New Rules on Local Competition: A Massive Power Grab by the FCC
 

Edward Whelan*

When Congress enacted the Telecommunications Act of 1996 in February, it emphasized that the 1996 Act was intended to provide a "pro-competitive, de-regulatory national policy framework" for telecommunications. A bare six months later, however, the FCC showed once again how a federal agency reacts to a deregulatory mandate.

On August 8, the FCC issued its first major rulemaking under the 1996 Act, its First Report and Order (FCC 96-325) on the local competition provisions in new section 251. The First Report is a veritable bureaucratic monument. Its 668 single-spaced pages and 3,276 footnotes reflect careful craftsmanship, impressive legal and economic cleverness, and lots of plain old hard work. But, at bottom, what is most remarkable about these rules purporting to implement section 251 is that they constitute a massive power grab by the FCC.

Comparing the 1996 Act's provisions governing pricing of unbundled network elements to the FCC's rules on this same matter provides an instructive illustration of this power grab. Section 251 requires incumbent local exchange carriers (ILECs) — like the Baby Bells and GTE — to open up their networks to competing local exchange carriers (CLECs). In particular, section 251 requires ILECs to negotiate with CLECs to provide them access to the ILECs' "network elements" — the various pieces, such as the wire to the home, that constitute the local network — at rates that are just and reasonable. Under section 252, the state commissions have exclusive authority (so long as they in fact exercise it) to arbitrate and approve ILEC-CLEC agreements for network elements. Indeed, section 252(d)(1) expressly sets forth a general pricing standard for the state commissions — not the FCC — to apply in determining what network element charges are just and reasonable: the charge is to be "based on the cost . . . of providing the . . . network element" and "may include a reasonable profit."

In sum, the 1996 Act itself establishes that the agency with the preeminent role in pricing network elements is the state commission, not the FCC. There is, of course, nothing novel about such allocation of responsibility over a core aspect of the local exchange. Rather, Congress has replicated here essentially the same predominant role that state commissions have exercised over the local exchange all the way back to enactment of the Communications Act of 1934. Such a role is sensible not only because it comports with the state commissions' comparative experience and expertise, but also because state commissions have a continuing obligation, under a well-settled application of the Fifth Amendment's Takings Clause, to provide ILECs the opportunity to earn a fair return on their past invested capital. Fittingly, the cost-plus-a-reasonable-profit pricing standard set forth in section 252(d)(1) permits state commissions to ensure that ILECs are able to recover their actual embedded costs.

The First Report would implement a radically different vision of the relative roles of the FCC and the state commissions in pricing network elements. In essence, the FCC would demote state commissions to the status of FCC lackeys. In the First Report, the FCC concludes that it has authority to prescribe a pricing methodology for network elements — which it calls TELRIC, or Total Element Long Run Incremental Cost — that "every state should, to the maximum extent feasible, immediately apply." Under TELRIC, the charge for a network element is to be based on the forward-looking, incremental (rather than actual embedded) costs directly attributable to that element, together with a reasonable share (again, as defined by the FCC) of forward-looking joint and common costs. Moreover, these forward-looking costs are to be estimated not on the basis of the ILEC's actual network technology but rather on the hypothetical assumption that the ILEC's network were reconstructed using the most efficient available technology. TELRIC, the FCC assures us, replicates to the greatest extent possible the conditions of a competitive market.

This FCC power grab is highly suspect legally. The FCC's exercise of authority over prices for network elements rests, ultimately, on its position that its regulatory power is co-extensive with the reach of the 1996 Act. There are two clear problems with this position. First, the 1996 Act itself carves out a preeminent role for state commissions in pricing network elements. Second, section 2(b), which was not amended by the 1996 Act, expressly provides (with exceptions not relevant here) that nothing in the Communications Act of 1934 (which includes new sections 251 and 252) shall be construed to give the FCC jurisdiction over intrastate telecommunications. Section 2(b) effectively sets forth a reverse-Chevron rule of construction: namely, the FCC has jurisdiction over intrastate telecommunications only if, and insofar as, the granting of such jurisdiction is unambiguous. Since the 1996 Act can reasonably be read as giving primary authority over pricing of network elements to the state commissions, the FCC does not have plenary authority over this matter.

Even if the FCC did have authority to price network elements, its TELRIC standard is also legally dubious. It is, at the very least, peculiar that "cost" in section 252(d)(1) should be defined as some hypothetical, forward-looking, policy-wonk-economist measure rather than according to the ordinary measure of costs actually incurred. This peculiarity is all the more troubling since the TELRIC standard would require that network elements be priced in complete disregard for the obligations that the state commissions have to ILECs under the Takings Clause. To base costs on a hypothetical best-available-technology network rather than the ILECs' actual networks compounds the problem, since state commission regulation has discouraged ILECs from revamping their network technology. Especially in light of the Supreme Court's recent decision in United States v. Winstar, 116 S. Ct. 2432 (1996) (government liable in damages for breach of obligations to regulated thrift institutions), it is highly questionable (not to mention imprudent) to construe "cost" in a manner that might result in billions of dollars of compensable damages to the ILECs.

The FCC's pricing rules for network elements also appear to be bad policy. Rather than trying to replicate, through regulatory artifice, the conditions of a competitive market, the FCC ought to be bringing about, as rapidly as possible, the transition to real (rather than regulatorily contrived) competition. Congress, in the 1996 Act, recognized that in many places the local exchange market is no longer a natural monopoly. In other words, it is economically possible for facilities-based competitors to emerge to challenge the ILECs. But if network elements are priced at a TELRIC measure that hypothesizes that the ILEC is using the most efficient available technology, there will be no incentive for a new entrant to build its own network. Instead, it will be cheaper and easier for the entrant to live as a parasite off the ILEC's existing network. The 1996 Act's promise of technological innovation, investment, and new jobs will be betrayed. And the FCC will undoubtedly continue to micromanage the contrived competition that it will have fostered.

The criticisms that I have offered with respect to the FCC's pricing rules on network elements apply in similar fashion to most of the First Order's key provisions. The FCC has engaged in a massive power grab at the expense of Congress, whose deregulatory will it thwarts; at the expense of the state public utilities commissions, whom it reduces to FCC flunkies; and at the expense of incumbent local exchange carriers, whose property rights it willfully tramples.

* Edward Whelan is assistant general counsel for regulatory affairs at GTE Corp.

   

2001 The Federalist Society