Incumbent telephone companies make a last stand

April 1, 2000

The companies tell the 8th Circuit Court that the Telecom Act "takes private property" unconstitutionally because the FCC's method of setting interconnection prices is unjust. But regardless of the legal outcome, the incumbents may yet prevail if the November elections put a Republican in the White House.

By Stephen N. Brown

The Telecommunications Reform Act of 1996 established two ways to make local phone markets competitive: Incumbents were to "unbundle" (lease or sell certain parts of their networks to competitors), and at the same time, competitors were to be encouraged to build new local facilities. The law supposedly does not emphasize one path over the other. Now, after four years of litigation, rulemakings, and abortive legislative proposals to amend the Telecom Act, the incumbents are making a final effort to regain lost ground by arguing that the Federal Communication Commission (FCC) has overly emphasized unbundling to the detriment of facilities-based competition.

The Telecom Act became law in January 1996, and by August of that year, the FCC completed its rules to implement the law. Local phone companies and state utility commissions immediately challenged the rules, saying to the U.S. 8th Circuit Court of Appeals that the FCC had no authority to issue such rules and that such authority resided only with the states. By the end of 1996, the court had agreed with their complaint and set aside the agency's rules. Over two years later, the Supreme Court overturned the lower court's decision and restored the FCC's primacy.

Meanwhile, in late 1997, SBC Communications challenged as unconstitutional the Telecom Act's conditions under which incumbents could enter the long-distance market. The company, joined by other incumbents, won its argument at a federal district court, but the lower court's ruling was reversed by the U.S. 5th Circuit Court of Appeals. This issue was finally settled in January 1999 when the Supreme Court refused to hear any further appeal.

In 1999, the incumbents launched a legislative effort to amend the Telecom Act to allow incumbents to offer data services in long-distance markets. That initiative died. The incumbents tried but failed to stop the FCC from imposing "line sharing," where the incumbents' share their digital subscriber lines with competitors.

Undaunted by this litany of failure, the incumbents appeared before the 8th Circuit Court last August to argue that they were being deprived of their 5th Amendment rights to just compensation for competitors' use of incumbents' facilities. The lower court has yet to make a ruling, but no matter who wins, the decision is sure to be appealed to the Supreme Court, so there will be no resolution before 2001. Although the immediate legal issue deals with property rights, the ultimate question the court must answer is whether the Telecom Act must be administered in a way that is equally faithful to the law's dual intent of unbundling incumbents' networks and encouraging competitors to build new facilities.

The companies object to the FCC's pricing method known as TELRIC, the total element long-run incremental cost methodology. The point and counterpoint between the incumbents and the FCC quickly get to the heart of the issue. The companies told the court: "Because of rapid technological progress in telecommunications, reproduction costs are now lower than historical costs...TELRIC allows incumbents to recover only the forward-looking costs of a hypothetical network, which are necessarily lower than those of a real network....TELRIC strands [the companies'] past investments."

But technological advancement always reduces the value of earlier technology. Thus, the U.S. Department of Justice, acting as the FCC's attorney, countered by saying reproduction costs in "competitive markets tend to correspond [not to] the cost of reproducing the existing plant...[but to] the current cost of reproducing the service with the most modern technology available."

Placing economic principles into practice is easier said than done. The incumbents told the court that "any projection of costs...must acknowledge...realities: Networks are built to last longer than the blink of an eye; they cannot be rebuilt instantaneously every time a marginally more efficient technology or configuration comes along; decisions made in one stage of deployment necessarily limit the options available in later stages; early decisions lock a carrier into a technology or design." The incumbents also tie their criticisms to one of the Telecom Act's original purposes: "The FCC's use of unrealistic...assumptions has an intensely practical, real-world consequence. It frustrates Congress's purpose of promoting facilities-based competition."

But the Department of Justice responded that the companies "misperceive Congressional intent....[I]t did not elevate facilities-based competition over other entry strategies and clearly did not intend to promote inefficient entry [into local markets]."

This defense of FCC policy fits perfectly with the agency's often expressed opinion that replacing the wired network is too expensive for the country (see Lightwave, March 2000, page 18, and December 1998, page 14). Although the companies say the FCC is giving short-shrift to its obligation to encourage the building of new wired facilities, this is well within the commission's prerogative, according to the Department of Justice. The Justice Department told the 8th Circuit Court that the "Supreme Court recognized that much of the Telecom Act was ambiguous and that Congress was 'well aware' that ambiguities would be resolved by 'the implementing agency.'" Also, in an apparent game of judicial hard-ball, the Justice Department reminded the 8th Circuit that since the lower court had been overruled in its 1996 decision by the Supreme Court, the same thing could happen again. "The Supreme Court rejected on the merits much of this Court's [the 8th Circuit] analysis...the Supreme Court's decision undermines the basis for this Court's prior decision," the Justice Department asserted.

The Justice Department's stance that the "ambiguous legislation" was designed to be resolved or clarified by the implementing agency highlights the vulnerability of current national policy. It is unstable because its longevity is strictly a function of the FCC decision-makers who are in power for the time being. If the agency's commissioners change, as they surely will with a Republican president, then the agency's policy changes, too.

One leading contender for president has already expressed an unfavorable opinion of the process. Sen. John McCain (R-AZ), one of five U.S. senators who voted against the Telecom Act's passage, said in a recent editorial, "The Telecommunications Reform Act of 1996 is a lemon and it's not hard to understand why...the Act represents Congress's attempt to cater to the fundamentally irreconcilable interests of the telecom industry's big incumbent players and their big-business customers....I've never been on the Act's bandwagon and never will be."

The instability of current policy is most clear when considering three "ifs." If the Supreme Court continues to see the Telecom Act as a law where all ambiguities are settled by the implementing agency and if McCain is elected president, then a new set of FCC commissioners can reverse the agency's TELRIC methodology and line-sharing decisions, even if the incumbents lose their legal arguments. The new holders of power can justify the change by saying they are trying to restore balance to a federal policy that places too much emphasis on access to current facilities and too little emphasis on building new facilities, and there would be nothing anyone could do about it.

Of course, those commercial interests who would move into power if the presidency changes hands would be delighted. But this kind of change would lead to a repetition of the see-saw unpredictability that has characterized the last four years of telecommunications policy, which has been much more a function of raw political power than of long-lived principles that supersede political parties. Thus, the flap over McCain's letters to the FCC, which received much attention in January, was much ado about politics as usual. At least in writing his letters, McCain left a deliberately visible trail, a tactic not practiced by most Washington power brokers.

Ultimately, there are two ways to achieve a stable national telecommunications policy from 2001 through 2005. Congress could reclaim its share of authority over the making of national telecommunications policy by amending the Telecom Act, something that is possible if the same party controls both the executive and legislative branches. The other way is for the current party in power to retain the presidency, which assures continuity with the current regime of FCC decision-makers. We will know more in November.

Stephen N. Brown writes on public policy in telecommunications. He can be contacted by e-mail at [email protected] or telephone: (615) 399-1239.