU- NICATIONS COMMISSION, AND NATIONAL ASSOCIA- TION OF RAILROAD AND UTILITIES COMMISSIONERS a TELEPHONE AND TELEGRAPH Co. BT AL., ON APPEAL FROM THE DISTRICT COURT OF THE UNITED STATES FOR THE SOUTHERN DISTRICT OF NEW YORK BRIEF FOR THE UNITED STATES OPINION BELOW The opinion of the United States District Court for the Southern District of New York (R. 561) is reported in 14 F. Supp. 121. JURISDICTION The decree of the District ‘Court. was entered March 24, 1936. (R. 584:) Petition for appeal (1) \ 2 was filed April 6, 1936, and was allowed‘ the same day. (R. 586, 594.) Jurisdiction of this Court is conferred by See. 402 (a) of the Act of June 19, 1934, e. 652, 48 Stat. 1093 (U.S. C., Title 47, See. 402 (a)}, and by the Act of October 22; 1913, ¢. 32, 38 Stat. 220 (U.S. C., Title 28, See. 47), as amended by the Act of Feb- tuary 13, 1925, c. 229, 43 Stat. 938 (U. S. C., Title 28, Sec. 345). | QUESTIONS PRESENTED - The attack upon the “original cost” provisions of the order of the Federal Communications Com- mission concerns the accounting prescribed for property already in public service which is‘ ac- quired from another public utility, whether a: con- trolled or independent company, and which the acquiring company uses or is about to use in tele- phone service. The order of the Commission pro- vides that, in the case of such acquisitions, the cost of the property to the company which first dedi- eated it to publie service shall be included by the acquiring company in one set of balance-sheet ac- counts, and the difference between such “original cost”’ and the amount paid for the property by the accounting company (whether in cash or other con- sideration) shall be credited or debited to another balance-sheet account, account 100.4. - These and other related provisions give rise to the following questions: _ ; (1) Whether the segregation of amounts repre- sented by account 100.4 into a separate balance- 3 sheet account is so arbitrary as to be unauthorized ' by the Act and in violation of the Fifth Amend- ment. There is also involved the subsidiary ques- tion whether accpunt 100.4 is a suspense account or, as its classification indicates, a telephone ip investment account. % (2) Whether a provision by virtue of which the Commission may, when appropriate, direct that amounts in account. 100.4 be written off is so un- reasonable as to be unauthorized by the Act and in violation of the Fifth Amendment. (3) Whether the provision that amounts in ac- count 100.4, after they have been subdivided ac- - eording to their character, shall be. written off, amortized, or other disposition thereof made, as ~ the Commission shall direct, is unauthorized by the Act because the provision in question does net it- self set forth the rules to be applied by the Com- mission in issuing these directions. (4) Whether the failure to allow depreciation as such against amounts in account 100.4, even though the Commission may, in appropriate cir- cumstances, permit an equivalent operating-ex- — pense charge, is so arbitrary as to be unauthor- ized by the Act and in violation of the Fifth Amendment. » ‘ (5) Whether the cost and trouble involved in complying with the original cost provisions is so burdensome as to constitute a violation of the Fifth Amendment. | ers oO. See sje’ Ue ne aad oA ' re oe re Raa A lace Naa 9 Mae San en ee] mat a » a « ’ ‘. . — pea rsanted each Dieta at AaB naa Ss ib ne TE 4 Apart from the foregoing questions arising un- der the original cost provisions, the following fur- ther questions are presented: ees, (6) Whether the requirement that the charges to certain accounts shall be just and reasonable ‘and that payments in excess thereof shall not be included in operating expenses is so arbitrary as to be unauthorized sy the Act and in violation of the Fifth Amendment: (7) Whether certain classifications of physical property are so indefinite as to be unauthorized by the Act and in violation of the Fifth Amendment. STATUTE INVOLVED Section 220 of the Act of June 19, 1934, ec. 652, 48 Stat. 1078 (U.S. C., Tit. 47, Sec. 220), known _ as the Communications Act of 1934, provides in part as follows: (a) The Commission may, in its discre- tion, prescribe the forms of any and all ac- counts, records, and memoranda to be kept .by carriers subject to this Act, including the accounts, records, and memoranda of the movement of traffic, as well as of the re- ceipts and expenditures of moneys. (b) The Commission shall, as soon as practicable, prescribe for such carriers the classes of :property for which depreciation charges may be properly included under op- erating expenses, and the percentages of de- preciation-which shall be charged with re- spect to each of such classes of property, 5 classifying the carriers as it may deem _ proper for this purpose. The Commission -may, when it deems necessary, modify the . classes and percentages so prescribed. Such carriers shall not, after the Commission has prescribed the classes of property for which depreciation charges may be _ included, charge to operating expenses any deprecia- tion charges.on classes of. property other than those prescribed by the Commission, or, after the Commission has prescribed per- centages of depreciation, charge with respect to any class of property a percentage of de- preciation other than, that prescribed there- for by the Commission. No such carrier shall in any case include in any form under its operating or other expenses any deprecia- tion or other charge or expenditure included elsewhere as a depreciation charge or other- - wise under its eperating or other expenses. * * * * * (d) In ease of failure or refusal on the part of any such carrier to keep such ac- counts, records, and memoranda on the books and in the manner prescribed by the © Commission, or to submit such accounts, records, memoranda, documents, papers, and gorrespondence as are kept to the in- spection of the Commission or any of its authorized agents, such carrier shall forfeit to the United States the sum of $500 for each day of the continuance of each such offense. (e) Any person who shall willfully make any false entry in the accounts of any book 105168362 - anaadiitbaptascie eis on. eee a Ses PRR Coe Se Fe ee of accounts or in any record or memoranda kept by any such carrier, or who shall will- fully destroy, mutilate, alter, or by any other means or device falsify any such ac- count, record, or memoranda, or who shall willftilly neglect or fail to make full, true, and correct entries in such accounts, rec- ords, or memoranda of all facts and trans- actions appertaining to the business of the carrier, shall. be deemed guilty of a misde-‘ meanor, and shall be subject, upon convic tien, to a fine of not less than $1,000 nor more than $5,000 or imprisonment for a term of not less than one year nor more than three years, or both such fine and. imprisonment * * *, * * * ; * * (g) After the Commission has prescribed the forms and manner of keeping of ac- counts, records, and memoranda to be kept by any person as herein provided, it shall be unlawful for such person to keep any other accounts, records, or memoranda than those so prescribed or such as may be ap- proved by the Commission or to keep the accounts in any other manner than that pre- - scribed or approved by the Commission. Notice of alterations by the Commission in the required manner or form of keeping ac- counts shall be given to such persons by the Commission at least six months before the same are to take effect. ; ; Other pertinent provisions of the Act are set ; forth in the Appendix, infra, pp. 71-74. j 7 STATEMENT This is an appeal from a decree of a specially constituted three-judge District Court dismissing, except in two minor particulars, a bill to set aside and enjoin an order of the Federat Communica- tions Commission issued on June 19, 1935, to be- © come effective on January 1, 1936, prescribing a uniform system of accounts for telephone com- panies subject to the Communications Act of 1934. The plaintiffs and intervening plaintiffs below are. the American Telephone and Telegraph Company and 36 telephone companies controlled by it, which - will sometimes be referred to herein as the Bell companies. (R. 2-3, 244-245, 335: Moody’s 1935 Public Utilities Marmal, pp. 82, 83, 94, 116.) The additional plaintiffs below are 7 telephone com- _ panies independent of the Bell system, but con- trolled by a single holding company, which group will sometimes be referred to-as the Associated companies. (R. 237; Moody’s 1936 Public Utili- ties Manual, pp. 2088-2089). All 44 plaintiffs have joined in the appeal. The facts and issues are the same as to both groups of appellants, except that the ‘‘original cost’’ provisions of the system of accounts prescribed by the Commission affect a very much larger proportion of the property of the Associated companies than of the Bell companies. The present proceeding was instituted pursuant to Section 402 (a), infra, p. 73, of the Communica- tions. Act of 1934 (hereinafter sometimes referred Pye en = z 5 “4 3 ‘4 3 t ; & = : : 5 8 to as the Communieations Act). This section pro- vides that the statutory provisions relating to the enforcement or setting aside of orders of the Inter- state Commerce Commission shall apply to suits to set aside orders of the Communications Commis- sion (with exceptions immaterial here). Appellee, National Association of Railroad and Utilities Commissioners, representing the regulatory com- missions of 46 states, which had taken part in the proceedings before the Communications Commis- sion leading to the order under attack here, was allowed by the District Court to intervene as a party defendant in support of the Commission’s order. (R. 266, 268, 271.) : | Prior to the enactment of the Communications Act, the accounts of telephone companies engaged as common carriers in interstate communication were subject to regulation by the Interstate Com- merce Commission under Section 9 (5) of the Interstate Commerce Act.’ Section 220 of the Communications Act, which closely parallels the language of various subsections of Section 20 of the Interstate Commerce Act, conferred upon the Communications Commission authority to pre- sczibe the accounts to be kept by. such telephone carriers. The Communications Act repealed the : This authority was first vested in the Interstate Com- merce Commission when the Mann-Elkins Act of June 18, 1910 (36 Stat. 544), extended the definition of “common car- rier”, as used in the Interstate Commerce Act, to include telephone companies. Mt ee eae kn een cash Raden ea aticent cette 9 - provisions of the Interstate Commerce’ Act relat: ing to telephone companies, but. provided that all outstanding orders of the Interstate Commerce Commission : issued under these repealed pro- visions. should continue in effect until modified or superseded by the Communications Commission (Sees. 602 (b), 604 (a)). The Interstate Commerce Commission first exer- cised authority over telephone company accounts in December 1912, when it prescribed a uniform system of accounts effective January 1,1913. (R. 19.) These accounting rules remained in effect, substantially without change, during the next 20 years. (Ib.) They were superseded by a revised - system of accounts (sometimes referred to herein as the 1933 System of Accounts) promulgated by the Interstate Commerce Commission in November _ 1932 and effective, except as to very small com- panies, January 1, 1933. The ‘order of the Commission prescribing these accounts and the accounts themselves are set forth in full in the record. (R. 345-456.) Certain objections to the accounts were filed by a number of State regu- latory commissions. (R. 15-16.) The Interstate : Commerce. Commission, after the enactment of the ! Communications Act but before its effective date . (Sec. 607), issued a report on these objections but no order. “(R. 15-84.) - . The Communications Commission authorized the filing of objections to-the foregoing report of the ° = ay 10 Interstate Commerce Commission; held a hearing on these objections ; adopted a ‘‘draft of a Uniform System of Accounts’? which it submitted to all _ interested parties; entertained exceptions to these accounting rules, which exceptions. were considered at a conference with representatives ef the tele- phone companies and of the state commissions; and on June 19, 1935, issued the order prescribing the system of accounts under attack in this ease. (R. 91-92.) These accounts (hereinafter some- times referred to as the 1936 System of Accounts) and the order putting them in effect are set forth in full in the record. (R. 85-220.)° The parties stipulated to submit the case for final . decree upon the pleadings and the affidavits filed in support of and in opposition to plaintiffs’ appli- - cation for an interlocutory injunction. (R. 552- _ 593, 559.) Five affidavits were so filed by the Bell companies (R. 307, 317, 324, 331, 334), one by the Associated companies (R. 457), six by the Com- munications Commission (R. 468, 484, 500, 523, 531, 544), and affiants for the Bell companies submitted rebuttal affidavits reaffirming certain of their orig- inal conclusions ad statements (R. 553-557). All of the affidavits deal with the interpretation. and - . effect of the 1936 System of Accounts. The District Court unanimously held that the accounting rules prescribed by the Communica- tions Commission are not, with two minor excep- tions, arbitrary, unreasonable, or such as to de- prive appellants of rights guaranteed by the Fifth 11 Amendment. ad 561-572.) ‘The court filed, pur- suant to Equity Rule 70%, findings of fact (R. 573-578, 583-584) and conclusions of law (R. 578- 583). The accounting provisions which appellants challenge have been stayed pending the appeal-to this Court. | ARGUMENT I THE LIMITED GROUNDS UPON WHICH APPELLANTS MAY ATTACK THE ORDER OF THE COMMISSION This Court has said that in a suit to set aside an order of the Interstate Commerce Commission the only questions which are open for review are - whether there have been ‘‘violations of the Consti- tution, or of the power conferred by statute, or an exercise of power so arbitrary as virtually to transcend the authority conferred.’’ Kansas City Southern Ry. Co. v. United States, 231 U. S. 423, 440. In such a proceeding the court may not ‘‘under the guise of exerting judicial power, usurp merely administrative functions by setting aside a lawful. administrative order upon our conception as to whether the administrative power has been wisely exercised.’’ Interstate Commerce Commis- sion v. Illinois Central R. R. Co., 215 U. S. 452, 470. When the Commission is exercising delegated legislative power to preStribe the accounts to be kept by common carriers (Interstate Commerce Commission v. Goodrich Transit Co.; 224 U. S. 194), there is a wide range for the exercise of ad- ministrative judgment and discretion with which the courts will not interfere by substituting their . judgment for that of the administrative body. An attack upon an order prescribing accounts ‘‘is, and must be, rested at bottom upon the contention that the regulations embodied in it are so entirely at odds with fundamental principles of correct ac- counting as intrinsically to manifest an abuse of. . } power.’’. Kansas City Southern Ry. Co. v. United States, supra, p. 444. The question presented is . ~ lz whether the regulations of the Commission ‘‘do violence to’’ generally accepted principles of ac- counting, that is, whether they are ‘‘so clearly con- trary to these and other applicable principles that they should be set aside as being in excess of the powers conferred by Congress upon the Commis- sion.”’ Jb.,p.447. Itis not enough that the court is of the opinion that the accounting rule ‘‘ought to be’’ other than that prescribed; this is not ‘‘a : sufficient ground to declare that the Commission had abused its power.’’ Jb., p. 456. | 4 These principles have been recently reaffirmed | and restated. In Norfolk & Western Ry. Co. v. United States, 287 U. S. 134, 141, involving the validity of an accounting order of the Interstate | Commerce Commission, the Court said: _ Within broad limits that body’s detetmina- tion is necessarily beyond revision and cor- rection by the courts. * * * Whether the Commission should make special classifica- tions to fit exceptional cases lies within the _—_ 13 discretion conferred, and courts ought not to be called upon to interfere with or correct alleged errors With respect to accounting practice. If we were in disagreement with the Commission as to the wisdom and pro- priety of the order, we are without power to usurp its discretion and substitute our own. Since, as this Court said in the Norfolk & W est- ern case (p. 143), the test of validity is whether the order is so ‘‘arbitrary and outrageous’”’ as to ‘amount to an abuse of power’’, those vested with administrative authority to prescribe accounting rules may determine controverted questions in more than one way. In the present case the Interstate Commerce Commission expressed an adverse opin- ion upon certain accounting rules which the Com- munications Commission subsequently adopted, but it does not follow that the decision of the latter body is therefore ‘‘arbitrary and outrageous’’. That it is not, but is, on the contrary, well within the zone of reasonableness and therefore within the scope of ad- ministrative discretion would seem a fair inference from the'fact that the order of the Communications Commission is actively supported (R. 562; Fg. II, R. 574) by an association representing some 46 state public utility regulatory bodies.’ 2 The order of the Michigan Public Utilities Commission . of December 3, 1935, referred to in the brief of additional appellants (p. 8), did not “reject” the 1936 System of Ac- counts. The order was entered after the filing of the present suit, Lie sal a stay order and temporary injunction 1051686-36——3 14 Appellants contend that the order of the Com- mission is so arbitrary that it amounts to a denial of due process. This suit was brought before the order had gone into effect. In large part the arbi- trary characteristics of the order asserted by ap- pellants rest upon disputed interpretations of the meaning of the order. If the Commission, in ad- ministering the order, adopts the meaning and in- terpretation’ which its witnesses place upon the order, most of the constitutional questions raised by appellants will never require adjudication. Unless or until the Commission adopts or threatens to adopt a construction of its order which might render it invalid, no constitutional right of appel- lants is infringed. ‘“‘In the circumstances, no case, is presented, either by pleadings or proof, calling on a fedeal court of equity to rule upon the cor- rectness of some other construction which may never be adopted.”’ Edelman v. Boeing Air Trans- port, Inc., 289 U. S. 249, 253. This Court has rigidly adhered to the rule “‘never to anticipate a question of constitutional law in advance of the necessity of deciding it.’’ Steamship Co. v. Im- migration Commissioners, 113 U. S. 33, 39. See Abrams v. Van Schaick, 293 U. 8. 188; Wilshire Oil Co., Inc. v. United States, 295 U. S. 100. against the 1936 System of Accounts. The order of the Michigan Commission merely revoked a prior order under which this System would automatically have become the accounting rules of the Michigan Commission. 15 Il » THE ORIGINAL COST PROVISIONS ARE WITHIN THE COM- MISSION’S STATUTORY AUTHORITY AND THEY DO NOT INFRINGE RIGHTS GUARANTEED BY THE DUE PROCESS CLAUSE OF THE-FIFTH AMENDMENT : ¢ 1. THE ORIGINAL COST PROVISIONS The meaning, effect and purpose of the original | cost provisions of the Commission’s order will appear more clearly if the comparable provisions of the 1933 System of Accounts are first set forth. In this system a’ single balance-sheet account, 100, covers telephone plant. . Account 109 is the total of the primary telephone plant.accounts, 201 to 280, inclusive, and it includes both property 1 in tele- phone service and that held under a. definite plan for such service. (R. 378.) The primary tele- phone plant accounts include such intangibles as those represented by account 201, ‘‘Organization’”’, and account 202, ‘‘Franchises”’; they also include account 280, ‘‘Construction work in progress’’, and account 278, ‘‘Untdistributed cost. of property”’. (R. 393.) When property ‘‘in use in telephone service”’ is purchased from another public utility, the accounting is as follows: (1) the appropriate primary plant accounts are charged on the basis of land at ‘‘estimated current value’’, tangible petsonalty at “‘eurrent cost new’’, franchises at “original cost’’, and construction work i in progress - ret me F} + » oof : ‘ 4 rh t - x : a ad J Cee ee eee Ske ls ag UE ee clita aR AS LM READ AE eS i ae LA SE a iM ei hE ee tk SoS Rc Aan i A 16 at ‘“eost’’;* (2) depreciation and amortization reserves are credited with thé estimated reserve . requirements applicable to the plant; and the dif- ference between the net of (1) and (2), on the one hand, and, on the other hand, the cost of the prop- erty to the accounting company is credited or debited to account 278. (R. 365-366:) To state the matter more simply, what goes into account 278 is the difference between the present value of the property acquired (franchises being valued at original cost) and the amount paid to acquire the property. Since account 100 is the sum of the primary tele- _ phone plant accounts, one of which is account 278, under this system the full amotint paid another utility for telephone property is included in the balance-sheet account covering telephone plant, irrespective of whether it is proper under sound accounting principles to capitalize the. entire ex- penditure. Moreover, amounts entered in account 278 may continue there indefinitely whether such asset value as this investment may have originally : represented continues to exist or not. This is so } because amounts in account 278 are not subject to ! depreciation charges and because the accounting ~ company is not required to amortize balances in In lieu of these charges, the accounting company may, with the approval of the Commission, charge to its primary plant accounts the amounts catried on the books of the vendor with respect to the property purchased. (R. 366.) 17 278 although it is given the option of doing so (account 413, R. 414) by debiting surplus. Under this system the balance-sheet account representing telephone plant may be inflated by transfers between controlled companies, in which transactions price is a matter of indifference since they involve a mere shift of assets from the parent company’s left hand pocket to its right hand pocket. (R. 536.) Furthermore, such transfers may be made the medium for writing up the pri- mary telephone plant accounts, on which deprecia- tion charges are based, to current cost new. The extent of such write-ups rests largely in the dis- cretion of the accounting company. It is well known that appraisals of reproduction cost vary widely and appraisals made simply for the purpose of entering transactions on the books of account are not subjected to the check .of adversary pro- ceedings.’ The fact that write-ups of this char- acter are permitted destroys the trustworthiness of the accounts from the standpoint of investors and makes them unreliable for use in arriving at original cost of construction, a recognized relevant factor, to be considered along with other relevant factors, in determining value in rate litigation. Smyth v. Ames, 169 U. 8. 466, 547; McCardle v. *“Many so-called ‘appraisals’ are little more than esti- mates and the values obtained by them have no substantial basis.” Montgomery, Auditing Theory and Practice, 5th Ed., p. 278. Aa the ahd 18 > Indianapolis Water Co., 272 U. S. 400, 410-411; Los Anaeles Gas & Electric Corp. vy. Railroad Com- ‘mission, 289 U.S. 287, 306." The nature of the telephone business is such that it is, and for efficient operation must be, a terri- torial monopoly; in fact it is substantially a na- tion-wide monopoly. Accordingly, such telephone property as is acquired from another utility is usually acquired from a controlled or affiliated.com- pany.” The opportunities for possible abuse per- mitted by. the 1933 System of Accounts in connec- tion with such acquisitions is therefore a matter of primary importance. Another defect in the 1933 System of Accounts is that there is no uniformity in the basis on which property is carried in the primary telephone plant ‘The phrase which this Court has used is “original cost _ of construction”. In the case of property dedicated to the public service, cost at the time of first dedication the Com- mission's definition of original cost) is the practical equiv- alent of original cost of construction. In the Los Angeles case cited above, where there had been no change in owner- ship, original: cost of construction and cost to the owner were the same, and both forms of expression were used. Obviously, the amount which a subsequent owner pays to acquire property is not the same as original cost of con- struction. *Of the total property acquired from other utilities by the Bell Companies sinee 1915, two-thirds has been acquired from companies, all or substantially all the stock of which was owned by Bell Companies. (R. 336.) The remaining one-third was acquired “partly from affiliated and partly from independent companies”. (Zd.) 19 accounts and therefore no uniformity in the basis on which depreciation charges are computed. Property constructed by the accounting company or purchased from non-utilities is carried at cost. Property purchased from another utility since January 1, 1933, is carried either at reproduction cost new or at the amount shown on the books of the predecessor company. ‘‘Going or completed plant’? purchased before January 1, 1933, is car- ried on varying bases, as indicated below.’ The 1936 System of Accounts splits up the bal- ance-sheet account representing telephone plant into four balance-sheet accounts. Account 100.1 is limited to property-‘‘used in telephone service’’. Account 100.2, ‘‘Telephone plant under construc- tion’’, represents a transfer of account 280 (1933 System) from the primary telephone plant ac- counts to a balance-sheet account. Account 100.3, ‘‘Property held for future telephone use’’, is a segregation into a separate baiance-sheet account of telephone property not in use but held for such 7Instruction 13 (p. 33) of the.Uniform System of Ac- counts for Telephone Companies, First Issue, effective January 1, 1913, provided that when a-going or completed plant was purchased, the constituent elements should be charged to the appropriate plant accounts at structural value (estimated cost of reproduction less depreciation) if the consideration given exceeded total structyral value; and that if the consideration did not exceed such value, it should be distributed through the accounts ‘in proportion to the structural value of the constituent elements appropriate to the respective accounts. ste — e x spade ahs ta Setanta, * ks ot he Nees eS ae ee ee eee Pere ved Otetle Ww nw ~ roe 26 “‘Organization”’, the balances in the plant accounts will not show the amount actually expended for plaat. - 3. ACCOUNT 100.4 IS NOT A SUSPENSE ACCOUNT In the 1936 System of Accounts the balance-sheet accounts on the asset side are grouped under four headings: ‘‘Investments,’’- ‘‘Current Assets,”’’ “Other Assets,’’ ‘Prepaid Accounts and Deferred Charges.”” (R. 121.) The grouping in the 1933 System of Accounts was similar. (R. 376-377.) The first group, as its designation ‘‘ Investments”’ implies, consists of relatively permanent assets and the aecounting rules are ¢arefully framed ‘to main- tain this characteristic of the accounts included therein. For example, property in the telephone plant accounts is that ‘‘which ordinarily has a serv- ice life of more than 1 year’’ (Instruction 20 (A), R. 107) and account 101.2, ‘Advances to affiliated companies,’’ which is in the ‘‘Investments”’ group, comprises advances which are to be funded or which are not subject to current cash settlement (Instruction 3.(M), R. 101). Not only does the classification of account 100.4 in the investment group indicate that it represents assets of a semi- permanent character, but it is given a sub-number under the main account number covering telephone plant. If the Commission had regarded this ac- count as a suspense account or had intended others to so regard it, it would have been included in the . Pee WP eetEe ose = ; 27 group of balance-sheet accounts designated ‘‘Pre- paid Accounts and Deferred Charges.’’ Appellants, in contending that account 100.4 is a suspense account, treat the account as if items therein would permanently remain in the same con- tingent status as when they are first entered. -It may be true that at that moment such iterns are subject to the contingency that the Commission will re- quire them to be written off by a charge to surplus. But the statement in the accounting rules ‘‘shall be disposed of,’’ ete., in accordance with the di- rections of the Commission presupposes that the Commission will make prompt disposition of these amounts. Once the Commission has acted as thus provided, amounts which it requires to be written off will be extinguished from the account and the balance remaining in the aecount will thereafter represent investment in assets of just as real and permanent a character as those represented by the other telephone plant balance-sheet accounts, 100.1, 100.2, and 100.3. The basis for the preceding statement is as foal- lows: Apart from writing off, the Commission may provide for amortization or it may provide for other disposition of amounts in 100.4. If it pro- vides for amortization, it will direct that over a given period of time a charge be made.to operating expense or to surplus and a corresponding :redit to amortization reserve and that, at the end of such period, the sum of these charges be debited to amortization reserve and credited to account 100.4. 98 During this period the amount for which amortiza- tion is provided has ‘as much the character of an investment asset as has property which is subject to depreciation charges.’ The other kind of in- vestment represented by 100.4, as, for example, excess value of land over and above original cost, will consist of amounts as to which the Commis- sion. has directed that they be retained in the account. . . The supposititious balance-sheet set forth in the brief of additional appellants (p. 16) is based on testimony of one of:appellants’ witnesses that a balance sheet would be incomplete if it failed ‘‘to call specific attention.on its face to the fact that the Commission must extinguish this item [account 100.4] and may extinguish it immediately.’? (R. 320.) As we have already shown, the statements that the Commission may extinguish the account is correct in the sense that at the moment amounts are first entered therein, some or all of them may be extinguished, but is substantially incorrect as applied to the status of the account after the Com- mission has given the directions which the account- ing rules call for.” The statement that the Com- ® Such property remains in the plant account at the orig- inal amount charged thereto until its retirement, when plant account is credited and depreciation reserve is debited. 1° Tn the case. of any’ balancé sheet published before the Commission had so acted, if it would be sound accounting ' practice to append a note to account 100.4, the note could be so amplified as to guard against giving investors or others a misleading impression as to the character of the account. Pern te ee $ ee Ont) tee tern diel Sal 0 i inte BSF “* 29 mission must extingui@) account 100.4 is based upon a misinterpretation of its order. The Commission’s chief accountant stated that the proper interpfetation of account 100.4 was that amounts therein ‘“‘would be disposed of, after the character of the item had been determined, in a . manner consistent with the general rules underly- ing the uniform system of accotmts for the dis- tribution pf expenditures, according to their char- acter, to operating expenses, income, surplus, or remain an investment.”? (R. 476.) Another ae- counting officer of the Commission declared that appellants’ assumption that amounts in 100.4 must be extinguished is ‘‘unwarranted’’ and “fails to express the provisions of the Revised System of Accounts.’’ (R, 518.) The acting director of the accounting department of the Wisconsin Public Service Commission, which had prescribed for elec- tric utilities an account comparable to 100.4, ex- pressed the opinion that, in view of the provision for subdividing this account aecording to the char- acter of the amounts therein, amounts in 100.4 “might be permanently retained in the investment accounts, depreciated or amortized over the life of the property, or subject to such other disposition as might be appropriate.’’ (R. 527.) He also said that after the Commission knows the facts it may then issue appropriate directions ‘‘for the retention ‘or the disposal of the account in accordance with the principles set forth in the system of accounts.”’ (R. 528.) 105168—36——5 30 Appellants’ argument that a reserve of surplus must be maintained against account 100.4 presup- poses that the Commission will arbitrarily and im- properly direct that all amounts in this account be written off, irrespective of their nature. This ar- gument, as the District Court said, ‘‘requires the assumption that the Commission will act improp- erly in the future under 100.4 (¢). This cannot be presumed.’ (R.568.) If the Commission should in the future improperly order a write-off, the car- rier could protect its rights by contesting the va- lidity of this order in the courts. | Appellants stress the word ‘‘adjustment”’ in the title of account 100.4. But the inclusion of this account among those grouped as ‘‘Investments”’ and its exclusion from_ those grouped under the heading ‘‘Prepaid Accounts and Deferred Charges”? removes any possible ambiguity arising from use of this word. Appellants place great reliance upon Matter of New York Edison Co. v. Maltbiec, 244 App. Div. 685, affirmed per curiam 271 N. Y. 103. The uniform system of accounts for electric corporations pre- scribed by the New York State Public Service Commission contained a definition of original cost similar to that in the 1936 System of Accounts and provided for entering amounts in account 143 on the same basis that amounts are entered in ac- count 100.4. But account 143 differed radically from account 100.4. The former was a true sus- 5 pein 3 ET eee eee Sheantabs * - sae rae RS RT aan ie aOR a Ry Dil el Set te te Tota. . pense account. Its title was “Suspense to be am- ortized.”’ It appeared among the balance-sheet accounts under the heading ‘‘Deferred Debits’’, a group corresponding to those set forth under the heading ‘‘Prepaid Accounts and Deferred Charges”’ in the 1936 System of Accounts. There was entered in account 143 not only amounts equiv- alent to those entered in account 100.4, but also miscellaneous debit items subject to amortization by order of the Commission and losses from prop- erty retirements not provided for in the depre- ciation reserves. . Account 143 differed from account 100.4 in an- other important respect. Amounts in account 143 were to be ‘‘written off’? over such period and in such manner as the Commission might prescribe ; in other words, the account was to be written off in its entirety out of surplus. By way of contrast, the 1936 System of Accounts authorizes disposi- tion of amounts in account 100.4 according to the character of the individual items—by an imme- diate write-off out of surplus, by amortization through debits to surplus over a period of years (infra, pp. 45-46), by amortization through charges to operating expense over a period of years (id.), by indefinite retention in this telephone plant in- vestment account. This flexibility, the court below said, ‘‘distinguishes the system at bar from that held invalid in’? the New York Edison ease. (R. 568. ) | : [ee ee Pe saci aah kali BYR? li aaa IY i Ak ll A Rin SALA Na a hola eet IRL H6s eat oe Wistiete bible, cutie wae cskucen While the Government does not assent to all of the reasoning of the New York Appellate Division, the holding itself, so far as it involves the original cost provisions of the order of the New York Com- mission, is clearly distinguishable. 4. THE PROVISION THAT THE COMMISSION MAY DIRECT THAT PART OF THE EXPENDITURE MADE TO ACQUIRE THE PROP- ERTY OF ANOTHER UTILITY BE WRITTEN OFF IS REASONABLE AND WITHIN THE COMMISSION'S STATUTORY AUTHORITY Additional appellants appear to contend that ae- count 100.4 (C) is void in so far as it authorizes the Commission to direct the writing off of amounts in this account. They assert in their brief (p. 14) that the Commission ‘‘has no power to re- quire these appellants to write off and take as a loss a part of what ‘ey actually paid for their ’ Since the Commission has not as yet 2 directed the writing off of any amount, the conten- tion necessarily is that the Commission is wholly without statutory authority to preéseribe an ac- property.’ counting rule the effect of which is to deny the right to capitalize, under any and all circumstances, the entire amount expended in the acquisition ‘of | property of another utility. The contention is without merit unless such a rule is so utterly incon- |e. sistent with accepted accounting principles that it cannot be said to be an accounting rule which the statute authorizes the Commission to prescribe. The Commission, when it prescribes a system of accounts, is not exercising its‘rate-making power 33 but, as shown later (infra, pp. 57-58), its power to prescribe accounts includes the power to establish accounts which will aid it in carrying out its other statutory duties, including that of prescribing rea- sonable rates and, charges. We therefore submit that the Commission is authorized to prescribe ac- counts which accord with the principles enforced ‘and applied in rate proceedings. Particularly is such action authorized if it serves to make effective another principle which this Court has recognized as within the power to prescribe accounts, namely, to make the accounts correspond with the substance of the transactions they record (Kansas City South- ern Ry. Co. v. United States, 231 U. 8. 423, 440, mfra, p. 63). There is no hard and fast, immutable line be- tween expenditures which properly may be capital- ized and those which may not. The extent to which’ it is proper to capitalize overhead expenses during construction is a frequent source of controversy and wide differences of view in rate proceedings. See Los Angeles Gas & Elec. Corp. v. Railroad Commission, 289 U.S..287, 294, 310. The question _of whether an expenditure may be capitalized or * not is no different in principle from the question of when and under what circumstances an expendi- ture once capitalized should be extinguished from capital account. The latter was the principal issue _ presented in Kansas City Southern Ry. Co. v. United States, 231 U. 8. 423. The price paid for ee Te ee datendenheesinastibil es 34 the purchase of property in transactions between controlled companies is. no criterion as to what should be entered into the capital account of the purchasing company. (R.536.) Where buyer and seller are under common control, part of the pur- chase price for equipment may be excluded from the purchaser’s property account in a rate proceed- ing. Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151, 157. It must also be borne in mind that even when the transaction is between independent companies the amount paid to acquire going telephone prop- erty may frequently be in excess of every element of value inherent in the property, including going- concern and good-will value. Since the modern telephone system, if it is to function efficiently, must be closely coordinated and unified with re- spect to both physical facilities and operating pol- icies, an independent concern may have a very sub- stantial ‘‘nuisance’’ value enabling it to command a price in excess of actual value. Tri-State Telephone & Telegraph Co. Proposed — Control, 180 I. C. C. 229, illustrates this nuisance value. The Tri-State owned the telephone ex- changes in St. Paul and a Bell company those in Minneapolis. From a plant and engineering standpoint the two telephone properties consti- tuted one telephone exchange area and the same operating practices had to be observed in both cities if delays, inefficiency and undue cost were. to a — ence nes ce alt ~ a i TY : 35 be avoided. The two companies had been only par- tially successful in satisfactorily coordinating service, and the difficulties in doing this were in- creasing and promised to become much more serious. The Bell company believed that inde- pendent operation of the St: Paul exchange con- stituted a serious hazard to its Minneapolis invest- ment. Accordingly, it agreed to buy substantially all the Tri-State stock for $19,510,101. This price was more than double the appraised value of the assets represented by the stock, excluding organi- zation expenses and ‘going value, and more than "150% of such value if these intangibles were in- cluded. The difference between price and value was so great that the Commission refused to issue - a certificate that the acquisition would be in the public interest.” If the foregoing transaction had been carried out aud the Bell Company had then taken over the Tri-State property, the cost thereof would have been the amount paid for the stock, or over 50% more than every,element of value attaching to the assets acquired, including intangibles. Under the 1933 System of Accounts this excess would go into _ Within fifteen months of this decision an agreement was reached for the sale to the Bell Company of the Tri-State stock for approximately $7,000,000 less than the price pre- viously agreed upon and the Commission thereupon issued a certificate of public interest under Section 5 (9) of the Inter- state Commerce Act. TZri-State Telephone & Telegraph Co. Control, 193 I. C. C. 383. . . shit ‘ rad Sipie oSTae. als pe BINT ra lala > ne P Bit ASE ihre vt al RAE ARE SA is eT tal ta ete aye rreaghes 2 36 account 278, and therefore into the balance-sheet account representing telephone plant, unless the company voluntarily amortized all or a part of the excess by debiting surplus. An accounting system which permits this kind of an inflation of the tele-. phone plant account impairs its integrity. We do not contend that payments in excess of value for going telephone concerns or their property may not be justified from a business standpoint, but that the excess payment should be charged against past or future profit and loss, either by an immediate debit to surplus or by amortization chargeable to ‘surplus over a period of time. Furthermore, such charges should not be left to the discretion of the accounting company, but should be subject to the control of the regulatory body whose duty it is to prescribe uniform accounts and to see that ‘they are carried out in accordance with their intended purpose and effect. Acquisition of Control. of: Northwestern Long Distance Telephone Co., 71 I. C. C. 530, is another instance where the purchase price was largely dic- tated by nuisance value: A Bell company agreed to pay $545,000‘for the property, of a company operating toll lines between exchanges all of which were reached by the Bell company’s toll lines. The latter’s facilities were ample to handle the business of both companies for years to come. The value to the purchaser of the property to be acquired was therefore only its junk or salvage value, as the Commission recognized by stating that the invest- ment could bé amortized in a few years’ time out of the additional revenues to be obtained from business formerly handled by the competitor. An accounting system which provides that a com- pany may, whatever the circumstances, record its telephone plant on its balance sheet in terms of the money, plus the value of any consideration other than money,” exchanged for telephone ‘plant, con- eeats data which is truly informing and supplies that which is likely to be misleading. Acquisition of Illinois Southern Telephone Co., 145 I. C. C. 43, illustrates this situation. A new company was to be formed to buy all the assets of four existing telephone companies (the stockholders of which were identical), giving in exchange therefor cash (derived from sale to the public of certain amounts of its bonds and preferred stock) and 40,000 shares of its common stock. In substance, therefore, tliere was a mere recapitalization involving no change in beneficial ownership, but ‘‘cost’’ to the new com- pany was the cash which it had paid out and the value attributable to its common stock. The almost untrammeled latitude afforded the company’s offi- cers and accountants in determining ex parte such 12 See Mstruction 20 (B) of the 1933 System of Accounts (R. 365) and account 100.4, par (A), of the 1936 System of Accounts (R. 123). . ee er ee eae . common stock value is obvious * and the epportu- nity afforded to mislead investors is equally obvi- ous. Although the Interstate Commerce Commis- sion refused to issue a certificate of public interest, upon -the ground that the proposed financing ‘*would increase largely the securities outstanding in the hands of the public without the addition of any property’’, the transaction was carried out under approval given by the Illinois Commerce Commission (H. Rept. No. 1273, 73d Cong., 2d Sess., p. XIX).” Possibly appellants will urge that public regula- tion of acquisitions of telephone property is ade- quate to guard against abuse and that therefore no good reason exists for the adoption ‘of an account- ing rule which permits the Commission to direct the writing off of part of the consideration given for telephone property acquired from another utility. There’are a number of grounds why such a contention must be rejected. *8 The Illinois Commerce Commission, in approving the acquisition, apparently made no independent examination of the property appraisals which were submitted to it and apparently assumed that the no-par common stock would be capitalized at the minimum of $5 a share required by Illinois law. (145 I. C. C. 43,45.) Actually, tlie new com- pany capitalized its common stock at eight times this amount, $40 a share. (Poor's Public Utilities Manual, 1929, p. 1300.) ‘4 The company making the acquisition is not an ap- pellant, but it is controlled by the same holding company as the additional appellants. (Moody's Public Utilities Manual, 1935, p. 510.) : —_— wees aL FD ek na 39 The question of possible state regulation may be ‘summarily put aside. The Federal Government is not constrained to withhold exercise of its constitu- tional powers because the individual states may step into the breach if it does not act. The very purpose of Federal control within the interstate commerce field is to achieve uniformity in regula- tion, which-cannot be achieved under the varying regulatory provisions (or none at all) of the laws of the several states. Such regulatory powers as are or have been vested in the federal Governmeént are inadequate to meet the purposes of the accounting provision in - question. Section 221 (a) of the Communications Act, infra, p. 72, and the preceding Section 5 (18) of the Interstate Commerce Act, which relate to consolidations of property of two companies and acquisitions of stock or leasehold control, do not require federal approval of these transactions; they merely provide that any federal law making "the transaction unlawful shall not apply to a trans- action approved thereunder. Section 214- (a) of the Communications Act, infra, p. 72, makes it un-— lawful to acquire or operate a telephone ‘‘line’’ without a certificate from the Commission, but there was no similar provision applicable to tele- phone companies in the Interstate Commerce Act. (Compare See. (1) 18 of that Act.) Accordingly, in the case of property acquisitions prior to the summer of 1934, there wis no necessity for obtain- ee 40 ing federal approval unless the acquisition might otherwise fall within the prohibitions of the fed- eral antitrust laws. But apart from this consider- ation, there is no reason why such regulatory con- - trol as these statutory provisions authorize should not be supplemented by an appropriate exercise ‘* of the Commission’s power to regulate accounts. The disparity between price and the value of the property acquired need not be so great so as to make the transaction not.in the public interest, even though the price might be in excess of every element of value which it would be proper to carry | in capital account as a continuing asset. 5. PARAGRAPH (C) OF ACCOUNT 100.4 IS NOT INVAT 1D BY REASON OF THE FACT THAT IT DOES NOT ITSELF LAY DOWN THE RULES BY WHICH THE COMMISSION WILL ACT: IN DIRECT- ING THE WRITING OFF, OTHER DISPOSITION, OR AMORTIZA- ‘TION OF AMOUNTS IN THIS ACCOUNT. Paragraph (C) of account 100.4 provides that amounts in this account shall be written off, dis- posed of, or amortized according to the directions ~ of the Commission. Apart from the contention already considered that this operates to make aec- count 100.4 a suspense account, appellants attack this provision (Br., pp. 27-31), not on taconstitu- tional grounds, but on the ground that it is beyond the Commission’s statutory authority. The con- tentions seem to be (1) that when an accounting regulation fails to state specifically the rule or rules in accordance with which amounts entered e Nines La Da aA RI ee tM A Ab SE SRG CL Co te po oe peep er eatin 41 therein shall be ultimately disposed of, it does not constitute an accounting rule of the kind contem- plated by the statute and (2) that the authority given the Commission to prescribe a system of ac- counts does not include the authority to reserve to itself power of control over the disposition of par- ticular items. The two contentions are so inter- related that no attempt will be made to consider them separately. | | There is no doubt that account 100.4 clearly specifies the accounting requirements which it im- poses. Paragraph (A) sets forth the exact method whereby amounts to be entered in the account shall be determined. Paragraph (B) requires a sub- division of these amounts according to their char- acter. Paragraph (C) provides that the company shall follow the directions given by the Commission as to the subsequent disposition of amounts re- corded in the account. , ~. oa = a GEST Nie Se PS a nee ee ae LI TE POETS OO TR WT IRIE 8 IN KR EMER oe ay ARC ore SRI a PUT ae NO pete ae DENS Oe eee RO REE OY te LO TR ss PROM R MTR SS Sigs fol MR FOOL Re Lae Pe AE Op Re? i = ” . oe . nes ; 9) or small cost of such items.’ (Instruction 25 (D), ‘R. 114.) The Commission may be ex- pected to permit the use, in appropriate cases, of the same principle of averaging for determining - to what extent property previously acquired from other utilities is still in existence. Congress has authorized the Commission to re- quire telephone companies to file with it a statment showing original cost of their property. (Sec. 213 (c).) The grant of this authority amounts to ~ a legislative determination that to require the fur- nishing of this information is not unreasonably burdensome. _ III THE PROVISION THAT THE.CHARGES TO CERTAIN AC- COUNTS SHALL BE JUST AND REASONABLE AND THAT PAYMENTS IN EXCESS THEREOF SHALL BE CHARGED AS A NON-OPERATING EXPENSE IS NOT ARBITRARY OR - UNREASONABLE * Instruction 2 (B. 1) provides (R. 98): ‘ All charges to the accounts prescribed in this classification for telephone plant, in- come, operating revenues, and operating expenses shall be just and reasonable and any payments by the company in excess of such just and reasonable charges shall be included in account 323, ‘‘Miscellaneous income eharges’’. We subscribe to appellants’ statement (Br.; p. 37) that net operating income is ‘‘one of the most 56 vital items in the companies’ statements, of wide interest to investors and others’’. ‘But their fur- ther statement: ‘‘ Whether an outlay of an operat- ing expense was reasonable or unreasonable, being paid and non-recoverable, it nevertheless is an out- lay which should enter inte the computation of net operating income,’’ rests upon the untenable propo- sition that any amount, however unreasonable, which a controlling company exacts in payment for services or property should be charged in full to operating expense. In such circumstances the excess payment is not a true expense of operation or a true item of cost of property, but is special tribute levied by reason of corporate control. If. this tribute is accounted for a8 operating expense or is added to telephone plant account (thereby increasing depreciation charges, an operating ex- pense), the statement-of net operating income on the books of account is falsified by the inclusion therein of items which ought to be a charge against non-operating income. (R. 513.) All but a small fraction of the country’s tele- phone business is performed by holding company systems so that amounts paid for telephone plant and for services chargeable to operating expense are “‘in a large part paid to affiliated companies and are not results of arms-length transactions’’. (R. 539.) In rate litigation, charges for services and for property, in transactions between compa- nies in the same system, are recognized, in the com- | OS webs ni Tine i asters yee ois PUR 3 fo Sakbicnca inhale Litera, tote aA tines bere athe od —_—— 57 putation of operating income and of property de- voted to the public service, only to the extent that the charges are reasonable. Smith v. Illinois Bell Telephone Co., 282 U. 8. 133; Lindheimer-v. Illi- nois Bell Telephone Co., 292 U. 8S. 151; Dayton Power & Light Co. v. Public Utilities Commission, 292 U.S. 290; Columbus Gas & Fuel Co. v. Public ‘ Utilities Commission, 292 U. S. 398. In the liti- gation before the#ourt in the two telephone cases - it was found that the average annual overpay- ments to the parent company for services during a five-year period had amounted to $545,443 and that equipment had been purchased from a sub- sidiary of the same parent at prices in ‘excess of what was reasonable. (292 U. 8S. 151, 157, 165.) One of the duties of the Communications Com- mission is to prescribe just and reasonable charges | for telephone companies. (Sec. 205.) It is also specifically authorized to examine into transactions which relate to the furnishing of equipment sup- plies, research, services, finances, etc., which may affect carriers’ charges for the services which they render. (Sec. 215 (a).) In Norfolk & Western Sad Ry. Co. v. United States, 287 U.S. 134, the carrier, in challenging an order which required it to clas- sify certain coal mines as non-transportation prop- erty, contended (pp. 138-139) that the general discretion given the Interstate Commerce Commis- sion to prescribe a uniform system of accounts was limited by the purposes and ends for which such - 08 accounts are to be kept, as exhibited in other sec- tions of the Act. This Court adopted this as a proper test to apply and one of the grounds (pp. 140-141) upon which it affirmed the Commission’s _order was that two other sections of the Act “‘draw the very distinction’’ between transportation and non-transportation property which the accounting rule in question had long enforced. ane, In Kansas, City Southern Ry. Co. v.. United States, 231 U. S. 423, the Court gave as a reason for sustaining an accounting order, that it would aid the Commission in the performance of other of . its statutory duties. The Court said (p. 445): Since the regulation of the railroad car- rier by the public authority, arid especially the fixing of the rates to be charged, depend primarily upon two fundamental considera- tions, (a) the{value of the property. that is employed in the public service, and (b) the current cost of carrying on that service, it is clear that the maintenance of a proper . line of distinction between property ac- counts and operating accounts is essential to the execution by the Interstaté Commerce Commission of the supervisory and regula- tory powers conferred upon it by Congress. - See also Interstate Commerce Commission v. _ Goodrich Transit Co., 224 U. 8, 194, 211, 213-214, 216. : Since the power to prescribe uniform accounts ‘includes the power to inquire into expenditures and their proper assignment in the accounts’’ and 09 «power to prevent evasion * * * and detect in any formal compliance or in the assignment of expenses a“‘possible concealment of forbidden prac- tices’? (Smith v. Interstate Commerce Commis- sion, 245 U.S. 33, 43, 45), the power clearly exists to prescribe accounting rules designed to prevent eva- _ sion before the event rather than after.. This is the purpose and effect of the provision as to just and reasonable charges. It enables the Commission to pertog ina practicable manner the duty rest- ing on i to see — accounts subject to its juris- _-ddiction truly reflect™the transactions which they purport to record. Without this power, the bur- den of determining whether entries recording transactions between affiliated companies represent a true statement of operating income, operating ex- pense or telephone plant account ‘‘ would be such as to destroy all effective regulation”’; each and every : such entry would have to be audited by the Com- mission ‘‘before any credence whatsoever could be attached to it.’’ (R. 539.) | _ The regulation in question is therefore justified on two grounds, first, as an aid in the performance of other duties which the statute imposes upon the Commission and, second, as a reasonable means for making effective a cardinal principle qf any ae- counting system promulgated by a regulatory body, that the accounts shall faithfully represent the sub- stance of the transactions which they record (infra, p. 63). 60 Appellants assert (Br. p. 37) that the statute makes failure to comply with an accounting order of the Commission a penal offense and assert (Br., p. 38) that the obvious purpose of the accounting rule as to just and reasonable charges ‘‘is to allow the Commission, through fear of criminal prosecu- -tion, to impose its judgment on the company as to - the reasonableness of every outlay”’. , Appellants do not specify the penal provisions to '» which they refer. Section 220 (e), supra, pp. 5-6, and Sections 501 and 502, infra, pp. 73--74, which see- tions contain the only penal provisions which might be applicable, are limited to acts done ‘wilfully and knowingly” or ‘‘wilfully’’. It is clear that, in the absence of actual bad faith, an entry of a charge in excess of an aryount which was subsequently de- termined to be just and reasonable would not be the wilful or knowing violation condemned by these sections. In addition, Section 220 (d), supra, p. - 5, provides a forfeiture, which under Section 504, infra, p. 74, is recoverable in a civil suit, if a carrier fails or refuses to keep such accounts as the Com- mission shall prescribe and in the manner pre- seribed by it. In any proceeding under this section the defendant would be free to make the defense, if it is a valid one, that ‘‘just-and réasonable”’ is not a sufficiently definite standard to support a money forfeiture. The provisions of Section 220 (d) are almost identical with those of Section 20 (6) of the Inter- - state Commerce Act. - Although the latter section 61 . has been in effect since 1906 (Act of June 29, 1906, 34 Stat. 594), the only reported case under this sec- , tion, United States v. Clyde S. S. Co., 36 F. (2d) ~ 691, certiorari denied 281 U. 8. 744, was a proceed- ing, not for failure to keep accounts as prescribed, but for refusal to permit the Commissiof to inspect accounts and records. The Interstate Commerce Commission endeavors to adjust infractions of its accounting rules through correspondence or conference and, if necessary, issues 2 report, but usually not an. order, indicating the correction to bemade. United States v. Atlanta, Birmingham & Coast R. R. Co., 282 U. 8. 522. If’ the carrier still resists, the Commission issues an order, the legality of which may be tested in a suit to set. it aside. Norfolk & Western Ry. Co. v. _ United States, supra; Atlanta, Birmingham & Coast R. R. Co. v. United States, 296 U.S. 33. We submit that it is improper to assume that the Com- munications Commission will proceed in any less reasonable or orderly manner, or that ‘the forfei- tures authorized by Section 220 (d) will operate to coerce appellants into submission to the will of the Commissiqn.. The requirement that the charges to certain ac- counts shall be just and reasonable materially affects only a very limited class of transactions. Typical of these are contracts under which a hold- ing company furnishes services to subsidiaries or under which one company supplies equipment to 62 another, both being under common control. Since the terms of such contracts are usually uniform for all affiliated companies, the reasonableness of the charges thereunder can be readily removed from the area of doubt by presenting the matter to the Commission pursuant to Instruction 9 (R. 104). After it issues its directions or order, the contents _ of the words ‘‘just and reasonable’’ and the obli- _ gation of the company with respect thereto are precise and definite. As was said of a tax which was attacked as failing to define the scope of the obligation, but which might be clarified by admin- istrative action, ‘‘The demands of due process are satisfied if reasonably clear definition is afforded in time to give the taxpayer an. opportunity to comply.’ Pacific Tel. & Tel. Co. v. Seattle, 291 U. S. 300, 304. ieee We also submit that the words ‘“‘just and rea- sonable’’ furnish an adequate guide to the obliga- tions which the requirement in question imposes. The District Court pertinently observed (R. 571) that the cases such as United States v. Cohen Grocery Co., 255 U. S. 81, upon whieh appellants rely, are distinguishable because the statutory’ ‘provisions there held to be too vague or: indefinite were ‘‘without the specialized content of the word ‘reasonable’ with regard to charges involved in the determination of rates.’’ (R. 571.) The words “*just and reasonable”’ or their opposite ‘‘unjust and unreasonable”’ are repeatedly used in defining obligations imposed by the Interstate Commerce eS Pant ac. Ruse: 63 Act. See Sections 1.(5), 1.(6), 1 (11), 1 (12), 15 (1), HARB), 15 (6), 15 (7). The requirement.that the charges to certain ac- counts shall be just and reasonable does not give the Commission the power to ‘‘require recordirg what the Commission may think should have been done, instead of what actually occurred.’’ (App. Br., p. 38.) The real question at issue is whether form rather than substance shall determine what ‘factually occurred’? and whether the’ company shall be the final arbiter of this question. Insistence that accounts shall correspond to the ° substance of the transactions which they record does not amount to giving the Commission power to interfere in management. In Kansas City. Southern Railway Co. v. United States, 231.U. 8. 423, 440, the carrier argued that the authority to prescribe uniform accounts was confined to regu- lation of their form and that regulation which dealt with substance, that is, with the accounting re- quired ‘in particular circumstances, would consti- tute unauthorized interference with management. This Court said (pp. 440-441) : The very object of a system of accounts is to display the »ertinent financial operations of the company, and throw light upon its present condition. If they are to truly do this, the form must correspond with the sub- stance. * * * There is no direct inter- ference with the internal affairs of the cor- poration; and if such interference indirectly Eero — _ eee “ —— ees a 64 results, it is only such as is incidental to the lawful control of the carrier by the Federal - authority * * *, See also Norfolk d& Western Ry. Co. v. United States, 287 U. S. 134, 143; Interstate Commerce Commisston v. Goodrich Transit Co., 224 U.S. 194, 211. - IV _ @ 4 THE PROVISIONS GOVERNING CLASSIFICATION OF PHYSI- CAL PROPERTY ARE NOT ARBITRARY OR UNREASO. - ABLE ; One of appellants’ grounds of attack is that the distinction, between accounts 100.1 and 100.3 is so . indefinite as to be arbitrary. Account 100.1 em- braces the property ‘‘used in telephone service’”’ and account 100.3 is designated as ‘‘ Property held for future telephone use.’” (R.123.). The alleged ambiguity concerns the word ‘‘used’’ in account 100.1 in its relation to ‘‘spare’’ plant, that is, sub- sidiary parts of a larger unit, such as a cable, switchboard, underground duct, etc. which may be temporarily not in use (R. 342,556). We submit that whatever ambiguity, if any, once existed, has been dispelled by the evidence presented in this case. Each of the Commission’s witnesses (except one, who failed to state his interpretation), includ- ing the Commission’s chief accountant and its chief accountant in a telephone investigation undertaken i pursuant to a Senate ‘Resolution, definitely inter- , preted account 100.1 as including such spare plant. #i. ss