Petitioners Brief — Verizon Communications Inc. v. Federal Communications Commission

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IN THE APR

Supreme Court of the United States

OCTOBER TERM, 2000 ! OFFICE OF THE CLERK

,&.

VERIZON COMMUNICATIONS INC., ET AL.,*

Petitioners,

Vv.

FEDERAL COMMUNICATIONS COMMISSION AND THE

UNITED STATES OF AMERICA,

Respondents.

On Writ of Certiorari to the

United States Court of Appeals

for the Eighth Circuit

BRIEF FOR PETITIONERS

MARK L. EVANS

MICHAEL K. KELLOGG

HENK BRANDS

KELLOGG, HUBER, HANSEN,

TODD & EVANS, P.L.L.C.

1650 M Street, N.W.

Washington, D.C. 20036

(202) 326-7900

Counsel for

BellSouth Corporation,

SBC Communications Inc.,

United States Telecom

Association, and Verizon

Entities

CHARLES R. MORGAN

JAMES G. HARRALSON

BELLSOUTH CORPORATION

1155 Peachtree Street, N.E.

Atlanta, GA 30309

(404) 249-2641

Counsel for

BellSouth Corporation

April 9, 2001

Oo is set

WILLIAM P. BARR

M. EDWARD WHELAN

VERIZON

1850 M Street, N.W.

Washington, D.C. 20036

(202) 463-5200

PATRICK F. PHILBIN

Counsel of Record

JENNIFER R. BROSNAHAN

KIRKLAND & ELLIS

655 Fifteenth Street, N.W.

Washington, D.C. 20005

(202) 879-5000

MICHAEL E. GLOVER

VERIZON

1320 N. Courthouse Rd.

Arlington, VA 22201

(703) 974-2944

Counsel for Verizon Entities

Additional Counsel Listed on Inside Cover

° p. il.

ANDREW G. MCBRIDE JAMES D. ELLIS

SCOTT DELACOURT PAUL K. MANCINI

WILEY, REIN & FIELDING SBC COMMUNICATIONS INC.

1776 K Street, N.W. 175 E. Houston

Washington, D.C. 20006 San Antonio, TX 78205

(202) 719-7135 (210) 351-3500

HENRY WEISSMANN ROGER K. TOPPINS

MUNGER, TOLLES & GARY PHILLIPS

OLSON LLP SBC COMMUNICATIONS INC.

355 South Grand Avenue 1401 Eye Street, N.W.

Los Angeles, CA 90071 Suite 1100

(213) 683-9100 Washington, D.C. 20005

(202) 326-8891

Counsel for Verizon Entities

Counsel for

SBC Communications Inc.

LAWRENCE E. SARJEANT

LINDA L. KENT

KEITH TOWNSEND

JOHN W. HUNTER

JULIE E. RONES

UNITED STATES TELECOM

ASSOCIATION

1401 H Street, N.W.

Suite 600

Washington, D.C. 20005

(202) 326-7371

Counsel for United States

Telecom Association

QUESTION PRESENTED

Whether the court of appeals erred in holding that neither the

Takings Clause nor the Telecommunications Act of 1996

requires incorporation of an incumbent local exchange carrier’s

“historical” costs into the rates that it may charge new entrants

for access to its network elements.

Am we

LIST OF PARTIES AND RULE 29.6 STATEMENT

The Petitioners in this Court are:

Verizon Entities, consisting of:

Verizon Communications Inc.

GTE Service Corporation

GTE Alaska Incorporated

GTE Arkansas Incorporated

Verizon California Inc. (f/k/a GTE California Incorporated)

Verizon Florida Inc. (f/k/a GTE Florida Incorporated)

GTE Midwest Incorporated

Verizon South Inc. (f/k/a GTE South Incorporated)

GTE Southwest Incorporated

Verizon North Inc. (f/k/a GTE North Incorporated)

Verizon Northwest Inc. (f/k/a GTE Northwest Incorporated)

Verizon Hawaii Inc. (f/k/a GTE Hawaiian

Telephone Company Incorporated)

Verizon West Coast Inc. (f/k/a GTE West Coast Incorporated)

Contel of Minnesota, Inc.

Contel of the South, Inc.

BellSouth Corporation

SBC Communications Inc.

United States Telecom Association

The parties to the proceedings in the Eighth Circuit are listed

in the caption of the decision below, see Appendix A to the

Petition for Writ of Certiorari, and in Appendix F to the

Petition for a Writ of Certiorari.

Pursuant to Supreme Court Rule 29.6, Petitioners state as

follows:

On June 30, 2000, GTE Corporation and Bell Atlantic

Corporation closed their merger, and Bell Atlantic Corporation

subsequently changed its name to Verizon Communications

Inc. Verizon Communications Inc. is the ultimate parent of

each of the other Verizon Entities listed above. No publicly

ili

owned company owns 10% or more of the stock of Verizon

SBC Communications Inc. has no parent company, and no

publicly owned company owns more than 10% of its stock.

BellSouth Corporation has no parent company, and no

publicly owned company owns more than 10% of its stock.

TABLE OF CONTENTS

Page

QUESTION PRESENTED .............0.0.0cceeeee i

LIST OF PARTIES AND RULE 29.6 STATEMENT .... ii

TABLE OF CONTENTS ...............0.ceceeeeee iv

TABLE OF AUTHORITIES ................0.0005. vi

TT ceeauads l

OPINIONS AND ORDERS BELOW ................. 1

RE ee 2

PERTINENT CONSTITUTIONAL AND

STATUTORY PROVISIONS ............0.0.0000. 2

hae Se a 2

A. The Regulatory Background Prior to 1996 ........ 2

B. The Telecommunications Act of 1996 ........... 5

C. The FCC’s Local Competition Order ............ 8

I a a 14

SUMMARY OF ARGUMENT ................-000- 16

SICA SAE ESTES IES Rk nr 19

I. SECTION 252(d)(1) REQUIRES USE OF

HISTORICAL COSTS FOR NETWORK-

NSE DUNG cecccccceccesccccocccces 19

Il. UNDER CONSTITUTIONAL PRINCIPLES,

SECTION 252 CANNOT BE CONSTRUED TO

GPS REES CREE oc wecccccecccccccseses 23

A. Section 252 Mandates a Pricing Methodology

Designed To Provide Constitutional

RD ccbcdeuseuseeeccoedseeess 24

B. TELRIC Violates Section 252(d)(1) Because It

Shifts Methodologies Without Providing for

Recovery of Past Prudent Investment ....... 26

C. The FCC’s Efforts To Deflect Scrutiny from

1. Under the “total effect” test, TELRIC’s

deficiencies cannot be cured by looking

to revenues earned from ail of an

incumbent’s operations ............... 32

2. TELRIC must be evaluated now as a

final agency action that is contrary to the

ED e\ccundeeddeneseevducssetesdeees 37

D. Section 252(d)(1) Should Be Construed To

Avoid the Serious Constitutional Questions

WEED Sos c cc vseseéecsuseecss 42

Ill. THE FCC’S DECISION TO ABANDON

HISTORICAL COSTS WAS CONTRARY TO

THE PURPOSES OF THE ACT AND

ARBITRARY AND CAPRICIOUS .......... 44

A. Abandoning Historical Costs Frustrated

Congressional Objectives and Was Not

Supported By Any Rational Explanation... . . 44

B. The FCC’s Effort To “Mimic” Competitive

Outcomes Frustrates the Purposes of the Act . 48

GRPCEED cv cccevedsessesesvecceedeeccesees 50

TABLE OF AUTHORITIES

Cases Page(s)

Ashwander v. Tennessee Valley Auth.,

+n ds oc cecnepeesedsedusivewis 42

AT&T Corp. v. Iowa Utils. Bd.,

525 U.S. 366 (1999) ....... 2, 5, 8, 13, 15, 19, 36, 46, 48

cl! Atlantic Tel. Cos. v. FCC,

24 F.3d 1441 (D.C. Cir. 1994) .............0.4.. 25, 44

Bennett v. Spear,

nd edt ace shecueleeenas 21

Brooks-Scanlon Co. v. Railroad Comm'n,

ee eed ecicaiescedeulen 18, 33

Calfarm Ins. Co. v. Deukmejian,

_ gE re ee eC 35

California Dental Ass'n v. FTC,

re cnn coddeededduseneaweentens 21

Chevron U.S.A. Inc. v. Natural Resources

Defense Council, Inc.,

Se ED ocd ckceencceevecsuces 16, 23, 26

Chicago, M. & St. P. Ry. v. Public Utils. Comm'n,

EE «bbb cen edesineveceveeceecens 34

Corning Glass Works v. Brennan,

ET ocd ocutnacccasadececuxctous 20

Duquesne Light Co. v. Barasch,

488 U.S. 299 (1989) ........ 3, 17, 25, 27, 28, 34, 38, 42

Eastern Enters. v. Apfel,

EEE Se eeeceeduncnccescocesess 17, 30

Vii

Federal Power Comm'n v. Hope Natural Gas Co.,

awd Guiedeses sensdbusens 2, 26, 38

Federal Power Comm'n v. Natural Gas Pipeline Co.,

DES UB. SIS (IDEA) . oc cccccccccccccccccceces 24, 38

Gomez v. United States,

ee tite ee ea cee eeceal 18, 42

GTE South Inc. v. Morrison,

oe eed eee ews 41

Gustafson v. Alloyd Co.,

ne eae 23

In re Permian Basin Area Rate Cases,

I OE eee oe 24, 38

Iowa Utils. Bd. v. FCC,

Fe ee 15

. Jersey Cent. Power & Light Co. v. FERC,

Se ee CO is Ge SUED cc cccctccsccccceces 38

Kaiser Aetna v. United States,

ed ee a ee 17, 30

Legal Servs. Corp. v. Velazquez, ,

eee 42

McDermott Int'l, Inc. v. Wilander,

I aa a oe 20

Missouri ex rel. Southwestern Bell Tel. Co. v.

Public Serv. Comm'n,

ee ED bbc snd senecducucduevedoss 3, 45

Monongahela Navigation Co. v. United States,

es ED 86066 4686446604004060K0K00008 26

Motor Vehicle Mfrs. Ass'n v. State Farm Mut.

Auto. Ins. Co.,

es IE o Gad h ud neesdueeeesecsCdeudees 46

ee es

Vill

NLRB v. Catholic Bishop,

6 ee ceed ted decgduus 18, 43

Ohio Bell Tel. Co. v. Public Utils. Comm’n.,

tedden es ass GSN ee kes ie 22

Pennsylvania Coal Co. v. Mahon,

ee ea te ewan ehh ws 27

Phelps v. United States,

IE a ae 25

Presault v. ICC,

ES re Se ee mem err 38

Smith v. Illinois Bell Tel. Co.,

i cece ccuee redone ckeen 18, 34

Solid Waste Agency v. U.S. Army Corps of Eng’rs,

ce ce ouheeden bes 18, 23, 43

United States v. Menasche,

id el Onde aden eile 21

United States v. Riverside Bayview Homes, Inc.,

i be cela eda crates ones 43, 44

United States v. Security Indus. Bank,

ee eee ecu we kneeeteees 17, 43

United States v. Winstar Corp.,

I a aca ca lind deekaedeeesda de 30

USTA v. FCC,

ee ce MI, DEED 50s siecccecéskdeeeceds 3

West v. Chesapeake & Potomac Tel. Co.,

ee econ dae sted 22, 38, 47

Constitutional Provisions and Statutes

Takings Clause, U.S. Const. amend. V ................ 2

EE Cec cbuduadaeetavusddneoubeneiua 2

Pc ccsecvedunwsedddeesessaebounbes 2

EEE SbbeccNsecvensksendunseueeesaseens 2

as IDs dns sc cedcccdducddcsseececencs 6

Dc ci saviuesccaeseducususessees 7

es ac ccknietecndececcnecnaseWeued 6

pe EE 4c ¢abdedndeeasedécuee keke 22, 46

oo ccc deceescednckkadnbudsaeknn 7

EE Sdcbddtwanednddnsesdinkxepeaens 2, 32

SPE Fc dVAdceniadviaeceedsvewcedaens 1}

SP os uhadndndedsskdnddl ccataweses 1]

SP ED cid cdedevdcdcéadidivesasiens 46

47 U.S.C. § 252(d)(1) .. 1, 16, 18-20, 22, 24-26, 40, 42, 50

Sy ee IE o ci diensnadedsscteeaucns 7,21

GF Bis OID 6 6d cc eccccdecccccdace 7, 20, 21

bc cc cndadsvdenwitdasscdences 46

PP ED bb ecdéndedwedaddnendesawdenvenss 6

er es Cs 6 bbddeeuu dackscdecdeuceveuces 8

es ED cctucksudccanstecegecceediess 7

ED aedsdnbkecrocseecasadabeeeeeses 35

EE oa kk hiv beebeedeednedGeseesadas 35

SP EE nddececdsasidedasineesedducdseds 2

ee ee ere ee ey

Regulations

i senea es 40

I I oo ccc cchedihucesncceenssss 2

Administrative Agency Orders

Bottleneck Servs. Establishment of a Framework

for Network Architecture Development

of Dominant Carrier Networks,

Slip Op., R.93-04-003, I.93-04-002,

Dec. 95-12-016, 62 CPUC2d 575

nr ED ioe deen beens esesees eu es 46

Federal-State Joint Board on Universal Service,

Fifth Report & Order,

ps EE « cb oce ceheeeseeebeee 13, 45

Federal-State Joint Board on Universal Service,

Ninth Report & Order,

ee ewe sane Cekedeneus 46

FERC Order No. 888,

GE FG, TRAD, SEO C NEED cc cccccccqecsccccccess 12

In re Access Charge Reform,

eG Ee ee eee 4,12

In re Federal-State Joint Board

on Universal Service,

CC Docket No. 96-45,

geet et Bf 9, 12, 13, 36, 45

In re Implementation of Sections of the Cable

Television Consumer Protection and

Competition Act of 1992: Rate Regulation,

Report & Order and Further

Notice of Proposed Rulemaking,

co Ee 20, 45

In re Implementation of the Local Competition

Provisions of the Telecommunications Act of 1996,

Third Report & Order and Fourth

Further Notice of Proposed Rulemaking,

oh pete BO RS rere rrr ee 15

In re Price Cap Performance Review

for Local Exchange Carriers,

Fourth Report & Order,

12 F.C.C.R. 16,642 (1997),

rev'd in part, USTA v. FCC,

Be a ee Cie Ge BONED ov cb vccccecccsececes 47

Proceeding on Motion of the Comm'n To Examine

N.Y. Tel. Co.'s Rates for Unbundled

Network Elements,

N.Y. Pub. Serv. Comm’n

scene dans pean eeseeneeteeses 14

Promotion of Competitive Networks in

Local Telecommunications Markets,

Notice of Proposed Rulemaking,

FCC No. 99-141,

PO FAs CTR CH 0, CRUD ce ccccccccvcesvess 6

Proposed Rules Regarding Implementation

of §§ 40-15-10] et seq. - Requirements

Relating to Interconnection and

Unbundling, Decision Adopting Rules,

Docket No. 95R-556T, Decision No. C96-347

SE UE GE, SUED ceccesccccccncvcoscess 47

Report & Order, Jn re Federal-State

Joint Board on Universal Service,

ER EE ee eee 4

xii

Legislative Materials

Se, SE, SU: SPUUP CUNO 0 vc cccccccedesccccce 7, 23

H.R. Rep. No. 104-458 (1996) ..........ccccecveees 5,6

Hearing Before the Antitrust Subcomm.

of the Senate Judiciary Comm.,

1999 WL 8084924 (Feb. 25, 1999)

(statement of Joel I. Klein, Assistant Att’y Gen.,

Antitrust Div., U.S. Dep’t of Justice) ............... 14

Texts and Treatises

William J. Baumol & J. Gregory Sidak, Stranded Costs,

18 Harv. J.L. & Pub. Pol’y 835 (1995) ............. 49

Black's Law Dictionary (6th ed. 1990) ............... 19

James C. Bonbright et al., Principles of Public Utility Rates

DM cet scchcicearehicdivaceeuwaese 19, 44

Hon. Stephen Breyer, Regulation and Its Reform

Lee Tse Bodie ec leE Cuaen eet sedeen 20, 45

P. Huber, M. Kellogg & J. Thorne,

The Geodesic Network II: 1993 Report

on Competition in the Telephone Industry ............ 5

Reed Hundt, You Say You Want a Revolution

cack abusnhhedet he iedekehes 6460000 0nsees 8

Alfred E. Kahn, Letting Go: Deregulating the

Process of Deregulation, or: Temptation

of the Kleptocrats and the Political Economy

of Regulatory Disingenuousness (1998) ............. 4

Webster's Third New International Dictionary

TE 94.5424 cuebburaGhiheeseonie eee cknesnaws 19

Xili

Miscellaneous

1999 Statistics of Communications Common Carriers

ee eee

Accounting Policy Division, Common Carrier Bureau,

FCC, Hybrid Cost Proxy Model, Version 2.6,

Revised Model Results: Wirecenter Support

Spreadsheet (Jan. 20, 2000)

<http://www.fcc.gov/ccb/apd/hcpm/wesupport.xls> . ..

C. Michael Armstrong, Break Up the Baby Bells!,

Wels St. 5., DEM. GB, BOGS 0 occ ccccscsscsvcsonenes

Brief for FCC & US.,

AT&T Corp. v. Iowa Utils. Bd.,

525 U.S. 366 (1999) (No. 97-831) ........... 005.

Brief for FCC,

Texas Office of Pub. Utils. Counsel v. FCC,

183 F.3d 393 (Sth Cir. 1999) (No. 97-60421) .......

Comments of MCI Telecomms. Corp., in

Implementation of the Local Competition

Provisions in the Telecommunications Act of 1996,

CC Docket No. 96-98 (filed May 16, 1996) .......

Comments of the United States Tel. Ass’n,

In re Access Charge Reform, Price Cap

Performance Review for Local Exchange Carriers,

CC Docket Nos. 96-262, et al.

(Hled Sam. TD, TERT) a cvcvecccvctotectcenaecews

Connecticut Research, 1995/96 Local

Telecommunications Competition

Ul §.. Perit

Council of Economic Advisors,

1996 Economic Report of the President

CIPO TGRE) on cccccccvncctsovesesesssussnnes

XIV

Declaration of Alfred E. Kahn and Timothy J. Tardiff,

submitted with Reply Comments of Bell Atlantic,

In re Implementation of the Local Competition

Provisions in the Telecommunications Act of 1996,

CC Docket No. 96-98 (filed May 30, 1996) ........

Reed Hundt, FCC Chairman, Antitrust and

Interconnection: Old Wine in New

Bottles, Remarks at Antitrust Conf.

for Corp. General Counsels,

1996 WL 646783 (Nov. 8, 1996) ...........00055.

John J. Keller, Ringing Bell: AT&T's New President

Is Wasting No Time in Shaking Things Up,

Pe Bg I By FOOD occ ccccccccccccccccces

Merrill Lynch, MFS Communications

DT Terrence kee eececceosseceeccccs

Supplemental Aff. of Dennis B. Trimble,

in Appendix to GTE Service Corp.’s Motion

for Stay Pending Judicial Review

and for Expedited Judicial Review,

Towa Utils. Bd. v. FCC,

_ 120 F.3d 753 (8th Cir. 1997) (No. 96-3321) ........

Testimony of Dennis B. Trimble, GTE Corp.,

In re Petitions of AT&T Communications, et al., for

Arbitration of Unresolved Issues from Interconnection

Negotiations with GTE South, Inc. Pursuant to § 252

of the Telecommunications Act of 1996,

Virginia State Corp. Comm’n Case Nos.

PUC960117, et al. (Nov. 21, 1996) ............4..

Transcript, “AT&T Investment Community Meeting”

i Mee cheebeescecccccccccocccccccces

INTRODUCTION

The local telephone network represents one of the largest

private capital investments in this country. This massive

investment was induced by a regulatory regime that offered

shareholders the opportunity to recover prudent investment plus

a reasonable return through retail telephone rates. The

Telecommunications Act of 1996 gives competitors the right to

exclusive use of portions of that network to provide their own

telephone service. At the same time, the Act mandates that

“just and reasonable” rates be established for this new use, and

further specifies that these rates must recover “the cost . . . of

providing” the network element and “may include a reasonable

profit.” 47 U.S.C. § 252(d)(1). The Act creates a new

wholesale market for network elements and provides a

mechanism whereby the competitors who profit from using

these elements must fully compensate the incumbent owners.

The FCC has now declared that “the cost” of providing

ongoing use of this capital-intensive network cannot include

any recovery of past capital investment. The FCC has thus

rewritten “cost” to mean “value,” and has equated value with

its own speculation as to what it might cost to provide a

hypothetical network that is continuously updated with

instantaneous and ubiquitous deployment of the most up-to-

date technology in an optimally efficient design. With a stroke

of the regulatory pen, the FCC has decreed that the existing

network is worth about half of what it was the day before. The

FCC’s action results in systematic undercompensation of

incumbent carriers for the network elements they are compelled

to provide competitors. It contravenes the text and purpose of

the statute and the constitutional standard of just compensation

incorporated in it.

OPINIONS AND ORDERS BELOW

The court of appeals’ decision is reported at 219 F.3d 744,

and is reprinted in the appendix to the petition for certiorari

(“Pet. App.”) at pages 1a-43a. The Local Competition Order,

In re Implementation of the Local Competition Provisions of

the Telecommunications Act of 1996, First Report and Order,

is reported at 11 F.C.C.R. 15,499.

JURISDICTION

The court of appeals had jurisdiction pursuant to 28 U.S.C.

§ 2342(1) and 47 U.S.C. § 402(a). The Eighth Circuit issued

its opinion and judgment on July 18, 2000. Petitioners timely

filed a petition for certiorari on October 4, 2000. This Court

has jurisdiction under 28 U.S.C. § 1254(1).

PERTINENT CONSTITUTIONAL AND

STATUTORY PROVISIONS

This case involves the Takings Clause, U.S. Const. amend.

V (“nor shall private property be taken for public use without

just compensation”); sections 251 and 252 of the

Telecommunications Act of 1996, 47 U.S.C. §§ 251, 252; 5

U.S.C. § 706; and 47 C.F.R. §§ 51.501-51.511. The statutory

provisions are reproduced in the appendix to this brief.

STATEMENT

A. The Regulatory Background Prior to 1996

For most of the twentieth century, local telephone service

was treated as a natural monopoly and was provided under a

system of exclusive local franchises. Typically, a State granted

a single company (now known as the incumbent local exchange

carrier or incumbent “LEC”) an exclusive franchise to provide

local telephone service within a designated area. See AT&T

Corp. v. lowa Utils. Bd., 525 U.S. 366, 371 (1999). The

incumbent was required to serve all customers within its

service area and to make the massive investments necessary to

satisfy this and other service mandates. For their part,

regulators set retail rates designed to ensure that the incumbent

had an opportunity to recover its costs plus a reasonable rate of

return, as required by the Constitution. See, e.g., Federal

Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 601-

04 (1944).

Because the local network carries both intrastate and

interstate calls, part of the cost of the local network has always

been allocated to the federal jurisdiction, and the Federal

Communications Commission (“FCC”) has set charges

associated with interstate calls sufficient to recover those costs.

Thus, for decades state and federal regulators have been

responsible for setting rates that allow incumbents to recover

their costs and make a reasonable rate of return.

For over 60 years, both state and federal regulators have used

cost-of-service ratemaking based on historical (or “embedded”’)

costs to ensure adequate compensation. Under this method,

regulators generally set rates to recover the full amount of

prudently invested capital. See, e.g., Duquesne Light Co. v.

Barasch, 488 U.S. 299, 309 (1989). The theory behind this

method is that the measure of value of the property dedicated

to public use (and hence what the government must pay for) is

not the value of the physical equipment, which might fluctuate

over time, but rather the amount of capital invested, which is

fixed once the investment is made. See, e.g., Missouri ex rel.

Southwestern Bell Tel. Co. v. Public Serv. Comm'n, 262 U.S.

276, 290 (1923) (Brandeis, J., joined by Holmes, J.,

concurring).

In the years leading up to the 1996 Act, some States and the

FCC began to adopt a modified version of historical cost

ratemaking through a system known as “price caps.” Under

this system, an incumbent’s current rates (which were set to

recover historical costs) are taken as a starting point and are

adjusted downward each year by a factor reflecting expected

productivity gains (and typically are adjusted upward to reflect

an inflation index). See generally USTA v. FCC, 188 F.3d 521,

524 (D.C. Cir. 1999). By determining rates through these

adjustments, which place “caps” on prices, this system

eliminates the need to redetermine periodically a carrier’s costs.

Nevertheless, because the system uses rates designed to recover

historical costs as its baseline and modifies them to reflect

productivity gains based on actual industry data, it still provides

incumbents an opportunity to recover historical costs. See /n

re Access Charge Reform, 12 F.C.C.R. 15,982, 9 27 (1997);

Brief for FCC at 8-9, Texas Office of Pub. Util. Counsel v.

FCC, 183 F.3d 393 (Sth Cir. 1999) (No. 97-60421).

Regulators have also used their control over incumbents’

rates to pursue a social policy known as “universal service.”

To ensure that all Americans receive basic telephone service at

affordable rates, regulators set rates for residential and rural

customers substantially below cost. They then set rates for

business and urban customers well above cost to subsidize the

below-cost rates. See Report & Order, Jn re Federal-State

Joint Board on Universal Service, 12 F.C.C.R. 8776, 8784

4 11 (1997) (hereinafter “Universal Service Order’). These

implicit cross-subsidies have created lopsided markets in which

incumbents often served the bulk of customers below cost

while relying on a narrow segment to make up the difference.

A second way in which regulators kept basic rates low was

by extending the depreciation lives of incumbents’ equipment.

By ignoring the economic lives oi .ssets, regulators could

reduce costs to be recovered in current rates by pushing

recovery into the future. As a result, as the FCC has admitted,

incumbents accumulated significant “depreciation reserve

deficiencies” on their books, reflecting that the undepreciated

value of some equipment exceeds its economic value.

' See J.A. 364-65 (J 659 n.1633); see also Comments of the United States

Tel. Ass’n at 74, In re Access Charge Reform, Price Cap Performance

Review for Local Exchange Carriers, CC Docket Nos. 96-262, et al. (filed

Jan. 29, 1997) (estimating depreciation reserve deficiency for large LECs

at $17.9 billion); Alfred E. Kahn, Letting Go: Deregulating the Process of

Deregulation, or: Temptation of the Kleptocrats and the Political Economy

of Regulatory Disingenuousness 7-8 (1998) (describing the “grossly

inadequate” depreciation rates set for incumbents).

The exclusive franchise was central to this regulatory regime.

Only by restricting competitive entry could regulators ensure

that the extra margin built into the rates of “high-value”

customers would actually flow to the incumbent serving other

customers below cost. If competition were allowed, implicit

subsidies would become subsidies for new entrants — those

entrants would “cream skim” away high-margin customers,

pocket the margin, avoid serving high-cost customers, and

“leave the incumbents holding the bag for universal service.”

AT&T Corp., 525 U.S. at 393.

B. The Telecommunications Act of 1996

The Telecommunications Act of 1996 (the “Act”) was

prompted by a growing recognition that alternative facilities

and technologies were emerging that would make competition

possible among multiple providers of local telephone service.

These alternative systems included cable networks that could

be upgraded for providing telephony, fiber networks in urban

centers, and fixed wireless loops.’ The premise of the Act was

that the local market was no longer a natural monopoly and that

more than one firm could efficiently provide local service. See

AT&T Corp., 525 U.S. at 371-72.

2? See, e.g., H.R. Rep. No. 104-458, at 148 (1996) (cable service is

available to 95% of American homes and “[{s]ome of the initial forays of

cable companies into the field of local! telephony therefore hold the promise

of providing the sort of local residential competition that has consistently

been contemplated”); Connecticut Research, 1995/96 Local

Telecommunications Competition, at IV-2 (7th ed. 1995) (“Cable TV

providers, long distance companies, and the new C-LECs .. . were all

announcing plans to offer a pretty full array of telecommunications services

to almost al! classes of telecommunications customers.”); P. Huber, M.

Kellogg & J. Thorne, The Geodesic Network II: 1993 Report on

Competition in the Telephone Industry 2.54 (“The cable industry is now

moving fast toward two-way capabilities and a head-on challenge to the

telephone’s hegemony in two-way communications.”’).

The purpose of the Act, therefore, was to encourage the

development of this emerging facilities-based competition.

Congress explicitly proceeded on the assumption that

“meaningful facilities-based competition is possible,” H.R.

Rep. No. 104-458, at 148 (1996), and intended the “opening

[of} all telecommunications markets to competition” to

“accelerate rapidly private sector deployment of advanced

telecommunications and information technologies and

services,” id. at 113. The FCC has acknowledged that the

“most substantial benefits to consumers” promised by the Act

“will be achieved through facilities-based competition.”

Promotion of Competitive Networks in Local

Telecommunications Markets, Notice of Proposed Rulemaking,

FCC No. 99-141, 14 F.C.C.R. 12,673, 4 4 (1999).

To allow competition, the Act terminated the incumbents’

exclusive franchise and prohibited other state-imposed barriers

to entry. See 47 U.S.C. § 253(a). To further foster the

development of facilities-based competition, the Act imposed

three new duties on incumbents vis-a-vis their competitors.

First, the Act required each incumbent to allow other carriers

to “interconnect” their facilities with the incumbent’s network.

See id. § 251(c)(2). That requirement ensured that entrants

could achieve ubiquity (i.e., the ability for their customers to

call and be called by all telephone subscribers) without

replicating the incumbent’s entire network.

Second, Congress required incumbents to sell their retail

services to new entrants at wholesale rates so that entrants

could resell the services under their own brand names. See id.

§ 251(c)(4). Beyond just enabling “reseller” competition, this

requirement was intended to foster facilities-based competition

by allowing entrants to build sufficient scale to support

investment in facilities.

> Of Reed Hundt, FCC Chairman, Antitrust and Interconnection: Old

Third, Congress required incumbents to provide competitors

access to certain pieces of their networks, known as “unbundled

network elements” or “UNEs.” See id. § 251(c)(3). This

requirement was intended to encourage the rapid deployment

of new facilities by ensuring that new entrants could begin to

compete even if they had only partial facilities and needed to

rely in part on elements |t.ased from the incumbent’s network.

The incumbents’ duty to provide UNEs is also subject to

important restrictions. The Act directs the FCC to limit access

to incumbents’ UNEs to those elements that competitors

genuinely need to obtain from the incumbent in order to

compete. See id. § 251(d)(2). The Act also requires that

incumbents be paid constitutionally sufficient compensation for

forced uses of their property. The Act specifies that the prices

for interconnection and UNEs shall be “just and reasonable,”

“shall be based on the cost. . . of providing the interconnection

or network element,” and “may include a reasonable profit.”

Id. § 252(d)(1)(A), (B). In addition, Congress used retail rates

as the basis for wholesale prices, thereby preserving

incumbents’ ability to recover historical costs (which are

reflected in retail rates). See H.R. Rep. No. 104-204, pt. 1, at

72 (1995) (“{I]t is the Committee’s intent that there be a

recognition of pricing structures for telephone exchange service

in the State.”).

Congress also recognized that, by abolishing the incumbents’

exclusive franchises, it had made the old universal service

system of implicit subsidies untenable. Congress therefore

directed the FCC, after consultation with a Federal-State Joint

Board, to establish new funding mechanisms that must be

“specific, predictable and sufficient” to “preserve and advance

universal service.” 47 U.S.C. § 254(b)(5), (d). Congress also

Wine in New Bottles, Remarks at Antitrust Conf. for Corp. General

Counsels, 1996 WL 646783 (Nov. 8, 1996) (resale was a “competitive

stepping stone to facilities-based competition” in long distance markets).

demanded prompt action on these reforms and required the

FCC to complete a proceeding to “implement the

recommendations from the Joint Board” by May 1997. /d.

§ 254(a)(2). :

C. The FCC’s Local Competition Order

The FCC was dissatisfied with the 1996 Act. As then-

Chairman Reed Hundt later admitted, the FCC thought the Act

had not gone far enough to favor new entrants and was “tilted

toward the local phone companies’ advantage.” Reed Hundt,

You Say You Want a Revolution 154 (2000). Hundt believed

that the FCC could use its “broad authority” in writing the

implementing rules to change the balance struck in the Act:

“like the modern engineers trying to straighten the Leaning

Tower of Pisa, we could aspire to provide the new entrants to

the local telephone markets a fairer chance to compete than

they might find in any explicit provision of the law.” Jd.

On August 8, 1996, the FCC issued its Local Competition

Order. Section 251 required the FCC to address two issues: (i)

what parts of the network would be made available to entrants,

and (11) what the prices for those UNEs would be. On the first

issue, as this Court has already determined, the FCC ignored

the limiting standards set by Congress in section 251(d)(2). See

AT&T Corp., 525 U.S. at 387-92. Instead, the agency decreed

virtually unlimited access to incumbents’ networks. See J.A.

288, 292-94 (YJ 278, 286-287). The FCC thereby enabled an

entrant to obtain, and resell, finished service through the fiction

of buying a combined set of the incumbent’s network elements

— the so-called UNE platform or “UNE-P.”

On pricing, the FCC categorically rejected incumbents’

arguments that UNE prices should be set to allow incumbents

the opportunity to recover historical costs. See id. at 375-76,

397-401 (49 672-673, 704-707). Instead, the FCC concluded

that it should set prices by projecting the forward-looking costs

of a hypothetical carrier that always uses throughout its

network only the most up-to-date technology deployed in the

most efficient network configuration. See id. at 379-80, 382-84

(49 679, 683-685). The FCC dubbed the novel methodology it

invented for projecting these costs “Total Element Long Run

Incremental Cost” or “TELRIC.” Jd. at 378-79 (4 678).

TELRIC’s only concession to the reality of the existing

network was that it assumed that wire centers would remain in

the same location. See id. at 383-84 (4 685).

TELRIC completely ignores incumbents’ past investments.

The FCC’s asserted justification for brushing aside these

embedded costs was that incumbents were “inefficient” and

that their historical costs would “reflect inefficient or obsolete

network design and technology.” Jd. at 383 (§ 684); see also id.

at 375-76 (4 672); Universal Service Order {J 224-225, 228.

And the FCC’s express goal in adopting TELRIC was to

produce dramatically /ower prices than would be dictated by

historical costs. See J.A. 399-400 (4 706) (historical costs

would require “increasing the rates for interconnection and

unbundled elements”); id. at 398-99 (4 705) (historical costs

would favor incumbents by inflating prices). Indeed, potential

entrants were clamoring for forward-looking costs precisely

because they knew that the FCC’s formula would produce

substantially lower prices for UNEs. See, e.g., id. at 340-42,

359-61 (449 635, 655); Comments of MCI Telecomms. Corp. at

63, 65, in Jmplementation of the Local Competition Provisions

in the Telecommunications Act of 1996, CC Docket No. 96-98

(filed May 16, 1996) (prices using historical costs would be

“higher than” prices using forward-looking costs; “rates based

on historical costs are excessive”).

The FCC ensured that TELRIC would yield lower prices by

indulging in three assumptions that could not be met in any

real-world market. First, TELRIC assumes that prices will

always immediately reflect the costs of the most efficient

technology and network configuration. See J.A. 383-84 (§ 685).

TELRIC thus hypothesizes a fantasy world in which carriers

would repeatedly rip out and instantaneously rebuild their

entire plant every time a newer technology hits the market or a

more efficient configuration could be achieved. The FCC has

never disputed that such a fantasy carrier could never exist in

reality, but it has nonetheless used this fiction to justify radical

downward repricing of the existing network. Second, TELRIC

contradictorily presumes that the economic depreciation rate for

equipment would be the same as the extended depreciation rate

used by regulators in the prior monopoly regime. See id. at

395-96 (§ 702). Third, TELRIC similarly presumes that

carriers in its fictional world of constant network replacement

would nonetheless continue to have the same cost of capital

established for incumbents in the stable, low-risk monopoly

system of the past. See id. at 385-86, 395-96 (YJ 687-688,

702).

TELRIC had its intended effect: it produced massive price

reductions from historical costs. The FCC itself set “proxy

prices” that it said approximated TELRIC, and they resulted in

60% discounts from historical costs.* Moreover, the FCC

required States to use those proxies until they had completed

new TELRIC cost studies. See J.A. 326 (§ 619). The FCC

made clear that its proxies were ceilings. States could “select

lower prices,” but they were warned to provide justifications on

the record “especially for setting a rate above a default proxy

ceiling.” /d. When state utility commissions began applying

TELRIC, they typically produced discounts of 50% below

historical cost.’ Indeed, TELRIC projects that the entire local

* See Supplemental Aff. of Dennis B. Trimble, #¥ 17-18, in Appendix to

GTE Service Corp.’s Motion for Stay Pending Judicial Review and for

Expedited Judicial Review, Jowa Utils. Bd. v. FCC, 120 F.3d 753 (8th Cir.

1997) (No. 96-3321) (J.A. 462-63).

* See, e.g., Testimony of Dennis B. Trimble, GTE Corp., in Jn re Petitions

of AT&T Communications, et al., for Arbitration of Unresolved Issues from

Interconnection Negotiations with GTE South, Inc. Pursuant to § 252 of the

Telecommunications Act of 1996, Virginia State Corp. Comm'n Case Nos.

PUC960117, et al., Tr. 726-28 (Nov. 21, 1996).

exchange infrastructure throughout the country could be rebuilt

for about $180 billion — roughly half the $342 billion actually

invested in the existing infrastructure® and only six times the

amount that incumbents pour into capital expenditures on the

network each year.’

Nor does TELRIC effect only a one-time downward

revaluation of the network. Rather, incumbents are subject to

further downward repricing of the network each time an entrant

seeking network elements requests an arbitration under the Act.

See 47 U.S.C. § 252(a), (b). Thus, through TELRIC, all

incumbents’ past and future investments are continuously

subject to retroactive reclassification as “inefficient” and hence

unrecoverable.

The FCC categorically determined that historical costs

should not be included in UNE prices. It stated that including

those costs would “interfere” with its policy goal of optimizing

“efficient” competition. J.A. 399-400 (§ 706). The agency

determined that incumbents were not entitled to recover

historical costs, see id. at 375-76, 397-401 (Yj 672, 704-707),

and that precluding their recovery would not be confiscatory,

see id. at 418-23 (49 733-740). At the same time, the FCC

vaguely hinted that it might consider addressing some stranded

historical costs in a future proceeding — which it has never

done. In the Local Competition Order, the FCC suggested that

° TELRIC projects that, on average, it costs $885 per line to construct a

local exchange network, and the FCC has projected that there are roughly

202.9 million access lines in the country. See Accounting Policy Division,

Common Carrier Bureau, FCC, Hybrid Cost Proxy Model, Version 2.6,

Revised Model Results: Wirecenter Support Spreadsheet (Jan. 20, 2000)

<http://www.fcc.gov/ccb/apd/hcpm/wcsupport.xls>. Compare 1999

Statistics of Communications Common Carriers tbl. 2.7, at 42 (Aug. 11,

2000) (actual investment is $342 billion).

” See 1999 Statistics of Communications Common Carriers tbl. 2.7, at 42

(Aug. 11, 2000) (incumbents invested $29.5 billion in capital assets in

1999).

historical costs might be considered in the Universal Service

Order. See id. at 400-01 (4 707). In the Universal Service

Order, the FCC ignored recovery of historical costs but

Suggested it might consider the question in its Access Charge

Order. See Universal Service Order 4 230 n.593. In its Access

Charge Order, the FCC again made no provision for recovering

historical costs and instead suggested yet again that it would

consider the issue in a “separate order.” Jn re Access Charge

Reform, 12 F.C.C.R. 15,982, 9§ 14, 49 (1997). Not

surprisingly, that order has never materialized.*

The FCC’s rush to implement TELRIC as the price for UNEs

sold by incumbents to competitors contrasts starkly with its

sputtering implementation of TELRIC in reforming federal

universal service funding. In explaining its four-year delay in

implementing universal service reforms, the FCC asserted that

the models available for calculating TELRIC were too

* In contrast, other agencies have forthrightly acknowledged that they must

provide recovery of costs stranded by major changes in their regulatory

regimes. FERC, for example, repeatedly recognized the need to provide for

stranded cost recovery in its proceeding entitled Promoting Wholesale

Competition Through Open Access Non-Discriminatory Transmission

Services by Public Utilities; Recovery of Stranded Costs by Public Utilities

and Transmitting Utilities. See, e.g., FERC Order No. 888, 61 Fed. Reg.

21,540, 21,630 (1996) (“[W]e believe that the utility is entitled to recover

legitimate, prudent and verifiable costs that it incurred under the prior

regulatory regime to serve that customer.” (emphasis added)); FERC Order

No. 888-A, 62 Fed. Reg. 12,274, 12,373 (1997) (recognizing that agency

“cannot change the rules of the game without providing a mechanism for

recovery of the costs caused by such regulatory-mandated change”); FERC

Order No. 888-B, 62 Fed. Reg. 64,688, 64,688-89 (1997) (permitting

recovery of “legitimate, prudent, and verifiable wholesale stranded costs”);

see also Council of Economic Advisors, 1996 Economic Report of the

President at 187 (GPO 1996) (“A strong case therefore can be made for

allowing utilities to recover stranded costs where these costs arise from

after-the-fact mistakes or changes in regulatory philosophy toward

competition, as long as the investments were initially authorized by

regulators.”).

unreliable to be used. See, e.g., Universal Service Order

{4 244-245; Federal-State Joint Board on Universal Service,

Fifth Report & Order, 13 F.C.C.R. 21,323, 4 3, 60 (1998).

When the FCC did act, it left completely intact the massive

implicit subsidies embedded in intrastate retail rates. See

Universal Service Order J 14. Instead, it tinkered with a tiny

explicit federal fund and replaced it with a new fund calculated

using TELRIC. Thus, while this Court expected that the

distortions caused by implicit subsidies would “be phased

out,” AT&T Corp., 525 U.S. at 394, the FCC has declined to

implement the Act in that fashion.

The adverse effect of the FCC’s radically discounted

TELRIC prices, aggravated by the FCC’s blanket unbundling

of UNEs, was predictable. Subsidized access to the

incumbent’s network provided a powerful distorting incentive

for entrants to rely on UNEs and at the same time devalued

investments some entrants had started to make in facilities of

their own. As a result, many entrants rapidly changed their

plans away from deploying competing facilities.”

In New York alone, for example, by the end of calendar year

2000, competitors using Verizon’s UNEs were serving 1.8

* MFS, for example, a competitive access provider that already had

facilities deployed in many urban centers, quickly announced plans to “re-

orient{] its network build-out focus away from building to end-users and

instead . . . [to] connect[ing] to the customer via incumbent local exchange

carrier unbundled loops.” Merrill Lynch, MFS Communications at 2 (Nov.

7, 1996). And AT&T touted the UNE platform to investors as “another way

to resell” that would give AT&T a “52 percent” discount below retail rates

~ more than two to three times the discounts set according to the statutory

standards for wholesale services. Transcript, “AT&T Investment

Community Meeting” at 5 (Mar. 3, 1997) (J.A. 469). See also John J.

Keller, Ringing Bell: AT&T's New President Is Wasting No Time in Shaking

Things Up, Wall St. J., Dec. 24, 1996, at Al (explaining that AT&T

canceled plans to build facilities and elected instead to purchase elements

and services from incumbents).

million customers and had eclipsed facilities-based

competitors. The losses imposed by TELRIC pricing for those

UNEs are massive. While the average historical cost for a

copper loop is $33.20 per month, the average TELRIC price for

a loop is $14.52 — a discount of over 56%.'°

In addition, implementing TELRIC pricing for UNEs while

implicit subsidies remain embedded in retail rates created

further foreseeable problems. First, entrants focused on cherry-

picking high-margin urban and business customers,'' and

thereby diverted into their own coffers the revenues designed

to support universal service. Second, because retail rates for

residential customers remained below cost, competition for

residential customers developed more slowly than it should

have. Ironically, these below-cost retail price ceilings have led

to further political pressure to reduce UNE prices even more as

entrants claim that they cannot compete for residential

customers unless deeper discounts enable them to match

incumbents’ state-imposed, below-cost retail rates. See, e.g.,

C. Michael Armstrong, Break Up the Baby Bells!, Wall St. J.,

Mar. 28, 2001, at A22 (complaining that “Verizon’s

‘wholesale’ price in New Jersey is twice the amount that retail

customers pay”’).

D. Judicial Review

. In their initial challenge to the Local Competition Order,

incumbents argued primarily (i) that the FCC’s unbundling

rules providing blanket access to incumbents’ networks

'° See Proceeding on Motion of the Comm'n To Examine N_Y. Tel. Co.'s

Rates for Unbundled Network Elements, N.Y . Pub. Serv. Comm'n Case No.

98-C-1357, Hearing Ex. 323, Part A-1, Section 5, at 1.

'' See, e.g., Hearing Before the Antitrust Subcomm. of the Senate

Judiciary Comm., 1999 WL 8084924 (Feb. 25, 1999) (statement of Joel I.

Klein, Assistant Att’y Gen., Antitrust Div., U.S. Dep’t of Justice) (“These

new entrants typically, and naturally, set their sights first on urban business

customers as the most profitable slice of the local exchange market . . . .”).

violated the terms and purposes of the Act; (ii) that the FCC

lacked statutory authority to issue rules governing the Act’s

pricing provisions at all; and (iii) that the FCC’s pricing rules

— particularly TELRIC — were unlawful. The Eighth Circuit

rejected incumbents’ challenge to the FCC’s approach to

blanket unbundling. It agreed, however, that the FCC lacked

jurisdiction over pricing and therefore did not address the

incumbents’ substantive challenges to TELRIC. See Jowa

Utils. Bd. v. FCC, 120 F.3d 753 (8th Cir. 1997).

In AT&T Corp. v. lowa Utilities Board, 525 U.S. 366 (1999),

this Court agreed with incumbents that the FCC had violated

the Act by failing to impose any meaningful restriction on

access to network elements. The Act required the FCC “to

apply some limiting standard, rationally related to the goals of

the Act, which it has simply failed to do.” Jd. at 388. The

Court therefore vacated the FCC’s “primary unbundling rule”

and remanded to the FCC. /d. at 375."

In AT&T Corp., this Court also reversed the Eighth Circuit's

ruling on jurisdiction over pricing and remanded for the Eighth

Circuit to address substantive challenges to TELRIC. On

remand, the Eighth Circuit rejected incumbents’ argument that

the pricing standard in the Act required that network-element

prices be based on the actual, historical costs of the

incumbent’s existing network. The court declared the term

“cost” ambiguous and deferred entirely to the FCC’s decision

to base prices solely on forward-looking costs. See Pet. App.

'2 On remand, the FCC produced a new rule that actually expanded access

to network elements even further. See /n re Implementation of the Local

Competition Provisions of the Telecommunications Act of 1996, Third

Report & Order and Fourth Further Notice of Proposed Rulemaking, 15

F.C.C.R. 3696 (Nov. 5, 1999). When incumbent carriers sought judicial

review, the FCC succeeded in having the case held in abeyance on the

ground that it intended to reconsider some aspects of the order. The agency

has now been “reconsidering” the order ever since 1999, while incumbents’

challenges go unheard.

10a-14a (citing Chevron U.S.A. Inc. v. Natural Resources

Defense Council, Inc.,467 U.S. 837, 842-43 (1984)). Although

the court acknowledged that incumbents had argued for a

construction of the Act that would hew to constitutional

standards, it applied the wrong standard to incumbents’ claim

as it concluded that petitioners’ “takings claim is not ripe for

review.” Jd. at 17a.

Incumbents also argued that, even if the Act would permit a

forward-looking cost methodology, it required UNE prices to

be based on the forward-looking costs actual firms would incur,

not on an unattainable fantasy. The Eighth Circuit agreed and

explained that the Act demanded prices based on the actual cost

of providing elements to competitors, “not on the cost some

imaginary carrier would incur by providing the newest, most

efficient, and least cost substitute.” /d. at 8a. In setting the

pricing standards of section 252(d)(1), “Congress was dealing

with reality, not fantasizing about what might be.” /d. at 9a.

SUMMARY OF ARGUMENT

1. The plain text, structure, and purpose of section 252

make it clear that prices must include historical costs. Section

252(d)( 1) requires rates for network elements that are “based on

the cost . . . of providing” the network element and “may

include a reasonable profit.” The ordinary meaning of the word

“cost” is past expenditure, and particularly where the term has

been used with precisely that meaning in the field of telephone

rate regulation for half a century, there is no basis for applying

a different meaning here. Further, the Act’s authorization of a

“reasonable profit” makes sense only if “cost” refers to

historical cost and “profit” refers to a return after full recovery

of investment.

2. a. Constitutional considerations also require that the

term “cost” be read to mean historical costs. Section 252(d)(1)

requires that network-element rates be “just and reasonable,” a

formulation that this Court has long understood to demand

adherence to constitutional standards of just compensation.

Indeed, since the Act effects a taking of property for which

network-element rates are to provide the compensation, the

pricing standard must be construed to adhere to constitutional

norms. See, e.g., United States v. Security Indus. Bank, 459

U.S. 70, 78-80 (1982).

b. In Duquesne Light Co. v. Barasch, 488 U.S. 299

(1989), the Court explained that, when a ratemaker undertakes

a fundamental shift in rate methodologies, the new

methodology must be evaluated to determine whether it

continues to provide constitutionally adequate compensation

for previous investments, as measured under the old

methodology. See id. at 312. TELRIC violates the Just

Compensation Clause because it represents a fundamental shift

in methodology that makes no provision for the recovery of

prior prudent investment, but rather is designed to preclude

such recovery. TELRIC thus constitutes an extreme form of

the opportunistic switch in ratemaking methodologies

condemned in Duquesne. It impermissibly changes the rules of

the game after substantial investment has been induced under

the prior regulatory regime. See Eastern Enters. v. Apfel, 524

U.S. 498, 532-36 (1998); Kaiser Aetna v. United States, 444

U.S. 164, 179-80 (1979).

c. While never denying that TELRIC would strand

investment, the FCC sought to salvage the methodology by

claiming that it would not threaten incumbents’ overall

“financial integrity.” But any effort to dilute the impact of

TELRIC by sweeping in revenues from ai/ of an incumbent's

other operations violates fundamental takings principles. The

government cannot take part of a person’s property and claim

that it need not pay for it fully on the ground that the person has

remaining net worth. Rather, when the government takes a

portion of a person’s property it must pay fully for what it has

taken. In a regulatory context, this means that a regulatory

system must pay its own way. A regulator cannot make up a

deficiency in its own rates by pointing to competitive revenues,

revenues under the control of a different regulator, or any other

revenues it is not responsible for generating. See Brooks-

Scanlon Co. v. Railroad Comm'n, 251 U.S. 396, 399 (1920);

Smith v. Illinois Bell Tel. Co., 282 U.S. 133 (1930).

The FCC’s various suggestions that incumbents’

constitutionally based arguments for interpreting the Act are

somehow not “ripe” are equally misplaced. TELRIC is a final

rule that systematically undercompensates incumbents. It is

subject to review now for its failure to adhere to the standard of

compensation spelled out in section 252(d)(1) of the Act.

d. Because, at a minimum, TELRIC raises serious

constitutional questions, the agency must demonstrate a clear

congressional mandate for its adoption. See Solid Waste

Agency v. U.S. Army Corps of Eng’rs, 121 S. Ct. 675, 683

(2001); NLRB v. Catholic Bishop, 440 U.S. 490, 506-07

(1979). That standard is not met here. Thus, the FCC’s

reading of the word “cost” must be rejected. It is the Court’s

“settled policy to avoid an interpretation of a federal statute that

engenders constitutional issues if a reasonable alternative

interpretation poses no constitutional question.” Gomez v.

United States, 490 U.S. 858, 864 (1989).

3. Finally, the FCC’s adoption of TELRIC is contrary to

the purpose of the statute and is arbitrary and capricious. For

years, the FCC and other telephone utility regulators have

rejected forward-looking replacement cost models as inherently

unworkable and unreliable. Rejection of historical cost in favor

of the FCC’s novel and unwieldy replacement-cost model

frustrates the congressional goal of swift implementation of the

Act. Finally, the FCC’s effort to have prices reflect an

imaginary and unattainable level of efficiency undermines

incentives for facilities-based competition and short-circuits the

very competitive process that Congress intended to set in

motion. See AT&T Corp., 525 U.S. at 424 (Breyer, J.,

concurring in part and dissenting in part).

ARGUMENT

I. SECTION 252(d)(1) REQUIRES USE OF HISTORICAL

COSTS FOR NETWORK-ELEMENT PRICES.

The Act requires that prices for network elements “shall be

_. . based on the cost . . . of providing the interconnection or

network element.” 47 U.S.C. § 252(d)(1) (emphasis added).

Even assessed in a contextual vacuum, the word “cost” cannot

be read to exclude past capital expenditure. The plain,

dictionary meaning of the word “cost” includes the entire

amount paid for any particular item or service. See Webster's

Third New International Dictionary 515 (1993) (defining cost

as “the amount or equivalent paid or given or charged or

engaged to be paid or given for anything bought or taken in

barter or for service rendered”); Black’s Law Dictionary 345

(6th ed. 1990) (“Expense; price. The sum or equivalent

expended, paid or charged for something.”). Thus, the ordinary

understanding of the word “cost” is, by its nature, “historical”

~ it focuses on all that has been paid to produce a good or

service. The concept of “cost” — what was in fact paid for

something - is distinct from the concept of “value,” which is

the price that would be paid on the open market.

More importantly, in the specific context in which the word

is used here — telephone utility ratemaking — the term “cost” has

been used for more than fifty years to refer to this same concept

of past expenditure, or “historical cost.” See James C.

Bonbright et al., Principles of Public Utility Rates 211 (2nd ed.

1988) (“(O}riginal, legitimate cost of plant and equipment, with

reasonable allowances for interest during construction and for

working capital, is the governing basis of calculation.”); see

also MCI Communications Corp. v. American Tel. & Tel. Co.,

708 F.2d 1081, 1118 n.52 (7th Cir. 1983) (“cost” is interpreted

“in a utility ratemaking setting to refer to the revenues required

to meet all the accounting, historical or embedded costs of the

entire utility enterprise” (emphasis omitted)); Hon. Stephen

Breyer, Regulation and Its Reform 38 (1982) (“([RJegulators

almost uniformly assume that a firm’s rate base (which

determines the allowable profit) equals the book value of its

historical investment.”). Indeed, two years before Congress

enacted section 252, the FCC itself reaffirmed, in the context

of cable rate regulation, that “[o}riginal cost is the normal, now

traditional method used for public utility valuation.”

Implementation of Sections of the Cable Television Consumer

Protection and Competition Act of 1992: Rate Regulation,

Report & Order and Further Notice of Proposed Rulemaking,

9 F.C.C.R. 4527, 4555, § 55 (1994).

Where a statute addresses a specialized field and uses a term

that has acquired a fixed meaning in that context, the statute

must be construed to apply that settled meaning. See

McDermott Int'l, Inc. v. Wilander, 498 U.S. 337, 342-43 (1991)

(construing the undefined statutory term “seaman” to have its

established meaning under maritime regulation); Corning Glass

Works v. Brennan, 417 U.S. 188, 201-02 (1974) (construing the

undefined statutory term “working conditions” to have its

established meaning under labor regulation). Although the

FCC points to the theoretical possibility that the word “cost”

can mean different things in different contexts, the fact remains

that, in the context in which the word is used here, “cost” has

had a consistent meaning for decades — i.e., “historical” cost.

Given this longstanding usage, it is implausible to conclude

that rates “based on the cost” would exclude past capital

investment.

Beyond the word “cost” itself, the text and structure of

several interrelated provisions of sections 251 and 252 confirm

that section 252(d)(1) uses the word “cost” in its usual sense.

First, section 252(d)(1)(B) states that the prices for network

elements “may include a reasonable profit.” A profit cannot be

realized absent full recovery of costs, including capital costs.

California Dental Ass'n v. FTC, 526 U.S. 756, 768 (1999)

(“[A]ccording to a generally accepted definition ‘profit’ means

gain from business or investment over and above expenditures,

or gain made on business or investment where both receipts or

payments are taken into account. . . .” (internal quotation

marks omitted)). The FCC itself acknowledged that, “in plain

English, profit is defined as ‘the excess of returns over

expenditure in a transaction or a series of transactions.” J.A.

393 (4 699) (citing Webster's New Collegiate Dictionary 931

(10th ed. 1994)). Yet the FCC treated return on investment as

simply another forward-looking “cost.” This left no room for

consideration of what constituted a reasonable profit because,

in the agency’s view, profit was “embodied” in its own

definition of cost. See J.A. 393-95 (4 700). The FCC’s reading

thus renders irrelevant the entire subsection of the Act

addressing “profit,” thereby violating a cardinal canon of

statutory construction. See, e.g., Bennett v. Spear, 520 U.S.

154, 173 (1997); United States v. Menasche, 348 U.S. 528, 538

(1955).

The Act’s bifurcation of the pricing determination into “cost”

and “profit” neatly tracks the two-step process traditionally

associated with cost-of-service ratemaking. Historical

expenditure constitutes the ratebase, to which a rate of return

calibrated to the nature and risk of the industry is applied. The

use of the word “reasonable” to modify “profit” supports this

view. It has meaning in this context only as a reference to the

exercise of discretion by a regulator in setting a rate of return.

If “cost” in section 252(d)(1)(A) is read as exclusively

“economic cost,” the phrase “reasonable profit” in section

252(d)(1)(B) is a non sequitur.

Second, several provisions of the Act make clear that it does

not authorize or contemplate a wholesale reexamination of the

incumbent carriers’ actual costs. The FCC was required to

“complete all actions necessary” to implement the local

competition provisions, including pricing standards, within six

months of the Act’s enactment. See 47 U.S.C. § 251(d)(1).

Section 252(d)(1) itself expressly forbids the conduct of a

traditional ratemaking inquiry: “cost,” it directs, shall be

“determined without reference to a rate-of-return or other rate-

based proceeding.” The FCC itself explained that this directive

“does not further define the type of costs that may be

considered, but rather specifies a type of proceeding that may

not be employed.” J.A. 397-98 (§ 704). And as the FCC

noted, Congress was “eager to set in motion expeditiously the

development of local competition” and wished to avoid “the

costs and administrative burdens associated with a traditional

rate case.” /d. The strong inference from the congressional

desire for swift action and the limitations Congress placed on

the procedures to be employed is that “cost” refers to

something already established and readily available, i.e.,

historical cost as documented on incumbents’ books. The

Act’s prohibition of familiar ratemaking procedures in the

name of rapid implementation plainly forbids, a fortiori, the

use of a novel, complex, and difficult-to-administer

hypothetical cost model."

The parallel provisions in the Act for determining wholesale

prices for services to be resold (as opposed to “elements’’)

further support the conclusion that “cost” in section 252

includes historical cost. In the resale context, the Act provides

for wholesale prices based on retail rates, which Congress

noted would continue to permit incumbents to recover

'? Similarly, because it precludes the traditional procedures associated

with the adjustment or reduction of a utility’s rate base, the Act necessarily

Suggests that Congress intended that rates be based on existing cost figures.

Any other approach would raise due process concerns. Rudimentary

principles of due process would require notice and a right to be heard before

incumbents could be denied recovery of prudent capital investments whose

recovery had previously been approved by state regulators. See Ohio Bell

Tel. Co. v. Public Utils. Comm'n., 301 U.S. 292, 300 (1937); West v.

Chesapeake & Potomac Tel. Co., 295 U.S. 662, 675-77 (1935).

historical costs. See H.R. Rep. No. 104-204, at 72 (1995).

Having preserved the incumbent’s opportunity to recover

historical costs on the resale of services, Congress can hardly

be thought to have contemplated the exclusion of all historical

costs for the pricing of network elements. If Congress was not

“fantasizing” about hypothetical costs in the context of pricing

services, it is implausible to maintain that it nonetheless

authorized a purely hypothetical standard for pricing network

elements. See Gustafson v. Alloyd Co., 513 U.S. 561, 569

(1995) (statutes are to be interpreted as part of “a symmetrical

and coherent regulatory scheme’’).

Finally, as discussed below, under Chevron step one

constitutional considerations constrain the permissible reading

of the word “cost” for two reasons: (1) the Act’s requirement

of “just and reasonable” rates expressly incorporates a

constitutional standard; and (2) the doctrine of constitutional

avoidance precludes an interpretation that raises serious

constitutional questions. See, e.g., Chevron U.S.A. Inc. v.

Natural Resources Defense Council, Inc., 467 U.S. 837, 843

n.9 (1984) (court employs all “traditional tools of statutory

construction” on first step of Chevron); Solid Waste Agency v.

U.S. Army Corps of Eng’rs, 121 S. Ct. 675, 683-84 (2001)

(same).

Il. UNDER CONSTITUTIONAL PRINCIPLES,

SECTION 252 CANNOT BE CONSTRUED TO

AUTHORIZE TELRIC.

Because of what it says and because of what it does, section

252 must be construed to mandate constitutionally sufficient

compensation. The Act’s command that rates be “just and

reasonable” explicitly incorporates the constitutional standard

of just compensation. Moreover, because the Act effects a

taking of property for which network-element rates are to

provide the compensation, the rates must satisfy constitutional

norms.

The FCC has fundamentally shifted rate methodologies in

midstream so as to preclude incumbents from recovering their

embedded costs — that is, past prudent investment made in

reliance on the prior regulatory regime. The FCC’s action is

precisely the kind of opportunistic switch this Court

condemned in Duquesne. Because TELRIC violates the

Constitution, it violates the Act.

A. Section 252 Mandates a Pricing Methodology

Designed To Provide Constitutional Compensation.

In requiring that rates be “just and reasonable,” section

252(d)(1) incorporates the Fifth Amendment's guarantee of just

compensation and thus expressly commands that any rate

methodology be designed to produce the full measure of

compensation due under the Constitution. The phrase “just and

reasonable” is a term of art that has long been construed to

require compensation that meets constitutional standards. See,

e.g., /n re Permian Basin Area Rate Cases, 390 U.S. 747, 769-

70 (1968); Federal Power Comm'n v. Natural Gas Pipeline

Co., 315 U.S. 575, 586 (1942).

Section 252 is a classic utility rate regulation scheme. It

forces a dedication of property, it directs compensation through

just and reasonable rates, and it designates a class of users

required to pay the compensation through those rates. Thus,

the overarching purpose of section 252 is compensatory. Its

core command ~ as with any utility ratemaking regime — is not

only that incumbents should receive full compensation, but also

that they should receive full compensation through the rates.

The very objective of a utility ratemaking regime is to avoid

future government liability for an uncompensated taking by

requiring the regulator to design rates that will fully

compensate the utility. Such a regime ensures that the utility is

fully compensated, that the liability for compensation is borne

by a designated class of private users (not by the public

treasury), and that investors’ expectations are settled by a

predictable mechanism that informs investors in advance how

they will be paid.

The Fifth Amendment is implicated in this case because,

under the 1996 Act and the FCC’s implementing regulations,

incumbents are being compelled to turn over parts of their

networks for their competitors’ exclusive use. See J.A. 285-86

(§ 268) (an entrant purchasing “access to an unbundled network

facility is entitled to exclusive use of that facility for a period

of time”). The Act thus accomplishes a taking that demands

constitutionally adequate compensation. Where a utility is

compelled to dedicate its property to public use, the

government must provide the utility the full compensation due

under the Constitution. See, e.g., Duquesne, 488 U.S. at 307-

O08.

It is because of this imperative for just compensation that

utility statutes, like the one here, are often explicit in

demanding “just and reasonable” rates. But even in the absence

of such specific direction, this statute would have to be

construed to provide compensation that meets the constitutional

minimum. Where Congress conscripts private property for

public use and establishes a mechanism for compensation, the

strong presumption must be that Congress intends the

mechanism itself to provide the full measure of compensation

due under the Constitution. See, e.g., Phelps v. United States,

274 U.S. 341, 344(1927). And especially in the utility context

where the statute not only effects a taking but also prescribes a

class of persons to pay, the rates must provide constitutional

compensation. An agency cannot be permitted to create

unintended liability for the Treasury by construing the statute

in a manner that would result in an uncompensated taking of

property. See Bell Atlantic Tel. Cos. v. FCC, 24 F.3d 1441,

1445 (D.C. Cir. 1994).

For these reasons, the Constitution constrains any

construction of the word “cost” in section 252(d)(1). That term

must be construed to preserve the opportunity for incumbents

to recover all costs they are entitled to recover under the

Constitution. An agency interpretation of that term that fails to

provide for such recovery violates the statute and the

constitutional standard that it incorporates. Moreover, the

agency’s interpretation of what costs the Constitution requires

to be recovered is not entitled to deference under Chevron

U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467

U.S. 837 (1984). This is so not only because an agency’s

interpretation of constitutional requirements generally is not

entitled to deference, see infra pp. 42-44, but also because the

judiciary, not the political branches, has the exclusive province

to determine what just compensation requires. See, e.g.,

Monongahela Navigation Co. v. United States, 148 U.S. 312,

327 (1893) (“It does not rest with the public, taking the

property, through congress or the legislature, its representative,

to say what compensation shall be paid, or even what shall be

the rule of compensation.”).

B. TELRIC Violates Section 252(d)(1) Because It Shifts

Methodologies Without Providing for Recovery of

Past Prudent Investment.

In its Local Competition Order, the FCC made a profound

change in the measure of costs incumbents are permitted to

recover. It abandoned the longstanding regime under which

incumbents were given the opportunity to recover their actual

investment and moved to an extreme version of replacement

costs. This fundamental shift in methodologies necessarily

raises the question whether the new methodology is sufficient

to provide a constitutionally adequate return with respect to

investments made under the prior regime. The principles

established by this Court in Duquesne provide the template for

evaluating such shifts.

At the inception of a regulatory regime, when investors first

choose to dedicate their property to public use, a regulator has

some flexibility in choosing a methodology for determining

compensation. Any of several methods, including an historical

cost method or a reproduction-cost method, could satisfy

constitutional requirements. See Federal Power Comm'n v.

Hope Natural Gas Co., 320 U.S. 591, 602 (1944). Once the

government has selected a methodology and induced

substantial investment under that regime, however, the

government’s ability to switch methodologies is necessarily

constrained.

After the government has induced private investment that has

produced valuable property under one set of regulatory rules,

there will often be a strong temptation to use government

power to appropriate some or all of that value to the benefit of

the public at reduced cost. Changing rate methods in

midstream can accomplish precisely such an appropriation of

value by effectively foreclosing recovery of a constitutional

return on the very investments that were made in reliance on

the original method. No less than in other instances of

expropriation of private property, the Fifth Amendment

precludes the government from inducing substantial investment

in reliance upon one set of rules and then reaping the rewards

of that investment by unilaterally altering the rules of the game.

The Constitution thus does not preclude all changes in

methodology. What it does preclude is a switch in

methodologies unaccompanied by some mechanism to

compensate for investment stranded by the shift in

methodologies itself. This is simply a specific application of

the bedrock principle that “a strong public desire to improve the

public condition is not enough to warrant achieving the desire

by a shorter cut than the constitutional way of paying for the

change.” Pennsylvania Coal Co. v. Mahon, 260 U.S. 393, 416

(1922) (Holmes, J.).

In Duquesne, the Court applied this principle in evaluating a

shift in ratemaking methodologies. Duquesne involved a

“sligh{t] modifi[cation]” of the rate method within the context

of an historical cost system. 488 U.S. at 310. Rather than

allowing some recovery of investments that, although prudent

when made, had not proved “used and useful,” the new method

eliminated any recovery for such investments. /d. at 304-05,

310n.7. The Court evaluated whether this slight change raised

constitutional difficulties by determining whether the shift

adversely affected investors’ opportunity to recover all their

previous prudent investment and an appropriate rate of return

under the old methodology. The Court determined that the new

method was still projected to produce recovery that was “within

the constitutional range of reasonableness” as measured under

the old methodology. Id. at 312. Under Duquesne, in other

words, the new system must still provide for recovery of the

investments made under the prior system and a return on that

investment that would have been constitutionally sufficient

under the old system. Indeed, in concurrence, Justice Scalia,

joined by Justices White and O’Connor, observed that, for

courts to determine whether a rate methodology provided a

constitutionally adequate “fair return,” “all prudently incurred

investment may well have to be counted.” Jd. at 317.

The FCC’s newly minted TELRIC methodology plainly fails

the Duquesne test. Duquesne involved a slight modification

within the context of an historical cost rate method. Here, in

contrast, TELRIC jettisons historical costs altogether in favor

of an extreme version of replacement costs. The FCC fully

understood that TELRIC rates would be below historical costs

and would not allow recovery of those costs. That was the

intent of TELRIC, see supra p. 9, and, given the assumptions

built into the methodology, its inexorable effect. TELRIC thus,

by design, falls short of satisfying the constitutional test applied

in Duquesne. The FCC never disputed that TELRIC would

strand investment on UNEs. Nor could it do so. The FCC

itself set “proxy prices” to approximate TELRIC and produced

forward-looking costs that are roughly 60% below historical

costs. See supra p. 10. With a stroke of the pen, the FCC thus

redefined as “unrecoverable” half the costs that incumbents

have incurred in establishing and maintaining the networks that

now must be sold off piecemeal to new entrants.

As if forewarning against the FCC’s conduct here, the

Duquesne Court contrasted the sligm shift in that case with

changes that more fundamentally alter risks. See 488 U.S. at

312 n.7, 315. The Court admonished against shifts that would

allow the government opportunistically to reap the benefits of

investments without paying for them: “[A] State’s decision to

arbitrarily switch back and forth between methodologies in a

way which required investors to bear the risk of bad

investments at some times while denying them the benefit of

good investments at others would raise serious constitutional

questions.” Id. at 315 (emphasis added).

The FCC’s abrupt shift to TELRIC is precisely the sort of

fundamental and opportunistic switch condemned in Duquesne.

For decades, regulators have reaped the benefits of the

historical cost method, which worked to the government’s

advantage as long as asset values were stable or rising. By

promising investors a fair opportunity to recover all capital

prudently invested and insulating them from the risk of asset

value fluctuation, regulators could insist on lower rates of

return and extended depreciation schedules. Because they did

not have to compensate investors for the risk that their

investments would suffer fluctuations in market value,

regulators could keep consumers’ rates low and stable. For

their part, investors were never allowed to profit when the

value of the network was increasing. Returns were based on

capital investment. Most importantly, for all the investment

sunk under the prior regime, investors have never been

compensated for the risk that recovery would be based on the

vagaries of fluctuations in asset value.

The FCC has used the Act as an opportunity to conjure up a

hypothetical world where replacement costs are substantially

below book value. And it has used its newfound regulatory

authority to impose that extreme version of a replacement-cost

methodology on incumbents — a shift it seeks to make without

ever having paid investors for the risk of such a shift and

without providing for the investment that will be stranded as a

result.

The FCC’s bait-and-switch is particularly egregious here,

moreover, because the regulators’ own decisions have

magnified the amount that will be stranded by the shift. One of

the ways regulators promoted universal service under the prior

system, for example, was artificially prolonging depreciation

lives to push off recovery of costs into the future. See supra

p. 4. That meant that incumbents carried accounts reflecting

undepreciated investments in assets, even though those

accounts no longer corresponded to the economic value of the

assets. Switching to TELRIC abruptly cuts off recovery of

those amounts, even though recovery had been promised as a

critical component of the past system.

The harsh retroactivity of the FCC’s about-face is patent.

The switch effectively reaches back and recharacterizes the

legal effect of an incumbent's actions by recategorizing

investments that were prudent (and therefore could be

recovered) as now unrecoverable — long after the investments

were made. TELRIC thus has the effect of rewriting the terms

of thousands of regulatory transactions closed long ago. See

Eastern Enters. v. Apfel, 524 U.S. 498, 532-36 (1998); see also

id. at 548 (Kennedy, J., concurring) (“If retroactive laws change

the legal consequences of transactions long closed, the change

can destroy the reasonable certainty and security which are the

very objects of property ownership.”). It accomplishes that

result by suddenly exposing the utility to a regulatory risk —

repricing based on the unattainable efficiencies of an imaginary

carrier — that was never accounted for in the original method for

determining compensation. The effect is to wipe out a

significant portion of the recovery on past investments that had

always been counted on as a necessary component for

supplying a constitutional return under the old regime.

Investors never would have agreed to invest the huge sums

necessary to construct a telephone network if, rather than

offering a stable opportunity to recover all prudent investments,

the government had instead reserved the right to eliminate any

opportunity to recover investments upon a whim. In this

instance no less than in others, the Court must look with

extreme skepticism on government action that would eliminate

the basis on which private parties have relied in making

substantial investments. See, e.g., Kaiser Aetna v. United

States, 444 U.S. 164, 179-80 (1979) (government consent to

plan to dredge pond created “expectancies” amounting to a

property interest that the government could not later frustrate

by declaring pond a navigable waterway open to public without

paying just compensation); cf. United States v. Winstar Corp.,

518 U.S. 839, 863-64 (1996) (plurality opinion); id. at 913

(Breyer, J., concurring) (government adherence to contractual

obligations is necessary to induce private parties to “undertake

the risk of government contracting”).

Duquesne simply recognizes that, where the government has

invited reliance on its regulatory system to induce investment,

it cannot fundamentally alter the rules with impunity. TELRIC

violates Duquesne because it changes rate methodologies

without providing any mechanism to preserve incumbents’

opportunity to recover prior investments made in reliance on

the historical cost regime.

C. The FCC’s Efforts To Deflect Scrutiny from the

Constitutional Defects in TELRIC Are Meritless.

Throughout the rulemaking proceeding the FCC peremptorily

dismissed the “serious constitutional questions” identified in

Duquesne. Incumbents repeatedly insisted that they were

entitled to an opportunity to recover their embedded costs and

proposed numerous alternative mechanisms that would have at

least preserved the opportunity to recover embedded costs that

were not recoverable through TELRIC rates. See J.A. 398-99,

399-400 (9 705, 706). The FCC responded that, “[e]ven if the

incumbent LECs’ contention is correct,” id. at 399-400 (4 706),

setting rates to allow recovery of embedded costs stranded by

TELRIC would “interfere” with its policy goals of managing

competition to optimize “efficient” entry. See id. But the

FCC’s policy predilections cannot excuse its failure to comply

with the dictates of the statute and the Constitution.

The FCC conclusorily asserted that the amount of investment

stranded by TELRIC would not “necessarily” be “significant.”

Id. at 400-01 (§ 707). But the FCC’s statutory and

constitutional duty was to ensure that incumbents were fully

compensated for the newly established UNE wholesale

business. Prices for network elements must reflect the “cost”

of the elements, not some lesser portion of the cost based on the

agency’s unexplained pronouncement that the difference is not

“significant.” The FCC cannot deny that TELRIC prices are

half the historical costs of UNEs and therefore require

incumbents to operate the entire wholesale enterprise at a

substantial loss. In addition, as explained more fully below, the

significance of the losses caused by TELRIC cannot be watered

down by looking at the company’s overall financial position.

See infra pp. 32-37.

Ultimately, the FCC has advanced two legal arguments to

justify its failure to make any provision for the recovery of past

investment. The first argument — advanced in the Order itself

— is that, although the UNE rates will not in themselves allow

recovery of historical investment, they are not confiscatory

because incumbents have not shown that their overall “financial

integrity” would be impaired. J.A. 420-22 (4¥ 736-738). The

second argument — advanced in litigation and embraced by the

court below — is that incumbents’ arguments are somehow not

“ripe.” Both lines of argument are fallacious.

1. Under the “total effect” test, TELRIC’s

deficiencies cannot be cured by looking to

revenues earned from ail/ of an incumbent’s

operations.

The FCC seeks to deflect the charge that TELRIC rates are

confiscatory by claiming that the rates need not provide

constitutionally sufficient recovery in themselves. Instead, in

its Order, the FCC distorted the Duquesne “total effect” test by

claiming that it could look to ai// of an incumbent’s overall

revenues to make up for any deficiency in TELRIC rates. It

thus concluded that TELRIC rates would not be confiscatory

because unspecified “revenues from other services” might

make up any shortfall, J.A. 421 (9 737), and because

incumbents had not proven that their overall “financial

integrity” would be impaired, id. at 421-22 (4 738). The FCC’s

conclusion that it can compel an incumbent to sell UNEs at

noncompensatory rates, so long as the firm as a whole remains

profitable, violates the most basic tenets of the Just

Compensation Clause as well as section 252’s command that

UNE rates be “just and reasonable.”

It is axiomatic that, when the government takes some portion

of a person’s property, it must pay in full for the part it has

taken. The government cannot take property from a person and

evade compensation on the ground that the person still has

remaining net worth or, in the case of a corporation, a

profitable bottom line. Thus, the government could not compel

General Motors to sell Chevrolets below cost simply because,

due to earnings on Cadillacs and Buicks, the company as a

whole remained profitable.

This principle applies with full force where, as here, an

agency has ratemaking power over part of a firm’s overall

business. This Court long ago recognized that, where a

regulator controls revenues in only a segment of a firm’s

overall business, it must allow the particular enterprise over

which it has control to make a sufficient return to stand on its

own. The regulator may not force the enterprise it is regulating

to operate at a loss and claim that the deficiency can be covered

by other parts of the firm’s business whose revenues the

regulator is not responsible for generating. Thus, in Brooks-

Scanlon Co. v. Railroad Comm'n, 251 U.S. 396, 399 (1920),

the seminal case applying this principle, this Court held that

regulators could not justify below-cost railway rates by

claiming that the railroad was still profitable due to healthy

returns in its competitive lumber business.

The principle underlying Brooks-Scanion is that a regulator

may not set below-cost rates in one line of business and claim

that the deficiency is offset by revenues from a different line of

business unless it can legitimately claim responsibility for

generating those off-setting revenues — as, for example, where

the regulator has used its power to enable an off-setting

supracompetitive return. Thus, as the Brooks-Scanlon Court

recognized, a regulator cannot take credit for revenues earned

in a competitive market because it is not responsible for those

revenues and they represent the return due the firm for risking

capital in the competitive enterprise. As Justice Holmes

explained, earnings from competitive operations are the firm’s

private property, and a firm “no more can be compelled to

spend that [money] than it can be compelled to spend any other

money to maintain a railroad for the benefit of others who do

not care to pay for it.” Jd.

The same underlying principle is reflected in the rule that a

regulator may not justify deficient rates by pointing to revenues

from operations under a different sovereign’s jurisdiction. See,

e.g., Smith v. Illinois Bell Tel. Co., 282 U.S. 133 (1930);

Chicago, M. & St. P. Ry. v. Public Utils. Comm'n, 274 U.S.

344, 350-51 (1927). The first regulator cannot claim that its

action enabled the firm to earn those revenues and thus cannot

claim credit for them as a “payment” to compensate for any

shortfalls in rates it has imposed. Those revenues are already

spoken for: the other sovereign has determined that they are

necessary to compensate the utility for the business conducted

under its jurisdiction.

The “total effect” test from Duquesne is fully consistent with

these principles. Contrary to the FCC’s assertion, that test does

not give a regulator license to rely on revenues outside its

control to cure a deficiency in the rates it has set for a regulated

service. Rather, the “total effect” test focuses solely on those

revenues the regulator has control over and is responsible for

generating. It simply provides that, where a regulator has

control over multiple services of a firm, it may set the rate for

one service below cost so long as it compensates for the

shortfall by using its regulatory power to enable an offsetting

extra return on another product. Thus, where a regulator uses

its regulatory power to restrict competitive entry, it can

legitimately claim credit for the off-setting revenue because it

has enabled the supracompetitive return. In short, the test

simply recognizes that a regulator may create cross-subsidies

within the range of services under its regulatory control. It is in

this context that this Court has said that subsidiary puts-and-

takes in a rate order are not of constitutional dimension, as long

as the regulator has set rates in the aggregate to provide a

sufficient return on the regulated part of the business under its

control. See Duquesne, 488 U.S. at 310, 314.

In Hope and Duquesne, the company at issue was a regulated

monopoly in ail its operations. In those cases, therefore, it was

proper to consider the company’s overall revenue from all

operations in determining the sufficiency of a rate order. But

those cases clearly do not mean that, where a regulator’s

control is limited to part of a business, that regulator can justify

anon-compensatory rate on a regulated service by claiming that

revenues from sources outside its control make up the

difference. Thus, the core principle under the total effect test

is that the regulator can claim credit only for revenues that are

under its control and that it is in fact responsible for generating

through restrictions on competition or other uses of its

regulatory power.’

Thus, the FCC’s duty — both under the foregoing principles

and the express directive of section 252 — was to set UNE rates

that would allow the UNE business to generate a sufficient

return to stand on its own. The Act established a new UNE

wholesale business, and section 252’s command that rates be

“just and reasonable” and “based on the cost . . . of providing”

the UNE was directed specifically at ensuring that UNE rates

fully covered the costs of that business. Congress thus intended

that the costs of UNEs be reflected in UNE prices — not in the

prices for other services. For ratemaking purposes, therefore,

the FCC was required to treat the UNE business as a discrete

enterprise and set rates sufficient to allow that enterprise to pay

for itself. Apart from this statutory obligation, the principles

underlying Brooks-Scanion prohibited the FCC from justifying

deficient UNE rates by pointing to other revenues that it could

claim no credit for generating. In any event, looking to

revenues from any other source to make up for deficient UNE

rates would mean creating a new cross-subsidy in rates, an

approach that runs flatly counter to the express congressional

directives elsewhere in the Act to ensure that implicit subsidies

are eliminated. See, e.g., 47 U.S.C. § 254(d), (e); see also

'* The Supreme Court of California applied this principle to strike down

a statutory test for determining the adequacy of insurance rates where the

test “refer[red] to the financial position of the company as a whole, not

merely to the regulated lines of insurance.” Calfarm Ins. Co. v. Deukmejian,

771 P.2d 1247, 1254 (Cal. 1989). The court explained: “If an insurer had

substantial net worth, or significant income from sources unregulated by

[this statute], it might be able to sustain substantial and continuing losses on

regulated insurance without danger of insolvency. In such a case the

continued solvency of the insurer could not suffice to demonstrate that the

regulated rate constitutes a fair return.” Jd.

AT&T Corp., 525 U.S. at 393-94 (section 254 “requires that

[implicit] universal-service subsidies be phased out’”’).

The FCC’s reasoning in paragraphs 736-738 of the Order

flatly contravenes these basic precepts. Incumbents are

engaged in numerous businesses over which the FCC has no

ratemaking authority. These include businesses that have long

been competitive, such as wireless service and yellow pages, as

well as the traditional retail local telephone business, now open

to competition and still under state regulatory jurisdiction. It is

plainly impermissible for the FCC to claim that revenues from

any of these businesses can be counted to offset deficient UNE

rates. Indeed, the FCC expressly acknowledged that, in

evaluating the adequacy of TELRIC rates, it could consider

solely revenues under its jurisdiction. See J.A. 421 (§ 737

n.1756). While vaguely suggesting that “revenues for other

services under [its] jurisdiction” might be counted, id. at 421

( 737), the FCC never identified which revenues those were,

nor could it do so.'*

In the very next paragraph, the FCC did a complete about-

face. Having just acknowledged that it could look only to

revenues under its jurisdiction, the FCC concluded that

TELRIC rates are sufficient because incumbents have not

shown that their overall “financial integrity” will be impaired.

By using that standard, the FCC failed to limit its inquiry to

revenues for which it was responsible and instead sought to _

conscript all of an incumbent’s revenues to cure the obvious

inadequacy of TELRIC rates. This is plainly impermissible.

'S. The primary sources of revenue regulated by the FCC are interstate

access charges and interstate long distance rates. But access charges are set

to compensate incumbents for the cost of transporting interstate traffic over

their local networks. While the FCC has at times suggested that it might

consider adjustments to access charges to address stranded historical costs,

see Universal Service Order 4 230 n.593, it has never raised those charges

to compensate for below-cost UNE rates. Instead, it simply avoided the

issue in its Access Charge Reform Order. See supra p. 12. As for revenues

from incumbent LECs’ nascent entry into interstate long distance markets,

those markets are highly competitive and thus also provide no source of

revenues for the FCC to count.

The FCC thus failed to conduct the inquiry demanded by

Duquesne — whether TELRIC rates for UNEs will preserve

incumbents’ opportunity to recover their past prudent

investment. It sidestepped the issue by applying an improper

standard — whether TELRIC rates are so disastrously deficient

that they will drag an incumbent’s entire enterprise into

financial jeopardy.

2. TELRIC must be evaluated now as a final

agency action that is contrary to the Act.

The FCC’s second effort to avoid any scrutiny of TELRIC

conflates several distinct concepts. The FCC contended below,

and the Eighth Circuit held, that petitioners’ constitutionally

based arguments are somehow not “ripe”; that TELRIC cannot

be evaluated against constitutional standards now because it is

impossible to challenge a rate methodology; and that

petitioners’ claims concerning inherent constitutional defects

in TELRIC should instead be addressed in dozens (or

hundreds) of federal district court actions on review of

individual arbitrations under section 252(e)(6) of the Act.

None of these contentions can withstand scrutiny.

First, assertions that incumbents’ “takings claim” is not

“ripe” are wholly out of place. In this case, petitioners have not

brought a takings claim seeking compensation. Instead, this

action is a petition for review, pursuant to the Administrative

Procedure Act, seeking an evaluation of whether the FCC has

acted unlawfully by promulgating a rule that violates the 1996

Act. The relief petitioners seek is correction of the FCC’s

pricing methodology so that it carries forth Congress’ intent to

provide for recovery of embedded costs through the rates paid

by third-party users. This is thus a challenge to final agency

action, and the petition for review and the constitutional

arguments that underpin it are indisputably ripe for

consideration. It is quintessentially the role of this Court to

review Claims that the agency is not properly implementing its

enabling statute.

Second, to the extent the FCC’s blanket assertions that courts

“cannot review a methodology” are meant to suggest that only

specific sets of rates can be reviewed and that an underlying

methodology is immune from review, that is plainly not the

law. An agency’s selection of a rate methodology is subject to

judicial review — and has always been reviewed — in the same

way as other final agency actions: for compliance with the

governing statute and requirements of reasoned

decisionmaking. Ratemaking is by its nature a teleological

process by which the ratemaker must define the target at the

outset — what costs are required to be recovered under the

statute — and then must develop a methodology reasonably

aimed at achieving that recovery. In other words, ratemaking

requires a regulator to define the acceptable outcome in

advance and to choose a method designed to achieve that end.

And the agency must determine whether the projected outcome

of its methodology meets the statutorily prescribed objective.

See Permian Basin, 390 U.S. at 792; J.A. 420-21 (§ 736)

(acknowledging that, in adopting TELRIC, FCC must “consider

whether the end result of incumbent LEC rates is just and

reasonable”). This requirement is but a specific application of

the broader principle that, when it takes property, the

government must make a “reasonable, certain, and adequate

provision for obtaining compensation at the time of the taking.”

Presault v. ICC, 494 U.S. 1, 11 (1990) (emphasis added)

(internal quotation marks omitted).

This Court has repeatedly entertained challenges to rate

methodologies at the time of their promulgation to determine

whether they were rationally designed and projected to provide

a constitutionally adequate return. In Duquesne, for example,

the Court examined the effect that a new rate method “will”

have. 488 U.S. at 312; accord Hope Natural Gas, 320 U.S. at

603-05; Federal Power Comm'n v. Natural Gas Pipeline Co.,

315 U.S. 575, 596-98 (1942); West v. Chesapeake & Potomac

Tel. Co., 295 U.S. 662, 675-77 (1935); see also Jersey Cent.

Power & Light Co. v. FERC, 810 F.2d 1168, 1178 (D.C. Cir.

1987) (en banc) (under “total effect” test, a court must

determine whether a “rate order may reasonably be expected to

Phe a ASE ALINE I Re 6

maintain financial integrity and attract necessary capital’’)

(emphasis added) (internal quotation marks omitted)."°

Thus, where, as here, a methodology is not designed to

achieve an acceptable outcome, a firm is not relegated solely to

piecemeal attacks on specific rates resulting from the defective

methodology. Rather, the firm may challenge the defective

methodology itself. Were it otherwise, no methodology the

agency put in place — no matter how deliberately non-

compensatory or capricious — could be challenged. The agency

could set compensation by spinning a roulette wheel each year,

and the utility would be limited to annual challenges to the

results produced by the roulette wheel."

Here, as outlined above, the Act must be read, in light of

Duquesne, to provide for recovery of embedded costs.

TELRIC is expressly designed io preclude that recovery.

Nothing more is required for the Court to be able to determine

now that TELRIC does not comply with the Act.

At times, the FCC’s vague claims about “ripeness” seem

intended to suggest that TELRIC cannot be evaluated now

because it is somehow uncertain whether TELRIC will produce

figures higher or lower than historical costs. That is nonsense.

'© The FCC would tur these precedents on their head. Pointing to the fact

that the courts in some of these cases found the methodological errors

inconsequential, the FCC leaps to the grand claim that no methodology may

ever be reviewed. That misses the point: first, the courts were reviewing the

methodology in those cases, and second, where they found subsidiary

mistakes inconsequential it was precisely because they could determine that

the methodologies, despite any possible errors, were still aimed at and were

projected to achieve an acceptable outcome. The Court has never suggested

that a methodology is immune from review when it is designed to produce

inadequate results.

'7 Indeed, the FCC’s wait-and-see mantra begs the question: When is the

“end result” arrived at that makes it possible to evaluate the impact of a

methodology? Apparently, in the FCC’s view, it is arrived at when the

continuing losses mount to the magnitude that they impair the overall

financial integrity of the company. In other words, the FCC’s vague

ripeness claims are merely a repackaging of its erroneous contention that the

government can take incumbents’ property without compensation for as long

as incumbents remain financially viable overall.

The FCC adopted TELRIC with the express purpose of

producing prices lower than historical costs, see supra p. 9, and

applications of TELRIC both in the FCC’s own proxy prices

and in state arbitrations have produced massive discounts

below historical costs, see supra pp. 10-11. In any event,

feigned agnosticism concerning the outcome TELRIC will

produce relative to historical costs, far from providing a reason

to hold judicial review at bay, only highlights another FCC

error. As explained above, an agency charged with ensuring

“just and reasonable” rates has a duty to establish a

methodology designed to produce constitutional compensation.

The FCC cannot avoid its duties by suggesting that, though not

designed to do so, TELRIC might serendipitously end up

covering incumbents’ historical costs in the end. That is the

antithesis of the project Congress demanded. Section 252(d)(1)

requires reasoned decisionmaking, not agnosticism. It requires

shooting at a defined target, not shooting in the dark.

Third, the FCC has also suggested that judicial review must

wait because, even though the FCC has cut the rate base in half

by precluding consideration of historical costs, States in

individual arbitrations might somehow set rates of return at

sufficiently supranormal levels that prices will ultimately cover

historical costs anyway. Thus, the FCC has argued that

incumbents must wait to challenge specific rate determinations

as they arise from individual arbitrations. But the rates that

TELRIC will produce are necessarily unlawful because the

FCC’s Order expressly foreclosed the States from addressing

and rectifying the core defects in TELRIC. The FCC

prohibited setting rates of return with a view to allowing

historical cost recovery. See 47 C.F.R. § 51.505(d)(1). Indeed,

the agency repeatedly stated that setting UNE rates to cover

historical costs would interfere with the FCC’s policy

objectives. See J.A. 398-400 (Y¥ 705-706). The FCC’s order,

moreover, requires the States to start with the existing rate of

return, and places the burden on incumbents to demonstrate

with specificity that the business risks — defined exclusively in

terms of facilities-based entry by competitors — justify any

change in the rate of return. See J.A. 395-96 (§ 702). In short,

SARA IE SINT RINT TE LO LOE LIER GEIB ELE ONT AE LE EER LE SONS BM IY A I . -_

‘

the FCC sharply cabined the States’ discretion to ensure that

they would not adjust the rate of return to produce rates

sufficient to cover historical costs, or otherwise to ensure that

the overall effect of the rates is compensatory. Correction of

the FCC’s methodological errors by the States would thus be

impossible.

Because state commissions cannot correct the central defect

in TELRIC, district court actions under section 252(e)(6) to

review individual arbitrations are simply not a mechanism for

addressing incumbents’ claims. Indeed, the notion that

incumbents’ claims can be shunted off to section 252(e)(6)

cases suffers from a further defect. The district court’s primary

role in a section 252(e)(6) case is reviewing a state arbitration

for compliance with the Act as interpreted by the FCC, not

entertaining challenges to the FCC’s directives. In fact, the

government has argued that, if FCC rules are not struck down

on direct review, they “are no longer subject to further

challenge in district court proceedings under section 252(e)(6),”

Br. for FCC & U.S. at 40 n.14, AT&T Corp. v. lowa Utils. Bd.,

525 U.S. 366 (1999) (No. 97-831), and at least one court of

appeals has agreed, see GTE South Inc. v. Morrison, 199 F.3d

733, 742-43 (4th Cir. 1999).

In addition, it is ironic that the FCC would now hold out the

possibility of state-by-state jiggering of the rate of return as the

cure-all for TELRIC. The suggestion that individual States,

while barred from explicitly considering historical costs, might

nonetheless jury-rig some adjustments to come up with

numbers that cover those costs in the end plainly cannot

salvage TELRIC as a product of reasoned decisionmaking by

the FCC. The FCC, moreover, previously insisted before this

Court that the Act required nationally uniform implementation

and that the sort of state-to-state variation it is now touting

Would lead only to “anticompetitive uncertainties that would

impair effective implementation” of the Act. Br. for FCC &

U.S., supra, at 41. Indeed, the FCC criticized the “protracted

and piecemeal litigation” of section 252(e)(6) actions — which

it now offers as the only avenue for incumbents to raise their

Claims — as a wholly inadequate mechanism for addressing

“fundamental disputes about the core provisions of the 1996

Act.” Jd. at 16.

D. Section 252(d)(1) Should Be Construed To Avoid

the Serious Constitutional Questions TELRIC

Raises.

The Court need not decide that TELRIC violates the

Constitution to grant the petitions for review. Statutes must be

interpreted not only to avoid constitutional violations, but also

to avoid the need to reach serious constitutional questions. It

is the Court’s “settled policy to avoid an interpretation of a

federal statute that engenders constitutional issues if a

reasonable alternative interpretation poses no constitutional

question.” Gomez v. United States, 490 U.S. 858, 864 (1989);

see also Legal Servs. Corp. v. Velazquez, 121 S. Ct. 1043, 1050

(2001); Ashwander v. Tennessee Valley Auth., 297 U.S. 288,

347 (1936) (Brandeis, J., concurring).

This principle of judicial restraint decides this case.

Petitioners maintain that the Act requires using historical costs

for network-element prices. See supra pp. 19-31. It is

indisputable that an interpretation of the word “cost” in section

252(d)(1) that includes historical costs is at least one

permissible reading of the statute. It is also undisputed that

network-element prices that recover historical costs and a

reasonable return are beyond constitutional reproach.

On the other side of the equation, in TELRIC the government

has “switched” ratemaking methodologies in a manner that will

necessarily preclude recovery of significant amounts of prudent

capital investment. In Duquesne, this Court described such a

radical shift in valuation methods in the very language used by

the Ashwander line of cases when it stated that such a shift

“would raise serious constitutional questions.” Duquesne, 488

U.S. at 315. And as explained above, TELRIC surely presents,

at a minimum, serious questions of confiscation of incumbents’

property.

Thus, assuming arguendo that there are two permissible

readings of the words “the cost . . . of providing the . . .

network element” in section 252(d)(1), this Court must choose

the more inclusive reading of the phrase that raises no

constitutional difficulties. The fact that the FCC has chosen the

narrow reading of “cost” as only “economic cost” should bear

no weight in the Court’s analysis. Federal courts do not defer

to constitutionally problematic agency interpretations of

statutes. Indeed, as this Court recently emphasized, “[wJhere

an administrative interpretation of a statute invokes the outer

limits of Congress’ power, we expect a clear indication that

Congress intended that result.” Solid Waste Agency v. U.S.

Army Corps of Eng’rs, 121 S. Ct. 675, 683 (2001). In other

words, there must be an exceedingly clear statement of

congressional desire to test constitutional limits. See id.

(“Congress does not casually authorize administrative agencies

to interpret a statute to push the limit of congressional

authority.”); NLRB v. Catholic Bishop, 440 U.S. 490, 506-07

(1979). Thus, in order to sustain TELRIC, the FCC must

demonstrate that Congress dictated the exclusion of historical

costs from network-element prices. This is a burden that the

agency cannot sustain. To the contrary, the FCC has stated that

the statute “does not specify whether historical or embedded

costs should be considered or whether only forward-looking

costs should be considered” in setting prices for network

elements. J.A. 398-99 (¥ 705). This concession precludes a

finding of the kind of clarity demanded by Solid Waste and

Catholic Bishop.

To sidestep the principle of constitutional avoidance, both

the FCC and the court below have pointed to United States v.

Riverside Bayview Homes, Inc., 474 U.S. 121 (1985), as if that

case established some general exemption from the principle of

avoidance whenever the constitutional issue at stake involves

the Takings Clause. That is simply false. See, e.g., United

States v. Security Indus. Bank, 459 U.S. 70 (1982).

Riverside Bayview involved an agency interpretation of a

statute that, even if applied, would not necessarily have effected

a taking of property. The Court held only that a narrowing

construction is not warranted if there is no “substantial

argument” that application ofa statute “will necessarily or even

probably constitute a taking” in an “identifiable set of

instances.” Riverside Bayview, 474 U.S. at 129 n.5. That

analysis is inapposite here. Here, incumbents are being forced

to turn over pieces of their networks to competitors, a

requirement that plainly accomplishes a taking of their

property. The only question is whether the rates paid by

competitors will provide constitutionally sufficient

compensation to ensure that there is not an

uncompensated taking. Indeed, one factor driving the Court’s

analysis in Riverside Bayview — the availability of a Tucker Act

proceeding to provide compensation for any taking — is

particularly inapplicable here because Congress clearly

intended network-element rates in themselves to provide

compensation, not to create liability for the government under

the Tucker Act. In a case such as this, as the D.C. Circuit has

explained, a narrowing construction is demanded to ensure that

the FCC does not “use statutory silence or ambiguity to expose

the Treasury to liability both massive and unforeseen.” Bell

Atlantic Tel. Cos. v. FCC, 24 F.3d 1441, 1445 (D.C. Cir. 1994).

Ill. THE FCC’S DECISION TO ABANDON

HISTORICAL COSTS WAS CONTRARY TO THE

PURPOSES OF THE ACT AND ARBITRARY AND

CAPRICIOUS.

Apart from its constitutional infirmities, the FCC’s resort to

TELRIC rested on two fundamentally flawed determinations

that undermined the purposes of the Act and that the FCC

wholly failed to support with reasoned explanations.

A. Abandoning Historical Costs Frustrated

Congressional Objectives and Was Not Supported

By Any Rational Explanation.

For decades, historical costs have been used for determining

the rates incumbent LECs receive for dedicating their property

for public use. Indeed, the FCC itself has “strongly espoused”

“the original-cost . . . principle of ratemaking . . . for many

years.” James C. Bonbright et a/., Principles of Public Utility

Rates 212 (2d ed. 1988). Only two years before inventing

TELRIC, in fact, the FCC had rejected a replacement cost

methodology for cable television rates and explained that

“[o}riginal cost is the normal, now traditional method used for

public utility valuation.” Jmplementation of Sections of the

Cable Television Consumer Protection and Competition Act of

1992: Rate Regulation, Report & Order and Further Notice of

Proposed Rulemaking, 9 F.C.C.R. 4527, 4555, 4 55 (1994). In

that order, the FCC heaped criticisms upon replacement cost

methodologies, charging that they are “speculative,”

“contentious,” “unwieldy,” “difficult to apply consistently,”

“likely to produce ratebase values that would not generate

reasonable rates,” “unworkable,” and conducive to “a

contentious exercise in competing opinions.” /d. JJ 55, 62.

Such criticisms are hardly new. Justice Brandeis long ago

observed that replacement cost methodologies are

administratively unworkable because they degenerate into

battles between experts who give opinions “on things that never

happened and estimates requiring the projection of the

engineer’s imagination into the future and methods of

construction and installation that have never been and never

will be adopted by sane men.” Missouri ex rel. Southwestern

Bell Tel. v. Public Serv. Comm'n, 262 U.S. 276, 300 (1923)

(Brandeis, J., joined by Holmes, J., concurring); see also Hon.

Stephen Breyer, Regulation and Its Reform 38-39 (1982) (“[T]o

determine the replacement cost of a plant or equipment is too

complex a task for an administrative process.”’).

The FCC’s own experience abundantly confirms that

TELRIC is an unmanageable project. In the parallel universal

service proceeding, the agency repeatedly concluded that there

simply were no cost models accurate enough to implement

TELRIC. Only after four years of revising and updating

various cost models did the agency finally decide that TELRIC

could be used to project costs accurately. See Universal

Service Order 4] 244-245; Federal-State Joint Board on

Universal Service, Fifth Report & Order, 13 F.C.C.R. 21,323,

§] 3, 60 (1998). And even then the FCC was endorsing

TELRIC solely for determining relative cost comparisons for

purposes of federal universal service support, and admitted that

figures from its TELRIC model “may not be appropriate . . . for

other purposes, such as determ.iing prices for unbundled

network elements.” See Federal-State Joint Board on

Universal Service, Ninth Report & Order, 14 F.C.C.R. 20,432,

9 41 & n. 125 (1999).

A novel cost measure that, if applied with any care,

necessarily entails such difficulties in implementation frustrates

one of the important objectives of the Act — namely, the

“expeditious introduction of competition.” AT&T Corp. v.

Iowa Utils. Bd., 525 U.S. 366, 425 (1999) (Breyer, J.,

concurring in part and dissenting in part). Congress made it

clear that it intended the Act to be implemented swiftly. See 47

U.S.C. § 251(d)(1); id. § 252(b)(1), (e)(4). Saddling that

process with the burdens of implementing a novel price

measure such as TELRIC necessarily would frustrate the goal

of speeding the transition to competition.

The same problems with TELRIC — i.e., the abrupt change it

entailed from the established historical cost methodology, the

FCC’s own criticisms of replacement-cost methodologies, and

the agency’s inability to find a satisfactory mechanism for

implementing the cost measure for four years — also show that

the agency was at least required to provide a cogent

explanation for its decision to abandon historical costs in favor

of TELRIC. See Motor Vehicle Mfrs. Ass'n v. State Farm Mut.

Auto. Ins. Co., 463 U.S. 29, 57 (1983).

But the only reasons the agency gave were wholly

inadequate. To start, the FCC’s only stated reason for

dismissing prior concerns about the workability of forward-

looking cost measures was that “a number of states” had

“already implemented” forward-looking measures for setting

UNE prices. J.A. 381 (4 681). To the extent that the States

cited had adopted forward-looking methodologies applicable to

UNE pricing at all, they had done so in principle and had made

little progress toward implementing the methodologies by

determining costs. This dearth of real-world experience hardly

provided a sound basis for the FCC to conclude that TELRIC

was practicable."

'* See, e.g., Bottleneck Servs. Establishment of a Framework for Network

The FCC also claimed that basing prices on incumbents’

historical costs would promote “inefficient” entry because

incumbents’ costs reflected inefficiencies. But that assertion

was wholly conclusory. Under prevailing regulations,

incumbents’ costs were either reviewed in the past to ensure

that recovery was calibrated to prudent investments, or else

they were regulated under price cap regimes that reduced rates

according to projections of achievable efficiencies. In either

case, simply assuming now that incumbents’ costs are riddled

with inefficiencies runs counter to the determinations inherent

in the existing rate regime. The FCC cannot simply reject those

determinations without providing any rationale for its change

in course. Not only was such an approach arbitrary, but it also

raises a serious due process concern, because changes in rate

regimes that alter the basis for a firm’s recovery demand

procedural due process protections. See, eg., West v.

Chesapeake & Potomac Tel. Co., 295 U.S. 662 (1935).

Moreover, the agency’s blithe assumptions about supposed

incumbent inefficiency are inconsistent with the FCC’s own

contemporaneous position that price-cap regulation of rates was

providing proper incentives for incumbents to operate

efficiently. For a decade, the FCC has taken the view that it has

been ensuring efficiency by reducing incumbents’ rates by a

productivity factor reflecting efficiency savings that reasonably

could be achieved. Indeed, less than a year after announcing

TELRIC, the FCC concluded that a rate reduction of 6.5

percent would reflect reasonable efficiency gains for

incumbents. See /n re Price Cap Performance Review for

Local Exchange Carriers, Fourth Report & Order, 12 F.C.C.R.

16,642, J 1 (1997), rev'd in part, USTA v. FCC, 188 F.3d 521,

526-27 (D.C. Cir, 1999) (striking down even 6.5% as

Architecture Development of Dominant Carrier Networks, Slip Op., R.93-

04-003, 1.93-04-002, Dec. 95-12-016, 62 CPUC2d 575 (Cal. PUC Dec. 6,

1995); Proposed Rules Regarding Implementation of §§ 40-1 5-101 et seq. -

Requirements Relating to Interconnection and Unbundling, Decision

Adopting Rules, Docket No. 95R-556T, Decision No. C96-347 (Colo. PUC

Mar. 29, 1996).

unjustifiedly high). That squarely contradicts the implication,

inherent in the adoption of hypothetical TELRIC projections,

that 50% discounts from incumbents’ costs are necessary to

reflect efficient levels.

B. The FCC’s Effort To “Mimic” Competitive

Outcomes Frustrates the Purposes of the Act.

The very goal the FCC set for itself in TELRIC — attempting

to project the costs of an impossibly idealized, least-cost, most-

efficient carrier — frustrated the objectives of the Act by short-

circuiting the process of competition the Act was intended to

set in motion. Congress envisioned a system in which entrants

achieved efficiencies and introduced innovations that gradually

created the genuine benefits of a competitive market, not a

system that decreed the supposed benefits of competition

(lower prices) by regulatory fiat. As Justice Breyer has noted:

The competition that the Act seeks is a process, not an

end result; and a regulatory system that imposes through

administrative mandate a set of prices that tries to

mimic those that competition would have set does not

thereby become any the less a regulatory process, nor

any the more a competitive one.

AT&T Corp., 525 U.S. at 424 (Breyer, J., concurring in part and

dissenting in part).

The FCC’s economic rationales for TELRIC also suffered

from further flaws. First, even if it were correct that prices

should reflect an accurate measure of forward-looking costs,

incumbents’ historical costs — the amounts actually expended

in building the network — are a far better measure of those costs

than is TELRIC. As will be explained in our brief in response

to the FCC’s appeal in No. 00-587, TELRIC’s false

assumptions about how any market would work result in

unrealistic projections even as a forward-looking cost

methodology.

Second, the FCC provided no basis for its assertions that

prices based on historical costs would foster “inefficient” entry.

Beyond its unexplained assumption that incumbents were

inefficient, the FCC offered no reason to explain why, even if

historical-cost prices were higher, inefficient competitors

would be induced to enter the market. A potential entrant

would evaluate its prospects of competing not only against the

incumbent, but also against its best estimate of efficient

competing entrants.

Third, the FCC ignored the threat to genuine competition

from UNE prices that are too /ow. If prices are too low — as

they are with TELRIC’s unattainable assumptions — network

elements become an irresistible option for entrants and will

choke off facilities-based entry. It would be irrational for

entrants to deploy new facilities if they could purchase UNEs

at prices below any costs they could hope to achieve.

Finally, as Professor Kahn has explained, the FCC ignored a

further compelling efficiency reason for retaining the

historical-cost method: “Entirely apart from the inescapable

question of equity that [denying recovery of historical costs]

would raise, it is a reasonable economic (as well, perhaps, as

constitutional) question whether a market system can survive

if governments feel free opportunistically to change the rules of

the regulatory game at the expense of investors, when it is

temporarily to the advantage of consumers to do so.”

Declaration of Alfred E. Kahn and Timothy J. Tardiff, ¥ 13,

J.A. 160-61, submitted with Reply Comments of Bell Atlantic,

In re Implementation of the Local Competition Provisions in

the Telecommunications Act of 1996, CC Docket No. 96-98

(filed May 30, 1996). Investments made today under a

TELRIC pricing regime will become tomorrow’s sunk,

historical investments, and as one of AT&T’s own economists

concedes, the failure to allow recovery of stranded historical

costs can produce “disincentive[s] for future investment.”

William J. Baumol & J. Gregory Sidak, Stranded Costs, 18

Harv. J.L. & Pub. Pol’y 835, 836 (1995).

CONCLUSION

For the foregoing reasons, the judgment of the court of

appeals should be reversed insofar as it permitted the FCC to

preclude recovery of historical costs under section 252(d)(1).

MARK L. EVANS

MICHAEL K. KELLOGG

HENK BRANDS

KELLOGG, HUBER, HANSEN,

TODD & EVANS, P.L.L.C.

1650 M Street, N.W.

Washington, D.C. 20036

(202) 326-7900

Counsel for

BellSouth Corporation,

SBC-Communications Inc.,

United States Telecom -

Association, and Verizon

Entities

CHARLES R. MORGAN

JAMES G. HARRALSON

BELLSOUTH CORPORATION

1155 Peachtree Street, N.E.

Atlanta, GA 30309

(404) 249-2641

Counsel for

BellSouth Corporation

Respectfully submitted,

WILLIAM P. BARR

M. EDWARD WHELAN

VERIZON

1850 M Street, N.W.

Washington, D.C. 20036

(202) 463-5200

PATRICK F. PHILBIN

Counsel of Record

JENNIFER R. BROSNAHAN

KIRKLAND & ELLIS

655 Fifteenth Street, N.W.

Washington, D.C. 20005

(202) 879-5000

MICHAEL E. GLOVER

VERIZON

1320 N. Courthouse Rd.

Arlington, VA 22201

(703) 974-2944

Counsel for Verizon Entities

ANDREW G. MCBRIDE

SCOTT DELACOURT

WILEY, REIN & FIELDING

1776 K STREET, N.W.

WASHINGTON, D.C. 20006

(202) 719-7135

HENRY WEISSMANN

MUNGER, TOLLES &

OLSON LLP

355 SOUTH GRAND AVENUE

Los ANGELES, CA 90071

(213) 683-9100

Counsel for Verizon Entities

April 9, 2001

JAMES D. ELLIS

PAUL K. MANCINI

SBC COMMUNICATIONS INC.

175 E. Houston

San Antonio, Texas 78205

(210) 351-3500

ROGER K. TOPPINS

GARY PHILLIPS

SBC COMMUNICATIONS INC.

1401 I Street, N.W.

Suite 1100

Washington, D.C. 20005

(202) 326-8891

Counsel for

SBC Communications Inc.

LAWRENCE E. SARJEANT

LINDA L. KENT

KEITH TOWNSEND

JOHN W. HUNTER

JULIE E. RONES

UNITED STATES TELECOM

ASSOCIATION

1401 H Street, N.W.

Suite 600

Washington, D.C. 20005

(202) 326-7371

Counsel for United States

Telecom Association

ADDENDUM

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SEC. 251. [47 U.S.C. 251] INTERCONNECTION,

(a) GENERAL DuTy OF TELECOMMUNICATIONS

CARRIERS.—Each telecommunications carrier has the duty—

(1) to interconnect directly or indirectly with the

facilities and equipment of other telecommunications

carriers; and

(2) not to install network features, functions, or

capabilities that do not comply with the guidelines and

standards established pursuant to section 255 or 256.

(b) OBLIGATIONS OF ALL LOCAL EXCHANGE

CARRIERS.—Each local exchange carrier has the following

duties:

(1) RESALE.—The duty not to prohibit, and not to

impose unreasonable or discriminatory conditions or

limitations on, the resale of its telecommunications

services.

(2) NUMBER PORTABILITY.—The duty to provide,

to the extent technically feasible, number portability in

accordance with requirements prescribed by the

Commission.

(3) DIALING PARITY.-The duty to provide

dialing parity to competing providers of telephone

exchange service and telephone toll service, and the

duty to permit all such providers to have

nondiscriminatory access to telephone numbers,

operator services, directory assistance, and directory

listing, with no unreasonable dialing delays.

(4) ACCESS TO RIGHTS-OF-WAY.—The duty to

afford access to the poles, ducts, conduits, and rights-of-

way of such carrier tec competing providers of

telecommunications services on rates, terms, and

conditions that are consistent with section 224.

(5) RECIPROCAL COMPENSATION.—The duty to

establish reciprocal compensation arrangements for the

transport and termination of telecommunications.

(3) UNBUNDLED ACCESS.—The duty to provide,

to any requesting telecommunications carrier for the

provision of a _ telecommunications service,

nondiscriminatory access to network elements on an

EXCHANGE CARRIERS.—In addition to the duties contained in unbundled basis at any technically feasible point on

subsection (b), each incumbent local exchange carrier has the rates, terms, and conditions that are just, reasonable, and

following duties: nondiscriminatory in accordance with the terms and

(1) DUTY TO NEGOTIATE.—The duty to negotiate

in good faith in accordance with section 252 the

particular terms and conditions of agreements to fulfill

the duties described in paragraphs (1) through (5) of

subsection (b) and this subsection. The requesting

telecommunications carrier also has the duty to

negotiate in good faith the terms and conditions of such

agreements.

(2) INTERCONNECTION.—The duty to provide, for

the facilities and equipment of any requesting

telecommunications carrier, interconnection with the

local exchange carrier’s network—

(A) for the transmission and routing of

telephone exchange service and exchange

access;

(B) at any technically feasible point

within the carrier’s network;

provided by the local exchange carrier to itself

or to any subsidiary, affiliate, or any other party

to which the carrier provides interconnection;

and

(D) on rates, terms, and conditions that

are just, reasonable, and nondiscriminatory, in

accordance with the terms and conditions of the

agreement and the requirements of this section

and section 252.

conditions of the agreement and the requirements of this

section and section 252. An incumbent local exchange

carrier shall provide such unbund!ed network elements

in a manner that allows requesting carriers to combine

such elements in order to provide such

telecommunications service.

(4) RESALE.—The duty—

(A) to offer for resale at wholesale rates

any telecommunications service that the carrier

provides at retail to subscribers who are not

telecommunications carriers; and

(B) not to prohibit, and not to impose

unreasonable or discriminatory conditions or

limitations on, the resale of such

telecommunications service, except that a State

commission may, consistent with regulations

prescribed by the Commission under this

section, prohibit a reseller that obtains at

wholesale rates a telecommunications service

that is available at retail only to a category of

subscribers from offering such service to a

different category of subscribers.

(5) NOTICE OF CHANGES.—The duty to provide

reasonable public notice of changes in the information

necessary for the transmission and routing of services

using that local exchange carrier’s facilities or

networks, as well as of any other changes that would

affect the interoperability of those facilities and

networks.

(6) COLLOCATION.—The duty to provide, on

rates, terms, and conditions that are just, reasonable, and

nondiscriminatory, for physical collocation of

equipment necessary for interconnection or access to

unbundled network elements at the premises of the local

exchange carrier, except that the carrier may provide for

virtual collocation if the local exchange carrier

demonstrates to the State commission that physical

collocation is not practical for technical reasons or

because of space limitations.

(d) IMPLEMENTATION.—

(1) INGENERAL.—Within 6 months after the date

of enactment of the Telecommunications Act of 1996,

the Commission shall complete all actions necessary to

establish regulations to implement the requirements of

this section.

(2) ACCESS STANDARDS.—In determining what

network elements should be made available for

purposes of subsection (c)(3), the Commission shall

consider, at a minimum, whether—

(A) access to such network elements as

are proprietary in nature is necessary; and

(B) the failure to provide access to such

network elements would impair the ability of

the telecommunications carriers seeking access

to provide the services that it seeks to offer.

(3) PRESERVATION OF STATE ACCESS

REGULATIONS.~In prescribing and enforcing regulations

to implement the requirements of this section, the

Commission shall not preclude the enforcement of any

regulation, order, or policy of a State commission that-

(A) establishes access and

interconnection obligations of local exchange

carriers;

(B) is consistent with the requirements

of this section; and

implementation of the requirements of this

section and the purposes of this part.

(e) NUMBERING ADMINISTRATION.—

(1) COMMISSION AUTHORITY AND

JURISDICTION.-The Commission shall create or

designate one or more impartial entities to administer

telecommunications numbering and to make such

numbers available on an equitable basis. The

Commission shall have exclusive jurisdiction over those

portions of the North American Numbering Plan that

pertain to the United States. Nothing in this paragraph

shall preclude the Commission from delegating to State

commissions or other entities all or any portion of such

jurisdiction.

(2) Costs.-The cost of establishing

telecommunications numbering administration

arrangements and number portability shall be borne by

all telecommunications carriers on a competitively

neutral basis as determined by the Commission.

(f) EXEMPTIONS, SUSPENSIONS, AND MODIFICATIONS.—

(1) EXEMPTION FOR CERTAIN RURAL TELEPHONE

COMPANIES.—

(A) EXEMPTION.—Subsection (c) of this

section shall not apply to a rural telephone

company until (i) such company has received a

bona fide request for interconnection, services,

or network elements, and (ii) the State

commission determines (under subparagraph

(B)) that such recuest is not unduly

economically burdensome, is_ technically

feasible, and is consistent with section 254

(other than subsections (b)(7) and (c)(1)(D)

thereof).

(B) STATE TERMINATION OF EXEMPTION

AND IMPLEMENTATION SCHEDULE.~—The party

making a bona fide request of a rural telephone

company for interconnection, services, or

network elements shall submit a notice of its

request to the State commission. The State

commission shall conduct an inquiry for the

purpose of determining whether to terminate the

exemption under subparagraph (A). Within 120

days after the State commission receives notice

of the request, the State commission shall

terminate the exemption if the request is not

unduly economically burdensome, is technically

feasible, and is consistent with section 254

(other than subsections (b)(7) and (c)(1)(D)

thereof). Upon termination of the exemption, a

State commission shall establish an

implementation schedule for compliance with

the request that is consistent in time and manner

with Commission regulations.

exemption provided by this paragraph shall not

apply with respect to a request under subsection

programming, and seeking to provide any

telecommunications service, in the area in

which the rural telephone company provides

video programming. The limitation contained

in this subparagraph shall not apply to a rural

telephone company that is providing video

programming on the date of enactment of the

Telecommunications Act of 1996.

(2) SUSPENSIONS AND MODIFICATIONS FOR

RURAL CARRIERS.~A local exchange carrier with fewer

than 2 percent of the Nation’s subscriber lines installed

in the aggregate nationwide may petition a State

commission for a suspension or modification of the

application of a requirement or requirements of

subsection (b) or (c) to telephone exchange service

facilities specified in such petition. The State

commission shall grant such petition to the extent that,

and for such duration as, the State commission

determines that such suspension or modification—

(A) is necessary—

(i) to avoid a significant adverse

economic impact on users of

telecommunications services generally;

(ii) to avoid imposing a

requirement that is unduly economically

burdensome; or

(ili) to avoid imposing a

requirement that is_ technically

infeasible; and

(B) is consistent with the public interest,

convenience, and necessity.

The State commission shall act upon any petition filed

under this paragraph within 100 days after receiving

such petition. Pending such action, the State

commission may suspend enforcement of the

requirement or requirements to which the petition

applies with respect to the petitioning carrier or carriers.

(g) CONTINUED ENFORCEMENT OF EXCHANGE ACCESS

AND INTERCONNECTION REQUIREMENTS.—On and after the date

of enactment of the Telecommunications Act of 1996, each

local exchange carrier, to the extent that it provides wireline

services, shall provide exchange access information access, and

exchange services for such access to interexchange carriers and

information service providers in accordance with the same

equal access and nondiscriminatory interconnection restrictions

and obligations (including receipt of compensation) that apply

to such carrier on the date immediately preceding the date of

enactment of the Telecommunications Act of 1996 under any

court order, consent decree, or regulation, order, or policy of the

Commission, until such restrictions and obligations are

explicitly superseded by regulations prescribed by the

Commission after such date of enactment. During the period

beg :s«ing on such date of enactment and until such restrictions

and obligations are so superseded, such restrictions and

obligations shall be enforceable in the same manner as

regulations of the Commission.

(h) DEFINITION OF INCUMBENT LOCAL EXCHANGE

CARRIER.—

(1) DEFINITION.—-For purposes of this section,

the term “incumbent local exchange carrier" means,

with respect to an area, the local exchange carrier that-

(A) on the date of enactment of the

Telecommunications Act of 1996, provided

telephone exchange service in such area; and

(B)(i) on such date of enactment, was

- deemed to be a member of the exchange carrier

association pursuant to section 69.601(b) of the

Commission’s regulations (47 C.F.R.

69.601(b)); or

(ii) is a person or entity that, on or after

such date of enactment, became a successor or

assign of a member described in clause (i).

(2) TREATMENT OF COMPARABLE CARRIERS AS

INCUMBENTS.—The Commission may, by rule, provide

for treatment of a local exchange carrier (or class or

category thereof) as an incumbent local exchange carrier

for purposes of this section if—

(A) such carrier occupies a position in

the market for telephone exchange service

within an area that is comparable to the position

occupied by a carrier described in paragraph (1);

(B) such carrier has substantially

replaced an incumbent local exchange carrier

described in paragraph (1); and

public interest, convenience, and necessity and

the purposes of this section.

(i) SAVINGS PROVISION.—Nothing in this section shall be

construed to limit or otherwise affect the Commission’s

authority under section 201.

SEC. 252. [47 U.S.C. 252] PROCEDURES FOR

NEGOTIATION, ARBITRATION, AND APPROVAL OF

AGREEMENTS.

(a) AGREEMENTS ARRIVED AT THROUGH

NEGOTIATION.—

(1) VOLUNTARY NEGOTIATIONS.—Upon

receiving a request for interconnection, services, or

network elements pursuant to section 251, an incumbent

local exchange carrier may negotiate and enter irto a

binding agreement with the requesting

telecommunications carrier or carriers without regard to

the standards set forth in subsections (b) and (c) of

section 251. The agreement shall include a detailed

schedule of itemized charges for interconnection and

10a

each service or network element included in the

agreement. The agreement, including any

interconnection agreement negotiated before the date of

enactment of the Telecommunications Act of 1996,

shall be submitted to the State commission under

subsection (e) of this section.

(2) MEDIATION.—Any party negotiating an

agreement under this section may, at any point in the

negotiation, ask a State commission to participate in the

negotiation and to mediate any differences arising in the

course of the negotiation.

(b) AGREEMENTS ARRIVED AT THROUGH COMPULSORY

ARBITRATION.—

(1) ARBITRATION.—During the period from the

135th to the 160th day (inclusive) after the date on

which an incumbent local exchange carrier receives a

request for negotiation under this section, the carrier or

any other party to the negotiation may petition a State

commission to arbitrate any open issues.

(2) DUTY OF PETITIONER.—

(A) A party that petitions a State

commission under paragraph (1) shall, at the

same time as it submits the petition, provide the

State commission all relevant documentation

concerning—

(i) the unresolved issues;

(ii) the position of each of the

parties with respect to those issues; and

(iii) any other issue discussed

and resolved by the parties.

(B) A party petitioning a State

commission under paragraph (1) shall provide a

copy of the petition and any documentation to

the other party or parties not later than the day

lla

on which the State commission receives the

petition.

(3) OPPORTUNITY TO RESPOND.—A_ non-

petitioning party to a negotiation under this section may

respond to the other party’s petition and provide such

additional information as it wishes within 25 days after

the State commission receives the petition.

(4) ACTION BY STATE COMMISSION.—

(A) The State commission shall limit its

consideration of any petition under paragraph

(1) (and any response thereto) to the issues set

forth in the petition and in the response, if any,

filed under paragraph (3).

(B) The State commission may require

the petitioning party and the responding party to

provide such information as may be necessary

for the State commission to reach a decision on

the unresolved issues. If any party refuses or

fails unreasonably to respond on a timely basis

to any reasonable request from the State

commission, then the State commission may

proceed on the basis of the best information

available to it from whatever source derived.

each issue set forth in the petition and the

response, if any, by imposing appropriate

conditions as required to implement subsection

conclude the resolution of any unresolved issues

not later than 9 months after the date on which

the local exchange carrier received the request

under this section.

(5) REFUSAL TO NEGOTIATE.—The refusal of any

other party to the negotiation to participate further in the

12a 13a

negotiations, to cooperate with the State commission in (B) may include a reasonable profit.

carrying out its function as an arbitrator, or to continue (2) CHARGES FOR TRANSPORT AND

to negotiate in good faith in the presence, or with the TERMINATION OF TRAFFIC.—

assistance, of the State commission shall be considered (A) IN GENERAL.—For the purposes of

a failure to negotiate in good faith. compliance by an incumbent local exchange

arbitration under subsection (b) any open issues and imposing commission shall not consider the terms and

conditions upon the parties to the agreement, a State conditions for reciprocal compensation to be

(1) ensure that such resolution and conditions

meet the requirements of section 251, including the

regulations prescribed by the Commission pursuant to

section 251;

(2) establish any rates for interconnection,

services, or network elements according to subsection

(d); and

(3) provide a schedule for implementation of the

terms and conditions by the parties to the agreement.

(d) PRICING STANDARDS.—

(1) INTERCONNECTION AND NETWORK ELEMENT

CHARGES.—Determinations by a State commission of the

just and reasonable rate for the interconnection of

facilities and equipment for purposes of subsection

(c)(2) of section 251, and the just and reasonable rate

for network elements for purposes of subsection (c)(3)

of such section—

(A) shall be-

(i) based on the cost (determined

without reference to a rate-of-return or

other rate-based proceeding) of

providing the interconnection or

network element (whichever is

applicable), and

(ii) nondiscriminatory, and

commission shall— just and reasonable unless—

(i) such terms and conditions

provide for the mutual and reciprocal

recovery by each carrier of costs

associated with the transport and

termination on each carrier’s network

facilities of calls that originate on the

network facilities of the other carrier;

and

(ii) such terms and conditions

determine such costs on the basis of a

reasonable approximation of the

additional costs of terminating such

calls.

(B) RULES OF CONSTRUCTION.—This

paragraph shall not be construed—

(i) to preclude arrangements that

afford the mutual recovery of costs

through the offsetting of reciprocal

obligations, including arrangements that

waive mutual recovery (such as bill-and-

keep arrangements); or

(ii) to authorize the Commission

or any State commission to engage in

any rate regulation proceeding to

establish with particularity the

l4a

additional costs of transporting or

terminating calls, or to require carriers

t& maintain records with respect to the

additional costs of such calls.

(3) WHOLESALE PRICES FOR

TELECOMMUNICATIONS SERVICES.—For the purposes of

section 251(c)(4), a State commissin~ shall determine

wholesale rates on the basis of retai! »ates charged to

subscribers for the telecommunication service

requested, excluding the portion thereof attributable to

any marketing, billing, collection, and other costs that

will be avoided by the local exchange carrier.

(ce) APPROVAL By STATE COMMISSION.—

(1) APPROVAL REQUIRED.—Any interconnection

agreement adopted by negotiation or arbitration shall be

submitted for approval to the State commission. A

State commission to which anagreement is submitted

shall approve or reject the agreement, with written

findings as to any deficiencies.

(2) GROUNDS FOR REJECTION.—The State

commission may only reject—

(A) an agreement {or any portion

thereof) adopted by negotiation under

subsection (a) if it finds that—

(i) the agreement (or portion

thereof) discriminates against a

telecommunications carrier not a party

to the agreement; or

(ii) the implementation of such

agreement or portion is not consistent

with the public interest, convenience,

and necessity; or

(B) an agreement (or any portion

thereof) adopted by arbitration under subsection

1Sa

(b) if it finds that the agreement does not meet

the requirements of section 251, including the

regulations prescribed by the Commission

pursuant to section 251, or the standards set

forth in subsection (d) of this section.

(3) PRESERVATION OF

AUTHORITY .—Notwithstanding paragraph (2), but

subject to section 253, nothing in this section shall

prohibit a State commission from establishing or

enforcing other requirements of State law in its review

of an agreement, including requiring compliance with

intrastate telecommunications service quality standards

or requirements.

(4) SCHEDULE FOR DECISION.-If the State

commission does not act to approve or reject the

agreement within 90 days after submission by the

parties of an agreement adopted by negotiation under

subsection (a), or within 30 days after submission by the

parties of an agreement adopted by arbitration under

subsection (b), the agreement shall be deemed

approved. No State court shall have jurisdiction to

review the action of a State commission in approving or

rejecting an agreement under this section.

(5) COMMISSION TO ACT IF STATE WILL NOT

ACT.-If a State commission fails to act to carry out its

responsibility under this section in any proceeding or

other matter under this section, then the Commission

shall issue an order preempting the State commission's

jurisdiction of that proceeding or matter within 90 days

after being notified (or taking notice) of such failure,

and shall assume the responsibility of the State

commission under this section with respect to the

proceeding or matter and act for the State commission.

16a

(6) REVIEW OF STATE COMMISSION ACTIONS.—In

a case in which a State fails to act as described in

paragraph (5), the proceeding by the Commission under

such paragraph and any judicial review of the

Commission's actions shall be the exclusive remedies

for a State commission’s failure to act. In any case in

which a State commission makes a determination under

this section, any party aggrieved by such determination

may bring an action in an appropriate Federal district

court to determine whether the agreement or statement

meets the requirements of section 251 and this section.

(f) STATEMENTS OF GENERALLY AVAILABLE TERMS.—

(1) INGENERAL.—A Bell operating company may

prepare and file with a State commission a statement of

the terms and conditions that such company generally

offers within that State to comply with the requirements

of section 25] and the regulations thereunder and the

standards applicable under this section.

(2) STATE COMMISSION REVIEW.-A State

commission may not approve such statement unless

such statement complies with subsection (d) of this

section and section 251 and the regulations thereunder.

Except as provided in section 253, nothing in this

section shall prohibit a State commission from

establishing or enforcing other requirements of State

law in its review of such statement, including requiring

compliance with intrastate telecommunications service

quality standards or requirements.

(3) SCHEDULE FOR REVIEW.—The State

commission to which a statement is submitted shall, not

later than 60 days after the date of such submission—

(A) complete the review of such

statement under paragraph (2) (including any

reconsideration thereof), unless the submitting

17a

Carrier agrees to an extension of the period for

such review; or

(B) permit such statement to take effect.

(4) AUTHORITY TO CONTINUE

REVIEW.—Paragraph (3) shall not preclude the State

commission from continuing to review a statement that

has been permitted to take effect under subparagraph

(B) of such paragraph or from approving or

disapproving such statement under paragraph (2).

(5) DUTY TO NEGOTIATE NOT AFFECTED.—The

submission or approval of a statement under this

subsection shall not relieve a Bell operating company of

its duty to negotiate the terms and conditions of an

agreement under section 251.

(g) CONSOLIDATION OF STATE PROCEEDINGS.~Where

not inconsistent with the requirements of this Act, a State

commission may, to the extent practical, consolidate

proceedings under sections 214(e), 251(f), 253, and this section

in order to reduce administrative burdens on

telecommunications carriers, other parties to the proceedings,

and the State commission in carrying out its responsibilities

under this Act.

(h) FILING REQUIRED.—A State commission shall make

a copy of each agreement approved under subsection (e) and

each statement approved under subsection (f) available for

public inspection and copying within 10 days after the

agreement or statement is approved. The State commission

may charge a reasonable and nondiscriminatory fee to the

parties to the agreement or the party filing the statement to

cover the costs of approving and filing such agreement or

statement.

(i) AVAILABILITY TO OTHER TELECOMMUNICATIONS

CARRIERS.-A local exchange carrier shall make available any

interconnection, service, or network element provided under an

18a

agreement approved under this section to which it is a party to

any other requesting telecommunications carrier upon the same

terms and conditions as those provided in the agreement.

(j) DEFINITION OF INCUMBENT LOCAL EXCHANGE

CARRIER.—For purposes of this section, the term "incumbent

local exchange carrier" has the meaning provided in section

251(h).

SEC. 253. [47 U.S.C. 253] REMOVAL OF BARRIERS TO

ENTRY.

(a) INGENERAL.-No State or local statute or regulation,

or other State or local legal requirement, may prohibit or have

the effect of prohibiting the ability of any entity to provide any

interstate or intrastate telecommunications service.

(b) STATE REGULATORY AUTHORITY.-Nothing in this

section shall affect the ability of a State to impose, on a

competitively neutral basis and consistent with section 254 of

this section, requirements necessary to preserve and advance

universal service, protect the public safety and welfare, ensure

the continued quality of telecommunications services, and

safeguard the rights of consumers.

AUTHORITY.-Nothing in this section affects the authority of a

State or local government to manage the public rights-of-way

or to require fair and reasonable compensation from

telecommunications providers, on a competitively neutral and

nondiscriminatory basis, for use of public rights-of-way on a

nondiscriminatory basis, if the compensation required is

publicly disclosed by such government.

(d) PREEMPTION.-If, after notice and an opportunity for

public comment, the Commission determines that a State or

local government has permitted or imposed any statute,

regulation, or legal requirement that violates subsection (a) or

19a

(b) of this section, the Commission shall preempt the

enforcement of such statute, regulation, or legal requirement to

the extent necessary to correct such violation or inconsistency.

(e) COMMERCIAL MOBILE SERVICE

PROVIDERS.-Nothing in this section shall affect the application

of section 332(c)(3) of this title to commercial mobile service

providers.

(f) RURAL MARKETS.-~It shall not be a violation of this

section for a State to require a telecommunications carrier that

seeks to provide telephone exchange service or exchange access

in a service area served by a rural telephone company to meet

the requirements in section 214(e)(1) of this title for designation

as an eligible telecommunications carrier for that area before

being permitted to provide such service. This subsection shall

not apply—

(1) to a service area served by a rural telephone

company that has obtained an exemption, suspension, or

modification of section 251(c)(4) of this title that

effectively prevents a competitor from meeting the

requirements of section 214(e)(1) of this title; and

(2) to a provider of commercial mobile services.

SEC. 254, [47 U.S.C. 254] UNIVERSAL SERVICE.

(a) PROCEDURES TO REVIEW UNIVERSAL SERVICE

REQUIREMENTS.~

(1) FEDERAL-STATE JOINT BOARD ON

UNIVERSAL SERVICE.-Within one month after February

8, 1996, the Commission shall institute and refer to a

Federal-State Joint Board under section 410(c) of this

title a proceeding to recommend changes to any of its

regulations in order to implement sections 214(e) of this

title and this section, including the definition of the

services that are supported by Federal universal service

20a

support mechanisms and a specific timetable for

completion of such recommendations. In addition to

the members of the Joint Board required under section

410(c) of this title, one member of such Joint Board

shall be a State-appointed utility consumer advocate

nominated by a national organization of State utility

consumer advocates. The Joint Board shall, after notice

and opportunity for public comment, make its

recommendations to the Commission 9 months after

February 8, 1996.

(2) COMMISSION ACTION.-The Commission

shall initiate a single proceeding to implement the

recommendations from the Joint Board required by

paragraph (1) and shall complete such proceeding

within 15 months after February 8, 1996. The rules

established by such proceeding shall include a

definition of the services that are supported by Federal

universal service support mechanisms and a specific

timetable for implementation. Thereafter, the

Commission shall complete any proceeding to

implement subsequent recommendations from any Joint

Board on universal service within one year after

receiving such recommendations.

(b) UNIVERSAL SERVICE PRINCIPLES.-The Joint Board

and the Commission shall base policies for the preservation and

advancement of universal service on the following principles:

(1) QUALITY AND RATES.-Quality services

should be available at just, reasonable, and affordable

rates.

(2) ACCESS TO ADVANCED SERVICES.~Access to

advanced telecommunications and information services

should be provided in all regions of the Nation.

(3) ACCESS IN RURAL AND HIGH COST AREAS.-

Consumers in all regions of the Nation, including low-

2la

income consumers and those in rural, insular, and high

cost areas, should have access to telecommunications

and information services, including interexchange

services and advanced telecommunications and

information services, that are reasonably comparable to

those services provided in urban areas and that are

available at rates that are reasonably comparable to rates

charged for similar services in urban areas.

(4) EQUITABLE AND NONDISCRIMINATORY

CONTRIBUTIONS.~All providers of telecommunications

services should make an equitable and

nondiscriminatory contribution to the preservation and

advancement of universal service.

(5) SPECIFIC AND PREDICTABLE SUPPORT

MECHANISMS.-There should be specific, predictable and

sufficient Federal and State mechanisms to preserve and

advance universal service.

(6) ACCESS TO ADVANCED

TELECOMMUNICATIONS SERVICES FOR SCHOOLS,

HEALTH CARE, AND LIBRARIES.-Elementary and

secondary schools and classrooms, health care

providers, and libraries should have access to advanced

telecommunications services as described in subsection

(h) of this section.

(7) ADDITIONAL PRINCIPLES.-Such other

principles as the Joint Board and the Commission

determine are necessary and appropriate for the

protection of the public interest, convenience, and

necessity and are consistent with this chapter.

(1) IN GENERAL.-Universal service is an

evolving level of telecommunications services that the

Commission shall establish periodically under this

section, taking into account advances in

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telecommunications and information technologies and

services. The Joint Board in recommending, and the

Commission in establishing, the definition of the

services that are supported by Federal universal service

support mechanisms shall consider the extent to which

such telecommunications services—

(A) are essential to education, public

health, or public safety;

(B) have, through the operation of

market choices by customers, been subscribed

to by a substantial majority of residential

customers;

telecommunications networks by

telecommunications carriers; and

(D) are consistent with the public

interest, convenience, and necessity.

(2) ALTERATIONS AND MODIFICATIONS.-The

Joint Board may, from time to time, recommend to the

Commission modifications in the definition of the

services that are supported by Federal universal service

support mechanisms.

(3) SPECIAL SERVICES.-In addition to the

services included in the definition of universal service

under paragraph (1), the Commission may designate

additional services for such support mechanisms for

schools, libraries; and health care providers for the

purposes of subsection (h) of this section.

(d) TELECOMMUNICATIONS CARRIER

CONTRIBUTION.-Every telecommunications carrier that

provides interstate telecommunications services shall

contribute, on an equitable and nondiscriminatory basis, to the

specific, predictable, and sufficient mechanisms established by

the Commission to preserve and advance universal service. The

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Commission may exempt a carrier or class of carriers from this

requirement if the carrier’s telecommunications activities are

limited to such an extent that the level of such carrier’s

contribution to the preservation and advancement of universal

service would be de minimis. Any other provider of interstate

telecommunications may be required to contribute to the

preservation and advancement of universal service if the public

interest so requires.

(e) UNIVERSAL SERVICE SUPPORT.-After the date on

which Commission regulations implementing this section take

effect, only an eligible telecommunications carrier designated

under section 214(e) of this title shall be eligible to receive

specific Federal universal service support. A carrier that

receives such support shall use that support only for the

provision, maintenance, and upgrading of facilities and services

for which the support is intended. Any such support should be

explicit and sufficient to achieve the purposes of this section.

(f) STATE AUTHORITY.-A State may adopt regulations

not inconsistent with the Commission’s rules to preserve and

advance universal service. Every telecommunications carrier

that provides intrastate telecommunications services shall

contribute, on an equitable and nondiscriminatory basis, in a

manner determined by the State to the preservation and

advancement of universal service in that State. A State may

adopt regulations to provide for additional definitions and

standards to preserve and advance universal service within that

State only to the extent that such regulations adopt additional

specific, predictable, and sufficient mechanisms to support such

definitions or standards that do not rely on or burden Federal

universal service support mechanisms.

(g) INTEREXCHANGE AND INTERSTATE

SERVICES.-Within 6 months after February 8, 1996, the

Commission shall adopt rules to require that the rates charged

by providers of interexchange telecommunications services to

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subscribers in rural and high cost areas shall be no higher than

the rates charged by each such provider to its subscribers in

urban areas. Such rules shall also require that a provider of

interstate interexchange telecommunications services shall

provide such services to its subscribers in each State at rates no

higher than the rates charged to its subscribers in any other

State.

(h) TELECOMMUNICATIONS SERVICES FOR CERTAIN

PROVIDERS.~-

(1) IN GENERAL.-

(A) HEALTH CARE PROVIDERS FOR

RURAL AREAS.~-A telecommunications carrier

shall, upon receiving a bona fide request,

provide telecommunications services which are

necessary for the provision of health care

services in a State, including instruction relating

to such services, to any public or nonprofit

health care provider that serves persons who

reside in rural areas in that State at rates that are

reasonably comparable to rates charged for

similar services in urban areas in that State. A

telecommunications carrier providing

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