83.7 F
Charlotte Amalie
Wednesday, July 24, 2024


Sept. 22, 2002 – The report submitted to the Public Services Commission on Sept. 13 by the hearing examiner for its investigation into the rates of Innovative Telephone:
– Included two key decisions that may reduce Innovative profits in the future;
– Cast some light on hidden accounting practices of the phone company.
– Denied a refund to phone company customers.
– Demonstrated the unusual balance of powers in utility regulation in the territory.
– Left some mysteries unsolved.
Frederick G. Watts, senior partner in a St. Thomas law firm, was appointed by the PSC to conduct the first of what are now legally mandated biennial financial reviews of the telephone company. Also participating in that process, which began last year, were the phone company and AUS Pathways Inc., a mainland consulting firm that works in the utility field.
The 53-page report written by Watts, resembles a carefully drafted decision by a judge after a long investigation and several hearings. Watts was often called upon to make complex legal and economic judgments on such arcane matters as the "cost of equity" — i.e., what is the appropriate profit for the phone company. In some instances, two or more expert witnesses disagreed as to, for example, what, if any, extra profits should be allowed for investors dealing with the V.I. economy, as opposed to that of the mainland.
Rulings that could affect rate of return
As to reducing the profit level for Innovative – which is not discussed in those words in the Hearing Examiner's Report – two decisions were made following lengthy and conflicting testimony.
In the first instance, Watts ruled that Innovative could not count as expenses any taxes that the phone company did not pay but would have paid, had the V.I. government's Economic Development Commission not granted the company extensive tax breaks.
The bottom-line significance of that decision is that the company can no longer claim these "taxes" as expenses, and thus cannot pass on to its telephone users a claimed business expense that in the view of the hearing examiner did not exist.
Innovative argued that its EDC tax exemptions (90 percent of corporate income taxes and 100 percent of property and gross receipts taxes) should be disregarded, and the taxes should be viewed as having been paid, because the arrangement between the EDC and the phone company is not subject to regulation by the PSC. Watts rejected that argument.
The dollar amounts of taxes not paid but claimed as expenses was not disclosed in the report.
Mainland observers marveled that Innovative even attempted the argument, given the recent controversies in business circles about "creative accounting" by the likes of Enron and Global Crossing.
Much of the Hearing Examiner's Report covers the complex question of the appropriate rate of return for Innovative. Since the phone company in effect has a monopoly, its rates are subject to approval by the PSC. The commission by law must find that rate of return higher than 8 percent is "imperative" before it can go into effect.
The witness for Innovative in this regard argued that the risks encountered by Innovative were such that a 13.84 percent rate of return was warranted, and asked that the hearing examiner recommend that rate. Watts, however, after calculating the relative sizes of the phone company's debts, both short and long term, and the value of the equity (or ownership) stake, concluded that the PSC should regard 10.62 percent as an "imperative" rate of return, and not the larger margin asked by the phone company.
Intimations of accounting practices
As to Innovative's secretive finances, some clues emerged between the lines of the report, clues that are that much more interesting because of the phone company's continuing success in keeping its finances hidden from public scrutiny.
(The Source had asked to see the financial reports submitted by the company to the PSC, something that is routinely available to the press and the public from agencies that regulate mainland phone companies. Innovative strongly opposed the request. The PSC voted to deny the request, with commission member Alric Simmonds, the governor's deputy chief of staff, casting the deciding vote for secrecy in what otherwise would have been a 3-3 tie. See "PSC drops 911 fee probe, denies access to records".)
The mystery of how Innovative is able to secure such huge subsidies from a Federal Communications Commission-sponsored agency — $25 million a year — given the low-wage, low-tax nature of the V.I. economy may have been solved in part by Innovative's claims to the hearing examiner that taxes not paid should be counted as taxes paid.
Were Innovative's subsidy applications to Washington also based, in part, on such a claim, the expense base charged in those applications would be similarly enlarged, and thus the subsidy would grow as well. It is not known whether Innovative's non-payment of taxes is claimed as an expense in the subsidy reporting system.
Two other murky pieces of financial reporting were studied by the hearing examiner:
– The interactions of the finances of the phone company and those of its parent corporation, Innovative Communication Corp. Watts quoted the technical consultants as saying "the public does not benefit from the current practice of 'capturing' all of the benefits of a consolidated tax filing at the parent level and not 'flowing back' a portion of that benefit to the regulated telephone company."
In lay terms, the non-regulated parent company, ICC, is getting the benefits that might otherwise go to the regulated phone company, and the regulated phone company does not have to lower its rates to customers as a result.
– Innovative's reporting on investments in modern technology. The report stated that "… the technical consultants observed several practices on the part of the company that were challenged. Specifically, the method used to account for investment in network modernization and addition was not complete, and therefore did not meet the used and useful test generally applied to rate base adjustments."
In other words, to count as an actual investment, which legitimately earns a rate of return, an expenditure must be for something useful — something, in fact, used, and accounted for appropriately.
Refund to customers denied
While Watts appeared concerned about these accounting practices in terms of setting appropriate rates for Virgin Islands telephone services, the same practices, if carried out in the reports to Washington, might overstate the company's expenditures, and thus overstate the subsidies owed to the phone company.
As to whether Innovative's finances were such as to warrant a rebate to consumers, Watts wrote that "it is incumbent upon the hearing examiner to state that Innovative has not overearned its authorized rate of return in the test year. Accordingly, the hearing examiner finds no basis to order a 'rebate' or 'refund' of any portion of the earnings realized by Innovative Telephone Company during that period of time as proposed by the technical consultants [AUS] in their submission to this proceeding."
An unusual balance of powers in regulation
Regulating utilities in the Virgin Islands is a different process than is usually seen on the mainland. This can be seen by reading between the lines of the Hearing Examiner's Report.
The principal difference between mainland and V.I. practices is the total absence of consumer advocates in the latter process.
Mainland rate-setting processes often have either non-governmental consumer groups playing a formal role in the hearing or, as in the case of the District of Columbia, have a tax-supported organization appearing on behalf of the co
nsumers. These entities study the issues, write briefs, argue before the hearing examiner and otherwise play a major role in the decision-making process.
Not so in the Virgin Islands. As Watts was careful to state in his long, thoughtful report, the participants in the process included only the phone company and the PSC's technical consultants, the New Jersey-based AUS Pathways. No other voices were raised.
AUS argued for a rebate to phone users and questioned some of Innovative's accounting practices. But there were no consumer advocates asking, for instance, why Innovative, with the largest per-line subsidy for a company of its size in the United States (about $31.20 per line per month), should have a monthly consumer fee ($18.55 per line) that is higher than 90 percent of the mainland phone bills, according to a General Accounting Office study. The federal subsidy is supposed to lower phone bills in hard-to-serve parts of the nation, such as the sparsely populated mountain states and the Alaskan outback.
Had AUS, or anyone else, raised these two points, it presumably would have been documented in the Hearing Examiner's Report. There was no such mention in the report.
Unanswered questions
While Watts' report cast some light on some of Innovative's murky financial transactions, it left some questions unanswered. There is, for example, the question of what the gross and net income of Innovative Telephone are.
In 1999, the last year for which data are available, Innovative had a gross income of $122 million, according to the FCC, which no longer releases such information.
In 1997, the last year such a report was available, the U.S. Department of Agriculture, then a lender to the V.I. Telephone Corp., which became Innovative Telephone, reported the profit of the firm was $16,105,000.
Given Innovative's aggressive business activity, and the fact that the federal subsidy has increased by $10 million a year since 1997, it would seem unlikely that either the gross or the net income of Innovative could have declined since that time.
With this as background, the Hearing Examiner's Report speaks of "total revenues of more than $51 million" for calendar year 2001. The report does not further define "total revenues" for the year. It may be that the definition of "total revenues" used currently by the company and the definition of "gross income" used by the FCC in the past are quite different.
Then there is the question of the "Lifeline" account. Lifeline is a small-scale, federally funded program that provides several hundred low-income V.I. residents with a specific subsidy to meet their phone bills. The program is used sparingly in the USVI, and much more vigorously in California, where a much higher proportion of phone users are assisted.
This is a pass-through subsidy, unlike the major subsidies (of $31.20 per line per month) that go directly to Innovative. In the case of Lifeline, the moneys go to the low-income residents in the form of lower rates.
Given this background, there is this puzzling passage in the report:
"… Innovative sought restoration of the $2.2 million Lifeline account to the revenue [i.e. profits] requirement for the company. Innovative argues that it is required to contribute to this account by PSC actions and it should have been recognized by the consultants …"
How can a pass-through subsidy to one group of consumers be used to justify higher rates for the balance of the customers? How can Innovative "be required to contribute" to a program that appears to be 100 percent federally funded?
The hearing examiner ruled that "additional scheduled contributions to the Lifeline account" by Innovative could be suspended on the grounds that the accumulated sum at the present "appears to meet all foreseeable needs."

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