Respondents Brief — General Communications, Inc. v. Iowa Utilities Board

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Nos. 00-511, 00-555, 00-587, 00-590, 00-602

IN THE

Supreme Court of the Gnited States

VERIZON COMMUNICATIONS INC., ef al,

Petitioners,

FEDERAL COMMUNICATIONS COMMISSION AND THE

UNITED STATES OF AMERICA,

Respondents.

On Writ of Certiorari

to the United States Court of Appeals

for the Eighth Circuit

RESPONDENT?’S BRIEF OF AT&T CORP.

MARK C. ROSENBLUM DAVID W. CARPENTER*

LAWRENCE J. LAFARO PETER D. KEISLER

RICHARD H. RUBIN DAVID L. LAWSON

AT&T CORP STEPHEN B. KINNAIRD

295 North Maple Avenue C. FREDERICK BECKNER III

Basking Ridge, NJ 07920 SIDLEY AUSTIN BROWN &

(908) 221-8410 WoopD

1722 Eye St., N.W.

Washington, D.C. 20006

(202) 736-8000

Counsel for Respondent

June 8, 2001 * Counsel of Record

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

BEST AVAILABLE COPY

QUESTION PRESENTED

1. 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?

LIST OF PARTIES AND AFFILIATES

The parties to the proceedings in the Eighth Circuit are

listed in Appendix A and Appendix D of AT&T’s Petition for

Certiorari at 1a and 222a-224a.

Pursuant to Supreme Court Rule 29.6, respondent states as

follows: AT&T provides telecommunications, cable, and

other services. AT&T has no parent company. No publicly

held company owns more than 10 percent of AT&T's stock.

iil

TABLE OF CONTENTS

QUESTION PRESENTED ooo... co ccccccccecececeeeeeee

LIST OF PARTIES AND AFFILIATES .......................

SECTION 252(d)(1)(A) DOES NOT REQUIRE

A _HISTORICAL-COST RATEMAKING

THE TAKINGS CLAUSE DOES NOT RE-

QUIRE THE 1996 ACT TO BE INTERPRETED

TO MANDATE HISTORICAL-COST RATE-

A. Even If TELRIC Required That Network Ele-

ments And Interconnections Be Provided Be-

low Historical Cost, The LECs Have Presented

No Serious Takings Claim............000.00000000000.....

B. The Adoption Of TELRIC Would Raise No

Substantial Takings Claim Even If The Meth-

od Governed The Determination Of All Of

The LECs’ Regulated Revenues .......................

C. The LECs’ Claims Of A “Switch” In Method-

ologies Are Legally Meritless And Depend On

Erroneous Extrarecord Assertions.....................

TABLE OF CONTENTS - continued

1. TELRIC Is Not An Impermissible Switch

In Methodologies That “Strands” Invest-

GS ccc coccceccccscconescccccesocescosccsconssensosososoos Becese

Ill. THE FCC’S REJECTION OF THE LECS’

HISTORICAL-COST PROPOSALS WAS NOT

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

A. All Ratemaking Methods Are Hypothetical

And There Is No Basis For The Claim That

Other Methods Would Fulfill The Act’s Objec-

tives At Lower Administrative And Other

B. Competitive Pricing Of Network Elements

Does Not Frustrate The Act’s Purposes ............

CI dccteccccsescsccccsccecestnenesneinesssiinsincnimnmnsannenn

TABLE OF AUTHORITIES

CASES Page

AT&T Corp. v. Iowa Utils. Bd., 525 US. 366

EERE SEE A See ee He He 15, 24, 48

American Commercial Lines, Inc. v. Louisville &

Nashville R.R., 392 U.S. 571 (1968) ..00000000000..... 4]

American Paper Inst., Inc. v. American Elec.

Power Serv. Corp., 461 U.S. 402 (1983)............ 41

B&O RR v. United States, 345 US. 146

inhi aa a aaa 15, 26

Bell Atl. Tel. Cos. v. FCC, 79 F.3d 1195 (D.C.

ia caeeead oe 5

Brooks-Scanion Co. vy. Railroad Comm'n, 251

I a alae lial 28

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

Council, Inc., 467 U.S. 837 (1984) .0000.. oo... 17

Consumers’ Counsel v. FERC, 914 F.2d 290

I a 44

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

RA ea, ee passim

Entergy Gulf States, Inc. v. Louisiana PSC, 726

I 44

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

EBERT AE, 31

FPC v. Hope Natural Gas Co., 320 US. 591

A ICI 3, 20, 22, 31

FPC v. Texaco, Inc., 417 U.S. 380 (1974)............ 15, 28

Kansas Gas & Elec. Co. v. State Corp. Comm'n,

720 P.2d 1063 (Kan. 1986), vacated in part,

481 U.S. 1044 (1987) occ eceeeee 44

Keystone Bituminous Coal Ass'n v. DeBenedictis,

480 U.S. 470 (1987) o.oo ccccccccccseeseeeseeeseessee 41

Long Island Lighting Co. v. PSC, 523 N.Y.S.2d

615 (N.Y. App. Div. 1987). eee _ 44

Louisville Bridge Co. v. United States, 242 U.S.

SS ae Ae 41

TABLE OF AUTHORITIES -— continued

Page

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

STITT ssecctretipttennsinarsilaniniaiitntanaligitisiiesietariatiasne 31

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

United Distribution Cos., 498 US. 211

TTT cicesicnesshseseisintinaniaiiienstlinaineitosmenmdiniimcmanpith 21, 32, 40

Munn vy. Illinois, 94 U.S. 113 (1876) ..........0.0..--- 39

National Ass'n of Greeting Card Publishers v.

United States Postal Serv., 462 US. 810

I cccnnsevsiasicsnnmmninninnsinansapusinininiterepesseine 14, 18, 19

Nebbia v. New York, 291 U.S. 502 (1934)............. 39

New Orleans v. FERC, 67 F.3d 947 (D.C. Cir.

ee 43

Olson v. United States, 292 U.S. 246 (1934)......... 30

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

IE cinctnvonipeinssntinesiindnenmipeemssccocessininimeinanetmnnnes 28, 40

Reno v. Flores, 507 U.S. 292 (1993).................6 25

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

FPC v. Natural Gas Pipeline Co., 315 U.S. 575

TTI sncinnssinuitevesapinemancimanedmetaninsnpieuminni 3, 30, 31

TWA, Inc. v. CAB, 385 F.2d 648 (DC. Cir.

Tic iceicicticaneenceninndiiangethtnsicicagsndeciininanaianmniiui 44

Tennessee Elec. Power Co. v. TVA, 306 U.S. 118

IIT ccceicesstiatsnentntedeiniasicemenstnaaiiinimmaieieanentneces 40

United States ex rel. TVA v. Powelson, 319 U.S.

SES ES Ae RE ESSE 30

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

United States v. Riverside Bayview Homes, Inc.,

oo) 8 15, 25, 28, 33

United States v. Security Indus. Bank, 459 US.

RARE TE ETE SRST 25

United States v. Winstar Corp., 518 U.S. 839

ibe ET ARATE AE EEO 41

vii

TABLE OF AUTHORITIES - continued

CONSTITUTION AND STATUTES Page

U.S. Comst. amend. Vou... cccccccccceccccceceeee. 30

IT Oe 14, 18

ERAN area eee DTT 17, 23

Le passim

220 Ill. Comp. Stat. 5/13-502(c).000.0. on... 46

Mich. Comp. Laws Ann. § 484.2208(9)....... 46

Minn. Stat. Ann. § 237.5900. 46

RT 46

Tex. Util. Code Ann. § 58.055(c)..00.oo oo... 46

Utah Code Ann. § 54-8b-3.3(5)..000 46

Wy. Stat. Ann. § 37-15-402(a) 00... 46

ADMINISTRATIVE DECISIONS

Application by Bell Atl. New York for Author-

ization Under Section 271 of the Communi-

cations Act, 15S FCC Red. 3953 (1999), aff'd,

220 F.3d 607 (D.C. Cir. 2000) 200... 9

Connecticut Light & Power Co., 43 FERC.

9 63,029 (1984) occ cecccceseeveseeseesee 44

Continuing Prop. Records Audit, 14 FCC Red.

ENF eR 6, 38

Federal-State Joint Bd. on Universal Serv., 14

FCC Red. 20156 (1999) occ, 24, 47

Implementation of Sections of the Cable Tele-

vision Consumer Protection and Competition

Act of 1992: Rate Regulation, 9 FCC Red. 4527

SCARE | APSO ee 46

Joint Application by SBC Communications Inc.,

S.W. Bell Tel. Co. for Provision of In-Region

InterLATA Servs. in Kan. & Okla., No. 00-217,

2001 WL 55637 (F.C.C. Jan. 22, 2001)............. 9

Rates for Dominant Carriers, 4 FCC Red. 2873

RE EL i 4,5

Vill

TABLE OF AUTHORITIES -— continued

Rates for Dominant Carriers, 5 FCC Red. 6786

ITT scshcsiotianetiiieeedgaiteeteinintaenipenianloiemmandeiesmeanisitie 4, 6

Represcribing the Authorized Rate of Return for

Interstate Servs. of Local Exchange Carriers, 5

og ES, Se 5

Separation of Costs of Regulated Tel. Serv. From

Costs of Nonregulated Activities, 2 FCC Rcd.

I iets ietitaeesaat oat ainiaiiaanaeaaaliote 4

SCHOLARLY AUTHORITIES

W. Baumol & T. Merrill, Does The Constitution

Require That We Kill The Competitive Goose?

Pricing Local Phone Service Jo Rivals, 73

Be ie Sk Se ccnmrescsnresccsnsssesccesess 36

S. Breyer, Regulation and Its Reform (1982)......... 21

C. Horngren et al, Cost Accounting: A

Managerial Emphasis (10th ed. 2000)............... 18

H. Hovenkamp, Zhe Takings Clause and

Improvident Regulatory Bargains, 108 Yale

lie STE sscecrcnncieptindsiinnsinindaieniinnniensnias 36, 39, 40

1 A. Kahn, 7he Economics of Regulation (1988)... 3

A. Kahn & W. Shew, Current Issues In Telecom-

munications Regulation: Pricing, 4 Yale J. on

BE, SE I sccnedccnenscepsiestantiinceevolesoosneimnnaits 18, 42

C. Phillips, Jr., The Regulation of Publi- Utilities

SEIT i ssciecibdikidendatcnenidenmitniinnininanesiaieeiueabnibiine 21

J. Rossi, The Irony of Deregulatory Takings, 77

Bik I Se ED scessdiicheninicnncscsnssnvineenitcse 4]

R. Seavoy, Zhe Origins Of The American

Business Corporation, 1784-1855 (1982).......... 39

OTHER AUTHORITIES

BellSouth Corp. 10-K (filed Mar. 2, 2001)............ 12

Black's Law Dictionary (7th ed. 1999)................. 14, 18

TABLE OF AUTHORITIES -— continued

FBN Telecom Year In Review — 2, Federal Filings

Newswire, Jan. 2, 2001.00.00... ccc cccccccccesseeeeeee

Qwest Communications Int’! Inc. 10-K (filed

RESIST ere ee ee

SBC Communications Inc. 10-K (filed Mar. 12,

anti chieestiatdbestiniachintncsiadiisihdias nagiiamiesiiiantaritiansddiidienss

Verizon Communications Inc. 10-K405 (filed

TT I eT aT El aan

M. Farrell, /CG Tanks, Depressing Other CLECs,

Multichannel News, Oct. 2, 2000 ......................

R. Farzad, Has the Telecom War Been Won?,

Dow Jones News Service, May 15, 2001...........

Federal Communications Comm’n, /nterstate

Rate of Return Summary, available at

http://www. fcc.gov/Bureaus/Common_Carrier/

Reports/FCC-State_Link/ IAD/ror00.pdf............

Federal Communications Comm’n, /999 Sta-

tistics of Communications Common Carriers

En ee

Federal Communications Comm’n, 7rends in

Telephone Service (2000), available in Press

Release, Federal Communication Comm’n,

FCC Releases Study on Telephone Trends

ETE

Press Release, Federal Communications Comm’ n,

FCC Releases Latest Data on Local Telephone

Competition (May 21, 2000) .00000....00..ce.,

R. Fisher, From the Desk of . . . Robert Fisher,

Comm. Today, Dec. 22, 200000000000...

R. Krause, Verizon's New York Fight Key to

AT&T Challenge, Investors’ Bus. Daily, Aug.

SRE APSE een

S. Levine et al., 200/: We Make Eight Predictions

for the Year in Telecom, America’s Network,

ESS at

Page

TABLE OF AUTHORITIES - continued

J. Mulqueen, /CG Hit Hard by Revenue Shortfall,

Resignations, Interactive Week, Oct. 8, 2000.....

S. Schiesel, For Most Local Phone Users, Choice

Is Not Yet an Option, N.Y. Times, Nov. 21,

S. Schiesel, Sitting Pretty: How Baby Bells May

Conquer Their World, N.Y. Times, Apr. 22,

STITT ss chicielocscenieceteiesseildesaimepnenipetcaiendenneiindamenooneaienin

P. Sherer, Deals & Deal Makers: Too Much

Telecom, Wall Street J., Aug. 15, 2000..............

J. St. Onge, A Bankruptcy Boom Is Starting To

Have Ripple Effects, Dow Jones News Service,

Page

— SS

STATEMENT OF THE CASE

AT&T’s Petitioner’s Brief demonstrated that the Eighth

Circuit erred by vacating the FCC’s TELRIC regulation

insofar as it requires that interconnection and network

element rates be based on the costs of efficiently replacing the

relevant facilities of the incumbent local exchange carrier

(“LEC”). This holding, among other errors, is inconsistent

with the Eighth Circuit’s correct conclusion that the terms and

“stated purposes” of the Telecommunications Act of 1996 are

best promoted by a forward-looking incremental cost method.

The Eighth Circuit’s holding would require either a forward-

looking method that is less favorable to LECs than TELRIC

or the reproduction cost method that long has been uniformly

condemned as irrational and as the worst of all possibilities.

Because the Eighth Circuit’s holding is so plainly

untenable, the incumbent LECs separately petitioned for

review and claimed that the Eighth Circuit was wrong in

upholding the use of any forward-looking cost method. They

contend that it is plain from the Act’s terms and from the

context in which it was enacted that Congress required

interconnection and network element rates to be based on the

“historical costs” that are recorded in the LECs’ books. They

further claim that any other construction of the Act would

present serious issues under the Takings Clause and that the

FCC’s rejection of historical cost was arbitrary and

capricious.

As explained in detail below, these contentions are

baseless. They are squarely foreclosed by the Act’s terms.

Moreover, they rest on the notion that the FCC was required

to repudiate the economic and regulatory principles that

provided the background for the 1996 Act. At that time, the

FCC (and virtually all states) had determined that historical-

cost ratemaking could not foster efficiency and had

abandoned it even for the purpose of setting the LECs’

maximum earnings and revenues from their overail regulated

services. Still more pertinently, the FCC and states had held

that historical costs were irrelevant to competitive markets,

and where competition had been authorized with other LEC

services, they had required that LECs provide access to the

essential facilities that they control under forward-looking

cost standards. The LECs’ Brief does not even acknowledge

these facts. Instead, it attempts to divert the Court’s attention

from them by making a series of extrarecord assertions about

the effects of the FCC’s TELRIC rules that are out of order,

unsupported by any competent evidence or findings, and

demonstrably false.

AT&T’s Petitioner’s Brief provided a full statement of

background to the FCC’s adoption of TELRIC. But to place

the LECs’ claims in context requires some additional

discussion.

1. In the past, the FCC and individual states would

periodically conduct “rate cases” to determine the overall

revenue requirements and earnings that incumbent LECs

would be allowed in the respective interstate or intrastate

jurisdictions. These determinations were based on estimates

of the LECs’ overall “costs of service.” While there are

different cost of service methods, each uses a formula in

which total annual revenues were to be the sum of the LECs’

(1) reasonable operating expenses, (2) depreciation (that is,

the loss in value of investment in the LECs’ plant during the

year), and (3) a reasonable return on the LECs’ net

investment (sometimes called the “rate base”). The second

and third prongs of this formula required a determination of

the value of the LECs’ total investment.

While regulatory authorities would regulate a utility’s

overall revenues and earnings under these standards, they

generally did not make cost of service determinations for

individual services during the time in which LECs had

monopolies over all the telecommunications services and

equipment used in their franchised territories. Rather, the

overall revenue requirements were allocated among

individual services to promote various social objectives and to

reflect the “value of service.” Charges for basic residential

local service were set at relatively low levels and charges for

residential long distance service, business services, and other

services were set at higher levels.

2. To determine the depreciation and return on investment

components of revenue requirements, regulators must first

determine the value of the LECs’ overall investment. Prior to

1944, this determination was made under a “fair value”

method in which regulatory bodies were required to consider

a host of factors such as the original cost of the property, the

cost of replacing the functions that make it valuable, and the

cost of reproducing the precise equipment that the LEC was

then using. Smyth v. Ames, 169 U.S. 466, 547 (1898). To

implement “fair value” ratemaking, courts increasingly

required determinations of the costs of reproducing the LECs’

existing facilities “brick by brick.” 1 A. Kahn, 7he

Economics of Regulation 37-38, 112-13 (1988).

In 1944, this Court held that fair value ratemaking is no

longer constitutionally required. FPC v. Hope Natural Gas

Co., 320 U.S. 591, 602-05 (1944). The FCC and most states

then generally began to set rates under a method that is

variously referred to as “original cost,” “historical cost,”

“embedded cost” or “prudent investment.” Under this

method, the current value of the LECs’ investment is the

amount of the historical book investments of the LEC, minus

investments that were found imprudent at the time they were

made, minus prudent investments that were found not to be

currently “used and useful” in the provision of the regulated

service, and minus accumulated depreciation.

3. Beginning in the 1980s, the FCC and virtually all state

commissions determined that it was not in the public interest

to continue to attempt to regulate the overall revenues and

earnings of LECs under such “backward-looking” historical

prudent-investment methods. They determined that this

method could not be administered in ways that would foster

efficiency and prevent LECs from earning excessive

monopoly profits.

For example, the FCC determined that _historical-cost

regulation gave LECs no “incentive . . . to control expenses”

and that, under many conditions, it actually created positive

incentives for them to “gold plate” their networks, to install

capacity far in excess of that currently required to provide

regulated services, and otherwise “to adopt inefficient, capital

intensive approaches to business operations.” Rates for

Dominant Carriers, 5 FCC Red. 6786, 6790 (§ 29 n.30)

(1990). The reason was that, absent determinations of

imprudence, the LECs’ regulated rates would allow them to

recover and earn a full economic return on whatever amounts

were invested. /d. § 29 & n.30 (citing authorities). Further,

to the extent that excess capacity was installed to allow LECs

to provide future regulated or unregulated services that face

competition, today’s monopoly ratepayers would subsidize

the LECs’ future competitive operations. Separation of Costs

of Regulated Tel. Serv. From Costs of Nonregulated

Activities, 2 FCC Red. 1298, 1301 (¥ 16) (1987).

And the FCC found that regulatory bodies could not

“administer” a prudent-investment methodology in ways that

would either “counteract these incentives” or otherwise foster

efficiency, for a number of independent reasons. Rates for

Dominant Carriers, 4 FCC Red. 2873, 2890 (9 31) (1989).

First, it stated that regulators could never be assured of

“obtaining accurate cost information as the carrier itself is the

source of nearly all information about its costs.” /d. Second,

it concluded that even if it obtained accurate historical-cost

information, it did not have the “the resources to review in

detail the thousands of individual business judgments a carrier

makes before” making any investment. /d. at 2890 (¥ 31).

Third, the FCC found that even if there were the “vast

increase[s] in [its] resources . . . required” to conduct these

after-the-fact retrospective reviews, it “could not hope to

secure the kind of information that would permit [it] to

second-guess a carrier’s managers.” Jd. at 2909 (§ 78).

Finally, the FCC concluded that even “if [it] were to try to

make these type of judgments, it would be very difficult to

enforce them.” /d.

The FCC and virtually all states thus decided to abandon

historical cost of service regulation. Instead, they adopted

“price caps” or other forms of “incentive” regulation that

partially sever the link between a LEC’s costs and its

earnings. These systems make no judgment that LECs’

existing rates reflect the efficient costs of service. Rather,

they seek to assure only that future regulation does not

introduce any greater inefficiencies. They thus “cap” a LEC’s

existing prices at their current levels, and require future

annual reductions_in the overall rates by percentages that are

intended to represent the LEC’s expected attainable increases

in productivity, adjusted for inflation. Conversely, future

increases are permitted if the rate of inflation exceeds the

presumed percentage increase in the LEC’s productivity.

Price cap regulations take away the LECs’ prior right to

recover all their historical prudent investment. In particular,

under the FCC’s price cap rules, a LEC will not recover the

FCC’s authorized rate-of-return (11.25%') on its prudent

historical investment if it fails to achieve the presumed levels

of efficiency and productivity. But price cap regulations do

not completely sever the link between a LEC’s book “costs”

and prices. The FCC regulations continue to require LECs to

account for costs and to calculate rates of return, and these

calculated rates of return can have consequences for the

LECs’ earnings. For example, until recently, FCC regulations

required LECs to “share” with ratepayers returns above

certain levels. See Bell Atl. Tel. Cos. vy. FCC, 79 F.3d 1195,

1199 (D.C. Cir. 1996). In addition, if calculated rates of

' Represcribing the Authorized Rate of Return for Interstate Servs. of

Local Exchange Carriers, 5 FCC Red. 7507 (1990).

return fall below certain levels (today 10.25%), LECs are

entitled to rate increases. Rates for Dominant Carriers, 5

FCC Rcd. at 6802 (4 127). Most fundamentally, the FCC

periodically reexamines its regulations or resets the

productivity offsets, and the calculated rates of return are used

in these proceedings.

For these reasons, while price caps do not guarantee

recovery of prudent investment, they also do not eliminate

LECs’ incentives to include inappropriate investments in their

ratemaking books. Indeed, it recently came to light that

these books contain many entries for equipment that either

was never installed or has been discarded. See Continuing

Prop. Records Audit, 14 FCC Red. 7019, 7019 (¥ 1) (1999).

4. At the same time, while regulatory authorities

abandoned direct regulation of the overall regulated earnings

of LECs, they continued to exercise jurisdiction to determine

appropriate prices of individual LEC services or products.

This was necessary because competition had been authorized

with a number of LEC retail services in the intervening years,

- and while LEC competitors could themselves provide some of

the components of these services, they had to obtain other

essential inputs from the incumbent LECs. The LECs’

control over these essential inputs gave them the ability to

prevent competition through one of two related methods that

effect price-cost squeezes and give the LECs the ability to

charge prices that their competitors cannot match. First, the

LECs could misallocate the costs of competitive retail

services to their monopoly operations, recover them from

captive ratepayers, and thereby use monopoly revenues to

2 Both AT&T’s and the LECs’ economic experts have acknowledged

this point. See, e.g, AT&T’s Opposition to the Four RBOCs’ \V.otion to

Vacate the Decree, William Baumol Aff. at 31, United States v. Western

Elec. Co., No. 82-0192 (D.D.C. filed Dec. 7, 1994), Motion of Bell

Atlantic Corp., BellSouth Corp., NYNEX Corp., and Southwestern Bell

Corp. to Vacate the Decree, David Sappington Aff. at 11, United States v.

Western Elec. Co., No. 82-0192 (D.D.C. filed July 6, 1994).

subsidize below-cost retail prices that their competitors could

not match. Second, the LECs could charge their competitors

prices for access to their essential facilities that exceed the

economic costs which the LECs incur when they use those

same facilities to provide competing services.

To prevent such anticompetitive pricing, states and the FCC

almost uniformly held that the LECs’ historical “sunk” costs

were irrelevant, and they generally regulated the relevant

LEC rates under a long run incremental cost method that is

called “Total Service Long Run Incremental Cost” or

“TSLRIC.” See AT&T Pet’rs’ Br. 6-12. It is based on the

full economic cost of replacing the LECs’ facilities with the

most efficient generally available alternatives.

5. To foster local competition, the 1996 Act requires that

LECs provide competitors with interconnections and access

to network element at rates that are based on the “cost” of

“providing” them. In the FCC rulemaking proceeding, the

LECs’ economic experts acknowledged that the efficiency

objectives of the Act would be best met by basing these rates

on long run incremental cost and by allowing LECs to recover

investments in any currently underdepreciated assets either

through rates for other services or through explicit subsidy

payments.’ Further, the record evidence demonstrated in

detail that, in addition to the other factors that made use of

historica! cost inappropriate, the method would be difficult to

administer in ways that would insure that LECs and their

competitors incurred the same costs in using essential LEC

facilities. See, e.g, AT&T Reply Comments (May 30, 1996),

W. Baumol et al. Reply Aff. at 5-7 & n.5 (JA 146-48).

* See Bell Atlantic Comments (May 16, 1996), Robert Crandall Decl. at

6 (JA 84-85); see also id, Jerry Hausman Aff. at 2-3 (JA 89-92); GTE

Comments (May 16, 1996), Edward Beauvis Aff. at 2-4, (JA 103-07); US

WEST Comments (May 16, 1996), Robert Harris and Dennis Yao Report

at 5 (JA 136-38); Bell Atlantic Reply Comments (May 30, 1996), Alfred

Kahn and Timothy J. Tardiff Decl. at 8 (JA 160-62).

As economic experts explained to the FCC, under a

historical-cost method LECs would have the incentive and the

ability to misallocate retailing and other costs to network

elements, to artificially raise their competitors’ costs, and to

require their competitors’ customers to pay twice for retail

functions and for facilities that the competitors were

themselves providing. A historical-cost method would further

require tribunals to attempt to allocate statewide costs among

areas having different population densities and to exclude the

cost of facilities not needed to meet existing demand for

regulated telecommunications _ services. The experts

explained that all of these problems would be avoided by a

“bottoms up” TSLRIC method that determined the costs that

are today required to be incurred to install and operate

properly sized facilities. See, e.g, AT&T Comments (May

16, 1996), W. Baumol et al. Aff. at 3-13 (JA 60-73); W.

Baumol et al. Reply Aff. at 1-7 & n.5 (JA 140-48).

The FCC adopted a TSLRIC method to govern the setting

of rates for interconnections and network elements. However,

the FCC called the method Total Element Long Run

Incremental Cost or “TELRIC” because it would primarily be

applied to determine the cost of providing network elements,

not the cost of services. AT&T Pet’rs’ Br. 17-19.

6. The record before the Court contains no evidence of

what the LEC interconnection and network element rates

would be under either a historical-cost method or TELRIC.

The LECs’ Petitioners’ Brief has nonetheless sought to color

the proceedings in this Court by relying on a series of

unadjudicated and self-serving extrarecord assertions. LEC

Br. 10, 31, 40.

For example, the LECs repeatedly claim that TELRIC

produces rates that are “50% below historical cost.” /d@

Their principal contention is that an FCC model shows that

the TELRIC of the total national LEC networks is $180

billion, but that the amount that the LECs “actually invested”

is $342 billion. /d@ at 10-11 & nn.6-7.

But the statistics on which the LECs rely provide no

support for their claim. Preliminarily, the FCC model in

question is used to determine the cost of providing

“universal” basic telephone service. It thus does not cost all

the facilities that LECs make available as network elements

(which include facilities used to offer specialized and

advanced telecommunications services), but only the facilities

required to provide basic service. The FCC has thus found

that universal service cost calculations cannot be presumed to

reflect the appropriate level of network element rates under

TELRIC *

More fundamentally, the $342 billion to which the LECs

refer is derived from a table that tracks their gross capital

investment.’ But for purposes of comparison with TELRIC’s

valuation of LEC networks, the more relevant figure is net

depreciated historical investment, which reflects the estimated

losses in value in their equipment due to the development of

lower cost substitutes and to wear and tear. This represents

the current value of the LEC networks under an historical-

cost ratemaking method. According to the LECs’ same

statistical source, the incumbent LECs’ net investment is

about $166 billion.® TELRIC thus calculates a significantly

higher current value to the LECs network — $180 billion plus

the value of facilities excluded from the universal service cost

calculations— than does a historical-cost method ($166

* Application by Bell Atl. New York for Authorization Under Section

271 of the Communications Act, 15 FCC Red. 3953, 4087 (¥ 245) (1999),

aff'd, 220 F.3d 607, 619-20 (D.C. Cir. 2000); Joint Application by SBC

Communications Inc., SW. Beil Tel. Co. for Provision of In-Region

InterLATA Servs. in Kan. & Okl., No. 00-217, 2001 WL 55637, 4 84 (FCC

Jan. 22, 2001).

*LEC Br. 11 n6 (citing Federal Communications Comm'n, /999

Statistics of Communications Common Carriers tbl. 2.7, at 32 (Aug. 11,

2000)).

* Federal Communications Comm'n, /999 Statistics of Communi-

cations Common Carriers tbl. 2.9, at 50 (Aug. 11, 2000).

billion). | While these two figures are not perfectly

comparable, they foreclose any claim that TELRIC

necessarily produces dramatically lower valuations, much less

valuations 50%-60% lower than historical cost.

The only other sources the LECs cite for the claimed 50%

difference are assertions in their own affidavits and hearing

exhibits. LEC Br. 10 nn.4 & 5, 14.10. But those assertions

have not been credited or adopted by any court or agency, and

they do not remotely establish the proposition the LECs urge

upon this Court.’

The LECs also contend that TELRIC produces “radically

discounted” prices which will inevitably induce massive

inefficient entry by competitors, that those competitors will

be able to seize substantial market share by targeting and

winning business customers that are particularly profitable to

serve, and that the LECs will unfairly be left predominantly

with residential customers who are falsely asserted to be

unprofitable to serve.® Jd at 5, 13-14. The LECs attempt to

’ For example, the LECs cite their November, 1996 testimony before a

state commission for the proposition that “[w}hen state utility commis-

sions began applying TELRIC, they typically produced discounts of 50%

below historical cost.” LEC Br. 10. That claim is facially false because

no state commission had applied TELRIC at that time (three months after

TELRIC’s adoption), and the testimony merely compared two sets of

proposed rates in one state. The LECs also cite LEC testimony in New

York for the proposition that the historical monthly cost “for a copper

loop” is $33.20 while the TELRIC price “for a loop” is $14.52 (id. at 14) -

an apple-to-oranges comparison, because the TELRIC price to which they

refer was calculated solely for fiber loops, which the New York commis-

sion concluded were less costly than copper loops. And the remaining

unadjudicated assertions that the LECs cite relate to the separate FCC

““proxy prices” which were not even derived through TELRIC and which

are not before this Court. /d at 10 & n.4; Pet. App. 18a-2 1a.

* As LECs have elsewhere demonstrated, their provision of residentiai

local telephone service generally is profitable for them on a stand-alone

basis. That is so even where LECs set retail rates for “basic telephone

service” to “residential and rural customers . . . below cost” (LEC Br. 4),

support these claims with citations to a handful of newspaper

articles and analyst reports from 1996 and 1997. /d at 13 n9.

But TELRIC has been in effect for nearly five years,” and

none of these consequences has remotely occurred. To the

contrary, most prices approved by regulators as TELRIC-

compliant have proven too high to support competitive entry.

In that regard, the Vice-Chairman of the lead Petitioner

(Verizon) has publicly stated that local competitors who lease

its network elements in New York cannot profitably compete

with it at current prices,’® and AT&T has shown that the same

circumstances are likewise present elsewhere in the country.'!

for they more than make up the difference from the access charges they

collect from long distance carriers for every call placed or received by a

residential customer, from the charges for residential customers’ intrastate

toll calls, from the charges for “vertical features” like Call Waiting and

Caller ID, from the “subscriber line charges” that appear on every

customer's bill, and from the explicit universal service subsidy payments

that the LECs receive for serving particular residential customers. See,

e.g., Direct Testimony of Frank Hatzenbuehler, U S WEST

Communications, Inc., The /nvestigation and Suspension of Tariff Sheets

Filed by U S WEST Communications, No. 96S-331T (Colo. Pub. Utils.

Comm'n Dec. 13, 1996).

* Although the Eighth Circuit initially stayed the FCC’s rules on

jurisdictional grounds, the States announced that they would continue to

apply TELRIC anyway. See AT&T Pet'rs’ Br. 21 & n.23.

'° He has stated that “leasing (Bell Atlantic’s network elements] costs

AT&T $22 per residential customer per month,” so “‘[w]hoever is buying

(AT&T's) $24.95 product (its basic local service package) knows they're

not making any money on it.”” R. Krause, Verizon's New York Fight Key

to AT&T Challenge, investors’ Bus. Daily, Aug. 15, 2000, at A6 (quoting

Ivan Seidenberg). As he recognized, new entrants incur a host of

substantial start-up, operating and marketing costs beyond the cost of

leasing network elements, so inflated rates deny competitors the

“margins” they need to offer local residential service profitably. /d

'' See, eg., Comments of AT&T Corp. in Opposition to SBC _

Communication Inc.'s Section 271 Joint Application for Kansas and

Oklahoma, Michael Lieberman Decl., CC Docket No. 00-217 (Nov. 15,

2000), Reply Comments of AT&T Corp. in Opposition to Verizon New

As a consequence, the more recent newspaper articles and

analyst reports state that the competitive LEC industry now

stands on the verge of collapse. “[I}nvestors [have] los[t]

confidence in the fundamentals of the CLEC business

model,” M. Farrell, JCG Tanks, Depressing Other CLECs,

Multichannel News, Oct. 2, 2000, at Finance 48. “[TJhere

has been ‘carnage’ among CLEC stocks,” J. Mulqueen, /CG

Hit Hard by Revenue Shortfall, Resignations, \nteractive

Week, Oct. 8, 2000, and numerous competitive LECs have

filed for bankruptcy.'? At the same time, incumbent LECs

continue to. add more access lines and their profits are

soaring,'’ and “with their seemingly impenetrable local-

service fortresses, are emerging as the hands-down

winners.”'* These reports thus state that the immediate

England Inc.’s Section 271 Application for Massachusetts at 24, CC

Docket No. 00-176 (Nov. 2, 2000).

'2 EBN Telecom Year In Review - 2, Federal Filings Newswire, Jan. 2,

2001; S. Levine et al., 200]: We Make Eight Predictions for the Year in

Telecom, America’s Network, Jan. 1, 2001, at 40; R. Fisher, From the

Desk of... Robert Fisher, Comm. Today, Dec. 22, 2000; P. Sherer, Deals

& Deal Makers: Too Much Telecom, Wall Street J., Aug. 15, 2000, at C1;

J. St. Onge, A Bankruptcy Boom Is Starting To Have Ripple Effects, Dow

Jones News Service, Oct. 5, 2000.

'3 See BellSouth Corp. 10-K, at 34-36 (filed Mar. 2, 2001) (reporting

over $500 million growth in local services revenues to over $11 billion

and access line growth of approximately 400,000 lines); SBC

Communications Inc. 10-K, at 143 (filed Mar. 12, 2001) (reporting local

service revenues increasing by 13.2% to over $22 billion and strong

access line growth); Qwest Communications Int’! Inc. 10-K, Ex. 13, at F1-

F4 (filed Mar. 16, 2001) (reporting increased local voice revenues and

addition of over 340,000 access lines); Verizon Communications Inc. 10-

K405, at F7-F8 (filed Mar. 23, 2001) (reporting over $700 million growth

in local services revenues to over $21 billion driven by increased usage of

local network facilities).

'*R Farzad, Has the Telecom War Been Won?, Dow Jones News

Service, May 15, 2001; S. Schiesel, Sitting Pretty: How Baby Bells May

Conquer Their World, N.Y. Times, Apr. 22, 2001, at Money & Business

““prospects for local competition look abysmal’” because

“*fiJn most of the country, it is just not happening.’”’*

In short, to say the least, the Court should not assume the

truth of the LECs’ extrarecord assertion that TELRIC

produces rates that have caused significant competitive losses

for the LECs and that will leave them serving predominantly

“below-cost” customers. And the LECs’ tactics underscore

the wisdom of this Court’s refraining from constitutional

judgments regarding claims of confiscation until it has before

it real numbers that have been subject to the adversarial

process and scrutinized by regulatory agencies and the lower

courts.

SUMMARY OF ARGUMENT

There is no merit to the LECs’ claim that the FCC acted

unlawfully by refusing to require use of historical-cost

methods to set rates for interconnection and network

elements. The LECs’ statutory claims are foreclosed by the

Act’s terms, its context, and its purposes — all of which

demonstrate that, if anything, Congress intended to prohibit

the use of historical-cost ratemaking. And there is no

substance to the LECs’ claim that the stature has to be

construed to require a historical-cost method to, prevent

takings or that it was arbitrary and capricious for the FCC to

reject this method.

1. By requiring that rates be based on “cost,” 47 U.S.C.

§ 252(d)(1A), Congress did not mandate that

interconnection and network element rates be set based on the

historical costs recorded in the LECs’ ratemaking books.

Even when the term “cost” is used in isolation, the LECs’

dictionaries and this Court’s decisions establish that the term

'® See S. Schiesel, For Most Local Phone Users, Choice Is Not Yet an

Option, N.Y. Times, Nov. 21, 2000, at Cl (quoting B. Adamik, President,

The Yankee Group).

can mean either original cost or efficient replacement cost.

National Ass'n of Greeting Card Publishers v. United States

Postal Serv., 462 U.S. 810, 831-32 (1983), Black's Law

Dictionary 349 (7th ed. 1999).

Here, the textual context squarely forecloses the LECs’

claim that “cost” must (or even can) mean the amount that

was originally expended for an element, recorded in the

LECs’ ratemaking books, and purportedly determined to be

prudent in prior rate-of-return ratemaking proceedings.

Section 252(d)(1)(A)(i) requires that the rates be “based on

the cost (determined without reference to a rate-of-return or

other rate-based proceeding) of providing the interconnection

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

added). The LECs’ are seeking to rewrite the statute so that it

requires that rates be based on the “cost {determined with

reference to a rate-of-return or other rate-based proceeding]

of purchasing the element”. This claim is peculiarly spuri-

ous, for when the Communications Act requires determina-

tions based on “original cost,” it says so expressly. /d. § 213.

The LECs are also wrong in claiming that original cost

ratemaking is required by the historical “context” of the 1996

Act. Congress enacted the 1996 Act long after the FCC and

many state commissions had abandoned historical-cost

ratemaking on the ground that it fostered inefficiency and

could not be administered to prevent LECs from earning

excessive profits from their overall regulated operations.

More pertinently, it was then black letter law that historical

costs are irrelevant to competitive markets, and the FCC and

states had long used TSLRIC and other forward-looking

methods where, as here, the question was the rates that LECs

should be permitted to charge competitors for access to

essential facilities.

Further, the Act requires not only that network element

rates be based on cost, 47 U.S.C. § 252(d)(1)(A)(i), but also

that they be “nondiscriminatory,” id. § 252(d1)(Aii). The

FCC’s unchallenged findings establish that TELRIC

EEE

represents the costs that LECs incur in using the elements and

that to base rates on historical cost would violate the ban on

discrimination. In all events, even if the Act does not require

forward-looking methods, it at least gives the FCC “broad

methodological leeway” to determine interconnection and

network element rates under forward-looking methods.

AT&T Corp. v. lowa Utils. Bd., 525 U.S. 366, 423 (1999)

(Breyer, J., concurring in part and dissenting in part).

2. The LECs alternatively claim that § 252(d)(1) must be

construed to require historical-cost ratemaking to avoid

“serious” issues under the Takings Clause. In their view, the

rejection of historical cost and the adoption of a forward-

looking method raises “substantial arguments” that an

uncompensated taking will “necessarily” result. United States

v. Riverside Bayview Homes, Inc., 474 US. 121, 128 n5

(1985). This contention is baseless.

First, the adoption of TELRIC could not itself present a risk

of a taking even if it were certain that LECs will hereafter be

able to prove that network element rates have denied them

recovery of historical costs that they have a right to recover.

The Order provides that LECs may then petition the FCC for

the right to recover the shortfall in other rates that are within

the FCC’s jurisdiction. This remedy bars any claim that the

adoption of TELRIC will necessarily result in a taking. /d;

FPC v. Texaco, Inc., 417 U.S. 380, 391-92 (1978); B&O R.R.

v. United States, 345 U.S. 146, 148 (1953).

Second, under this Court’s holdings, a ratemaking body’s

decision to adopt historical cost, replacement cost, or some

hybrid method to value a utility’s investment itself raises no

constitutional issue under the Takings Clause. See Duquense

Light Co. v. Barasch, 488 U.S. 299, 310 (1989). There

cannot be a substantial takings issue until a rate order is

entered whose “total effect” could be said to deny the utility

the opportunity to earn a return on investment that reflects the

risks of operating under the agency’s ratemaking method-

ology. /d. Here, moreover, TELRIC expressly requires that

LECs receive a full risk-adjusted return, so it facially

mandates precisely what the Takings Clause requires.

The LECs also rely on the Court’s statement that it would

raise “serious constitutional questions” if agencies were “to

arbitrarily switch back and forth between [ratemaking]

methodologies in a way which required investors to bear the

risk of bad investments at some times while denying them the

benefit of good investments at others.” /d. at 315. But

TELRIC does not represent even a one-time “switch” in

ratemaking methodologies, much less an arbitrary switching

back and forth that could have such consequences. The

TELRIC regulation has no effect on the ratemaking methods

that apply to the LECs’ interstate and intrastate telephone

services. It governs only the new wholesale arrangements

that the 1996 Act requires LECs to provide for the first time

in order to foster competition. Moreover, by adopting a

forward-looking method for this purpose, the FCC followed

its own prior decisions.

3. The FCC’s rejection of historical-cost ratemaking was

not arbitrary and capricious. The FCC had previously found

historical-cost ratemaking could not promote efficiency in

regulating the LECs’ regulated businesses as a whole, much

less prevent the LECs from misusing their control over

monopoly facilities to impede competition with their own

local services. More fundamentally, there was abundant

evidence before the FCC — which was overwhelmingly

supported by the experience and findings of state, federal, and

foreign regulatory tribunals and the LECs’ own submissions

in other fora — that a forward-looking cost method could be

more readily and reliably administered to promote the

procompetitive objects of the 1996 Act.

ARGUMENT

I. SECTION 252(d)(1(A) DOES NOT REQUIRE A

HISTORICAL-COST RATEMAKING METHOD.

Section 252(d)(1) adopts three requirements that govern the

setting of “just and reasonable rates” for interconnections and

network elements. 47 U.S.C. § 252(d)(1)(A). First, the rates

must be “based on the cost (determined without reference to a

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

interconnection or network element.” Jd. § 252(d)(1)(A)(i).

Second, they “may include a reasonable profit.” /d.

§ 252(d)(1)(B). Third, the rates must be “nondiscriminatory.”

Id. § 252(d)(1)(A){ii).

In the LECs’ view, these terms, the Act’s structure, and the

historical context in which it was enacted establish that

Congress intended to require that interconnection and

network element rates be based on the historical costs that are

recorded in the LECs’ ratemaking books. They claim that

“cost” means the “amount paid” for the facility in question

(LEC Br. 19), that prior ratemaking orders establish that the

LECs’ expenditures are prudent (id. at 47), and that Congress

intended the term “‘cost’ [to] refer[] to something already

established and readily available,” i.e., the LECs’ “historical

cost as documented on [their] books.” /d at 22.

There is no basis for these contentions. If anything, the Act

forecloses the method the LECs propose. In all events, the

FCC’s rejection of their proposal was a _ reasonable

interpretation of the Act and is entitled to deference.

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

U.S. 837, 843-45 (1984),

1. First, there is no substance to the LECs’ contention that

the plain meaning of the term “cost” is the “entire amount

paid” for an asset. LEC Br. 19 (citing Black's Law

Dictionary 345 (6th ed. 1990)). This dictionary now contains

30 different definitions of “cost,” and these include forward-

looking replacement cost: that is, “[t]he cost of acquiring an

asset that is as equally useful or productive as an asset

currently held.” Black's Law Dictionary 349-50 (7th ed.

1999). This Court has thus held that “cost” is a term that has

“no technical meaning,” that “connotes the use of judgment,”

and that it permits both historical and forward-looking

approaches. National Ass'n of Greeting Card Publishers v.

United States Postal Serv., 462 U.S. 810, 832 (1983).

These principles have special force in the context of the

Communications Act in general and of § 252(d)(1) in

particular. Where Congress wished to permit or require the

use of “original” or historical cost for a regulatory purpose

under the Communications Act, it said so expressly. See 47

U.S.C. § 213(b)-(d). Moreover, in § 252(d)(1), the term

“cost” is used in a context which manifestly does not

compel — and, if anything, forecloses — the LECs’ proposed

construction.

The LECs’ claim is that § 252(d)(1) requires that rates be

based on the “historical cost” of purchasing the facilities that

comprise the network element or interconnection in question.

But that is not what § 252(d)(1) says. It requires that rates be

based on the “cost” of “providing” the facility. The cost of

“providing” an interconnection or network element is

manifestly not what was paid for the relevant facilities 1 in the

past, for that amount is “sunk” and unavoidable. '®

2. The LECs also claim that § 252(d)(1) has to be

construed to require a historical-cost method because that was

'© See AT&T Pet'rs’ Br. 21-37; see also A. Kahn & W. Shew, Current

Issues In Telecommunications Regulation: Pricing, 4 Yale J. on Reg. 191,

225 (1987); C. Horngren et al., Cost Accounting: A Managerial Emphasis

378, 396 (10th ed. 2000) (defining “relevant costs” as “those expected

future costs . . . that differ among the alternative courses of action being

considered,” and “especially emphasiz[ing]} the idea that all past costs and,

in particular, book value (original cost minus accumulated appreciation) of

the existing equipment, are irrelevant” (second emphasis omitted)).

LLL ee ee

the prevailing method of determining costs of service and of

setting “just and reasonable” rates at the time the 1996 Act

was passed. This claim is wrong, both legally and factually.

First, this Court has held that when Congress uses the term

“cost” without further specification, it has authorized the

ratemaking agency to reject “‘fully allocated’” costs or other

historical-cost methods, even if they had represented the

ratemaking and “accounting methods current at the time the

bill was enacted.” National Ass'n of Greeting Card

Publishers, 462 U.S. at 817 & n.3, 831.

Second, the LECs’ claim rests on a false factual premise.

Historical cost was not the current method when the 1996 Act

was passed. To the contrary, the FCC and most states had by

then abandoned historical-cost ratemaking even for the

purpose of regulating the LECs’ overall revenues and

earnings. The FCC found that this method gave the LECs

incentives to be inefficient and that regulators simply could

not administer this ratemaking method in ways that would

prevent excessive rates. See supra pp. 3-6. Beyond that,

even when historical-cost ratemaking had been previously

used to establish maximum overall revenues and earnings, the

FCC and states had rejected this ratemaking method where, as

here, the issue is the individual rates that LECs should charge

their competitors for access to essential facilities. These rates

had long been set under TSLRIC and other forward-looking

replacement cost methods. AT&T Pet’rs’ Br. 6-12.

Congress was fully aware of the adverse effects of

historical-cost ratemaking. Both the House and Senate had

passed bills banning the use of such rate-of-return regulation

to establish LECs’ maximum earnings. See Order, 9 704 (JA

397-98). Although these prohibitions were deleted by the

Conference Committee from the 1996 Act, it is preposterous

to claim that Congress intended simultaneously to require that

network-element and interconnection rates be set under this

method.

Beyond that, the language that was not deleted from the

1996 Act squarely bars the LECs’ claim (LEC Br. 22, 47) that

amounts recorded in the LECs’ ratemaking books must be

deemed to be reasonable estimates of cost. The LECs base

this claim on their assertions that prior state and federal

ratemaking proceedings established the “prudence” of these

costs. But the parenthetical terms of § 252(d)(1A)(i)

expressly foreclose any such claim. That section mandates

that the cost of providing the element be “determined without

reference to a rate-of-return or other rate-based proceeding.”

47 U.S.C. § 252(d)(1)(A)(i). Thus, although the LECs are

correct that one purpose of the Act is to allow interconnection

agreements to be adopted swiftly, § 252(d)(1)(A) prohibits

tribunals from doing so by treating prior rate-of-return

ratemaking proceedings as establishing that “readily

available” entries on the LECs’ ratemaking books represent

the costs of providing a network element or interconnection.

Compare LEC Br. 22."”

The LECs’ claims are also foreclosed by the fact that

§ 252(d)(1) specifies a method for setting rates that are “just

and reasonable.” 47 U.S.C. § 252(d)(1). The Court has held

that the “just and reasonable” standard authorizes ratemaking

tribunals to adopt any ratemaking method that produces

permissible end results. See FPC v. Hope Natural Gas Co.,

320 U.S. 591, 602 (1944); Wisconsin v. FPC, 373 U.S. 294,

309 (1963). In particular, the Court has rejected claims that

this standard requires historical-cost methods and has held

'' The LECs rely (LEC Br. 22) on the FCC’s statement that this

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

considered, but rather specifies a type of proceeding that may not be

employed to determine the cost of interconnection and unbundled network

elements.” Order, § 704 (JA 397). But whether or not § 252(d)(1A)

would bar prudent-investment ratemaking and the consideration of certain

costs, it bars any claim that prior ratemaking proceedings establish that

entries on LEC books represent actual costs of providing network

elements.

that it authorizes forward-looking replacement cost methods.

Mobil Oil Exploration & Producing S.E., Inc. vy. United

Distribution Cos., 498 U.S. 211, 224-25 (1991).

3. The LECs also erroneously claim that there are other

provisions of the Act that establish that § 252(d)(1)(A)

requires the use of historical-cost ratemaking and prohibits

forward-locking methods. Their principal contention is based

on § 252(d)(1)(B), which provides that network element and

interconnection rates “may include a reasonable profit.” 47

U.S.C. § 252(d)(1)(B). The LECs contend that unless

historical-cost ratemaking is used, the “entire” subsection that

addresses “profit” would be “irrelevant.” LEC Br. 20-21.

This claim is nonsense. There simply is no relevant

difference between historical-cost and forward-looking

methods for purposes of affording a “profit” to a regulated

utility.

Under both historical and forward-looking cost methods,

the utility is to receive revenues that recover the sum of its (1)

reasonable operating expenses and taxes; (2) the allowed

depreciation on its investment; and (3) a prescribed rate-of-

return multiplied by the current value of the utility’s

investment. See generally S. Breyer, Regulation and Its

Reform 36-37, 40-41 (1982). Under both methods, the object

of the rate-of-return on investment component is to allow the

utility to earn a “reasonable profit” — that is, to earn revenues

in excess of reasonable expenditures — and to pay dividends to

the utility’s shareholders. /d'* Under both methods, the

profit is to reflect the risk of operating under the regulatory

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

310, 315 (1989).

'* The “return on investment” component is generally comprised of two

elements: the cost of servicing the utility's debt (i.e., paying interest on

bonds) and return on equity (i.e., the earning and profits from which

dividends are paid). S. Breyer, Regulation and Its Reform 40-41 (1982),

C. Phillips, Jr., The Regulation of Public Utilities 388 (1993).

For present purposes, the only difference between

historical-cost and forward-looking methods is the way in

which they calculate the magnitude of the “reasonable profit”

that the regulated firm will be allowed to earn. Historical-

cost methods value the investment to which the rate-of-return

is applied based on the original cost of the plant, less amounts

found to be imprudent and less depreciation. By contrast,

TELRIC values the investment based on the current efficient

costs of establishing facilities that provide the same functions

as the LEC network. Each method can arrive at a value of the

LECs’ gross investment that is less than the LECs’ “actual”

past expenditures. Each can thus also be conceived of as

having “written off’ some fraction of that investment — just as

LECs and other corporations routinely write off some of their

investments for financial accounting purposes and report

earnings and profits to shareholders on this basis in SEC and

other filings. See AT&T Pet’rs’ Br. 4.

The basis for the LECs’ current claim is that the return on

investment component of the rate formula is referred to in the

FCC’s Order (as it is in many contexts) as representing the

“cost of capital” — that is, the earnings that a utility must

receive to be able to attract debt and equity capital

investments. Return on investment can thus be conceived of

as a cost of providing a network element or interconnection

within the meaning of § 252(d)(1A) — such that no separate

determination is required under § 252(d)(1)(B). LEC Br. 21.

But the use of the term “cost of capital” is equally apt under a

historical-cost method. See Hope Natural Gas Co., 320 US.

at 603. So notions of “profit” can be “embodied” in a

“definition of cost” under historical-cost methods as well.

LEC Br. 21. Thus, if the LECs’ claim were valid, the Act

would foreclose both historical-cost and forward-looking

methods. But the claim is clearly not valid. Whether a

ratemaking body uses the term “return on investment” or

“cost of capital,” it is exercising discretion to allow the LEC

an opportunity to earn a “reasonable profit.”'”

4. Finally, the LECs’ claims are barred by an independent

requirement of § 252(d)(1)(A) that they simply ignore. The

Act mandates not only that network element and inter-

connection rates be based on costs, 47 USC.

§ 252(d)(1XA)(i), but also that the rates be “nondiscrim-

inatory.” /d § 252(d)(1)A)ii); accord id. § 251(c)(2), (3).

Congress adopted this separate requirement to make it explicit

that LECs cannot provide interconnections and network

elements to competitors at economic costs that are higher than

the LECs themselves incur when they use the same facilities

to provide their own competing services. Order, ¥¥ 217-218,

859-862 (JA 277-78, 434-36). The LECs cannot and do not

challenge the FCC’s finding that TELRIC represents the

economic costs that LECs incur when they use network ele-

ments in their retail services and that it would be discrimin-

atory if LECs could impose higher costs on competitors. /d.

Thus, § 252(d)(1A)(ii) independently forecloses the LECs’

claim that they have a statutory right to base network element

rates on historical costs whenever historical costs are higher

than rates set under TELRIC.

For all the foregoing reasons, the Act should, if anything,

be held to foreclose historical-cost ratemaking. But to reject

the LECs’ interpretive claims, the Court need only hold that

the “general terms” of §252(d)(1) convey “broad

methodological leeway” and “say little about the ‘method

'? The LECs also have made claims (LEC Br. 22-23) based on the

separate standard that § 252(d\2) adopts for setting rates for the

“wholesale services for resale” authorized by § 251(c)(4). Because this is

a separate statutory provision, it would be besides the point even if it did

guarantee the LECs recovery of their “historical costs.” But it does not.

To the contrary, the provision allows new entrants to obtain services that

are offered at retail below their costs and that are subsidized by other

services (such as exchange access) and universal service payments under

section 254 of the Act. Order, 49 875, 907-908 (JA 436-37, 437-38).

employed’ to determine a particular rate.” AT&T Corp. v.

Jowa Utils. Bd, 525 US. 366, 423 (1999) (Breyer, J.,

concurring in part and dissenting in part).

Il. THE TAKINGS CLAUSE DOES NOT REQUIRE

THE 1996 ACT TO BE INTERPRETED TO

MANDATE HISTORICAL-COST RATEMAKING.

The LECs alternatively argue that the Takings Clause of the

Fifth Amendment required the FCC to reject TELRIC and to

adopt a method that guarantees that LECs will recover all

their historical costs in their rates for network elements and

interconnections. The LECs here concede — as they must —

that the Eighth Circuit correctly held that they have not shown

that the FCC’s adoption of a forward-looking method has

resulted or will result in an uncompensated taking of their

property and that any takings claim is not ripe for review and

premature. LEC Br. 37.

However, the LECs contend that they do not have to prove

an actual uncompensated taking to invalidate forward-looking

pricing. Although § 252(d)(1) does not compel a historical-

cost method, they claim that such a method would

nonetheless have represented a permissible interpretation of

the statutory terms and that historical-cost ratemaking would

raise no constitutional issues. By contrast, they contend that

the rates that are set under the FCC’s forward-looking

approach will give rise to “serious constitutional questions”

under the Takings Clause and that the FCC was required to

adopt an historical-cost interpretation to avoid any

constitutional doubts. LEC Br. 37.

The short answer to this claim is that “historical cost” is not

a permissible interpretation of § 252(d)(1MA)i). Even if

“cost” could be construed to mean “historical” cost — which is

doubtful - the LECs cannot and have not disputed that —

including all historical cost in network element and

interconnection rates would’ violate the separate

“nondiscrimination” requirements of § 252(d)(1)(A)ii) and

§ 251(c)(2), (3). See supra p. 23.

In all events, the LECs’ claims are otherwise meritless.

“The ‘constitutional doubts’ argument has been the last refuge

of many an interpretive lost cause.” Reno v. Flores, 507 US.

292, 314 n.9 (1993). “Statutes should be interpreted to avoid

serious constitutional doubts, not to eliminate all possible

contentions that the statute might be unconstitutional.” /d

(citation omitted), And when agency regulations are

challenged on the ground that they may be implemented in

ways that could give rise to future takings claims, the

acceptance of these interpretative contentions can “merely

frustrate[] permissible applications of a statute or regulation.”

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

121, 128 (1985). The Court has thus held that it will not

invalidate an agency’s implementing regulation unless there

is a “substantial argument” that “there is an identifiable class

of cases in which application of a statute will necessarily

constitute a taking.” Jd at 128 n.5; see United States v.

Security Indus. Bank, 459 U.S. 70, 75-76 (1982).

The LECs cannot make this showing. Even if the FCC

were here regulating the LECs’ overall regulated revenues,

this Court’s holdings establish that historical cost and

forward-looking replacement cost are each permissible

methodologies, and the FCC’s adoption of a forward-looking

method is no more likely to produce “end results” that give

rise to takings claims than is a historical-cost method.

Accordingly, the LECs’ claims that TELRIC will necessarily

produce unconstitutional results are not based on the terms of

the regulation. Rather, they rest on a series of extrarecord

factual assertions about the future effects of the regulation

that are procedurally improper, factually unsupported,

erroneous. -

A. Even If TELRIC Required That Network

Elements And Interconnections Be Provided

Below Historical Cost, The LECs Have Presented

No Serious Takings Claim.

Preliminarily, the adoption of TELRIC would raise no

federal constitutional question even if there were substantial

claims that TELRIC would result in rates for network

elements and interconnections that exclude costs that LECs

incur in providing them and that the LECs are entitled to

recover. If that were to occur, the FCC has made it clear that

the LECs are entitled to seek to recover that shortfall through

other FCC-regulated charges. Under this Court’s holdings,

this remedy precludes any claim that the adoption of TELRIC

itself presents a serious risk of an uncompensated taking.

First, contrary to the LECs’ suggestions, even if it were

certain that TELRIC rates would be below cost, that would

not itself establish an uncompensated taking. In B&O

Railroad vy. United States, 345 U.S. 146 (1953), the Court

dismissed a takings claim that rested only on the allegation

that a railroad had been required to ship a particular

commodity at a rate below its costs. The Court held that “so

long as rates as a whole afford railroads just compensation for

their over-all services to the public the Due Process Clause

should not be construed as a bar to the fixing of

noncompensatory rates for carrying some commodities.” /d.

at 150. Similarly, in Duquesne Light Co. v. Barasch, the

Court held that it was irrelevant that the utility had been

denied any compensation for its prudent investment in a

cancelled plant, for the utility’s overall revenue from all its

regulated operations was sufficient to allow it to attract

capital. 488 U.S. 299, 310-12 (1989).

Second, the FCC’s Order provides that in the event network

element rates do not cover all the costs that LECs are entitled

to recover, they can seek to make up the difference through

other FCC-authorized charges. In particular, before the FCC,

the LECs had claimed that they are threatened with a future

shortfall because they formerly were required to depreciate

their equipment over artificially long periods of time and that

they had substantial “depreciation reserve deficiencies” which

could not be recovered in network element rates under

TELRIC. In actual fact, subsequent events have eliminated

any deficiencies, and the FCC recently found that LECs now

have substantial depreciation reserve surpluses.”°

However, the detisive fact for present purposes is that the

FCC’s TELRIC Order did not hold that the LECs are to be

barred from recovering any depreciation reserve or other

shortfall. It merely concluded — consistent with the testimony

of the LECs’ economic experts (see AT&T Pet’rs’ Br. 16-

17) — that including these amounts in network element and

interconnection rates is not the proper remedy for

underdepreciated assets, for artificially inflating these charges

will distort local competition. Order, § 706 (JA 399-400).

The FCC thus provided that after TELRIC is implemented,

the LECs will be free to come to the FCC and demonstrate

that there was an unrecovered depreciation deficiency or

some other shortfall The FCC would then consider

authorizing the recovery of these amounts in universal service

surcharges or in other rates within its jurisdiction. /d $j 706-

707 (JA 399-401)?!

No LEC has attempted to show that it in fact has a shortfall

in its rates due to a depreciation reserve deficiency or

otherwise. The LECs’ claim to this Court rests on the ground

that, if a LEC were to make such a showing, the FCC might

fail to take the corrective action that would prevent an

uncompensated taking of the LEC’s property.

° Federal-State Joint Bd. on Universal Serv., 14 FCC Red. 20156,

20345 (§ 427) (1999).

*! The LECs complain that it has not yet done so. LEC Br. 11-12, 36

n.15. But whether there are residual unrecovered historical costs can only

be determined after state commissions set TELRIC-based rates.

However, under settled law, these facts do not state a

substantial claim that the adoption of TELRIC will

necessarily result in a taking of LEC property. If an

uncompensated taking were to occur, it would be a

consequence not of the adoption of TELRIC, but of the

FCC’s failure to enter an appropriate order in a future

proceeding in which the LEC demonstrated a shortfall. This

Court has held that where, as here, an agency’s regulation

rests on a reasonable interpretation of the underlying statute

and is otherwise facially valid, it cannot be invalidated based

on speculation that the agency would effect an uncompen-

sated taking in a future proceeding. Riverside Bayview

Homes, Inc., 474 U.S. at 128.

Even more pertinently, there have been two prior cases in

which federal agencies adopted new ratemaking methods and

in which the utility’s remedy in the event of a claimed

shortfall was to seek relief before the agency. In each case,

the Court rejected the same claim that the LECs make here:

that the new regulatory regime was unlawful because it failed

to adopt mechanisms to guarantee utilities the recovery of any

shortfall. FPC v. Texaco, Inc., 417 U.S. 380, 392-93 (1974);

Permian Basin Area Rate Cases, 390 U.S. 747, 770-71

(1968).

The LECs have attempted to avoid these holdings by

advancing another claim. They contend that, under the

Takings Clause, the FCC cannot rely on revenues from other

services or explicit subsidy payments to make up for any

shortfalls that may result from the LECs’ provision of

unbundled network elements. In their view, the teaching of

Brooks-Scanion Co. v. Railroad Comm'n, 251 U.S. 396, 399

(1920), is that in assessing the total effect of the order of a

regulatory agency, the inquiry must be limited to the

“segment” of the business whose “revenues” the agency “has

control over and is responsible for generating.” LEC Br. 33,

34 (emphasis omitted). It follows, the LECs claim, that the

Takings Clause required the FCC to assure that the LECs’

“UNE business” will “generate a sufficient return to stand on

its own.” /d. at 35.

But UNEs are not the only revenues that the FCC regulates,

so this latter claim would be erroneous even if the LECs’

reading of Brooks-Scanlon were sustainable.” The FCC not

only has jurisdiction over the pricing standards for network

elements, but also over LEC interstate exchange access and

other interstate charges that generate over 25% of their $112

billion in annual revenues.” Further, the LECs are now

earning returns on their interstate investment of between

17.5% and 20.8%.”* There is no basis for any claim that LEC

revenues from interstate services could not make up for any

shortfall resulting from the LECs’ provision of UNEs at

TELRIC-based rates.

B. The Adoption Of TELRIC Would Raise No

Substantial Takings Claim Even If The Method

Governed The Determination Of All Of The

LECs’ Regulated Revenues.

The LECs’ claim suffers from a far more fundamental

defect. Even if TELRIC governed the determination of all of

the LECs’ regulated revenues, the fact that it does not

guarantee a return that formally applies to all the LECs’

* Brooks-Scanion’s holding is only that an agency cannot require a

firm to operate a regulated business (there, a railroad) at a loss and rely on

unregulated revenues (there, from !umber yards and sawmills) to make up

the difference.

> Federal Communication Comm'n, Trends in Telephone Service,

Tables 16.2 and 16.4 (2000) ($29 billion in access and subscriber line

charges), available in Press Release, Federal Communication Comm'n,

FCC Releases Study on Telephone Trends (Dec. 21, 2000).

** The weighted average return of the price-cap carriers (LECs) for

2000 was 19.53%. Federal Communications Comm'n, /nterstate Rate of

Return Summary, available at http://www.fcc.gov/Bureaus/Common_

Carrier/Reports/FCC-State_Link/IAD/ror00. pdf

historical costs and investment presents no issue under the

Takings Clause.

The Takings Clause does not afford any firm a right to

recover its historical costs. It requires that the government

pay “just compensation” when “private property” is dedicated

to a public use. U.S. Const. amend. V. It has been settled for

a century that just compensation does not equal the “costs”

incurred by an owner in acquiring or developing property.

As a general matter, just compensation is determined by the

current value of the property measured by its fair market or

rental value — ordinarily “what a willing buyer would pay in

cash to a willing seller.” United States vy. Miller, 317 U.S.

369, 374 (1943). The current fair market value “may be more

or less than the owner’s investment. He may have acquired

the property for less than its worth or he may have paid a

speculative and exorbitant price.” Olson v. United States, 292

U.S. 246, 255 (1934). But “the Fifth Amendment allows the

owner only the fair market value of his property; it does not

guarantee him a return of his investment.” United States ex

rel. TVA v. Powelson, 319 U.S. 266, 285 (1943). Just

compensation under the Takings Clause is thus forward-

looking, not backward looking.

These same rules apply to regulated monopolies. _ In Smyth

v. Ames, 169 U.S. 466 (1898), the Court rejected a claim that

a railroad was entitled to rates that would fully compensate it

for its historical investment in property dedicated to public

use. /d at 543. It held that this property must be valued —

like ordinary property taken for public use — based on the

current “fair value” of utility property rather than its historical

cost. /d at 546-47. Recognizing that in most circumstances

there is no ready market for such property and hence no

established fair market value, Smyth required courts to

determine value by considering a variety of types of evidence

— including the “origina! cost of construction” and the

“present” cost of reproducing the plant — and to compute the

depreciation and return on investment components of rates

based on this valuation. /d at 547.

In FPC v. Hope Natural Gas Co., 320 U.S. 591 (1944), the

Court abandoned the rule of Smyth v. Ames as a constitutional

requirement, stating that, strictly speaking, “‘fair value’ is the

end product of the process of rate-making not the starting

point.” /d. at 601. Hope thus upheld rates that had been set

under a historical-cost method, but expressly declined to

adopt prudent investment as a constitutional requirement or to

prohibit use of forward-looking replacement cost methods. It

stated that a rate order is constitutional if its “end result” is to

provide the opportunity for a return on investment

“commensurate with returns on investments in other

enterprises having corresponding risks.” /d at 603. The

Court held that the choice of ratemaking methodology itself

raises no constitutional issue. /d.

Since Hope was decided, this Court has repeatedly rejected

claims that utilities are entitled to recover their “prudent

investments” and that the use of a “fair market value” method

is impermissible. In Market Street Railway v. Railroad

Commission, 324 U.S. 548, 564-65, 569 (1945), the Court

upheid a rate order that limited the carrier’s compensation to

the fair market value of its assets, which (due to declining

demand) were less than a third of its historical costs and were

also less than the estimates of replacement costs. The Court

has similarly rejected claims that a regulated firm has a right

to have its rates “‘base[d] .. . on [its] own [historic] costs.’”

FERC v. Pennzoil Producing Co., 439 U.S. 508, 517 (1979).

More recently, in Duquesne, the Court upheld a decision of

the Pennsylvania Supreme Court which (based on an

intervening change in state law) had revised a rate order so

that it denied the utility any return on certain investments that

had been prudent when made, but that were no longer “used

and useful.” 488 U.S. at 312 n.7. The Court noted that

Pennsylvania had thereby adopted elements of fair value

ratemaking, which attempts more closely to “mimic[]” a

competitive market. /d. at 308, 315. The Court again

rejected the claims that prudent historical investment should

be adopted as the constitutionally required ratemaking

methodology because, among other things, such a rule would

“unnecessarily foreclose alternatives which could benefit both

consumers and investors” — such as “a return to some form of

the fair value rule just as its practical problems may be

diminishing.” /d. at 316 & n.10.

The Court thus held that a rate order will be confiscatory

only if the “rates jeopardize the financial integrity of the

companies, either by leaving them insufficient operating

capital or by impeding their ability to raise future capital.” /d.

at 312. In this regard, the Court noted that the “impact of

certain rates can only be evaluated in the context of the

system under which they are imposed,” for “[t]he risks a

utility faces are in large part defined by the rate

methodology.” /d. at 314-15. And it reaffirmed that the

method adopted to value the utilities’ investment presents no

constitutional issue, for errors in valuation “may well be

canceled out by countervailing errors or allowances in another

part of the rate proceeding”: e.g. by the authorized rates of

return and depreciation. /d at 314; see id. at 317 (Scalia, J.,

concurring) (no substantial takings questions are presented in

a case that “challenges techniques rather than consequences’).

Since Duquesne, this Court has upheld rate orders that used

forward-looking replacement cost methods to set “just and

reasonable” rates. Mobil Oil Exploration & Producing S.E.,

Inc. v. United Distribution Cos., 498 U.S. 211, 224 (1991).

In short, under this Court’s decisions, the adoption of a

forward-looking replacement cost method itself raises no

constitutional issues under the Taking Clause, and a

subsequent rate order is valid so long as it allows returns on

investment that reflect the risks of operating under that

regime. TELRIC’s terms expressly require such returns. As

the FCC made explicit, TELRIC requires that depreciation

and rate-of-return calculations reflect all the risks of operating

in an environment in which rates are based on the costs of

efficiently replacing the particular network element at issue.

Order, 9687 (JA 385). On its face, TELRIC is thus a

perfectly reasonable and valid method that requires

consideration of all the relevant factors, and it palpably will

not “necessarily” lead to uncompensated takings of property

in any “identifiable class of cases.” Riverside Bayview

Homes, Inc., 474 U.S. at 128 & n.5. Further, before the FCC,

the LECs did not introduce any evidence that the necessary or

even likely effect of the adoption of TELRIC could possibly

be to jeopardize the “financial integrity” of their companies or

of even any segment of them. Compare Order, §] 738-739

(JA 421-22), with Duquesne, 488 U.S. at 312.

Finally, the reason that the validity of rate orders depends

entirely on their “end result” is that any ratemmaking method

can be applied in ways that either do or do not allow the

utility to earn an appropriate risk-adjusted return on

investment. Accordingly, forward-looking methodologies

like TELRIC are no more likely to result in meritorious taking

claims than are historical prudent-investment or other

ratemaking methods.”°

C. The LECs’ Claims Of A “Switch” In Method-

ologies Are Legally Meritless And Depend On

Erroneous Extrarecord Assertions.

The consideration of the LECs’ taking-based claims can

thus begin and end with the fact that there is no basis for a

claim that TELRIC would result in rates that are confiscatory

even if LECs’ only business were the provision of network

elements.

However, the LECs also make two related claims that

purport to be based on the Takings Clause. Each rests on

> Indeed, there have been many recent cases in which utilities raised

taking claims under prudent-investment regimes. See infra p. 44 nn.31-

32.

assertions that the adoption of TELRIC represents a “switch”

in ratemaking methodologies that will deny LECs the

recovery of substantial costs that they putatively had a right to

recover under the historical prudent cost method that

purportedly governed their operations before TELRIC was

adopted. First, the LECs rely on Duquesne’s statement that it

would “raise serious constitutional questions” if an agency

were “to arbitrarily switch back and forth between

methodologies in a way which required investors to bear the

risk of bad investments at some times while denying them the

benefit of good investments at others.” 488 US. at 315.

Second, the LECs’ claim that the adoption of TELRIC

breached a “regulatory compact” in which LECs made their

network investments in exchange for a guarantee that they

always would recover all of their historical investments.

These claims are legally baseless. Further, they rest on the

LECs’ extrarecord assertions that TELRIC has been, or might

be, applied in particular ways. But these claims are out of

order in an appeal from the “final agency action” that adopted

TELRIC. Compare LEC Br. 37. In addition, the claims do

not rest on competent evidence, and are demonstrably

erroneous.

The basic fallacy of both LEC claims is that TELRIC

simply does not represent a “switch” in ratemaking

methodologies. The FCC’s adoption of TELRIC to set

interconnection and network elements rates has no effect on

the ratemaking methods that govern the interstate and

intrastate telecommunications services that LECs have

historically provided. These services continue to be subject to

the ratemaking methods that were in effect before the 1996

Act was adopted and implemented. For the same reasons,

TELRIC does not “rewrit[e] the terms of thousands of

regulatory transactions [long] closed” (id. at 30), and the

rhetoric of “harsh retroactivity” and a regulatory “bait and

switch” that pervades the LECs’ Brief is simply inapt. /d. at

29, 30. That is particularly so because it has been the case for

more than a decade that the LECs have been subject to a price

cap regime in which they did not have any right to a return on

all historical prudent investment.

Rather than change the regulatory treatment of the LECs’

existing interstate and intrastate telephone services, the FCC

adopted TELRIC to govern the pricing of new wholesale

arrangements — interconnections and network elements — that

LECs were required to provide for the first time by virtue of

the 1996 amendments to the Communications Act. By

adopting TELRIC for this purpose, the FCC was following

the same ratemaking method that governed the setting of rates

for other essential facilities that LECs provide to their

competitors. And while the new arrangements allow new

entrants to offer local services that compete with those of the

LECs, in the nearly five years since TELRIC was adopted,

fewer than 3% of the nation’s telephone lines have switched

to firms that use unbundled network elements to offer

competing services.”°

1. TELRIC Is Not An impermissible Switch In

Methodologies That “Strands” Investment.

The “serious constitutional questions” that Duquesne

identified arise only if an agency arbitrarily switches

ratemaking methods back and forth “in a way which required

investors to bear the risk of bad investments at some times

while denying them the benefit of good investments at

others.” Duquesne, 488 U.S. at 315. Here, there has been no

switching of methods, much less switching back and forth.

And the effect of the adoption of TELRIC was neither to

require investors to bear the risk of bad investment nor to

deny them the benefit of good ones. In short, the LECs

*° Press Release, Federal Communications Comm'n, FCC Releases

Latest Data on Local Telephone Competition (May 21, 2000) (new

entrants serve 8.5% of lines, about one third of them using unbundled

network elements).

simply have not made the showing that would, in Duquesne’s

words, “raise serious constitutional questions.” /d.

The LECs are thus reduced to contending that Duquesne

adopted another very different rule, sub silentio. Specifically,

they contend that, under Duquesne, a tribunal cannot lawfully

adopt a forward-looking method unless it demonstrates that it

will permit a utility to achieve rates that fall with the same

range as would result from the operation of an historical

prudent-investment method. LEC Br. 27. The LECs claim

that the adoption of TELRIC violates this rule because it

allegedly was “designed” to produce network valuations that

are 50%-60% lower than those that would be produced under

a historical-cost method. LEC Br. 40. In their view, it

follows that TELRIC will unlawfully “strand” the LECs’

prudent investment. These claims have no basis even apart

from the LECs’ misplaced reliance on the concept of

“stranded investment.”

Duquesne did not adopt a rule under which regulatory

agencies could depart from historical-cost methods only if

they showed that the departure would have no substantial

”” “Stranded” investment refers to “investments in specialized, durable

assets that may have seemed necessary, or at least justifiable, when

constructed and placed into service under a regime of price and entry

controls but that have become underutilized or even useless under

deregulation,” such as an electric generation plant that is idled by an

agency order requiring transmission of competitively generated power. H.

Hovenkamp, The Takings Clause and Improvident Regulatory Bargains,

108 Yale L. J. 801, 802-03 (1999) (book review). Stranding would only

occur under the Act if the LECs’ network facilities became underutilized

because competitors constructed and used alternative facilities. By

no stranding occurs. See W. Baumol & T. Merrill, Does The Constitution

Require That We Kill The Competitive Goose? Pricing Local Phone

Service To Rivals, 73 N.Y.U. L. Rev. 1122, 1143 (1998). Because the

sole issue here relates to the rates LECs receive when they lease out their

facilities, the LECs reliance on the FERC’s stranded-cost orders is wholly

misplaced, LEC Br. 12 n.8.

effect on the resulting rate levels. The object of all

ratemaking is to foster efficiency and to prevent rates that

recover inefficient or wasteful expenditures. The Federal

Constitution could not preclude the adoption of a ratemaking

method merely because it is more effective in carrying out

these objects than the prudent-investment method (which the

FCC previously determined to foster inefficiencies that

regulators are incapable of preventing).

The LECs are simply wrong in arguing that Duquesne held

otherwise. Their contentions rest only on the Court’s

statement that the utility had not claimed that the “total

effect” of the revised rate order was unconstitutional, for this

order differed in only de minimis ways from the prior order

that the utility was seeking to reinstate. Duquesne, 488 U.S.

at 311-12. That was a description of the two orders, not a

statement of constitutional requirements.

Contrary to the LECs’ misstatement (LEC Br. 9, 40), the

FCC did not “adopt{] TELRIC with the express purpose of

producing prices lower than historical costs.” Rather, the

FCC determined that the competitive goals of the Act

demanded pricing based on economic costs, “which may be

higher or lower than historical embedded costs.” Order, 9 705

(JA 399). And, there is palpably no basis for the LECs’ claim

that the FCC adopted TELRIC because it was designed to

value the LECs’ networks at levels 50-60% lower than would

a prudent historical-cost method. As explained above (supra

pp. 8-13), these claims rest on extrarecord assertions that are

unsupported, that rest on apples-to-oranges comparisons, and

that are inconsistent with the very data sources upon which

the LECs rely.

But even if the overall network valuations were certain to

be lower under TELRIC, that would only raise the question of

why this difference exists. If it were the product of facts that

would have foreclosed the LECs’ recovery of the difference

under strict applications of a prudent-investment

methodology, the difference obviously would have no

constitutional or other significance. For example, any

prudent-investment regulator would exclude from the rate

base the substantial amount of phantom assets that appear on

the LECs’ books, but that are not in use in the LECs’

networks. Continuing Prop. Records Audit, 14 FCC Red.

7019, 7019 (4 1) (1999). It should similarly exclude the vast

amounts of excess capacity the LECs have installed to

provide unregulated enhanced services in the future. In this

regard, a major reason that AT&T and others advocated

TELRIC is that it is a very efficient way of determining how

the LEC networks should be sized to meet existing demand

and of preventing LECs from recovering from competitors the

costs of present excess capacity that was installed to support

the LECs’ future competitive services.

Finally, even if TELRIC were certain to produce lower

asset values and thus a lower “rate base” than would other

ratemaking methods, the “end result” could still be the same.

The effects of a lower TELRIC rate base “may well be

cancelled out by countervailing errors or allowances in

another part of the rate proceeding.” Duquesne, 488 US. at

314. Indeed, the favorable effects of depreciation” or cost-

of-capital”’ allowances may offset any effect of the different

2° TELRIC permits economic depreciation that reflects expected price

declines and the risk of obsolescence associated with technological

change, Order, § 686 (JA 384-85). That would result in higher depre-

ciation allowances than the LECs receive under historical-cost methods,

particularly if it were true (compare LEC Br. 4) that regulators require

artificially prolonged useful lives.

2° In Duquesne Light Co. v. Barasch, the Court held that the regulators’

exclusion of certain prudent investments from a utility's rate base raised

no constitutional issue, for the utility had received a rate-of-return higher

than the minimum that would have been required under a prudent-

investment method. 488 U.S. 299, 312 (1989). In making its

determinations under TELRIC, the FCC currently uses a rate-of-return of

11.25%, which was established in 1990. See supra p. 5n.1. That was an

exceedingly generous rate-of-return even at that time, and because interest

methods for valuing the rate base. Thus, the “end result”

could be the same under either method.

2. The LECs’ Regulatory Compact Claim Is

Meritless.

There is similarly no foundation for the LECs’ suggestion

that the adoption of TELRIC violated a regulatory compact in

which they built local networks in exchange for a promise

that they could recover their historical costs in rates. The

LECs assert — without citation of authority — that under any

constitutional ratemaking regime “investors expectations are

settled by a predictable mechanism that informs investors in

advance how they will be paid.” LEC Br. 24. But that

assertion is squarely foreclosed by Duquesne, which upheld a

revised rate order that excluded $35 million of investment

that was recoverable under the prior ratemaking method. 488

U.S. at 312-14. And while regulatory compacts can exist, the

LECs simply are not parties to one.

First, contracts specifying regulatory duties and

entitlements were sometimes entered into during the

nineteenth-century, usually in the form of corporate charters

to internal improvement corporations or franchises for use of

the public right-of-way. See R. Seavoy, 7he Origins Of The

American Business Corporation, 1784-1855, at 39-51 (1982).

However, this Court then held that the power to regulate rates

existed independently of any compact to dedicate property to

public use. See Munn v. Illinois, 94 U.S. 113, 125-26, 133

(1876); accord Nebbia v. New York, 291 U.S. 502, 536-39

(1934). And rate regulation was imposed on the LECs after

they had made their investment, not as the quid pro quo in a

regulatory compact. See H. Hovenkamp, 7he Takings Clause

and Improvident Regulatory Bargains, 108 Yale L. J. 801,

804-05 (1999) (book review).

rates and costs of equity are radically lower today, a much lower rate-of-

return could now be applied under a prudent-investment regime.

Further, neither the state nor federal regulatory schemes

ever guaranteed any LEC that it could recover all historical

costs. To the contrary, the LECs expanded and maintained

their networks subject to the very general standard that the

rates must be “just and reasonable,” which affords the agency

considerable “pricing flexibility” to change methodologies as

the public interest requires. Mobil Oil Exploration &

Producing S.E., Inc., 498 U.S. at 224. Under this regime, the

LECs unilaterally decide which investments to make. To

enforce the “just and reasonable” standard, regulators can

review a LEC’s investments long after they were made to

decide whether they should be included, in whole or part, in

the “rate base” under the policies that the regulatory body

then chooses to apply. See Hovenkamp, supra, at 822.

Under these systems, it is well settled that even if a

regulatory commission made an affirmative decision to

include an investment in a rate case in one year, the

commission may make a different determination in future

years by either adopting a different policy or ratemaking

standard or by applying its prior standard more rigorously.

As this Court has held, “[t}he declaration of a specific policy

creates no vested right in its maintenance in utilities then

engaged in the business,” Zennessee Electric Power Co. v.

TVA, 306 U.S. 118, 141 (1939), and a court will not “set aside

[a rate order] merely because the Commission has on an

earlier occasion reached another result” under a different

ratemaking standard. Permian Basin Area Rate Cases, 390

U.S. 747, 784 (1968).

The fact that the regulatory environment was structured to

encourage LECs to invest in their network to promote

universal service does not create a binding obligation to base

rates on historical costs. Uniess the government has by

express terms of a contract committed itself to a particular

regulatory course, it is not bound to compensate a regulated

entity that claims to have relied on the prior scheme. See

United States vy. Winstar Corp., 518 U.S. 839 (1996);

Louisville Bridge Co. v. United States, 242 U.S. 409, 420

(1917); J. Rossi, The /rony of Deregulatory Takings, 77 Tex.

L. Rev. 297, 308-09 (1998) (book review). The LECs have

no more right than any other entity to be compensated for the

inability te recover all past investment due to regulatory

change. Cf. Keystone Bituminous Coal Ass'n v.

DeBenedictis, 480 US. 470, 495 (1987) (describing

“regulatory takings”).

Ill. THE FCC’S REJECTION OF THE LECS’

HISTORICAL-COST PROPOSALS WAS NOT

ARBITRARY AND CAPRICIOUS.

Finally, there is no substance to the LECs’ claims that it

was arbitrary and capricious for the FCC to reject historical-

cost ratemaking and to adopt a forward-looking method. As

this Court has held, the determination of the proper cost

standard to use in setting rates is one of the “kind of basic

judgments about economic policy” that is uniquely committed

to the discretion of federal agencies and that courts are ill-

suited to second-guess. American Commercial Lines, Inc. v.

Louisville & Nashville R.R., 392 U.S. 571, 590 (1968).

Accordingly, to succeed on their claims, the LECs must show

that the FCC failed “adequately [to] consider[] the factors

relevant to choosing a rate that will best serve the purposes of

the statute” and that it “committed a ‘clear error of

judgment’” in rejecting historical-cost ratemaking. American

Paper Inst., Inc. y. American Elec. Power Serv. Corp., 461

U.S. 402, 413 (1983). The LECs have not come close to

satisfying this demanding standard.

Indeed, the reasonableness of the FCC’s rejection of

historical cost is established by the most elementary

principles of economics and by the decade of regulatory and

antitrust decisions that provided the background to the 1996

Act and that have been discussed throughout this brief.

First, the FCC and most states had determined that

historical-cost ratemaking fosters’ inefficiencies that

regulators are incapable of controlling even in the very

different context of regulating the LECs’ overall revenues and

earnings. The regulatory task in the performance of this

function is merely determining the reasonable costs of a

regulated firm as a whole and attempting to prevent it from

earning monopoly profits. This function required no

determinations of costs attributable to individual different

facilities, functions, services, and locales. Nor did it present

the regulated firm with incentives to misallocate costs among

different facilities, functions, services, or areas to prevent or

distort competition.

Second, the FCC and states had determined that historical-

cost ratemaking methods are flatly inappropriate when the

issue is establishing the conditions that will allow competition

with retail services of the incumbent LEC. There is no truism

more elementary in all of economics than that historical costs

are irrelevant because they are “sunk” and “unavoidable,”””

and that the relevant costs to decisionmaking in competitive

markets are forward-looking costs. These are the “real” and

“economic” costs that LECs incur when they use the essential

facilities that they control to provide services at retail in

competition with other firms. For that reason, these are the

costs that the FCC and other regulatory bodies have long

relied upon in determining the rates that LECs may charge

prospective competitors for access to those essential facilities.

Against this background, to accept the LECs’ claims that

rates for network elements and interconnections should be

based on historical cost, the FCC would have had to repudiate

its own consistent prior decisions and the decisions of other

regulatory bodies and antitrust authorities. AT&T Pet’rs’ Br.

6-12. The notion that its failure to do so could have been

arbitrary and capricious stands basic principles of

Regulation: Pricing, 4 Yale J. on Reg. 191, 225 (1987).

administrative law on their head. And there is not the

slightest substance to the claims that the LECs have made. ~

A. All Ratemaking Methods Are Hypothetical And

There Is No Basis For The Claim That Other

Methods Would Fulfill The Act’s Objectives At

Lower Administrative And Other Costs.

The LECs’ primary claim is that it was arbitrary to reject

their historical-cost proposals because the alternative forward-

looking method is “hypothetical” and difficult to administer.

These contentions are baseless.

1. As Professors Baumol, Willig, and Ordover testified

before the FCC, “[a}// cost-based ratemaking standards

(including embedded cost ratemaking) involve hypothetical

constructs.” Baumol et al. Reply Aff. at 6 n4 (JA 147).

Prudent historical-investment and replacement-cost methods

are both “hypothetical” for each seeks to foster efficiency by

determining not what the utility is spending, but what it

should be spending. The only difference is that one method

makes hypothetical determinations by looking “forward” and

the other by looking “backward.”

TELRIC and other efficient replacement-cost methods

determine the particular facilities that are required to meet the

existing demand and what it would cost to construct and

operate them from the “bottom up.” It thus determines what

an appropriately sized network should cost by looking

forward.

Prudent historical-investment ratemaking makes the same

determination on a backward-looking basis. It begins with

the utility’s existing assets and determines whether they

should have been configured differently. But it does so by

examining all of the historical decisions that caused the

existing configurations to decide whether they are ones that

“*reasonable utility management .. . would have made, in

good faith, under the same circumstances, and at the relevant

point in time.”” New Orleans v. FERC, 67 F.3d 947, 954

(D.C. Cir. 1995). As Judge Levanthal stated, “a conclusion of

imprudence reflects a view of how business should be

conducted.” 7WA, Inc. v. CAB, 385 F.2d 648, 656 (D.C. Cir.

1967).

In circumstances where costs were rising rapidly and

commissions had strong incentives to determine if utilities

had acted inefficiently in ways that harm the public,

applications of the prudent-investment methodology have

entailed extraordinarily detailed retrospective reviews of all

the stages in a utility’s internal decisionmaking processes

over long periods of time. Based on these archeological

expeditions, commissions have made assessments of the

reasonableness of each incremental investment made during

that period.*' When imprudence is found, commissions then

determine what costs the utility would have incurred in the

hypothetical world in which it had been prudent. These

inquiries entail such things as deciding what costs would have

been if construction of a new plant had or had not been

temporarily halted, abandoned or accelerated, if the utility

had or had not sold off certain facilities and purchased

substitutes, or if the utility had managed itself differently in

myriad other respects.”

2. One reason that leading economists urged a forward-

looking method is that there is evidence the existing LEC

networks are inefficient, contain phantom assets, and were

intentionally overbuilt with capacity that is not needed to ~

meet existing demand, but that will be used only to provide

unregulated enhanced and other new services in the future.

| See, e.g., Long Island Lighting Co. v. PSC, 523 N.¥.S.2d 615 (N.Y.

App. Div. 1987), Kansas Gas & Elec. Co. v. State Corp. Comm'n, 720

P.2d 1063 (Kan. 1986), vacated in part, 481 U.S. 1044 (1987), Entergy

Gulf States, Inc. v. Louisiana PSC, 726 So.2d 870 (La. 1999).

32 See cases cited inn.31. See also, e.g., Consumers’ Counsel v. FERC,

914 F.2d 290, 2% (D.C. Cir. 1990); Connecticut Light & Power Co., 43

FERC § 63,029, at 65,228, 65,231 (1988).

See supra pp. 7-8. In this context, TELRIC and other

forward-looking methods are the lowest cost methods of

determining the efficient level of investment required to meet

the existing demand, for they simply size and then cost a

network from the “bottom up.”

By contrast, the administrative and litigation costs of

rigorously making these same determination under a

backward-looking __historical-cost method would be

prohibitive. It would require penetrating the LECs’ books

and reviewing years of network planning decisions. The

problems would have been radically compounded by the fact

that the objective of the 1996 Act is not to determine the

LECs’ average statewide costs, but to determine the costs that

LECs incur in providing services in discrete areas having

different population densities and terrain. Order, ¥ 965 (JA

439). Because the LECs’ historical costs are kept on state-

wide or similar bases, this would have required allocations of

book costs that would be complex and arbitrary. In short, the

LECs have it exactly backwards in claiming that a prudent

historical-cost approach would have helped in “speeding the

transition to competition.” LEC Br. 46. If rigorously applied

in an attempt to foster the Act’s procompetitive goals, a

prudent-investment method would be slower, not speedier,

and more expensive, not cheaper. Furthermore, as the FCC

found, the end result of that process likely would have been

rates that impede or foreclose competition, not rates that

promote it. Order, J 705 (JA 398-99).

3. The LECs’ claims that forward-looking costing is

administratively infeasible rest primarily on Justice

Brandeis’s 1923 opinion that criticized fair value ratemaking

and summarized his reasons for then believing prudent-

investment methods could achieve the same benefits at lesser

costs. LEC Br. 45. But Justice Brandeis was addressing the

determinations of the costs of service of an entire firm based

on its books — where the sole object is to prevent the firm

from earning monopoly profits”? He was not addressing the

matter of determining the cost of providing different facilities

and functions in different locales — where the object is to

assure that incumbent monopolists and their competitors

obtain the same essential facilities at the same economic

costs. Justice Brandeis also made his statements before there

had been any experience with prudent-investment ratemaking,

much less the experience that caused it to be rejected by the

FCC and most states for the purpose for which Justice

Brandeis had thought it to be well suited. This was also long

before replacement cost pricing was not only proven

eminently feasible, but also became commonplace, by the

developments in computer modeling in more recent decades.

Finally, Justice Brandeis manifestly did not argue that a

commission should be required to use prudent investment if it

determined based on experience that another method would

be more effective for a different purpose.

The reality is that by 1996, forward-looking incremental

costing approaches were the norm in this context. They had

been successfully used for years by states in setting LEC

prices for individual services and facilities, and the states had

begun to apply long run incremental cost (“LRIC”) methods

to the pricing of network elements. See Order, | 631 (JA

334-36). Indeed, they are such a staple of state regulatory

oversight that LRIC cost studies are required by statute in

many jurisdictions. ** LRIC had been used by antitrust courts

in resolving claims that Bell companies had engaged in

predatory pricing by pricing individual services below their

33 Similarly, this was the subject matter of the FCC’s 1992 Order that

adopted historical-cost regulation to regulate retail cable television rates.

Implementation of Sections of the Cable Television Consumer Protection

and Competition Act of 1992: Rate Regulation, 9 F.C.C.R. 4527 (1994).

4220 I Comp. Stat. 5/13-502(c); Mich Comp. Laws Ann.

§ 484.2208(9); Minn. Stat. Ann. §§ 237.59, 237.772; Tex. Util. Code Ann.

§ 58.055(c); Utah Code Ann. § 54-8b-3.3(5), Wy. Stat. Ann. § 37-15-

402(a).

relevant costs; by the Surface Transportation Board in pricing

railroad services; and now has been adopted by the European

Commission in opening its local markets to competition. See

AT&T Pet’rs’ Br. 8-12, 19-21, 32-33. The LECs also ignore

that the FCC’s thoughtful and well-supported predictive

judgment has been proven correct — notwithstanding the

LECs’ claims of administrative unfeasibility, virtually all

states have, in fact, managed to apply forward-looking pricing

principles to estimate efficient replacement costs and

establish network element and interconnection rates. See id.

at 21n.23.°

In light of this experience, the LECs grasp at straws in

contending that the FCC did not provide adequate explanation

of the administrability of TELRIC. Indeed, in addition to

relying on the state regulatory experience, the FCC conducted

“an initial examination” of various LRIC computer models

that were submitted for the record, and concluded that “the

remaining practical and empirical issues can be resolved in

the near future.” Order, J 835 (JA 433).

Certainly, the FCC’s expert determination of what methods

are most cost effective is entitled to substantial deference,

particularly where, as here, most of the LECs’ complaints

about administrability are simply anachronistic.

°° The LECs falsely claim that it took the FCC four years “of revising

and updating various cost models” to “finally decide that TELRIC could

be used to project costs accurately.” Br. at 45. In fact, the FCC never

wavered from its initial proposal that universal service costs, like network

element and interconnection rates, should reflect forward-looking costs.

And the proceedings to choose a particular cost model and inputs were

completed in less than twenty-eight months, Federal-State Joint Bd on

Universal Serv., 14 FCC Red. 20156, 20161 (¥ 5) (1999), notwithstanding

the LECs’ steadfast refusal to cooperate and provide customer location

and other data within their sole control.

B. Competitive Pricing Of Network Elements Does

Not Frustrate The Act’s Purposes.

In the last two pages of their brief, the LECs make five

cursory arguments that TELRIC is contrary to the Act. LEC

Br. 48-49. One is a claim that they promise to elaborate on in

their response brief to AT&T’s and the FCC’s appeal. AT&T

will address that argument in its Petitioner’s Reply Brief. The

other four arguments can be summarily dismissed.

First, relying on an out-of-context statement from Justice

Breyer’s separate opinion in AT&T Corp. v. Iowa Utilities

Board, 525 U.S. 366, 424 (1999), the LECs claim that the

adoption of TELRIC short-circuits the “process” of

competition and seeks to mandate a set of retail prices that

would represent the “‘end result” of competition. LEC Br.

48 (emphasis omitted). But Justice Breyer addressed the

initial FCC rules in which there was no “limit” on the ~

facilities that could be leased as network elements under

TELRIC. Under the FCC’s current rules, the only facilities

that can be leased from the LECs are those that competitors

plainly need to offer competing services. As the FCC’s

findings establish, the availability of these facilities at

TELRIC-based rates is thus necessary for competition to

develop in the “unshared” parts of the network and to begin a

“process” that will drive retail prices closer to competitive

levels. Compare 525 U.S. at 430. By contrast, as the FCC

found, if LECs could impose higher prices under a historical-

cost method, the LECs could foreclose even the limited

competition that has developed in the last five years. Order,

q 705 (JA 398-99).

Second, LECs claim that the FCC did not justify its

assertions that historical costs would foster inefficient entry,

and wonder how higher rates could induce inefficient

competitors to enter the market. But the FCC’s point, fully

explained in the order, was that the entry — not the entrants —

would be inefficient if prices did not reflect true economic

costs. The FCC repeatedly pointed out that inflated network

element rates provide improper price signals and would cause

investments in facilities that LECs can provide at a lower

economic cost than any new entrant. See Order, {{] 620, 635-

636, 679, 708-711 (JA 327-28, 340-43, 379-80, 401-03).

Third, the LECs claim that the FCC ignored the threat to

genuine competition from UNE prices that are too low. The

LECs here simply repeat their unfounded claim that TELRIC

does not represent the economic costs of providing the

elements. If prices for essential inputs are set at economic

costs, there is no underpricing. Moreover, given the high

transactions costs of leasing network elements, new entrants

still have ample inducement to engage in facilities-based

competition, as AT&T is doing. See AT&T Pet’rs’ Br. 14-15.

In any event, Congress did not favor one entry strategy over

another, Order 9 12 (JA 271-72), and efficiency in network

element rates is not to be sacrificed based on projected and

dubious effects on facilities-based competition.

Finally, the LECs renew their regulatory-compact

arguments, now under the arbitrary-and-capricious banner,

claiming that the opportunistic changing of regulatory rules

will be a disincentive to future investment. But it is Congress

that has set the rules of this game; the FCC has simply

adopted methods consistent with those rules and suited for the

new competitive environment. Moreover, TELRIC is

structured to ensure a return on investment, see supra pp. 21-

23, and it gives the same incentives to capital investment as

exist in a competitive market.

CONCLUSION

For the reasons stated, the Eighth Circuit decision should be

affirmed insofar as it upheld forward-looking pricing.

Respectfully submitted,

MARK C. ROSENBLUM DAVID W. CARPENTER*

LAWRENCE J. LAFARO PETER D. KEISLER

RICHARD H. RUBIN DAVID L. LAWSON

AT&T CORP. STEPHEN B. KINNAIRD

295 North Maple Avenue C. FREDERICK BECKNER III

Basking Ridge, NJ 07920 SIDLEY AUSTIN BROWN &

(908) 221-8410 Woop

1722 Eye St., N.W.

Washington, D.C. 20006

(202) 736-8000

Counsel for Respondent

June 8, 2001 * Counsel of Record

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.