On certification to the Superior Court, Appellate Division, whose opinion is reported at 333 N.J. Super. 398 (2000).
The opinion of the court was delivered by: Verniero, J.
This appeal involves a final decision of the Board of Public Utilities (BPU) in respect of a rate petition filed by the New Jersey American Water Company (American Water). Within the context of that petition, the Division of the Ratepayer Advocate (Ratepayer Advocate) challenges the policy of the BPU that permits a utility to include half of its charitable contributions as operating expenses for purposes of calculating its service rates. Under that policy, a utility's ratepayers subsidize fifty percent of the utility's charitable contributions, whereas its shareholders bear the cost of the other fifty percent.
In reviewing the rate petition, the BPU applied its 50/50 sharing policy and allowed American Water to include half of its charitable contributions in its operating expenses. The Ratepayer Advocate objected on statutory and constitutional grounds. The Appellate Division affirmed the BPU's determination. We now reverse. We hold that the BPU's 50/50 sharing policy is arbitrary, lacks a sufficient basis in the record, and thus constitutes unreasonable agency action. Accordingly, no portion of a utility's charitable contributions may be subsidized by the utility's captive ratepayers. In view of that holding, we do not address the constitutional questions raised by the Ratepayer Advocate.
We begin by summarizing briefly the respective roles of the parties and the pertinent facts. The BPU consists of three members appointed by the Governor with the advice and consent of the Senate, and is administratively located within the executive branch. N.J.S.A. 48:2-1. The BPU is responsible for supervising and regulating public utilities in the State. N.J.S.A. 48:2-13.
The Ratepayer Advocate is administratively located within the BPU and "represents the financial interests of customers in matters relating to utility rates and policy." In re N.J. Am. Water Co., 333 N.J. Super. 398, 410 (App. Div. 2000). See generally Executive Reorganization Plan No. 001-1994, reprinted in N.J.S.A. 13:1D-1 (outlining function of Ratepayer Advocate and comparing it to predecessor, Office of Rate Counsel). The Ratepayer Advocate is "empowered to represent, protect, and advance the interests of all consumers of utility services, including residential, small business, commercial, and industrial ratepayers, in an effort to protect and promote the economic interests of all New Jersey ratepayers." Ibid.
American Water is a water utility engaged in the production, treatment, and distribution of water and the collection of sewage within its designated service territory, which includes parts of fifteen counties. Subject to the jurisdiction of the BPU, American Water provides water service to about 346,000 customers, and also provides sewer service to about 18,600 customers. It also sells water for resale to municipalities, authorities, and public utilities.
In January 1998, American Water filed a petition with the BPU to increase its rates for water and sewer service. The matter was transferred to the Office of Administrative Law and assigned to an Administrative Law Judge (ALJ), who heard testimony from representatives of American Water, the Ratepayer Advocate, and several other interested parties. Among its objections, the Ratepayer Advocate argued "that American Water should not be allowed to treat any portion of its charitable contributions as operating expenses." In re N.J. Am. Water Co., supra, 333 N.J. Super. at 401.
American Water's disputed charitable contributions amounted to $99,185. Under the BPU's 50/50 sharing policy, $49,592 of that amount was included in American Water's operating expenses. For rate-making purposes, $49,592 constituted .025 percent of the utility's total revenue requirements. Inclusion of that figure in American Water's operating costs would require residential ratepayers to pay an additional eight to ten cents annually on their water utility bills. During the administrative proceeding, American Water contended that its charitable donations are an important element of its responsibility to the communities it serves. In response, the Ratepayer Advocate argued that all of the charitable contributions should be excluded from operating expenses and thus be borne exclusively by the company's shareholders.
In January 1999, the ALJ rendered a decision that provided in part that the inclusion of charitable contributions was "a policy decision that only the Board of Public Utilities can make." Although acknowledging the reasonableness of the Ratepayer Advocate's arguments, the ALJ concluded that "there remain legitimate public policy concerns which the Board has heretofore seen fit to address in articulating a sharing policy. For purposes of this case I find a 50/50 sharing to be reasonable, but commend to the Board this issue as one deserving of further consideration on a generic basis[.]"
In March 1999, the BPU adopted in part, modified in part, and rejected in part the ALJ's decision. The BPU adopted that part of the ALJ's decision pertaining to the 50/50 sharing policy. (Because this appeal focuses solely on the contributions policy, we do not summarize or discuss the portions of the ALJ's and BPU's rulings unrelated to that issue.) The BPU memorialized its action in an order dated April 6, 1999. In that order the BPU states that it "continues to believe that charitable contributions by a public utility benefit ratepayers sufficiently to warrant some degree of rate recognition as an expense related to a utility's business operations." In support of its 50/50 sharing policy, the BPU explains that the policy "recognizes that a utility's customer benefit[s], either directly or indirectly, by virtue of contributions made to the community funds, educational campaigns, and the like." Moreover, the BPU notes that "[c]haritable contributions also enhance a utility's standing and good will in a community and therefore benefit shareholders. A 50/50 sharing policy properly balances ratepayer and stockholder interests."
Before the Appellate Division, the Ratepayer Advocate challenged the BPU's decision, arguing (1) that the BPU's ruling was erroneous because charitable contributions are not germane to a public utility, and (2) that the ruling violated the First Amendment of the United States Constitution and Article I, paragraph 6 of the New Jersey Constitution because it compelled ratepayers indirectly to subsidize charitable activities. In re N.J. Am. Water Co., supra, 333 N.J. Super. at 402. The Appellate Division affirmed the BPU's action. We granted the Ratepayer Advocate's petition for certification. 165 N.J. 601 (2000).
Title 48 sets forth the powers and duties of the BPU. The statute provides that the BPU has "general supervision and regulation of and jurisdiction and control over all public utilities as defined in this section and their property, property rights, equipment, facilities and franchises so far as may be necessary for the purpose of carrying out the provisions of this Title." N.J.S.A. 48:2-13a. Specifically, the agency is authorized to require that public utilities "furnish safe, adequate and proper service[.]" N.J.S.A. 48:2-23.
Pertinent to this appeal, the Legislature has entrusted the BPU with ensuring just and reasonable utility rates. N.J.S.A. 48:2-21. In that regard, N.J.S.A. 48:2-21(d) provides:
When any public utility shall increase any existing individual rates, joint rates, tolls, charges or schedules thereof, as well as commutation, mileage and other special rates, or change or alter any existing classification, the board, either upon written complaint or upon its own initiative, shall have power after hearing, upon notice, by order in writing to determine whether the increase, change or alteration is just and reasonable. The burden of proof to show that the increase, change or alteration is just and reasonable shall be upon the public utility making the same. The board, pending such hearing and determination, may order the suspension of the increase, change or alteration until the board shall have approved the same, not exceeding 4 months. If the hearing and determination shall not have been concluded within such 4 months the board may during such hearing and determination order a further suspension for an additional period not exceeding  4 months. The board shall approve the increase, change or alteration upon being satisfied that the same is just and reasonable. [(emphases added).]
To demonstrate that a requested rate increase is just and reasonable, "the utility must prove: (1) the value of its property or the rate base, (2) the amount of its expenses, including operations, income taxes, and depreciation, and (3) a fair rate of return to investors." In re Petition of Pub. Serv. Elec. & Gas, 304 N.J. Super. 247, 265 (App. Div.), certif. denied, 152 N.J. 12 (1997). In that context, this Court has stated that "rate making is a legislative and not a judicial function, and that the [BPU], to which the Legislature has delegated its rate-making power, is vested with broad discretion in the exercise of that authority." In re Petition of Pub. Serv. Coordinated Transp., 5 N.J. 196, 214 (1950).
Although the BPU's "rulings are entitled to presumptive validity[,]" In re Petition of Jersey Central Power & Light Co., 85 N.J. 520, 527 (1981), they are not immune from judicial review. The Legislature has authorized courts expressly to "review any order of the board and to set aside such order in whole or in part when it clearly appears that there was no evidence before the board to support the same reasonably or that the same was without jurisdiction of the board." N.J.S.A. 48:2- 46. In the same vein, a court will not sustain an action by the BPU, or that of any other administrative agency, when that action is found to be "arbitrary, capricious, unreasonable, or beyond the agency's delegated powers." In re Amendment of N.J.A.C. 8:31B-3.31, 119 N.J. 531, 544 (1990). See generally In re Pub. Serv. Elec. & Gas Co.'s Rate Unbundling, Stranded Costs & Restructuring Filings, 167 N.J. 377, 384-85 (2001) (outlining standard of review governing BPU orders).
New Jersey statutory law is silent on how to treat a regulated utility's charitable contributions. The seminal case in which this Court held that a utility's charitable contributions may be included as operating expenses in a rate petition is New Jersey Bell Telephone Co. v. Board of Public Utility Commissioners, 12 N.J. 568 (1953) (Bell). Prior to that case, the BPU's predecessor agency had "found that it was unreasonable to require the consumer to pay for [a utility's charitable contributions]." Id. at 595. The agency's position had been that "?in the determination of fair and reasonable rates, contributions and donations to charitable organizations are not a proper charge to operating expense.'" Id. at 596 (citation omitted).
In Bell, this Court rejected that position, directing the agency to permit a utility to include its charitable contributions "as an operating expense where it has an effect upon the creation of the service or product of the corporation and therefore may be considered as reasonably necessary in the rendition of service to the consumer." Ibid.
In the wake of Bell, "[t]he [BPU] has consistently permitted reasonable, nondiscriminatory charitable donations to qualify as operating expenses in a utility rate case." N.J. Dep't of the Pub. Advocate v. N.J. Bd. of Pub. Utils., 189 N.J. Super. 491, 515 (App. Div. 1983). See also In re N.J. Bell Tel. Co., 24 P.U.R.3d 181, 194 (Bd. of Pub. Util. Comm'rs 1958) ("We are required to follow the [S]supreme [C]court pronouncement on this matter in [Bell.]"). The BPU's 50/50 sharing policy replaced an earlier rule under which ratepayers bore seventy-five percent of the cost of a utility's charitable contributions. In explaining the current policy in the context of a previous rate petition, the BPU itself acknowledged some of the policy's troublesome aspects:
The [BPU] recognizes that [a utility's] contributions to charitable organizations result in direct and indirect benefits to the [utility's] employees, customers and communities because donations are made to community service agencies which are used by [the utility's] ratepayers. Donations are also made to universities and colleges located within or near the [utility's] service area.
However, the [BPU] also recognizes that ratepayers have no say as to whether to contribute, how much to contribute or to what agencies contributions should be made. Arguably, these contributions are not indispensable to providing service to customers. Moreover, forced ratepayer participation eliminates the personal tax deduction benefit that ...