BEFORE THE STATE BOARD OF EQUALI

BEFORE THE STATE BOARD OF EQUALIZATION

FOR THE STATE OF WYOMING

IN THE MATTER OF THE APPEAL OF )

WYOMING INTERSTATE COMPANY, LTD. ) Docket No. 99-75

FROM A DECISION BY THE )

DEPARTMENT OF REVENUE )

FINDINGS OF FACT

CONCLUSIONS OF LAW

DECISION AND ORDER

APPEARANCES

Lawrence J. Wolfe, Holland & Hart LLP , Cheyenne, Wyoming, and Elizabeth Herdes, Wyoming Interstate Company, Colorado Springs, Colorado, representing Wyoming Interstate Company, LTD, (WIC).

Harold Meier, Senior Assistant Attorney General, representing the Wyoming Department of Revenue (DOR).

DIGEST

The appeal arises from Notice of Appeal dated July 9, 1999, appealing the "Notice of Valuation" of a state assessed natural gas pipeline dated June 11, 1999. This matter was heard in a contested case hearing commencing on November 1, 2000, and continuing through November 2, 2000, by the State Board of Equalization (SBOE). Gayle R. Stewart, SBOE Staff Attorney, acted as hearing officer. SBOE members at the time of the hearing were Edmund J. Schmidt, Chairman, Roberta A. Coates, Vice-Chairman, and Ron Arnold, Member. Sylvia Hackl took Mr. Arnold's position on the Board at the time the order was entered but did not participate in the decision. The parties stipulated that the only question to be decided by SBOE is whether the capitalization rate used to determine value in the income approach to valuation should be adjusted for costs incurred in issuing debt.

JURISDICTION

Upon application of any person adversely affected, the SBOE is mandated to review final decisions of the DOR and "[h]old hearings after due notice in the manner and form provided in the Wyoming Administrative Procedure Act [Wyo. Stat. 16-3-101 through 16-3-115] and its own rules and regulations of practice and procedure." Wyo. Stat. 39-11-102.1 (c)(viii).

The SBOE is required to "[d]ecide all questions that may arise with reference to the construction of any statute affecting the assessment, levy and collection of taxes, in accordance with the rules, regulations, orders and instructions prescribed by the department." Wyo. Stat. 39-11-102(c)(iv). The rules of practice and procedure for appeals before the SBOE involving tax matters contemplate appeals from final administrative decisions of the DOR. Rules, Wyoming State Board of Equalization, Chapter 2, 3. The rules require appeals to be filed with SBOE within thirty (30) days of any administrative decision. Rules, Wyoming State Board of Equalization, Chapter 2, 5.

The Notice of Appeal was timely filed and the SBOE has jurisdiction to hear the case. [Stipulated Updated Summary of Uncontroverted Facts]. The SBOE is required to decide all issues relating to this appeal and give a written decision, citing findings of fact and conclusions of law following a hearing before the SBOE. Rules, Wyoming State Board of Equalization, Chapter 2, 32.

DISCUSSION

WIC owns and operates an interstate natural gas pipeline system that provides transportation of natural gas for customers across Wyoming and into Colorado. As a natural gas pipeline company, WIC's properties are state-assessed and valued by DOR. Wyo. Stat. 39-13-102(m).

The parties stipulated that the single issue in this appeal is: "Did the Department use an erroneous cost of capital by failing to include financing costs in the cost of debt, cost of common equity, and cost of preferred stock resulting in an overvaluation of WIC's property in violation of Wyoming law?" [Transcript p. 9].

For tax year 1999, WIC contends the DOR failed to arrive at the fair market value of WIC's property because the DOR failed to include financing or flotation costs in the various costs of capital to arrive at a total cost of capital. WIC contends that generally accepted appraisal standards require the DOR to include financing or flotation costs in the cost of capital when valuing WIC's property and this error resulted in overvaluation of WIC's property in violation of Wyoming law. DOR contends that it valued WIC's property uniformly and equally in accordance with Wyoming law and DOR regulations, that the capitalization rate included costs for financing debt and that WIC was valued at fair market value.

FINDINGS OF FACT

1. WIC is a regulated interstate natural gas pipeline company. [Transcript p. 29]. It has properties in Wyoming and Colorado. [Transcript p. 27].

2. WIC requested an extension of time for filing its annual report by letter dated January 25, 1999. The DOR granted WIC an extension until April 1, 1999. [DOR Exhibit 508].

3. The DOR valued Petitioner's property as a gas pipeline industry pursuant to Wyoming law for tax year 1999. The rules require specific procedures. [DOR Exhibit 504, Section 7.7]. The DOR used a unitary appraisal approach for Petitioner and the other natural gas pipeline companies assessed in Wyoming. This unitary appraisal "is that process of determining the value of a company as a whole without reference to individual parts." Rules, Department of Revenue, Chapter 7, 4(k). Once the unitary value is determined, a Wyoming allocation percentage is applied to WIC's value. From that value the portion which is determined to be exempt property (exemption adjustment factor) is removed and the assessment ratio (11.5%) is applied to determine the Wyoming assessed value. The resulting assessed value is apportioned between the counties where the company's facilities are located. Those counties are Albany, Laramie, Sweetwater and Carbon. [Stipulated Updated Summary of Uncontroverted Facts; DOR Exhibit 502].

4. The parties do not dispute the Wyoming allocation percentage or the exemption allocation factor which was applied to WIC's unit value. [Stipulated Updated Summary of Uncontroverted Facts].

5. WIC does not dispute, for purposes of this case only, the capital structure that the DOR determined for natural gas companies in the DOR's Capitalization Rate Study. [DOR Exhibit 501; Stipulated Updated Summary of Uncontroverted Facts].

6. On June 11, 1999, the DOR issued its final determination letter, confirming the preliminary valuation the DOR had determined for WIC's Wyoming property. [Transcript p. 45; WIC Exhibit 108].

7. WIC appealed the DOR's final determination on June 9, 1999, believing that the capitalization rate was too low and was improper because it was not adjusted for financing or flotation costs. [Transcript pp. 45-46; WIC Exhibit 109].

8. There are three traditional approaches to value when performing a unit valuation as required by the DOR Rules, Uniform Standards of Professional Appraisal Practices (USPAP) and generally accepted appraisal standards: 1) the income approach, 2) cost approach, and 3) sales comparison approach. [Transcript p. 125; WIC Exhibit 162]. The DOR did four approaches to value and relied upon three. The three approaches they relied upon were the yield capitalization approach which is also called the income approach, the HCLD, which is the historical cost less depreciation, and a Rate Base Model approach. The income approach requires the determination of two components; (1) the anticipated future income from the property; and (2) the capitalization rate (which is known as the cost of capital). To estimate the value, the income is divided by the cost of capital. Thus, if either component is incorrect, then mathematically, the resulting value is incorrect. The DOR gave the yield capitalization approach a 50 percent weight; the HCLD approach 25 percent and the Rate Base Model approach was given a 25 percent weight. [Transcript pp. 125-126]. WIC agreed with the DOR's decision not to use a sales comparison approach because it is rare for comparable sales to take place. [Transcript p. 126].

9. DOR's final assessment of WIC's property was as follows:

Fair Market Value $62,524,689

Level of Assessment 11.50%

Taxable Assessed Valuation 7,190,339

[WIC Exhibit 108].

10. Financing or flotation costs are the costs of issuing debt and equity that would be incurred by a typical buyer of WIC's property when raising capital to make such a purchase. Examples of financing or flotation costs include loan origination fees, title and mortgage insurance, underwriting fees, legal and accounting fees, prospectus fees, printing and distribution costs, security registration fees. [Transcript p. 49; WIC Exhibit 110, p. 0179]. While the terms "financing costs" and "flotation costs" are synonymous, the term "flotation costs" is used in this decision.

11. At issue in this case is the proper and lawful determination of the capitalization rate by the DOR. A capitalization rate, or cost of capital, is that rate of return of and on the amount a buyer invests in property. It is the rate used to discount the future value of the anticipated benefits from a property to a present-day value. [Transcript p. 135]. The amount of the rate depends on such factors as the amount of apparent risk in an investment, the rates of return for comparable investments, the prospective rates of return on alternative investments, and the costs involved obtaining the return. [Transcript pp. 136-141; WIC Exhibit 184].

12. In March of each year, the DOR holds a public hearing to solicit industry comment on its capitalization rate studies for the various state assessed industries and invites all the industries to make presentations on capitalization rates. [Transcript p. 36]. During these hearings WIC attempted to convince the DOR to adjust the capitalization rate for flotation costs starting in 1996 and continuing each year to 1999. [Transcript pp. 46-50, WIC Exhibit 110]. At the March, 1999, hearing eleven cost of capital studies were presented for various Wyoming assessed properties. [Transcript pp. 49-50, 58-64; WIC Exhibits 110-117, 147-149]. Nine out of the eleven studies supported including flotation costs in the cost of capital. [Transcript p. 64; WIC Exhibits 110-117, 149]. No information was presented to the SBOE by either party as to whether or not DOR accepted an adjustment for flotation costs in any other industry when setting capitalization rates. However, in reviewing the 1999 Study for Capitalization Rates for State Assessments, [WIC Exhibit 105] it does not appear that adjustments were made for flotation costs for any industry.

13. In developing the capitalization rate, the State of Wyoming is required by rule and regulation to apply it by industry, and by sub-grouping in accordance with Rule, Department of Revenue, Chapter 7 7. [Transcript p. 375; DOR Exhibit 504].

14. After the capitalization rate hearing in 1999, the DOR determined the capitalization rate to be used for the gas pipeline industry for companies rated Baa was 10.75%. This capitalization rate did not include a separate adjustment for flotation costs. [Transcript pp. 38, 39; WIC Exhibit 104 p. 0067; WIC Exhibit 166].

15. In developing its capitalization rate the DOR, considers all costs, including flotation costs to be in the price or value in the market place. It does not believe an adjustment is necessary. The DOR considers the value determined at the market place to be the ultimate determination of costs. [Transcript pp. 367, 368]. The only evidence to support DOR's theory was the testimony of Mr. Uhrich and Mr. Chubb. No treatises, texts or other materials were introduced to support the theory.

16. The DOR applied their capitalization rate that did not include a change for flotation costs to all gas pipeline property. [Transcript p. 350].

17. Wyoming law requires the DOR to determine the fair market value of WIC's property by using generally accepted appraisal standards, Wyo. Stat. 39-13-103(b)(ii). Generally accepted appraisal standards are those widely recognized and accepted practices within the appraisal community which are based upon economic, financial, and appraisal theory, all tied together and are used to derive fair market value. Generally accepted appraisal standards include the USPAP and are compiled from textbooks, manuals, courses, treatises, studies and the practices of appraisal experts. [Transcript pp. 119-120; WIC Exhibit 160]. The DOR generally agrees with this definition of generally accepted appraisal standards. [WIC Exhibit 180 p. 1243]. Other generally accepted appraisal standards can be found in publications adopted by the International Association of Assessing Officers (IAAO), which put out a series of textbooks, supplemental textbooks and course materials and teachings. [Transcript pp. 361-363].

18. Dr. John Davis, Ph.D., MAI, SRPA, ASA, testified generally accepted appraisal standards require the inclusion of flotation costs in the cost of capital in order to arrive at the fair market value of WIC's property. [Transcript pp. 107-108; WIC Exhibit 121]. Mr. Uhrich, of DOR, agreed appraisal theory has its roots in finance theory when the income approach to valuation is used. [Transcript p. 360]. Financial, economic and appraisal theory support the inclusion of flotation costs in order to arrive at a total cost of capital. [Transcript pp. 183, 184]. The total cost of capital should reflect both the required return paid to investors and the flotation fees paid to the investment banker. [Transcript pp. 184, 187; WIC Exhibit 124 p. 0682; WIC Exhibit 153 p. 1096]. The DOR failed to take a second step in the analysis. They looked at the secondary market to determine the costs of the equity, debt and preferred stock but the DOR failed to look at the primary market and adjust for the flotation costs of debt, equity and preferred stock. [Transcript p. 148]. The costs from the secondary market, the stock market information, does not adjust for the flotation costs in the primary market. [Transcript p. 284].

19. Dr. Stephen Gaske, Ph.D., testified that one financial concept is that money is not free and there are costs associated with issuing stocks and bonds. These are the costs that are paid for the privilege of issuing stocks or bonds. [Transcript pp. 248, 250- 252]. Many financial texts adjust the cost of capital for the costs of issuing the stocks and bonds. [WIC Exhibits 130-137, 139-144, 153]. An appraisal text approves the adjustment of the capitalization rate for flotation costs. [WIC Exhibit 124].

20. The costs of flotation are incurred in what is called the primary market which is where the initial stock or bond offering occurs as opposed to the secondary market where stocks are traded. The flotation costs of the seller in the primary market are a much larger percentage than the costs sellers and buyers incur on the secondary market. [Transcript p. 291].

21. Thus, we conclude that prices and yields derived from the secondary market do not reflect either brokerage fees or flotation costs. Consequently, an adjustment to the capitalization rate must be made in order to reflect the flotation costs a company would incur in raising capital in the primary market in order to purchase assets such as the WIC pipeline. [Transcript p. 291].

22. In determining value using the band of investment method an appraisal text explains: "Because most properties are purchased with debt and equity capital the overall capitalization rate must satisfy the market return requirements of both investment positions." The conclusion is the buyers need for capital in the form of flotation costs must be included in the capitalization rate calculation. [ WIC Exhibit 122, p. 0668, Transcript pp. 207, 208].

23. Flotation costs may vary according to bond rating. [Transcript p. 202]. Flotation cost information varies from year to year and is available in Public Utility Tracker. [Transcript p. 202]. Flotation costs vary with industry. [Transcript p. 202]. The percentage of flotation costs to the total acquisition costs varies with the size of the initial stock offering and the market cost of capital. [Transcript p. 291]. The risk of the company can affect the flotation costs. [Transcript p. 317]. The larger the offering the smaller the percentage of expenses. Business Financial Management, Cooley and Roden, 1988. [WIC Exhibit 132, pp. 0764-0765].

24. An Interstate Natural Gas Pipeline Industry 1998 Cost of Capital Study prepared by Tom Tegarden included an adjustment to the cost of capital to include flotation costs. Mr. Tegarden is an MAI, the highest appraisal designation offered by the IAAO, and teaches the appraisal of public utility property tax course at Wichita and the course presented by the DOR. [Transcript pp. 47-49, WIC Exhibit 110]. Mr. Tegarden states in his study: "Many studies have been made regarding the amount of flotation costs for debt and equity capital. All of these studies essentially reach the conclusion that a flotation cost adjustment must be made when estimating the cost of capital." [WIC Exhibit 110 p. 0179].

25. The adjustment for flotation costs is a relatively new concept. Dr. Davis did not start adjusting for flotation costs until 1996. [Transcript p. 229]. The idea was controversial in the 1970's and 1980's but is now widely accepted in the financial area. [Transcript p. 267]. The costs must be earned otherwise it would be impossible for investors to earn the cost of equity even if the investment were from retained earnings because retained earnings are generated by the original issuance of stock and debt. [Transcript p. 268; Exhibit WIC 142, p. 0949]. Flotation costs for debt should be reduced for the tax shelter provided when adjusting the capitalization rate for flotation costs. [Transcript pp. 109, 270].

26. The DOR rules have not changed since 1993. [Transcript p. 344]. Since the rules have not changed but the concept of adjusting the capitalization rate has been accepted since the adoption of the rules, it would be logical the rules of the DOR do not address the issue.

27. When the band of investment method is used to value property the assumption is that the "typical buyer" will issue stock and debt in the same proportion to the company owning the property, therefore the "typical buyer" for market valuation will not purchase the company using retained earnings but by issuing stocks, debt and preferred stocks. [Transcript p. 201]

28. The DOR assumed the typical buyer would finance the purchase of WIC because they assumed the buyer would have a 36 percent debt, 63 percent equity and 1 percent preferred stock. [Transcript pp. 232, 289].

29. To estimate market value the appraiser must be certain that all data and assumptions used are market oriented. The market includes flotation costs. [Transcript p. 232; WIC Exhibit 122, p. 0667].

30. We find persuasive the financial textbooks and materials that support the inclusion of flotation costs in the cost of capital as necessary to achieve a total cost of capital and therefore a close estimate of fair market value of the subject property.

31. A total cost of capital must compensate the buyer for opportunities missed and risks taken. [WIC Exhibit 122, p. 0668]. Moreover, the costs associated with each of the financing tools of debt, common equity and preferred stock, must be sufficient to attract a buyer and be typical of the market. To accomplish these goals, the rates used in the cost of capital must provide the buyer with complete recovery of the buyer's full investment. That is, the buyer must have a return of his investment (recovery of the amount invested) and a return on his investment (a profit or return on the amount invested). To ensure that the rates in the cost of capital provide a complete recovery, an appraiser must determine all of the costs -- including flotation costs -- associated with each type of financing typically used in the capital structure. The flotation costs must be included in the return of and return on the investment or the investor will not be made whole and achieve the desired return. [Transcript pp. 133-142; WIC Exhibits 165, 167, 184]. To determine a total cost of capital an appraiser must determine all of the costs associated with each type of financing used in the capital structure.

32. We find that an appraiser must consider flotation costs when deriving the capitalization rate in the band of investment income methodology to estimate value.

33. Instead of developing a total cost of capital, the DOR developed a partial cost of capital that failed to include flotation costs. The DOR considered only the market costs of debt, common equity, and preferred stock, by reviewing such published sources as Moody's, Standard & Poor's, and The ValueLine Investment Survey. The DOR's partial cost of capital was 10.75%. [Transcript pp. 131-133].

34. The DOR, in its 1999 cost of capital study for the gas pipeline industry, said the reason it did not make a flotation cost adjustment to its cost of capital was "because data was not readily available." [Transcript pp. 189-190, 226; WIC Exhibit 104 p. 0063]. This may be accurate. However, "The Public Utility Financing Tracker" costs $350 per year for a subscription and may contain sufficient information to develop flotation costs for the industries for which the DOR develops capitalization rates. [Transcript pp. 273-276; WIC Exhibit 151].

35. There was testimony regarding how other states that value utility property using unitary valuations are dealing with flotation costs. Some states make an adjustment for flotation costs, some states do not and the issue is under active litigation in other states. [Transcript pp. 76-77, 378-381, 422-426; WIC Exhibits 190 and 191]. We make no findings regarding the litigation in other states.

36. We do not find Dr. Gaske's study persuasive. [WIC Exhibits 127, 128, 129(b)]. These studies included electric companies that may have a different risk than gas distribution utilities. The studies may have included different bond rated companies than WIC, and the stock offering would have been a different size than a buyer would require for WIC. [Transcript pp. 316-317, 321]. The study was ten years in span and during this time the Federal Energy Regulatroy Commission, the regulatory agency of WIC, made a substantial change in regulations that Dr. Gaske and this SBOE found may change the risk for WIC. [Transcript pp. 319, 410]. The study should have been filtered for such influences. Because Dr. Davis' study and recommendation was derived from the flawed data of Dr. Gaske, the SBOE is unable to endorse Dr. Davis' calculations.

37. We agree that the development of a capitalization rate is an art and not a science. [Transcript pp. 338, 355, 356]. However, we believe that to the best of an appraiser's ability, all market influences should be included in the capitalization rate development. [Transcript pp. 374, 375]. It appears information is available to develop flotation costs for like industries with like bond ratings and such information should be used to develop a capitalization rate.

CONCLUSIONS OF LAW

38. Petitioner's notice of appeal was timely and the SBOE has jurisdiction to decide this matter.

39. Petitioner has the burden of going forward and the ultimate burden of persuasion. See, Rules, Wyoming State Board of Equalization Chapter 2, 19, which provide:

Except as specifically provided by law or in this section, the Petitioner shall have the burden of going forward and the ultimate burden of persuasion, which burden shall be met by a preponderance of the evidence. If petitioner provides sufficient evidence to suggest the Department determination is incorrect, the burden shifts to the Department to defend its action. For all cases involving a claim for exemption, the Petitioner shall clearly establish the facts supporting an exemption. In proceedings involving the question of whether or not there is a taxable event under Wyoming law, the Petitioner shall have the burden of going forward and the Department shall have the ultimate burden of persuasion.

40. The DOR's appraisal is presumed valid if determined in accordance with applicable statutes, rules, regulations and other directives developed under public scrutiny. Basin Elec. Power Coop. v. Department of Revenue, 970 P.2d 841, 851 (Wyo. 1998).

41. Gas utility companies are assessed by the DOR in accordance with Wyo. Stat. 39-13-102(m)(vii) at fair market value.

42. Capitalization rates are to be developed using the Band of Investment method in accordance with Rules, Department of Revenue, Chapter 7, 7(a)(i). This rule does not address an adjustment for flotation costs.

43. The presumption of validity is rebuttable and may be overcome by sufficient credible evidence that is more than a mere difference of opinion. Basin at 851, citing Teton Valley Ranch v. State Bd. of Equalization, 735 P.2d 107 (Wyo. 1987). We conclude that WIC has presented sufficient credible evidence to overcome the presumption. Once WIC presented the requisite credible evidence to overcome the initial presumption of validity in favor of the DOR valuation, the SBOE is required to equally weigh the evidence of all parties measured against the appropriate burden of proof. Basin at 851.

44. WIC as the party challenging the DOR's valuation has the "ultimate burden of persuasion to prove by a preponderance of evidence that the DOR's value was not derived in compliance with the required constitutional and statutory methodology standard for valuing a state-assessed property." Basin at 851.

45. The Wyoming Supreme Court, in at least eleven decisions, has consistently interpreted Wyo. Const. Article 15, 11 to mandate "only a rational method [of appraisal], equally applied to all property, which results in essential fairness." Basin Elec. Power Coop. v. Department of Revenue, 970 P.2d 841, 851 (Wyo. 1998); citing Holly Sugar v. State Board of Equalization, 839 P.2d 959, 963 (Wyo. 1992) quoting Teton Valley Ranch v. State Board of Equalization, 735 P.2d 107, 115 (Wyo. 1987). WIC, as the party challenging the DOR valuation, must prove by a preponderance of evidence at least one of the elements of the standard has not been fulfilled. Basin at 852.

46. Under Wyoming law, all taxable property is to be valued annually at its fair market value. Fair market value is defined as:

The amount in cash, or terms reasonably equivalent to cash, a well informed buyer is justified in paying for a property and well informed seller is justified in accepting, assuming neither party to the transaction is acting under undue compulsion, and assuming the property has been offered in the open market for a reasonable time...

Wyo. Stat. 39-11-101(a)(vi).

Wyoming law requires fair market value to be determined by using generally accepted appraisal standards. Wyo. Stat. 39-13-103(b)(ii) (1999).

47. We conclude that it is appropriate to define generally accepted appraisal standards as set forth in Finding of Fact No. 17. There does not appear to be a disagreement between WIC's experts and the DOR over the meaning of this phrase. We agree that it is an evolutionary concept and as appraisal theories are propounded, tested in the real world and adopted, they become incorporated into generally accepted appraisal standards.

48. We conclude that generally accepted appraisal standards require the costs of equity, preferred stock and debt be adjusted for flotation costs. We find support for this conclusion from the testimony of the two experts, Dr. Gaske and Dr. Davis, the many learned treatises and the treatment of financing costs by the other cost of capital studies. The authorities are uniform and unanimous in their conclusion that flotation costs are incurred whenever there are new issues of debt or equity. The simple examples presented by WIC as supported by the statements in the learned treatises all demonstrate that flotation costs are real and quantifiable. Mr. Tegarden's statements in his cost of capital studies are a sound summary of the recognition in the appraisal field that flotation costs are a necessary adjustment in all appraisals. [WIC Exhibit 110 p. 0179].

49. Our conclusion that flotation costs are a necessary component of the determination of the costs of debt and equity also finds support in the appraisal literature, expert testimony and the DOR's own practices that reflect the necessity to determine a total cost of capital in the income approach. All investors expect a return of and on their investment, an economic concept that is fundamental to the income approach and not disputed by the DOR. [WIC Exhibit 180 p. 1252]. If flotation costs are not included in this calculation, only a partial cost of capital is determined because the costs of financing are not being fully recovered. Such a partial cost of capital is not consistent with appraisal theory nor the rules of the DOR. Rules, Wyoming Department of Revenue Chapter 7, 7.

50. The DOR's chief witness, Mr. Uhrich, begrudgingly acknowledged that flotation costs such as brokerage fees, registration fees, accounting fees, legal fees, and loan origination fees are expenses of doing business and should be recognized in determining the costs of capital. [Transcript p. 371] He testified, however, that flotation costs are already accounted for because the DOR uses market data to develop its costs of debt and equity. The sum total of evidence on the record concerning the DOR's justification for not considering flotation costs as relevant to developing a company's capital structure within the band of investment method is contained in the following exchange between WIC's attorney and Mr. Uhrich:

Q. Why do you use the marketplace - - I think the terminology is the primary market with brokers and other issuers of stock?

A. Well, the primary market, as we've listened for a day and a half, is that area where there is a great deal of negotiation, discussion, preparation of issuance of shares of stock or shares of debt that are influenced by other things outside of the buyers' and sellers' arena. There are a lot of negotiated things as to what are those costs, what are the additional things.

You go to the secondary market because that's where you actually find the buyers and the sellers of shares of stock, shares of debt, the financial instruments that are actually being publicly traded on a daily basis.

Q. How do you - - you heard the testimony here that, well, the secondary market doesn't take into consideration these financing costs. What's your response to that?

A. Well. The primary market does not deal with buyers and sellers. It's an establishment of an issue. It doesn't deal with what buyers and sellers deal with. What they want is a return on and return of their investment, which is publicly traded and financial information you readily find by picking up a Wall Street Journal that's been referenced here a number of times.

Q. You actually feel, then, that the secondary market gives you a true representation of the actual values in the marketplace?

A. Yes.

[Transcript p. 346]

Other than Mr. Uhrich's testimony set forth above, the DOR offered no support for their position that flotation costs are recognized when the DOR utilized the secondary-market data to develop its costs of debt and equity. No appraisal or financial treatises were offered in support of this view. There is no discussion of it in the Appraisal of Real Estate text. It is not addressed in the Uniform Standards of Professional Appraisal Practices (USPAP). Finally, no other expert witnesses besides Mr. Uhrich testified in support of this conclusion.

51. When the DOR selects its market costs for debt, common equity, and preferred stock from secondary-market data reported, it must go further to adjust the costs of capital to recognize the impact of flotation costs. The DOR erred by not making the further adjustment for flotation costs, particularly when information is readily available to determine flotation costs.

52. Applying the standards from the Basin case, we conclude that the appraisal methods used by the DOR are not a rational method and do not result in essential fairness. Given our conclusion that generally accepted appraisal standards require that capitalization rates be adjusted for flotation costs, we conclude that the method used by the DOR to value WIC is not in conformance with Wyoming law. It is, therefore, not a rational method that can be applied to WIC. The method also fails to result in essential fairness, since it does not comport with Wyoming law and overvalues WIC.

53. However, the SBOE is not satisfied that WIC presented sufficient evidence to determine what are the proper flotation costs for the natural gas pipeline industry. As was previously noted above in Finding of Fact No. 36, Dr. Gaske's study included other types of utilities such as electric utilities which may have different risk factors than the gas pipeline industry. In addition, the study included companies with bond ratings different than WIC and undoubtedly contained stock offerings that were substantially different in size than would be required for WIC. Finally, Dr. Gaske's study was over a span of ten years and may well have been influenced by significant changes in FERC regulations during the years in question. But there was evidence on the record that data is available in the primary markets to determine if a flotation cost adjustment is appropriate. By this decision the SBOE is not attempting to substitute its judgment for that of the DOR. Rather we are saying that if sufficient, statistically-relevant data exists for the appraiser to recognize the influence of flotation costs on the cost of capital, he must use that information in the exercise of his appraiser judgment.

54. The evidence of how other states treat flotation costs played no role in our decision. Our decision is based on our interpretation of Wyoming law and is not affected by the actions of other states applying their own laws.

55. The DOR should study flotation costs in the primary markets and consider their effect when developing capitalization rates. There was simply no evidence in this hearing to suggest that the secondary market contains an adjustment for flotation costs.

ORDER

IT IS THEREFORE HEREBY ORDERED:

The valuation of the Petitioner is remanded to the DOR to perform a study of like properties to determine if an adjustment for flotation costs can be made when calculating the capitalization costs. The valuation of the DOR is reversed and remanded for recalculation.

THIS SPACE INTENTIONALLY LEFT BLANK

Pursuant to Wyo. Stat. 16-3-114 and Rule 12, Wyoming rules of Appellate Procedure, any person aggrieved or adversely affected in fact by this decision may seek judicial review in the appropriate district court by filing a petition for review within 30 days of the date of this decision.

Dated this 28^th day of February, 2001.

STATE BOARD OF EQUALIZATION

Edmund J. Schmidt, Chairman

Roberta A. Coates, Vice-Chairman

ATTEST:

Wendy J. Soto, Executive Secretary