Federal Communications CommissionFCC 07-176

Before the

Federal Communications Commission

Washington, D.C. 20554

In the Matter of
Establishing Just and Reasonable Rates for Local Exchange Carriers / )
)
)
) / WC Docket No. 07-135

Notice of Proposed Rulemaking

Adopted:October 2, 2007Released:October 2, 2007

Comment Date:[30 days after publication in the Federal Register]

Reply Comment Date:[45 days after publication in the Federal Register]

By the Commission:

I.Introduction

  1. In this Notice, we initiate a rulemaking proceeding to consider whether the current rules governing the tariffing of traffic-sensitive switched access services by local exchange carriers (LECs) are ensuring that rates remain just and reasonable, as required by section 201(b) of the Communications Act of 1934, as amended (the Act).[1] In particular, we focus on allegations that substantial growth in terminating access traffic may be causing carriers’ rates to become unjust and unreasonable because the increased demand is increasing carriers’ rates of return to levels significantly higher than the maximum allowed rate. Although it is reasonable for carriers to seek to increase demand for their services, it is also critical to ensure that rates remain just and reasonable over time as costs and demand change. It has become increasingly important to ensure the reasonableness of rates since the deemed lawful provision in section 204(a)(3) of the Act was adopted because that provision protects unsuspended rates from refund liability.[2] As discussed in detail below, to achieve these goalswe tentatively conclude that certain rule modifications are necessary, and we seek comment on those as well as other proposals.

II.Background

A.Tariff Process for Local Exchange Carriers

  1. Incumbent LECs are required to file and maintain tariffs with the Commission.[3] Carriers subject to rate-of-return regulation must file tariffs every two years for a two-year period as provided in section 69.3(f), but may file tariffs at any time pursuant to the policy that tariffs are carrier initiated.[4] The National Exchange Carrier Association, Inc. (NECA) files an access tariff each year on behalf of the carriers that participate in that tariff. Tariffs must be filed in advance of their effective date in order to provide the Commission and the public with notice of changes in carriers’ rates, terms, and conditions of service, and to provide an opportunity for interested parties to evaluate and comment on proposed tariffs.[5] Pursuant to section 204 of the Act, the Commission, during the notice period, may suspend the effectiveness of a tariff and initiate an investigation to determine whether the tariff is just and reasonable.[6] In the Streamlined Tariff Order, the Commission concluded that the statute “contemplates pre-effective tariff review by identifying specific actions that we can take, i.e., suspension and investigation, prior to the effective date of the tariff [and that] pre-effective review is a useful tool to assure carriers' compliance with sections 201 through 203 of the Act."[7] If a tariff investigation has not been completed within five months of the tariff’s specified effective date, the proposed tariff goes into effect subject to the results of the investigation.[8] At the conclusion of the investigation, the Commission may prescribe rates prospectively and order refunds as necessary for any period in which the tariff was in effect.[9]
  2. In the 1996 Act, Congress enacted section 204(a)(3), which provides that LEC tariffs that take effect on seven days notice after filing (when rates are reduced) or 15 days notice (for any other change) after filing are “deemed lawful” unless rejected or suspended and investigated by the Commission.[10] In the Streamlined Tariff Order,the Commission concluded that a tariff filed pursuant to section 204(a)(3) (a “streamlined” tariff) that takes effect, without prior suspension and investigation, is conclusively presumed to be reasonable under section 201 and is thus protected from retrospective refund liability in a formal complaint proceeding, even if the carrier is ultimately found to have overearned.[11]
  3. The Commission may investigate the lawfulness of an effective tariff pursuant to section 205 of the Act.[12] In this case, if the Commission finds that the tariff is unlawful, the Commission may prescribe lawful rates prospectively and require that any subsequently filed tariffs conform to such prescription.[13] The section 204 refund mechanism, however, is unavailable in a section 205 proceeding.[14]
  4. Parties may also challenge the lawfulness of effectivetariffs through the formal complaint process.[15] Rate-of-return carriers are required to set their tariff rates at levels targeted to produce no more than an 11.25 percent return on investment based on an analysis of historical or projected cost data and the historical or projected demand for services,[16] but may ultimately exceed the target rate of return up to the allowed maximum.[17] Section 65.700 of the Commission’s rules establish a maximum allowable rate of return for carriers subject to that section that is equal to the prescribed rate plus the amount specified in either section 65.700(a), (b), or (c).[18] Compliance with the prescribed rate of return is measured over a two-year period (the “monitoring period”).[19] Carriers that exceed the maximum allowable rate of return at the end of the two-year monitoring period have unlawfully “overearned” – i.e., their rates have violated the “just and reasonable” rate requirement in section 201 – and are subject to formal complaint on that basis alone.[20] Prior to the adoption of the 1996 Act, a successful complainant could seek retrospective damages for any overpayments made during the period in which the unlawful tariff was in effect.[21] As explained in paragraph 3, retrospective damages no longer are available for tariffs filed under section 204(a)(3) of the Act that take effect without prior suspension and investigation.

B.The Commission’s Rules for Establishing Tariff Rates

  1. Rate-of-return carriers. Commission rules provide rate-of-return LECs with alternative means for filing interstate access tariffs. Most rate-of-return LECs participate in the traffic-sensitive pool managed by NECA and participate in the traffic-sensitive tariff filed annually by NECA for participating members.[22] The rates in the traffic-sensitive tariff are set based on the projected aggregate costs (or average schedule settlements) and demand of all pool members and are targeted to achieve an 11.25 percent return.[23] Each participating carrier receives a settlement from the pool based on its costs plus a prorata share of the profits, or based on its settlement pursuant to the average schedule formulas. Stated differently, revenues in excess of costs are shared among all pool members. Cost and average schedule carriers may choose to enter or leave the NECA pool on July 1 of any year by providing notice to NECA by the preceding March 1.[24]
  2. Alternatively, a rate-of-return carrier may file access tariffs pursuant to the provisions of section 61.38 (section 61.38 carrier) or section 61.39 (section 61.39 carrier). Under section 61.38, a carrier is required to file access tariffs in even numbered years to be effective for a two-year period.[25] A section 61.38 carrier files tariffed rates based on its projected costs and demand and targets its rates to earn an 11.25 percent return. If the demand of a section 61.38 carrier increases above the level projected by the carrier in its tariff filing during the tariff period, it does not share the increased revenues with any other carrier. Accordingly, a section 61.38 carrier retains the increased revenues to the extent they exceed any increase in costs, protected from retrospective refund liability by the deemed lawful provision of the Act, but rates that result in earnings over 11.25 percent are subject to complaint and the Commission could order prospective rate changes.
  3. Finally, a rate-of-return carrier that has 50,000 or fewer access lines in a study area may elect to file its access tariffs in accordance with section 61.39 of the Commission's rules, which was adopted in the Small Carrier Tariff Order.[26] A carrier choosing to proceed under this rule is required to file access tariffs in odd numbered years to be effective for a two-year period.[27] The initial rates of section 61.39 carriers are set based on historical costs (or average schedule settlements) and associated demand for the preceding year.[28] These carriers do not share their costs and revenues with any other carrier. Thus, if demand increases, the carrier retains the revenues to the extent they exceed any cost increase, protected from retrospective refund liability by the deemed lawful provision of the Act. Section 61.39 carriers’ rates are required to be just and reasonable, may be challenged in a complaint proceeding, and the Commission can order prospective rate changes for rate-of-return violations.[29] Section 61.39 carriers were required to file tariffs this year.[30]
  4. Price cap carriers. In 1990, the Commission adopted a new pricing structure for larger LECs that focused on prices rather than earnings to maintain just and reasonable interstate access rates.[31] Pursuant to rules set forth in Part 61 of the Commission’s rules, the rates of price cap LECs must comply with a series of price cap indexes or ceilings that are designed to give price cap LECs some pricing flexibility, while at the same time ensuring that interstate access rates remain just and reasonable.[32] Price cap carriers are permitted to earn returns significantly higher, or potentially lower, than the prescribed rate of return that incumbent LECs are allowed to earn under rate-of-return regulation. Price cap LECs are not subject to complaints for excess earnings. Price cap LECs file access tariffs annually to become effective on July 1.[33]
  5. Competitive local exchange carriers. Competitive LECs are considered nondominant carriers and are thus subject to minimal rate regulation. Section 61.26 allows competitive LECs to tariff interstate access charges if the charges are no higher than the rate charged for such services by the competing incumbent LEC (the benchmarking rule).[34] The Commission established an exemption for rural competitive LECs[35] competing against non-rural incumbent LECs, pursuant to which rural competitive LECs may file tariffs provided that their rates are no higher than the access rates prescribed in the NECA access tariff, assuming the highest rate band for local switching.[36] Competitive LECs may not tariff rates that are higher than those noted above, but may negotiate any such higher charges with interexchange carriers (IXCs).

III.Discussion

  1. With this Notice, we initiate a rulemaking proceeding toexamine whether our existing rules governing the setting of tariffed rates by LECs provide incentives andopportunities for carriers to increase access demand endogenously with the result that the tariff rates are no longer just and reasonable. Several IXCs have filed complaints, either with this Commission or with United States federal district courts pursuant to sections 206-209 of the Act, alleging that such increases in access traffic have caused the involved LECs to earn a rate of return grossly in excess of the maximum allowed rate of return.[37] As discussed below, we tentatively conclude that we must revise our tariff rules so that we can be confident that tariffed rates remain just and reasonable even if a carrier experiences or induces significant increases in access demand.[38]
  2. In the cases that have given rise to this inquiry, increased switched access traffic appears to be caused by the deployment of chat lines, conference bridges, or other similar high call volume operations in the service areas of certain rate-of-return or competitive LECs.[39] The LECs may provide space in their central offices for the call operators’ equipment and may provide other services, including telephone numbers, for the call service operators. The chat lines or conference services, along with the associated number(s), are advertised, generally on the Internet, as being free (or for the cost of a long-distance call). Users of these services make interstate calls to those numbers and the local exchange carriers assess interstate access charges on the IXCs that deliver the calls.[40] The applicable per minute access charge rates are often high because many of the carriers involved in these arrangements are small carriers whose rates were set based on higher than average per minute costs and a low volume of traffic based on historical levels. AT&T and Qwest allege that the LECs experiencing or creating this access growth share the access revenues they receive with the service providers whose services are generating the demand growth.[41] As a direct result of the increase in traffic volume, the LECs are alleged to be earning returns on these access services that are substantially above the maximum rate ofreturn authorized by the Commission.[42]
  3. Factual background. To understand the effect of our current rules on carrier behavior and to assess whether any rule changes are necessary, we need to establish a more complete record as to the activities that are occurring, how the services are provided, and how compensation occurs between the involved parties. We believe that traffic may be stimulated through a variety of means, including conference bridges, chat line facilities, call center operations, and help desk provisioning. We invite interested persons to comment on the prevalence of these types of operations and to describe in detail how each type of service is provisioned. Interested persons should also identify other types of operations that may result in significant stimulation of access traffic and describe their provisioning arrangements. Parties should explain what fees, including both interstate and intrastate fees, the service provider pays to the LEC. We also ask interested parties to describe in detail what monies or other benefits the LEC provides to the provider of the stimulating activity, including, for example,direct payments, revenue sharing, commissions, or free services. If possible, parties should quantify these benefits to the provider of the stimulating service. We understand that carriers complaining about the access stimulation arrangements also offer conferencing and other services that may result in increased traffic. We ask such carriers to explain how they provide each of the above mentioned services, including what charges they assess on the provider, whether access charges are assessed on such calls, and what compensation, if any, is paid to such provider.
  4. Just and reasonable rates. Section 201(b) of the Act, whichrequires that rates be just and reasonable, guides the Commission in its review of carriers’ rates.[43] Oversimplifying somewhat, to establish their rates, rate-of-return carriers calculate a revenue requirement, which is intended to recover expenses plus a reasonable rate of return. Once the revenue requirement is determined, carriers propose prices for all interstate services, which, when multiplied by historical or projected demand, are targeted to equal the revenue requirement. If, after rates are set, actual demand and expenses differ from the estimated demand and expenses, the realized rate-of-return may be greater or less than the targeted rate of return. The limited information we have suggests that, in certain instances,some LECs are experiencing dramatic increases in demand for switched access services. If the average cost per minute falls as demand grows, the realized rates of return are likely to exceed the authorized rate of return and thus the tariffed rates become unjust and unreasonable at some point. It is well established that there is a large fixed cost to purchasing a local switch and that the marginal or incremental costof increasingthe capacity of a local switch is low (some contend that it is zero) and certainly less than the average cost per minute of the local switch. Thus, if the average revenue perminute remains constant as demand grows, but the average cost per minute falls (which occurs if the marginal cost per minute is less than the average cost per minute) then profits (or return) will rise. Thisprinciple is equally applicable to all LECs. Moreover, the cost of local switching increases incrementally, while the price for local switching is established based on average costs, which are significantly higher. As a result, most of the switch costs are recovered by the demand used to establish the local switching rate. Carriers offering tandem switching services would experience a similar effect for their tandem switching costs. Accordingly, when local switching demand increases significantly, a carrier’s increased revenues generally will exceed any cost increases. As a result, a carriers’ rate of return at some point is likely to exceed the maximum allowed rate of return, making the rates unjust and unreasonable.
  5. A similar effect to that associated with local switching would also occur in the transport segment of the exchange access network. As demand increases, the number of circuits needed for transmission will increase. Again, the incremental cost is lower than the average cost (although the disparity is likely not as great as in the local switching case), which would lead to the rates for transport becoming unreasonable at some point as demand increases.
  6. We invite interested persons to comment on the analysis of the previous two paragraphs.