Competitive Implications of Forbearance Petitions and the Special Access Debate

1. Competitive Implications of Forbearance Petitions and the Special Access Debate Presented to NARUC Staff Subcommittee on Accounting and Finance October 14, 2008 Peter Bluhm Director, Telecommunications Research and Policy National Regulatory Research Institute

2. Forbearance statute – part 1 SEC. 10. [47 U.S.C. 160] COMPETITION IN PROVISION OF TELECOMMUNICATIONS SERVICE. (a) Regulatory flexibility.--Notwithstanding section 332(c)(1)(A) of this Act, the Commission shall forbear from applying any regulation or any provision of this Act to a telecommunications carrier or telecommunications service, or class of telecommunications carriers or telecommunications services, in any or some of its or their geographic markets, if the Commission determines that-- (1) enforcement of such regulation or provision is not necessary to ensure that the charges, practices, classifications, or regulations by, for, or in connection with that telecommunications carrier or telecommunications service are just and reasonable and are not unjustly or unreasonably discriminatory; (2) enforcement of such regulation or provision is not necessary for the protection of consumers; and (3) forbearance from applying such provision or regulation is consistent with the public interest. NRRI

3. Forbearance statute – part 2 47 U.S.C. § 160 cont. (b) Competitive Effect To Be Weighed.--In making the determination under subsection (a)(3), the Commission shall consider whether forbearance from enforcing the provision or regulation will promote competitive market conditions, including the extent to which such forbearance will enhance competition among providers of telecommunications services. If the Commission determines that such forbearance will promote competition among providers of telecommunications services, that determination may be the basis for a Commission finding that forbearance is in the public interest. * * * * (e) State Enforcement After Commission Forbearance.--A State commission may not continue to apply or enforce any provision of this Act that the Commission has determined to forbear from applying under subsection (a). NRRI

4. Species of forbearance - preview • Forbearance adds a new question to traditional legal analysis of utility regulation. Now the questions are: • What is the business activity? • Does government have authority to affect the activity? • Has government’s authority been limited by preemption? • Has government’s authority been limited by forbearance? • Four species (at least) of forbearance: • Competitive duties - § 251 • Federal regulation of non-special access broadband • Cost allocations • ARMIS reporting NRRI

5. Species # 1 – Interconnection duties • Qwest-Omaha (Dec. 2005) - FCC decides to forbear from imposing on Qwest: • Some “dominant carrier regulations” for interstate mass markets. • price cap, rate of return, tariffing, and 60-day discontinuance regulations for interstate mass market exchange access services and mass market broadband Internet access services. ¶ 15. • UNE loops and dedicated transport • “limited to portions of its Omaha MSA service territory where a facilities-based competitor has substantially built out its network.” ¶ 2. • FCC did market analysis at small geographic scale. • 20 FCC Rcd 1945 NRRI

6. Species #2 - Broadband forbearance • Verizon • forbear from applying Title II of the Act and the Computer Inquiry rules to its broadband services • Granted by lapse of time on March 20, 2006. • Other carriers • AT&T, Embarq, Frontier (2007) • Qwest (August, 2008) NRRI

7. Qwest broadband forbearance • Forbearance from dominant carrier tariff filing, cost support, discontinuance, and domestic transfer of control rules, and certain Computer Inquiry requirements, • Applies to existing non-TDM-based, packet-switched services capable of transmitting 200 kilobits per second (kbps) or greater in each direction. Also applies to existing non-TDM-based, optical transmission services. • Includes, e.g. Frame Relay, ATM, Virtual Private Network (VPN), Local Area Network (LAN), Ethernet-Based services, Video Transmission services, Optical Network services, and Wave-Based services. • Excludes all TDM-based DS1 and DS3 services NRRI

8. Species #3 - Cost Assignment • FCC granted AT&T forbearance from cost assignment rules, with conditions. April, 2008. • FCC found AT&T satisfied all three statutory tests for forbearance: • Absent rules, rates would not be unjust, unreasonable or discriminatory. • Absent rules, there is no harm to consumers. • Forbearance is in the public interest. • Scope is one statute, plus rules from Parts 32, 25, 64 and 69. NRRI

9. Conditions • AT&T must provide accounting data on request by the FCC. ¶ 21. • AT&T must implement a method of preserving the integrity – for both costs and revenues – of its accounting system . . . to ensure that if FCC in the future makes a request for accounting data the result will be reliable. • Compliance plan must be filed. • Wireline Competition Bureau must approve plan. NRRI

10. Rationale - Just, reasonable and nondiscriminatory rates • Regulation has moved from rate of return to price caps. • FCC “no longer routinely need[s] the accounting data derived from the Cost Assignment Rules for rate regulation functions.” ¶ 17, 19. • Earnings sharing (high-end adjustment) eliminated in 1997. • No productivity factor currently used (since CALLS). ¶ 19. • Pricing flexibility relief has “generally” eliminated applicability of low-end adjustment mechanism. ¶ 19. • “[F]lourishing competition increasingly constrains prices. ¶ 18. NRRI

11. Rationale - Protection of Consumers • The Cost Assignment Rules impose costs that outweigh their benefits. • Rules distort the market “by diverting AT&T resources that would otherwise be directed to positive activities that generate consumer benefit.” • Rules “could negatively affect innovation, efficiency and competitiveness” of services provided to consumers.” ¶ 36. NRRI

12. Rationale - Public Interest • Forbearance “will promote competitive market conditions and enhance competition as contemplated by section 10(b) and that forbearance is in the public interest.” ¶ 39, 44. • Less spent on compliance with “unnecessary regulations to which its nondominant competitors are not subject.” • More capital for investments.” ¶ 41. • Faster introduction of new products. No longer need to analyze new products for 6 months before introduction. NRRI

13. Scope - Rules affected • Section 220(a)(2) of the Act (to a limited extent) • Rules: • Section 32.23 (nonregulated activities) • Section 32.27 (transactions with affiliates) • Part 64, Subpart I (allocation of costs); • Part 36 (jurisdictional separations); • Part 69, Subparts D and E (cost apportionment); NRRI

14. Cost Assignment Forbearance - Companies affected • AT&T and BellSouth – April 24, 2008 Order • Verizon and Qwest – September, 2008 Order NRRI

15. Effects on interstate rates • “AT&T will remain subject to dominant carrier regulation of its interstate exchange access services, including price cap regulation of most exchange access services.” ¶ 14, 18. • “BOCs are not subject to price cap regulation for (1) the exchange access services for which they have been granted phase II pricing flexibility; and (2) certain of their services that are provided pursuant to rate-of-return regulation.” Note 50. NRRI

16. Effects on enforcement • “Complaints under section 208 will remain an important mechanism for enforcing the provisions of the Act, including the justness and reasonableness of special access rates.” NRRI

17. Effects on accounting • AT&T generally will continue to maintain its USOA accounts according to FCC rules. ¶ 23. • AT&T will still be able to provide a jurisdictional breakdown of its revenues. ¶ 21. • AT&T will have “flexibility to adapt its accounting procedures to changing market conditions in its region, while still ensuring that consumers are protected from unjust, unreasonable, and unjustly or unreasonably discriminatory rates.” ¶ 23. • “AT&T is subject to Generally Accepted Accounting Principles (GAAP) for its financial accounting.“ ¶ 23. NRRI

18. Interaction with other FCC dockets • Parties had argued that cost assignment data could be useful in pending rulemaking proceedings, including universal service, intercarrier compensation and special access. • “We do not deny that cost accounting data could be useful when the Commission moves forward with these and other comprehensive reform proposals. . . . [D]epending on the approach adopted by the Commission, these data may not be relevant to adopted reforms at all. We believe that the Commission’s possible need for this information in a proceeding at some future point is speculative.” ¶ 45. NRRI

19. Interaction with § 272(e)(3) • Section 272(e)(3) is an imputation requirement. Protects non-competitive service rates. • FCC previously directed each BOC to continue to impute to itself its highest tariffed rate for access, including access provided over joint-use facilities • No forbearance from imputation obligation. NRRI

20. Interaction with § 254(k) • Section 254(k) prohibits a telecommunications carrier from using services that are not competitive to subsidize services that are subject to competition. • “[W]e do not forbear from section 254(k) of the Act. . . . AT&T remains subject to section 254(k) itself. We, therefore, condition the forbearance granted here on annual certification by AT&T that it will comply with its obligations under section 254(k) in the absence of the Cost Assignment Rules, and will maintain and provide any requested cost accounting information necessary to prove such compliance.” ¶ 30. NRRI

21. Interaction with separations comprehensive reform • State members filed a letter arguing against “piecemeal forbearance decisions that would overthrow existing separations procedures.” Suggested waiting for broader rulemaking. • When FCC has before it a forbearance petition, it held that it has no “leeway to choose our procedural vehicle and the timing of resolution outside the limitations of [the forbearance statute]” ¶ 13. NRRI

22. Data not needed for separations • Smith v. Illinois Bell was a 1930 Supreme Court case held that where a telephone company claims that state rates are so low as to be confiscatory, the company must show that its earnings calculations exclude the value of property attributable to interstate services. • Smith doesn’tprevent granting forbearance. ¶ 25. • “[J]urisdictional separations . . . have reduced significance under price caps because “price cap regulation reduces a BOC’s incentives to allocate costs improperly.” Indeed, the Commission has acknowledged that statutory, regulatory, and market changes since Smith v. Illinois Bell may have eliminated the need for federal separations rules generally.” ¶ 25. • State need for separations data can still be met. • “We believe that AT&T, working cooperatively with the state commissions in its region, can develop methods of separating costs, satisfying any remaining need states have for jurisdictional separations information. ¶ 25. NRRI

23. State needs for cost data • “Commenters disagree on the extent to which states rely on the data produced by our Cost Assignment Rules for intrastate rate regulation and other state regulatory purposes. . . . We need not resolve this factual dispute.” • The FCC does “not have authority . . . to maintain federal regulatory requirements that meet the three-prong forbearance test with regard to interstate services in order to maintain regulatory burdens that may produce information helpful to state commissions for intrastate regulatory purposes solely.” ¶ 33. NRRI

24. State authority unaffected • “[S]tate commissions may exercise their own state authority to conduct their rate and other regulation as permitted under state law. We emphasize that we do not in this Order preempt any state accounting requirements adopted under state authority.” ¶ 33. • “AT&T has committed to work with the state commissions in its in-region territory to address state needs. . . . In addition, AT&T states that total company cost information will remain readily available if needed for valid regulatory purposes. Further, AT&T explained that, because its petitions affect cost accounting data only, AT&T will continue to provide intrastate revenue data to any state commission in its territory as needed. Thus, we expect that states will be able to obtain from AT&T all cost accounting information needed for state regulatory purposes following our forbearance from the Cost Assignment Rules.” ¶ 34. NRRI

25. Dissent by Copps and Adelstein • Rules needed to ensure that telecommunications services are offered on rates, terms and conditions that are just, reasonable and not unjustly or unreasonably discriminatory. • These rules are needed for in-region long distance service. • These rules are needed for intercarrier compensation and universal service. • States rely on this data. • “Petitioners have not offered any alternative—other than a “trust us” approach—for ensuring that the public interest is protected.” • “[M]ore transparency and increased accountability to facilitate more effective federal and state oversight must be critical parts of any plan to put the country’s economy on a sounder footing. Now is not the time to permit the Petitioners and those that follow them—who all play an enormous role in our economy—to shut their books and assume that’s all they need to do.” NRRI

26. AT&T’s Compliance Plan • Filed July, 2008 • Section 272 obligations regarding long distance affiliate transactions • Explicit billing will continue with affiliates. • Affiliates will still pay tariffed or approved contract prices in most cases. • AT&T will impute costs if “an AT&T ILEC provisions in-region interLATA using access to its telephone exchange service or exchange access.” p.7. • Annual certification of 254(k) compliance. • Will maintain some accounting procedures. • Including most recent CAM ratios in case needed for future reporting (AT&T reserves right to revise ratios). P. 12. NRRI

27. Species #4 - Service quality and facilities reporting to ARMIS • AT&T ARMIS petition • Granted Sept, 2008 (FCC 08-203) • Also applies to other ARMIS-filing carriers who will promise to continue filing 43-05 and 43-06 for two more years. ¶ 12. NRRI

28. ARMIS - background • ARMIS was created in 1990 as part of price caps. • Intended “to monitor two potential concerns raised by price cap regulation: first, that carriers might lower quality of service, instead of being more productive, in order to increase short term profits; and second, that carriers might not spend money on infrastructure development.” ¶ 2. • ARMIS reports were “safety nets” that would “provide the Commission and the states with information to determine whether the Commission’s and the states’ regulatory goals concerning quality of service were being met.” ¶ 2. NRRI

29. Holding and Transition • ARMIS service quality and infrastructure reports eliminated. • Report 43-05 Service Quality; • Report 43-06 Customer Satisfaction; • Report 43-07 Infrastructure; and • Report 43-08 Operating Data • FCC held that these reports are not needed to ensure rates are just and reasonable nor unduly discriminatory. ¶ 8. • But, forbearance on 43-05 and 43-06 delayed effect for 2 years. • All ARMIS carriers filed letters saying they would continue filing 43-05 and 43-06 for two more years, through September, 2010. NRRI

30. Protection of consumers 1. FCC has no use for this ARMIS data. • Smaller ILECs and non-ILECs don’t file the data. ¶ 11. • Larger companies file the data, but they are not subject to any federal service quality rules. The FCC originally deferred to the states on this subject. • NB: If the FCC doesn’t have a current use for industry data, this seems a precedent that it must grant a request to forbear from reporting on that subject. 2. Data are not comprehensive, and don’t apply to all providers in the market. Without this, consumers cannot make “truly informed choices.” ¶ 12. NRRI

31. State need for ARMIS data 1. FCC held that it cannot deny a forbearance petition where the regulation involved solely benefits the states. ¶ 9. • Same rule applies to state ratemaking (¶ 9) and state consumer protection activities. (¶ 14). • “Interest by state commissions or other groups in comparing intrastate service quality between states, or within a state between carriers, does not create a federal need.” ¶ 14. 2. States “remainfree to adopt their own reporting requirements and service quality standards, as many already have done today.” ¶ 13. • Nothing in FCC order “prevents state commissions from exercising their state authority to seek any relevant information, or from standardizing their data collections with each other.” ¶ 14. NRRI

32. Overall, what’s missing? • Financial • Part 64 and other controls on nonregulated activity • Separations • Some service quality • Some consumer satisfaction • Some infrastructure NRRI

33. What Does This Mean To the States? • No preemption, but no help either. • If states decide they will need cost assignments or service quality reports, perhaps they should act collectively. • Reduce carrier cost. • Increase value of data. • States may have new freedoms. • Effect on separations uncertain. • States may have fewer restrictions on how they perform separations when setting large carrier rates. • States may have few or no restrictions on what investment, expenses and revenues they assign to nonregulated. NRRI

34. The Special Access Debate

35. NARUC Resolution of Feb. 2007 • NARUC directed the Committee on Telecommunications, Federal Regulatory Subcommittee, to “examine the competitive issues involving special access in selected markets.” • Resolution mentioned that special access is a key input for business customers and for other telecom carriers, including wireless and IXCs. • Resolution recited that NARUC has had a • “long-standing interest in ensuring that sufficient competition exists in local exchange markets so that market-based rates can apply to wholesale services such as special access, and where competition is judged not to be sufficient, regulatory policies should be adopted that prevent dominant carriers with excessive market power from operating in a manner that harms competition.” NRRI

36. FCC Regulation of Special Access • Around 1990, FCC began setting rates using price caps. • Starting in 2001, FCC granted pricing flexibility on the basis of a proxy measure of competition. • Sellers can increase rates in areas with “Phase II” pricing flexibility. • The proxy criteria for Phase II are complex. Decisions are made by MSA. The triggers are based on the number of wire centers with signficant collocation in the MSA. The standard for “channel terminations” (loops) is different than for “transport” (interoffice transport). • FCC started a docket in 2005; refreshed the record in 2007. NRRI

37. GAO Report – Nov. 2006 • Concluded that in 16 major metropolitan areas, • facilities-based competition for dedicated access services exists in a relatively small subset of buildings. • The FCC needs to improve its data collection and analysis in order to determine the true extent of competition in special access markets. NRRI

38. NARUC project history • Began work in spring of 2007 • Focused on 50 largest MSAs. • Survey of purchasing data sent to buyers. • Asked about volumes of purchases, prices. • Five buyers responded. • Survey also sent to sellers. • One RBOC responded with data. • Survey results disappointing • Quality varied. E.g. One wireless carrier sent no pricing • Some questions turned out to be ambiguous. NRRI

39. NRRI Contract • Formed contract in April, 2008 • NRRI’s task: • Do existing data provides an adequate basis to determine whether ILECs have market power over wholesale point-to-point services in some or all areas? • If so, are ILECs are using that market power to increase prices above competitive levels, particularly in areas subject to maximum (Phase II) FCC regulatory flexibility? NRRI

40. Data survey • NRRI undertook a new data collection in 2008. • The original data deadline was Sept. 26. Data still coming in. Likely to receive data from 4 buyers and 1 seller. • Data so far suggest a continuing heavy reliance of wireless carriers and CLECs on RBOC-provided DS-1 and DS-3 circuits. • The big task is to interpret why. • Buyers are also objecting to terms in some discount contracts. NRRI