# Respondents Brief — Federal Communications Commission v. Iowa Utilities Board

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Respondents Brief
- **Published:** January 1, 2002
- **Citation:** 537 U.S. 807

## Text

' 1iZ |
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Nos. 00-511, 00-555, 00-587, 00-590, 2

IN THE

Supreme Court of the Anited S|

J
ate

Supreme Court, U3.

FILBD

8 2001

VERIZON COMMUNICATIONS, INC., ef al., OFFICE OF THE CLERK

Petitioners,

Vv.
FEDERAL COMMUNICATIONS COMMISSION AND
UNITED STATES OF AMERICA,

am ,
J u L s Respondents.

G0 | WorRLDCoM, INC., ef ail..

ye , Petitioners,
Vv.

VERIZON COMMUNICATIONS, INC., ef a/.,

Respondents.

FEDERAL COMMUNICATIONS COMMISSION AND
UNITED STATES OF AMERICA,

Petitioners,
v.

IOWA UTILITIES BOARD, et al.,
Respondents.

AT&T Corp.,
Petitioner,
Vv.
IOWA UTILITIES BOARD, ef al.,
Respondents.

GENERAL COMMUNICATION, INC.,
Petitioner,
Vv.
IOWA UTILITIES BOARD, ef ail.,
Respondents.

On Writ of Certiorari to the
United States Court of Appeals
for the Eighth Circuit

BRIEF ON THE MERITS OF SPRINT CORPORATION

IN OPPOSITION TO PETITIONERS VERIZON
COMMUNICATIONS, INC., ET AL.

DAVID P. MURRAY

WILSON-EPES PRINTING CO., INC.

Counsel of Record
RANDY J. BRANITSKY
KEVIN M. MILLER
WILLKIE FARR & GALLAGHER
1155 21st Street, N.W.
Washington, D.C. 20036
(202) 328-8000
Counsel for Respondent
Sprint Corporation

- (202) 789-0096 - WASHINGTON, O. C. 20001

BEST AVAILABLE COPY

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.

(i)

ii
RULE 29.6 STATEMENT
In accordance with Rule 29.6 of the Rules of this Court,
Sprint Corporation (“Sprint”) states as follows:
Sprint is a corporation organized for the purpose of
engaging in telecommunications and related businesses

and is publicly traded under the names Sprint FON and
Sprint PCS. Sprint Communications Company L.P. is a

wholly-owned subsidiary of Sprint.

TABLE OF CONTENTS

QUESTION PRESENTED .......:0scscsesssssesessosesesesesesesesese
Ee

A.

B.
C.
D

The FCC’s Local Competition Order..................
Judicial Review of the Local Competition

1. The First Eighth Circuit Decision................

SS ae

3. The Eighth Circuit’s Decision On Remand
SE MNEIPED Dintsenentnsctesstnsmssntsessosscensscesesessesesseses

SUMMARY OF ARGUMENT ..............ccccssseseseseeseseeees

lL NOTHING IN THE ACT REQUIRES

INCORPORATION OF AN ILEC’s HIS-
TORICAL COSTS INTO THE RATES FOR

A. Section 252(d)(1) Is Ambiguous And Does
Not Require The Use Of Historical Costs
In Establishing UNE Rates ......................00+

B. Other Provisions Of The Act Do Not
Compel The Use Of Historical Costs For

10
11
14

14

14

19

C.

iv
TABLE OF CONTENTS—Continued

1. The Act Expresses No Preference For
Historical Cost Models And There Is
No Reason To Infer One ..............-..0000++

2. The Act’s Resale Pricing Provision
Does Not Implicitly Endorse Historical
Or Forward-Looking Cost Models.........

The FCC’s Choice Of A Forward-Looking

Cost Methodology Was Not Arbitrary Or
Capricious And Is Entitled To Deference....

1. Historical Costs Are Antithetical To

2. TELRIC Is Not “Unmanageable” ..........
3. The FCC Did Not “Abandon”

. THE FCC’s SELECTION OF THE TELRIC
METHODOLOGY DOES NOT VIOLATE
THE TAKINGS CLAUSE ............cccscerssereeeenees

A.

TELRIC Does Not Represent A Consti-
tutionally Suspect Shift In Methodologies...

The ILECs’ Theoretical Attacks On
TELRIC Are Barred By The Well-Settled
“T otal Effect” Test For Regulatory

The Doctrine Of Constitutional Avoidance
Does Not Require The Inclusion Of

22

23

24
25

26

27

27

33

33
41

Vv

TABLE OF AUTHORITIES
CASES Page
AT&T Corp. v. Iowa Utils. Bd., 525 U.S. 366

American Public Gas Ass'n v. Federal Power
Comm ‘n, 567 F.2d 1016 (D.C. Cir. 1977)......... 20

American Trucking Ass'ns, Inc. v. Atchison,
Topeka & Santa Fe Ry., 387 U.S. 397 (1967)... 30

Apex Plumbing Supply, Inc. v. U.S. Supply Co.,

142 F.3d 188 (4th Cir. 1998) oo... .ccccccccceceseseee 18
Appalachian Power Co. v. EPA, 135 F.3d 791
ES ER Oe ee 15
Baltimore & Ohio R.R. v. United States, 345 U.S.
UE crinnshlcicihiesiniinintataniecima titties 35
Bell Atl. Tel. Cos. v. FCC, 24 F.3d 1441 (D.C.
Soran Wei iihernincethnsensictlinietsipeitainsintentirsitalomatinss 39
Brooks-Scanlon Co. v. Railroad Comm'n of La.,
ee I icctniecetiiinrtceninarnaiasiitatecnsitinneats 33, 35
Burlington N. R.R. v. Surface Transp. Bd., 114
ee 18
Capital Network Sys., Inc. v. FCC, 28 F.3d 201
8 ER ee 15, 16
Chevron U.S.A., Inc. v. Natural Res. Def.
Council, Inc., 467 U.S. 837 (1984) .....c.ccccccececeee 11, 23
Duquesne Light Co. v. Barasch, 488 U.S. 299
IE ee a passim
Federal Power Comm'n v. Hope Natural Gas
OM a passim

GTE S., Inc. v. Morrison, 6 F. Supp. 2d 517

(E.D. Va. 1998), aff'd, 199 F.3d 733 (4th Cir.

Pai dicseiiitiniitintitishasiatitisitininatinainsstaitiniieasas 19, 21, 22
Illinois Bell Tel. Co. v. FCC, 988 F.2d 1254

SUED MND SHUNT ctrdibieitepsiasincechinstitinnsiinsiiniginttemensents 17, 32

vi
TABLE OF AUTHORITIES—Continued

Iowa Utils. Bd. v. FCC, 120 F.3d 753 (8th Cir.
1997), aff'd in part and rev'd in part sub nom.
AT&T Corp. v. lowa Utils. Bd., 525 U.S. 366

ED ccccntnssesessecesessssnvssesesensseasssmenneessncsnnnnemecnsees passim
Jersey Cens. Power & Light Co. v. FERC, 810

F.2d 1168 (D.C. Cir. 1987)..........cccccccesersesersenees 37
Market St. Ry. v. Railroad Comm'n of Cal., 324

CAB, SED Ca cccncssecssccnsensessenenessesssnsssneseseese 29, 30, 31
Missouri ex rel. Southwestern Bell Tel. Co. v.

Public Serv. Comm'n, 262 U.S. 276 (1923) ...... 16
Mobil Oil Exploration & Producing Southeast,

Inc. v. United Distrib. Cos., 498 U.S. 211

| 16
National Rural Telecom Ass'n v. FCC, 988 F.2d

uN —————————————— 22, 31
New York Cent. R.R. v. White, 243 U.S. 188

ee 30
In re Permian Basin Area Rate Cases, 390 U.S.

pL 31, 36
Railway Labor Executives’ Ass'n v. United

States, 987 F.2d 806 (D.C. Cir. 1993) ..........000+ 39
Southwestern Bell Tel. Co. v. AT&T Commu-

nications of the Southwest, Inc., No. A 97-CA-

132 SS, 1998 WL 657717 (W.D. Tex. Aug.

Se passim
Tennessee Elec. Power Co. v. Tennessee Valley

Auth., 306 U.S. 118 (1939) .......cccccecseeeeseseneeeeees 28, 30
Texas Office of Pub. Util. Counsel v. FCC, 183

F.3d 393 (Sth Cir. 1999), cert. granted sub

nom. GTE Serv. Corp. v. FCC, 530 U.S. 1213,

cert. dismissed, 121 S. Ct. 423 (2000)............+++ 20, 41

Vii
TABLE OF AUTHORITIES—Continued

Page
Town of Concord v. Boston Edison Co., 915 F.2d
kg 5 EE a ee 24
United States v. Miller, 317 U.S. 369 (1943)......... 30
United States v. Riverside Bayview Homes, Inc.,
ET NS a 13, 39
In re Valuation Proceedings Under §§ 303(c) &
306 of the Reg’! Rail Reorg. Act, 439 F. Supp.
1351 (Regional Rail Reorg. Ct. 1977)............... 35, 36
Williamson County Reg’! Planning Comm'n vy.
Hamilton Bank, 473 U.S. 172 (1985) ........c0.000«. 38, 40
AGENCY DECISIONS

Application of Ameritech Mich. Pursuant to
Section 271 of the Communications Act of
1934, as amended, To Provide In-Region,
InterLATA Services in Mich., 12 F.C.C.R.
EET Se ee 4
In re Implementation of the Local Competition
Provisions in the Telecomms. Act of 1996, 11

ot ET passim
Policy and Rules Concerning Rates for Dominant

Carriers, 5 F.C.C.R. 6786 (1990) ......ccccccccceceseee 21

STATUTES

47 U.S.C. § 201(B)...........c.cccccceeee scosctugataminemestenats 4
47 U.S.C. § 251(C)(2)....cccccccceeseeee . --» <paealiliiiminmatstas 2
i TT 3
A 3
a. ae 4,19
| 21
| passim
47 U.S.C. § 252A) 1 Ai) ...cceccccececcececcececeseeceneee 3

47 U.S.C. § 252d) 1B) ........cecceceseesessesessecessecneees 3

viii
TABLE OF AUTHORITIES—Continued

Page
47 U.S.C. § 252(d)(3) ..sescesereeresserserssennennersnennensnes 22, 23
47 U.S.C. § 252(€)(6)...ceceeecerersereserssnsennsensenenennenes 38
AT U.S.C. § 254 ....cccscsssseesssessenenesnenenennsnenenssnnenennenes 26, 37
RULES
47 C.F.R. § 51.505(b)(1) (2000) ........cescerersererrenenes 2, 6
47 C.F.R. § 51.505(b)(2) (2000) ........cssereesereerrenes 6
47 C.F.R. § 51.505(b)(3) (2000) ........ceeecererenrerenees 7
47 C.F.R. § 51.505(C) (2000)........sceeeserserereereneenes 7
CONGRESSIONAL MATERIAL
S. Conf. Rep. No. 104-230 (1996).......ssserererenenes 2
OTHER AUTHORITIES
Edwin Mansfield, Microeconomics (6th ed.
1988) .....scececcscscsssssssssrssssesesrersnsssssssssnssensnnenenessees 19
Kenneth Culp Davis & Richard J. Pierce, Jr.,
Administrative Law Treatise (3d ed. 1994)........ 16
Laurence H. Tribe, American Constitutional Law
(2d Cd. 1988) .......cscesssersesereressnsnsssnsnssrnsnersenenenenes 36
Michael K. Kellogg et al., Federal Telecom-
munications Law (1st ed. 1992)........esseeeeeeees 22
Michael K. Kellogg et al., Federal Telecom-
munications Law (2d ed. 1999)........seeeeeeeees 26
Reed E. Hundt, You Say You Want A Revolution
(2000)........cssssesssssssesssenenesssenenensnsnsesnsnsnsnsnenenensnes 5

Webster’s New World Thesaurus (new rev. ed.
19B5) ..cccccccocsrcsscesoerserseserssseesensoorees nee 16

PRELIMINARY STATEMENT

Pursuant to Supreme Court Rules 24.2 and 25.1, Sprint
Corporation (“Sprint”) respectfully submits this Respondent’s
Brief on the Merits in Opposition to Petitioners Verizon
Communications, Inc., et al. addressing the following
question:

Whether the court of appeals erred in holding that
neither the Takings Clause nor the Telecommunications
Act of 1996 (“Act”) 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.

Supreme Court Order List (Jan. 22, 2001) at 4.
STATEMENT OF THE CASE

A. Background

Unlike many of the private parties in these proceedings,
Sprint has substantial local and long distance operations.
Sprint has participated both as a new entrant and as an
incumbent local exchange carrier (“ILEC”) in state-regulated
arbitrations pursuant to Section 252 of the Act. These
experiences have given Sprint a balanced perspective on the
challenges of opening local telephone markets to competition
while satisfying the divergent interests of new entrants and
ILECs. The “long distance side” of Sprint, like other new
entrants, is interested in obtaining access to unbundled net-
work elements (“network elements” or “UNEs”) of ILECs at
rates and on terms that permit meaningful local competition.
The “local side” of Sprint, like other ILECs, is interested in
ensuring that it receives just and reasonable compensation for
providing UNEs to new entrants.

Sprint believes that the UNE pricing methodology adopted
by the Federal Communications Commission (“FCC”) strikes
the proper balance in implementing the Act’s pro-competitive
objectives. The FCC established a forward-looking, long-run

2

methodology for pricing UNEs based on “the most efficient
telecommunications technology currently available and the
lowest cost network configuration, given the existing location
of the incumbent LEC’s wire ceniers.” JA 51.' This meth-
odology, which is known generally as “Total Element Long
Run Incremental Cost” or “TELRIC,” attempts to replicate
prices that would prevail in a competitive environment, while
ensuring that the ILEC is justly compensated for the use of its
network elements at prices reflecting what it would cost to
replace the functionalities provided by those elements today.

B. The Act

The Act seeks to transform state-sanctioned local monop-
olies into fully competitive markets on a national scale. See
S. Conf. Rep. No. 104-230, at 113 (1996) (the primary goal of
the Act is to increase competition in both local and long
distance telephone markets as swiftly as possible). Congress
recognized the practical and economic impediments that new
entrants would face if forced to replicate all of the ILEC’s
existing local network infrastructure. Congress thus estab-
lished comprehensive requirements “intended to facilitate
market entry.” AT&T Corp. v. Iowa Utils. Bd., 525 U.S. 366,
371 (1999) (“JUB I’). “Foremost” among them is the ILEC’s
“obligation under [the Act] to share its network with
competitors.” /d.

Section 251(c) provides three complementary avenues for
new entrants to obtain access to an ILEC’s network. First, a
new entrant may “interconnect” its facilities with an ILEC’s
existing local network. JA 12-13. This enables the new
entrant to transmit and receive calls to and from all local
telephone subscribers without replicating an entire telephone
network.

' The Court has agreed to the submission of a deferred Joint Appendix
(“JA”).

3

Second, a new entrant may purchase an ILEC’s retail
services at wholesale rates and then resell the services to local
customers under the new entrant’s brand name. JA 13. This
enables the new entrant to compete on the basis of price and
service, without investing in any of its own facilities.

Third, and most relevant here, a new entrant may lease
UNEs from the ILEC. /d. New entrants may use the leased
UNEs, alone or in combination with the new entrant’s own
network facilities, to offer new and different competitive
services. ILECs are to receive “just [and] reasonable”
compensation for leasing UNEs, “based on the cost. . . of
providing” the element, including a “reasonable profit.”
JA 13, 23.

Contrary to the ILECs’ assertions, the Act expresses no
preference for “facilities-based competition” among these
three alternatives. This Court—and the Eighth Circuit—have
already rejected that notion. In upholding the FCC’s so-
called “all elements” rule, which allows competitors to
provide local telephone service relying solely on leased
UNEs, this Court held that:
[T]he [FCC] reasonably omitted a facilities-ownership
requirement. The 1996 Act imposes no such limitation;
if anything, it suggests the opposite, by requiring in
§ 251(c)(3) that incumbents provide access to “any”
requesting carrier. We agree with the [Eighth Circuit]
that the [FCC’s] refusal tu impose a facilities-ownership
requirement was proper.

IUB I, 525 U.S. at 392-93. The Eighth Circuit similarly held

that:
[A}fter study, we do not believe that the Act’s exclusive
goal is facilities-based competition. While Congress
may have envisioned facilities-based competition in
local telephone markets to occur down the road,
Congress clearly included measures in the Act, such as
the interconnection, unbundled access, and resale
provisions, in order to expedite the introduction of

4

pervasive competition into the local telecommunications
industry. Congress recognized that the amount of time
and capital investment involved in the construction of a
complete local stand-beside telecommunications net-
work are substantial barriers to entry, and thus required
incumbent LECs to allow competing carriers to use their
networks in order to hasten the influence of competitive
forces in the local telephone business.

Iowa Utils. Bd. v. FCC, 120 F.3d 753, 816 (8th Cir. 1997),
aff'd in part and rev'd in part sub nom. AT&T Corp. v. lowa
Utils. Bd., 525 U.S. 366 (1999). Cf JA 271-272 (¥ 12)
(“Section 251 neither explicitly nor implicitly expresses a
preference for one particular entry strategy.”).”

C. The FCC’s Local Competition Order

Congress expressly authorized the FCC to promulgate rules
implementing the Act’s pro-competitive requirements and set
few limits on the agency’s exercise of that authority. JA
10, 14. As this Court has recognized, the key provisions of
the Act are subject to multiple interpretations and Congress
was “well aware” that these ambiguities would be resolved by
the FCC. JUB I, 525 US. at 397.

2The ILECs’ contention that Congress valued facilities-based
competition over UNE-based competition is also disingenuous. For
example, SBC, BellSouth, and Ameritech successfully argued to the FCC
that UNE-based competition is the equivalent of facilities-based
competition for purposes of meeting the requirements of Section
271(ch 1A) (“Presence of a Facilities-Based Competitor”) of the Act,
which prohibits Bell Operating Companies from offering long distance
services in the areas in which they are the incumbent until they have
proven that those local markets are effectively open to competition.
Application of Ameritech Mich. Pursuant to Section 271 of the
Communications Act of 1934, as amended, to Provide In-Region,
InterLATA Servs. in Mich., 12 F.C.C.R. 20,543, 20,590-91 (f] 86-87)
(1997).

3 The ILECs use statements from former FCC Chairman Reed Hundt to
assert that the FCC “was dissatisfied with the 1996 Act” and purposely

,.

Virtually the entire telecommunications industry partici-
pated in the FCC’s rulemaking proceedings, which culmi-
nated in the Local Competition Order. A significant part of
these efforts focused on the appropriate compensation that
new entrants should pay to lease UNEs from ILECs. Most
ILECs favored a pricing methodology that would allow
recovery of the “historical costs” of their network elements.
JA 359-361 (655). Most new entrants argued that a
forward-looking methodology was necessary to allow com-
petition to develop. JA 340-342 (4 635).

The FCC carefully evaluated the various cost method-
ologies proposed by the commenters, JA 325-423 (J 618-
740), and ultimately determined that TELRIC was the most
effective and fair means to implement the Act’s pro-
competitive goals, JA 379-380 (4 679). Based on substantial
economic commentary and analysis, the FCC concluded that
a forward-looking cost methodology, such as TELRIC, would
best replicate the conditions of a competitive market. JA
379-380, 398-399 (9 679, 705). Typically, new firms enter a
market and set prices based on the costs of building the most
efficient facilities necessary to compete. Incumbents must
then respond to those prices, even if their existing facilities
are less efficient. JA 379-380 (4679). Forward-looking
pricing of UNEs helps to achieve a similar result. New
entrants cannot immediately compete on equal terms because
the costs of entry (viz., replicating a ubiquitous local network)

discriminated against the ILECs in favor of new entrants. These post-
employment statements are irrelevant; they have also been misleadingly
selected and quoted out of context. In the same passages cited by the
ILECs, the former Chairman emphasized that the FCC “did not want to
confer advantage on particular companies.” Reed E. Hundt, You Say You
Want A Revolution 155 (2000). He also noted that the Act produced “a
mountain of ambiguity” and that subsequent regulations interpreting these
ambiguities may allow new entrants a “fairer chance to compete,”
consistent with Congress’ goal of opening the local telephone market to
competition. See id. at 154.

6

are vastly too prohibitive to be incurred all at once. /owa
Utils. Bd. v. FCC, 120 F.3d at 816. A methodology based on
forward-looking economic costs helps to “drive retail prices
to their competitive levels” by setting costs at levels firms
would face in a competitive market. JA 380 (4 679). This, in
turn, “give[s] appropriate signals to producers and consumers
and ensure{s] efficient entry and utilization of the
telecommunications infrastructure.” JA 333 ({ 630).

The FCC also took steps to ensure that the TELRIC
methodology allows ILECs to recover the full forward-
looking cost of leased UNEs, by measuring the long-run,
incremental cost of the network element based on: (i) the use
of the “most efficient telecommunications ~ technology
currently available and the lowest cost network configuration,
given the existing location of the incumbent LEC’s wire
centers,” JA 51; (ii) the cost of capital, thus allowing ILECs
to recover normal economic profit, id. and (iii) the useful life
of the element, as measured by its economic depreciation
rate, id. In addition, TELRIC allows for a reasonable share of
joint and common costs. JA 51-52.

The FCC concluded that TELRIC would not always result
in forward-looking costs that are below historical costs.
Although the application of TELRIC to certain elements of an
ILEC’s local telephone network, such as switches and other
computer-based components, may result in forward-looking
costs below historical costs, the opposite may be true for
other elements such as loops, whose costs are driven by
material or labor. JA 398-399, 400-401 (4 705, 707). At the
same time, the FCC determined that an ILEC’s existing wire
centers should be used as a component of TELRIC, precisely
to “encourage[] facilities-based competition to the extent that
new entrants, by designing more efficient network
configurations, [would be] able to provide the service at a
lower cost than the incumbent LEC.” JA 384 (¥ 685).

7

The FCC considered and addressed each of the objections
to TELRIC raised by the ILECs. By designing a forward-
looking cost methodology that simulates a competitive
market, the FCC sought to ensure that the rates eventually
produced by TELRIC are properly balanced and enable new
entrants to compete for local customers from the outset.
JA 383-384 (§ 685). On the one hand, if UNE rates are set
below forward-looking costs, new entrants might be deterred
from building competing facilities. Moreover, some new
entrants might be induced to enter using network elements
where it would not otherwise be economically efficient for
them to do so. On the other hand, if UNE rates are set too
high, which a methodology based on historical or
“embedded” costs might produce, competitive entry may
never occur. Because the costs of immediately building a
completely ubiquitous local network would be prohibitive for
any one firm, most new entrants must rely in part on leased
UNEs to provide a full range of local services. Excessive
UNE rates would make it impossible for new entrants to price
these services at competitive levels, effectively impeding
market entry.‘

* The ILECs claim that TELRIC pricing has caused “many entrants” to
alter plans “away from deploying competing facilities.” Brief for
Petitioners (“Pet’r Br.”) at 13, 49. This claim is rebutted by FCC data
indicating that no single method of competitive entry predominates. See
Industry Analysis Division, FCC, Local Telephone Competition: Status as
of December 31, 2000 (May 2001). The isolated examples they cite to
from 1996 fail to demonstrate that TELRIC caused “many new entrants”
to halt facilities-based entry. At that time, the FCC’s pricing rules were
vacated and the individual state commissions were in the process of
determining UNE pricing in individual arbitrations. Moreover, a myriad
of reasons may explain why a particular company would modify a
business strategy away from expending the massive amounts of capital
needed for facilities-based entry. For example, a particular new entrant
may have difficulty in raising the needed capital. See Letter from
Chairman Michael Powell to Congress of 5/4/01, at 1. A new entrant may
also reasonably wait to invest in facilities until it has reached sufficient

8

The FCC similarly rejected the ILECs’ argument that
forward-looking costs should be based exclusively on an
ILEC’s existing network, without regard to available, more
efficient substitutes. JA 383 (4 684). Because this approach
would allow ILECs to recover costs “that reflect inefficient or
obsolete network design and technology,” the FCC found it
would be “essentially an embedded cost methodology.” /d.
A forward-looking methodology, in contrast, rationally
examines what it would cost to replace the functions that
make a network asset valuable. This includes currently
available substitutes that perform the same functions as the
original network element, but embody more efficient
technologies to do so. JA 382-384 (fff 683-685).

The FCC also found that a forward-looking cost
methodology would not result in-a “taking” of the ILECs’
property without just compensation. Under this Court’s pre-
cedents, the “just and reasonable” standard of the Takings
Clause requires, in the regulatory context, an examination of
the “total effect” of the actual rates established by the agency.
JA 419-421 (49 734-737). After reviewing the record, the
FCC found that “{njo- incumbent LEC has provided
persuasive evidence that prices based on a forward-looking

scale by servicing customers through resale and UNEs, which in many
parts of the country new entrants have failed to reach even today, five
years after the Act’s passage.

‘The ILECs claim that TELRIC “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.” Pet’r Br. at 9-10. This
assertion is exaggerated. TELRIC rationally measures the cost of
providing the actual network element by asking what cost the ILEC or any
other carrier would bear in the marketplace, at the time the UNE rates are
established, to replace the functions of the network element at issue with
currently available efficient substitutes consistent with the ILEC’s
existing wire center. UNE rates are typically in place for the term of an
interconnection agreement, which is commonly three to four years, and
are not changed “every time a newer technology hits the market.”

9

economic cost methodology would have a significant impact
on its ‘financial integrity.” JA 422 (4738). Even so, the
FCC specifically ordered the ILECs to “seek relief from the
Commission’s pricing methodology if they provide specific
information to show that the pricing methodology, as applied
to them, will result in confiscatory rates.” /d. (9739). The
FCC also determined that TELRIC is consistent with the “just
and reasonable” standard used for takings that result in a
physical occupation of property. JA 422-423 (4 740).

Finally, the FCC determined that state commissions would
be able to implement TELRIC in setting UNE ates.
A number of state commissions were already using forward-
looking methodologies similar to TELRIC in setting retail
rates for local services. JA 334-336, 381 (99631, 681).
As the FCC found, “the record demonstrates that
such approaches are practical and implementable.” jA 381
(¥ 681).

D. Judicial Review of the Local Competition Order

1. The First Eighth Circuit Decision

Challenges to the Local Competition Order were consoli-
dated in the Eighth Circuit and first decided in 1997. Among
other things, the Eighth Circuit invalidated the FCC’s pricing
rules—including TELRIC—holding that the Act gives state
public utility commissions, not the FCC, general jurisdiction
to interpret and implement the Act’s pricing provisions. Jowa
Utils. Bd. v. FCC, 120 F.3d at 794.

2. JUBI

On review, this Court held, inter alia, that Section 201(b)
of the Act gives the FCC jurisdiction to adopt rules to
implement all of the Act’s local competition provisions.
IUB I, 525 U.S. at 377-86. The Court reversed the Eighth
Circuit’s ruling that the FCC lacked the statutory authority to
establish national pricing rules, reinstated the FCC’s pricing
rules, and remanded so that the Eighth Circuit could review
the substantive challenges to them. /d. at 377-78.

10

3. The Eighth Circuit’s Decision On Remand
(“7UB IT”)
The Eighth Circuit found that the term “cost” in
§ 252(d)(1) is “ambiguous” and that the FCC was authorized
to interpret the term to allow for a forward-looking cost
methodology like TEL? IC. Jowa Utils. Bd. v. FCC, 219 F.3d
744, 751-52 (8th Cir. 20°) (“JUB IT’) (FCC Pet. App. 1 1a).
The Eighth Circuit further held that the FCC’s “use of a
forward-looking cost methodology was reasonable . . . [and]
that the FCC explained in detail its reason for selecting [such]
a methodology to implement the new competitive goals of the
Act.” Id. at 752 (FCC Pet. App. 12a).°

The Eighth Circuit also rejected the ILECs’ argument that
the doctrine of constitutional avoidance required the FCC to
use a historical cost methodology. “[A] takings claim,” the
court correctly noted, “cannot be based on the ratemaking
methodology, but rather it must be based on the rate itself.”
Id. at 754 (FCC Pet. App. 17a). Accordingly, the Eighth
Circuit held that:

“It is not enough that a party merely speculates that a
government action will cause harm.” We do not need to
disregard Chevron deference and interpret the statute in
accordance with the petitioners’ views in order to avoid
an unconstitutional taking in this instance. The
possibility that a regulatory program may result in a

ing does not justify the use of a narrowing
construction. In such circumstances, the adoption of a
narrowing construction might frustrate a potentially
permissible application of a statute. Because the
consequences of the FCC’s choice to use TELRIC
methodology cannot be known until the resulting rates

® The Eighth Circuit’s vacation of Rule 505(b)(1) is addressed in
Sprint’s previously-filed Brief on the Merits in Support of Petitioners
Federal Communications Commission and United States of America.

11
have been determined and applied, the constitutional
claim is not ripe.
Id. at 754 (citations omitted) (FCC Pet. App. 17a-18a).

SUMMARY OF ARGUMENT

The FCC’s choice of the TELRIC methodology is entitled
to substantial deference. Under Chevron, the agency’s
decision should be upheld unless “Congress has . . . addressed
the precise question at issue” and unambiguously foreclosed
the agency’s choice or the agency’s reasoning was arbitrary.
Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467
U.S. 837, 842-43, 845 (1984) (“Chevron”). The Act, as this
Court found, “is in many important respects a model of
ambiguity or indeed even self-contradiction” that imposes
few restraints on the FCC’s exercise of its implementing
authority. See JUB I, 525 U.S. at 397 (the Act grants “most
promiscuous rights” to the FCC). In applying Chevron
deference to FCC regulations promulgated under the Act, this
Court has held that such regulations should be affirmed
unless they exceed the few “clear limits” that the Act
contains. /d.

The Act does not mandate or prohibit any particular pricing
methodology for UNEs. As the Eighth Circuit correctly
found, “the term ‘cost,’ as it is used in [Section 252(d)(1)], is
ambiguous and . . . Congress has not spoken directly on the
meaning of the word in this context.” JUB IJ, 219 F.3d at 751
(FCC Pet. App. lla). The responsibility for interpreting and
implementing that provision thus belongs to the FCC, not the
courts. /d. at 752 (FCC Pet. App. 12a). The FCC evaluated
numerous alternatives, including historical and forward-
would best serve the dual goals of fairly compensating ILECs
for UNEs while promoting the competitive market condi-
tions desired by Congress. JA 325-423 (99 618-740). The
FCC also “explained in detail its reason for selecting a

12

forward-looking cost methodology to implement the new
competitive goals of the Act.” JUB II, 219 F.3d at 752 (FCC
Pet. App. 12a). The agency’s expert judgment to use
TELRIC, rather than a methodology that includes historical
costs, was well-reasoned, supported by the record, and should
be affirmed.

The ILECs assert that TELRIC is an “unmanageable”
methodology and that it was arbitrary and capricious for the
FCC to adopt it. This claim is readily disproved. In adopting
TELRIC, the FCC found that the methodology was both
practical and implementable by-the states. These findings
have been confirmed by experience, as state commissions
around the country have successfully applied TELRIC in
establishing UNE rates within the timetables set by the Act.
Even after the Eighth Circuit invalidated the FCC’s
promulgation of TELRIC on jurisdictional grounds, a
majority of state commissions adopted the methodology,
independently concluding that it best served the goals of
fairly compensating ILECs, promoting local competition, and
ensuring efficient entry, utilization, and expansion of the
telecommunications infrastructure.

The FCC’s adoption of the TELRIC methodology does not
violate the Fifth Amendment to the United States
Constitution. The ILECs wrongly claim that the FCC
“shifted” methodologies from a historical to a forward-
looking cost methodology and that this “opportunistic switch”
results in an uncompensated taking. This argument is based
on an analytical artifice that lacks factual and legal
foundation. Congress charged the FCC with implementing an
entirely new regulatory regime that opens decades-held
monopolies to competition. The FCC was not bound by any
of the historical and forward-looking cost methodologies used
by the agency or the states in establishing rates during the
monopoly era. Rather, the FCC was obligated to use its
expert judgment in adopting a methodology that both
comports with the Act’s UNE pricing standards and promotes

13

the pro-competitive goals of Congress. The FCC’s adoption
of TELRIC helps to implement the new Act and in no way
resembles the type of “opportunistic switch” from a settled
cost methodology that might raise constitutional concerns
under this Court’s precedents.

The ILECs’ “takings” challenge to the TELRIC method-
ology itself also fails. A takings claim must be based on an
actual rate, not the ratemaking methodology. “It is not theory
but the impact of the rate order which counts.” Federal
Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 602
(1944) (“Hope Natural Gas”). As the Eighth Circuit found,
the ILECs’ takings claim remains purely theoretical. The
ILECs presented no credible evidence during the FCC
rulemaking that TELRIC prices or the Act’s overall pricing
scheme would significantly affect their financial integrity.
Nor have they provided any persuasive evidence of such
effects here. Even if a takings challenge to the TELRIC
methodology were ripe, it would still fail. The TELRIC
methodology allows ILECs to recover their full forward-
looking costs of providing UNEs to new entrants. When
properly applied, the methodology comports with the Act’s
requirement that ILECs receive “just and reasonable”
compensation for leasing UNEs. The ILECs are entitled to
no more.

Finally, the ILECs wrongly argue that the “constitutional
avoidance” doctrine negates Chevron deference and requires
adoption of a historical cost methodology. Mere allegations
that a regulatory program may result in a taking does not
justify the use of a narrowing construction which might
frustrate a potentially permissible application of a statute. See
United States v. Riverside Bayview Homes, Inc., 474 US.
121, 128-29 (1985) (“Riverside Bayview Homes”). The Act
provides a mechanism for the ILECs to receive compensation
through state-arbitrated UNE rates, thus obviating any basis
for a limiting construction. The ILECs have not shown that

14

any actual rates derived from TELRIC are so unjust as to be
confiscatory. Their unsubstantiated claims of potential con-
stitutional infirmity provide no basis for this Court to
disregard Chevron deference in favor of the ILECs’
restrictive views of the Act’s UNE pricing provisions.

ARGUMENT

I. NOTHING IN THE ACT REQUIRES INCORPO-
RATION OF AN ILEC’s HISTORICAL COSTS
INTO THE RATES FOR UNEs.

Section 252(d)(1) of the Act requires “just and reasonable”
rates for UNEs “based on the cost . . . of providing the. . .
network element. . . . and may include a reasonable profit.”
JA 22-23. The Eighth Circuit properly determined that
Section 252(d)(1) is ambiguous as to the cost methodology
that may be employed in establishing UNE rates. /UB II, 219
F.3d at 751-53 (FCC Pet. App. 10a-14a). The Eighth Circuit
thus upheld the FCC’s adoption of a forward-looking cost
methodology as a reasonable interpretation of the statute. /d.
at 752-53 (FCC Pet. App. lla-14a). The ILECs challenge
these holdings, arguing that the “plain text, structure, and
purpose of Section 252” demonstrate that Congress
unambiguously intended for an ILEC’s “historical” costs to
be included in the UNE rate methodology. Brief for
Petitioners (“Pet’r Br.”) at 16, 19-21. These arguments are
unpersuasive when measured against the statutory language
and scheme.

A. Section 252(d)(1) Is Ambiguous And Does Not
Require The Use Of Historical Costs In
Establishing UNE Rates.

The ILECs’ “plain text” argument relies heavily on various
dictionary definitions of “cost” that have little relevance to
the term’s use in the ratemaking context. According to the
ILECs, “cost” simply means the amount paid for an item at
the time it was purchased or built. /d. at 19. They contend,

15

therefore, that the term “cost,” as used in Section
252(d)(1)(A)(i), must include all of an ILEC’s past expen-
ditures, i.e., “historical” costs. Jd. The ILECs also rely on
the purported use of the term “cost” in the pre-Act monopoly
era, arguing that “for decades” the telecommunications
industry has used the term “cost” to mean “historical” cost
and that Congress intended for the term’s use in Section
252(d)(1) to be vested with that same meaning. /d. at 20.

Contrary to the ILECs’ assertions, the term “cost,” when
used in the regulatory ratemaking context, is susceptible to
different meanings and is not confined to a particular
dictionary definition. The Act neither defines the term
“cost,” as used in Section 252(d)(1), nor does it require that
UNEs be priced based on any particular cost methodology.
As the Eighth Circuit found, “Congress has not spoken
directly on the meaning of the word in this context... .
‘[T]he word “cost” is a chameleon, capable of taking on
different meanings, and shades of meaning, depending on the
subject matter and the circumstances of each particular
usage.”” JUB II, 219 F.3d at 751-52 (emphasis added)
(quoting Strickland v. Commissioner, Maine Dep't of Human
Servs., 48 F.3d 12, 19 (1st Cir. 1995)) (“the word ‘cost’ is a
chameleon”) (FCC Pet. App. 11a); see Appalachian Power
Co. v. EPA, 135 F.3d 791, 809 (D.C. Cir. 1998) (noting
“essential ambiguity of the word”). Such an ambiguous term
confers, in the words of Justice Breyer, “‘broad
methodological leeway,’” and “say[s] little about the ‘method
employed’ to determine a particular rate.” JUB I, 525 U.S. at
423 (citation omitted). The FCC, therefore, properly
exercised its authority in interpreting the term to permit a
forward-looking cost methodology for establishing UNE
rates. See id. at 397.’

” Similarly, the Act's “just and reasonable” pricing provisions are the
type of “ambiguous statutory terms” that require “substantial deference to
the interpretation the [FCC] accords them.” Capital Network Sys., Inc. v.

16

Moreover, Section 252(d)(1) refers to the “cost. . . of
providing” the UNE to new entrants. This language supports
the use of a forward-looking methodology by directing the
inquiry to the costs resulting from a new entrant’s use of the
UNE today, and not what the UNE cost to the ILEC when
originally purchased. Any rational firm, including an ILEC,
would replace these elements with the most efficient available
technologies. See Missouri ex rel. Southwestern Bell Tel. Co.
v. Public Serv. Comm’n, 262 U.S. 276, 311-12 (1923)
(Brandeis, J., concurring) (the proper inquiry “would be, not
what it would cost to reproduce the identical property, but
what it would cost to establish a plant which could render the
service, or in other words, at what cost could an equally
efficient substitute be then produced”); see also Mobil Oil
Exploration & Producing Southeast, Inc. v. United Distrib.
Cos., 498 U.S. 211, 219 (1991). TELRIC properly sets prices
based on the “replacement costs” that firms would currently
incur to provide the same UNE functions. This approach
properly compensates ILECs for the fair value of the assets
they use in “providing” UNEs to new entrants, consistent
with the language of Section 252(d)(1).°

FCC, 28 F.3d 201, 204 (D.C. Cir. 1994). Indeed, for more than half a
century, the statutory mandate that rates be “just and reasonable” has been
understood as granting an agency discretion to choose between a forward-
looking and a historical-cost approach. Hope Natural Gas Co., 320 U.S.
at 602; see Kenneth Culp Davis & Richard J. Pierce, Jr., Administrative
Law Treatise § 3.4 (3d ed. 1994) (agency setting “just and reasonable”
rates has discretion in selecting rate methodology to comport with
statutory policy decisions).

* The ILECs make a weak attempt to distinguish the term “cost” from
the term “value.” They argue that by compensating ILECs for the
replacement cost that would be paid on the open market for the functions
of the network element, TELRIC improperly measures “value” not “cost.”
This purported distinction is overstated. The terms “cost” and “value” are
widely recognized as being synonymous. Webster's New World
Thesaurus 156, 804 (new rev. ed. 1985). The ILECs also ignore the
remainder of the statutory language, which requires examination of the

17

Section 252(d)(1) also expressly requires that UNE rates be
established “without reference to a rate-of-return or other
rate-based proceeding ... .” JA 23 (emphasis added).
Historical costs are invariably determined in a rate-of-return
proceeding. See Illinois Bell Tel. Co. v. FCC, 988 F.2d 1254,
1258-59 (D.C. Cir. 1993) (“Illinois Bell IT’). This statutory
language further suggests that Congress did not intend for,
let alone mandate that, historical costs be included in
UNE prices.

The ILECs also overstate the telecommunications indus-
try’s past usage of the term “cost” as requiring a historical
cost methodology. Pet’r Br. at 19. Forward-looking cost
methodologies have been part of this country’s regulatory
tradition for over fifty years, and there was a time when this
Court believed that the Constitution mandated such an
approach. See Duquesne Light Coe. v. Barasch, 488 U.S. 299,
308 (1989) (“Duquesne”). Several states were also imple-
menting forward-looking methodologies to encourage local
telephone competition before the Act. JA 334-336, 381
({] 631, 681). In all events, the FCC was under no obligation
to use a particular cost methodology from the pre-Act era to
implement the pricing provisions of Section 252(d)(1). The
Act creates a new regime that fundamentally shifts the
provision of local telecommunications services away from the
past monopoly environment to a new competitive environ-
ment. Congress mandated that new entrants have access to
UNEs to compete in the local telecommunications market.
The Act did not require the FCC to apply remnants of the old
monopoly system to the pricing methodology that it was

“cost . . . of providing” the UNE. This language supports a methodology
that looks to the current value of the assets used to provide the’ UNE
functions, for the reasons shown.

18

: jurisdictionally authorized to implement, and the FCC found
no reasonable basis to do so.”

Finally, the ILECs argue that Congress “clearly” mandated
the use of historical costs because Section 252(d)(1)(B)
contains the terms “may include a reasonable profit.” The
ILECs claim that a “reasonable profit” cannot be realized
unless all of an ILEC’s historical costs are first recouped.
This argument fails for several reasons.

Use of “[t]he word ‘may’ in a statute normally confers a
discretionary power, not a mandatory power.” Apex
Plumbing Supply, Inc. v. U.S. Supply Co., 142 F.3d 188, 192
(4th Cir. 1998) (citation omitted). Congress thus provided the
FCC with discretion to incorporate a “reasonable profit” into
the pricing methodology, but did not require the agency to
do so.

As the Eighth Circuit also noted, “[a] ‘profit’ can be made
whether a historical cost or forward-looking cost method-
ology is used.” JUB II, 219 F.3d at 752 (FCC Pet. App. 13a).
The FCC addressed this point during the rulemaking,
explaining that “(t]he concept of normal profit is embodied in
forward-looking costs because the forward-looking cost of
capital, i.e., the cost of obtaining debt and equity financing, is
one of the forward-looking costs of providing the network
elements.” JA 393 (4700); see also Burlington N. R.R. v.
Surface Transp. Bd., 114 F.3d 206, 210, 212-14 (D.C. Cir.
1997) (rates based on forward-looking costs of “hypothetical

°The ILECs wrongly suggest that, because the FCC stated in the
entirely different context of cable rate regulation that “‘[o}riginal cost is
the normal, now traditional method used for public utility rate valuation,”
the agency must use a historical cost methodology here. Pet’r Br. at 20
(citation omitted). In implementing the Cable Act, which is governed by
a more traditional ratemaking scheme, the FCC was not attempting to
choose the measure of cost best suited to opening a market to competition.
The FCC is fully authorized to choose a regulatory tool best suited to one
context and a different regulatory tool best suited to a different situation.

19

‘stand-alone railroad’” provide “a competitive return on all
investments the railroad actually made at their current
value”). Thus, an ILEC can “obtain a ‘reasonable profit’
without recovering all of its embedded costs.” Southwestern
Bell Tel. Co. v. AT&T Communications of the Southwest, Inc.,
No. A 97-CA-132 SS, 1998 WL 657717, at *11 (W.D. Tex.
Aug. 31, 1998) (“SWBT”); see also GTE S., Inc. v. Morrison,
6 F. Supp. 2d 517, 529 (E.D. Va. 1998), aff'd, 199 F.3d 733
(4th Cir. 1999) (“GTE South’).

Lastly, in a competitive environment, market forces drive
rates to forward-looking costs. JA 379-380 (4 679). Profits
in excess of forward-looking costs are not “normal.” Edwin
Mansfield, Microeconomics 252-53 (6th ed. 1988); SWBT,
1998 WL 657717, at *10; see JA 393-395 (¥ 700). By argu-
ing that forward-looking costs do not provide them with a
“reasonable profit,” the ILECs essentially argue that they are
entitled to more profit than is available in either a competitive
or a regulated market. While the ILECs may prefer such a
windfall, the Act does not allow, much less require, it. The
FCC was not authorized to include anything more than a
“normal” profit in its forward-looking cost methodology.
Had the FCC granted ILECs a “supra-normal” profit, as they
apparently urge, the agency would have violated the Act’s
mandate that rates be “reasonable.” JA 393-394 (4 700
& n.1707).

B. Other Provisions Of The Act Do Not Compel
The Use Of Historical Costs For UNE Pricing.

1. The Act Expresses No Preference For
Historical Cost Models And There Is No
Reason To Infer One.

Congress required the FCC to “complete all actions
necessary to establish regulations to implement” the Act
within six months. JA 14. From this “congressional desire
for swift action,” and Section 252(d)(1)’s proscription against

20

the use of “rate-of-return or other ratemaking proceeding[s],”
the ILECs attempt to infer that Congress intended for the term
“cost” to mean “already established and readily available”
historical costs. Pet’r Br. at 22. This argument rests on the
false premise that forward-looking cost models are “novel,
complex, and difficult-to-administer,” while historical cost
models are easy to use and ready off-the-shelf. /d.

Modern economic modeling has made forward-looking
cost methodologies, in the words of the FCC, both “practical
and implementable.” JA 381 (9681); see also American
Public Gas Ass'n v. Federal Power Comm’n, 567 F.2d 1016,
1036-37 (D.C. Cir. 1977) (forward-looking cost metho-
dologies have been routinely used by regulatory agencies to
establish rates). Numerous courts and agencies have
specifically endorsed forward-looking cost methodologies
where the regulatory goal is “to encourage competition.”
Texas Office of Pub. Util. Counsel v. FCC, 183 F.3d 393,
411-12 & nn.12-13 (Sth Cir. 1999), cert. granted sub nom.
GTE Serv. Corp. v. FCC, 530 U.S. 1213, cert. dismissed, 121
S. Ct. 423 (2000) (“GTE”). Most experts within and outside
the government also agree that a historical cost spproach is no
less difficult or complex to administer than a forward-looking
model. JA 333-334, 340-342 (J 630, 635).

The notion that the FCC was incapable of evaluating
anything but a historical cost methodology during the six-
month rulemaking period established by the Act is far-fetched
and readily disproved by the administrative record. The FCC
evaluated several approaches—including historical and
forward-looking cost methodologies—in promulgating imple-
menting regulations for Section 252(d)(1). The Local
Competition Order contained over 100 paragraphs addressing
pricing methodologies and was issued within the six-month

21

statutory timeframe. JA 325-423 (J 618-740).'° Moreover,
the Act contemplated that these new rules, once issued, would
be applied by the state commissions to establish actual UNE
rates in individual arbitrations over at least another nine-
month period. JA 21-22.

The ILECs’ argument also wrongly presumes that state
commissions would be incapable of applying anything other
than historical cost models in setting UNE rates. This claim
similarly is disproved by the record. State commissions have
not found TELRIC “novel, complex, and difficult-to-
administer.” Pet’r Br. at 22. In the five years since the Act’s
passage, state commissions throughout the country have
established UNE rates using TELRIC. See, e.g., GTE South,
6 F. Supp. 2d at 526-30; SWBT, 1998 WL 657717, at *16
(upholding Texas PUC’s use of TELRIC and finding
TELRIC “compelled” by the Act). Indeed, many state
commissions independently decided to use TELRIC during
the period when the FCC’s pricing rules were invalidated by
the Eighth Circuit on jurisdictional grounds.

Lastly, there is no reason to believe that a historical cost
methodology would be easier to apply or would result in
more accurate rates than other cost models, as the ILECs
wrongly suggest. In 1990, the FCC moved away from
traditional cost of service regulation based on historical costs
and adopted a “new system” of price cap regulation. Policy
and Rules Concerning Rates for Dominant Carriers,
5 F.C.C.R. 6786 (1990). Historical costs, therefore, were not
“readily available” to the agency and would have had to be

° The ILECs contend that due process requires “notice and a right to
be heard” when a change in rate methodology affects a firm’s recovery.
Pet’r Br. at 22 n.13, 47. The ILECs received notice of and participated in
the proceedings before the FCC, thereby satisfying any purported “due
process” concerns. JA 328 (4622) (describing Notice of Proposed
Rulemaking requesting comments on the type of pricing methodology for
network elements), JA 359-361 (§ 655) (describing ILECs’ argument for
the use of historical costs).

22

developed essentially from scratch. The historical costs
carried on an ILEC’s books are not generally allocated to
particular categories of network elements. The relevant
inputs to historical cost models, therefore, cannot be
calculated by simply adding up a series of historical cost
figures. The need for economic modeling to determine and
verify particular network element prices still exists with the
use of historical costs. GT7E South, 6 F. Supp. 2d at 527
(upholding Virginia commission’s refusal to adopt GTE’s
historical cost model which was labeled a “black box”
because its operation and assumptions could not be tested or
effectively challenged by others). For these reasons, there is
no basis to presume that use of historical costs would be any
less difficult or complex to administer than a forward-looking
cost model. See National Rural Telecom Ass'n v. FCC, 988
F.2d 174, 178 (D.C. Cir. 1993) (“rate of return regulation is
costly to administer, as it requires the agency endlessly to
calculate and allocate the firm’s costs”) (“National Rural
Telecom”). To the contrary, the complexity and unwieldiness
of rate-of-return proceedings has led many agencies to
abandon historical cost pricing. Regulators have increasingly
found forward-looking cost methodologies to be more
reliable and practical than historical cost models. See
Michael K. Kellogg et al., Federal Telecommunications Law
§ 9.2 (Ist ed. 1992) (“In practice, rate of return regulation
usually culminates in poor regulation of cost, with prices
allowed to float upward.”), id. § 9.8 (“We now know that by
the early 1980s the Bell System had accumulated a vast
library of accounting books that belonged alongside dime-
store novels and other works of fiction.”).

2. The Act’s Resale Pricing Provision Does
Not Implicitly Endorse Historical Or
Forward-Looking Cost Models.

The ILECs also wrongly contend that the Act’s resale
pricing provision, 47 U.S.C. § 252(d)(3), demonstrates a

23

congressional intent to use historical costs to price network
elements. Pet’r Br. at 22-23. Section 252(d\(3) requires
ILECs to provide their retail services to new entrants at
wholesale discounts for resale. The resale price is based on
the ILEC’s retail tariffs, regardless of how those retail tariffs
are set in a particular state. In those states that establish retail
tariffs based on forward-looking cost models, the wholesale
discount price would reflect that cost methodology. JA 438-
439 (4 915). Conversely, in those states that use historic cost
methodologies, the wholesale discount price would reflect
those models. /d. Section 252(d)(3) is thus agnostic as to the
cost methodology used by a particular state. Neither
Congress nor the FCC expressed any preference for setting
wholesale rates based on historical costs.''

C. The FCC’s Choice Of A Forward-Looking Cost
Methodology Was Not Arbitrary Or Capri-
cious And Is Entitled To Deference.

The Eighth Circuit correctly held that the FCC’s use of a
forward-looking cost methodology was reasonable and well-
explained. /UB II, 219 F.3d at 752 (FCC Pet. App. 12a). The
ILECs dispute the FCC’s choice, arguing that: (1) historical
costs would be a better measure than forward-looking costs;
(2) forward-looking costs methodologies are “unmanage-
able”; and (3) the FCC failed adequately to explain its reasons
for “abandoning” historic costs. Pet’r Br. at 44-49. These
challenges, at bottom, relate to the wisdom of the FCC’s
policy decision that a forward-looking cost methodology
would better serve Congress’ goal of rapid competition than a
historical cost model. Under Chevron, that policy decision
was for the FCC to make. 467 U.S. at 865 (“When a
challenge to an agency construction of a statutory provision,

'' The ILECs’ reference to the Act’s resale pricing standards is ironic,
since they argue elsewhere that their retail rates are often established at
prices “substantially below cost.” See Pet’r Br. at 4 (emphasis added).

24

fairly conceptualized, really centers on the wisdom of the
agency’s policy, rather than whether it is a reasonable choice
within a gap left open by Congress, the challenge must fail.”).

1. Historical Costs Are Antithetical To The
Act’s Objectives.

The FCC did not exclude historical cost models on a whim.
The agency carefully considered the issue and concluded that
pricing UNEs based on the historical or “embedded” costs
carried on an ILEC’s accounting books would be antithetical
to the pro-competitive goals of the Act. The FCC recognized
that these historical costs could be higher or lower than the
costs derived from a forward-looking cost model. JA 398-
399 (4 705). Even so, the FCC reasoned that the use of
historical costs in determining the rates paid by new entrants
would force competitors to pay for the existing inefficiency
of the ILECs’ networks and would not “ensure the efficient
investment decisions and competitive entry contemplated by
the ... Act.” JA 399 (4705). Allowing ILECs to price
UNEs based on historical costs would force new entrants to
price their retail services based on those costs. Because
ILECs control the only facilities currently available to
provide widescale local service, they could then undercut the
prices of any potential competitors. JA 441-442 ({ 1065).
An incumbent could “set its own rates based on the present
value of providing the service”’—that is, by writing off
obsolete investments just as a competitive firm would—while
forcing competitors to “pass along to [their] customers the
inflated, monopoly-era historical costs (the ILEC] seeks to
charge new entrants.” SWBT, 1998 WL 657717, at *13.
Forward-looking pricing for network elements, by contrast,
places everyone “on a level playing field.” /d.; see also Town
of Concord v. Boston Edison Co., 915 F.2d 17, 18-19 (1st Cir.
1990) (Breyer, J.). As the FCC explained, “[t}he substantial
weight of economic commentary in the record suggests that
an ‘embedded cost’-based pricing methodology would be

25

pro-competitor—in this case the incumbent LEC—rather than
pro-competition.” JA 398 (¥ 705). The FCC thus concluded
that historical cost pricing would frustrate the Act’s
objectives. JA 398-399 (4 705).

The FCC also built sufficient flexibility into TELRIC to
ensure that state commissions account for the effects of
competition on ILECs. State commissions must consider
these effects in setting the depreciation rates and cost of
capital. JA 395-396 (¥ 702). The FCC found that:

the currently authorized rate of return at the federal or
state level is a reasonable starting point for TELRIC
calculations, and incumbent LECs bear the burden of
demonstrating with specificity that the business risks
that they face in providing unbundled network elements
and interconnection services would justify a different
risk-adjusted cost of capital or depreciation rate.
JA 395 (4 702). “States may adjust the cost of capital if a
party demonstrates to a state commission that either a higher
or lower level of cost of capital is warranted.” JA 396
({ 702). Thus, contrary to the ILECs’ claims, TELRIC allows
State commissions to account for the effects of competition on
investment incentives.

2. TELRIC Is Not “Unmanageable.”

The ILECs’ characterization of TELRIC as “unmanage-
able” is factually incorrect, Pet’r Br. at 45, for the reasons
previously shown. The FCC made a reasoned determination
that TELRIC would be “implementable” based on the proven
experience of various state commissions. JA 334-336, 381
(77 631, 681). The practical experience of these state
commissions was especially informative because, as the FCC
recognized, state commissions would be the ones establishing
UNE rates based on the FCC’s methodology. JA 381 (§ 681).
Virtually every state commission has applied TELRIC in
post-Act arbitrations, confirming the soundness of the FCC’s

26

determination that TELRIC would be manageable to imple-
ment. Michael K. Kellogg et al., Federal Telecommuni-
cations Law § 2.4.4.2 (2d ed. 1999."

3. The FCC Did Not “Abandon” Historical
Cost Models.

In a final attempt to portray the FCC’s rulemaking as
“arbitrary and capricious,” the ILECs claim that the FCC
failed adequately to explain its “decision to abandon
historical costs in favor of TELRIC.” Pet’r Br. at 46 This
claim rests on a false premise. Prior to the Act, ILECs had no
obligation to lease UNEs to competitors and the FCC was
never called on to establish a cost methodology for UNE
access. TELRIC is not an abrupt change from past practices.
It is part of the FCC’s implementation of an entirely new
regime. Far from abandoning a settled methodology, the
FCC was charged with promulgating a new one that provided
just and reasonable compensation while promoting Congress’
goal of rapid competition. The FCC fully explained its
reasons for selecting a forward-looking cost methodology and

"2 The ILECs utterly ignore the fact that TELRIC has been successfully
implemented by the states and argue instead that TELRIC is an
“unmanageable project” based on the FCC’s experience in the universal
service proceeding. Pet’r Br. at 45; see also id at 12-13. That is not a
valid comparison. The states’ actual experience with TELRIC is the most
relevant inquiry. The FCC’s universal proceedings are vastly more
complicated than a state commission arbitration to determine UNE prices
for an individual ILEC. Congress created a wholesale change in the way
universal service would be advanced nationally in the post-Act
environment. JA 29-48. To implement these requirements, the FCC has
conducted a complex, ongoing nationwide proceeding, which involves all
state commissions, virtually all local and long distance carriers and other
interested parties, and requires the FCC to work with and receive
recommendations from a joint federal-state board. /d; see also Michael
K. Kellogg et al., Federal Telecommunications Law § 2.5 (2d ed. 1999)
(“Perhaps the most daunting task assigned to the [FCC] by the 1996 Act
was a thorough review and restructuring of the existing federal universal-
service guarantees.”’).

27

for rejecting the use of historical costs. JA 325-423
(7 618-740). It was within the FCC’s authority to make
these determinations and its selection of TELRIC was not

arbitrary or capricious.
Il. THE FCC’s SELECTION OF THE TELRIC

METHODOLOGY DOES NOT VIOLATE THE
TAKINGS CLAUSE.

The FCC’s decision to exclude historical costs in the UNE
rates that ILECs may charge new entrants does not violate the
Takings Clause. Pet’r Br. at 24-26. The ILECs construct
three arguments in an attempt to implicate constitutional
takings principles. They first claim that the FCC’s
implementation of TELRIC was an “opportunistic switch”
from a prior, well-settled historical cost methodology that
provided for recovery of past prudent investment. /d. at 26-
31. They next attack the TELRIC methodology itself, which
they contend will force them to lease UNEs to new entrants at
“a loss.” Jd. at 31-42. Finally, they argue that this Court
must adopt a narrow construction of Section 252(d)(1)}—
which, in their view, would require the incorporation of
historical costs—in order to avoid “serious constitutional
questions” raised by TELRIC. /d. at 42-44. None of these
claims has merit.

A. TELRIC Does Not Represent A Constitu-
tionally Suspect Shift In Methodologies.

The ILECs wrongly argue that, in adopting TELRIC, the
FCC “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.” Jd. at 26. “This fundamental shift,” the ILECs
contend, “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.” Jd.

28

The ILECs’ attempt to cast TELRIC as a “fundamental
switch” in cost methodologies is overstated. The Act does
not purport to impose any cost methodology on the states in
setting retail rates for an ILEC’s traditional local services.
Any purported “expectations” the ILECs may have based on
the particular methodologies employed by the states for these
services—whether they be based on historical or forward-
looking costs—are unaffected by the Act. The Act's pricing
standards instead apply to an entirely new regime that is
designed to open local markets to rapid competition. ILECs
had no prior obligation to provide UNEs to new entrants and
there was no established methodology for pricing these
elements. The TELRIC methodology was chosen by the FCC
to implement the Act’s pro-competitive requirements. The
FCC was not bound by any particular methodology used to
set rates in the pre-Act monopoly environment in determining
how UNEs should be priced in the new competitive
environment. Nor did the ILECs have any vested right to
expect that they would be shielded from a methodology based
on forward-looking rather than historical costs. As this Court
explained decades ago:

[w]hether competition between utilities shall be prohib-

ited, regulated or forbidden is a matter of state policy.

That policy is subject to alteration at the will of the

legislature. The declaration of a specific policy creates

no vested right to its maintenance in utilities then

engaged in the business or thereafter embarking in it.
Tennessee Elec. Power Co. v. Tennessee Valley Auth., 306
U.S. 118, 141 (1939) (“Tennessee Electric”).

The ILECs also wrongly attempt to use Duquesne as
authority for the proposition that, whenever a regulatory
agency adopts a new rate methodology, it must guarantee that
the carriers recover “all their previous prudent investment and
an appropriate rate of return under the old methodology.”
Pet’r Br. at 27. Thus, once regulators base rates on historical
costs, the ILECs contend, it creates a promise that must be

29

honored under the Constitution. Any change in future rates
must provide for recovery of those costs, regardless of the
present value of the underlying network assets. /d.

Duquesne expressly refutes the ILECs’ proposition that
recovery of historical costs is constitutionally required. The
Takings Clause prevents rates that are “so unjust as to destroy
the value of [the] property for all the purposes for which it
was acquired.” Duquesne, 488 U.S. at 307; see also Market
St. Ry. v. Railroad Comm’n of Cal., 324 U.S. 548, 567 (1945)
(the Takings Clause prevents only “governmental destruction
of existing economic values” and does not require compen-
sation based on “the present reproduction value of something
no one would presently want to reproduce” or the “historical
valuation of a property”) (emphasis added) (“Market Street
Railway”). Indeed, prior to Duquesne, “it was thought that
the Constitution required” compensation based on “present
value.” Duquesne, 488 U.S. at 308 (emphasis added). In
Duquesne, this Court explained that the Constitution does not
mandate a single theory of valuation, stating, in pertinent
part, that:

[C]ircumstances 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 the [regulators] free to decide
what ratesetting methodology best meets their needs in
balancing the interests of the utility and the public.
Id. at 316; see also Hope Natural Gas, 320 U.S. at 602 (The
Takings Clause does not confine regulators “to the use of any
single formula or combination of formulae in determining
rates.”). Under Duquesne, therefore, the FCC had broad
authority to establish a cost methodology for UNE rates that,
in the agency’s expert view, “best meets” the objectives of
the new Act, regardless of the cost methodologies used by the
agency or the states in the pre-Act regime.

30

Even assuming, for argument’s sake, that TELRIC repre-
sented a “shift” in methodologies, it would not raise a serious
constitutional question. As shown, TELRIC provides just
compensation to the ILECs by permitting full recovery of the
current fair value of the UNEs. The Takings Clause requires
no greater compensation, see United States v. Miller, 317
U.S. 369, 374 (1943), and the ILECs have no right to expect
more. The ILECs acknowledge that the measure for
evaluating an alleged property deprivation is the reasonable,
investment-backed expectations of the property owner. Pet’r
Br. at 29. This Court has repeatedly held that reasonable
investors cannot expect an existing ratemaking scheme to be
permanent or claim entitlement to particular regulatory
treatment. E.g., Tennessee Electric, 306 U.S. at 141; see also
American Trucking Ass’ns, Inc. v. Atchison, Topeka & Santa
Fe Ry., 387 U.S. 397, 416 (1967). Cf New York Cent. R.R. v.
White, 243 U.S. 188, 198 (1917) (“No person has a vested
interest in any rule of law, entitling him to insist that it shall
remain unchanged for his benefit.”). It is thus constitu-
tionally permissible for a regulatory agency to establish new
rates based on a changed methodology that excludes
historical costs prudently invested. In Duquesne, for
- example, this Court upheld rates that reflected the “current
market value” of the utility’s investments, even though this
approach denied recovery of tens of millions of dollars of
prudently incurred historical expenditures. 488 U.S. at 312-
14. Similarly, in Hope Natural Gas, the Court affirmed the
adoption of a new approach for calculating the rate base, even
though the resulting rates “might produce only a meager
return” on the prior rate base. 320 U.S. at 605. In Market
Street Railway, the regulatory commission based rates on the
present value of a company’s assets ($7.95 million), even
though the “book value” of the property exceeded $41 million
and its “historical reproduction costs” exceeded $25 million.
324 U.S. at 564-68. The Court held that the regulated entity
was not constitutionally entitled to compensation based on

31

“the historical valuation of a property whose . . . current
financial statements showed the value no longer to exist, or
on an investment after it has vanished, even if once prudently
made.” Jd. at 567; see also In re Permian Basin Area Rate
Cases, 390 U.S. 747, 784 (1968) (Courts will not “set aside [a
rate order] merely because the [regulatory agency] has on an
earlier occasion reached another result.”) (“Jn re Permian
Basin”). These authorities make clear that the ILECs and
their investors had no reasonable basis to “count on” a
historical cost methodology “as a necessary component for
supplying a constitutional return under the old regime.” Pet’r
Br. at 30.

Duquesne also establishes that changes in regulatory
treatment implicate the Takings Clause only under narrow
circumstances; viz., when the state “arbitrarily switch[es]
back and forth between methodologies in a way which
require[s] investors to bear the risk of bad investments at
some times while denying them the benefit of good
investments at others.” 488 U.S. at 315. The FCC adopted
TELRIC to implement the Act’s new UNE access require-
ments. The agency has not arbitrarily switched “back and
forth” between cost methodologies and nothing in the record
remotely resembles such opportunistic rate manipulation.
Moreover, as shown, the FCC had moved away from
traditional cost of service regulation based on historical costs
in favor of price cap regulation several years before the Act’s
passage. Policy and Rules Concerning Rates for Dominant
Carriers, 5 F.C.C.R. 6786 (1990). Price cap regulation
establishes rates by considering, among other things,
“expected savings from innovation and other economies” that
are necessarily “forward-looking.” National Rural Telecom,
988 F.2d at 178. It is indeed ironic for the ILECs to claim
that the FCC’s so-called “switch” to TELRIC has a
constitutional dimension here, given that they did not
challenge the constitutionality of the FCC’s “switch” from

32

traditional cost of service regulation to price cap regulation
over a decade ago.

In addition to the legal flaws in the ILECs’ analysis, their
claim that the purported “switch” to TELRIC “wipe(s] out a
significant portion of the recovery on past investments” lacks -
any credible factual basis. The ILECs assert that they have
invested $342 billion in their networks over time, based on
newly introduced data that they provided to the FCC in a
separate, unrelated context. Pet’r Br. at 10-11. Apart from
the questionable relevance of these data, they show that
approximately $176 billion of that original investment has
been depreciated on the ILECs’ books—a point conveniently
missing from the ILECs’ analysis. 1/999 Statistics of
Communications Common Carriers, table 2.9, at 51 (rel. Aug.
11, 2000). Even under a historical cost methodology, the
ILECs’ original investment is worth only $166 billion today
based on their own data. Cf. Illinois Bell II, 988 F.2d at
1258-59 & n.5 (“Since depreciation is an operating cost,
investors recover such amounts dollar for dollar.”) (citing
Breyer & Stewart, Administrative Law and Regulatory Policy
237 n.59 (2d ed. 1985)). In comparison, the ILECs contend
that TELRIC values those same assets at $180 billion. Pet’r
Br. at 10-11. The ILECs’ argument that TELRIC “under-
values” their networks and “strands” historical costs in a
“harshly retroactive” way is thus wholly unsupported.

Although there is no evidence in the record regarding the
extent of UNE leasing by new entrants, it is beyond dispute
that ILECs continue to control more than 92% of the local
markets. See Industry Analysis Division, FCC, Local Tele-
phone Competition: Status as of December 31, 2000, at Table
1 (May 2001). The ILECs, therefore, continue to recover the
vast majority of their “historical” network costs through the
retail rates established by the state commissions in traditional
intrastate rate-of-return proceedings. It seems likely that
most, if not all, of an ILEC’s undepreciated historical costs
existing in 1996 will have been recovered through its retail

33

rates long before any meaningful UNE-based competition
takes hold.

B. The ILECs’ Theoretical Attacks On TELRIC
Are Barred By The Well-Settled “Total Effect”
Test For Regulatory Takings.

This Court has held that “[i]t is not theory but the impact of
the rate order which counts.” Hope Natural Gas, 320 U.S. at
602. Accordingly, the Court has rejected theoretical
challenges to rate methodologies and examined instead the
“total effect” of actual rates for takings purposes. /d. An
uncompensated taking results only if application of the
ratemaking methodology produces overall rates so low as to
“jeopardize the [regulated entity’s] financial integrity . . .
either by leaving [it with] insufficient operating capital or by
impeding [its] ability to raise future capital.” Duquesne, 488
U.S. at 312. This “total effect” test is necessary to ensure that
regulators have sufficient methodological leeway to resolve
the complicated economic judgments and difficult policy
issues involved in setting rates. Jd. at 314.

The ILECs make no credible attempt to satisfy the “total
effect” test in challenging TELRIC. Rather, they contend that
the FCC “misapplied” the test “by looking to revenues earned
from all of an incumbent’s operations” in order to “cure” the
“below-cost” UNE rates resulting from TELRIC. Pet’r Br. at
32 (emphasis in original). Relying on Brooks-Scanlon Co. v.
Railroad Commission of Louisiana, 251 U.S. 396, 399 (1920)
(“Brooks-Scanlon”), the ILECs argue that the FCC may not
set “below-cost” rates in one line of business and offset any
such deficiency from revenues in a different, unregulated line
of business. Pet’r Br. at 33-34.

These arguments mischaracterize the record. TELRIC
does not result in “below-cost” rates. As previously shown,
TELRIC allows for full recovery of an ILEC’s costs plus a
reasonable profit, based on a forward-looking methodology.

34

Nor did the FCC “‘distort[]’ the Duquesne ‘total effect’ test
by claiming that it could look to a// of an incumbent's overall
revenues to make up for any deficiency in TELRIC rates,” as
the ILECs wrongly suggest. /d. at 32 (citing JA 421-422
(4 738)) (emphasis in original). The agency explained its
analysis as follows:

In adopting the rules that govern [UNE] rates, under
Hope Natural Gas we must consider whether the end
result of incumbent LEC rates is just and reasonable.
Incumbent LECs argue that establishing a rate structure
that does not permit recovery of historical or embedded
costs is confiscatory. We disagree. As stated above, the
Court has consistently held since Hope Natural Gas that
it is the end result, not the method used to achieve that
result, that is the issue to be addressed. . .. Moreover,
the Court has upheld as reasonable changes in
ratemaking methodology when the change resulted in
the exclusion of historical costs prudently incurred.
Thus, the mere fact that an incumbent LEC may not be
able to set rates that will allow it to recover a particular
cost incurred in establishing its regulated network does
not, in and of itself, result in confiscation.

Moreover, Hope Natural Gas requires only that the end
result of our overall regulatory framework provides
LECs a reasonable opportunity to recover a return on
their investment. In other words, incumbent LECs’
overall rates must be considered, including the revenues
for other services under our jurisdiction.

JA 420-421 (99 736-737 & n.1756) (emphasis added). The
record thus shows that the FCC properly analyzed the ILECs’
\neoretical “taking” claims to TELRIC under this Court’s
precedents. The FCC did not look to revenues from
unregulated segments of the ILECs’ businesses, as the ILECs
claim, but rather expressly confined its analysis to whether
the “end result of [the agency’s] overall regulatory frame-
work” provided for just compensation, including the ILECs’

35

revenues from other services expressly under the FCC’s
jurisdiction.'?

Based on the evidence before it, the FCC concluded that
TELRIC “should produce rates for monopoly elements and
services that approximate what the incumbent LECs would be
able to charge if there were a competitive market for such
offerings. We believe that a forward-looking economic cost
methodology enables incumbent LECs to recover a fair re-
turn on their investment, i.e., just and reasonable rates.” JA
421-422 (§ 738). Even so, the FCC ordered that ILECs “may
seek relief from the Commission’s pricing methodology if
they provide specific information to show that the pricing
methodology, as applied to them, will result in confiscatory
rates.” JA 422 (¥ 739).

The ILECs’ reliance on Brooks-Scanion is thus misplaced.
In Brooks-Scanion, this Court held that the regulatory agency
could not look to the profits earned by a railway company in a
separate, unregulated lumber business to subsidize losses
being incurred by the company in a regulated, unprofitable
rail line. 251 U.S. at 399. As shown, the FCC based its
analysis on the markets it regulates, not on any unregulated
businesses of the ILECs. Brooks-Scanlon was also decided
before this Court adopted the “total effect” test. Subsequent
decisions have held that Brooks-Scanion in no way precludes
an agency from considering revenues from all parts of an
entity’s regulated business when applying the test. See, e.g.,
Baltimore & Ohio R.R. v. United States, 345 U.S. 146, 150
(1953); In re Valuation Proceedings Under §§ 303(c) & 306

'’ The above-cited record also shows that the FCC properly looked to
this Court’s precedents on just compensation, and did not attempt to
interpret on its own “what costs the Constitution requires” to be
recovered—as the ILECs wrongly suggest. Pet’r Br. at 25-26. The Court
should reject the ILECs’ attempt to parlay this fictitious argument into
another ground for negating Chevron deference to the FCC’s
interpretation of “cost” in Section 252(d)(1).

36

of the Reg’l Rail Reorg. Act, 439 F. Supp. 1351, 1357 n.12
(Regional Rail Reorg. Ct. 1977).

Rather than coming forward with any specific information
to prove a confiscatory rate, the ILECs have attempted
instead to rewrite this Court’s regulatory takings jurispru-
dence. In so doing, the ILECs have turned Duquesne on its
head. As shown, Duquesne holds that there is no single rate
methodology mandated by the Constitution and that it is
constitutionally permissible for a ratemaker to change
methodologies, even where doing so excludes historical costs
prudently invested. The ILECs argue just the opposite here,
stating that:

[t]he 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.

Pet’r Br. at 37 (emphasis added). This assertion demonstrates
that it is the ILECs—not the FCC—that have misapplied

Duquesne.

The ILECs’ attempt to avoid the “total effect” test is not
surprising, since “[o]nly the most egregiously confiscatory
rate structure would have difficulty meeting” the “total
effect” test reaffirmed there. Laurence H. Tribe, American
Constitutional Law § 9-3 n.3 (2d ed. 1988). A utility thus
bears a heavy burden in proving that rates are confiscatory
under this standard. Jn re Permian Basin, 390 U.S. at 767.
The ILECs failed to meet that burden before the FCC, JA
421-422 (9738), and they have failed to meet it here.
Although they broadly assert in their merits brief that state
commissions “applying TELRIC ... typically produced
discounts of 50% below historical cost,” this “evidence” is
based on the self-serving testimony of a single witness in an
arbitration. The ILECs’ claim that TELRIC leaves billions in
network costs “stranded” is also belied by their own data, as
shown supra pp. 33-34. These claims fail to demonstrate that

37

the “total effect” of the FCC’s pricing rules is so unjust as to
be confiscatory. The ILECs have not shown that they are
unable to maintain their financial integrity or to attract
necessary capital as a result of TELRIC or the Act’s overall
pricing scheme. See Duquesne, 488 U.S. at 312; Jersey Cent.
Power & Light Co. v. FERC, 810 F.2d 1168, 1178 (D.C. Cir.
1987) (en banc).'* Nor have they attempted to account for the
substantial new sources of revenue that the Act now makes
available to them by, among other things, allowing them
access to the various long distance and other markets
foreclosed by the AT&T consent decree. The ILECs’ failure
to come forward with any such evidence, five years after the
Act was adopted, leaves no doubt that their “constitutional”
challenge to TELRIC is not really based on takings
principles, but rather on the policy choices properly made by
the FCC."°

Finally, rejection of the ILECs’ theoretical challenges to
the TELRIC methodology will not foreclose judicial review
of whether TELRIC-derived rates are themselves “confis-
catory.” Pet’r Br. at 40. Duquesne explicitly holds that a
takings challenge must be based on the effect of a rate, not
the methodology employed. The Act authorizes state
commissions to conduct arbitrations to establish UNE rates
and provides an avenue for judicial review of those

“To the contrary, the ILECs’ stock values have appreciated
substantially since August 8, 1996, the date the FCC released its Local
Competition Order. See Yahoo Finance Historical Quotes, available at
http://chart.yahoo.com/d (providing split-adjusted historical stock data
showing that from August 8, 1996 to June 1, 2001 stock prices for (i)
BellSouth rose from $19.11 per share to $40.56 per share; (ii) SBC rose
from $22.12 per share to $42.05 per share; and (iii) GTE/Verizon rose
from $25.82 per share to $54.74 per share).

'* The fact that the FCC has not concluded its Universal Service Order
(“USO”) proceedings does not save the ILECs’ “takings” claim. The
ILECs receive explicit universal service support, as well as compensation
from the Act’s other pricing provisions. JA 29-48.

38

determinations. JA 25-26. As much as the ILECs may prefer
to challenge the constitutionality of the FCC’s methodology
in this proceeding, such a challenge can only proceed after
the UNE rates that are a product of that methodology have
been set and the effect of those rates can be tested.

C. The Doctrine Of Constitutional Avoidance
Does Not Require The Inclusion Of Historical
Costs In UNE Prices.

Having constructed their theoretical “takings” challenge to
TELRIC, the ILECs next argue that the doctrine of
“constitutional avoidance” negates Chevron deference and
requires this Court to interpret Section 252(d)(1) in a way that
avoids raising “serious constitutional questions.” Pet’r Br. at
42. These questions can only be avoided, the ILECs contend,
by interpreting the statute their way; viz., to include historical
costs. The Eighth Circuit correctly rejected this argument.
IUB II, 219 F.3d at 754 (FCC Pet. App. 16a-18a). This Court
should do the same.

The doctrine of constitutional avoidance is inapplicable in
these circumstances because the Act provides a mechanism
for the ILECs to receive compensation through state-
arbitrated UNE rates. The Fifth Amendment does not
proscribe the taking of property. “| Jt proscribes the taking of
property without just compensation.” Williamson County
Reg’! Planning Comm'n v. Hamilton Bank, 473 U.S. 172, 194
(1985) (“Williamson County”). The Fifth Amendment
requires only that an adequate mechanism for compensation
exist. Jd.

A narrowing construction of a statute to avoid a
constitutional problem need only be invoked in those cases in
which the application of a statute will necessarily constitute a
taking and no means of compensation exists. Thus, in
Riverside Bayview Homes, this Court did not invoke the
doctrine of constitutional avoidance because (1) the
regulation did not necessarily constitute a taking, and (2) even

39

if it did, a mechanism for compensation existed via the
Tucker Act. The Court explained that, as long as
compensation is available for those whose property is in fact
taken, the government action is not unconstitutional. Because
the availability of compensation negates any Constitutional
concerns, “adoption of a narrowing construction does not
constitute an avoidance of a constitutional difficulty, it
merely frustrates permissible applications of a statute or
regulation.” Riverside Bayview Homes, 474 U.S. at 128. As
this Court explained,

the possibility that the application of a regulatory

program may in some instances result in the taking of

individual pieces of property is no justification for the

use of narrowing constructions to curtail the program if

compensation will in any event be available in those

cases where a taking has occurred.

Id."° See also Railway Labor Executives’ Ass'n v. United
States, 987 F.2d 806, 816 (D.C. Cir. 1993) (“Because just
compensation is presumptively available under the Tucker

© Contrary to the ILECs’ assertion, it was appropriate for both the FCC
and the Eighth Circuit to rely on Riverside Bayview Homes as support for
the argument that a limiting construction of the Act is not warranted. The
ILECs criticize the FCC and the Eighth Circuit for supposedly reading
Riverside Bayview Homes to establish a general exemption from the
principle of constitutional avoidance when the issue involves the Takings
Clause. Pet’r Br. at 43-44. Neither the FCC nor the Eighth Circuit even
Suggested that Riverside Bayview Homes stands for that proposition.
Rather, the case stands for the principle that the doctrine of constitutional
avoidance should only be invoked when a taking necessarily occurs and
there is no means available for compensation. When that principle is
applied in this case, it is clear that a narrowing interpretation is not
warranted. By contrast, in Bell Atlantic Telephone Cos. v. FCC, 24 F.3d
1441 (D.C. Cir. 1994), a pre-Act case that, like Riverside Bayview Homes,
involved the doctrine of constitutional avoidance, the D.C. Circuit applied
a limiting construction to the Communications Act and vacated FCC
regulations that required local exchange carriers to provide physical
_ collocation because the Communications Act did not expressly authorize
such a taking or provide a compensation mechanism for it. /d at 1445.

40

Act, there is neither an unconstitutional result nor a
constitutional doubt to be averted by interpretation.”).

Just as the Tucker Act provided a means for compensation
in the Riverside Bayview Homes and Railway Labor cases,
and thereby removed the need for a limiting construction of
the statutes at issue, the UNE compensation provisions of
Section 252(d)(1) remove the need for any limiting
construction of the statute to “avoid” a constitutional problem
here. As the ILECs concede, the Act embodies the consti-
tutional standard for just compensation. Their real argument
is with the FCC’s choice of TELRIC to provide it. The FCC
was authorized to adopt a forward-looking cost model. That
choice—-even if deemed a “switch” in methodologies, as the
ILECs contend—allows for adequate recovery by ILECs of
their costs of providing UNEs to new entrants. TELRIC is
thus consistent with the requirements of Section 252(d)(1)
and the Takings Clause.

Moreover, as shown, an agency’s choice between prudent-
investment, historical cost, forward-looking cost, and replace-
ment cost methodologies does not raise constitutional
questions per se. Each method may provide just compen-
sation when reasonably applied. Conversely, each method
could result in unjust rates if misapplied. For these reasons,
courts require financial data showing the actual effect of rates
—not abstract methodological challenges—when evaluating a
takings claim. The ILECs’ takings claim is based solely on
the choice of methodology made by the FCC and not on any
credible evidence that TELRIC-derived rates are confis-

catory.

The FCC has also ordered the ILECs to seek relief from the
agency should they have credible evidence that TELRIC, “as
applied to them, will result in confiscatory rates.” JA 422
(4 739). The ILECs have yet to avail themselves of that
remedy, which itself forecloses a takings challenge at this
time. See Williamson County, 473 U.S. at 194-96.

4l

Finally, TELRIC is not a “novel” methodology that tests
“the outer limits of Congress’ power,” as the ILECs attempt
to suggest. Pet’r Br. at 43. Forward-looking cost method-
ologies like TELRIC have been widely accepted in the
professional literature, were implemented by several state
utility commissions prior to passage of the Act, see
JA 334-336 (9631 & nn.1508-14), and have already
passed constitutional muster, see GTE, 183 F.3d at 411-13
& nn.12-13.

Under these circumstances, adoption of a narrowing
construction of Section 252(d)(1) would not “avoid” any
serious constitutional question. It would instead frustrate the
FCC’s lawful interpretation of the provision to implement the
Act’s pro-competitive objectives. As the Eighth Circuit
correctly found, there is no “need to disregard Chevron
deference and interpret the statute in accordance with the
[ILECs’] views in order to avoid an unconstitutional taking in
this instance.” /UB I/, 219 F.3d at 754.

CONCLUSION

For the foregoing reasons, Sprint respectfully requests that
this Court affirm the FCC’s UNE pricing rules in all respects.

Respectfully submitted,

DAVID P. MURRAY

Counsel of Record
RANDY J. BRANITSKY
KEVIN M. MILLER
WILLKIE FARR & GALLAGHER
1155 21st Street, N.W.
Washington, D.C. 20036
(202) 328-8000

Counsel for Respondent
Sprint Corporation

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385014_0422%3A19. Public record. Not legal advice.