Respondents Brief — At&t Corp. v. Iowa Utilities Board

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JUN 5 200 | JUN 8 2008

Nos. . ode 00-587, 00-590 and 00-602

In the Supreme Court of the United States

CLERK

VERIZON COMMUNICATIONS, INC., ET AL., PETITIONERS

Vv.

FEDERAL COMMUNICATIONS COMMISSION, ET AL.

AND RELATED CASES

ON WRITS OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

BRIEF FOR RESPONDENTS

FEDERAL COMMUNICATIONS COMMISSION AND

THE UNITED STATES

BARBARA D. UNDERWOOD

Acting Solicitor General

Counsel of Record

JOHN E. INGLE JOHN M. NANNES

Deputy Associate General Acting Assistant Attorney

Counsel General

— N. BOURNE LAWRENCE G. WALLACE

Deputy Solicitor General

Federal Communications

Commission BARBARA MCDOWELL

Washington, D.C. 20554 Assistant to the Solicitor

General

CATHERINE G. O’SULLIVAN

NANCY C. GARRISON

Attorneys

Department of Justice

Washington, D.C. 20530-0001

(202) 514-2217

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)

TABLE OF CONTENTS

Opinions below

Jurisdiction

Statutory provisions involved

Statement

Summary of argument

Argument:

I. The FCC reasonably construed Section 252(d)(1)

of the 1996 Act to permit the use of forward-

looking costs to determine network elements

prices

A. The FCC’s construction of “cost” is consistent

with the language, structure, and purposes of

the Act

B. The principle of constitutional avoidance does

does not require that “cost” be construed as

historical cost

II. The FCC reasonably determined that a forward-

looking cost methodology most effectively imple-

ments the competitive objectives of the 1996 Act

and is administratively workable

Conclusion

TABLE OF AUTHORITIES

Cases:

AT&T v. FCC, 220 F.3d 607 (D.C. Cir. 2000)

AT&T v. Iowa Utils. Bd., 525 U.S. 366 (1999)

2, 4, 8,

16, 19, 35, 45, 47

Alabama Elec. Coop, Inc. v. FERC, 684 F.2d 20

(D.C. Cir. 1982)

Baltimore & Ohio R. R. v. United States, 345 US.

146 (1953)

Bell Atl.-Del, Inc. v. McMahon, 80 F. Supp. 2d

(III)

Cases—Continued:

BellSouth Corp. v. FCC, 162 F.3d 678 (D.C. Cir.

1998)

Broad River Power Co. v. South Carolina, 281 US.

537 (1930)

Brooks-Scanlon Co. v. Railroad Comm nu, 251 U.S.

396 (1920)

Burlington N. R. R. v. Surface Transp. Bd.,

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

Chevron U.S.A. Inc. v. NRDC, Inc., 467 U.S. 837

(1984) 9, 12, 18, 47

City of Los Angeles Dep’t of Airports v. United

States Dep't of Transp., 103 F.3d 1027 (D.C. Cir.

1997)

Colorado Springs Prod. Credit Ass n v. Farm

Credit Admin., 967 F.2d 648 (D.C. Cir. 1992)

Competitive Telecomms. Ass n v. FCC, 117 F.3d

1068 (8th Cir. 1997)

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

(1989) 13, 17, 28, 29, 30, 46, 48

FERC v. Pennzoil Producing Co., 439 U.S. 508

(1979)

Farmers Union Cent. Exch., Inc. v. FERC,

734 F 2d 1486 (D.C. Cir.), cert. denied, 469 U.S.

1034 (1984) .

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

320 U.S. 591 (1944) 27, 28, 29, 46

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

Va. 1998), aff’d on other grounds, 199 F.3d 733

(4th Cir. 1999)

General Tel. Co. of the S.W. v. United States,

449 F. 2d 846 (5th Cir. 1971)

Iowa Utils. Bd. v. FCC, 120 F.2d 753 (8th Cir.

1997), aff'd in part and rev’d in part, 525 U.S. 366

(1999) 7-8, 45

Lucas v. South Carolina Coastal Council, 505 U.S.

1003 (1992)

Cases—Continued: Page

MCI Communications Corp. v. AT&T, 708 F.2d

1081 (7th Cir.), cert. denied, 464 U.S. 891 (1983) 17,

18, 42

Market St. Ry. v. Railroad Comm u, 324 U.S. 548

(1945) 28

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

Public Serv. Comm u, 262 U.S. 276 (1923) 49

Mobil Oil Exploration & Producing S.E., Inc. v.

United Distribution Cos., 498 U.S. 211 (19917 20

National Ass n of Greeting Card Publishers v.

United States Postal Serv., 462 U.S. 810 (1983) ............... 19

National Mining Ass n v. Babbitt, 172 F.3d 906

(D.C. Cir. 1999) 27

National Rural Telecom Ass’n v. FCC, 988 F.2d 174

(D.C. Cir. 1993) 31, 48, 49

Potomac Elec. Power Co. v. ICC, 744 F.2d 185

(D.C. Cir. 1984) 20

Public Citizen v. United States Dep’t of Justice,

491 U.S. 440 (1989) 40

Reno v. Flores, 507 U.S. 292 (1993) 40

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

(1930) 34, 35

Smyth v. Ames, 169 U.S. 466 (1898) 19, 46

Southwestern Bell Tel. Co. v. FCC, 153 F.3d 523

(8th Cir. 1998) 37, 44

Strickland v. Commissioner, Me. Dep’t of Human

Servs., 48 F.3d 12 (Ist Cir.), cert. denied, 516 U.S.

850 (1995) 18

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

393 (5th Cir. 1999), cert. granted sub nom. GTE

Serv. Corp. v. FCC, 530 US. 1213, cert. dismissed,

121 S. Ct. 423 (2000) 10, 11, 40

Time Warner Entmt Co. v. FCC, 56 F.3d 151

(D.C. Cir. 1995), cert. denied, 516 U.S. 1112

(1996) 44

USTA v. FCC, 188 F.3d 521 (D.C. Cir. 1999) 44

Cases—Continued: Page

United States v. 564.54 Acres of Land, 441 U.S 506

(1979)

United States v. Miller, 317 U.S. 369 (1943)

United States v. Riverside Bayview Homes, Inc.,

474 US. 121 (1985) 10,

United States v. Security Indus. Bank, 459 U.S. 70

(1982)

Valuation Proceedings Under Sections 303(c) and

306 of the Reg Rail Reorganization Act, In re, 493

S 8 &&

F. Supp. 1351 (Spec. Ct. 1977) 34

Constitution, statutes and regulations:

U.S. Const. Amend. V (Takings Clause) passim

Administrative Procedure Act, 5 U.S.C. 701

——— ** 14, 41

Tele communications Act of 1996, Pub. L. No. 104-104,

110 Stat. 56 1,2

Title I, 110 Stat. 61:

47 U.S.C. 153(29) (Supp. IV 1998) 3, 24

47 U.S.C. 251-253 (Supp. IV 1998) 2

47 U.S.C. 251 (Supp. IV 1998) 7, 8, 32, 40

47 U.S.C. 251(c)(2) (Supp. IV 1998) 3

47 U.S.C. 251(c)(2)-(4) (Supp. IV 1998) 3

47 U.S.C. 251(c)(3) (Supp. IV 1998) 3, 10, 41, 44

47 U.S.C. 251(c)(4) (Supp. IV 1998) 24, 25, 44

47 U.S.C. 251(c)(4)(B) (Supp. IV 1998) 26

47 U.S.C. 251(d)(2) (Supp. IV 1998) .............. 3, 8, 41, 44

47 US.C. 251(d\(2)(A) (Supp. IV 1998) 3

47 U.S.C. 251(d)(2)(B) (Supp. IV 1998) 3

47 U.S.C. 252 (Supp. IV 1998) .............. 10 7, 8, 32, 40, 48

47 U.S.C. 252(c)(2) (Supp. IV 1998) 11, 48

47 US.C. 252(c)(3) (Supp. IV 1998) 11

47 U.S.C. 252(d)(1) (Supp. IV 1998) - passim

47 U.S.C. 252(d)(1)(A) (Supp. IV 1998) ........... 4, 11, 16

47 US. C. 2 (Supp. IV 1998) 24

47 U.S.C. 252(d)(1(B) (Supp. IV 1998) .... 4, 12, 22, 23

VII

Statutes and regulations Continued:

47 U.S.C. 252(d)(3) (Supp. IV 1998)

47 U.S.C. 252(e)(5) (Supp. IV 1998)

47 U.S.C. 254 (Supp. IV 1998)

47 U.S.C. 25400) (Supp. IV 1998)

47 U.S.C. 254(e) (Supp. IV 1998)

47 U.S.C. 271 (Supp. IV 1998)

Title VI, § 601(a)(2), 110 Stat. 143

47 U.S.C. 543(b)

47 C.F.R.:

Section 51.315(b)

Section 51.315(c)-(f)

Section 51.505(b)(1)

Miscellaneous:

Access Charge Reform, First Report and Order,

In re, 12 F.C.C.R. 15,982 (1997)

Access Charge Reform, Sixth Report and Order,

F. C. C. No. 00-193 (May 31, 2000)

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

Authorization To Provide In-Region, Inter-LATA

Servs. in Massachusetts (CC Docket No. 01-9),

FCC 01-130 (Apr. 16, 2001), appeal pending sub nom.

WorldCom, Inc. v. FCC, No. 01-1198 (D.C. Cir.

filed Apr. 25, 2001)

Harvey Averch & Leland L. Johnson, Behavior Of

The Firm Under Regulatory Constraint, 52 Am.

Econ. Rev. 1052 (1962)

William J. Baumol & Thomas W. Merrill:

Deregulatory Takings, Breach Of The Regulatory

Contract, And The Telecommunications Act of

1996, 72 N.Y.U. L. Rev. 1037 (1997)

Does The Constitution Require That We Kill The

Competitive Goose? Pricing Local Phone Services

To Rivals, 73 N.Y.U. L. Rev. 1122 (1998)

1998 Biennial Regulatory Review—Review of Deprecia-

tion Requirements for Incumbent LECs, In re,

15 F.C.C.R. 242 (1999)

Vill

Miscellaneous—Continued: Page

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

Rates (2d ed. 1988) 19

20 C.J.S. Costs (1940) 18

Dennis W. Carlton & Jeffrey M. Perloff, Modern

Industrial Organization (2d ed. 1994) 45

Jim Chen, The Second Coming of Smyth v. Ames,

77 Tex. L. Rev. 1535 (1999) 32-33, 46, 47

Commission Recommendation on Interconnection in a

Liberalised Telecommunications Market (Pt. 1,

Interconnection Pricing), 0.J. 1993 L073/42 21

Ex Parte No. 347 (Sub-No. 1), Coal Rate Guidelines,

Nationwide (ICC Feb. 8, 1983) 20

Ex Parte No. 347 (Sub-No. 1), Coal Rate Guidelines,

Nationwide, 1 I. C. C. 2d 520 (1985), aff d sub nom.

Consolidated Rail Corp. v. United States,

812 F.2d 1444 (3d Cir. 1987) 20

Federal-State Joint Bd. on Universal Serv.,

Recommended Decision, In re, 12 F.C. C. R. 87

(1996) 49

Federal-State Joint Bd. on Universal Serv., Report

and Order, In re, 12 F. C. C. 8776 (1997) .... 10, 49

Federal-State Joint Bd. on Universal Serv., Tenth

Tenth Report and Order, In re, 14 F. C. C. R. 20,156

(1999) 38

Federal-State Joint Bd. on Universal Serv., Ninth

Report and Order and Eighteenth Order on

Reconsideration, In re, 14 F. C. C. R. 20,432 (1999) 37

David Gabel & David I. Rosenbaum, Who's Taking

Whom: Some Comments And Evidence on the

Constitutionality of TELRIC, 52 Fed. Comm. L.J.

239 (2000) 38, 46, 48

Herbert Hovenkamp, The Takings Clause and

Improvident Regulatory Bargains, 108 Yale L.J. 801

(1999) 32, 39, 40, 46

Miscellaneous—Continued: Page

Peter W. Huber, Michael K. Kellogg & John Thorne,

Federal Telecommunications Law (2d ed. 1999) .............. 21

Implementation of the Local Competition Provisions

in the Telecommunications Act of 1996, First Report

and Order, In re, 11 F. C. C. R. 15,499 (1996) . passim

Implementation of the Local Competition Provisions

in the Telecommunications Act of 1996, Third

Report and Order and Fourth Further Notice of

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

petitions for review pending sub nom. United States

Telecomm. Ass n v. FCC, Nos. 00-1015 et al. (D.C.

Cir. Jan. 19, 2000) 8

Implementation of the Local Competition Provisions

in the Telecommunications Act of 1996 (CC Docket

No. 96-98), FCC 00-183 (June 2, 2000), petition for

review pending sub nom. Competitive Telecomms.

Ass n v. FCC, No. 00-1272 (D.C. Cir. June 23,

2000) 38

Industry Analysis Division, FCC:

Local Telephone Competition at the New Millennium

(2000) 2

Local Telephone Competition: Status as of June 30,

2000 (2000) 1-2, 45

Interstate Rate of Return Summary (FCC Apr. 10,

2001) 29

Interstate Rate of Return Summary, Years 1991

Through 2000 (FCC May 3, 2001) 29

Hank Intven, Jeremy Oliver & Edgardo Sepulveda,

Telecommunications Regulation Handbook (2000) ....... 21, 22

Jean-Jacques Laffont & Jean Tirole, Competition In

Telecommunications (2000) 49

Richard J. Pierce, Jr., Public Utility Regulatory

Takings: Should the Judiciary Attempt to Police

the Political Institutions? , 77 Geo. L.J. 2031

(1989) 19-20

Jim Rossi, The Irony Of Deregulatory Takings, 77

Tex. L. Rev. 297 (1998) 46

Miscellaneous—Continued:

Paul A. Samuelson & William D. Nordhaus, Econo-

mics (16th ed. 1998)

Seth Schiesel, No End to Upheaval in Telecom

Industry, N.Y. Times, Dec. 18, 2000

Page

OPINIONS BELOW

The opinion of the court of appeals (No. 00-587 Pet. App.

la-43a) is reported at 219 F.3d 744. The Local Competition

Order of the Federal Communications Commission (FCC) is

reported at 11 F.C.C.R. 19,392.

JURISDICTION

The judgment of the court of appeals was entered on July

18, 2000. Verizon’s petition for a writ of certiorari in No. 00-

511 was filed on October 4, 2000, and was granted on January

22, 2001. The jurisdiction of this Court rests on 28 U.S.C.

1254(1).

STATUTORY PROVISIONS INVOLVED

The relevant provisions of the Telecommunications Act of

1996 (1996 Act), Pub. L. No. 104-104, 110 Stat. 56, are re-

produced in the appendix to our petition in No. 00-587 (U.S.

Pet. App.) 104a-125a and in the Joint Appendix (J.A.) at 9-48.

In referring to the provisions of the 1996 Act, we have cited

the 1998 Supplement to the United States Code.

STATEMENT

1. a. Throughout most of the United States, local tele-

phone service in each community has long been dominated

by a single incumbent “local exchange carrier,” or LEC.

That incumbent LEC, whether a regional Bell company or

an independent carrier, owns almost all of the loops (the

wires that connect telephones to switches) in its service

area, along with the switches (which direct calls to their

destinations) and the transport trunks (which carry calls

between switches). The incumbents’ control over those

facilities has solidified their de facto monopoly position in

most local telecommunications markets. Indeed, even today,

after years of efforts to open those markets to competition,

incumbents still provide service over approximately 93% of

local telephone lines. See Industry Analysis Division, FCC,

(1)

Local Telephone Competition: Status as of June 30, 2000, at

1 (2000); see also Industry Analysis Division, FCC, Local

Telephone Competition at the New Millennium, Table 6

(2000) (as of December 1999, incumbents controlled approxi-

mately 94% of total local telecommunications revenues).

The barriers to entry into local telecommunications mar-

kets are different from, and vastly more formidable than, the

barriers to entry into the long-distance market. It has been

economically practicable for some long-distance carriers to

build their own interexchange infrastructure—e.g., to lay

cable or build microwave networks connecting local calling

areas to one another—because they can rely (albeit at a cost)

on the LECs on either end of an interexchange call to route

the call through the various switches and local loops from the

eall's origin to its destination. But, at least with current

technology, it would be economically impracticable for even

the largest prospective competitor to duplicate completely

the functions of an incumbent LEC’s entire network. And,

without rights of interconnection, a potential competitor

could not gradually enter the market through partial dupli-

cation of those functions; a new carrier would win few cus-

tomers if its customers could call only one another and not

customers on the incumbent LEC’s separate (and completed)

network.

b. “Until the 1990’s, local phone service was thought to

be a natural monopoly. * * * Technological advances,

however, have made competition among multiple providers

of local service seem possible.” AT&T v. Iowa Utils. Bd.

(Iowa Utils. Bd. D, 525 U.S. 366, 371 (1999). Congress

enacted the Telecommunications Act of 1996 (1996 Act), Pub.

L. No. 104-104, 110 Stat. 56, to open local telecommuni-

cations markets to full competition. Congress recognized

that no prospective entrant could replicate, at least in the

short term, all of an incumbent’s existing local network

infrastructure. Accordingly, in the local competition pro-

visions of the 1996 Act, 47 U.S.C. 251-253, Congress pro-

vided the means for potential competitors to enter local

markets by using the incumbents’ networks in a variety of

ways. See 47 U.S.C. 251(c)(2)-(4).

Central to the local competition provisions is Section

251(c)(3), which entitles a new entrant to gain “access” to

(i. e., to lease) an incumbent’s “network elements,” such as

loops, switching capability, and other components and capa-

bilities of the incumbent’s network. 47 U.S.C. 251(c)(3); see

also 47 U.S.C. 153(29) (defining “network element”). That

provision permits new entrants, some of which may also

have network elements of their own, to lease from an

incumbent those elements that they need to provide services

to their own customers.! The 1996 Act further permits new

entrants to “interconnect” their own facilities with those in

the incumbent’s network “at any technically feasible point.”

See 47 U.S.C. 251(c)(2).

An incumbent may charge a new entrant for inter-

connection and access to network elements. If the incumbent

and the new entrant cannot agree on those charges, the 1996

Act authorizes the state public utility commission, acting as

arbitrator, to set the rates that the incumbent may charge.?

1 An incumbent’s obligation to lease network elements to new en-

trants extends only to those elements designated by the FCC under

Section 251(d)(2). That provision states that, “[iJn determining what

network elements should be made available for purposes of” Section

251(c)(3), the FCC “shall consider, at a minimum,” certain competitive

standards. 47 U.S.C. 251(d)(2). With respect to most elements, the

statutory standard that the FCC must consider is whether “the failure to

provide access to such network elements would impair the ability of the

telecommunications carrier seeking access to provide the services that it

seeks to offer.” 47 U.S.C. 251(d)(2)(B); see also 47 U.S.C. 251(d)(2)(A)

(providing that, with respect to “proprietary” elements, the relevant

standard is whether “access to such network elements * * * is

necessary”). See note 6, infra.

2 A state commission may opt out of that statutory role, in which case

the FCC would resolve individual disputes between carriers over the

The state commissions must set rates that are “nondis-

criminatory” and “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).3 The rates “may include a reasonable

profit” for the incumbent. 47 U.S.C. 252(d)(1). In setting

such rates, the state commissions must follow the FCC’s

pricing rules that give content to that statutory standard.

See Jowa Utils. Bd. I, 525 U.S. at 383-385.

The 1996 Act also conferred significant benefits on in-

cumbent LECs. For example, the 1996 Act “relieves the

[regional Bell companies] of several of the burdens imposed

by the [1982 AT&T consent decree], particularly by

prescribing in [47 U.S.C.] § 271 a method whereby [they] can

achieve a long-sought-after presence in the long distance

market.” BellSouth Corp. v. FCC, 162 F.3d 678, 690 (D.C.

Cir. 1998) (emphasis and citation omitted); see also 1996 Act,

Title VI, S 601(a)(2), 110 Stat. 143 (superseding GTE consent

decree). The 1996 Act further entitles incumbent LECs, like

other telecommunications carriers, to invoke its local com-

petition provisions to expand their operations into new geo-

rates to be charged for providing interconnection and access to network

elements. See 47 U.S.C. 252(e)(5).

3 Section 252(d)(1), titled “Interconnection and network element

charges,” provides in full:

Determinations by a State commission of the just and reasonable rate

for the interconnection of facilities and equipment for purposes of

subsection (e) C) of section 251 of this title, and the just and rea-

sonable rate for network elements for purposes of subsection (c)(3) of

such section—

(A) shall be—

(i) based on the cost (determined without reference to a

rate-of-return or other rate-based proceeding) of providing the

interconnection or network element (whichever is applicable),

and

(ii) nondiscriminatory, and

(B) may include a reasonable profit.

graphic areas and compete for the customers of other incum-

bents.

2. In August 1996, the FCC issued its initial order ad-

dressing the most basic issues involving local competition

arising under the 1996 Act. See In re Implementation of the

Local Competition Provisions in the Telecommunications

Act of 1996, First Report and Order (Local Competition

Order), 11 F.C.C.R. 15,499 (1996). A cornerstone of that

order is the FCC’s choice of the cost methodology—“total

element long-run incremental cost,” or TELRIC-that state

public utility commissions are to employ in resolving dis-

putes between carriers about the “cost[s]” that Section

252(d)(1) allows the incumbent to recover from the new en-

trant for providing interconnection and network elements.

See Local Competition Order (paras. 674-703), J.A. 376-396.

TELRIC embodies a “forward-looking” approach to calcu-

lating the cost of providing network elements and inter-

connection. The essential objective of any forward-looking

methodology is to determine what it would cost in today’s

market to replace the functions of an asset that make it

useful. That is the asset’s “forward-looking” cost (also

known as its “replacement” or “economic” cost), as distin-

guished from the cost of duplicating the asset in every

physical particular. Thus, under a forward-looking meth-

odology, if an incumbent bought an analog switch in 1985 at a

fixed cost of $150 per line, and an efficient carrier would

address the same business needs today by purchasing a

digital switch at a fixed cost of $100 per line (more efficient

digital switches have supplanted analog switches in the

market), the latter figure is the appropriate basis for deter-

mining what a new entrant would pay the incumbent to lease

switching capacity. Similarly, if a loop cost $100 to install in

1985 but would cost $150 to install today (because, for

example, labor costs have increased), the rate for leasing

that loop would be based on the higher current cost figure.

In asking what it would cost to replace the functions that

make an asset valuable, a forward-looking cost methodology

requires an inquiry into currently available substitutes—

including assets that perform the same functions as the asset

in the incumbent’s network, but that do not resemble the

asset in all respects (e.g., because they embody more

efficient technology than the original asset). Some incum-

bents urged the FCC to foreclose any consideration of cur-

rently available substitutes in TELRIC. The FCC rejected

the incumbents’ suggestion as arbitrarily limiting the

inquiry into the forward-looking cost of replacing an asset’s

useful functions in today’s market. See Local Competition

Order (paras. 683-685), J. A. 382-384.*

The forward-looking purchase price of an asset is only one

variable in the TELRIC compensation calculus. TELRIC

also takes into account (1) the duration of an element’s useful

life, as reflected in an appropriate economic depreciation

schedule; (2) the cost of capital (i. e., the required return, or

profit, on investment); and (3) various types of expenses,

such as maintenance expenses. See Local Competition

Order (para. 703), J.A. 396. One of TELRIC’s principal

objectives is to ensure an incumbent’s opportunity, when

leasing network elements to others, to recover the full

forward-looking cost of those elements (including the cost of

capital) over their useful lives.

Many of the essential details of implementing TELRIC

are left to state public utility commissions. For example, the

FCC did not set depreciation schedules itself; rather, state

4 The FCC determined that TELRIC should, however, take as given

the incumbent’s existing wire centers (i.e., its switch locations), thereby

confining the inquiry to efficient alternatives that are compatible with the

basic geographical design of the existing network. Local Competition

Order (para. 685), J.A. 383-384. The FCC observed that such a limitation

would give new entrants additional incentives to save costs by

constructing facilities of their own embodying “more efficient network

configurations.” Ibid.

commissions determine, among other things, how best to

adopt “specific depreciation rate adjustments that reflect

expected asset values over time,” including, where relevant,

“expected declines in the value of capital goods.” Local

Competition Order (para. 686), J.A. 384-385. Similarly, the

state commissions have wide discretion to determine the

appropriate cost of capital (or return on investment); they

are authorized to increase the cost of capital, if warranted, to

compensate incumbents for the risk of increased com-

petition. Local Competition Order (para. 702), J.A. 395-396.

The FCC rejected the argument of several incumbent

LECs that the 1996 Act entitles them to rates for inter-

connection and network elements that are based on the

“historical” (or embedded“) costs reflected on their account-

ing books. The FCC recognized that those costs could be

either higher or lower than forward-looking costs. Local

Competition Order (para. 705), J.A. 398-399. The FCC

reasoned that the use of historical costs would be

economically arbitrary and would frustrate the competitive

objectives of the 1996 Act. See Local Competition Order

(paras. 704-711), J.A. 397-403.°

3. In 1996 and 1997, the Eighth Circuit stayed and then

invalidated the FCC’s pricing rules on the ground that the

1996 Act gives state public utility commissions, not the FCC,

general jurisdiction to interpret the pricing provisions of

Sections 251 and 252. Jowa Utils: Bd. v. FCC, 120 F.3d 753,

5 At the same time that the FCC promulgated the pricing rules dis-

cussed in the text, the FCC also promulgated other rules, which have

come to be known as the “combinations” rules. See Local Competition

Order (paras. 292-297), J. A. 295-299. In Iowa Utilities Board I, this Court

reversed the Eighth Circuit’s decision invalidating one of those rules,

47 C.F.R. 51.315(b); on remand, the Eighth Circuit again invalidated

others of those rules, 47 C.F.R. 51.315(c)-(f), and this Court granted

certiorari to consider that aspect of the court of appeals’ decision. We

address the combinations rule question in our brief as petitioners in this

consolidated case.

794-800 (1997). The Eighth Circuit’s jurisdictional orders

remained in effect until early 1999. During that period, the

great majority of state commissions voluntarily applied the

FCC’s basic forward-looking methodology in adjudicating

disputes between incumbents and new entrants over the

rates to be charged for interconnection and network ele-

ments. See note 12, infra. In January 1999, this Court re-

versed the Eighth Circuit’s jurisdictional ruling, holding that

the FCC has statutory authority to establish national pricing

standards under Sections 251 and 252. Joa Utils. Bd. I, 525

U.S. at 376-385. The Court remanded the case to the Eighth

Circuit to address (among other things) the substantive

validity of the FCC’s cost methodology.

4. In July 2000, the Eighth Circuit issued its decision on

remand. The court upheld the FCC’s authority to prescribe

a pricing methodology based on forward-looking costs, in-

validated a key component of the particular methodology

that the FCC adopted, and rejected, as premature, the

incumbents’ Takings Clause challenge to the methodology.

U.S. Pet. App. 10a-18a.

First, the court of appeals rejected the incumbents’

argument that, in providing that the rates that they may

charge new entrants for interconnection and network ele-

ments are to be based on “cost,” Congress dictated a metho-

dology based on historical cost. The court concluded that

“the term ‘cost,’ as it is used in the statute, is ambiguous, and

This Court separately upheld several of the FCC’s rules on the

merits but invalidated a portion of the FCC’s original implementation of

the “necessary” and “impair” standards of Section 251(d)(2), see note 1,

supra, and remanded to the FCC for further rulemaking. See Jowa Utils.

Bd. I, 525 U.S. at 387-392. The FCC issued an order on remand in

December 1999. See In re Implementation of the Local Competition

Provisions of the Telecommunications Act of 1996, Third Report and

Order and Fourth Further Notice of Proposed Rulemaking, 15 F. C. C. R.

3696 (1999), petitions for review pending sub nom. United States

Telecomm. Ass'n v. FCC, Nos. 00-1015 et al. (D.C. Cir. Jan. 19, 2000).

Congress has not spoken directly on the meaning of the word

in this context.” U.S. Pet. App. lla. The court therefore

recognized that the FCC has the authority to make

reasonable rules to resolve any such ambiguity. Id. at 1la-

12a (citing Chevron U.S.A. Inc. v. NRDC, Inc., 467 U.S. 837,

842-843 (1984)). The court then concluded that the FCC’s

adoption of a methodology based on forward-looking costs

was reasonable. Id. at 12a. The court noted that “(florward-

looking costs have been recognized as promoting a com-

petitive environment which is one of the stated purposes of

the [1996] Act.” Jbid. The court found that the FCC had

adequately explained its conclusion that a methodology

based on forward-looking costs “would best ensure efficient

investment decisions and competitive entry,” and thus

implement the new competitive goals of the Act.” Ibid.

Second, the court of appeals invalidated the FCC’s rule

specifying that, apart from the “wire center” exception (see

note 4, supra), the forward-looking cost of an element should

be “based on the use of the most efficient telecommuni-

cations technology currently available and the lowest cost

network configuration,” 47 C.F.R. 51.505(b)(1). U.S. Pet.

App. 6a-10a. The court held that the regulation is contrary

to “the plain meaning” of Section 252(d)(1) and thus does not

satisfy step one of this Court’s Chevron analysis. Id. at 8a;

see also id. at 4a.

Third, the court of appeals rejected, as premature, the

incumbents’ assertion that the FCC’s methodology, in-

cluding its consideration of forward-looking costs, raises a

serious Fifth Amendment takings issue that the 1996 Act

should be construed to avoid. The court concluded that “the

present takings claim is not ripe for review” because, “(until

the actual rates are established” by state public utility com-

missions, “we cannot conclude whether the impact of

7 That aspect of the court of appeals’ opinion is among the questions

presented by our petition in this consolidated case.

TELRIC driven rates will constitute a taking.” Pet. App.

17a. The court observed that a mere “possibility that a

regulatory program may result in a taking does not justify

the use of a narrowing construction.” Id. at 17a-18a (citing

United States v. Riverside Bayview Homes, Inc., 474 US.

121, 128-129 (1985)).

5. The local competition provisions of the 1996 Act are

complemented by 47 U.S.C. 254, the provision of the 1996

Act relating to “universal service.” For many years, federal

and state regulators sought to ensure low rates for

subscribers in “high cost” areas through a variety of implicit

and explicit cross-subsidy mechanisms. For example, incum-

bent LECs often charged retail rates to customers in

densely populated urban areas that well exceeded the cost of

serving those customers; those revenues were then used to

subsidize the retail rates charged customers in remote rural

areas that are much more expensive to serve. Congress

recognized that the emergence of local competition would

tend to erode the source of such cross-subsidies, as new

‘entrants won the business of customers who would other-

wise pay above-cost rates to incumbents. A central objec-

tive of Section 254 is to phase out the implicit cross-subsidies

and replace them with explicit and competitively neutral

funding mechanisms supported by all providers of telecom-

munications services, including new entrants that provide

service through the use of an incumbent’s network elements

under Section 251(c)(3).

In 1997, the FCC issued rules implementing Section 254

and, among its determinations, chose a forward-looking cost

methodology similar to TELRIC as a key factor in deter-

mining the level of federal funding to supplement state

efforts to subsidize affordable service to high cost areas. See

In re Federal-State Joint Bd. on Universal Serv., Report

and Order, 12 F.C.C.R. 8776 (1997). In 1999, the Fifth

Circuit adjudicated various challenges to that Order. Texas

Office of Pub. Util. Counsel v. FCC, 183 F.3d 393 (1999).

Among its holdings, that court rejected the argument of

certain ineumbent LECs that construing Section 254 to per-

mit the use of a methodology based on forward-looking costs

is barred by the Takings Clause. Id. at 413 & n. 14. In June

2000, this Court granted a petition for a writ of certiorari on

that issue, filed by GTE, one of the corporate predecessors

(along with Bell Atlantic) to Verizon Communications, Inc.

GTE Serv. Corp. v. FCC, 530 U.S. 1213 (No. 99-1244). On

November 2, 2000, the Court granted Verizon’s unopposed

motion to dismiss that case. 121 S. Ct. 423.

SUMMARY OF ARGUMENT

In order to stimulate competition in loca] telecommuni-

cations markets, Congress, in the 1996 Act, gave new en-

trants the right to interconnect with, and to lease elements

of, incumbents’ existing networks. 47 U.S.C. 252(c)(2) and

(3). Congress provided that incumbents would be compen-

sated for doing so at rates based on “the cost * * * of

providing the interconnection or network element.”

47 U.S.C. 252(d)(1)(A). The FCC, in the rulemaking pre-

scribed by the 1996 Act, determined that such rates should

be based on forward-looking costs—i.e., the cost of obtaining

the features or functions of a network element that make it

useful—rather than the historical costs reflected on incum-

bents’ accounting books. The FCC reasoned that setting

network element rates on the basis of forward-looking costs,

which emulate rational economic choices in a competitive

market, would send appropriate signals for entry, invest-

ment, and pricing in markets moving from monopoly to

competition. The FCC’s choice of a methodology based on

forward-looking costs is reasonable and is consistent with

the text, structure, and purposes of the 1996 Act.

A. In so holding, the court of appeals recognized that “the

term ‘cost,’ as it is used in the [1996 Act], is ambiguous, and

Congress has not spoken directly on the meaning of the word

in this context,” U.S. Pet. App. lla. Accordingly, the FCC is

authorized to adopt reasonable rules to resolve that ambigu-

ity. See Chevron U.S.A. Inc. v. NRDC, Ine, 467 U.S. 837,

842-843 (1984).

1. Verizon nonetheless contends, relying on dictionary

definitions, regulatory practice, and other provisions of the

1996 Act, that the word “cost” in 47 U.S.C. 252(d)(1) can

refer only to historical cost. Verizon is mistaken.

First, the dictionary definitions on which Verizon relies,

which equate “cost” with the amount paid or to be paid for

an item, do not contain any temporal restriction. Those def-

initions could equally refer to the amount that would be paid

for the item today (i. e., the forward-looking cost), as opposed

to the amount that was paid for the item in the past (i.e., the

historical cost).

Second, at different times and in different contexts, regu-

lators have used both forward-looking and historical costs to

set rates, and this Court has recognized that neither ap-

proach is compelled either by the Constitution or by various

statutes authorizing ratemaking in similarly general terms.

Indeed, in the particular context of opening local tele-

communications markets to competition, state regulators

had already concluded, in advance of the enactment of the

1996 Act, that forward-looking costs should be used to set

the rates at which incumbents provide facilities to new en-

trants. It is unlikely that Congress intended to foreclose

such an approach in the new competitive environment con-

templated by the 1996 Act.

Third, the other provisions of the 1996 Act on which Veri-

zon relies do not dictate any particular construction of the

word “cost” in Section 252(d)(1). Rather, those provisions

provide further indication of the considerable discretion that

Congress vested in the FCC to implement the Act. For

example, the statutory provision that network element rates

“may include a reasonable profit,” 47 U.S.C. 252(d)(1)(B)

(emphasis added), not only does not limit the FCC to

adopting a particular definition of “cost,” since the concept of

profit is equally relevant to forward-looking and historical

approaches; the provision also reflects that Congress in-

tended that the FCC would make fundamental choices about

the rate methodology, including choices concerning whether,

or how, profit is to be taken into account.

2. Nor does the doctrine of constitutional avoidance re-

quire a construction of Section 252(d)(1) that reads the term

ost“ to refer exclusively to historical cost. Verizon has not

demonstrated that the FCC’s forward-looking cost meth-

odology presents serious Takings Clause concerns. And that

is true whether one considers the impact of the methodology

on incumbents’ overall returns, as this Court’s precedents

indicate, or on incumbents’ compensation for network ele-

ments standing alone.

In a series of cases, including Duquesne Light Co. v.

Barasch, 488 U.S. 299, 312, 314 (1989), the Court has ex-

plained that a change in regulatory methodology—including

one that denies a regulated company recovery of prudently

incurred historical costs—constitutes a taking only if “the

net effect” of the change is to “leav[e] [the company] insuffi-

cient operating capital” or impedle] [its] ability to raise

future capital.” No such “net effect” has been shown here.

To the contrary, the incumbents have continued to enjoy

generous returns, on both their interstate and intrastate

activities, in the years since they were required to lease

network elements at rates based on forward-looking costs.

In any event, even if one focuses on the adequacy of the

incumbents’ compensation for leasing network elements in

isolation, Verizon has offered no cogent reason to eonelude

that the incumbents will receive constitutionally inadequate

compensation under a methodology based on forward-look-

ing costs. Under traditional just compensation principles,

when the government commits private property to public

use, it is required to pay the owner the fair market value of

the property. The government is not required to pay the

owner whatever higher price the property might have

fetched in the past. The concept of fair market value is

closely akin to the concept of forward-looking cost; both

focus on the cost of an item in the current market, which may

reflect changes in technology, production, or other factors

since the item was originally placed into service.

Verizon also asserts that the FCC’s methodology will

leave the incumbents with “stranded investment” for which

they will never be fully compensated. But Duquesne recog-

nizes that the Constitution does not prohibit all regulatory

changes that produce stranded investment, but only those

that have a confiscatory effect on a company’s net returns.

The FCC found in this proceeding, moreover, that the

incumbents’ claims of stranded investment were unsub-

stantiated and were based on unrealistic assumptions about

the rate of competitive entry into local markets. The

passage of time has given no greater validity to the incum-

bents’ claims. In any event, the FCC has expressly pre-

served the option of providing a remedy for stranded

investment, if the incumbents demonstrate the need for one.

B. The FCC’s decision to adopt a forward-looking meth-

odology for setting network element rates satisfies the

reasoned decisionmaking standards of the Administrative

Procedure Act, 5 U.S.C. 701 et seg. The FCC reasonably

concluded, and adequately explained, that a forward-looking

methodology would most effectively implement Congress’s

purposes underlying the 1996 Act—z.e., to expedite the

development of competition in local telecommunications

markets, to facilitate the efficient use of existing network

facilities, and to encourage new entrants to make economi-

cally rational choices about whether, or how, to enter local

markets. At the same time, the FCC recognized that the use

of a historical cost methodology could impair the develop-

ment of competition; in those circumstances where historical

costs exceed forward-looking costs, for example, competitors

could be deterred from entering the market or induced to

construct inefficient, duplicative facilities.

Contrary to Verizon’s assertions, the FCC’s choice of a

forward-looking methodology does not undermine Con-

gress’s goal of encouraging efficient facilities-based competi-

tion. It was, after all, Congress, not the FCC, that made the

decision to accelerate competition in local telecommunica-

tions markets by enabling new entrants to lease some ele-

ments of incumbents’ networks, as many new entrants must

in order to develop competitive services. As the FCC recog-

nized, a historical-cost approach would arbitrarily impede

new entrants’ ability to use that entry vehicle. Moreover, as

experience since the adoption of the 1996 Act indicates, new

entrants are offering competing local telecommunications

services through facilities that they have purchased or built,

as well as through facilities leased from incumbents and

through resale. Indeed, new entrants have strong practical

incentives to avoid having to rely on incumbents to provide

the facilities on which they depend to serve their customers.

Finally, there is no merit to Verizon’s suggestion that a

forward-looking approach is so “administratively unwork-

able” that the FCC lacked discretion to adopt it. As ex-

plained above, the FCC concluded that a forward-looking

approach is far superior to a historical approach for mea-

suring the costs relevant here—the costs on which incum-

bents would base charges for network elements in a truly

competitive market. Moreover, as demonstrated by decades

of experience, a historical cost approach, no less than a

forward-looking one, presents significant administrative

difficulties. Under a historical approach, no less than under

other approaches, regulators would have to make complex

judgment calls about appropriate depreciation rates, rates of

return, and allocations of joint and common costs to various

aspects of the network.

ARGUMENT

I. THE FCC REASONABLY CONSTRUED SECTION

252(D)(1) OF THE 1996 ACT TO PERMIT THE USE

OF FORWARD-LOOKING COSTS TO DETERMINE

NETWORK ELEMENT PRICES

A. The FCC’s Construction Of “Cost” Is Consistent With

The Language, Structure, And Purposes Of The Act

1. In the 1996 Act, Congress provided that the “just and

reasonable rate” at which an incumbent LEC may lease a

network element to a new entrant is a rate “based on the

cost * * * of providing the * * * network element.”

47 U.S.C. 252(d)(1)(A). As the court of appeals recognized,

Congress did not itself prescribe how that “cost” is to be

determined; rather, Congress left it to the FCC to determine

which of the various possible methods for measuring “cost”

would best serve the purposes of the Act. See U.S. Pet.

App. lla (“We conclude the term ‘cost,’ as it is used in the

statute, is ambiguous, and Congress has not spoken directly

on the meaning of the word in this context.”); see generally

AT&T v. Iowa Utils. Bd. (Iowa Utils. Bd. D, 525 U.S. 366,

397 (1999) (observing that the 1996 Act “is in many

important respects a model of ambiguity”—ambiguity that

“Congress [was] well aware” would “be resolved by the

implementing agency”).

In making that determination, the FCC considered the

comments of economists and other experts as well as the

experience of those States that had already moved to open

their own local telecommunications markets to competition.

The FCC concluded that the appropriate “cost * * * of pro-

viding” a network element, for purposes of Section 252(d)(1),

is the forward-looking cost of that element—i.e., the cost in

today’s market of obtaining the features or functions of the

element that make it useful. The FCC noted that the

forward-looking cost of an element may, depending upon the

—

individual context, be either higher or lower than its

historical cost. See Local Competition Order (para. 705),

JA. 398-399.

The FCC found support for its adoption of a forward-

looking cost methodology in the purposes of the 1996 Act: to

stimulate the expeditious development of competition in

local telecommunications markets; to ensure the efficient use

of existing network facilities, many of which embody signifi-

cant economies of scale and scope; and to encourage new

entrants to make economically rational decisions about

whether, or how, to enter a given market. The FCC ex-

plained that setting prices under a forward-looking meth-

odology emulates rational economic behavior in a com-

petitive market, because a firm considers forward-looking

costs, not historical costs, in making decisions about entry,

expansion, and price. See Local Competition Order (paras.

620, 679, 740), J.A. 327-328, 379-380, 422-423; see also

Duquesne Light Co. v. Barasch, 488 U.S. 299, 308 (1989)

(forward-looking costs mimiel] the operation of the

competitive market”); MCI Communications Corp. v.

AT&T, 708 F.2d 1081, 1116-1117 (7th Cir.) (It is current

and anticipated cost, rather than historical cost that is

relevant to business decisions to enter markets.”), cert.

denied, 464 U.S. 891 (1983). The FCC thus concluded that

the forward-looking methodology embodied in TELRIC

would send appropriate signals for entry, investment, and

pricing to potential competitors in local telecommunications

8 Thus, although “[tJhe FCC fully understood that TELRIC rates

would be below historical costs” (Verizon Pet. Br. 28) in many instances,

the FCC also understood that TELRIC rates could be above historical

costs depending upon individual circumstances. Indeed, when the Iowa

Utilities Board challenged the FCC’s jurisdiction to set prices for network

elements, it expressed concern that TELRIC would produce higher, not

lower, network element rates in Iowa than would a historical cost meth-

odology. See Mot. of Iowa Utils. Bd. for Stay at 9, Jowa Utils. Bd. v. FCC,

No. 96-3321 (8th Cir. Sept. 19, 1996).

markets. See Local Competition Order (paras. 620, 630),

J.A. 327-328, 333-334.

2. Verizon nonetheless contends (Verizon Pet. Br. 19-23)

that the term “cost,” as used in Section 252(d)(1), must be

construed, under step one of Chevron U.S.A. Inc. v. NRDC,

Inc., 467 U.S. 837, 842-843 (1984), to refer exclusively to

historical costs. Verizon asserts that its preferred reading is

compelled by dictionary definitions, traditional regulatory

usage, and statutory structure. The court of appeals

correctly rejected that claim. See U.S. Pet. App. 10a-14a.

a. Verizon first attempts to read a historical component

into dictionary definitions describing “cost” as, for example,

“the amount or equivalent paid or given or charged or

engaged to be paid or given for anything.” Verizon Pet. Br.

19. But such conventional definitions accommodate forward-

looking and historical interpretations with equal ease. Those

definitions do not specify whether the relevant “cost” is an

amount that would be paid or charged today to provide net-

work elements (i. e., the forward-looking cost) or an amount

that was paid or charged in the past (i. e., the historical cost).

Courts and commentators have recognized that the word

“cost” is “one of equivocal meaning,” Strickland v. Com-

missioner, Me. Dep't of Human Servs., 48 F.3d 12, 19 (Ist

Cir.) (quoting 20 C.J.S. Cost (1940)), cert. denied, 516 U.S.

850 (1995), which may encompass both forward-looking and

historical costs. See, e.g., MCI Communications, 708 F.2d at

1116-1117 (observing that methodologies based on forward-

looking cost (e.g., “long-run incremental cost”) and historical

cost (e. g., “fully distributed cost”) “can be viewed as simply

different ways of defining the average total cost (‘ATC’) of a

particular product or service”) (emphasis omitted). As

Justice Breyer noted in his separate opinion in Jowa Utilities

Board I, “general terms” of the sort used in the 1996 Act to

articulate the network element pricing standard—such as

the term “based on cost“ in Section 252(d)(1)—“give

ratesetting commissions broad methodological leeway” and

“say little about the ‘method employed’ to determine a

particular rate.” 525 U.S. at 423 (Breyer, J., concurring in

part and dissenting in part).

It was particularly reasonable for the FCC to construe the

1996 Act to authorize a forward-looking cost methodology,

because, under the plain language of Section 252(d)(1), rates

are to be based “on the cost (determined without reference

to a rate-of-return or other rate-based proceeding) of pro-

viding the interconnection or network element.” The “cost

* * * of providing” a network element—such as a local loop

connecting a house to a telephone switch—is most reason-

ably construed as the cost of procuring that element on

today’s market. It cannot as readily be construed as the cost

that an incumbent happened to pay for its facilities many

years in the past.

b. Contrary to Verizon’s assertion, regulatory history

supplies no single definitive meaning of “cost.” Indeed, one of

the treatises upon which Verizon relies for a fixed reading of

“cost” to mean historical cost acknowledges that, in the

utility ratemaking context in particular, “‘[cJost’ * is a

word of many meanings”—including, specifically, both

historical “original-cost” and forward-looking “reproduction-

cost.” James C. Bonbright et al., Principles of Public Utility

Rates 109 (2d ed. 1988). Thus, although the term “cost”

today is not confined to forward-looking cost, the “view of

9 Accord, e. g., National Ass n of Greeting Card Publishers v. United

States Postal Serv., 462 U.S. 810, 832 (1983) (observing that the statutory

term “attributable costs,” which Congress directed the Postal Service to

consider in setting postal rates, “has no technical meaning” and “connotes

the use of judgment” by the expert agency); Alabama Elec. Coop., Inc. v.

FERC, 684 F.2d 20, 27 (D.C. Cir. 1982) (noting that le lost itself is an

inexact standard”).

10 Ratemaking based upon “fair value,” a version of forward-looking

cost, was once thought to be constitutionally required. See Smyth v.

Ames, 169 U.S. 466 (1898); see also Richard J. Pierce, Jr., Public Utility

historic cost as the apodictically indicated measure of ‘actual

cost,’ is not * * * supported by the applicable law.” City of

Los Angeles Dep’t of Airports v. United States Dep’t of

Transp., 103 F.3d 1027, 1032 (D.C. Cir. 1997).

Moreover, as we previously noted (see U.S. Pet. Br. 24-

25), regulators, with court approval, have long employed

methodologies based on forward-looking costs. In the 1980s,

for example, the Interstate Commerce Commission (ICC)

adopted a forward-looking cost methodology, based on “most

efficient” alternatives, to determine the maximum rate that

a market-dominant railroad could charge a coal shipper that

was the “captive” of that railroad. See also, e.g., Mobil Oil

Exploration & Producing S.E., Inc. v. United Distribution

Cos., 498 U.S. 211, 219, 221-226 (1991) (upholding FERC’s

“replacement-cost-based method” of pricing existing natural

Regulatory Takings: Should the Judiciary Attempt to Police the Political

Institutions?, 77 Geo. L. J. 2031 & n.5 (1989) (cataloguing cases).

1 Under the ICC’s standard, the railroad could charge the captive

shipper no more than the “stand alone” cost of transporting the coal,

defined as the forward-looking cost that the shipper itself would incur

were it to transport the coal to its destination using the most efficient

railroad system that could be configured to accomplish that task. See Ex

Parte No. 347 (Sub-No. 1), Coal Rate Guidelines, Nationwide, 1 I. C. C. 2d

520, 542-546 (1985), aff'd sub nom. Consolidated Rail Corp. v. United

States, 812 F.2d 1444, 1451, 1457 (3d Cir. 1987); see also Ex Parte No. 347

(Sub-No. 1), Coal Rate Guidelines, Nationwide (unpublished decision

issued Feb. 8, 1983), slip op. 10-13 (delineating substantially similar

interim standard). The D.C. Circuit (in an opinion joined by then-Judge

Scalia) upheld the ICC’s use of that methodology. The court reasoned

that, although the methodology “deals with hypothetical and not actual

transportation situations, it provides an appropriate analytical tool for

determining whether a return on noncompetitive traffic ‘properly reflects

the high demand for the service, but is not set at an unreasonably high or

“monopoly” level. Potomac Elec. Power Co. v. ICC, 744 F.2d 185, 198-

194 (D.C. Cir. 1984) (quoting interim ICC Guidelines); see also Consoli-

dated Rail Corp., 812 F.2d at 1453-1457 (affirming in full final ICC

guidelines); Burlington N. R. R. v. Surface Transp. Bd., 114 F.3d 206, 212-

215 (D.C. Cir. 1997) (affirming application of those guidelines).

gas, which “approximated * * * the current cost of finding

new gas fields, drilling new wells, and producing new gas”).

In the years preceding the enactment of the 1996 Act, a

number of state public utility commissions, in acting to open

their own local telecommunications markets to competition,

recognized the appropriateness of using forward-looking

costs as the basis for determining the rates at which

incumbents could be required to open their facilities to new

entrants. See Local Competition Order (paras. 631, 681),

J. A. 334-336, 381." The European Commission has endorsed

a forward-looking methodology similar to TELRIC—based

on a model hypothesizing “an efficient operator employing

modern technology”—as a means of opening European tele-

communications markets to competition.” It is exceedingly

12 Moreover, during the period from 1996 through early 1999 when the

FCC’s pricing rules were stayed and then vacated by the Eighth Circuit

on jurisdictional grounds, the overwhelming majority of state commissions

independently and voluntarily embraced the essentials of TELRIC in

their implementation of the local competition provisions of the 1996 Act.

See Peter W. Huber, Michael K. Kellogg & John Thorne, Federal Tele-

communications Law § 2.4.4.1, at 185 (2d ed. 1999) (“While the Jona

Utilities Board case was being litigated, most states used their price-

setting authority in ways closely following the FCC models.”). The federal

courts have consistently endorsed that choice on the merits in their review

of the state commissions’ actions. See, ¢.g., GTE S. Inc. v. Morrison, 6 F.

Supp. 2d 517, 528-530 (E.D. Va. 1998), aff'd on other grounds, 199 F.3d 733,

742-744, 749 (4th Cir. 1999); Bell Atl.-Del., Inc. v. McMahon, 80 F. Supp.

2d 218, 235-236 (D. Del. 2000).

13 See Commission Recommendation on Interconnection in a Liber-

alised Telecommunications Market (Pt. 1, Interconnection Pricing), OJ.

1998 L073/42 (“Interconnection costs should be calculated on the basis of

forward-looking long run average incremental costs, since these costs

closely approximate those of an efficient operator employing modern

technology.”); see also Hank Intven, Jeremy Oliver & Edgardo Sepulveda,

Telecommunications Regulation Handboook 3-25 (World PB nk 2000)

(“[T]oday most regulators and experts generally agree that the ideal ap-

proach for calculating the level of interconnection charges would be one

based on forward-looking costs of supplying the relevant facilities and

unlikely that Congress intended to foreclose the FCC from

adopting the very methodology that other regulators had

found singularly appropriate to promote competition in the

telecommunications industry and other regulated industries.

ce. The structure of the 1996 Act’s local competition pro-

visions does not, as Verizon suggests, demand that “cost” in

Section 252(d)(1) be read to mean “historical cost.” Indeed,

the very provisions on which Verizon relies suggest, if

anything, that Congress intended to vest the FCC with

broad discretion in selecting an appropriate cost meth-

odology. :

First, Verizon claims that reading “cost” as “historical

cost” is necessary to give meaning to Section 252(d)(1)(B),

which states that rates for interconnection and network ele-

ments “may include a reasonable profit.” Verizon Pet. Br.

20. That is so, Verizon asserts, because “profit” generally

means an excess in returns over costs, while the Order at

issue here viewed profit as one component of forward-look-

ing costs themselves, leaving no independent significance to

the separate statutory reference to “profit.” Id. at 21.

As the court of appeals recognized, however, La] ‘profit’

can be made whether a historical cost or forward-looking

cost methodology is used.” U.S. Pet. App. 13a. Verizon’s

arguments turn not on a difference between historical costs

and forward-looking costs, but on a difference between two

permissible characterizations of “profit,” each of which is

equally applicable to a historical cost regime or a forward-

looking cost regime. Under either regime, “profits” may be

characterized as either (1) the recovery of revenues in excess

of (historical or forward-looking) costs, with costs defined to

exclude the opportunity costs represented by the decision to

invest capital in telecommunications plant rather than else-

where or (2) the recovery of a particular (historical or

services.”); id. at 3-23 (noting countries that have adopted such an

approach).

forward-looking) cost itself, i.e, the opportunity cost of

capital. See Local Competition Order (paras. 699-703), J.A.

393-396. The FCC’s description of a “reasonable profit” as

the recovery of the cost of capital (along with all other

relevant costs) under a forward-looking regime reflects the

latter characterization. But that does not mean that the FCC

was reading the reference to “profit” out of Section 252(d)(1).

Moreover, as the court of appeals observed, Congress’s

“use of the word ‘may’ [in Section 252(d)(1)(B)] indicates that

the inclusion of a reasonable profit is not mandatory but

permitted.” U.S. Pet. App. 13a. Such discretionary langu-

age provides additional support for the conclusion that Con-

gress was not itself dictating any particular pricing meth-

odology for network elements. Rather, Congress sought to

leave to the FCC the task of formulating the details of the

pricing methodology, specifically including the question of

whether, or how, profit is to be taken into account.

Second, Verizon contends that the accelerated imple-

mentation schedule that Congress established with respect

to the local competition provisions of the 1996 Act, see

47 U.S.C. 251(d)(1), and the prohibition on the use of rate-of-

return or other rate-based proceedings in establishing rates,

see 47 U.S.C. 252(d)(1), create the “strong inference * * *

that ‘cost’ refers to something already established and

readily available, i.e. historical cost as documented on

incumbents’ books.” Verizon Pet. Br. 22. Both provisions, to

the extent that they bear on the matter at all, militate

against Verizon’s construction of “cost.”

Section 251(d)(1)’s directive that the FCC complete within

six months “all actions necessary to establish regulations to

implement the requirements of this section” reflects Con-

gress’s intent to expedite competitive entry into local

markets. See Local Competition Order (para. 704), J.A. 397-

398. The FCC’s construction of “cost” advances that

objective better than does Verizon’s construction. As the

FCC concluded, setting rates for network elements on the

basis of forward-looking costs will stimulate the

development of efficient competition, while setting rates on

the basis of historical costs would retard and distort such

competition. See Local Competition Order (paras. 620, 705),

J.A. 327-328, 398-399.

The parenthetical restriction in Section 252(d)(1)(A)(i),

which requires network element rates to be “determined

without reference to a rate-of-return or other rate-based

proceeding,” “does not further define the type of costs that

may be considered.” Local Competition Order (para. 704),

J.A. 397-398. But that provision does contemplate some de-

parture from traditional forms of ratemaking for telephone

companies, which had been conducted pursuant to historic

cost-based “rate-of-return or other rate-based proceedings.”

In any event, Verizon’s reliance on that parenthetical re-

striction starts from the false premise that the historical

costs of network elements (e.g., network “features, functions,

and capabilities,” 47 U.S.C. 153(29)) were “already estab-

lished and readily available” on incumbents’ accounting

books, and thus could be applied in streamlined ratemaking

proceedings. See Verizon Pet. Br. 22. In fact, historical cost

data in the telecommunications industry traditionally fo-

cused on an incumbent’s revenue needs in other contexts,

not on the proper level of compensation for the competitive

use of discrete facilities. The use of such existing data to

develop reliable historical cost figures for particular catego-

ries of facilities would, therefore, have been exceedingly

difficult. See pp. 48-49, infra.

Third, Verizon argues that, because the 1996 Act ties the

wholesale rates that new entrants may be charged for tele-

communications services sold for resale under Sections

251(c)(4) and 252(d)(3) to incumbents’ retail rates (which

allegedly were set on the basis of historical costs), principles

of symmetry in statutory construction dictate that historical

costs be the basis for network element rates as well. Veri-

zon Pet. Br. 22-23. But nothing in the text of Sections

251(c)(4) and 252(d)(3) — which provide that new entrants

may purchase such services “at wholesale rates,” which are

to be based on “retail rates charged to subscribers”—in-

exorably ties those rates to historical costs. Any such con-

nection depends upon the particular ratemaking method that

state regulators employed to develop the pertinent retail

rates.

Moreover, even if the rates for services sold for resale

would in many instances be derived in some respect from

historical costs, that does not mean that Congress intended

that network element rates also would be tied to historical

costs. The network element and resale entry vehicles are

separate options for new entrants and serve distinct pur-

poses. The pricing standards for those entry vehicles are

contained in separate statutory subsections and are de-

scribed in distinct terms. Section 252(d)(1) provides that

rates for network elements should be based upon “cost” and

thus should be developed from the ground up. Construing

“cost” to mean forward-looking cost serves the competitive

purposes of the 1996 Act by ensuring that new entrants

make efficient choices about whether to lease network

elements or build facilities of their own. Local Competition

Order (para. 620), J.A. 327-328.

Section 252(d)(3), on the other hand, provides that -

wholesale rates for resale services should be developed from

the top down—starting with existing retail rates and

excluding the portion of such rates attributable to categories

of “costs that will be avoided by the local exchange carrier.”

4 Section 252(d)(3) provides that:

For the purposes of section 251(c)(4) of this title, a State commission

shall determine wholesale rates on the basis of retail rates charged to

subscribers for the telecommunications service requested, excluding

the portion thereof attributable to any marketing, billing, collection,

and other costs that will be avoided by the local exchange carrier.

47 U.S.C. 252(d)(3).

That standard recognizes that incumbents’ retail rate struc-

tures traditionally have been laden with implicit subsidies

and thus are not necessarily cost-based (with reference to

either historical or forward-looking costs). The wholesale

rate standard ensures that companies choosing to enter the

market through resale have a margin within which to com-

pete, regardless of whether an incumbent’s retail service

rates are cost-based, above-cost, or below - cost. Given the

different purposes underlying the prieing standards for

network elements and resale services, as well as the differ -

ent statutory language describing those standards, there is

no reason to conclude that Congress intended that the pric-

ing standards be symmetrical in their reliance on historical

costs. In other words, even if Congress understood that

wholesale rates for retail services ordinarily (but not

invariably) would have historical cost-based retail rates as a

starting point, it would not follow that Congress intended

that rates for network elements be based on historical, not

forward-looking, costs.

B. The Principle Of Constitutional Avoidance Does Not

Require That “Cost” Be Construed As Historical Cost

Verizon next invokes the principle of constitutional avoid-

ance to advance its construction of the term “cost” in Section

252(d)(1). Verizon contends that, in order te avoid Takings

Clause concerns, Section 252(d)(1) must be construed to

15 Congress’s purpose of ensuring a margin for competitive entry

through resale even for non-cost-based rates is evident in Section

25 1 (0B), which permits state commissions to “prohibit a reseller that

obtains at wholesale rates a telecommunications service that is available

at retail only to a category of subscribers from offering such service to a

different category of subscribers.” Presumably, Congress intended that

the provision could apply, for instance, to services provided at below-cost

retail rates (e.g., for rural customers), so that new entrants could compete

with incumbents with respect to subsidized services, but could not extend

the subsidy to new classes of customers that were not beneficiaries of the

subsidy under state ratemaking policy.

allow incumbent LECs to lease network elements at rates

based on whatever amount the incumbents may have paid

for those elements in the past. Verizon Pet. Br. 24-31.

This Court and others have rejected efforts to invoke

the avoidance principle in the Takings Clause context to

“frustrate[] permissible applications of a statute or regula-

tion” absent a concrete showing that government action will

necessarily produce a taking without just compensation.

United States v. Riverside Bayview Homes, Inc., 474 U.S.

121, 128 (1985); National Mining Ass’n v. Babbitt, 172 F.3d

906, 917 (D.C. Cir. 1999); ef. Federal Power Comm 'n v. Hope

Natural Gas, 320 U.S. 591, 602 (1944) (one who challenges

the constitutionality of a ratemaking order “carries the

heavy burden of making a convincing showing that it is in-

valid because it is unjust and unreasonable in its con-

sequences“). Verizon has not even attempted to make such

a showing here.

As an initial matter, any suggestion that the FCC’s adop-

tion of TELRIC will deny the incumbent LECS consti-

tutionally adequate compensation has a speculative quality,

since the actual rates that incumbents may charge for net-

work elements are ultimately set by state public utility

commissions, not by the FCC itself. The FCC has simply

16 Verizon contends that Riverside Bayview has no application where

the constitutional concern is not whether a taking has occurred, but rather

whether the compensation for the taking is just. Verizon Pet. Br. 43. But

Riverside Bayview is appropriately viewed as a specific application of the

principle that the constitutional avoidance doctrine is properly invoked to

prevent “serious constitutional problems,” not merely speculative ones.

Nor is United States v. Security Industrial Bank, 459 U.S. 70 (1982), to

the contrary. The Court has explained that Security Industrial Bank

involved a “substantial” claim that a particular construction of a statute

“would in every case constitute a taking.” Riverside Bayview, 474 U.S. at

128 n.5. Verizon does not attempt to demonstrate that the application of

TELRIC would produce unconstitutional results in all, or even a sub-

stantial number of, applications.

established the methodology that the state commissions are

to apply in individual circumstances. The FCC also has not

prescribed specific depreciation rates or rates of return—

both of which are necessary components of any network

element rates established under TELRIC. Instead, the

FCC has left it to state commissions to establish rates of re-

turn and depreciation rates. See Local Competition Order

(para. 702), J.A. 395-396; see also U.S. Pet. App. 17a (court of

appeals observes that, “(uJntil the actual rates are estab-

lished” by state commissions for network elements, “we

cannot conclude whether the impact of TELRIC driven

rates will constitute a taking”). In addition, the FCC has

expressly stated that incumbents may “seek relief from [its]

pricing methodology if they provide specific information to

show that the pricing methodology, as applied to them, will

result in confiscatory rates.” Local Competition Order (para.

739), J.A. 422. The FCC’s acknowledgment of the potential

for relief where confiscation can be demonstrated—rather

than merely asserted—undermines any suggestion that the

Order at issue will produce confiscatory results in any cir-

cumstance. Even aside from the foregoing considerations,

Verizon has failed to demonstrate that TELRIC raises

serious constitutional concerns.

As regulated public utilities, incumbent LECs are subject

to the regulatory takings analysis of Duquesne Light Co.,

supra, and Hope Natural Gas, supra. In Duquesne, as in a

consistent line of earlier decisions, this Court rejected the

argument that the Takings Clause protects utilities from

regulatory measures that deny them recovery of all pru-

dently incurred historical costs. See 488 U.S. at 301-302,

307-316; accord FERC v. Pennzoil Producing Co., 439 U.S.

508, 517-520 (1979); Market St. Ry. v. Railroad Comm’n, 324

U.S. 548, 553-554, 564-568 (1945). The Court explained that

the Constitution protects a public utility only from “the net

effect of the rate order on its property,” Duquesne, 488 U.S.

at 314, so that if the total effect of the rate order cannot be

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

id. at 310 (quoting Hope, 320 U.S. at 602).

Here, as in Duquesne, whether or not the challenged

methodology denies regulated companies full recovery of

certain prudently incurred historical costs is itself of no

constitutional significance. Indeed, unlike in Duquesne, the

incumbents here are allowed to recover the full forward-

looking costs of the facilities at issue—a measure closely

analogous to fair market value, which is the standard for

determining whether the government has paid just com-

pensation for private property taken for public use. See pp.

35-36, infra. And here, as in Duquesne, Injo argument has

been made” that the regulatory measure at issue “jeo-

pardizels] the financial integrity of the companies, either by

leaving them insufficient operating capital or by impeding

their ability to raise future capital.” 488 U.S. at 312. To the

contrary, Verizon and most other incumbents have enjoyed

extremely healthy returns in recent years, after they were

required to lease network elements at rates based on

forward-looking costs.

1. Verizon nonetheless contends that the FCC’s adoption

of TELRIC is inconsistent with Duquesne on the theory that

7 The interstate rates of return on the major incumbents’ regulated

activities in 1999, as measured under a historical cost approach, showed a

weighted arithmetic mean of 18.50%, including returns of 22.89% for GTE,

20.99% for BellSouth, 18.80% for SBC Communications, 19.06% for U S

WEST, and 13.66%-for Bell Atlantic. See Interstate Rate of Return Sum-

mary (FCC Apr. 10, 2001) (http://www.fec.gov/Bureaus/Common_Carrier/

Reports/FCC-State_Link/IAD/ror00.pdf). Preliminary reports on inter-

state regulated earnings in 2000 show even higher average returns of

19.53%. See Interstate Rate of Return Summary, Years 1991 through

2000 (FCC May 3, 2001) (http://www.fec.gov/Bureaus/Common_Carrier/

Reports/FCC-State_Link/IAD/ror00.pdf); see also Seth Schiesel, No End

to Upheaval in Telecom Industry, N.Y. Times, Dec. 18, 2000, at C30 (“The

local phone giants that formerly had Bell in their names, led by Verizon

Communications and SBC Communications, are ascendant these days,

even as the long-distance industry essentially collapses around them.”).

the FCC has improperly “switche[d]” compensation meth-

odologies. Verizon Pet. Br. 26-31.“ That argument turns

Duquesne on its head. In Duquesne, the Court upheld a

state law that “suddenly and selectively,” 488 U.S. at 313,

foreclosed recovery of a $35 million investment that was pru-

dent when made, even though the methodology in effect at

the time of the investment would have permitted such

recovery. Thus, Duquesne affirms the discretion of regula-

tors to alter rate-setting methodologies to accommodate

changes in regulatory policy, even if, as in Duquesne itself,

the new methodology results in “stranded” investment.

Verizon counters that a change in methodologies is per-

missible under Duquesne only if the new methodology pro-

duces a constitutionally adequate rate of return as measured

under the old methodology. Verizon Pet. Br. 27-28. That

argument is both inaccurate and irrelevant.

In the first place, Duquesne holds no such thing. The

passage on which Verizon relies states a sufficient, but not

necessary, basis for rejecting the utility’s constitutional

claim in that case. See Duquesne, 488 U.S. at 312. And, even

if Duquesne did stand for the rule that Verizon ascribes to it,

such a rule would not advance Verizon’s position here.

Under any plausible reading of Duquesne, the relevant

question is the “overall impact,” ibid., of a methodological

decision on a utility’s regulated returns, not the amount of

18 It is well settled that, within reasonable bounds, companies operat-

ing in regulated industries have no vested interest in any particular

regulatory regime. See, e g., General Tel. Co. of the S. W. v. United States,

449 F. 2d 846, 864 (5th Cir. 1971) (“The property of regulated industries is

held subject to such limitations as may reasonably be imposed upon it in

the public interest and the courts have frequently recognized that new

rules may abolish or modify pre-existing interests.”); cf. Lucas v. South

Carolina Coastal Council, 505 U.S. 1003, 1027 (1992) (“the property

owner necessarily expects the uses of his property to be restricted, from

time to time, by various measures newly enacted by the State in legiti-

mate exercise of its police powers”).

cost recovery allowed for individual facilities, such as a nu-

clear power plant in Duquesne or a telephone loop here.

Verizon has made no effort to show that the “overall impact”

of the FCC’s adoption of a forward-looking methodology to

determine the rates at which network elements are leased

leaves incumbents with a constitutionally inadequate return,

even as measured under a historical cost methodology. See

note 17, supra.

Moreover, Verizon’s argument rests on the erroneous

premise that, until 1996, the FCC had committed itself to a

historical cost methodology and that its adoption of TELRIC

marked an abrupt departure from that commitment. See

Verizon Pet. Br. 29. It is true that state and federal regu-

lators for many years used historical costs as the basis for

setting retail rates paid by consumers and charges for

particular services (such as use of the local network to

originate or terminate long-distance calls). The Order under

review here does not regulate those rates and charges.” It

instead regulates the charges paid by new entrants for the

use of network elements—an activity that had little pre-

cedent from which the FCC can be accused of departing.

And, even in those other contexts, the FCC and many state

commissions abandoned a pure historical cost approach years

ago because of its methodological shortcomings. See, e. g.,

National Rural Telecom Ass’n v. FCC, 988 F.2d 174, 178

(D.C. Cir. 1993) (discussing price cap regime). Thus, in

adopting a forward-looking methodology in the present con-

text, the FCC not only was addressing a new regulatory

subject matter, but also was continuing a trend away from

traditional forms of regulation based on historical costs.

19 See generally Access Charge Reform, Sixth Report and Order, FCC

No. 00-195 (iviayy 31, 2000), petitions for review pending sub nom. Texas

Office of Pub. Util. Counsel v. FCC, No. 00-60434 (5th Cir. filed June 26,

2000) (and consolidated cases).

Even if there were some plausible basis (which there is

not) for contending that the government has impermissibly

“switched” the rules on incumbent LECs, the appropriate

focus of inquiry would be the impact of the 1996 Act and

implementing regulations as a whole, not just of the in-

dividual regulatory decisions that the incumbents oppose.

See Colorado Springs Prod. Credit Ass’n v. Farm Credit

Admin., 967 F.2d 648, 653 (D.C. Cir. 1992) (it is appropriate

to consider the benefits and burdens of the “overall legis-

lative ‘transaction’” in assessing a takings claim). The 1996

Act confers significant benefits on Verizon and the other

major incumbents by, for example, eliminating or reducing

restrictions on their entry into the long-distance market in

return for their compliance with Sections 251 and 252. See

47 U.S.C. 271 (prescribing method whereby Bell companies

such as Verizon may obtain permission to enter long-

distance market); 1996 Act, Title VI, § 601(a)(2), 110 Stat.

143 (relieving GTE from restrictions on provision of long-

distance service); see generally BellSouth Corp. v. FCC, 162

F.3d 678, 690 (D.C. Cir. 1998) (describing benefits provided

to incumbent LECs by the 1996 Act).” It is, moreover, im-

plausible to assert, as Verizon now does, that the regulatory

steps necessary to open monopoly markets to full competi-

tion have either taken them by surprise or left them with

anything short of a robust return on their investments.”

2 Pursuant to Section 271, the FCC has authorized Verizon entities to

offer long distance services in New York and Massachusetts—activities

that such entities were precluded from engaging in before the adoption of

the 1996 Act. See AT&T v. FCC, 220 F.3d 607 (D.C. Cir. 2000); Applica-

tion of Verizon New England, Inc., et al. For Authorization To Provide

In-Region, Inter-LATA Servs. in Massachusetts (CC Docket No. 01-9),

FCC 01-130 (Apr. 16, 2001), appeal pending sub nom. WorldCom, Inc. v.

FCC, No. 01-1198 (D.C. Cir. filed Apr. 25, 2001).

2 See Herbert Hovenkamp, The Takings Clause and Improvident

Regulatory Bargains, 108 Yale L.J. 801 (1999) (repudiating incumbents’

claim of a breached “regulatory contract”); Jim Chen, The Second Coming

2. Relying on Brooks-Scanlon Co. v. Railroad Com-

mission, 251 U.S. 396 (1920), Verizon contends that, in deter-

mining the “total effect” of a methodological decision for pur-

poses of the Duquesne analysis, a regulator must disregard

profits from lines of business outside that regulator’s own

jurisdiction. See Verizon Pet. Br. 33-34. Indeed, Verizon

asserts, the FCC was required under Brooks-Scanlon “to set

UNE [i.e., network element] rates that would allow the

UNE business to generate a sufficient return to stand on its

own.” Id. at 35. Brooks-Scanion has no application to the

circumstances here. In any event, whether or not it is

appropriate under this Court’s authorities to assess the

incumbents’ returns from the leasing of network elements in

isolation, there is no reason to conclude that those returns

are constitutionally inadequate under the FCC’s methodol-

ogy. That is because the inquiry required under the FCC’s

methodology i. e., the cost of obtaining the useful features

of a network element in today’s ma ‘ket—is closely analogous

to an inquiry into fair market value. And fair market value

is the touchstone for determining whether just compensation

has been paid for private property taken for public use.

a. In Brooks-Scanlon, the Court held that a State could

not force a company engaged in an unregulated “sawmill and

lumber business” to operate an unprofitable railroad on the

theory that the losses from the railroad would be offset by

the profits from the sawmill and lumber business. 251 U.S.

at 399.” No similar arrangement is at issue here. The “total

—

of Smyth v. Ames, 77 Tex. L. Rev. 1535, 1566 (1999) (“The LECs’ exhaus-

tive knowledge of the laws, policy, and jurisprudence of regulated in-

dustries, compounded by their active lobbying before the passage of the

Telecommunications Act, estops them from plausibly complaining of sur-

prise, much less an unconstitutional violation of public faith.”) (internal

quotation marks omitted).

2 The Court acknowledged, however, that if a company wished to con-

tinue operating a railroad pursuant to a state charter, the company could

effects” inquiry mandated by Duquesne should, at a mini-

mum, permit consideration of a regulated firm’s overall rate

of return from all of its interrelated regulated activities. As

to those activities, the appropriate question is whether a

particular government policy requires the firm to “operate

its entire business at a loss,” for the firm is entitled only to

“just compensation for [its] over-all services to the public.”

Baltimore & Ohio R. R. v. United States, 345 U.S. 146, 148-

150 (1953) (emphasis added); see Broad River Power Co. v.

South Carolina, 281 U.S. 537, 544 (1930) (Brooks-Scanlon

simply prevents regulators from considering revenues from

an unregulated business in assessing whether a regulated

business may be abandoned as unprofitable).”

Verizon does not contend that the incumbent LECs are

being required to operate their “entire [regulated] business”

at a loss. Nor does Verizon contend that the incumbents are

being compelled to operate those activities within the federal

regulatory jurisdiction at an overall rate of return that is

unconstitutionally low.“ And for good reason. The available

data demonstrate that the incumbents’ interstate earnings

be required “to fulfil an obligation imposed by the charter even though

fulfilment in that particular may cause a loss.” 251 U.S. at 399.

2 Although one passage in Brooks-Scanlon states that Ja] carrier

cannot be compelled to carry on even a branch of business at a loss,” 251

U.S. at 399, Judge Friendly correctly observed, even before Duquesne,

that any such proposition is inconsistent with modern regulatory takings

precedent and “is not the law.“ In re Valuation Proceedings Under

Sections 303(c) and 306 of the Reg Rail Reorganization Act, 439 F. Supp.

1351, 1357 n.12 (Spec. Ct. 1977) (citing cases).

* Contrary to Verizon's suggestion (see Verizon Pet. Br. 34), the FCC

considered only the incumbents’ revenues from the federal jurisdiction in

assessing the net effect of its decision to adopt TELRIC. See Local

Competition Order (para. 737 & n.1756), J.A. 421 (citing Smith v. Illinois

Bell Tel. Co., 282 U.S. 133 (1930)). The FCC concluded that no incumbent

had presented persuasive evidence that the application of TELRIC would

have a significant impact on the financiai integrity of its federally

regulated activities. Local Competition Order (para. 738), J.A. 421-422.

have been robust and, if anything, have grown since the 1996

Act was enacted and implemented. See note 17, supra.”

b. Verizon’s contention that the FCC’s forward-looking

cost methodology presents serious Takings Clause concerns

fares no better if, as Verizon urges, the incumbents’ compen-

sation for leasing network elements is considered in isolation

from their compensation for other regulated activities.

Under traditional just compensation principles, when the

government commits private property to public use, it does

not compensate the owner for its historical costs—t.e., what-

ever amount the owner paid for the property in the past.

Instead, the government pays the owner the fair market

value of the property—.e., “what a willing buyer would pay

in cash to a willing seller” in the current market. United

States v. Miller, 317 U.S. 369, 374 (1943); accord United

States v. 564.54 Acres of Land, 441 U.S. 506, 513-514 (1979).

Fair market value is closely analogous to forward-looking

cost. Where there is a fully competitive market for an item,

its forward-looking cost (which includes a normal profit)

approximates the going market price; where there is not

(yet) a fully competitive market, ascertainment of an item’s

forward-looking cost requires a more direct inquiry into the

current costs of replacing its useful functions. Either way

* Notwithstanding Smith v. Illinois Bell Telephone Co,, supra, it is

arguable that, in the present context, no taking without just compensation

could be found unless the incumbents demonstrate an inadequate return

on the totality of their interrelated regulated activities, whether those

activities are principally regulated by the federal government or by the

States. The incumbents’ facilities that are at issue here (Le., network ele-

ments) are used to provide services within the jurisdiction of each

sovereign. And the incumbents’ obligation to provide interconnection and

network elements to new entrants at “just and reasonable” rates is

neither strictly interstate service nor strictly intrastate service as those

terms have traditionally been used. See Jowa Utils. Bd. J, 525 U.S. at 380

(recognizing that the local competition provisions of the 1996 Act “clearly

‘apply’ to intrastate service, and clearly confer ‘Commission jurisdiction’

over some matters”).

the inquiry is conducted, the forward-looking cost of any

item, like its fair market value, is affected by developments

in technology, production, and other factors since the item

was placed into service. In many cases, the forward-looking

cost of an asset may exceed its fair market value, because

the asset can be replaced in today’s market only by one that

has more sophisticated capabilities and therefore commands

a higher price.

What Verizon seeks here, in contrast, is a compensation

rule entitling incumbent LECs to recover the historical costs

of their assets, even (or, perhaps, especially) when those

costs far exceed the forward-looking cost and the fair market

value of those assets. Nothing in this Court’s Takings

Clause jurisprudence compels such a result.

3. Verizon also invokes the notion of “stranded invest-

ment” to justify setting network element rates based on his-

torical costs. Verizon claims that unspecified state or federal

regulators, at some unspecified point in the past, compelled

incumbent LECs to build facilities and then artificially

slowed the incumbents’ recovery of the costs of those

facilities by extending the depreciation schedules beyond the

facilities’ economic lives (thereby maintaining low retail

rates). Adoption of a ratemaking methodology based on

forward-looking costs now, Verizon contends, would uncon-

stitutionally deny incumbents the benefit of a putative regu-

latory bargain, under which they were supposedly guaran-

teed the eventual recovery of the full historical costs of those

facilities. See Verizon Pet. Br. 4, 29-30. That claim fails for

reasons already discussed and for additional reasons as well.

First, in Duquesne, this Court specifically held that a

regulatory action that produces “stranded” investment —i. e.,

investment for which a firm cannot recover its historical

costs—does not violate the Takings Clauses unless the firm

is left with an unconstitutionally low rate of return on the

totality of its regulated activities. See pp. 28-29, supra.

Verizon makes no such claim here. Instead, relying on cost

models developed for distinct universal service purposes“

and on other off-point sources,” Verizon asserts that the

application of TELRIC to determine network element rates

would disallow roughly half of the existing regulated rate

base. Verizon Pet. Br. 10-11. In the Order under review, the

FCC reasonably rejected similar claims, because they were

unsubstantiated and “unrealistically assumeld] that competi-

tive entry would be instantaneous,” whereas competition is,

in fact, developing only gradually. Local Competition Order

(paras. 688, 707), J. A. 385-386, 400-401. See Southwestern

Bell Tel. Co. v. FCC, 153 F.3d 523, 541 (8th Cir. 1998) (noting

the “relatively insignificant headway UNE purchasers have

mace in the telecommunications market”). In order for net-

work element prices to cause stranded investment (even as a

theoretical matter), an incumbent would have to lose a sub-

stantial share of its customers to a new entrant, and to do so

before the investment has been recovered through existing

mechanisms. As long as the incumbent retains a significant

26 The FCC has explained that the universal service cost model “may

not be appropriate * * * [for] determining prices for unbundled network

elements.” Jn re Federal-State Joint Bd. on Universal Serv., Ninth Report

and Order and Eighteenth Order on Reconsideration, 14 F.C.C.R. 20,432

(para. 41 & n.125) (1999).

27 Verizon cites various sources purporting to show that the costs of

network elements are significantly lower under a forward-looking meth-

odology than under a historical cost methodology. See Verizon Pet. Br. 10

nn.4 & 5. But those sources are inapposite. They make a comparison not

between forward-looking costs and historical costs, but rather between

forward-looking costs and retail revenues. Historical costs and retail

revenues are not commensurable; retail revenues can be higher or lower

than costs for reasons (e.g., implicit subsidies and retail-specific costs) that

have nothing to do with methodological differences in assigning costs to

the underlying facilities. Even apart from that conceptual flaw, the

figures cited by Verizon reflect only the incumbents’ self-serving allega-

tions in local competition litigation in 1996, soon after the Local Com-

petition Order was issued and before the States had come close to

completing forward-looking cost studies.

market share (as all of them still do), the incumbent

continues to recover the costs of its investments through,

among other things, access charges and local retail rates,

which are not set under the TELRIC methodology.”

Second, Verizon has not attempted to demonstrate that

incumbent LECs’ facilities are, in fact, “underdepreciated”

today. See Local Competition Order (paras. 738-739), J.A.

421-422. There is ample reason to conclude that they could

not make such a showing. In light of curative measures

adopted over the past 12 years, the FCC recently

determined that incumbents’ facilities are, as a general

matter, no longer underdepreciated and, indeed, that “their

depreciation reserves are at a historic high level of 51

percent of total plant” and increasing by “over $10 billion per

year.” In re 1998 Biennial Regulatory Review—Review of

Depreciation Requirements for Incumbent LECs, 15

F.C.C.R. 242 (para. 65) (1999); accord In re Federal-State

Joint Bd. on Universal Serv., Tenth Report and Order, 14

F.C.C.R. 20,156 (para. 427) (1999); David Gabel & David I.

Rosenbaum, Who’s Taking Whom: Some Comments And

Evidence on the Constitutionality of TELRIC, 52 Fed.

Comm. L.J. 239, 265-267 (2C00) (incumbents’ claims of

stranded investment are “spurious” because “the book value

2% The FCC has acted to protect incumbents’ access revenues from

rapid erosion in the new regulatory regime. See Competitive Telecomms.

Ass'n v. FCC, 117 F.3d 1068, 1073-1075 (8th Cir. 1997) (upholding

transitional rules that allow the assessment of certain access charges

against new entrants that lease network elements); Implementation of the

Local Competition Provisions of the Telecommunications Act of 1996 (CC

Docket No. 96-98), FCC 00-183 (June 2, 2000) (adopting rules that, pending

further study, preserve incumbents’ access revenues by denying new en-

trants access to loop and transport network element combinations unless

they provide a significant amount of local exchange service in addition to

any access services they might offer), petition for review pending sub

nom. Competitive Telecomms. Ass'n v. FCC, No. 00-1272 (D.C. Cir. filed

June 23, 2000).

of the [incumbents’] assets is significantly less than the

market value of the assets”).” Verizon does not mention that

determination, much less attempt to refute it.“

Third, even the most basic factual premise of Verizon’s

“stranded investment” argument—that state regulators

compelled, rather than simply approved, the investments at

issue—is subject to considerable doubt. As Professor

Hovenkamp has explained, “such situations must be re-

garded as the exception rather than the rule,” because, liln

most cases, the instigator of expansion is the regulated firm

itself.” Herbert Hovenkamp, The Takings Clause and Im-

provident Regulatory Bargains, 108 Yale L.J. 801, 822

(1999). More generally, Verizon’s claims of a breached “reg-

ulatory contract” are largely fictitious. In most eireum-

stances,” as Professor Hovenkamp has observed, “the utility

investor’s investment-backed expectations are not all that

different from the expectations of the investor in an ordinary

enterprise, who can almost never expect compensation for

obsolescence and only rarely for changes in government

policy.” Id. at 834. Thus, Igliven that society has been de-

bating the large costs and relatively small benefits of

regulation for more than twenty-five years, one can hardly

argue that perpetual freedom from competition must be a

29 Verizon errs in broadly asserting that the forward-looking cost of an

incumbent’s assets necessarily would be “substantially below book value.”

Verizon Pet. Br. 29. If assets have been in service for some time and have

been fully depreciated (although they still have a substantial useful life

remaining), the assets would no longer have any book value. A forward-

looking cost methodology would not take into account past cost recovery,

but instead would seek to provide an opportunity for full recovery of the

cost of replacing the assets’ useful functions.

0 In addition, the effect of any “underdepreciation” would most likely

be offset by the incumbents’ ample returns on investment, which have far

exceeded the incumbents’ cost of capital in recent years. See note 17,

supra (describing incumbents’ rates of return for 1999 and 2000). It is

meaningless to examine depreciation in isolation from other variables in

the compensation calculus, such as the cost of capital.

part of the investment-backed expectations of the utility

shareholder.” Ibid.

Finally, the FCC has not foreclosed the possibility of pro-

viding a remedy for stranded investment, if the need for

such a remedy is demonstrated. The FCC has explained,

however, that such a remedy would sensibly be implemented

not through the rates that new entrants pay for network

elements, but rather through a competitively neutral federal

or state funding mechanism. See Local Competition Order

(para. 739), J.A. 422. There is no logical reason to distort the

prices of all network elements, and thereby warp the course

of competition nationwide, simply to accommodate the in-

cumbents’ unsubstantiated claims that some facilities in

some States may remain underdepreciated despite recent re-

forms.“

In sum, the doctrine of constitutional avoidance invoked

by Verizon is properly applied only “to avoid serious consti-

tutional doubts, not to eliminate all possible contentions that

the statute might be unconstitutional.” Reno v. Flores, 507

U.S. 292, 314 n.9 (1993) (internal citation omitted); ef. Public

Citizen v. United States Dep’t of Justice, 491 U.S. 440, 481

(1989) (Kennedy, J., concurring in judgment) (constitutional

avoidance doctrine “should not be given too broad a scope

lest a whole new range of Government action be proscribed

by interpretive shadows cast by constitutional provisions

31 Verizon suggests, in passing, that the FCC’s implementation of

Section 254 casts doubt on its implementation of Sections 251 and 252. See

Verizon Pet. Br. 12-14. Verizon has forfeited any challenge to the FCC’s

implementation of Section 254. In GTE Serv. Corp. v. FCC, No. 99-1244,

one of Verizon's corporate predecessors challenged the adecuacy of

federal universal service funding under Section 254. Shortly after we filed

our brief on the merits, Verizon successfully moved to dismiss the case.

See 121 S. Ct. 423 (2000). The underlying decision of the Fifth Circuit,

rejecting all relevant challenges to the pace and nature of the FCC’s

implementation of Section 254, is thus now final and controlling. See

Texas Office of Public Util. Counsel v. FCC, 183 F.3d 393 (5th Cir. 1999).

that might or might not invalidate it”). At most, Verizon has

raised the possibility that TELRIC, after its implementation

by state commissions in individual circumstances, might pro-

duce constitutionally inadequate compensation. Such specu-

lation does not warrant application of the constitutional

avoidance doctrine to defeat the FCC’s reasonable construc-

tion of the 1996 Act.

II. THE FCC REASONABLY DETERMINED THAT

A FORWARD-LOOKING COST METHODOLOGY

MOST EFFECTIVELY IMPLEMENTS THE COM-

PETITIVE OBJECTIVES OF THE 1996 ACT AND IS

ADMINISTRATIVELY WORKABLE

Verizon contends that the FCC’s decision to adopt a

forward-looking, rather than historical, cost methodology to

determine rates at which incumbent LECs lease network

elements fails in various respects to satisfy the reasoned

decisionmaking standards of the Administrative Procedure

Act, 5 U.S.C. 701 et seg. See Verizon Pet. Br. 44-49. Those

challenges, too, are without merit.

1. A central premise underlying the 1996 Act is that it

would make little economic sense to expect new entrants,

particularly in the short term, to construct all of the tele-

communications facilities that they might need in order to

serve their customers. In some (but by no means all)

circumstances, the economic and social costs of duplicating

an incumbent’s facilities would exceed the corresponding

benefits: Significant resources would be expended, and

needless disruptions would occur (e.g., streets would be dug

up, customers would be inconvenienced), without commensu-

rate increase in the value or diversity of telecommunications

services. For that reason, and to jump-start competition in

local telecommunications markets, Congress directed the

FCC to identify those elements that new entrants should be

entitled to lease from incumbents at “cost.” 47 U.S.C.

251(c)(3) and (d)(2), 252(d)(1).

The FCC determined that basing the rates for access to

those elements on incumbents’ historical costs, when those

costs exceed forward-looking costs, would either keep new

entrants out of the market altogether or impair their com-

petitive position by inducing them to construct inefficient,

duplicative facilities. See Local Competition Order (paras.

620, 672, 679, 705), J. A. 327-328, 375-376, 379-380, 398-399."

The FCC reasoned that either result would conflict with

Congress’s goals of bringing meaningful competition to local

telecommunications markets on an accelerated basis, pro-

moting the efficient use of existing network facilities (many

of which embody enormous economies of scale and density),

and encouraging potential competitors to make economically

rational choices about whether, or how, to enter local

markets. See Local Competition Order (paras. 679, 704-707),

J.A. 379-380, 397-401.

That determination is entirely reasonable. A principal

objective of setting compensation levels in regulated indus-

tries has always been to “restore * * * the price that would

result through the mechanism of a truly competitive mar-

ket.” Farmers Union Cent. Exch., Inc. v. FERC, 734 F. ad

1486, 1510 (D.C. Cir.), cert. denied, 469 U.S. 1034 (1984).

And, as courts and commentators have recognized, historical

costs are “essentially irrelevant” to entry decisions in com-

petitive markets, “since those costs are ‘sunk’ and un-

avoidable and are unaffected by the new production

decision.” MCI Communications, 708 F.2d at 1117. In

attempting to saddle new entrants with an incumbent’s own

historical costs, Verizon asks this Court to ignore “[oJne of

the most important lessons of economics”—that “you should

look at the marginal costs and marginal benefits of decisions

82 Similarly, setting network element rates on the basis of historical

costs, if those costs were lower than forward-looking costs, would en-

courage inefficient use of incumbents’ facilities and deter the efficient

construction of new competitive facilities.

and ignore past or sunk costs.” Paul A. Samuelson &

William D. Nordhaus, Economics 167 (16th ed. 1998).

Nor does the FCC’s adoption of a forward-looking ap-

proach to costs in this proceeding constitute an arbitrary

departure from the FCC’s use of a historical approach to

costs in other proceedings. See Verizon Pet. Br. 44-45, 47-48.

The FCC did not simply change, without explanation, regu-

latory approaches that it had previously employed. Rather,

as discussed above, the FCC explained that setting network

elements rates based on forward-looking costs is the ap-

propriate approach in the new competitive environment con-

templated by the 1996 Act. The FCC’s earlier decisions

employing historical costs typically occurred in a monopoly

environment in which opening markets to competition was

not a primary goal.

Verizon thus errs in asserting that the FCC’s rejection of

a historical-cost methodology, on ground of economic ineffi-

ciency, is arbitrary given the FCC’s earlier justification for

price cap regulation as encouraging efficient operations.

Verizon Pet. Br. 47-48. Although the FCC adopted price

caps in part to provide incentives for incumbent LECs to act

efficiently, the FCC did so in the pre-1996 Act regulatory

environment. In that context, the FCC was concerned with

balancing the interests of incumbents and their (largely

captive) customers, not, as in the current context, with en-

couraging efficient competitive entry. It does not follow that

efficiency levels that were appropriate for the former task

are also appropriate for the latter task. Similarly, when the

Verizon also misconstrues the FCC’s 1997 adjustment of the price

cap productivity factor as reflecting a determination that incumbents were

operating efficiently. But that adjustment was designed to measure the

annual rate at which the incumbents’ efficiency improvement exceeded

that of the general economy. The FCC made no judgment about the

reasonableness of the incumbents’ underlying rates based on historical

costs. See generally In re Access Charge Reform, First Report and Order,

12 F. C. C. R. 15,982 (paras. 289-290, 295) (1997), aff d, Southwestern Bell

FCC chose a historical cost methodology for setting rates in

the cable television context, the FCC was concerned with

preventing a monopolist from charging excessive rates to its

retail customers, not with setting the rates that an incum-

bent could charge competitors for use of its facilities during a

transition to competition. See Time Warner Entmt Co. v.

FCC, 56 F.3d 151, 179, 184-185 (D.C. Cir. 1995), cert. denied,

516 U.S. 1112 (1996); 47 U.S.C. 543(b) (1994).

2. Verizon further suggests that the use of forward-

looking costs to set network element rates will discourage

facilities-based competition, producing instead a prolifera-

tion of competitors providing service solely through use of

the incumbent’s facilities. Verizon Pet. Br. 48-49. That

argument is without merit. To begin with, Verizon’s pro-

fessed policy concerns about the nature of the competition

that incumbents may encounter are analytically unhinged

from Verizon’s legal challenge to the FCC’s methodology for

determining network element rates. Congress, not the FCC,

made the basic decision to accelerate competition by giving

new entrants the right to enter local markets by leasing cer-

tain elements in the incumbent’s network rather than dupli-

cating all such elements on their own. See 47 U.S.C.

251(c\(3) and (d)(2).“ Even if (as Verizon suggests) there

were some policy justification for giving new entrants addi-

tional incentives to invest immediately in more facilities of

Tel. Co. v. FCC, 153 F.3d 523 (8th Cir. 1998). On review, the D.C. Circuit

did not find that the productivity adjustment was too demanding of

incumbents, as Verizon suggests. Verizon Pet. Br. 47-48. The court found

only that the productivity adjustment was inadequately supported in the

record. See USTA v. FCC, 188 F.3d 521, 524-526 (D.C. Cir. 1999).

34 Congress also authorized entry by resale of services purchased by

new entrants from incumbents at wholesale prices. 47 U.S.C. 251(c)(4).

The 1996 Act does not favor entry by one means over another. It does

contemplate, however, that new entrants ultimately will develop at least

some facilities of their own. See Local Competition Order (para. 12),

J.A. 271-272.

their own, it would make little sense to accomplish that

objective by forcing new entrants, in the circumstances in

which they are entitled to lease elements, to pay rates based

on whatever amounts happen to appear on an incumbent’s

accounting books. Those amounts would vary widely and

arbitrarily from incumbent to incumbent, and could be

higher or lower than the forward-looking costs of the ele-

ments at issue. The FCC’s decision to reject that approach

is reasonable.

Verizon’s policy concerns are refuted, moreover, by indus-

try developments under the new regulatory regime. Since

1996, network element rates have reflected forward-looking

costs. See p. 21 note 12, supra. And, both before and after

this Court’s decision in Jowa Utilities Board I, new entrants

have been able in many (but not all) contexts to lease the

elements necessary to provide service to their customers, as

some of them must in order to develop a customer base

sufficient to support further capital investments. See Jowa

Utils. Bd. I, 525 U.S. at 387-392. Yet, in many settings, ex-

tensive competition of any kind has yet to develop; incum-

bents still control approximately 93% of total local telecom-

munications lines, and much of the existing competition in

local markets, particularly in business markets, is provided

by carriers that have built or purchased facilities of their

own, rather than leasing the facilities from incumbents.”

Moreover, new entrants have strong inherent incentives to

build their own facilities, so as to avoid having to deal with,

and rely on, their chief competitors, the incumbents, in order

to do business. See Jowa Utils. Bd. v. FCC, 120 F.3d 753,

817 (1997), aff’d in part and rev’d in part, Jowa Utils Bd. I,

supra. Dennis W. Carlton & Jeffrey M. Perloff, Modern

Industrial Organization 501 (2d ed. 1994); see also U.S. Pet.

35 See Local Telephone Competition: Status as of June 30, 2000

(Industry Analysis Division, FCC, 2000) (available at http://www.fec.

gov/ccb/stats [file name: LCOM1200.PDF)).

Br. 42-44 (describing practical difficulties encountered by

new entrants in leasing network elements).

3. Verizon further argues that any forward-looking ap-

proach, which asks what it would cost to replace the func-

tions of network facilities in today’s market, is so “admini-

stratively unworkable” that the FCC lacks discretion to

adopt it. Verizon Pet. Br. 44-48. That claim is unsound.

For decades, commentators have debated the relative

merits of the historical cost approach (also known as the

“prudent investment” rule) and a forward-looking alterna-

tive that focuses on replacement costs (also known as the

“fair value” rule). That debate has not been resolved, and

each approach has its champions.” In Smyth v. Ames, 169

U.S. 466 (1898), this Court held that the use of a “fair value”

methodology in the ratemaking context was constitutionally

compelled; although the Court later rescinded that require-

ment in Hope Natural Gas, 320 U.S. at 602, the Court has

preserved that methodology as a regulatory option. Thus, in

Duquesne, the Court declined to adopt the historical cost

approach as a constitutional requirement, observing that

such a result would “foreclose a return to some form of the

fair value rule just as its practical problems may be

diminishing.” 488 U.S. at 316 & n.10. What Verizon asks of

the Court, however, is a policy-laden judicial determination

that such “practical problems” do foreclose a regulatory

agency’s discretion to adopt a forward-looking cost regime.

36 Verizon cites the articles of commentators who support the incum-

bent LECs’ challenge to TELRIC. For a sampling of the many articles on

the other side of the issue, see Gabel & Rosenbaum, supra; Hovenkamp,

supra; Chen, supra; William J. Baumol & Thomas W. Merrill, Does The

Constitution Require That We Kill The Competitive Goose? Pricing Local

Phone Services To Rivals, 73 N.Y.U. L. Rev. 1122 (1998); Jim Rossi, The

Irony Of Deregulatory Takings, 77 Tex. L. Rev. 297 (1998); William J.

Baumol & Thomas W. Merrill, Deregulatory Takings, Breach Of The

Regulatory Contract, And The Telecommunications Act of 1996, 72

N.Y.U. L. Rev. 1037 (1997).

As one commentator has observed, the incumbents seek

“Smyth v. Ames reborn, only in reverse”—a decision fore-

closing what, as embodied in TELRIC, “is arguably the fair

value rule at its theoretical best, a system of setting rates

‘according to the actual present value of [utility] assets’ so

that rate regulation can more effectively mimiel] the opera-

tion of the competitive market“ Jim Chen, The Second

Coming of Smyth v. Ames, 77 Tex. L. Rev. 1535, 1561 (1999)

(quoting Duquesne, 488 U.S. at 308).

In few, if any, contexts would the methodological discre-

tion of a regulatory agency merit greater judicial deference

than in this one. See generally Jowa Utils. Bd. I, 525 U.S. at

397; Chevron, 467 U.S. at 842-843. The FCC, after consider-

ing various approaches to setting network element rates,

including the forward-looking approach recently adopted by

several States, chose such an approach as the means of

determining “cost” in an industry undergoing the transition

from monopoly to competition. See Local Competition Order

(paras. 704-711), J.A. 397-403. The FCC observed that, in

that regulatory setting, a market-based, forward-looking

approach to cost offers a variety of theoretical advantages

over a historical cost approach. See Local Competition

Order (paras. 620, 705), J.A. 327-328, 398-399. The FCC

concluded that those advantages outweigh concerns—which,

the FCC found, are largely refuted by practical

experience—that a forward-looking methodology would be

more indeterminate than the alternatives. See, e.g., Local

Competition Order (para. 681), J.A. 381. That decision is

reasonable; nothing in the 1996 Act precludes it; and any

policy-based revision of that decision should come from the

FCC or from Congress, not from the federal courts.”

37 Verizon incorrectly suggests that the workability of TELRIC is

called into question by the amount of time that the FCC took to develop a

forward-looking cost model in the universal service context. Verizon Pet.

Br. 45-46. Section 252 contemplates that each state public utility com-

Indeed, Verizon’s expressions of concern about the “ad-

ministrative workability” of TELRIC ring hollow because

any historical cost methodology would present significant

administrative difficulties of its own. A historical cost meth-

odology, no less than other cost methodologies, requires

complex judgment calls about an appropriate rate of depre-

ciation, the cost of capital, and a method for allocating joint

and common costs to various aspects of the network. See,

e.g., National Rural Telecom Ass n, 988 F. 2d at 178; see gen-

erally Duquesne, 488 U.S. at 314 (“(tJhe economic judgments

required in rate proceedings are often hopelessly complex”).

Similarly, TELRIC’s inquiry into efficient technological

alternatives may not be “any more hypothetical in nature

than the judgments called for [under a historical cest ap-

proach] in determining whether or not capital costs, some of

which were incurred decades ago, were ‘prudently’ made or

are ‘used and useful.“ Gable & Rosenbaum, supra, 52 Fed.

Comm. L. J. at 254. Moreover, historical cost data in the

telecommunications industry have tended to focus on an

incumbent’s revenue needs in other contexts, not on the

proper level of compensation to incumbents for the competi-

tive use of particular facilities; as a result, those data have

traditionally been aggregated over large geographic areas,

mission will establish rates for network elements in its respective State.

See 47 U.S.C. 252(c)(2). The state commissions have been doing so, using

TELRIC or (during the period when the FCC’s pricing rules were stayed

or vacated) a similar methodology, for nearly five years. The alleged

complexity of forward-looking cost methodologies thus has not proved a

significant impediment to the state commissions’ ability to carry out their

responsibilities under the 1996 Act. In the universal service context, by

contrast, the FCC has been given the task of administering a national

program, which required the FCC itself to determine universal service

subsidy levels for carriers in every State. See 47 U.S.C. 254(a)(2) and (e).

Since the prospect of determining such subsidy levels through in-

dividualized proceedings was not practical for a single regulator, the FCC

understandably devoted considerable time to developing a model that

would eliminate the need for such proceedings.

typically covering the entire territory served by a single

company within a State.” It could therefore be exceedingly

difficult to use existing historical cost data to establish reli-

able historical cost figures for particular facilities, functions,

or features that new entrants may seek to lease.

Finally, the theoretical and practical shortcomings of the

historical cost approach were not well recognized when

Justice Brandeis wrote his dissenting opinion supporting

that approach in Missouri ex rel. Southwestern Bell Tele-

phone Co. v. Public Service Commission, 262 U.S. 276, 289-

311 (1923), an opinion on which Verizon places considerable

emphasis. The ensuing ‘5 years of experience have revealed

not just the substantial indeterminacy of historical cost

methodologies, but also their tendency to produce inefficient

overinvestment and misallocation of resources See, ¢.g.,

National Rural Telecom Ass’n, 988 F.2d at 178; Harvey

Averch & Leland L. Johnson, Behavior Of The Firm Under

Regulatory Constraint, 52 Am. Econ. Rev. 1052 (1962); Jean-

Jacques Laffont & Jean Tirole, Competition In Telecom-

munications 38 (2000). Moreover, Justice Brandeis was

addressing the use of such methodologies in the context for

which they were designed: determining a utility’s overall

revenue requirements. He did not address the use of such

costs in the quite different context presented here: deter-

mining compensation levels for the competitive use going

forward of particular network facilities, in circumstances

where the legislature has endorsed such use in order to

accelerate the transition from monopoly to competition.

38 See, e., In re Federal-State Joint Bd. on Universal Serv., Re-

commended Decision, 12 F.C.C.R. 87, 230 (para. 270) (1996); In re Federal-

State Joint Bd. on Universal Serv., Report and Order, 12 F.C.C.R. 8776,

8908 (para. 232) (1997).

CONCLUSION

The decision of the court of appeals should be affirmed

insofar as it sustained the FCC’s discretion to adopt a meth-

odology based on forward-looking costs to determine the

rates that incumbents are authorized to charge new entrants

for interconnection and network elements.

Respectfully submitted.

JOHN E. INGLE

Deputy Associate General

Counsel

LAURENCE N. BOURNE

Counsel

Federal Communications

Commission

JUNE 2001

BARBARA D. UNDERWOOD

JOHN M. NANNES

Acting Assistant Attorney

General

LAWRENCE G. WALLACE

Deputy Solicitor General

BARBARA MCDOWELL

Assistant to the Solicitor

General

CATHERINE G. O’SULLIVAN

NANCY C. GARRISON

Attorneys

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