GT Alert

A Divided FCC Sets New Rules for Local Telecom Competition

March 2003
By Mitchell F. Brecher, Greenberg Traurig, Washington, D.C. Office

  View or download the PDF version of this Alert here.

On February 20, 2003, following months of contentious lobbying and eleventh hour dealmaking among the Commissioners, a bitterly divided Federal Communications Commission voted on new rules to govern the manner in which competing telecommunications companies may utilize the networks of the incumbent local exchange telephone companies (primarily the Bell Companies – BellSouth, SBC, Qwest, and Verizon) to offer their own services. The FCC also eliminated most of the requirements governing access by competitors to telephone company broadband networks. As of the date of this Client Alert, the FCC has not yet issued the text of its decision (expected to exceed 400 pages). Thus, the information contained in this Client Alert is based upon the FCC’s news release and accompanying summary, as well as the statements issued by individual FCC Commissioners.

What the FCC Has Done

"The FCC has chosen not to eliminate the right of competing providers to purchase at government-established prices packages or platforms of network elements of the incumbent telephone companies."

The FCC has chosen not to eliminate the right of competing providers (usually referred to as Competitive Local Exchange Carriers or "CLECs") to purchase at government-established prices packages or platforms of network elements of the incumbent telephone companies (referred to as Incumbent Local Exchange Carriers or "ILECs"). Instead, the FCC has left to the state utility commissions the determinations of whether those network elements are necessary to provide service and whether the unavailability of those network elements will impair the CLECs’ ability to offer the services they wish to provide. This aspect of the FCC decision is generally perceived to be a "win" for the CLECs who lobbied for continuation of the right to utilize the assembled elements of the ILECs’ networks. However, as will be discussed below, this "victory" may be illusory as it most certainly will be appealed to the courts of appeal (and perhaps ultimately to the Supreme Court) and will result in several additional years of market uncertainty, something that the financially struggling telecommunications sector does not need.

The FCC has largely relieved ILECs of any obligation to make available to their competitors on an unbundled basis access to their broadband networks. This aspect of the decision is considered to be a "win" for the ILECs since they will be able to deploy new broadband network facilities (necessary to provide high speed services, including Internet access "services," throughout their operating territories, including to residential customers, without being obligated to make those broadband networks available to their competitors.

The FCC also eliminated Line Sharing. Line Sharing refers to the use of the high frequency portion of the local loop (the line which connects a customer premises with a telephone company central office) by CLECs. Line Sharing makes it possible for CLECs to provide high speed data service using ILEC facilities without having to purchase the entire local loop, including that part of the local loop used to provide voice telephone services. Data CLECs, including, for example, Covad Communications, have built their businesses around using Line Sharing to provide their services.

Background of the Controversy

Under the Telecommunications Act of 1996, competition in the provision of all telecommunications services is the national policy, as is deregulation of such services when competition makes continued regulation unnecessary. The 1996 Act contemplates three alternative means for providing local telecom services in competition with the incumbent LECs (such as the Bell Operating Companies and other franchised telephone companies). The three means for providing competing local telecom service are:

1. Facilities-based – Companies may construct their own telecommunications networks and interconnect those networks with those of the ILECs so that each company’s customers may communicate with each other;
2. Resale – CLECs may purchase from ILECs at wholesale prices any telecommunications services that the ILECs make available to consumers on a retail basis. CLECs may then resell those services to consumers at retail prices; and
3. Unbundled Network Elements – CLECs may purchase from ILECs on an unbundled basis individual elements of the ILECs’ networks which the CLECs may use to develop their own services.

Of the three alternative forms of local competitive entry, the unbundled network element entry has been the most controversial and subject to the most litigation. This is so for several reasons. First, the right of CLECs to acquire unbundled network elements for ILECs is not absolute. The Communications Act provides that access to unbundled network elements is required only when the FCC determines that: 1) access to such network elements is "necessary"; and 2) that the unavailability of a network element would "impair" the ability of a CLEC to provide the services it seeks to offer. Since 1996, the FCC and the courts have been struggling to determine how to apply the so-called "necessary" and "impair" standards. Second, there has been considerable acrimony with regard to whether and under what circumstances CLECs may acquire on an unbundled basis combinations of network elements which are already combined or assembled by the ILECs, and use those packages to offer services without doing any of the combination work themselves. This arrangement is commonly referred to as the Unbundled Network Element Platform or "UNE-P."

On two occasions, the FCC has adopted rules that have taken an expansive interpretation of the "necessary" and "impair" standards which has made it possible for CLECs to have access to the UNE-P. On both occasions, the United States Court of Appeals for the District of Columbia Circuit reversed the FCC decisions on the basis that the FCC had failed to show that its interpretation of the standards was consistent with the Communications Act. The FCC established a list of Unbundled Network Elements that must be made available. The FCC reviews its Unbundled Network Element list every three years to determine whether the list should be modified based on changes in the telecommunications marketplace. This examination is generally called the Triennial Review. The FCC was in the process of conducting one of its Triennial Reviews when the Court of Appeals reversed its prior Unbundled Network Element determination in May 2002. Recognizing that the FCC was in the process of conducting a review, the court of appeals delayed the effect of its decision until February 20, 2003.

The Importance of UNE-P from a Pricing Perspective

Underlying the debate about network elements in general and UNE-P in particular is the manner in which those elements are priced. The Communications Act requires that prices for Unbundled Network Elements be established by state utility commissions based on pricing rules set by the FCC. The prices are required to be based on the "cost" of providing those Unbundled Network Elements. In 1996, the FCC established a pricing standard for Unbundled Network Elements based on the long run incremental cost of providing those elements. The FCC calls this standard Total Element Long-Run Incremental Cost or "TELRIC." TELRIC pricing is based on what the ILECs’ cost of providing those Network Elements would be if their own networks were designed in the most efficient manner, without regard to how they were actually designed and built. The FCC’s TELRIC pricing standard was upheld by the Supreme Court in 2002. In contrast, the "wholesale" prices that ILECs are required to charge CLECs for services provided to end users are based on retail prices minus those costs that are avoided by the ILECs from not selling those services at retail. In general, TELRIC-based prices for Unbundled Network Elements result in lower prices to CLECs than wholesale prices for services, despite the fact that from an operational standpoint an assembled platform of ILEC network elements (i.e., UNE-P) may be the same as the "service" that the ILECs provide to end users at retail prices.

Since 1996, ILECs have complained that provision of UNE-P at TELRIC prices results in their being forced to sell virtual services to their competitors at prices that are below their own costs of providing service, and that the ILECs are therefore "subsidizing" their competitors. In contrast, CLECs claim that without UNE-P, there would be no local telecom competition since that is the only viable market entry strategy, at least for the short term, and that without UNE-P there would be no consumer choice of local service provider, and millions of consumers who purchase local service from CLECs using UNE-P would not be able to enjoy the competitive choices and resulting cost savings that are available to them. The two largest and most vocal proponents of UNE-P are AT&T and WorldCom, both of which are primarily long distance companies. Those companies have no significant local networks of their own, and rely on UNE-P purchased from the ILECs to offer their customers service packages that include local and long distance (MCI WorldCom’s "The Neighborhood" service is a prominent example of a UNE-P-based local service).

Politics at the FCC

By law, no political party may hold more than a simple majority of seats on the five-member FCC. Of the five current FCC commissioners, three are Republicans, two are Democrats. All have been appointed by President George W. Bush. FCC Chairman Michael Powell is a zealous believer in deregulation and reliance on marketplace forces. Given his policy views and the fact that twice FCC decisions requiring continued availability of a broad list of network elements through regulation have been reversed in court, led Chairman Powell to seek limitation of the list of Unbundled Network Elements and elimination of UNE-P. Of the other two Republican FCC commissioners, one clearly agreed with the Chairman. Both Democratic commissioners were sympathetic to the beliefs that access to ILEC Unbundled Network Elements (including UNE-P) remains necessary for there to be competition in the local telecom market, and that the individual states, rather than the FCC, are in the best position to make "necessary" and "impair" determinations based on specific market conditions in each state. To the surprise of many, the third Republican Commissioner, Kevin Martin, sided with the two Democrats, and voted against the FCC Chairman. Following that vote, several Republican Congressional leaders have been publicly critical of Commissioner Martin for not voting with his two Republican colleagues.

Business Analysis

Based on what is known about the FCC’s not-yet-issued ruling, the decision can best be described as a "mixed bag." For CLECs and local telephone competition, the FCC (by a 3-2 majority) seems to have gone out of its way to maintain the availability of UNE-P for competing with the ILECs. So long as those rules remain in effect, CLECs will enjoy the opportunity to persuade state utility commissions that UNE-P is needed in order for those companies to be able to offer local services in competition with the ILECs. With regard to broadband services, and those companies whose businesses require use of broadband (including, for example, Internet Service Providers), the picture is much bleaker. For example, Internet Service Providers will not enjoy the right to offer broadband Internet products using the ILECs’ data networks. Neither will companies like Covad be able to continue to purchase the right to use the high frequency portion of ILEC local loops. Many are suggesting that the result will be an emerging oligopoly in which two entities – the incumbent phone company and the cable company – will be the only providers of high speed Internet services, especially to residential customers.

What Happens Next?

The short answer is, no one knows for sure. It is a certainty that many companies will appeal the FCC decision. Each of the major ILECs will most definitely challenge the UNE-P portion of the FCC’s decision. Given that their challenges to similar FCC Unbundled Network Element rulings have led to court of appeals reversals, there is a strong possibility that the portion of the FCC ruling regarding Unbundled Network Elements will again be reversed. It is equally certain that CLECs as well as Internet Service Providers and their respective industry associations will appeal the broadband portion of the FCC ruling.

Once the FCC ruling is issued, parties will have 60 days to file their appeals. It is likely that appeal petitions will be filed in several – perhaps all – of the federal circuit courts of appeal. If that occurs, one circuit will be chosen on a "by chance" basis to hear the consolidated cases. Unless a court of appeals or the FCC itself issues a stay of the decision, the new rules will take effect pending appeal. This means that there will be proceedings before many state utility commissions to address what network elements must remain available.

At this point, the only "certainty" about the FCC decision is that the telecommunications and information technology sectors will be subject to at least several additional years of continuing uncertainty. How this uncertainty will affect those companies’ ability to attract capital, retain key personnel and customers, and grow their businesses is problematic.

If you have questions regarding any aspect of the FCC’s recent decision on telecommunications competition or about how this ruling or other FCC rules and policies may affect your business, please contact the Telecommunications or Information Technology practice groups of Greenberg Traurig.

© 2003 Greenberg Traurig

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