Financial Reporting Requirements and Rate of Return Methodology in the Domestic Offshore Trades

FEDERAL MARITIME COMMISSION

46 CFR Part 552

[Docket No. 94-07]

Financial Reporting Requirements and Rate of Return Methodology

in the Domestic Offshore Trades

AGENCY: Federal Maritime Commission.

ACTION: Notice of proposed rulemaking; reply comments.

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SUMMARY: The Commission is seeking reply comments to its Notice of

Proposed Rulemaking concerning financial reporting requirements and the

rate of return methodology in the domestic offshore trades. The

Commission has received seven comments on the proposed rule which have

raised issues which require further comment. Comments are requested on,

and are to be limited to, the calculation of the cost of capital,

working capital, the selection of proxy groups, and the deletion of

alternative methodologies.

DATES: Reply comments due December 5, 1994.

ADDRESSES: Comments (original and fifteen copies) to: Joseph C.

Polking, Secretary, Federal Maritime Commission, 800 North Capitol

Street, N.W., Washington, D.C. 20573-0001, 202-523-5725.

FOR FURTHER INFORMATION CONTACT:

Richard R. Speigel, Bureau of Trade Monitoring and Analysis, Federal

Maritime Commission, 800 North Capitol Street, N.W., Washington, D.C.

20573-0001, 202-523-5845

C. Douglass Miller, Office of the General Counsel, Federal Maritime

Commission, 800 North Capitol Street, N.W., Washington, D.C. 20573-

0001, 202-523-5740.

SUPPLEMENTARY INFORMATION: On April 7, 1994, the Federal Maritime

Commission (``FMC'' or ``Commission'') published a Notice of Proposed

Rulemaking (``NPR'') (59 FR 16592) which proposed to amend its

regulations governing financial reporting requirements and rate of

return methodology applicable to vessel-operating common carriers by

water in the domestic offshore trades. Among other things, the proposed

rule would change the method of determining the reasonableness of a

carrier's return on rate base from the comparable earnings test to the

weighted average cost of capital methodology. At the request of Matson

Navigation Company, the Commission extended the comment period for

interested parties to file until July 20, 1994 (59 FR 27002). Seven

parties filed comments on the NPR. Commenters include: American

President Lines (``APL''), Crowley Maritime Corporation (``Crowley''),

Matson Navigation Company, Inc. (``Matson''), Puerto Rico Maritime

Shipping Authority (``PRMSA''), United States Department of

Transportation (``DOT''), Marsoft Incorporated (``Marsoft''), and the

State of Hawaii (``Hawaii'').

Based on its review of the comments, the Commission has determined

that reply comments on four issues would be beneficial. In order that

the Commission have the most complete information available to enable

it to make an informed judgment in these matters, interested persons

are invited to submit comments on the issues discussed below.

Issue 1: Calculation of the Cost of Capital

PRMSA addresses the issue of the calculation of the before-tax

weighted average cost of capital (``BTWACC'') and its relationship to

the projected rate of return on rate base. PRMSA states that the

formula for the BTWACC contained in the proposed rule is correct.\1\

PRMSA asserts, however, that since the projected rate of return in the

proposed rule is computed on an after-tax basis--with return on rate

base being computed by dividing net income plus interest expense by the

trade rate base--the proposed before-tax weighted average cost of

capital is being compared to the after-tax projected return on rate

base. PRMSA suggests, therefore, that either the weighted average cost

of capital should be changed to an after-tax basis so it can be

compared to the after-tax projected return on trade rate base currently

specified, or the BTWACC should be retained and the projected return on

trade rate base should be changed to a before-tax basis.

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\1\The proposed rule states the before-tax weighted average cost

of capital will be calculated using the following equation:

BTWACC=(D/D+P+E)Kd+

(P/D+P+E)Kp(1/1-T)+

(E/D+P+E)Ke(1/1-T)

where:

Kd is the regulated firm's cost of long-term debt capital;

Kp is the regulated firm's cost of preferred stock capital;

Ke is the regulated firm's cost of common stock equity

capital;

D is the value of the regulated firm's long-term debt

outstanding;

P is the value of the regulated firm's preferred stock

outstanding;

E is the value of the regulated firm's common-stock equity

outstanding;

T is the corporate income tax rate

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PRMSA's comments appear to have merit. Therefore, the Commission is

proposing to retain the before-tax weighted average cost of capital

contained in the proposed rule and change the calculation of the

projected rate of return on rate base to a before-tax basis. Retention

of the BTWACC seems appropriate because it is employed by a large

majority of regulatory commissions. The before-tax weighted average

cost of capital would be calculated as it is in the proposed rule.

However, the projected rate of return on rate base stated in the

proposed rule would be changed to:

TP04NO94.000

The Commission thus proposes to amend section 552.6(d)(2) to read:

(2) Return on Rate Base. The return on rate base will be computed

by dividing Trade net income plus interest expense plus provision for

income taxes by Trade rate base.

The Commission requests comments on this amendment to the proposed

rule.

Issue 2: Working Capital

The proposed rule adopted Hawaii's suggestion in FMC Docket No. 91-

51, Financial Reports of Common Carriers by Water in the Domestic

Offshore Trades, that insurance expense be treated in the same manner

as other operating expenses in calculating working capital, i.e.,

include that amount applicable to the duration of an average voyage. In

its comments on this proposed rule, Hawaii suggests an additional

modification of the calculation of working capital, namely, the

exclusion of interest expense.

In support of its proposal, Hawaii states that interest expense is

a source of working capital funds, and is not paid to the bond holder

until after related revenue is received. Hawaii concludes, therefore,

that interest expense does not create a need for working capital.

Comments are requested on the validity of the proposal to exclude

interest expense from the calculation of working capital.

Issue 3: The Selection of Proxy Groups

A number of parties commented on the selection of the proxy group.

Hawaii indicates a concern with the criteria prescribed in selecting a

comparable group of companies when the proxy group is used in

determining the cost of common-stock equity. Hawaii believes that the

companies in the Value Line Investment Survey which satisfy the

Commission's criteria for the proxy group do not have business risks

similar to those of Matson. Hawaii claims that these companies are

generally consolidated companies; are not dominant in their trades; and

do not have statutory barriers to entry.

Marsoft states that according to its research only three marine

transportation companies and four trucking companies meet the proposed

guidelines for the proxy group. Marsoft does not believe that airlines,

railroads, or full-load trucking companies should be included in the

proxy group, because they do not provide comparable services. Marsoft

states that in many cases large, geographically and operationally

diverse companies will be compared to small, highly specialized private

carriers. Marsoft believes that the comparison may not be credible in

some cases.

PRMSA comments that the proxy group should not be restricted to the

freight transportation business. PRMSA asserts that equity capital in

the regulated carrier competes against the broad spectrum of companies

in the economy, not just against companies involved in freight

transportation. The nature of a business is said to be only one

ingredient of business risk, not the sole determinant. PRMSA notes that

as of June 1994, there were a total of 39 companies listed in Value

Line Investment Survey which were involved in air transport, trucking,

maritime, and railroading. Allegedly, not all of these companies were

involved in freight transportation as required by the proposed rule.

PRMSA concludes from this that the potential list of comparable

companies is highly limited.

Under the proposed rule, the proxy group is selected from companies

which operate and derive a major portion of their gross revenues

primarily as common carriers in the business of freight transportation,

and own and operate transportation vehicles or vessels. The Commission

requests specific suggestions on industries other than freight

transportation covered by the Value Line Investment Survey which have

business and financial risks similar to those of the domestic carriers

that may be added to the current proxy group criteria.

Issue 4: Deletion of Alternative Methodologies

The proposed rule revises paragraph (b) of section 552.1 by

deleting the provision that the methodology employed in each case will

depend on the nature of the relevant carrier's operations and financial

structure. Also, the proposed rule adds language to that paragraph that

specifies the extent of possible alternative methodologies. Paragraph

(b) reads:

(b) In evaluating the reasonableness of a VOCC's overall level

of rates, the Commission will use return on rate base as its primary

standard. A carrier's allowable rate of return on rate base will be

set equal to its before-tax weighted average cost of capital.

However, the Commission may also employ the other financial

methodologies set forth in Sec. 552.6(f) in order to achieve a fair

and reasonable result.

Paragraph (d) of the same section has been deleted. That paragraph

provided that the Commission may use some other basis for allocation

and calculation and may consider other operational factors in any

instance where it is deemed necessary to achieve a fair and reasonable

result.

APL informs that these provisions are at the heart of a major

dispute in FMC Docket No. 89-26, The Government of the Territory of

Guam, et al. v. Sea-Land Service, Inc. and American President Lines,

Ltd. It points out that the NPR does not give any reasons for the

proposed changes to section 552.1 and contends that the changes cannot

be legally adopted unless and until the FMC identifies its reasons for

such a change and allows opportunity for comment.

In the abbreviated comments it did provide, APL contends that the

proposed changes can have no substantive effect on a pending complaint

docket focused on a prior time period. APL further urges the Commission

to ``make clear, as a general matter, that its decision in the

prospective rulemaking proceeding is not intended to pre-judge issues

in the retrospective complaint proceeding.'' APL contends that sections

552.1(b) and 552.1(d) merely make explicit an agency's authority that

is implicit in any regulatory scheme. Further, APL questions why the

FMC would want to amend a regulation in a way that might imply that it

was denying itself the ability to do something necessary to achieve a

fair and reasonable result.

The Guam trade is unique in that the trade is a very small portion

of the carriers' overall service. However, whether the current method

of allocation is appropriate in such a case need not be decided here,

because the two carriers serving Guam, APL and Sea-Land Service, Inc.,

currently file most, if not all, of their rates with the Interstate

Commerce Commission. Neither carrier files full financial reports under

46 CFR Part 552. In the event an FMC-regulated carrier initiates such a

service in the future, the Commission will address the need for any

change in 46 CFR Part 552 in a separate rulemaking proceeding.

Paragraph (d) was eliminated because the Commission did not want such

determinations to be made on an ad hoc basis during a rate

investigation. It is essential that significant issues relating to the

underlying methodology to be employed in determining the reasonableness

of rates be settled prior to any rate investigation. The 180-day limit

specified by section 3 of the Shipping Act, 1933, 46 U.S.C. app. 845,

cannot be met if parties are permitted to change methodologies during

the course of a rate case. Moreover, it is unfair; parties to a rate

proceeding are entitled to rely on the Commission's rules. They should

not have to respond to ever-changing methodologies proposed by other

parties.

It is understandable that APL is concerned that the Commission's

decision here may affect the outcome in Docket No. 89-26. However, any

changes that may be made to Part 552 as a result of this proceeding

will only be applied prospectively. They will have no application in

pending cases such as Docket No. 89-26.

Conclusion

The Commission will permit reply comments to be filed by any

interested person, not only those that commented on the proposed rule.

Those parties who filed comments are on the attached list. All previous

commenters are directed to provide copies of their comments to anyone

upon request, so as to facilitate timely comments. Copies of comments

are also available for inspection and copying at the Commission's

Office of the Secretary. Pursuant to Commission Rule 53, 46 CFR 502.53,

parties shall serve reply comments on initial round participants.

By the Commission.

Joseph C. Polking,

Secretary.

Robert T. Basseches, David B. Cook, Eric C. Jeffrey, Cynthia Gurnee

Pugh, Shea & Gardner, 1800 Massachusetts Avenue, NW., Washington, DC

20036, (Counsel for American President Lines, Ltd.)

Michael G. Roberts, Vice President, Government Relations, Crowley

Maritime Corporation, 1500 K Street, NW., Suite 425, Washington, DC

20005

Stephen Todd Rudman, Assistant General Counsel, Matson Navigation

Company, Inc., P.O. Box 7452, San Francisco, CA 94120

Amy Loeserman Klein, Klein, Bagileo, Silverberg & Goldman, 1101 30th

St., NW.--Suite 120, Washington, DC 20007, (Counsel for Puerto Rico

Maritime Shipping Authority)

Rosalind A. Knapp, Deputy General Counsel, U.S. Department of

Transportation, 400 Seventh Street, SW., Washington, DC 20590

Arlie G. Sterling, President, Marsoft, Inc., One Financial Center,

25th Floor, Boston, MA 02111

Charles W. Totto, Executive Director, Division of Consumer Advocacy,

Department of Commerce and Consumer Affairs, State of Hawaii, P.O.

Box 541, Honolulu, HI 96809

[FR Doc. 94-27373 Filed 11-3-94; 8:45 am]

BILLING CODE 6730-01-M