Amicus Curiae Brief — Verizon Communications Inc. v. Federal Communications Commission

Supreme Court, U.S.

FILED

No. 00-511

IN THE

Supreme Court of the Anited Ptates, ..,

—

a \ N ¥ VERIZON COMMUNICATIONS INC., et al.,

Petitioners,

Vv.

FEDERAL COMMUNICATIONS COMMISSION AND

THE UNITED STATES OF AMERICA,

Respondents.

200|

On Writ of Certiorari to the

United States Court of Appeals

for the Eighth Circuit

BRIEF AMICI CURIAE FOR ALLEGIANCE

TELECOM, INC., DSLnet COMMUNICATIONS, LLC,

EL PASO NETWORKS, LLC, MPOWER

COMMUNICATIONS CORP., PACWEST TELECOM,

INC. AND US LEC CORP.

SUPPORTING RESPONDENTS

MARY C. ALBERT ANDREW D. LIPMAN

Vice President, Regulatory and ERIC J. BRANFMAN

Interconnection HARISHA J. BASTIAMPILLAI *

MORTON J. POSNER SWIDLER BERLIN SHEREFF

Regulatory Counsel FRIEDMAN, LLP

ALLEGIANCE TELECOM, INC. 3000 K Street, N.W.

1150 Connecticut Avenue, N.W. Suite 300

Suite 205 Washington, D.C. 20007

Washington, D.C. 20036 (202) 424-7500

(202) 464-6106 Counsel for Amici Curiae

Counsel for Allegiance Counsel of Record *

Telecom, Inc.

June 8, 2001

[Additional Counsel Listed On Inside Cover]

Witson-EPes PRINTING Co., INC. — (202) 789-0096 -— WASHINGTON, D. C. 20001

BEST AVAILABLE COPY (auuunanae

STEPHEN ZAMANSKY

General Counsel

DSLNET COMMUNICATIONS, LLC

545 Long Wharf Drive, Sth Floor

New Haven, Connecticut 0651 1

(203) 772-1000

Counsel for DSLnet

Communications, LLC

RUSSELL I. ZUCKERMAN

Senior Vice President &

General Counsel

RICHARD E. HEATTER

Vice President, Legal Affairs

FRANCIS D. R. COLEMAN

Vice President, Regulatory

Affairs

MPOWER COMMUNICATIONS

CORP.

175 Sully’s Trail - Suite 300

Pittsford, New York 14534

(716) 218-6568

Counsel for Mpower

Communications Corp.

ROBERT W. BAKER

Vice President and

General Counsel

EL PASO NETWORKS, LLC

1001 Louisiana Street

25th Floor

Houston, Texas 77002

(713) 420-7021

Counsel for El Paso

Networks, LLC

SUMNER N. SMITH

Senior Corporate Counsel

US LEC Corp.

6801 Morrison Boulevard

Charlotte, N.C. 28211

(704) 319-1119

Counsel for US LEC Corp.

IBEST AVAILABLE COPY

A. The Meaning of Cost

B. The Commission’s Interpretation Is En-

_ The FCC’s Interpretation of “Cost” Is

Consistent With The Legislative

History of the Act

. THE FCC’S TELRIC METHODOLOGY

PROVIDES CONSTITUTIONALLY ADE-

QUATE COMPENSATION

A. The Takings Standard

B. The RBOCs’ Stranded Cost Argument

C. The RBOCs Were Adequately Com-

pensated, And Will Continue To Be

Adequately Compensated, For Their

Historical Costs

TABLE OF CONTENTS—Continued

Ill. INVALIDATING TELRIC AT THIS STAGE

WOULD UNDO THE COMPETITIVE

ADVANTAGES MADE SINCE 1996...............

i IO cocsassssszcessennasessennnnensunasnensnaseatioamnsenansetan

Page

iii

TABLE OF AUTHORITIES

CASES Page

Alabama Elec. Co-op, Inc. v. FERC, 684 F.2d 20

(D.C. Cir. 1982) 5

American Public Gas Ass'n v. FPC, 567 F.2d

1016 (D.C. Cir. 1977) 11

Arkansas Power & Light Co. v. 1.C.C., 831 F.2d

569 (Sth Cir. 1987) 8

AT&T Corporation v. lowa Utilities Board, 525

U.S. 366 (1999) 5, 6, 16

Atlantic Mutual Insurance Co. v. Commissioner

of Internal Revenue, 523 U.S. 382 (1998) ......... 7

Burlington Northern R. Co. v. Surface Transp.

Bd., 114 F.3d 206 (D.C.Cir. 1997) 7

Burlington Northern R. Co. v. 1L.C.C., 985 F.2d

589 (D.C.Cir. 1993)........... 8

Charles River Bridge v. Proprietors of the

Warren Bridge, 36 U.S. (11 Pet.) 420 (1837)... 20

Chevron U.SA. Inc. v. Natural Resources

Defense Counsel, Inc., 467 U.S. 837 (1984)......2, 7, 13

Consolidated Rail Corp. v. U.S., 812 F.2d 1444

ee 8

Duquesne Light Company v. Barasch, 488 U.S.

Sait hahaa eseremesarinntnieraratereeetieies passim

Federal Power Commission v. Hope Natural

es Se CD cxrcenensmentemnesmennens 8

Heckler v. Community Health Services of

Crawford County, Inc., 467 U.S. 51 (1984)......., 20

Illinois Bell Telephone Company v. FCC, 988

fe ee 6, 19

Iowa Utilities Board v. FCC, 219 F.3d 744 (8th

GE, Se terccnevesenasenenencnnenssinpannnententomiemnnsenses 5, 6

Keefe v. Clark, 322 U.S. 393 (1944).......cccccccceeeeees 20

MidAmerican Energy Co. v. Surface Transp. Bd.,

169 F.3d 1099 (8th Cir. 1999) .0.........cccccceeseeees 7

iv

TABLE OF AUTHORITIES—Continued

National R.R. Passenger Corp. v. Atchinson,

Topeka, & Santa Fe Ry., 470 U.S. 451 (1985)...

National R.R. Passenger Corp. v. Boston and

Maine Corp., 503 U.S. 407 (1992) ........cceesseees

Permian Basin Area Rate Cases, 390 U.S. 747

Smyth v. Ames, 169 U.S. 466 (1898)............cccccs0000

State of Missouri ex rel Southwestern Bell

Telephone Co. v. Public Service Commission,

Oe

Stone v. Wisconsin, 94 U.S. 181 (1876)..............0+

Strickland v. Commissioner, Maine Dept. of

Human Services, 96 F.3d 542 (ist Cir. 1996)....

Texas Office of Pub. Util. Counsel v. FCC, 183

F.3d 393 (Sth Cir. 1999), cert. dismissed, 121

Ee, Ga Ge ccnceensenaremnsesmmeeneen

Town of Norwood v. FERC, 53 F.3d 377 (D.C.

United States v. Grand River Dam Auth., 363

ee a OEE ssinectnecaiitisiniincendiinineiontmmmeniaecaiens

US WEST Communications, Inc. v. Arizona

Corporation Commission, 3 P.3d 936 (Ariz.

47 U.S.C. § 252(d)(1 MA)(I) ......ccererervssrreserseeseseeees

ADMINISTRATIVE AGENCY ORDERS

Application of Verizon New England Inc., et al.,

for Authorization to Provide In-Region,

InterLATA Services in Massachusetts, CC

Docket No. 01-9, Memorandum Opinion and

Order, FCC 01-130 (Apr. 16, 2001)..............00+.

Page

20

Vv

TABLE OF AUTHORITIES—Continued

Standards and Safeguards for Competitive

Services, Decision, 1995 WL 933715 (Pa.

PUC 1995)

DPUC Investigation into the Southern New

England Tel. Co.’s Cost of Providing Service,

Decision, 1995 WL 509180 (Conn. DPUC

1995)

Implementation of the Local Competition

Provisions of the Telecommunications Act of

1996, CC Docket 96-98, First Report and

Order, 11 F.C.C.R. 15499 (1996) . :

Implementation of the Local Competition

Provisions of the Telecommunications Act of

1996, CC Docket No. 96-98, Third Report and

Order and Fourth Further Notice of Proposed

Rulemaking, 15 F.C.C.R. 3696 (1999) .............

In re Commission Investigation and Generic

Proceeding on Ameritech Indiana's Rates for

Interconnection, Unbundled Elements, and

Transport and Termination Under the

Telecommunications Act of 1996 and related

Indiana Statutes, TURC Cause No. 40611,

Order, 1998 WL 999945 (1998) .........cccseseseeees

In re Investigation Regarding Local Exchange

Competition for Telecommunications Services,

Docket No. TX95120631, Telecommuni-

cations Decision and Order, 1997 WL 795071

gn

In re Open Network Architecture Tariffs of Bell

Operating Companies, Order, 9 FCC Red. 440

Page

10

10

passim

vi

TABLE OF AUTHORITIES—Continued

In re 800 Data Base Access Tariffs and the 800

Service Management System Tariff and

Provision of 800 Services, Report and Order,

FCC 96-392, 11 FCC Red. 15227 (1996)..........

Investigation of _ the Communications

Infrastructure of the State of Hawaii, Order,

1995 WL 553009 (Hawaii PUC 1995) ..............

Methodology to Determine Long Run

Incremental Costs, Opinion and Order, 156

P.U.R. 4th 1 (Mich. PUC 1994) 000... eecceeeees

Rulemaking on the Commission’ s Own Motion to

Govern Open Access to Bottleneck Services

and Establish a Framework for Network

Architecture Development of Dominant

Carrier Networks, Decision, 1995 WL 790383

ge

Transition to Competition in the Local Exchange

Market, NY PSC Case No. 94-C-0095,

Opinion No. 96-13, 1996 WL 302398 (1996) ...

LEGISLATIVE MATERIALS

P.L. 104-104, Telecommunications Act of 1996,

S. Conf. Rep. 104-230 (1996) ..........ccccccscceseeeeees

P.L. 104-104, H.R. Rep. 104-204(1) (1995)...........

P.L. 104-104, S. Rep. 104-23 (1995) .........cccceeeees

MISCELLANEOUS

Association for Local Telecommunications

Services, The State of Local Competition 2001

BellSouth Corporation, Securities and Exchange

Commission Form 10-K, Annual Report (Dec.

Fey CD coseassnesssssssessnennemanissemennesseneneeqeenecsesens

Page

10

10

10

21

13

13

26

17, 29

vii

TABLE OF AUTHORITIES—Continued

Page

J. Bonbright, et al., Principles of Public Utility

Rates 109 (2d ed. 1988) 5

W. Baumol and T. Merril, Deregulatory Takings,

Breach of the Regulatory Contract, and the

Telecommunications Act of 1996, 72 N.Y.U.

L. Rev. 1037 (1997). 7

Jim Chen, Standing in the Shadows of Giants:

The Role of Intergenerational Equity in

Telecommunications Reform, 71 U. Colo. L.

Bae. SBE CHIE ccccssnsssscesssssvensscessssssssvssessemenseae 22, 30

David Gabel and David Rosenbaum, Who's

Taking Whom: Some Comments and Evidence

on the Constitutionality of TELRIC, 52 Fed.

CUED, 0.5. SIO GED csereveccesessssssepsesvececsssssssees passim

Herbert Hovenkamp, The Takings Clause and

Improvident Regulatory Bargains, 108 Yale

adie GIFS Coie creccensssscssensstnsenntenscsnreseunsnessessssssee 20

Alfred Kahn & William Shew, Current Issues in

Telecommunications Regulation: Pricing, 4

Yale J. on Reg. 191 (1987) .........ccccccesereeeseeeees 26

Bruce A. Kushnick, The Unauthorized Bio of the

BERD Bees (IFES CB) ccsmnsinne 17

MA DTE Docket No. 01-20, Direct Testimony of

Dr. William Taylor on Behalf of Verizon New

England d/b/a Verizon Massachusetts (May 4,

| 24

NARUC Staff Subcommittee on Commun-

ications, Local Competition Work Group

Summary Report (1996) ..........ssseceessesssesesseees 21

Proceeding to Determine Permanent Pricing for

Unbundled Network Elements, NCUC Docket

No. P-100 SUB 133D, Post-Hearing Brief of

GTE South Incorporated (1998) .........ccssseeerees 15

STATEMENT OF AMICI INTEREST

Allegiance Telecom, Inc., DSLnet Communications, LLC,

El Paso Networks, LLC, Mpower Communications Corp.,

PacWest Telecom, Inc. and US LEC Corp. are competitive

local exchange carriers (“CLECs”).' Amici provide both

traditional voice service and advanced telecommunications

services such as high-speed data service throughout the

United States. Amici provide such service both through

deployment of their own facilities and leasing of the facilities

of incumbent local exchange carriers (“ILECs”). Amici are

products of the Telecommunications Act of 1996 (“1996

Act”) and are the type of facilities-based carriers that

Congress envisioned would enter the market as a result of the

1996 Act.

The carriers submit this Amici Curiae brief to urge this

Court to defer to the reasonable interpretation of the pricing

requirements of the Act made by the _ Federal

Communications Commission in its Order implementing the

local competition provisions of the Act. /mplementation of

the Local Competition Provisions of the Telecommunications

Act of 1996, CC Docket 96-98, First Report and Order, 11

F.C.C.R. 15499 (1996) (“Local Competition Order”). In that

Order, the Federal Communications Commission imple-

mented a forward-looking cost methodology that is designed

to promote the development of competition in the local

exchange market. a

In adopting a forward-looking cost methodology, the FCC

chose an approach that would balance the interests of all

carriers, and consumers, and meet the pro-competitive goals

of the Act. This methodology has assisted Amici and other

' The parties have consented to the filing of this brief. The letters of

consent have been filed with the Clerk of the Court. Counsel for parties

did not author this brief in whole or in part. No person or entity, other

than Amici, made a monetary contribution to the preparation and

submission of this brief.

2

CLECs in providing competitive service throughout the

United States in an efficient, and cost-effective manner.

Adoption of the historical cost approach advocated by the

Regional Bell Operating Company (“RBOC”) petitioners

would undermine this provision of competitive service and

imperil the achievement of the goals of the 1996 Act.

Amici have invested substantial time and resources both in

proceedings before state public utility commissions

developing and applying this methodology, and in making

market entry and investment decisions based on this

methodology. Invalidation of the FCC’s forward-looking

cost methodology would have a wide-ranging impact on the

telecommunications industry and on Amici in particular. Use

of the historical cost methodology proposed by the RBOCs

would force Amici and other CLECs to make the unenviable

choice between inefficiently expending even more capital to

deploy duplicative facilities or to exit certain markets

altogether. Either choice would conflict with the goals

articulated by Congress when it enacted the Act.

For these reasons, Amici are filing this brief, and

respectfully request that this Court consider the important

perspective they provide.

SUMMARY OF ARGUMENT

1. Contrary to the assertion of the RBOCs, the meaning

of “cost,” both under the 1996 Act and in the context of the

telecommunications industry, is far from clear, for the term

has taken on various meanings throughout the years.

Moreover, the 1996 Act fundamentally restructured the

industry and transformed whatever notions of “cost” may

have existed prior to the Act.

Because the meaning of “cost” is ambiguous, the FCC’s

interpretation of the meaning of “cost” as forward-looking

cost, and its choice of a forward-looking cost methodology, is

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

Defense Counsel, Inc., 467 U.S. 837, 843 (1984)(“Chevron’”)

3

to deference if its interpretation is reasonable. The FCC’s

choice of methodology was neither arbitrary nor capricious,

and was eminently reasonable.

The FCC’s choice not only was appropriate, but also is the

one most consistent with the pro-competitive goals of the

1996 Act. Congress, in enacting the 1996 Act, sought to

foster increased competition, reduce consumer prices, and

spur deployment of facilities. The FCC’s methodology

promotes efficient entry of competitors and rational

deployment of facilities. The implementation of the FCC’s

Total Element Long Run Incremental Cost (“TELRIC”)

methodology has demonstrated that it has worked to make

tangible the goals of the Act. The use of TELRIC has spurred

significant facility investment by CLECs while at the same

time not diminishing the investment ardor of the ILECs. At

the same time, TELRIC has ensured that investment is not

wasted on the construction by CLECs of duplicative facilities

that could be constructed at lower cost by ILECs, but is

targeted to broaden the deployment of facilities. The result

has been the extension of the reach of competitive

telecommunications services at market-based prices.

2. The RBOCs have not demonstrated that FCC’s

TELRIC methodology fails to provide them constitutionally

adequate compensation or imperils their financial integrity.

The RBOCs base their Takings Claim on their historical costs

that are purportedly left “stranded” or unrecovered as a result

of the FCC’s asserted switch from an historical cost

ratemaking methodology to a forward-looking methodology.

The basis for recovery of these costs is rooted in a purported

compact federal and state regulators made with the RBOCs

that such costs would be recovered.

As this Court has held, however, when one bargains with

the state nothing passes by implication and promises are to be

narrowly construed. Contrary to the RBOCs’ assertions,

there has been no assurance from either federal or state

regulators that the stranded costs would be recovered, and

4

there was no basis for such expectations. Even assuming

arguendo that the RBOCs had a right to recover such costs,

they have not demonstrated that these costs were significant,

or that the compensation they are provided fails to recover

these costs. The RBOCs have failed to show that the reduced

rates “jeopardize the financial integrity of the companies,

either by leaving them insufficient operating capital or by

impeding their ability to raise future capital.” Duquesne Light

Company v. Barasch, 488 U.S. 299, 312 (1989) (“Duquesne

Light”).

3. Invalidating TELRIC at this time would “strand” the

investments of the CLECs. The CLECs made rational

economic decisions to enter markets and deploy facilities

based upon the FCC’s forward-looking methodology. A

switch to an historical cost approach would require CLECs

either to engage in inefficient overbuilding of facilities or to

exit markets. Either approach would result in a situation that

is a contrary to the intent of Congress. Replacing TELRIC

with an historical cost approach would frustrate the purpose

of the 1996 Act.

I. THE FCC’S CHOICE OF FORWARD-

LOOKING COSTS OVER HISTORICAL COSTS

WAS REASONABLE AND SHOULD BE

ACCORDED DEFERENCE

A. The Meaning of Cost

Section 252(d)(1)(A)(D) of the 1996 Act requires that “just

and reasonable rates” be sei for interconnection and network

elements and that these rates be “based on the cost

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

rate-based proceeding) of providing the interconnection or

network element.” 47 U.S.C. § 252(d)(1)(A)(i) (FCC Pet.

App. 118a-119a).* In implementing this statutory provision,’

? Since the parties are using a deferred appendix, citations to statutory

provisions and the Local Competition Order will be made to the Appendix

5

the FCC has prescribed that rates be based on a forward-

looking, replacement cost method which it terms TELRIC.

Local Competition Order, 44 678-690 (FCC Pet. App. 66a-

74a). The RBOCs argue that “the plain text, structure, and

purpose of Section 252 make it clear that prices must include

historical costs.” Brief for Petitioners, Verizon Communi-

cations, Inc., et al., at 16 (“Petitioners’ Brief’).

The meaning of “cost” in Section 252 is, however, far from

clear. The concept of “just and reasonable rates based on

cost” is a term in ratemaking for which “neither law nor

economics has yet devised generally acceptable standards.”

Permian Basin Area Rate Cases, 390 U.S. 747, 790 (1968),

accord Alabama Elec. Co-op, Inc. v. FERC, 684 F.2d 20, 27

(D.C. Cir. 1982)(cost “itself is an inexact standard”). As the

court below observed, the word “cost” is a “chameleon”

capable of many meanings in the regulatory context. Jowa

Utilities Board v. FCC, 219 F.3d 744, 752 (8th Cir. 2000)

(“Iowa Utilities Board IT” ), see Strickland v. Commissioner,

Maine Dept. of Human Services, 96 F.3d 542, 546 (1st Cir.

1996)(there is “ambiguity inherent in the word ‘cost.””).

Regulatory commissions have construed the term “cost” to

support both “historical cost” and forward-looking

reproduction cost approaches. See J. Bonbright, et al.,

Principles of Public Utility Rates 109 (2d ed. 1988). During

the period in which the FCC’s pricing rules were vacated,

many state commissions independently adopted the TELRIC

methodology as the one most in accord with the requirements

of the 1996 Act thus further supporting the FCC’s

attached to the FCC’s Petition for Writ of Certiorari as (FCC Pet.

App. ___).

> This Court previously determined that the FCC has jurisdiction to

design a pricing methodology to implement this statutory provision.

AT&T Corporation v. lowa Utilities Board, 525 U.S. 366, 385 (1999)

(“Iowa Utilities Board’).

6

interpretation.* The Eighth Circuit thus reasonably concluded

the term “cost” in Section 252 is “ambiguous.” Jowa Utilities

Board II, 219 F.3d at 752.

Even assuming arguendo that the word “cost” meant

“historical” cost in the monopoly era prior to the enactment of

the 1996 Act, the Act clearly effected a massive restructuring

of the status quo.” Thus, even if “cost” meant “historical cost”

prior to the 1996 Act, that meaning would have been placed

in doubt given the fundamental restructuring effected by the

1996 Act. This is reflected in the admonition in Section 252

that a “rate-of-return or other rate based” methodology not be

used to determine prices. 47 U.S.C. § 252(d)(1)(A)(i) (FCC

Pet. App. 118a-119a). Rate-of-return proceedings are based

upon use of historical costs. See Illinois Bell Telephone

Company v. FCC, 988 F.2d 1254, 1258-59 (D.C.Cir.

1993)(“Illinois Bell”). To promote competition, Congress

clearly intended a departure from traditional costing

principles.

* See, e.g., In re Commission Investigation and Generic Proceeding on

Ameritech Indiana's Rates for Interconnection, Unbundled Elements, and

Transport and Termination Under the Telecommunications Act of 1996

and related Indiana Statutes, Cause No. 40611, Order, 1998 WL 999945,

*4 (1998) (“JURC UNE Order’); In re Investigation Regarding Local

Exchange Competition for Telecommunications Services, Docket No.

TX95120631, Telecommunications Decision and Order, 1997 WL

795071, *8 (NJ. B.P.U. Dec. 2, 1997), aff'd in part and vacated in part,

AT&T Communications of New Jersey, Inc., et al.,v. Bell Atlantic-New

Jersey, Inc., et al.; MCI Telecommunications Corp., et al., v. Bell

Atlantic-New Jersey, Inc., et al., Nos. 97-5762, 98-0109 (D.N.J. June 6,

2000)

> As this Court noted:

The Telecommunications Act of 1996 fundamentally restructures

local telephone markets. States may no longer enforce laws that

impede competition, and incumbent LECs are subject to a host of

duties intended to facilitate market entry.

lowa Utilities Board, 525 U.S. at 372.

7

B. The FCC’s Interpretation Is Entitled To

Deference

If a statute is “silent or ambiguous with respect to the

specific issue, the question for this court is whether the

agency’s answer is based on a permissible construction of the

statute.” Chevron, 467 U.S. at 843. The Court is not to

decide whether the agency’s interpretation “represents the

best interpretation of the statute, but whether it represents a

reasonable one.” Atlantic Mutual Insurance Co. v.

Commissioner of Internal Revenue, 523 U.S. 382, 389 (1998).

The agency’s interpretation will be upheld unless it is

arbitrary, capricious, or manifestly contrary to the statute.

Chevron, 467 U.S. at 843-44.

The FCC’s adoption of TELRIC was neither arbitrary nor

capricious. Far from being the “novel, complex, difficult to

administer,” “extreme” methodology that the RBOCs claim it

to be, TELRIC is an extension of forward-looking,

reproduction cost principles that at one point were widely

used, and indeed were considered to be constitutionally

mandated.

1. TELRIC Is Neither Novel Nor Extreme

TELRIC is a long run incremental cost approach to

ratemaking—long favored by regulatory lawyers, economists,

and regulators—and is designed to replicate the market prices

that would result under competition. W. Baumol and T.

Merril, Deregulatory Takings, Breach of the Regulatory

Contract, and the Telecommunications Act of 1996, 72

N.Y.U. L. Rev. 1037, 1063 (1997). TELRIC closely

resembles the “Stand-Alone Cost” methodology adopted in

the early 1980s by the Interstate Commerce Commission

(now the Surface Transportation Board), and approved by the

courts, for regulating railroad rates. See, e.g., MidAmerican

Energy Co. v. Surface Transp. Bd., 169 F.3d 1099 (8th Cir.

1999); Burlington Northern R. Co. v. Surface Transp. Bd.,

114 F.3d 206 (D.C.Cir. 1997); Burlington Northern R. Co. v.

L.C.C., 985 F.2d 589, 300 (D.C.Cir. 1993); Arkansas Power

& Light Co. v. LC.C., 831 F.2d 569 (Sth Cir. 1987); Con-

solidated Rail Corp. v. U.S., 812 F.2d 1444 (3rd Cir. 1987).

Forward-looking incremental cost ratemaking is partially

rooted in “fair value” ratemaking, long thought by the courts

to be constitutionally required under the Fifth Amendment.

See Smyth v. Ames, 169 U.S. 466 (1898). Under fair value

ratemaking, a regulated firm is entitled to recover a return on

the full value of its services, which variously requires

reference to a number of indicators of the market value of the

firm’s “used and useful” assets and the cost of reproducing

those assets. David Gabel and David Rosenbaum, Who's

Taking Whom: Some Comments and Evidence on the

Constitutionality of TELRIC, 52 Fed. Comm. LJ. 239, 246

(2000) (“Gabel/Rosenbaum” ).

The principal criticism of fair value ratemaking was its

circularity and difficulty of administration.° This Court

eventually rejected the notion that fair value ratemaking was

constitutionally required. See Federal Power Commission v.

Hope Natural Gas, 320 U.S. 591, 602 (1944) (“Hope Natural

Gas”). The Court did not, however, prohibit fair value

ratemaking.

This Court has declined to elevate a single theory of

valuation to constitutional status. The Court has held:

[t}he adoption of a single theory of valuation as a

constitutional requirement would be inconsistent with

the view of the Constitution this Court has taken since

* According to Justice Brandeis’s concurring opinion in Southwestern

Bell, the present value of a utility could not be determined based on the

“capitalizing of its net earnings, since the earnings are determined in large

measure, by the rate which the company will be permitted to charge, and

thus the vicious circle would be encountered.” See State of Missouri ex rel

Southwestern Bell Telephone Co. v. Public Service Commission, 262 U.S.

276, 292 (1923).

9

Hope National Gas, supra. As demonstrated in

Wisconsin v. FPC, circumstances may favor the use of

one ratemaking procedure over another. The designation

of a single theory of ratemaking as a constitutional

requirement would unnecessarily foreclose alternatives

which could benefit both consumers and investors. The

Constitution within broad limits leaves States to decide

what ratesetting methodology best meets their needs in

balancing the interests of the utility and the public.

Duquesne Light Company, 488 U.S. at 316. The Court

specifically recognized that a rigid requirement of use of the

historical cost methodology would “foreclose a return to

some form of fair value ratemaking just as its practical

problems may be diminishing.” /d. at n. 10.

The Court in Duquesne Light was quite prescient in

predicting the return of fair value ratemaking. As discussed

above, the Surface Transportation Board, and its predecessor,

the Interstate Commerce Commission, have successfully used

approaches similar to TELRIC for years in determining the

prices railroads may charge for use of their bottleneck

facilities. As the FCC noted at the time it decided to use

TELRIC, prior to the 1996 Act, a number of state public

utility commissions independently employed, or had plans to

employ, some form of long-run incremental cost (“LRIC”)

methodology in their approach to setting prices for unbundled

network elements. Local Competition Order at | 631 (FCC

Pet. App. 56a-57a). The Public Utility Commission of Texas

had employed LRIC-pricing methodologies for many years.

Id. at n. 1508. Public utility commissions in Connecticut,

California, Hawaii, Michigan, and Pennsylvania in 1994-

1995 were requiring RBOCs to provide TSLRIC studies that

are nearly identical to TELRIC for numerous services,

including unbundled services.’

” CC Docket No. 96-98, Comments of AT&T Corp. at 49-50 (1996)

(“AT&T Comments”); DPUC Investigation into the Southern New

10

Prior to the 1996 Act, the RBOCs were amongst the most

ardent supporters of LRIC approaches. See Gabel/

Rosenbaum at 257. In the late 1980s, the FCC unbundled

certain services provided by RBOCs to promote efficient and

innovative use of the RBOCs’ networks by independent

enhanced service providers (“ESPs”) and to prevent

discrimination on the part of the RBOCs in their offerings of

certain basic service elements to competing ESPs and RBOC-

owned ESPs. Jn re Open Network Architecture Tariffs of Bell

Operating Companies, Order, 9 FCC Rcd. 440, ¢ 4 (1993).

These unbundled basic service “building blocks” were

designed to promote the ability of the RBOC’s ESP

competitors to compete effectively. Jd. To develop pricing for

some of these elements, the RBOCs used a forward-looking

cost model, SCIS, that calculated investment costs based on

replacement costs rather than historical or embedded costs.

Id. 4 21; In re 800 Data Base Access Tariffs and the 800 Serv-

ice Management System Tariff and Provision of 800 Services,

Report and Order, FCC 96-392, 11 FCC Red. 15227, 4 277

(1996).

Use of a “fantasy network” thus did not originate with the

FCC. In determining their costs, the RBOCs have for some

time clearly relied on networks that were far from actual. The

best evidence that TELRIC is not a novel or extreme

methodology comes from the RBOCs themselves.

England Tel. Co.'s Cost of Providing Service, Decision at 25, 1995 WL

509180 (Conn. DPUC 1995); Rulemaking on the Commission's Own

Motion to Govern Open Access to Bottleneck Services and Establish a

Framework for Network Architecture Development of Dominant Carrier

Networks, Decision, 1995 WL 790383 (Cal. PUC 1995); Investigation of

the Communications Infrastructure of the State of Hawaii, Order, 1995

WL 553009 (Hawaii PUC 1995); Methodology to Determine Long Run

Incremental Costs, Opinion and Order, 156 P.U.R. 4th 1, 1994 WL

570779 (Mich. PUC 1994); Standards and Safeguards for Competitive

Services, Decision, 1995 WL 933715 (Pa. PUC 1995).

11

2. TELRIC Is Capable of Practical Implementa

tion

Contrary to the RBOCs’ assertions, TELRIC is not

inordinately complex or difficult to administer (at least in

comparison to other cost-based ratemaking methodologies,

none of which are particularly simple or straightforward).

The FCC noted at the time of its implementation of TELRIC

that a number of states had already implemented forward-

looking costing methodologies to set prices for intercon-

nection and unbundled network elements or support the use

of such an approach. Local Competition Order, 4 681 (FCC

Pet. App. 67a). Agencies increasingly use forward-looking

cost methodologies based on economic modeling to set rates.

American Public Gas Ass'n v. FPC, 567 F.2d 1016, 1036-

1037 (D.C. Cir. 1977) (courts “have approved the use of . . .

hypothetical cost projection for some producers, as a means

of arriving at a reasonable individual rate”). History has

borne this out as 35 state public utility commissions have

applied the TELRIC methodology. Gabel/Rosenbaum at 245.

In fact, the historical cost methodology may be the more

speculative of the two methodologies, at least in the

telecommunications context. Under an historical cost

approach, one must not only determine the historical costs but

also if they were prudently incurred. Rate-of-return

regulation based upon prudently incurred historical costs

requires numerous estimates and predictive judgments.” Thus,

* As economists have observed:

[I}t is uncertain as to whether the factual inquiry required for the

conduct of a proper TELRIC study is any more hypothetical in

nature than the judgments called for in determining whether or not

capital costs, some of which were incurred decades ago, were

“prudently” made or are “used and useful.” Both the prudent and

used and useful standards require an agency or court to ascertain the

prospective demand for the products that will use the utility’s

facilities, the cost of alternative technologies, and the life-cycle

12

regardless of the methodology used, significant estimations

and future cost predictions need to be made.” The estimations

required in TELRIC are clearly not out of line with those that

are a standard feature of ratemaking.

Even Justice Brandeis, who was skeptical about the specu-

lative nature of estimating reproduction costs, noted that:

estimating reproduction cost was useful and appropriate

“as a means, either of supplying lacks in the proof of

actual cost and investment, or of testing the credibility of

the evidence adduced, or of showing that the cost of

installation had been wasteful,” and instances such as

“when book values, or property accounts, furnish[] no

trustworthy evidence either of cost or of real value.”

Gabel/Rosenbaum at 255. In regard to pricing for

interconnection and unbundled network elements, the

situation Justice Brandeis described exists. As has been

noted:

The problem with this [historical cost methodology] is

that the accounting systems currently used by the ILECs

do not contain the data that is required for making

pricing decisions regarding the provision of UNEs and

the pricing of interconnection. These accounting

systems were largely designed to track the financial

standing of the corporation. Accounting data is typically

costs of the facilities. All of these factors require considerable

speculation and by definition are hypothetical in nature.

Gabel/Rosenbaum at 254.

” Town of Norwood v. FERC, 53 F.3d 377, 380 (D.C. Cir. 1995). As

the D.C. Circuit observed in Norwood:

Long-range estimates are an integral feature of ratemaking and

financial analysis in general, and we have regularly approved

reliance on admittedly imperfect future cost estimates.

Norwood, 53 F.3d at 380.

- —— ————

13

not maintained at a level of granularity that is sufficient

for determining the cost of individual components of the

network or tariff elements.

Id. The RBOCs’ historical cost approach may thus be more

hypotheticai than the FCC’s TELRIC methodology. TELRIC

may actually be more readily administered and more reliable

than the historical cost approach.

3. The FCC’s Interpretation of “Cost” Is Consistent

With The Legislative History Of The Act

The FCC, when implementing the provisions of the 1996

Act, was faced with a novel and formidable task. The FCC

had to try to eradicate the effects of decades of monopoly

pricing and ensure that the pricing methodology it selected

would promote competition and ensure efficient competitive

entry into the local exchange market. The TELRIC

methodology it selected was and is the one most suited to that

task. This Court in Chevron observed that an agency will be

accorded considerable deference if its choice “represents a

reasonable accommodation of conflicting policies that were

committed to the agency’s care by the statute” and its choice

will not be disturbed “unless it appears that the

accommodation is not one that Congress would have

sanctioned.” Chevron, 467 U.S. at 845.

The choice the FCC made in adopting TELRIC was clearly

in accord with the pro-competitive statutory policy embodied

in the legislative history of the Act. The Act was designed to

provide for a “pro-competitive, deregulatory national policy

framework designed to accelerate rapidly private sector

deployment of advanced telecommunications and information

technologies and services to all Americans by opening all

telecommunications markets to competition.” P.L. 104-104,

Telecommunications Act of 1996, S. Conf. Rep. 104-230 at |

(1996). The goal of promoting competition was to “secure

lower prices and higher quality services for American

telecommunications consumers.” P.L. 104-104, H.R. Rep.

14

104-204(1) at 160 (1995). As the House Commerce

Committee Report noted:

Technological advances would be more rapid and

services would be more widely available and at lower

prices if telecommunications markets were competitive

rather than regulated monopolies.

Id. The FCC focused on implementing a cost methodology

that would both be pro-competition and eliminate the vestiges

of monopoly pricing.

Forward-looking pricing simulates the prices that would

result in a competitive market. The FCC noted that “in

dynamic competitive markets, firms take action based not on

embedded costs, but on the relationship between market-

determined prices and forward-looking economic costs.”

Local Competition Order, § 620 (FCC Pet. App. 5la).

Competition will drive prices down to forward-looking costs

even if such costs are lower than a firm’s historical costs. /d.

q 635.

The RBOCs argue that TELRIC hypothesizes a “fantasy

world” that is divorced from the “real-world market.”

Petitioners’ Brief at 9. In a “real-world” competitive world,

however, companies must consider the available alternatives.

If a new technology reaches the market, a company has the

option of maintaining its existing plant and declining to

partake of the new technology. To maintain its competitive

position, however, such a company must adjust its pricing to

meet the cost level that new competitors can achieve with the

new technology. Thus, focusing on replacement cost is not

the stuff of “fantasy”—rather, it accommodates the kind of

pricing one would expect in the competitive market that

Congress sought to create.

Requiring prices to be based on historical costs would

distort competitive market entry decisions. As _ the

Department of Justice noted in the Local Competition

Proceeding, “pricing above forward-looking costs would

Oca ick

15

subject competitors to substantial risk of a price squeeze

because the real cost of a network element for the incumbent

LEC will be its forward-looking economic cost, while the

cost to the new entrant will be the higher price charged for the

element by the LEC.” Local Competition Order, 4 635.

ILECs would then be able to nip competition in the bud.

The RBOCs argue that use of TELRIC will distort the

investment decisions of new entrants because it would “be

irrational for entrants to deploy new facilities if they could

purchase UNEs below any cost they could hope to achieve.”

Petitioners’ Brief at 49. The RBOCs assert that this will

make network elements “irresistible” and “choke off

facilities-based entry.” /d. The RBOCs fail to consider the

corollary of their argument. Setting prices at historical costs

levels, above long-run economic cost, will either (1)

encourage inefficient facilities-based entry by rivals with

costs below the ILECs’ historical costs, but above the ILECs’

economically meaningful forward-looking costs or (2) choke

off entry altogether. Efficiency dictates that the build-buy

decision be made based upon forward-looking, not historical,

costs. If an RBOC can build a loop on a forward-looking

basis for $15, but the RBOC’s historical cost is $30,'° the

'° The RBOCs contend that “TELRIC prices are half the historical cost

of UNEs.” Petitioners’ Brief at 31. Amici, by no means concede,

however, that TELRIC prices are half the historical costs, or that TELRIC

prices will always be lower than historical costs, particularly given the

inability of RBOCs to demonstrate in a tangible manner what their

historical costs are, and the manner in which particular inputs are defined

by the state public utility commissions. See supra at 12 (discussing

difficulty in quantifying RBOC historical cost) and infra at 23 (showing

variation in cost inputs used by state commissions). In a proceeding

before the North Carolina Utilities Commission, GTE, now part of

Petitioner Verizon, argued that its total historical costs in North Carolina

were actually “slightly lower than its total forward-looking costs.”

Proceeding to Determine Permanent Pricing for Unbundled Network

Elements, NCUC Docket No. P-100 SUB 133D, Post-Hearing Brief of

GTE South Incorporated at 47 (1998).

16

CLEC should be presented with a $15 price to buy the loop

from the RBOC. If presented with an option to buy the loop

from the RBOC for $30, and if the CLEC's cost to build the

loop itself is $20, it will either inefficiently build the loop

itself, even though the RBOC is the more efficient builder, or

not enter the market at all. The folly of the RBOCs’

argument is that it encourages the wasteful construction of

duplicative facilities and stifles market entry.

TELRIC encourages efficient entry and precludes the

wasteful deployment of facilities as demonstrated by the

example above, because the new entrant will make the

decision to build based on what is the most efficient and cost-

effective option. As Justice Breyer noted:

[o]ne can understand the basic logic of “unbundling” by

imagining that Congress required a sole incumbent

railroad providing service between City A and City B to

share certain basic facilities, say, bridges, rights-of-way,

or tracks, in order to avoid wasteful duplication of

those hard-to-duplicate resources while facilitating

competition in the remaining aspects of A-to-B railroad

service. Indeed, one might characterize the Act's basic

purpose as seeking to bring about, without inordinate

waste, greater local service competition. .. .

Iowa Utilities Board, 525 U.S. at 416-417 (Breyer, J.,

concurring in part/dissenting in part). Congress did not want

to encourage wasteful duplication of facilities by new

entrants. Under TELRIC, if the economic cost to the new

entrant dictates that the construction of its own facilities is

more efficient and cost-effective, it will build the facilities.

The problem with the historical cost approach is that:

[p]ermitting incumbent LECs to recover embedded costs

in the prices they charge competitors for interconnection

and unbundled network elements, while the incumbents

experience much lower incremental costs, will result in

inefficiently high prices that will either cause new

17

entrants to over-build existing systems instead of

maximizing the efficient use of the existing incumbent

LEC’s network, or discourage entry and investment in

the local market altogether.

Local Competition Order, 4 655.

Although the RBOCs assert that TELRIC prices serve as a

disincentive to CLEC investment, where UNE rates have

been appropriately cost-based upon a TELRIC methodology,

there has been substantial CLEC investment in facilities.

Since 1997, CLECs have invested $56 billion in

building their own networks. Association for Local Telecom-

munications Services, The State of Local Competition 200] at

20 (February 2001) (“ALTS Report’). Capital expenditures

for CLECs in 2000 were valued at $24.9 billion compared to

$33.6 billion for the RBOCs.'' /d. at 21. CLECs reinvest a

much larger portion of their revenues back into their facilities

than the RBOCs, 63.7% to 20.6% respectively. Id. CLECs

have deployed over 1,000 voice switches and 2,000 data

switches. /d. at 24. Since 1997, CLECs have almost tripled

the number of network route miles they have in service. /d. at

25. CLECs that either primarily rely on their own facilities,

or lease unbundled network elements from the RBOCs in

conjunction with their own facilities, comprise almost 70% of

the CLEC market. /d. at 12. Thus, contrary to RBOC

assertions that “many entrants rapidly changed their plans

away from deploying competitive facilities,” Petitioners’

Brief at 13, there has been significant facilities-based

investment under TELRIC, and this tracks what the FCC

'' In January 1997, Petitioner United States Telecom Association

reported that ILECs were investing more than $20 billion annually in their

networks. Bruce A. Kushnick, The Unauthorized Bio of the Baby Bells at

202 (1999 ed.). Thus, RBOC investment under TELRIC has not

decreased, but increased.

18

predicted would occur.'? The FCC correctly concluded that

use of TELRIC would best meet the pro-competitive goals of

the Act. TELRIC ensures efficient investment decisions and

competitive entry.

Il. THE FCC’S TELRIC METHODOLOGY PRO-

VIDES CONSTITUTIONALLY ADEQUATE

COMPENSATION

A. The Takings Standard

This Court has found that the quasi-public/quasi-private

status of a public utility creates a unique set of questions

under the Takings Clause of the Fifth Amendment. Duquesne

Light, 488 U.S. at 308. The Court has concluded that the

guiding principle in analyzing takings challenges in this

context is that the “Constitution protects utilities from being

limited to a charge for their property serving the public which

is sO ‘unjust’ to be confiscatory.” Jd. This Court has declined

to focus on the merits of a particular cost methodology, but

rather on the overall effect and impact of use of that

methodology, noting:

[I]t is not the theory but the impact of the rate order

which counts. If the total effect of the rate order cannot

be said to be unreasonable, judicial inquiry . . . is at an

end. The fact that the method employed to reach that

result may contain infirmities is not then important.

* * *

'? CLECs’ use of their own facilities should increase over time as

CLECs build out their own networks. The purchase of unbundled

network elements will serve as bridge that will provide CLECs “with the

ability to gain a sufficient volume of business to justify economical

deployment of their own facilities.” /mplementation of the Local

Competition Provisions of the Telecommunications Act of 1996, CC

Docket No. 96-98, Third Report and Order and Fourth Further Notice of

Proposed Rulemaking, 4 52 (1999) (“UNE Remand Order”); see ALTS

Report at 12.

19

[T]he economic judgments required in rate proceedings

are often hopelessly complex and do not admit of a

single correct result. The Constitution is not designed to

arbitrate these economic niceties. Errors to the

detriment of one party may well be canceled out by the

countervailing errors or allowances in another part of the

rate proceeding. The Constitution protects the utility

from the net effect of the rate order on its property.

Inconsistencies in one aspect of the methodology have

no constitutional effect on the utility’s property if they

are compensated by countervailing factors in some other

respect.

Id. at 310, 313. An end result is confiscatory only if it is

shown that the regulation “threatens the financial integrity of

the [regulated carrier] or otherwise impedes [its] ability to

attract capital.” J/linois Bell, 988 F.2d at 1263.

B. The RBOCs’ Stranded Cost Argument

The RBOCs claim that the purported shift by the FCC in

pricing methodologies from historical cost to forward-looking

costs “strands” half their historical costs. Petitioners’ Brief at

28. The RBOCs argue that regulators made a compact with

them:

[b]y 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.

Id. at 29.'° The threshold question is whether such a compact

or contract exists.

'? The RBOCs are espousing a “regulatory contract” theory which:

[I]n its simplest terms, . . . is an agreement with the state that

requires the utility to invest its resources in some expansion of the

enterprise, such as a new power generation plant. In return, the state

20

This Court has long held that “in grants by the public, nothing

passes by implication.” Charles River Bridge v. Proprietors

of the Warren Bridge, 36 U.S. (11 Pet.) 420, 546 (1837). As

has been observed:

[t]he Supreme Court has reiterated time and time again:

When one bargains with the state, nothing passes by

implication and promises are to be narrowly construed.

This principle dramatically undermines the claims that

utilities generally enjoy the benefits of a regulatory

contract protecting them from stranded costs.

Hovenkamp at 808-09, citing, inter alia, National RR.

Passenger Corp. v. Atchinson, Topeka, & Santa Fe Ry., 470

U.S. 451, 466 (1985)(“‘a law is not intended to create private

contractual or vested rights but merely declares a policy to be

pursued until the legislature shall ordain otherwise”); United

States v. Grand River Dam Auth., 363 U.S. 229, 235 (1960);

Keefe v. Clark, 322 U.S. 393, 396-97 (1944); Stone v.

Wisconsin, 94 U.S. 181 (1876).'*

The RBOCs have not established, nor can they establish,

that there was any such assurance from federal or state

regulators that they would recover their historical costs. As

the FCC noted:

guarantees a rate of return that . . . promises to remove the risk of

improvident investment... . If such a contract exists, deregulation

and the resulting obsolescence of stranded facilities require

compensation to the utilities, as the government would be reneging

on its side of the regulatory bargain.

Herbert Hovenkamp, The Takings Clause and Improvident Regulatory

Bargains, 108 Yale L.J. 801, 806 (1999) (“Hovenkamp”).

'* Similarly, given the substantial public interest involved on the side

of the government, only in the rarest cases would a plaintiff be able to

succeed against the government on an estoppel theory. Heckler v.

Community Health Services of Crawford County, Inc., 467 U.S. 51, 59-60

(1984).

would exceed the assurances that we or the states have

provided in the past.

Local Competition Order, 4 706 (FCC Pet. App. 87a).

The RBOCs have failed to demonstrate a basis that would

entitle them to recovery of their stranded costs. This fact has

been evidenced in recent court cases. The Court of Appeals

of Arizona rejected a claim that regulators had entered a

“regulatory contract” with the local ILEC. US WEST

Communications, Inc. v. Arizona Corporation Commission, 3

P.3d 936, 941-42 (Ariz. Ct. App. 1999). The U.S. Court of

Appeals for the Fifth Circuit struck down a takings challenge

to TELRIC in the universal service context finding that the

Supreme Court’s confiscatory rulemaking decisions “do not

require courts to engage in takings analysis whenever an

agency opens a previously regulated market to competition.”

Texas Office of Pub. Util. Counsel v. FCC, 183 F.3d

393, 413, n. 14 (Sth Cir. 1999), cert. dismissed, 121 S.Ct.

423 (2000).

The New York Public Service Commission denied

recovery of stranded revenues to companies operating under

incentive regulation plans, such as New York Telephone and

Rochester Telephone, that “gain opportunities for greater

earnings” under such plans but also “bear the risk of poor

earnings and stranded revenue.” Transition to Competition in

the Local Exchange Market, NY PSC Case No. 94-C-0095,

Opinion No. 96-13, 1996 WL 302398, *55 (1996); see also,

Local Competition Order, 4 656. NARUC, the body of state

public utility commission regulators, recommended in 1996

that companies operating under price cap regulation not be

allowed to recover their stranded investment costs. NARUC

Staff Subcommittee on Communications, Local Competition

Work Group Summary Report at 52-53 (1996); AT&T

22

Comments at 71-72, n. 105. In 1995, before the enactment of

the 1996 Act, BellSouth reported a writedown of $2.7 billion

because “it is doubtful that regulated rates sufficient to

recover the net book value of telephone plant could be

charged to and collected from customers due to expected

levels of future competition.” BellSouth Corporation,

Securities and Exchange Commission Form 10-K, Annual

Report at 34 (1995); AT&T Comments at 71-72, n. 105.

Thus, even the RBOCs had no expectation of recovering

stranded costs, and regulators certainly were not giving them

this impression.

C. The RBOCs Were Adequately Compensated, And

Will Continue to Be Adequately Compensated, for

their Historical Costs

Even assuming arguendo, that a regulatory contract has

been established, the RBOCs have failed to demonstrate that

TELRIC does not adequately compensate them for their

historical costs or that they have not already been adequately

compensated for such costs. In fact, the FCC noted that other

than advancing figures of stranded costs for which they

provided no basis, no ILEC had “provided persuasive

evidence that prices based on a forward-looking economic

cost methodology would have a significant impact on its

‘financial integrity,” which is the relevant standard under

Illinois Bell. Local Competition Order at 4 738 (FCC Pet.

App. 95a). The FCC, in fact, left the door open for ILECs to

make such a showing, and if they were able to do so, they

could petition to seek relief from the methodology. /d. 4 739

(FCC Pet. App. 95a). No ILEC has even attempted to make

such a showing of significant stranded costs.'°

'S Jim Chen, Standing in the Shadows of Giants: The Role of

Intergenerational Equity in Telecommunications Reform, 71 U. Colo. L.

Rev. 921, 935 (2000).

23

As noted above, it would be very difficult for the RBOCs

to quantify their historical costs, much less do a comparative

analysis. The FCC correctly concluded that based on the

record before it that there was no support for the claim that

significant residual costs would result from the use of a

forward-looking methodology. Local Competition Order, 4

707 (FCC Pet. App. 88a). As a commenter in the Local

Competition proceeding noted, “nominal losses in economic

value attributed to stranded investment should be weighed

against the appreciation in value that incumbent LECs have

experienced in share prices and market-to-book ratios.”

Local Competition Order, 4 659. RBOCs have claimed that

they have had to carry reserve deficiencies as a result of

lengthy depreciation schedules dictated by regulatory bodies,

but the market data belies this claim. The limited available

market data “clearly shows that the book value of the ILEC

assets is significantly less than the market value of the

assets.” Gabel/Rosenbaum at 266. As these economists con-

clude, “the fact that ILEC exchange assets are commanding

prices on the open market which are of a magnitude greater

than their book value vitiates the ILECs’ contention that

implementation of TELRIC will result in stranded costs.” /d.

The RBOCs also fail to show that TELRIC will not ade-

quately compensate them for any stranded cost that may

occur. As the FCC noted, TELRIC provides an adequate

return to the RBOCs because “properly designed depreciation

schedules should account for expected declines in the value

of capital goods.” Local Competition Order, 4 686 (FCC Pet.

App. 71la-72a).

The RBOCs mistakenly argue that the FCC has ensured

that TELRIC will yield massive price reductions by main-

taining low-risk cost of capital and extended depreciation

rates transplanted from the monopoly regime. Petitioners’

Brief at 10. In fact, the FCC left the determination of cost of

capital and depreciation rates to the states and clearly

encouraged the use of cost-of-capital and depreciation rates

24

that would adequately cover the RBOCs’ cost of capital and

accurately reflect the economic lives of their facilities. Local

Competition Order, 4 702 (FCC Pet. App. 83a). The imple-

mentation of TELRIC has borne this out. For instance, the

FCC had opined that its proposed cost of capital figures of

11.25% may have been too high given the current

marketplace cost of equity and debt, but it opted for a

forward-looking figure that would generate higher costs than

warranted by the actual state of competition. /d. The

Massachusetts Department of Telecommunications and

Energy went beyond the high FCC figure and utilized a cost

of capital of 12.16 percent that was higher than the cost of

capital it has used in setting Petitioner Verizon's retail local

rates. Application of Verizon New England Inc., et al., for

Authorization to Provide In-Region, InterLATA Services in

Massachusetts, CC Docket No. 01-9, Memorandum Opinion

and Order, FCC 01-130, 2001 WL 388287, 4 38 (Apr. 16,

2001).

The Indiana Utility Regulatory Commission (“IURC”)

likewise allowed for the economic lives that were substan-

tially shorter than those prescribed by the FCC, and shorter

than those suggested by the historical life indications of

Ameritech’s existing facilities,"® in order to reflect a possible

need to upgrade equipment more quickly to compete in an

evolving market. /URC UNE Order at 9-10. Thus, far from

being restricted to use of depreciation rates and cost of capital

from the monopoly regime, Petitioners’ Brief at 10, the

RBOCs have been pushing for, and often receiving, forward-

looking depreciation rates and costs of capital that go beyond

the competitive risks they face.'’

'© Ameritech is a subsidiary of Petitioner, SBC Communications, Inc.

'’ In fact, in a recent filing with the Massachusetts Department of

Telecommunications and Energy, Verizon, contrary to the argument it

makes here, cited the Local Competition Order for the proposition that

TELRIC requires a forward-looking cost of capital. Compare MA DTE

25

The application of TELRIC has demonstrated that it

protects the financial integrity of the RBOCs. Two

economists who studied the profitability of RBOCs since the

enactment of the 1996 Act found:

Given the rates of return on regulated investment, and

the rates of return on embedded investment, it seems

clear that the majority of telephone companies in the

survey are earning returns that are more than sufficient

to assure confidence in the financial integrity of their

enterprises, maintain their credit worthiness and to

enable them to attract additional capital. Based on this

data it would seem that the ILECs and their supporters’

contention, that use of the TELRIC methodology, on its

face, results in a taking, is not grounded in the reality

depicted by their earnings reports.

Gabel/Rosenbaum at 265. The RBOCs have failed to show

that, even if they are entitled to recovery of any stranded

costs, TELRIC fails to provide them with constitutionally

adequate compensation. Clearly the financial integrity of

their enterprises has not been imperiled, and is in no danger

of being imperiled.

In fact, it is premature to consider if there will be a

shortfall. As noted in the Local Competition proceeding, “the

size of any shortfall between historical costs and TSLRIC’s

forward-looking costs will not be determined for many years

after interLATA entry.” Local Competition Order, 4 655.

Petitioners concede that interstate access and long distance

charges are two sources of revenue that may provide recovery

for stranded costs. Petitioners’ Brief at 36, n. 15. For

instance, access charges for years have been set well in

excess of the Petitioners’ economic costs of providing access

Docket No. 01-20, Direct Testimony of Dr. William Taylor on Behalf of

Verizon New England d/b/a Verizon Massachusetts at 11 (May 4, 2001)

with Petitioners’ Brief at 10.

26

service to provide subsidies for universal service. Alfred

Kahn & William Shew, Current Issues in Telecommun-

ications Regulation: Pricing, 4 Yale J. Reg. 191, 193-95, 202,

n.28 (1987). Likewise, the RBOCs’ entry into the interLATA

market pursuant to the 1996 Act will provide substantial

revenue that should more than compensate for any nominal

stranded cost there may be. It should not be forgotten that the

RBOCs were among the supporters of the 1996 Act, and it is

reasonable to believe that it was their recognition of the

lucrative benefits of interLATA entry that fueled this support.

See, P.L. 104-104, S. Rep. 104-23 at 26-29 (1995). Thus,

regulators could use revenues from one of these areas to

offset any deficiency that arises from UNE rates, if such a

deficiency is ever demonstrated by the RBOCs.”*

Ill. INVALIDATING TELRIC AT THIS STAGE

WOULD UNDO THE COMPETITIVE AD-

VANCES MADE SINCE 1996

As has been demonstrated, the FCC clearly made not only

a reasonable choice, but the appropriate choice. The choice

was made after much deliberation and evaluation of the

alternatives and was substantially supported by the record

elicited in the proceeding. The choice of TELRIC resulted in

a rate order, the total effect of which is reasonable and does

not imperil the financial integrity of the RBOCs. As this

*'® See, Qwest Corporation v. U.S., 48 Fed.Cl. 672, 696 (2001). The

Court of Federal Claims noted that Plaintiff Qwest’s physical takings

claim must be considered in the “context of the comprehensive legal

framework established by the Telecom Act.” /d. The court noted that the

Telecom Act “created a matrix of interlocking opportunities for ILECs”

where “they could enter some new markets, but the quid pro quo was that

they open up their own local exchange markets to competition.” /d.; see

also, National Railroad Passenger Corp. v. Boston and Maine Corp., 503

U.S. 407, 418 (1992) (upholding broad construction by Interstate

Commerce Commission of its condemnation authority that implemented

and interpreted the statute in a manner that comports with its words and

structure).

27

Court has noted, under these circumstances, judicial inquiry

must end, and deference be given to the choice of the expert

agency.

Courts are reluctant to encroach on the province of expert

agencies particularly when “the economic judgments required

in rate proceedings are often hopelessly complex and do not

admit of a single correct result.” Duquesne Light, 488 U.S. at

314. As this Court has astutely observed, “the Constitution is

not designed to arbitrate these economic niceties.” /d. If the

Court were to invalidate TELRIC at this time, it would undo

the competitive inroads that have been made in the

telecommunications industry and imperil the already

precarious state of local competition. It would also “strand”

billions of dollars that have been invested in the CLECs and

their facilities. |The invalidation of TELRIC would

undermine the very pro-competitive goals that provide the

foundation of the 1996 Act.

The replacement of TELRIC with an historical cost

approach will not eliminate the asserted problem of stranded

investment, as now it will be the CLECs whose investment

will be stranded. As described above, the CLECs have

invested over $56 billion in building their networks since

1997. CLECs properly based their decisions to enter markets

and make investments based on the relationship between

market-driven prices and forward-looking economic costs. A

shift in the methodologies to historical costs would trap the

CLECs in the price squeeze described above. For example,

Petitioners argue that in New York the average historical cost

for a copper loop is $33.20 per month while the TELRIC

price is $14.52 per month.'” Petitioners’ Brief at 14. The

'? Once again, it should be noted that Amici do not concede the validity

of Petitioners’ unsubstantiated historical cost figures. These figures are

simply used by Amici to show that, taking Petitioners’ figures at face

value, basing UNE rates on such figures would either lead to wasteful

deployment or exit of some competitors.

28

forward-looking cost for the CLEC to construct its own loop

would be higher than the forward-looking cost for the RBOC

because the CLEC does not have the same economies of scale

and large customer base that the RBOC has. See, Local

Competition Order, 94 655, 679 (FCC Pet. App. 66a); UNE

Remand Order, 94 181-183. Thus, in most cases, the CLEC’s

cost to deploy that loop itself would be expected to be higher

than $14.52 per month.”

If the CLEC chooses to build the loop itself, this is

wasteful and an inefficient use of resources as it is more

efficient for the RBOC to build the loop. As the FCC has

noted, requiring CLECs to self-provision facilities such as

loops would “materially raise entry costs, delay broad-based

entry, and limit the scope and quality of a competitor's

offerings,” and is “not an adequate alternative for loops that a

carrier can obtain from an incumbent LEC.” UNE Remand

Order, ¥ 181; see id. at § 182. The historical cost approach

would thus lead to the inefficient overbuilding of facilities

that will delay competitive entry. Petitioners argue that the

“expeditious introduction of competition” is one of the

important objectives of the Act, but their approach would put

the brakes on such competitive entry. Petitioners’ Brief at

46; see also, at 48 (Congress “envisioned a system in which

entrants achieved efficiencies and introduced innovations that

gradually created the genuine benefits of a competitive

market... .”)

Some CLECs who have built some facilities (those as to

which the ILEC does not have a particular cost advantage)

while leasing others (as to which the ILEC has a cost

advantage because of economies of scale) from ILECs at

TELRIC prices may find that under the historical cost

approach it is cost-prohibitive to compete. The investments

made by these CLECs in their own facilities will be stranded

* The FCC has estimated that it costs $885 per line to construct a local

exchange network. Petitioners’ Brief at 11, n. 6.

29

by the change in methodology. They made a decision to enter

the market based on forward-looking prices for network

elements and invested in other facilities based upon the

expectation of being able to lease bottleneck facilities from

the ILEC at forward-looking prices. A doubling of the price

for a leased facility, as Petitioners contend, may make

continued use of that facility so costly that they have to exit

the market. This would frustrate the goal of promoting

competition.”'

Invalidation of TELRIC may also imperil much of the

competitive entry that has been made in the past five years.

While CLECs have made substantial investments to enter

markets, ILECs still dominate the local exchange market.

The ILECs control 92% of all local access lines. ALTS

Report at 9 (Feb. 2001).

Use of an historical cost approach will effectively preclude

CLEC utilization of ILEC network elements since it would be

cost-prohibitive to do so. Thus, CLECs, if they desire to

remain in the market, will be forced to overbuild ILEC

facilities at a time when available capital is scarce. Under

this scenario, available capital will be wasted on an inefficient

duplication of ILEC facilities when it would be much more

efficient and reasonable for the CLECs to lease network

elements from the ILEC. The capital wasted could be more

prudently invested in needed facilities to extend the reach of

telecommunications service, rather than to create duplicative

facilities.

The question ultimately becomes at what price do we want

to ensure the RBOCs’ recovery of their purportedly

“stranded” costs. The recovery of these costs creates costs of

*! The implications of the historical cost approach are not limited to use

of unbundled network elements. TELRIC is also utilized to price

interconnection and collocation services that are vital for connecting the

uetworks of two separate carriers. Basing interconnection and collocation

prices upon historical costs will further impede competition.

30

their own. As Professor Chen notes, “stranded cost recovery,

whether by legislative order or by a judicial finding of

confiscatory ratemaking, shifts costs from past utility

investors squarely onto the shoulders of current and future

customers.” Chen at 936. In 1996, Congress knew the

actions it would take might alter the financial bottom-line of

the RBOCs, but it felt that the advent of competition in the

local market was worth this cost. Additionally, it gave the

RBOCs incentive to allow for such competition by providing

for their entry into the long distance market once certain

requirements are met. By implementing TELRIC, the FCC

merely made manifest the choice Congress had already made,

i.e., to adopt a methodology that will promote the rapid and

efficient development of competition. The RBOCs, now well

on their way to achieving entry into the long distance market,

ask this Court to turn back local competition and retreat to the

monopoly days where their returns were protected, but at the

price of competition. This Court should reject this overture

and defer to the reasonable and appropriate choice made by

the FCC.

CONCLUSION

Wherefore, Amici respectfully request that this Court deny

the appeal of Petitioners Verizon Communications, Inc., ef

al., and uphold the Order of the Federal Communications

Commission pertaining to its TELRIC methodology.

MARY C. ALBERT

Vice President, Regulatory

and Interconnection

MORTON J. POSNER

Regulatory Counsel

ALLEGIANCE TELECOM, INC.

1150 Connecticut Avenue,

N.W.

Suite 205

Washington, D.C. 20036

(202) 464-6106

Counsel for Allegiance

Telecom, Inc.

STEPHEN ZAMANSKY

General Counsel

DSLNET COMMUNICATIONS, LLC

545 Long Wharf Drive, Sth Floor

New Haven, Connecticut 06511

(203) 772-1000

Counsel for DSLnet

Communications, LLC

RUSSELL I. ZUCKERMAN

Senior Vice President &

General Counsel

RICHARD E. HEATTER

Vice President, Legal Affairs

FRANCIS D. R. COLEMAN

Vice President, Regulatory

Affairs

MPOWER COMMUNICATIONS

CORP.

175 Sully’s Trail—Suite 300

Pittsford, New York 14534

(716) 218-6568

Counsel for Mpower

Communications Corp.

June 8, 2001

Respectfully submitted,

ANDREW D. LIPMAN

ERIc J. BRANFMAN

HARISHA J. BASTIAMPILLAI *

SWIDLER BERLIN SHEREFF

FRIEDMAN, LLP

3000 K Street, N.W.

Suite 300

Washington, D.C. 20007

(202) 424-7500

Counsel for Amici Curiae

Counsel of Record *

ROBERT W. BAKER

Vice President and General

Counsel

EL PASO NETWORKS, LLC

1001 Louisiana Street

25th Floor

Houston, Texas 77002

(713) 420-7021

Counsel for El Paso

Networks, LLC

SUMNER N. SMITH

Senior Corporate Counsel

US LEC Corp.

6801 Morrison Boulevard

Charlotte, N.C. 28211

(704) 319-1119

Counsel for US LEC Corp.