Verizon Communications, Inc. V. FCC - telecommunications access pricing and regulator accountability through administrative law and takings jurisprudence.

• Author: Legg, Michael J.

1. INTRODUCTION II. U.S. TELECOMMUNICATIONS REGULATION A. Deregulation Framework B. Access Pricing III. ADMINISTRATIVE LAW AND REVIEWING TELECOMMUNICATIONS ACCESS PRICES A. The Verizon Decision B. Administrative Law and Access Pricing IV. TAKINGS JURISPRUDENCE AND REVIEWING TELECOMMUNICATIONS ACCESS PRICES A. Takings and Telecommunications Before Verizon B. Takings and Telecommunications After Verizon V. CONCLUSION I. INTRODUCTION

   The need for regulators to manage changing economic conditions and technology in the telecommunications industry has given rise to access regimes characterized by broad guidelines and considerable flexibility for the regulator. The incumbent local exchange carriers ("ILECs") sought to challenge this broad discretion in Verizon Communications, Inc. v. Federal Communications Commission (1) which required the Supreme Court to scrutinize the Telecommunications Act of 1996 and Implementation of the Local Competition Provision in the Telecommunications Act of 1996, First Report and Order ("Local Competition Provisions"). (2) Two issues before the Court were (1) the legality of using forward-looking economic cost for setting rates for interconnection or leasing of network elements and further, the legality of defining forward-looking economic cost through the total element long-run incremental cost ("TELRIC") of the element which measures costs through a hypothetically efficient network; and (2) whether a rate-setting methodology could amount to a 'taking' for the purposes of the Fifth Amendment, which states "nor shall private property be taken for public use, without just compensation" (the "Takings Clause"). (3)

   This Article draws on the Supreme Court decision in Verizon to argue that the intersection of ambiguous telecommunications access statutes and the limits on judicial review as a result of the separation of powers and the application of Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc. (4) mean that administrative law has become an ineffective tool in ensuring the accountability of telecommunications regulators. Telecommunications regulation has become too reliant on regulatory expertise, and in the process, has ceded control over a vital area of economic policy to the regulator. (5) A dearth of regulator accountability can give rise to a technocratic approach that undermines democratic governance. This Article argues for Congress to address access pricing in greater detail. If further guidance is not provided, the Article argues, further challenges to TELRIC based on the Takings Clause and the Supreme Court's rate-setting cases can be expected. The limits on judicial review that are embodied in Chevron do not apply to the enforcement of a fundamental constitutional guarantee such as the Takings Clause. It follows that this constitutional protection will be more frequently invoked to establish a "just compensation" floor as a brake on the lack of regulator accountability.

2. U.S. TELECOMMUNICATIONS REGULATION

   The deregulation of the U.S. Telecommunications industry took place through the Telecommunications Act of 1996, which amended the Communications Act of 1934. (6) The application of the rules varies depending upon whether an entity is an ILEC, or a new entrant, referred to in the legislation as a competitive local exchange carrier ("CLEC").

   1. Deregulation Framework

      There are two types of rules. The first type may be described as the necessary conditions for a CLEC to enter the local call market, which apply equally to ILECs and CLECs. The rules require mandatory interconnection for the exchange of traffic to overcome the natural monopoly. (7) Interconnection must be provided at any technically feasible point, must be at least equal in quality to that provided by the ILEC to itself and must be provided according to rates, terms, and conditions that are nondiscriminatory. (8)

      The second type of rules aim to remove an ILEC's economic advantages flowing from its monopoly position by making it easier for CLEC's to enter the market. ILECs must unbundle network elements to allow CLECs to lease them, (9) and resell them so that the CLEC can buy service in bulk, brand it, and sell it under its own name. (10) A network element must be unbundled if it is necessary and if a lack of access to it would impair the CLEC's ability to offer the service. (11)

      As a result, competition in the local market may be achieved through either a CLEC building its own network and relying on the first type of rules (facilities-based competition), operating as a pure reseller using the second type of rules, or using a hybrid of both approaches whereby a CLEC uses some of its own facilities and leases the unbundled network elements that it lacks so as to combine them into a complete service. (12)

   2. Access Pricing

      The Telecommunications Act of 1996 provided for rates to be either negotiated or set by state commissions. (13) The Act provided for the "just and reasonable rate" for interconnection pursuant to Section 251(c)(2) and rates for unbundled network elements pursuant to Section 251(c)(3) to be determined by state commissions on the basis that they "shall 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 (whichever is applicable), and ... nondiscriminatory, and ... may include a reasonable profit." (14)

      The Federal Communications Commission's ("FCC's") Local Competition Provisions gave effect to Congress's mandate by ruling that the state commissions should set arbitrated rates for interconnection and access to unbundled elements pursuant to a forward-looking economic cost-pricing methodology. The FCC's pricing methodology provided for a new entrant seeking access to a network element of an ILEC to pay (1) any costs directly attributable to the CLECs' use (incremental or marginal costs); (2) a proportional share of the depreciation in the elements value from use over time; (3) a proportional share of joint and common costs, otherwise called overhead costs, associated with element use (i.e., personnel costs, billing costs, etc.); and (4) a share of the cost of the capital invested in the network element (either interest paid or the foregone returns on alternative investments), which is equivalent to a reasonable profit. (15)

      The FCC also considered three alternative access pricing theories. The FCC determined that the Telecommunications Act did not specify whether historical/embedded costs should be included in setting prices. However, the FCC decided that when calculating rates under TELRIC, it would not consider the embedded costs of facilities in place before February 8, 1996, the date of the Act's passage. (16) Embedded costs include any portion of the fixed costs of building the network that the incumbent has not yet recovered through its service prices. The FCC adopted this approach on the basis that adopting historical cost measures would advantage ILECs and hinder competition.

      The FCC excluded opportunity cost from TELRIC as part of the rejection of an Efficient Component Pricing Rule ("ECPR"). The FCC defined ECPR as pricing an input at the incremental cost of that input plus the opportunity costs that the ILEC incurs when the new entrant provides the services instead of the incumbent. The rejection was based on ECPR not being cost based and having no ability to move prices towards a competitive level, thus hampering the development of competition. (17)

      The FCC also ruled out the use of 'Ramsey Pricing' (18) because it would allocate common costs in inverse proportion to the sensitivity of demand for various network elements and services. This type of allocation could limit the extent of entry into local exchange markets by allocating more costs to, and thus raising the prices of, the most critical bottleneck inputs, the demand for which tends to be relatively inelastic. A methodology which hampers market entry is inconsistent with the Act's goals. (19)

      Additionally, the FCC decided that, at any point in time, the total element long-run incremental cost of an element should be measured based on the use of the most efficient telecommunications technology currently available and the lowest cost network configuration given the existing location of the ILEC's wire centers. (20) TELRIC included the costs explained above, except that they were based not on the costs associated with the ILEC's actual network, but on the costs associated with a hypothetically efficient network.

3. ADMINISTRATIVE LAW AND REVIEWING TELECOMMUNICATIONS ACCESS PRICES

   1. The Verizon Decision

      The Supreme Court examined the FCC's interpretation of the Telecommunications Act in accordance with the standard in Chevron, which involves a two step approach. First, does the statute clearly answer the interpretive inquiry? If so, apply the statute by its terms to affirm or reverse the agency. If not, the Court adopts a position of deference towards the agency and will only reject an interpretation if it is "unreasonable." (21)

      The FCC's rule adopting TELRIC was initially challenged in Iowa Utilities Board v. Federal Communications Commission, (22) where the Eighth Circuit upheld the choice of a forward-looking methodology, (23) but struck down the rule defining TELRIC as being based upon the use of a hypothetically efficient network. (24) Both issues were before the Supreme Court in Verizon.

      The Supreme Court found that the FCC could require state commissions to set the rates charged by incumbents for leased elements on a forward-looking basis unrelated to the incumbents' investment. The Court focused on the term "cost" in the statute (25) and found that apart from a prohibition against rate of return or other rate-based proceedings, the term was a chameleon capable of multiple interpretations. (26) In particular, the Court noted that the Act used "cost" as an intermediate term in the calculation of...