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

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Nos. 00-51 1, 00-555, 00-587, 00-590, FILED

IN THE

‘ JUL 8

Supreme Court of the United S ates, ° 200

VERIZON Co IMMUNICATIONS, INC., et al., OFFICF OF THB CLERK

Petitioners,

FEDERAL COMMUNICATIONS COMMISSION AND

UNITED STATES OF AMERICA,

—

J u L s Respondents.

4) | Wort pCoMm, INC., ef al.,

Pe U ¥ Petitioners,

VERIZON COMMUNICATIONS, INC., ef al,

Respondents.

FEDERAL COMMUNICATIONS COMMISSION AND

UNITED STATES OF AMERICA,

Petitioners,

IOWA UTILITIES BOARD, ef al...

Respondents.

AT&T Corp..,

Petitioner,

IOWA UTILITIES BOARD, ef al.,

Respondents.

GENERAL COMMUNICATION, INC.,

Petitioner,

Vv.

IOWA UTILITIES BOARD, ef al.,

Respondents.

On Writ of Certiorari to the

United States Court of Appeals

for the Eighth Circuit

BRIEF ON THE MERITS OF SPRINT CORPORATION

IN OPPOSITION TO PETITIONERS VERIZON

COMMUNICATIONS, INC., ET AL.

DAVID P. MURRAY

Counsel of Record

RANDY J. BRANITSKY

KEVIN M. MILLER

WILLKIE FARR & GALLAGHER

1155 21st Street, N.W.

Washington, D.C. 20036

(202) 328-8000

Counsel for Respondent

Sprint Corporation

WILSON-EPES PRINTING Co., INC. ad (202) 789-0096 - WASHINGTON, D C. 20001

BEST AVAILABLE COPY

QUESTION PRESENTED

Whether the court of appeals erred in holding that neither

the Takings Clause nor the Telecommunications Act of 1996

requires incorporation of an incumbent local exchange

carrier’s “historical” costs into the rates that it may charge

new entrants for access to its network elements.

(i)

RULE 29.6 STATEMENT

In accordance with Rule 29.6 of the Rules of this Court,

Sprint Corporation (“Sprint”) states as follows:

Sprint is a corporation organized for the purpose of

engaging in telecommunications and related businesses

and is publicly traded under the names Sprint FON and

Sprint PCS. Sprint Communications Company L.P. is a

wholly-owned subsidiary of Sprint.

TABLE OF CONTENTS

ey OEE acccccevctcsccntenciencnsnntemenenmmnsstes i

ea ENTITY seinnceccnntecossnsenstncenitenenseensntntes ii

a l

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

D. Judicial Review of the Local Competition

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

ie GR Ocrrnsersnsnsnstcceniorsinensinnssctnanniesesneeemestnnenes

3. The Eighth Circuit’s Decision On Remand

t,t aR RE 10

SUMMARY OF ARGUMENT .............ccscscescsssssseseesesees 1]

SPIT TS diceccenccsnscenssccescansnsnssnssceneneasestmnensnecseemenaeen 14

I. NOTHING IN THE ACT REQUIRES

INCORPORATION OF AN ILEC’s HIS-

TORICAL COSTS INTO THE RATES FOR

ai nrserenesssncncncsecntsesentuienenstinsetscnteeninennesssessesces 14

A. Section 252(d)(1) Is Ambiguous And Does

Not Require The Use Of Historical Costs

In Establishing UNE Rates o.oo. 14

B. Other Provisions Of The Act Do Not

Compel The Use Of Historical Costs For

a Ue ncnercrnetenentnnnsinnniscenenesnsensessesanines 19

TABLE OF CONTENTS—Continued

1. The Act Expresses No Preference For

Historical Cost Models And There Is

No Reason To Infer One ..............c000+000

2. The Act’s Resale Pricing Provision

Does Not Implicitly Endorse Historical

Or Forward-Looking Cost Models.........

C. The FCC’s Choice Of A Forward-Looking

Cost Methodology Was Not Arbitrary Or

Capricious And Is Entitled To Deference....

1. Historical Costs Are Antithetical To

The Act’s Objectives...........cccccereeeereeees

2. TELRIC Is Not “Unmanageable” ..........

3. The FCC Did Not “Abandon”

Historical Cost Models ..............0++e++e0

Il. THE FCC’s SELECTION OF THE TELRIC

METHODOLOGY DOES NOT VIOLATE

THE TAKINGS CLAUSE............cccccceeeeeeeeneeneees

A. TELRIC Does Not Represent A Consti-

tutionally Suspect Shift In Methodologies...

B. The ILECs’ Theoretical Attacks On

TELRIC Are Barred By The Well-Settled

“Total Effect” Test For Regulatory

C. The Doctrine Of Constitutional Avoidance

Does Not Require The Inclusion Of

Historical Costs In UNE Prices................+++.

CONCLUSION .....ccccsccsescessesscecseossesseesssnsenssesssessssssosseses

TABLE OF AUTHORITIES

CASES Page

AT&T Corp. v. lowa Utils. Bd., 525 U.S. 366

American Public Gas Ass'n v. Federal Power

Comm 'n, 567 F.2d 1016 (D.C. Cir. 1977)......... 20

American Trucking Ass'ns, Inc. v. Atchison,

Topeka & Santa Fe Ry., 387 U.S. 397 (1967)... 30

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

142 F.3d 188 (4th Cir. 1998) ooo... ccccccccceeseeees 18

Appalachian Power Co. v. EPA, 135 F.3d 791

EE eR 15

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

ERE eee ee 35

Bell Atl. Tel. Cos. v. FCC, 24 F.3d 1441 (D.C.

EE a a a 39

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

GEL Me ene 33, 35

Burlington N. R.R. v. Surface Transp. Bd., 114

ok ee 18

Capital Network Sys., Inc. v. FCC, 28 F.3d 201

A ee ne 15, 16

Chevron U.S.A., Inc. v. Natural Res. Def.

Council, Inc., 467 U.S. 837 (1984) ......cccccccccceeee 11, 23

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

Ee a ee passim

Federal Power Comm'n v. Hope Natural Gas

S| SE ee passim

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

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

RENN et A Na a 19, 21, 22

Illinois Bell Tel. Co. v. FCC, 988 F.2d 1254

AR aie aaa 17, 32

TABLE OF AUTHORITIES—Continued

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

1997), aff'd in part and rev'd in part sub nom.

AT&T Corp. v. lowa Utils. Bd., 525 U.S. 366

(( 4,6,9

ye passim

Jersey Cent. Power & Light Co. v. FERC, 810

ew folele 2), 37

Market St. Ry. v. Railroad Comm'n of Cal., 324

yyy 29, 30, 31

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

Public Serv. Comm'n, 262 U.S. 276 (1923) ...... 16

Mobil Oil Exploration & Producing Southeast,

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

(| ee 16

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

176 GAL. Clit. 1GBB) cccccccccccsecesesssccsesscssssssssssseese 22, 31

New York Cent. R.R. v. White, 243 U.S. 188

Se 30

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

(ae 31, 36

Railway Labor Executives’ Ass'n v. United

States, 987 F.2d 806 (D.C. Cir. 1993) ..........000+ 39

Southwestern Bell Tel. Co. v. AT&T Commu-

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

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

(UU passim

Tennessee Elec. Power Co. v. Tennessee Valley

Auth. 306 U.S. 118 (1939) ........cccccccceresseeesseeenes 28, 30

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

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

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

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

vii

TABLE OF AUTHORITIES—Continued

Page

Town of Concord v. Boston Edison Co., 915 F.2d

og | SE 24

United States v. Miller, 317 U.S. 369 (1943)......... 30

United States v. Riverside Bayview Homes, Inc.,

kT 13, 39

In re Valuation Proceedings Under §§ 303(c) &

306 of the Reg'l Rail Reorg. Act, 439 F. Supp.

1351 (Regional Rail Reorg. Ct. 1977)............... 35, 36

Williamson County Reg'l Planning Comm'n vy.

Hamilton Bank, 473 U.S. 172 (1985) ....cccccece000. 38, 40

AGENCY DECISIONS

Application of Ameritech Mich. Pursuant to

Section 271 of the Communications Act of

1934, as amended, To Provide In-Region,

InterLATA Services in Mich., 12 F.C.C.R.

EE nD 4

In re Implementation of the Local Competition

Provisions in the Telecomms. Act of 1996, 11

Flic BAe Cie cececcccsccconsscscsensesenscsnenenes passim

Policy and Rules Concerning Rates for Dominant

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

STATUTES

TRC en 4

i TTT LT 2

ae 3

ER 3

ht. . Ear 4,19

ST UB, © TEED cccccccseccocesscsesccsesseccscssesesoeseces 21

4 Se passim

47 U.S.C. § 252(d (1 (Ai) ......ecccccceccececcecececcececene 3

47 UBC, § ZSQG AB) ocecencesesecsosesccsesececcesesecsess 3

viii

TABLE OF AUTHORITIES—Continued

Page

47 U.S.C. § 252(d)(3) ...cssceseeseeseesereentensensensnenensners 22, 23

47 U.S.C. § 252(€)(6).....c.ssercereereereerereeeeenenesnereesnees 38

47 U.S.C. § 254....ccccccccsssssssssssesrenrensessenssersessrsrenses 26, 37

RULES

47 C.F.R. § 51.505(b)(1) (2000) ........cceeesereeneeeenees 2, 6

47 C.F.R. § 51.505(b)(2) (2000) ........ereeeseesereersenes 6

47 C.F.R. § 51.505(b)(3) (2000) ........ecceesereersereenes 7

47 C.F.R. § 51.505(C) (2000).........:ccccceeeeeererereerenes 7

CONGRESSIONAL MATERIAL

S. Conf. Rep. No. 104-230 (1996).......sssressereees 2

OTHER AUTHORITIES

Edwin Mansfield, Microeconomics (6th ed.

19BB) ....cccceccecsersseeesereorrsersocsccsoesssssoessessoseesosssses 19

Kenneth Culp Davis & Richard J. Pierce, Jr.,

Administrative Law Treatise (3d ed. 1994)........ 16

Laurence H. Tribe, American Constitutional Law

(2d Od. 1988) ........cscssssssssserersseerenessersessenssssssnees 36

Michael K. Kellogg et al., Federal Telecom-

munications Law (1st ed. 1992)........eeeeeees 22

Michael K. Kellogg et al., Federal Telecom-

munications Law (2d ed. 1999).........eeeeeeeeee 26

Reed E. Hundt, You Say You Want A Revolution

(2000)....c.ccecererssssssscersssrserersvsssncsseseesssensosssocsoreres 5

19B5) .....cecccsccessessssorersssnsesssessessessenssssssssssnsenssess 16

PRELIMINARY STATEMENT

Pursuant to Supreme Court Rules 24.2 and 25.1, Sprint

Corporation (“Sprint”) respectfully submits this Respondent’s

Brief on the Merits in Opposition to Petitioners Verizon

Communications, Inc., et al. addressing the following

question:

Whether the court of appeals erred in holding that

neither the Takings Clause nor the Telecommunications

Act of 1996 (“Act”) requires incorporation of an

incumbent local exchange carrier’s “historical” costs

into the rates that it may charge new entrants for access

to its network elements.

Supreme Court Order List (Jan. 22, 2001) at 4.

STATEMENT OF THE CASE

A. Background

Unlike many of the private parties in these proceedings,

Sprint has substantial local and long distance operations.

Sprint has participated both as a new entrant and as an

incumbent local exchange carrier (“ILEC”) in state-regulated

arbitrations pursuant to Section 252 of the Act. These

experiences have given Sprint a balanced perspective on the

challenges of opening local telephone markets to competition

while satisfying the divergent interests of new entrants and

ILECs. The “long distance side” of Sprint, like other new

entrants, is interested in obtaining access to unbundled net-

work elements (“network elements” or “UNEs”) of ILECs at

rates and on terms that permit meaningful local competition.

The “local side” of Sprint, like other ILECs, is interested in

ensuring that it receives just and reasonable compensation for

providing UNEs to new entrants. -

Sprint believes that the UNE pricing methodology adopted

by the Federal Communications Commission (“FCC”) strikes

the proper balance in implementing the Act’s pro-competitive

objectives. The FCC established a forward-looking, long-run

methodology-for pricing UNEs based on “the most efficient

telecommunications technology currently available and the

lowest cost network configuration, given the existing location

of the incumbent LEC’s wire centers.” JA 51.' This meth-

odology, which is known generally as “Total Element Long

Run Incremental Cost” or “TELRIC,” attempts to replicate

prices that would prevail in a competitive environment, while

ensuring that the ILEC is justly compensated for the use of its

network elements at prices reflecting what it would cost to

replace the functionalities provided by those elements today.

B. The Act

The Act seeks to transform state-sanctioned local monop-

olies into fully competitive markets on a national scale. See

S. Conf. Rep. No. 104-230, at 113 (1996) (the primary goal of

the Act is to increase competition in both local and long

distance telephone markets as swiftly as possible). Congress

recognized the practical and economic impediments that new

entrants would face if forced to replicate all of the ILEC’s

existing local network infrastructure. Congress thus estab-

lished comprehensive requirements “intended to facilitate

market entry.” AT&T Corp. v. lowa Utils. Bd., 525 U.S. 366,

371 (1999) (“UB I’). “Foremost” among them is the ILEC’s

“obligation under [the Act] to share its network with

competitors.” /d.

Section 251(c) provides three complementary avenues for

new entrants to obtain access to an ILEC’s network. First, a

new entrant may “interconnect” its facilities with an ILEC’s

existing local network. JA 12-13. This enables the new

entrant to transmit and receive calls to and from all local

telephone subscribers without replicating an entire telephone

' The Court has agreed to the submission of a deferred Joint Appendix

(“JA”).

Second, a new entrant may purchase an ILEC’s retail

services at wholesale rates and then resell the services to local

customers under the new entrant’s brand name. JA 13. This

enables the new entrant to compete on the basis of price and

service, without investing in any of its own facilities.

Third, and most relevant here, a new entrant may lease

UNEs from the ILEC. /d. New entrants may use the leased

UNEs, alone or in combination with the new entrant’s own

network facilities, to offer new and different competitive

services. ILECs are to receive “just [and] reasonable”

compensation for leasing UNEs, “based on the cost . . . of

providing” the element, including a “reasonable profit.”

JA 13, 23.

Contrary to the ILECs’ assertions, the Act expresses no

preference for “facilities-based competition” among these

three alternatives. This Court—and the Eighth Circuit—have

already rejected that notion. In upholding the FCC’s so-

called “all elements” rule, which allows competitors to

provide local telephone service relying solely on leased

UNEs, this Court held that:

[T]he [FCC] reasonably omitted a facilities-ownership

requirement. The 1996 Act imposes no such limitation;

if anything, it suggests the opposite, by requiring in

§ 251(c)(3) that incumbents provide access to “any”

requesting carrier. We agree with the [Eighth Circuit]

that the [FCC’s] refusal to impose a facilities-ownership

requirement was proper.

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

that:

[A]fter study, we do not believe that the Act’s exclusive

goal is facilities-based competition. While Congress

may have envisioned facilities-based competition in

local telephone markets to occur down the road,

Congress clearly included measures in the Act, such as

the interconnection, unbundled access, and resale

provisions, in order to expedite the introduction of

pervasive competition into the local telecommunications

industry. Congress recognized that the amount of time

and capital investment involved in the construction of a

complete local stand-beside telecommunications net-

work are substantial barriers to entry, and thus required

incumbent LECs to allow competing carriers to use their

networks in order to hasten the influence of competitive

forces in the local telephone business.

Iowa Utils. Bd. v. FCC, 120 F.3d 753, 816 (8th Cir. 1997),

aff'd in part and rev'd in part sub nom. AT&T Corp. v. lowa

Utils. Bd., 525 U.S. 366 (1999). Cf JA 271-272 (¥ 12)

(“Section 251 neither explicitly nor implicitly expresses a

preference for one particular entry strategy. sy

C. The FCC’s Local Competition Order

Congress expressly authorized the FCC to promulgate rules

implementing the Act’s pro-competitive requirements and set

few limits on the agency’s exercise of that authority. JA

10, 14. As this Court has recognized, the key provisions of

the Act are subject to multiple interpretations and Congress

was “well aware” that these ambiguities would be resolved by

the FCC. JUB I, 525 U.S. at 397.

?The ILECs’ contention that Congress valued facilities-based

competition over UNE-based competition is also disingenuous. For

example, SBC, BellSouth, and Ameritech successfully argued to the FCC

that UNE-based competition is the equivalent of facilities-based

competition for purposes of meeting the requirements of Section

271(cX 1A) (“Presence of a Facilities-Based Competitor”) of the Act,

which prohibits Bell Operating Companies from offering long distance

services in the areas in which they are the incumbent until they have

proven that those local markets are effectively open to competition.

Application of Ameritech Mich. Pursuant to Section 271 of the

Communications Act of 1934, as amended, to Provide In-Region,

InterLATA Servs. in Mich., 12 F.C.C.R. 20,543, 20,590-91 (F¥ 86-87)

(1997).

> The ILECs use statements from former FCC Chairman Reed Hundt to

assert that the FCC “was dissatisfied with the 1996 Act” and purposely

Virtually the entire telecommunications industry partici-

pated in the FCC’s rulemaking proceedings, which culmi-

nated in the Local Competition Order. A significant part of

these efforts focused on the appropriate compensation that

new entrants should pay to lease UNEs from ILECs. Most

ILECs favored a pricing methodology that would allow

recovery of the “historical costs” of their network elements.

JA 359-361 (9655). Most new entrants argued that a

forward-looking methodology was necessary to allow coin-

petition to develop. JA 340-342 (4 635).

The FCC carefully evaluated the various cost method-

ologies proposed by the commenters, JA 325-423 (4¥ 618-

740), and ultimately determined that TELRIC was the most

effective and fair means to implement the Act’s pro-

competitive goals, JA 379-380 (4 679). Based on substantial

economic commentary and analysis, the FCC concluded that

a forward-looking cost methodology, such as TELRIC, would

best replicate the conditions of a competitive market. JA

379-380, 398-399 (Fj 679, 705). Typically, new firms enter a

market and set prices based on the costs of building the most

efficient facilities necessary to compete. Incumbents must

then respond to those prices, even if their existing facilities

are less efficient. JA 379-380 (4679). Forward-looking

pricing of UNEs helps to achieve a similar result. New

entrants cannot immediately compete on equal terms because

the costs of entry (viz., replicating a ubiquitous local network)

discriminated against the ILECs in favor of new entrants. These post-

employment statements are irrelevant; they have also been misleadingly

selected and quoted out of context. In the same passages cited by the

ILECs, the former Chairman emphasized that the FCC “did not want to

confer advantage on particular companies.” Reed E. Hundt, You Say You

Want A Revolution 155 (2000). He also noted that the Act produced “a

mountain of ambiguity” and that subsequent regulations interpreting these

ambiguities may allow new entrants a “fairer chance to compete,”

consistent with Congress’ goal of opening the local telephone market to

competition. See id. at 154.

are vastly too prohibitive to be incurred all at once. /owa

Utils. Bd. v. FCC, 120 F.3d at 816. A methodology based on

forward-looking economic costs helps to “drive retail prices

to their competitive levels” by setting costs at levels firms

would face in a competitive market. JA 380 (4 679). This, in

turn, “give[s] appropriate signals to producers and consumers

and ensure{s] efficient entry and utilization of the

telecommunications infrastructure.” JA 333 (4 630).

The FCC also took steps to ensure that the TELRIC

methodology allows ILECs to recover the full forward-

looking cost of leased UNEs, by measuring the long-run,

incremental cost of the network element based on: (i) the use

of the “most efficient telecommunications technology

currently available and the lowest cost network configuration,

given the existing location of the incumbent LEC’s wire

centers,” JA 51; (ii) the cost of capital, thus allowing ILECs

to recover normal economic profit, id. and (iii) the useful life

of the element, as measured by its economic depreciation

rate, id. In addition, TELRIC allows for a reasonable share of

joint and common costs. JA 51-52.

The FCC concluded that TELRIC would not always result

in forward-looking costs that are below historical costs.

Although the application of TELRIC to certain elements of an

ILEC’s local telephone network, such as switches and other

computer-based components, may result in forward-looking

costs below historical costs, the opposite may be true for

other elements such as loops, whose costs are driven by

material or labor. JA 398-399, 400-401 (4] 705, 707). At the

same time, the FCC determined that an ILEC’s existing wire

centers should be used as a component of TELRIC, precisely

to “encourage[] facilities-based competition to the extent that

new entrants, by designing more efficient network

configurations, [would be] able to provide the service at a

lower cost than the incumbent LEC.” JA 384 (§ 685).

The FCC considered and addressed each of the objections

to TELRIC raised by the ILECs. By designing a forward-

looking cost methodology that simulates a competitive

market, the FCC sought to ensure that the rates eventually

produced by TELRIC are properly balanced and enable new

entrants to compete for local customers from ‘the outset.

JA 383-384 (§ 685). On the one hand, if UNE rates are set

below forward-looking costs, new entrants might be deterred

from building competing facilities. Moreover, some new

entrants might be induced to enter using network elements

where it would not otherwise be economically efficient for

them to do so. On the other hand, if UNE rates are set too

high, which a methodology based on historical or

“embedded” costs might produce, competitive entry may

never occur. Because the costs of immediately buiiding a

completely ubiquitous local network would be prohibitive for

any one firm, most new entrants must rely in part on leased

UNEs to provide a full range of local services. Excessive

UNE rates would make it impossible for new entrants to price

these services at competitive levels, effectively impeding

market entry.‘

* The ILECs claim that TELRIC pricing has caused “many entrants” to

alter plans “away from deploying competing facilities.” Brief for

Petitioners (“Pet’r Br.”) at 13, 49. This claim is rebutted by FCC data

indicating that no single method of competitive entry predominates. See

Industry Analysis Division, FCC, Local Telephone Competition: Status as

of December 31, 2000 (May 2001). The isolated examples they cite to

from 1996 fail to demonstrate that TELRIC caused “many new entrants”

to halt facilities-based entry. At that time, the FCC’s pricing rules were

vacated and the individual state commissions were in the process of

determining UNE pricing in individual arbitrations. Moreover, a myriad

of reasons may explain why a particular company would modify a

business strategy away from expending the massive amounts of capital

needed for facilities-based entry. For example, a particular new entrant

may have difficulty in raising the needed capital. See Letter from

Chairman Michael Powell to Congress of 5/4/01, at 1. A new entrant may

also reasonably wait to invest in facilities until it has reached sufficient

The FCC similarly rejected the ILECs’ argument that

forward-looking costs should be based exclusively on an

ILEC’s existing network, without regard to available, more

efficient substitutes. JA 383 (4 684). Because this approach

would allow ILECs to recover costs “that reflect inefficient or

obsolete network design and technology,” the FCC found it

would be “essentially an embedded cost methodology.” Id.

A forward-looking methodology, in contrast, rationally

examines what it would cost to replace the functions that

make a network asset valuable. This includes currently

available substitutes that perform the same functions as the

original network element, but embody more efficient

technologies to do so. JA 382-384 (ff 683-685).°

The FCC also found that a forward-looking cost

methodology would not result in a “taking” of the ILECs’

property without just compensation. Under this Court's pre-

cedents, the “just and reasonable” standard of the Takings

Clause requires, in the regulatory context, an examination of

the “total effect” of the actual rates established by the agency.

JA 419-421 (99 734-737). After reviewing the record, the

FCC found that “{njo incumbent LEC has provided

persuasive evidence that prices based on a forward-looking

scale by servicing customers through resale and UNEs, which in many

parts of the country new entrants have failed to reach even today, five

years after the Act’s passage.

$ The ILECs claim that TELRIC “hypothesizes a fantasy world in

which carriers would repeatedly rip out and instantaneously rebuild their

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

efficient configuration could be achieved.” Pet’r Br. at 9-10. This

assertion is exaggerated. TELRIC rationally measures the cost of

providing the actual network element by asking what cost the ILEC or any

other carrier would bear in the marketplace, at the time the UNE rates are

established, to replace the functions of the network element at issue with

currently available efficient substitutes consistent with the ILEC’s

existing wire center. UNE rates are typically in place for the term of an

interconnection agreement, which is commonly three to four years, and

are not changed “every time a newer technology hits the market.”

economic cost methodology would have a significant impact

on its ‘financial integrity.”” JA 422 (4738). Even so, the

FCC specifically ordered the ILECs to “seek relief from the

Commission’s pricing methodology if they provide specific

information to show that the pricing methodology, as applied

to them, will result in confiscatory rates.” Jd. (4739). The

FCC also determined that TELRIC is consistent with the “just

and reasonable” standard used for takings that result in a

physical occupation of property. JA 422-423 (4 740).

Finally, the FCC determined that state commissions would

be able to implement TELRIC in setting UNE ates.

A number of state commissions were already using forward-

looking methodologies similar to TELRIC in Setting retail

rates for local services. JA 334-336, 381 (99631, 681).

As the FCC found, “the record demonstrates that

such approaches are practical and implementable.” JA 381

(4 681).

D. Judicial Review of the Local Competition Order

1. The First Eighth Circuit Decision

Challenges to the Local Competition Order were consoli-

dated in the Eighth Circuit and first decided in 1997. Among

other things, the Eighth Circuit invalidated the FCC’s pricing

rules—including TELRIC—holding that the Act gives state

public utility commissions, not the FCC, general jurisdiction

to interpret and implement the Act’s pricing provisions. Jowa

Utils. Bd. v. FCC, 120 F.3d at 794.

2. JUBI

On review, this Court held, inter alia, that Section 201(b)

of the Act gives the FCC jurisdiction to adopt rules to

implement all of the Act’s local competition provisions.

IUB I, 525 U.S. at 377-86. The Court reversed the Eighth

Circuit’s ruling that the FCC lacked the statutory authority to

establish national pricing rules, reinstated the FCC’s pricing

rules, and remanded so that the Eighth Circuit could review

the substantive challenges to them. /d. at 377-78.

3. The Eighth Circuit’s Decision On Remand

(“JUB IT”)

The Eighth Circuit found that the term “cost” in

§ 252(d)(1) is “ambiguous” and that the FCC was authorized

to interpret the term to allow for a forward-looking cost

methodology like TELRIC. Jowa Utils. Bd. v. FCC, 219 F.3d

744, 751-52 (8th Cir. 2000) (“/UB IT’) (FCC Pet. App. 11a).

The Eighth Circuit further held that the FCC’s “use of a

forward-looking cost methodology was reasonable . . . [and]

that the FCC explained in detail its reason for selecting [such]

a methodology to implement the new competitive goals of the

Act.” Id. at 752 (FCC Pet. App. 12a).°

The Eighth Circuit also rejected the ILECs’ argument that

the doctrine of constitutional avoidance required the FCC to

use a historical cost methodology. “[{A] takings claim,” the

court correctly noted, “cannot be based on the ratemaking

methodology, but rather it must be based on the rate itself.”

Id. at 754 (FCC Pet. App. 17a). Accordingly, the Eighth

Circuit held that:

“It is not enough that a party merely speculates that a

government action will cause harm.” We do not need to

disregard Chevron deference and interpret the statute in

accordance with the petitioners’ views in order to avoid

an unconstitutional taking in this instance. The

possibility that a regulatory program may result in a

taking does not justify the use of a narrowing

construction. In such circumstances, the adoption of a

narrowing construction might frustrate a potentially

permissible application of a statute. Because the

consequences of the FCC’s choice to use TELRIC

methodology cannot be known until the resulting rates

° The Eighth Circuit’s vacation of Rule 505(bX1) is addressed in

Sprint’s previously-filed Brief on the Merits in Support of Petitioners

Federal Communications Commission and United States of America.

have been determined and applied, the constitutional

claim is not ripe.

Id. at 754 (citations omitted) (FCC Pet. App. 17a-18a).

SUMMARY OF ARGUMENT

The FCC’s choice of the TELRIC methodology is entitled

to substantial deference. Under Chevron, the agency’s

decision should be upheld unless “Congress has . . . addressed

the precise question at issue” and unambiguously foreclosed

the agency’s choice or the agency’s reasoning was arbitrary.

Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467

U.S. 837, 842-43, 845 (1984) (“Chevron”). The Act, as this

Court found, “is in many important respects a model of

ambiguity or indeed even self-contradiction” that imposes

few restraints on the FCC’s exercise of its implementing

authority. See JUB I, 525 U.S. at 397 (the Act grants “most

promiscuous rights” to the FCC). In applying Chevron

deference to FCC regulations promulgated under the Act, this

Court has held that such regulations should be affirmed

unless they exceed the few “clear limits” that the Act

contains. /d. .

The Act does not mandate or prohibit any particular pricing

methodology for UNEs. As the Eighth Circuit correctly

found, “the term ‘cost,’ as it is used in [Section 252(d)(1)], is

ambiguous and . . . Congress has not spoken directly on the

meaning of the word in this context.” /UB I/, 219 F.3d at 751

(FCC Pet. App. 11a). The responsibility for interpreting and

implementing that provision thus belongs to the FCC, not the

courts. /d. at 752 (FCC Pet. App. 12a). The FCC evaluated

numerous alternatives, including historical and forward-

looking cost methodologies, before determining that TELRIC

would best serve the dual goals of fairly compensating ILECs

for UNEs while promoting the competitive market condi-

tions desired by Congress. JA 325-423 (9618-740). The

FCC also “explained in detail its reason for selecting a

forward-looking cost methodology to implement the new

competitive goals of the Act.” /UB II, 219 F.3d at 752 (FCC

Pet. App. 12a). The agency’s expert judgment to use

TELRIC, rather than a methodology that includes historical

costs, was well-reasoned, supported by the record, and should

be affirmed.

The ILECs assert that TELRIC is an “unmanageable”

methodology and that it was arbitrary and capricious for the

FCC to adopt it. This claim is readily disproved. In adopting

TELRIC, the FCC found that the methodology was both

practical and implementable by the states. These findings

have been confirmed by experience, as state commissions

around the country have successfully applied TELRIC in

establishing UNE rates within the timetables set by the Act.

Even after the Eighth Circuit invalidated the FCC’s

promulgation of TELRIC on jurisdictional grounds, a

majority of state commissions adopted the methodology,

independently concluding that it best served the goals of

fairly compensating ILECs, promoting local competition, and

ensuring efficient entry, utilization, and expansion of the

telecommunications infrastructure.

The FCC’s adoption of the TELRIC methodology does not

violate the Fifth Amendment to the United States

Constitution. The ILECs wrongly claim that the FCC

“shifted” methodologies from a historical to a forward-

looking cost methodology and that this “opportunistic switch”

results in an uncompensated taking. This argument is based

on an analytical artifice that lacks factual and legal

foundation. Congress charged the FCC with implementing an

entirely new regulatory regime that opens decades-held

monopolies to competition. The FCC was not bound by any

of the historical and forward-looking cost methodologies used

by the agency or the states in establishing rates during the

monopoly era. Rather, the FCC was obligated to use its

expert judgment in adopting a methodology that both

comports with the Act’s UNE pricing standards and promotes

the pro-competitive goals of Congress. The FCC’s adoption

of TELRIC helps to implement the new Act and in no way

resembles the type of “opportunistic switch” from a settled

cost methodology that might raise constitutional concerns

under this Court’s precedents.

The ILECs’ “takings” challenge to the TELRIC method-

ology itself also fails. A takings claim must be based on an

actual rate, not the ratemaking methodology. “It is not theory

but the impact of the rate order which counts.” Federal

Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 602

(1944) (“Hope Natural Gas”). As the Eighth Circuit found,

the ILECs’ takings claim remains purely theoretical. The

ILECs presented no credible evidence during the FCC

rulemaking that TELRIC prices or the Act’s overall pricing

scheme would significantly affect their financial integrity.

Nor have they provided any persuasive evidence of such

effects here. Even if a takings challenge to the TELRIC

methodology were ripe, it would still fail. The TELRIC

methodology allows ILECs to recover their full forward-

looking costs of providing UNEs to new entrants. When

properly applied, the methodology comports with the Act’s

requirement that ILECs receive “just and reasonable”

compensation for leasing UNEs. The ILECs are entitled to

no more.

Finally, the ILECs wrongly argue that the “constitutional

avoidance” doctrine negates Chevron deference and requires

adoption of a historical cost methodology. Mere allegations

that a regulatory program may result in a taking does not

justify the use of a narrowing construction which might

frustrate a potentially permissible application of a statute. See

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

121, 128-29 (1985) (“Riverside Bayview Homes”). The Act

provides a mechanism for the ILECs to receive compensation

through state-arbitrated UNE rates, thus obviating any basis

for a limiting construction. The ILECs have not shown that

any actual rates derived from TELRIC are so unjust as to be

confiscatory. Their unsubstantiated claims of potential con-

stitutional infirmity provide no basis for this Court to

disregard Chevron deference in favor of the ILECs’

restrictive views of the Act’s UNE pricing provisions.

ARGUMENT

I. NOTHING IN THE ACT REQUIRES INCORPO-

RATION OF AN ILEC’s HISTORICAL COSTS

INTO THE RATES FOR UNEs.

Section 252(d)(1) of the Act requires “just and reasonable”

rates for UNEs “based on the cost . . . of providing the... .

network element. . . . and may include a reasonable profit.”

JA 22-23. The Eighth Circuit properly determined that

Section 252(d)(1) is ambiguous as to the cost methodology

that may be employed in establishing UNE rates. JUB II, 219

F.3d at 751-53 (FCC Pet. App. 10a-14a). The Eighth Circuit

thus upheld the FCC’s adoption of a forward-looking cost

methodology as a reasonable interpretation of the statute. /d.

at 752-53 (FCC Pet. App. lla-14a). The ILECs challenge

these holdings, arguing that the “plain text, structure, and

purpose of Section 252” demonstrate that Congress

unambiguously intended for an ILEC’s “historical” costs to

be included in the UNE rate methodology. Brief for

Petitioners (“Pet’r Br.”) at 16, 19-21. These arguments are

unpersuasive when measured against the statutory language

and scheme.

A. Section 252(d)(1) Is Ambiguous And Does Not

Require The Use Of Historical Costs In

Establishing UNE Rates.

The ILECs’ “plain text” argument relies heavily on various

dictionary definitions of “cost” that have little relevance to

the term’s use in the ratemaking context. According to the

ILECs, “cost” simply means the amount paid for an item at

the time it was purchased or built. /d. at 19. They contend,

therefore, that the term “cost,” as used in Section

252(d)(1(A)(i), must include all of an ILEC’s past expen-

ditures, i.e., “historical” costs. Jd. The ILECs also rely on

the purported use of the term “cost” in the pre-Act monopoly

era, arguing that “for decades” the telecommunications

industry has used the term “cost” to mean “historical” cost

and that Congress intended for the term’s use in Section

252(d)(1) to be vested with that same meaning. /d. at 20.

Contrary to the ILECs’ assertions, the term “cost,” when

used in the regulatory ratemaking context, is susceptible to

different meanings and is not confined to a particular

dictionary definition. The Act neither defines the term

“cost,” as used in Section 252(d)(1), nor does it require that

UNEs be priced based on any particular cost methodology.

As the Eighth Circuit found, “Congress has not spoken

directly on the meaning of the word in this context... .

‘[T]he word “cost” is a chameleon, capable of taking on

different meanings, and shades of meaning, depending on the

subject matter and the circumstances of each particular

usage."” JUBII, 219 F.3d at 751-52 (emphasis added)

(quoting Strickland v. Commissioner, Maine Dep't of Human

Servs., 48 F.3d 12, 19 (1st Cir. 1995)) (“the word ‘cost’ is a

chameleon”) (FCC Pet. App. 11a); see Appalachian Power

Co. v. EPA, 135 F.3d 791, 809 (D.C. Cir. 1998) (noting

“essential ambiguity of the word”). Such an ambiguous term

confers, in the words of Justice Breyer, “‘broad

methodological leeway,”” and “say[s] little about the ‘method

employed’ to determine a particular rate.” JUB I, 525 U.S. at

423 (citation omitted). The FCC, therefore, properly

exercised its authority in interpreting the term to permit a

forward-looking cost methodology for establishing UNE

rates. See id. at 397.’

” Similarly, the Act’s “just and reasonable” pricing provisions are the

type of “ambiguous statutory terms” that require “substantial deference to

the interpretation the [FCC] accords them.” Capital Network Sys., Inc. v.

Moreover, Section 252(d)(1) refers to the “cost . . . of

providing” the UNE to new entrants. This language supports

the use of a forward-looking methodology by wirecting the

inquiry to the costs resulting from a new entrant’s use of the

UNE today, and not what the UNE cost to the ILEC when

originally purchased. Any rational firm, including an ILEC,

would replace these elements with the most efficient available

technologies. See Missouri ex rel. Southwestern Bell Tel. Co.

v. Public Serv. Comm'n, 262 U.S. 276, 311-12 (1923)

(Brandeis, J., concurring) (the proper inquiry “would be, not

what it would cost to reproduce the identical property, but

what it would cost to establish a plant which could render the

service, or in other words, at what cost could an equally

efficient substitute be then produced”); see also Mobil Oil

Exploration & Producing Southeast, Inc. v. United Distrib.

Cos., 498 U.S. 211, 219 (1991). TELRIC properly sets prices

based on the “replacement costs” that firms would currently

incur to provide the same UNE functions. This approach

properly compensates ILECs for the fair value of the assets

they use in “providing” UNEs to new entrants, consistent

with the language of Section 252(d\(1)."

FCC, 28 F.3d 201, 204 (D.C. Cir. 1994). Indeed, for more than half a

century, the statutory mandate that rates be “just and reasonable” has been

understood as granting an agency discretion to choose between a forward-

looking and a historical-cost approach. Hope Natural Gas Co., 320 U.S.

at 602; see Kenneth Culp Davis & Richard J. Pierce, Jr., Administrative

Law Treatise § 3.4 (3d ed. 1994) (agency setting “just and reasonable”

rates has discretion in selecting rate methodology to comport with

statutory policy decisions).

® The ILECs make a weak attempt to distinguish the term “cost” from

the term “value.” They argue that by compensating ILECs for the

replacement cost that would be paid on the open market for the functions

of the network element, TELRIC improperly measures “value” not “cost.”

This purported distinction is overstated. The terms “cost” and “value” are

widely recognized as being synonymous. Webster's New World

Thesaurus 156, 804 (new rev. ed. 1985). The ILECs also ignore the

remainder of the statutory language, which requires examination of the

Section 252(d)(1) also expressly requires that UNE rates be

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

rate-based proceeding .. . .” JA 23 (emphasis added).

Historical costs are invariably determined in a rate-of-return

proceeding. See Illinois Bell Tel. Co. v. FCC, 988 F.2d 1254,

1258-59 (D.C. Cir. 1993) (“Illinois Bell IT’). This statutory

language further suggests that Congress did not intend for,

let alone mandate that, historical costs be included in

UNE prices.

The ILECs also overstate the telecommunications indus-

try’s past usage of the term “cost” as requiring a historical

cost methodology. Pet’r Br. at 19. Forward-looking cost

methodologies have been part of this country’s regulatory

tradition for over fifty years, and there was a time when this

Court believed that the Constitution mandated such an

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

308 (1989) (“Duquesne”). Several states were also imple-

menting forward-looking methodologies to encourage local

telephone competition before the Act. JA 334-336, 381

({] 631, 681). In all events, the FCC was under no obligation

to use a particular cost methodology from the pre-Act era to

implement the pricing provisions of Section 252(d)(1)._ The

Act creates a new regime that fundamentally shifts the

provision of local telecommunications services away from the

past monopoly environment to a new competitive environ-

ment. Congress mandated that new entrants have access to

\___ UNEs to compete in the local telecommunications market.

The Act did not require the FCC to apply remnants of the old

monopoly System to the pricing methodology that it was

“cost . . . of providing” the UNE. This language supports a methodology

that looks to the current value of the assets used to provide the UNE

functions, for the reasons shown.

jurisdictionally authorized to implement, and the FCC found

no reasonable basis to do so.”

Finally, the ILECs argue that Congress “clearly” mandated

the use of historical costs because Section 252(d)(1)(B)

contains the terms “may include a reasonable profit.” The

ILECs claim that a “reasonable profit” cannot be realized

unless all of an ILEC’s historical costs are first recouped.

This argument fails for several reasons.

Use of “(t]he word ‘may’ in a statute normally confers a

discretionary power, not a mandatory power.” Apex

Plumbing Supply, Inc. v. U.S. Supply Co., 142 F.3d 188, 192

(4th Cir. 1998) (citation omitted). Congress thus provided the

FCC with discretion to incorporate a “reasonable profit” into

the pricing methodology, but did not require the agency to

do so.

As the Eighth Circuit also noted, “[a] ‘profit’ can be made

whether a historical cost or forward-looking cost method-

ology is used.” JUB II, 219 F.3d at 752 (FCC Pet. App. 13a).

The FCC addressed this point during the rulemaking,

explaining that “(t]he concept of normal profit is embodied in

forward-looking costs because the forward-looking cost of

capital, i.e., the cost of obtaining debt and equity financing, is

one of the forward-looking costs of providing the network

elements.” JA 393 (4700); see also Burlington N. R.R. v.

Surface Transp. Bd., 114 F.3d 206, 210, 212-14 (D.C. Cir.

1997) (rates based on forward-looking costs of “hypothetical

°The ILECs wrongly suggest that, because the FCC stated in the

entirely different context of cable rate regulation that “‘[o}riginal cost is

the normal, now traditional method used for public utility rate valuation,”

the agency must use a historical cost methodology here. Pet’r Br. at 20

(citation omitted). In implementing the Cable Act, which is governed by

a more traditional ratemaking scheme, the FCC was not attempting to

choose the measure of cost best suited to opening a market to competition.

The FCC is fully authorized to choose a regulatory tool best suited to one

context and a different regulatory tool best suited to a different situation.

‘stand-alone railroad’” provide “a competitive return on all

investments the railroad actually made at their current

value”). Thus, an ILEC can “obtain a ‘reasonable profit’

without recovering all of its embedded costs.” Southwestern

Bell Tel. Co. v. AT&T Communications of the Southwest, Inc.,

No. A 97-CA-132 SS, 1998 WL 657717, at *11 (W.D. Tex.

Aug. 31, 1998) (“SWBT”); see also GTE S., Inc. v. Morrison,

6 F. Supp. 2d 517, 529 (E.D. Va. 1998), aff'd, 199 F.3d 733

(4th Cir. 1999) (“GTE South’’).

Lastly, in a competitive environment, market forces drive

rates to forward-looking costs. JA 379-380 (4679). Profits

in excess of forward-looking costs are not “normal.” Edwin

Mansfield, Microeconomics 252-53 (6th ed. 1988); SWBT,

1998 WL 657717, at *10; see JA 393-395 (§ 700). By argu-

ing that forward-looking costs do not provide them with a

“reasonable profit,” the ILECs essentially argue that they are

entitled to more profit than is available in either a competitive

or a regulated market. While the ILECs may prefer such a

windfall, the Act does not allow, much less require, it. The

FCC was not authorized to include anything more than a

“normal” profit in its forward-looking cost methodology.

Had the FCC granted ILECs a “supra-normal” profit, as they

apparently urge, the agency would have violated the Act’s

mandate that rates be “reasonable.” JA 393-394 (4700

& n.1707).

B. Other Provisions Of The Act Do Not Compel

The Use Of Historical Costs For UNE Pricing.

1. The Act Expresses No Preference For

Historical Cost Models And There Is No

Reason To Infer One.

Congress required the FCC to “complete all actions

necessary to establish regulations to implement” the Act

within six months. JA 14. From this “congressional desire

for swift action,” and Section 252(d)(1)’s proscription against

the use of “rate-of-return or other ratemaking proceeding[s],”

the ILECs attempt to infer that Congress intended for the term

“cost” to mean “already established and readily available”

historical costs. Pet’r Br. at 22. This argument rests on the

false premise that forward-looking cost models are “novel,

complex, and difficult-to-administer,” while historical cost

models are easy to use and ready off-the-shelf. Jd.

Modern economic modeling has made forward-looking

cost methodologies, in the words of the FCC, both “practical

and implementable.” JA 381 (9681); see also American

Public Gas Ass'n v. Federal Power Comm'n, 567 F.2d 1016,

1036-37 (D.C. Cir. 1977) (forward-looking cost metho-

dologies have been routinely used by regulatory agencies to

establish rates). Numerous courts and agencies have

specifically endorsed forward-looking cost methodologies

where the regulatory goal is “to encourage competition.”

Texas Office of Pub. Util. Counsel v. FCC, 183 F.3d 393,

411-12 & nn.12-13 (Sth Cir. 1999), cert. granted sub nom.

GTE Serv. Corp. v. FCC, 530 U.S. 1213, cert. dismissed, 121

S. Ct. 423 (2000) (“GTE”). Most experts within and outside

the government also agree that a historical cost approach is no

less difficult or complex to administer than a forward-looking

model. JA 333-334, 340-342 (Fj 630, 635).

The notion that the FCC was incapable of evaluating

anything but a historical cost methodology during the six-

month rulemaking period established by the Act is far-fetched

and readily disproved by the administrative record. The FCC

evaluated several approaches—including historical and

forward-looking cost methodologies—in promulgating imple-

menting regulations for Section 252(d)(1). The Local

Competition Order contained over 100 paragraphs addressing

pricing methodologies and was issued within the six-month

statutory timeframe. JA 325-423 (4 618-740).'° Moreover,

the Act contemplated that these new rules, once issued, would

be applied by the state commissions to establish actual UNE

rates in individual arbitrations over at least another nine-

month period. JA 21-22.

The ILECs’ argument also wrongly presumes that state

commissions would be incapable of applying anything other

than historical cost models in setting UNE rates. This claim

similarly is disproved by the record. State commissions have

not found TELRIC “novel, complex, and difficult-to-

administer.” Pet’r Br. at 22. In the five years since the Act’s

passage, state commissions throughout the country have

established UNE rates using TELRIC. See, e.g., GTE South,

6 F. Supp. 2d at 526-30; SWBT, 1998 WL 657717, at *16

(upholding Texas PUC’s use of TELRIC and finding

TELRIC “compelled” by the Act). Indeed, many state

commissions independently decided to use TELRIC during

the period when the FCC’s pricing rules were invalidated by

the Eighth Circuit on jurisdictional grounds.

Lastly, there is no reason to believe that a historical cost

methodology would be easier to apply or would result in

more accurate rates than other cost models, as the ILECs

wrongly suggest. In 1990, the FCC moved away from

traditional cost of service regulation based on historical costs

and adopted a “new system” of price cap regulation. Policy

and Rules Concerning Rates for Dominant Carriers,

5 F.C.C.R. 6786 (1990). Historical costs, therefore, were not

“readily available” to the agency and would have had to be

'° The ILECs contend that due process requires “notice and a right to

be heard” when a change in rate methodology affects a firm’s recovery.

Pet’r Br. at 22 n.13, 47. The ILECs received notice of and participated in

the proceedings before the FCC, thereby satisfying any purported “due

process” concerns. JA 328 (622) (describing Notice of Proposed

Rulemaking requesting comments on the type of pricing methodology for

network elements), JA 359-361 (4 655) (describing ILECs’ argument for

the use of historical costs).

developed essentially from scratch. The historical costs

carried on an ILEC’s books are not generally allocated to

particular categories of network elements. The relevant

inputs to historical cost models, therefore, cannot be

calculated by simply adding up a series of historical cost

figures. The need for economic modeling to determine and

verify particular network element prices still exists with the

use of historical costs. GT7E South, 6 F. Supp. 2d at 527

(upholding Virginia commission’s refusal to adopt GTE’s

historical cost model which was labeled a “black box”

because its operation and assumptions could not be tested or

effectively challenged by others). For these reasons, there is

no basis to presume that use of historical costs would be any

less difficult or complex to administer than a forward-looking

cost model. See National Rural Telecom Ass'n v. FCC, 988

F.2d 174, 178 (D.C. Cir. 1993) (“rate of return regulation is

costly to administer, as it requires the agency endlessly to

calculate and allocate the firm’s costs”) (“National Rural

Telecom”). To the contrary, the complexity and unwieldiness

of rate-of-return proceedings has led many agencies to

abandon historical cost pricing. Regulators have increasingly

found forward-looking cost methodologies to be more

reliable and practical than historical cost models. See

Michael K. Kellogg et al., Federal Telecommunications Law

§ 9.2 (Ist ed. 1992) (“In practice, rate of return regulation

usually culminates in poor regulation of cost, with prices

allowed to float upward.”), id. § 9.8 (“We now know that by

the early 1980s the Bell System had accumulated a vast

library of accounting books that belonged alongside dime-

store novels and other works of fiction.”’).

2. The Act’s Resale Pricing Provision Does

Not Implicitly Endorse Historical Or

Forward-Looking Cost Models.

The ILECs also wrongly contend that the Act’s resale

pricing provision, 47 U.S.C. § 252(d)(3), demonstrates a

congressional intent to use historical costs to price network

elements. Pet’r Br. at 22-23. Section 252(d)(3) requires

ILECs to provide their retail services to new entrants at

wholesale discounts for resale. The resale price is based on

the ILEC’s retail tariffs, regardless of how those retail tariffs

are set in a particular state. In those states that establish retail

tariffs based on forward-looking cost models, the wholesale

discount price would reflect that cost methodology. JA 438-

439 (| 915). Conversely, in those states that use historic cost

methodologies, the wholesale discount price would reflect

those models. /d. Section 252(d)(3) is thus agnostic as to the

cost methodology used by a particular state. Neither

Congress nor the FCC expressed any preference for setting

wholesale rates based on historical costs.'!

C. The FCC’s Choice Of A Forward-Looking Cost

_ Methodology Was Not Arbitrary Or Capri-

cious And Is Entitled To Deference.

The Eighth Circuit correctly held that the FCC’s use of a

forward-looking cost methodology was reasonable and well-

explained. /UB //, 219 F.3d at 752 (FCC Pet. App. 12a). The

ILECs dispute the FCC’s choice, arguing that: (1) historical

costs would be a better measure than forward-looking costs;

(2) forward-looking costs methodologies are “unmanage-

able”; and (3) the FCC failed adequately to explain its reasons

for “abandoning” historic costs. Pet’r Br. at 44-49. These

challenges, at bottom, relate to the wisdom of the FCC’s

policy decision that a forward-looking cost methodology

would better serve Congress’ goal of rapid competition than a

historical cost model. Under Chevron, that policy decision

was for the FCC to make. 467 U.S. at 865 (“When a

challenge to an agency construction of a statutory provision,

'' The ILECs’ reference to the Act’s resale pricing standards is ironic,

since they argue elsewhere that their retail rates are often established at

prices “substantially below cost.” See Pet’r Br. at 4 (emphasis added).

fairly conceptualized, really centers on the wisdom of the

agency’s policy, rather than whether it is a reasonable choice

within a gap left open by Congress, the challenge must fail.”).

1. Historical Costs Are Antithetical To The

Act’s Objectives.

The FCC did not exclude historical cost models on a whim.

The agency carefully considered the issue and concluded that

pricing UNEs based on the historical or “embedded” costs

carried on an ILEC’s accounting books would be antithetical

to the pro-competitive goals of the Act. The FCC recognized

that these historical costs could be higher or lower than the

costs derived from a forward-looking cost model. JA 398-

399 (4705). Even so, the FCC reasoned that the use of

historical costs in determining the rates paid by new entrants

would force competitors to pay for the existing inefficiency

of the ILECs’ networks and would not “ensure the efficient

investment decisions and competitive entry contemplated by

the .. . Act.” JA 399 (9705). Allowing ILECs to price

UNEs based on historical costs would force new entrants to

price their retail services based on those costs. Because

ILECs control the only facilities currently available to

provide widescale local service, they could then undercut the

prices of any potential competitors. JA 441-442 (¥ 1065).

An incumbent could “set its own rates based on the present

value of providing the service”’—that is, by writing off

obsolete investments just as a competitive firm would—while

forcing competitors to “pass along to [their] customers the

inflated, monopoly-era historical costs [the ILEC] seeks to

charge new entrants.” SWBT, 1998 WL 657717, at *13.

Forward-looking pricing for network elements, by contrast,

places everyone “on a level playing field.” Jd.; see also Town

of Concord v. Boston Edison Co., 915 F.2d 17, 18-19 (Ist Cir.

1990) (Breyer, J.). As the FCC explained, “[t}he substantial

weight of economic commentary in the record suggests that

an ‘embedded cost’-based pricing methodology would be

pro-competitor—in this case the incumbent LEC—rather than

pro-competition.” JA 398 (4 705). The FCC thus concluded

that historical cost pricing would frustrate the Act’s

objectives. JA 398-399 (4 705).

The FCC also built sufficient flexibility into TELRIC to

ensure that state commissions account for the effects of

competition on ILECs. State commissions must consider

these effects in setting the depreciation rates and cost of

capital. JA 395-396 (4 702). The FCC found that:

the currently authorized rate of return at the federal or

state level is a reasonable starting point for TELRIC

calculations, and incumbent LECs bear the burden of

demonstrating with specificity that the business risks

that they face in providing unbundled network elements

and interconnection services would justify a different

risk-adjusted cost of capital or depreciation rate.

JA 395 (§ 702). “States may adjust the cost o: capital if a

party demonstrates to a state commission that either a higher

or lower level of cost of capital is warranted.” JA 396

({ 702). Thus, contrary to the ILECs’ claims, TELRIC allows

State commissions to account for the effects of competition on

investment incentives.

2. TELRIC Is Not “Unmanageable.”

The ILECs’ characterization of TELRIC as “unmanage-

able” is factually incorrect, Pet’r Br. at 45, for the reasons

previously shown. The FCC made a reasoned determination

that TELRIC would be “implementable” based on th> proven

experience of various state commissions. JA 334 _36, 381

(77 631, 681). The practical experience of t' ese state

commissions was especially informative because, as the FCC

recognized, state commissions would be the ones establishing

UNE rates based on the FCC’s methodology. JA 381 (§ 681).

Virtually every state commission has applied TELRIC in

post-Act arbitrations, confirming the soundness of the FCC’s

determination that TELRIC would be manageable to imple-

ment. Michael K. Kellogg et al., Federal Telecommuni-

cations Law § 2.4.4.2 (2d ed. 1999)."”

3. The FCC Did Not “Abandon” Historical

Cost Models.

In a final attempt to portray the FCC’s rulemaking as

“arbitrary and capricious,” the ILECs claim that the FCC

failed adequately to explain its “decision to abandon

historical costs in favor of TELRIC.” Pet’r Br. at 46 This

claim rests on a false premise. Prior to the Act, ILECs had no

obligation to lease UNEs to competitors and the FCC was

never called on to establish a cost methodology for UNE

access. TELRIC is not an abrupt change from past practices.

It is part of the FCC’s implementation of an entirely new

regime. Far from abandoning a settled methodology, the

FCC was charged with promulgating a new one that provided

just and reasonable compensation while promoting Congress’

goal of rapid competition. The FCC fully explained its

reasons for selecting a forward-looking cost methodology and

'2 The ILECs utterly ignore the fact that TELRIC has been successfully

implemented by the states and argue instead that TELRIC is an

“unmanageable project” based on the FCC’s experience in the universal

service proceeding. Pet’r Br. at 45; see also id at 12-13. That is not a

valid comparison. The states’ actual experience with TELRIC is the most

relevant inquiry. The FCC’s universal proceedings are vastly more

complicated than a state commission arbitration to determine UNE prices

for an individual ILEC. Congress created a wholesale change in the way

universal service would be advanced nationally in the post-Act

environment. JA 29-48. To implement these requirements, the FCC has

conducted a complex, ongoing nationwide proceeding, which involves all

state commissions, virtually all local and long distance carriers and other

interested parties, and requires the FCC to work with and receive

recommendations from a joint federal-state board. /d; see also Michael

K. Kellogg et al., Federal Telecommunications Law § 2.5 (2d ed. 1999)

(“Perhaps the most daunting task assigned to the [FCC] by the 1996 Act

was a thorough review and restructuring of the existing federal universal-

service guarantees.”).

for rejecting the use of historical costs. JA 325-423

(7 618-740). It was within the FCC’s authority to make

these determinations and its selection of TELRIC was not

arbitrary or capricious.

Il. THE FCC’s SELECTION OF THE TELRIC

METHODOLOGY DOES NOT VIOLATE THE

TAKINGS CLAUSE.

The FCC’s decision to exclude historical costs in the UNE

rates that ILECs may charge new entrants does not violate the

Takings Clause. Pet’r Br. at 24-26. The ILECs construct

three arguments in an attempt to implicate constitutional

takings principles. They first claim that the FCC’s

implementation of TELRIC was an “opportunistic switch”

from a prior, well-settled historical cost methodology that

provided for recovery of past prudent investment. /d. at 26-

31. They next attack the TELRIC methodology itself, which

they contend will force them to lease UNEs to new entrants at

“a loss.” Jd. at 31-42. Finally, they argue that this Court

must adopt a narrow construction of Section 252(d)(1)—

which, in their view, would require the incorporation of

historical costs—in order to avoid “serious constitutional

questions” raised by TELRIC. /d. at 42-44. None of these

claims has merit.

A. TELRIC Does Not Represent A Constitu-

tionalty Suspect Shift In Methodologies.

The ILECs wrongly argue that, in adopting TELRIC, the

FCC “abandoned the longstanding regime under which

incumbents were given the opportunity to recover their actual

investment and moved to an extreme version of replacement

costs.” Jd. at 26. “This fundamental shift,” the ILECs

contend, “necessarily raises the question whether the new

methodology is sufficient to provide a constitutionally

adequate return with respect to investments made under the

prior regime.” Jd.

The ILECs’ attempt to cast TELRIC as a “fundamental

switch” in cost methodologies is overstated. The Act does

not purport to impose any cost methodology on the states in

setting retail rates for an ILEC’s traditional local services.

Any purported “expectations” the ILECs may have based on

the particular methodologies employed by the states for these

services—whether they be based on historical or forward-

looking costs—are unaffected by the Act. The Act’s pricing

standards instead apply to an entirely new regime that is

designed to open local markets to rapid competition. ILECs

had no prior obligation to provide UNEs to new entrants and

there was no established methodology for pricing these

elements. The TELRIC methodology was chosen by the FCC

to implement the Act’s pro-competitive requirements. The

FCC was not bound by any particular methodology used to

set rates in the pre-Act monopoly environment in determining

how UNEs should be priced in the new competitive

environment. Nor did the ILECs have any vested right to

expect that they would be shielded from a methodology based

on forward-looking rather than historical costs. As this Court

explained decades ago:

[w]hether competition between utilities shall be prohib-

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

That policy is subject to alteration at the will of the

legislature. The declaration of a specific policy creates

no vested right to its maintenance in utilities then

engaged in the business or thereafter embarking in it.

Tennessee Elec. Power Co. v. Tennessee Valley Auth., 306

U.S. 118, 141 (1939) (“Tennessee Electric”).

The ILECs also wrongly attempt to use Duquesne as

authority for the proposition that, whenever a regulatory

agency adopts a new rate methodology, it must guarantee that

the carriers recover “all their previous prudent investment and

an appropriate rate of return under the old methodology.”

Pet’r Br. at 27. Thus, once regulators base rates on historical

costs, the ILECs contend, it creates a promise that must be

honored under the Constitution. Any change in future rates

must provide for recovery of those costs, regardless of the

present value of the underlying network assets. /d.

Duquesne expressly refutes the ILECs’ proposition that

recovery of historical costs is constitutionally required. The

Takings Clause prevents rates that are “so unjust as to destroy

the value of [the] property for all the purposes for which it

was acquired.” Duquesne, 488 U.S. at 307; see also Market

St. Ry. v. Railroad Comm'n of Cal., 324 U.S. 548, 567 (1945)

(the Takings Clause prevents only “governmental destruction

of existing economic values” and does not require compen-

sation based on “the present reproduction value of something

no one would presently want to reproduce” or the “historical

valuation of a property”) (emphasis added) (“Market Street

Railway”). Indeed, prior to Duquesne, “it was thought that

the Constitution required” compensation based on “present

value.” Duquesne, 488 U.S. at 308 (emphasis added). In

Duquesne, this Court explained that the Constitution does not

mandate a single theory of valuation, stating, in pertinent

part, that:

[C]ircumstances may favor the use of one ratemaking

procedure over another. The designation of a single

theory of ratemaking as a constitutional requirement

would unnecessarily foreclose alternatives which could

benefit both consumers and investors. The Constitution

within broad limits leaves the [regulators] free to decide

what ratesetting methodology best meets their needs in

balancing the interests of the utility and the public.

Id. at 316; see also Hope Natural Gas, 320 U.S. at 602 (The

Takings Clause does not confine regulators “to the use of any

single formula or combination of formulae in determining

rates.”). Under Duquesne, therefore, the FCC had broad

authority to establish a cost methodology for UNE rates that,

in the agency’s expert view, “best meets” the objectives of

the new Act, regardless of the cost methodologies used by the

agency or the states in the pre-Act regime.

Even assuming, for argument’s sake, that TELRIC repre-

sented a “shift” in methodologies, it would not raise a serious

constitutional question. As shown, TELRIC provides just

compensation to the ILECs by permitting full recovery of the

current fair value of the UNEs. The Takings Clause requires

no greater compensation, see United States v. Miller, 317

U.S. 369, 374 (1943), and the ILECs have no right to expect

more. The ILECs acknowledge that the measure for

evaluating an alleged property deprivation is the reasonable,

investment-backed expectations of the property owner. Pet’r

Br. at 29. This Court has repeatedly held that reasonable

investors cannot expect an existing ratemaking scheme to be

permanent or claim entitlement to particular regulatory

treatment. E.g., Tennessee Electric, 306 U.S. at 141; see also

American Trucking Ass’ns, Inc. v. Atchison, Topeka & Santa

Fe Ry., 387 U.S. 397, 416 (1967). Cf: New York Cent. R.R. v.

White, 243 U.S. 188, 198 (1917) (“No person has a vested

interest in any rule of law, entitling him to insist that it shall

remain unchanged for his benefit.”). It is thus constitu-

tionally permissible for a regulatory agency to establish new

rates based on a changed methodology that excludes

historical costs prudently invested. In Duquesne, for

example, this Court upheid rates that reflected the “current

market value” of the utility’s investments, even though this

approach denied recovery of tens of millions of dollars of

prudently incurred historical expenditures. 488 U.S. at 312-

14. Similarly, in Hope Natural Gas, the Court affirmed the

adoption of a new approach for calculating the rate base, even

though the resulting rates “might produce only a meager

return” on the prior rate base. 320 U.S. at 605. In Market

Street Railway, the regulatory commission based rates on the

present value of a company’s assets ($7.95 million), even

though the “book value” of the property exceeded $41 million

and its “historical reproduction costs” exceeded $25 million.

324 U.S. at 564-68. The Court held that the regulated entity

was not constitutionally entitled to compensation based on

“the historical valuation of a property whose . . . current

financial statements showed the value no longer to exist, or

on an investment after it has vanished, even if once prudently

made.” Jd. at 567; see also In re Permian Basin Area Rate

Cases, 390 U.S. 747, 784 (1968) (Courts will not “set aside [a

rate order] merely because the [regulatory agency] has on an

earlier occasion reached another result.”) (“In re Permian

Basin”). These authorities make clear that the ILECs and

their investors had no reasonable basis to “count on” a

historical cost methodology “as a necessary component for

supplying a constitutional return under the old regime.” Pet’r

Br. at 30.

Duquesne also establishes that changes in regulatory

treatment implicate the Takings Clause only under narrow

circumstances; viz., when the state “arbitrarily switch[es]

back and forth between methodologies in a way which

require[s] investors to bear the risk of bad investments at

some times while denying them the benefit of good

investments at others.” 488 U.S. at 315. The FCC adopted

TELRIC to implement the Act’s new UNE access require-

ments. The agency has not arbitrarily switched “back and

forth” between cost methodologies and nothing in the record

remotely resembles such opportunistic rate manipulation.

Moreover, as shown, the FCC had moved away from

traditional cost of service regulation based on historical costs

in favor of price cap regulation several years before the Act’s

passage. Policy and Rules Concerning Rates for Dominant

Carriers, 5 F.C.C.R. 6786 (1990). Price cap regulation

establishes rates by considering, among other things,

“expected savings from innovation and other economies” that

are necessarily “forward-looking.” National Rural Telecom,

988 F.2d at 178. It is indeed ironic for the ILECs to claim

that the FCC’s so-called “switch” to TELRIC has a

constitutional dimension here, given that they did not

challenge the constitutionality of the FCC’s “switch” from

traditional cost of service regulation to price cap regulation

over a decade ago.

In addition to the legal flaws in the ILECs’ analysis, their

claim that the purported “switch” to TELRIC “wipe[s] out a

significant portion of the recovery on past investments” lacks

any credible factual basis. The ILECs assert that they have

invested $342 billion in their networks over time, based on

newly introduced data that they provided to the FCC in a

separate, unrelated context. Pet’r Br. at 10-11. Apart from

the questionable relevance of these data, they show that

approximately $176 billion of that original investment has

been depreciated on the ILECs’ books—a point conveniently

missing from the ILECs’ analysis. 1999 Statistics of

Communications Common Carriers, table 2.9, at 51 (rel. Aug.

11, 2000). Even under a historical cost methodology, the

ILECs’ original investment is worth only $166 billion today

based on their own data. Cf. Illinois Bell II, 988 F.2d at

1258-59 & n.5 (“Since depreciation is an operating cost,

investors recover such amounts dollar for dollar.”) (citing

Breyer & Stewart, Administrative Law and Regulatory Policy

237 n.59 (2d ed. 1985)). In comparison, the ILECs contend

that TELRIC values those same assets at $180 billion. Pet’r

Br. at 10-11. The ILECs’ argument that TELRIC “under-

values” their networks and “strands” historical costs in a

“harshly retroactive” way is thus wholly unsupported.

Although there is no evidence in the record regarding the

extent of UNE leasing by new entrants, it is beyond dispute

that ILECs continue to control more than 92% of the local

markets. See Industry Analysis Division, FCC, Local Tele-

phone Competition: Status as of December 31, 2000, at Table

1 (May 2001). The ILECs, therefore, continue to recover the

vast majority of their “historical” network costs through the

retail rates established by the state commissions in traditional

intrastate rate-of-return proceedings. It seems likely that

most, if not all, of an ILEC’s undepreciated historical costs

existing in 1996 will have been recovered through its retail

rates long before any meaningful UNE-based competition

takes hold.

B. The ILECs’ Theoretical Attacks On TELRIC

Are Barred By The Well-Settled “Total Effect”

Test For Regulatory Takings.

This Court has held that “[i]t is not theory but the impact of

the rate order which counts.” Hope Natural Gas, 320 U.S. at

602. Accordingly, the Court has rejected theoretical

challenges to rate methodologies and examined instead the

“total effect” of actual rates for takings purposes. /d. An

uncompensated taking results only if application of the

ratemaking methodology produces overall rates so low as to

“jeopardize the [regulated entity’s] financial integrity . . .

either by leaving [it with] insufficient operating capital or by

impeding [its] ability to raise future capital.” Duquesne, 488

U.S. at 312. This “total effect” test is necessary to ensure that

regulators have sufficient methodological leeway to resolve

the complicated economic judgments and difficult policy

issues involved in setting rates. /d. at 314.

The ILECs make no credible attempt to satisfy the “total

effect” test in challenging TELRIC. Rather, they contend that

the FCC “misapplied” the test “by looking to revenues earned

from all of an incumbent’s operations” in order to “cure” the

“below-cost” UNE rates resulting from TELRIC. Pet’r Br. at

32 (emphasis in original). Relying on Brooks-Scanlon Co. v.

Railroad Commission of Louisiana, 251 U.S. 396, 399 (1920)

(“Brooks-Scanlon”), the ILECs argue that the FCC may not

set “below-cost” rates in one line of business and offset any

such deficiency from revenues in a different, unregulated line

of business. Pet’r Br. at 33-34.

These arguments mischaracterize the record. TELRIC

does not result in “below-cost” rates. As previously shown,

TELRIC allows for full recovery of an ILEC’s costs plus a

reasonable profit, based on a forward-looking methodology.

Nor did the FCC “‘distort[]’ the Duquesne ‘total effect’ test

by claiming that it could look to all of an incumbent’s overall

revenues to make up for any deficiency in TELRIC rates,” as

the ILECs wrongly suggest. /d. at 32 (citing JA 421-422

(4 738)) (emphasis in original). The agency explained its

analysis as follows:

In adopting the rules that govern [UNE] rates, under

Hope Natural Gas we must consider whether the end

result of incumbent LEC rates is just and reasonable.

Incumbent LECs argue that establishing a rate structure

that does not permit recovery of historical or embedded

costs is confiscatory. We disagree. As stated above, the

Court has consistently held since Hope Natural Gas that

it-is the end result, not the method used to achieve that

result, that is the issue to be addressed. ... Moreover,

the Court has upheld as reasonable changes in

ratemaking methodology when the change resulted in

the exclusion of historical costs prudently incurred.

Thus, the mere fact that an incumbent LEC may not be

able to set rates that will allow it to recover a particular

cost incurred in establishing its regulated network does

not, in and of itself, result in confiscation.

Moreover, Hope Natural Gas requires only ‘nat the end

result of our overall regulatory framework provides

LECs a reasonable opportunity to recover a return on

their investment. In other words, incumbent LECs’

overall rates must be considered, including the revenues

for other services under our jurisdiction.

JA 420-421 (49 736-737 & n.1756) (emphasis added). The

record thus shows that the FCC properly analyzed the ILECs’

theoretical “taking” claims to TELRIC under this Court’s

precedents. The FCC did not look to revenues from

unregulated segments of the ILECs’ businesses, as the ILECs

claim, but rather expressly confined its analysis to whether

the “end result of [the agency’s] overall regulatory frame-

work” provided for just compensation, including the ILECs’

revenues from other services expressly under the FCC’s

jurisdiction."”

Based on the evidence before it, the FCC concluded that

TELRIC “should produce rates for monopoly elements and

services that approximate what the incumbent LECs would be

able to charge if there were a competitive market for such

offerings. We believe that a forward-looking economic cost

methodology enables incumbent LECs to recover a fair re-

turn on their investment, i.e., just and reasonable rates.” JA

421-422 (738). Even so, the FCC ordered that ILECs “may

seek relief from the Commission’s pricing methodology if

they provide specific information to show that the pricing

methodology, as applied to them, will result in confiscatory

rates.” JA 422 (4 739).

The ILECs’ reliance on Brooks-Scanion is thus misplaced.

In Brooks-Scanlon, this Court held that the regulatory agency

could not look to the profits earned by a railway company in a

separate, unregulated lumber business to subsidize losses

being incurred by the company in a regulated, unprofitable

rail line. 251 U.S. at 399. As shown, the FCC based its

analysis on the markets it regulates, not on any unregulated

businesses of the ILECs. Brooks-Scanlon was also decided

before this Court adopted the “total effect” test. Subsequent

decisions have held that Brooks-Scanion in no way precludes

an agency from considering revenues from all parts of an

entity’s regulated business when applying the test. See, e.g.,

Baltimore & Ohio R.R. v. United States, 345 U.S. 146, 150

(1953); Jn re Valuation Proceedings Under §§ 303(c) & 306

'’ The above-cited record also shows that the FCC properly looked to

this Court’s precedents on just compensation, and did not attempt to

interpret on its own “what costs the Constitution requires” to be

recovered—as the ILECs wrongly suggest. Pet’r Br. at 25-26. The Court

should reject the ILECs’ attempt to parlay this fictitious argument into

another ground for negating Chevron deference to the FCC’s

interpretation of “cost” in Section 252(d)(1).

of the Reg’! Rail Reorg. Act, 439 F. Supp. 1351, 1357 n.12

(Regional Rail Reorg. Ct. 1977).

Rather than coming forward with any specific information

to prove a confiscatory rate, the ILECs have attempted

instead to rewrite this Court’s regulatory takings jurispru-

dence. In so doing, the ILECs have turned Duquesne on its

head. As shown, Duquesne holds that there is no single rate

methodology mandated by the Constitution and that it is

constitutionally permissible for a ratemaker to change

methodologies, even where doing so excludes historical costs

prudently invested. The ILECs argue just the opposite here,

stating that:

[t]he FCC thus failed to conduct the inquiry demanded

by Duquesne—whether TELRIC rates for UNEs will

preserve incumbents’ opportunity to recover their past

prudent investment.

Pet’r Br. at 37 (emphasis added). This assertion demonstrates

that it is the ILECs—not the FCC—that have misapplied

Duquesne.

The ILECs’ attempt to avoid the “total effect” test is not

surprising, since “[o]nly the most egregiously confiscatory

rate structure would have difficulty meeting” the “total

effect” test reaffirmed there. Laurence H. Tribe, American

Constitutional Law § 9-3 n.3 (2d ed. 1988). A utility thus

bears a heavy burden in proving that rates are confiscatory

under this standard. Jn re Permian Basin, 390 U.S. at 767.

The ILECs failed to meet that burden before the FCC, JA

421-422 (9738), and they have failed to meet it here.

Although they broadly assert in their merits brief that state

commissions “applying TELRIC ... typically produced

discounts of 50% below historical cost,” this “evidence” is

based on the self-serving testimony of a single witness in an

arbitration. The ILECs’ claim that TELRIC leaves billions in

network costs “stranded” is also belied by their own data, as

shown supra pp. 33-34. These claims fail to demonstrate that

the “total effect” of the FCC’s pricing rules is so unjust as to

be confiscatory. The ILECs have not shown that they are

unable to maintain their financial integrity or to attract

necessary capital as a result of TELRIC or the Act’s overall

pricing scheme. See Duquesne, 488 U.S. at 312; Jersey Cent.

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

1987) (en banc).'* Nor have they attempted to account for the

substantial new sources of revenue that the Act now makes

available to them by, among other things, allowing them

access to the various long distance and other markets

foreclosed by the AT&T consent decree. The ILECs’ failure

to come forward with anv such evidence, five years after the

Act was adopted, leav-s no doubt that their “constitutional”

challenge to TELRIC is not really based on takings

principles, but rather on the policy choices properly made by

the FCC."

Finally, rejection of the ILECs’ theoretical challenges to

the TELRIC methodology will not foreclose judicial review

of whether TELRIC-derived rates are themselves “confis-

catory.” Pet’r Br. at 40. Duquesne explicitly holds that a

takings challenge must be based on the effect of a rate, not

the methodology employed. The Act authorizes state

commissions to conduct arbitrations to establish UNE rates

and provides an avenue for judicial review of those

“To the contrary, the ILECs’ stock values have appreciated

substantially since August 8, 1996, the date the FCC released its Local

Competition Order. See Yahoo Finance Historical Quotes, available ai

http://chart.yahoo.com/d (providing split-adjusted historical stock data

showing that from August 8, 1996 to June |, 2001 stock prices for (i)

BellSouth rose from $19.11 per share to $40.56 per share; (ii) SBC rose

from $22.12 per share to $42.05 per share; and (iii) GIE/Verizon rose

from $25.82 per share to $54.74 per share).

'S The fact that the FCC has not concluded its Universal Service Order

(“USO”) proceedings does not save the ILECs’ “takings” claim. The

ILECs receive explicit universal service support, as well as compensation

from the Act’s other pricing provisions. JA 29-48.

determinations. JA 25-26. As much as the ILECs may prefer

to challenge the constitutionality of the FCC’s methodology

in this proceeding, such a challenge can only proceed after

the UNE rates that are a product of that methodology have’

been set and the effect of those rates can be tested.

C. The Doctrine Of Constitutional Avoidance

Does Not Require The Inclusion Of Historical

Costs In UNE Prices.

Having constructed their theoretical “takings” challenge to

TELRIC, the ILECs next argue that the doctrine of

“constitutional avoidance” negates Chevron deference and

requires this Court to interpret Section 252(d)(1) in a way that

avoids raising “serious constitutional questions.” Pet’r Br. at

42. These questions can only be avoided, the ILECs contend,

by interpreting the statute their way; viz., to include historical

costs. The Eighth Circuit correctly rejected this argument.

JUB II, 219 F.3d at 754 (FCC Pet. App. 16a-18a). This Court

should do the same.

The doctrine of constitutional avoidance is inapplicable in

these circumstances because the Act provides a mechanism

for the ILECs to receive compensation through state-

arbitrated UNE rates. The Fifth Amendment does not

proscribe the taking of property. “[I}t proscribes the taking of

property without just compensation.” Williamson County

Reg’! Planning Comm'n v. Hamilton Bank, 473 U.S. 172, 194

(1985) (“Williamson County”). The Fifth Amendment

requires only that an adequate mechanism for compensation

exist. /d.

A narrowing construction of a statute to avoid a

constitutional problem need only be invoked in those cases in

which the application of a statute will necessarily constitute a

taking and no means of compensation exists. Thus, in

Riverside Bayview Homes, this Court did not invoke the

doctrine of constitutional avoidance because (1) the

regulation did not necessarily constitute a taking, and (2) even

if it did, a mechanism for compensation existed via the

Tucker Act. The Court explained that, as long as

compensation is available for those whose property is in fact

taken, the government action is not unconstitutional. Because

the availability of compensation negates any constitutional

concerns, “adoption of a narrowing construction does not

constitute an avoidance of a constitutional difficulty, it

merely frustrates permissible applications of a statute or

regulation.” Riverside Bayview Homes, 474 U.S. at 128. As

this Court explained,

the possibility that the application of a regulatory

program may in some instances result in the taking of

individual pieces of property is no justification for the

use of narrowing constructions to curtail the program if

compensation will in any event be available in those

cases where a taking has occurred.

Id."° See also Railway Labor Executives’ Ass'n v. United

States, 987 F.2d 806, 816 (D.C. Cir. 1993) (“Because just

compensation is presumptively available under the Tucker

'° Contrary to the ILECs’ assertion, it was appropriate for both the FCC

and the Eighth Circuit to rely on Riverside Bayview Homes as support for

the argument that a limiting construction of the Act is not warranted. The

ILECs criticize the FCC and the Eighth Circuit for supposedly reading

Riverside Bayview Homes to establish a general exemption from the

principle of constitutional avoidance when the issue involves the Takings

Clause. Pet’r Br. at 43-44. Neither the FCC nor the Eighth Circuit even

Suggested that Riverside Bayview Homes stands for that proposition.

Rather, the case stands for the principle that the doctrine of constitutional

avoidance should only be invoked when a taking necessarily occurs and

there is no means available for compensation. When that principle is

applied in this case, it is clear that a narrowing interpretation is not

warranted. By contrast, in Bell Atlantic Telephone Cos. v. FCC, 24 F.3d

1441 (D.C. Cir. 1994), a pre-Act case that, like Riverside Bayview Homes,

involved the doctrine of constitutional avoidance, the D.C. Circuit applied

a limiting construction to the Communications Act and vacated FCC

regulations that required local exchange carriers to provide physical

collocation because the Communications Act did not expressly authorize

such a taking or provide a compensation mechanism for it. /d. at 1445.

——~em

Act, there is neither an unconstitutional result nor a

constitutional doubt to be averted by interpretation.”).

Just as the Tucker Act provided a means for compensation

in the Riverside Bayview Homes and Railway Labor cases,

and thereby removed the need for a limiting construction of

the statutes at issue, the UNE compensation provisions of

Section 252(d)(1) remove the need for any limiting

construction of the statute to “avoid” a constitutional problem

here. As the ILECs concede, the Act embodies the consti-

tutional standard for just compensation. Their real argument

is with the FCC’s choice of TELRIC to provide it. The FCC

was authorized to adopt a forward-looking cost model. That

choice—even if deemed a “switch” in methodologies, as the

ILECs contend—allows for adequate recovery by ILECs of

their costs of providing UNEs to new entrants. TELRIC is

thus consistent with the requirements of Section 252(d)(1)

and the Takings Clause.

Moreover, as shown, an agency’s choice between prudent-

investment, historical cost, forward-looking cost, and replace-

ment cost methodologies does not raise constitutional

questions per se. Each method may provide just compen-

sation when reasonably applied. Conversely, each method

could result in unjust rates if misapplied. For these reasons,

courts require financial data showing the actual effect of rates

__not abstract methodological challenges—when evaluating a

takings claim. The ILECs’ takings claim is based solely on

the choice of methodology made by the FCC and not on any

credible evidence that TELRIC-derived rates are confis-

catory.

The FCC has also ordered the ILECs to seek relief from the

agency should they have credible evidence that TELRIC, “as

applied to them, will result in confiscatory rates.” JA 422

(9 739). The ILECs have yet to avail themselves of that

remedy, which itself forecloses a takings challenge at this

time. See Williamson County, 473 U.S. at 194-96.

Finally, TELRIC is not a “novel” methodology that tests

“the outer limits of Congress’ power,” as the ILECs attempt

to suggest. Pet’r Br. at 43. Forward-looking cost method-

ologies like TELRIC have been widely accepted in the

professional literature, were implemented by several state

utility commissions prior to passage of the Act, see

JA 334-336 (9631 & mnn.1508-14), and have already

constitutional muster, see GTE, 183 F.3d at 411-13

& nn.12-13.

Under these circumstances, adoption of a narrowing

construction of Section 252(d)(1) would not “avoid” any

serious constitutional question. It would instead frustrate the

FCC’s lawful interpretation of the provision to implement the

Act’s pro-competitive objectives. As the Eighth Circuit

correctly found, there is no “need to disregard Chevron

deference and interpret the statute in accordance with the

[ILECs’] views in order to avoid an unconstitutional taking in

this instance.” /UB II, 219 F.3d at 754.

CONCLUSION

For the foregoing reasons, Sprint respectfully requests that

this Court affirm the FCC’s UNE pricing rules in all respects.

Respectfully submitted,

DAVID P. MURRAY

Counsel of Record

RANDY J. BRANITSKY

KEVIN M. MILLER

WILLKIE FARR & GALLAGHER

1155 21st Street, N.W.

Washington, D.C. 20036

(202) 328-8000

Counsel for Respondent

Sprint Corporation

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