Regulatory Arbitrage Strategies and Tactics in Telecommunications

51 Pages·2016·2.71 MB·English

by  Rob Frieden

NORTH CAROLINA JOURNAL OF
LAW & TECHNOLOGY
Volume 5
Article 4
Issue 2Spring 2004
3-1-2004
Regulatory Arbitrage Strategies and Tactics in
Telecommunications
Rob Frieden
Follow this and additional works at:http://scholarship.law.unc.edu/ncjolt
Part of theLaw Commons
Recommended Citation
Rob Frieden,Regulatory Arbitrage Strategies and Tactics in Telecommunications, 5N.C. J.L. & Tech.227 (2004).
Available at:http://scholarship.law.unc.edu/ncjolt/vol5/iss2/4
This Article is brought to you for free and open access by Carolina Law Scholarship Repository. It has been accepted for inclusion in North Carolina
Journal of Law & Technology by an authorized administrator of Carolina Law Scholarship Repository. For more information, please contact
[email protected].
NORTH CAROLINA JOURNAL OF LAW & TECHNOLOGY
VOLUME 5, ISSUE 2: SPRING 2004
Regulatory Arbitrage Strategies and Tactics in
Telecommunications
I
Rob Frieden
Recently several states have launched investigations of
certain MCI telephone call routings based on competitors' claims
that the company eliminated or reduced payments it should have
made.2 The MCI investigations may uncover instances of unlawful
practices designed to shore up revenues, reduce payments to local
exchange carriers for call delivery, avoid tax liability and shift
local exchange access payment burdens to other carriers. Perhaps
more significantly the investigations may trigger closer scrutiny of
numerous strategies and tactics used by telecommunications
carriers to reduce payments they make to other carriers. Also, this
scrutiny may call attention to how carriers exploit inconsistent
regulatory treatment of functionally the same services. A fuzzy
line separates lawful efforts to achieve least cost routing of traffic
on one hand, and deliberate efforts unlawfully to reduce or avoid
financial obligations by deceiving other carriers as to where a call
originated on the other hand.3
Regulatory asymmetry occurs when telecommunications
service providers offer identical services, but incur different
government oversight burdens. More extensive regulation, the
duty to pay higher regulatory or legislative fees, and subsidy
obligations may apply to carriers based on artificial classifications
of services they offer such as geographical scope (intrastate versus
interstate) and type (telecommunications as a stand alone service
Rob Frieden is a Professor of Telecommunications at Pennsylvania State
University.
2S ee, e.g., Stephen Labaton, MCIDisputesF raudC laim By AT&T, N.Y. TIMES,
Aug. 5, 2003, at Cl; Christopher Stem, WorldCom Says Its Probe Refutes AT&T
Claim; BankruptP hone Firm Tells CourtN o Evidence Was Found That It
DisguisedC alls to Avoid Fees, WASH. POST, Aug. 5, 2003, at El.
3 See Barnaby J. Feder, The Line Between Cost Management and Deceit, N.Y.
TIMES, July 29, 2003, at Cl.
228 N.C. J.L. & TECH. [VOL. 5
versus one where telecommunications is a minor element of an
information service). Additionally, inconsistent regulatory
treatment may occur based on carrier classifications using
historical market share and perceptions of its market power.
Existing "legacy" regulatory classifications4 have established
arbitrary dichotomies based on which regulatory agency has
jurisdiction, what services qualify for promotion through favorable
regulatory treatment, and how carriers and regulators decide to
allocate costs.
Regulatory arbitrage5 results when stakeholders, such as
telecommunications service providers as MCI, exploit differences
4 The FCC has expressed a reluctance to apply legacy regulation when
conditions change. "Given our attempts to reduce the regulatory burden on
[incumbent local exchange carriers] ILECs, we are especially reluctant to
impose similar legacy regulation on new competitive carriers." Access Charge
Reform, 16 F.C.C.R. 9923, 9940 (2001). "I hope that, in future proceedings, the
Commission will be quicker to recognize that the reflexive extension of legacy
regulations to nascent technologies often harms the public interest." Provision
of Improved Telecommunications Relay Services and Speech-to-Speech
Services for Individuals with Hearing and Speech Disabilities, 18 F.C.C.R.
4761, 4774 (2003).
5 The FCC typically refers to regulatory arbitrage without providing a definition.
"We recognize that the existing intercarrier compensation mechanism for the
delivery of this traffic, in which the originating carrier pays the carrier that
serves the ISP, has created opportunities for regulatory arbitrage and distorted
the economic incentives related to competitive entry into the local exchange and
exchange access markets." Implementation of the Local Competition Provisions
in the Telecommunications Act of 1996, Intercarrier Compensation for ISP-
Bound Traffic, Order on Remand and Report and Order, 16 F.C.C.R. 9151, 9152
(2001). One definition provided by the Commission characterizes regulatory
arbitrage as "businesses making decisions based on regulatory classifications
rather than on customers' preferences and innovative and sustainable business
plans." Inquiry Concerning High-Speed Access to the Internet Over Cable and
Other Facilities, Internet Over Cable Declaratory Ruling, 17 F.C.C.R. 4798,
4846 (2002). Another FCC definition is "profit-seeking behavior that can arise
when a regulated firm is required to set different prices for products or services
with a similar cost structure." Developing a Unified Intercarrier Compensation
Regime, 16 F.C.C.R. 9610, 9616 n.18 (2001) [hereinafter Bill and Keep Carrier
Compensation Proposal] (referencing PATRICK DEGRABA, BILL AND KEEP AT
THE CENTRAL OFFICE AS THE EFFICIENT INTERCONNECTION REGIME 1 2 n.3
(F.C.C., O.P.P. Working Paper No. 33, 2000)); Patrick DeGraba, Central Office
SPRING 20041 REGULATORY ARBITRAGE STRATEGIES 229
in legislative and regulatory classifications to accrue financial and
competitive advantages achieved by avoiding regulatory burdens,
or by foisting payment obligations onto other carriers.
This article will examine tactics designed to exploit
regulatory arbitrage with an eye toward identifying areas where
inconsistent regulatory treatment distorts the competitive
marketplace without offsetting public interest benefits. The article
concludes that legislatures and regulators should eliminate
opportunities to avoid regulatory burdens through routing and
service classification tactics unless compelling reasons persist for
maintaining regulatory asymmetry. The Federal Communications
Commission and state public utility commissions have established
numerous service definitions, territorial and cost allocation policies
based on public policy or political considerations that have become
unsustainable in light of technological developments. Many of
these policies now have costs that exceed the public benefits
particularly in light of the competitive distortions they create and
the flawed justifications and assumptions underlying the policies.
I. The Death of Distance
Technological developments in telecommunications and
information processing increasingly make it unsustainable for
operators to charge distance sensitive (mileage based) rates.6
Much of the installed plant costs incurred by telecommunications
carriers does not vary as a function of usage.7 Historically the
FCC and state regulatory agencies have encouraged carriers to
recover non-traffic sensitive costs on a metered basis8 and to
Bill and Keep as a Unified Inter-CarrierC ompensation Regime, 19 YALE J. ON
REG. 37 (2002).
6 See FRANCES CAIRNCROss, THE DEATH OF DISTANCE: HOW THE
COMMUNICATIONS REVOLUTION WILL CHANGE OUR LIVES (1997).
7N on-traffic sensitive plant requires triggers costs that do not vary with the
degree of use. For example, the costs of procuring and installing a telephone
jack do not vary with the amount of calls made via that particular component.
The FCC acknowledged the need to recover non-traffic sensitive costs on a
flat-rate basis. "[N]on-traffic-sensitive costs-costs that do not vary with the
amount of traffic carried over the facilities-should be recovered through flat-
rate charges, and traffic-sensitive costs should be recovered through per-minute
230 N.C. J;L. & TECH. [VOL. 5
recover many types of both non-traffic sensitive and traffic
sensitive costs by averazinz the different costs triggered by high
and low volume-users. Cost averaging provides a simple "rough
S-
justice" solution to complex cost allocation problems,'0 but it
blunts cost differences among carriers, routes and users.
Inefficient and inequitable investment recovery would occur if
carriers charged usage or mileage based charges to recoup such
charges. This approach fosters competition and efficient pricing." Access
Charge Reform Price Cap Performance Review for LECs, 18 F.C.C.R. 14,976,
14,977 (2003), available at 2003 WL 21544089.
9 Implicit subsidies in telecommunications "result, in large part from rate
averaging between rural and suburban/urban areas and the recovery of certain
non-traffic sensitive costs through traffic sensitive per minute rates, which over-
recovers costs from higher volume users, often business customers." Review of
the Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers,
CC Docket No. 01-338, 2003 WL 22175730, at *17078 n.509 (F.C.C. Aug. 21,
2003); see generally Access Charge Reform, Price Cap Performance Review for
Local Exchange Carriers, Low-Volume Long Distance Users, Federal-State
Joint Board On Universal Service, 15 F.C.C.R. 12,962, 12,971-72 (2002)
(CALLS Order) (describing how high-volume users bear a greater share of the
non-traffic sensitive costs than low-volume users), affd in part, rev'd in part,
and remanded in part sub nom. Tex. Office of Pub. Util. Counsel v. Fed.
Communications Comm'n, 265 F.3d 313 (5th Cir. 2001).
10 The 1996 Act requires cost averaging to achieve universal service objectives:
Consumers in all regions of the Nation, including low-income
consumers and those in rural, insular, and high cost areas,
should have access to telecommunications and information
services, including interexchange services and advanced
telecommunications and information services, that are
reasonably comparable to those services provided in urban
areas and that are available at rates that are reasonably
comparable to rates charged for similar services in urban
areas.
47 U.S.C. § 254(b)(3) (2003). Additionally,
the rates charged by providers of interexchange
telecommunications services to subscribers in rural and high
cost areas shall be no higher than the rates charged by each
such provider to its subscribers in urban areas. Such rules
shall also require that a provider of interstate interexchange
telecommunications services shall provide such services to its
subscribers in each State at rates no higher than the rates
charged to its subscribers in any other State.
Id. § 254(g).
SPRING 2004] REGULATORY ARBITRAGE STRATEGIES
sunk and embedded costs. High volume users would
overcompensate the carrier while low volume users would
underpay.
Carriers should not bother to measure the distance between
call originator and call recipient if the cost of such metering
exceeds the cost differences in handling traffic of different
distances. Telephone companies, particularly long distance
carriers, typically average long and short haul traffic costs so that
they can offer a single, flat rate for all calls. Data communications,
including Internet-mediated services, have similar distance
insensitive cost characteristics.
Distance and traffic volume insensitivity means that
telecommunications and Internet service providers can offer a
single per minute or monthly rate for all calls within a wide
geographical area, e.g., the entire United States for long distance
telephone companies and the entire world for Internet Service
Providers ("ISPs"). Such a "postalized" rate averages whatever
cost differentials that still exist." Acknowledging the largely sunk
investment in telecommunications plant, some carriers now offer a
flat monthly rate for unlimited local and long distance calls. Such
"All You Can Eat" pricing12 has become standard for Internet
access in the United States, and ISPs have never priced access
based on the distance separating users and the sources of content,
or between senders and recipients of electronic mail.
The death of distance largely erodes the rationale for using
geography or political boundaries as the basis for differences in
how carriers allocate costs and price services. Indeed many of the
11
For example, carriers typically still incur different, mileage-based carriers
when they lease a dedicated line of varying distances. Local exchange carrier
line transport charges are mileage-based when a single carrier leases a line
instead of sharing it with other carriers.
12 ISPs initially offered unlimited Internet access to stimulate demand and
considered unused network capacity as available for loading at little if any
additional cost. Such promotional pricing does not burden heavy users with
higher charges even though such rates could help ISPs recover fixed costs.
Absent congestion ISPs could consider the incremental cost of handling more
traffic as near zero.
232 N.C. J.L. & TECH. [VOL. 5
reasons for such differences never had a justification on the basis
of cost as opposed to other political, social or public policy factors:
[E]fficiency has not been the only goal of
intercarrier compensation rules. For example, in
order to encourage universal services, . .. [the
Federal Communications] Commission and state
regulators historically set access charges [paid to
local exchange carriers] above cost. By doing so,
they hoped to be able to keep local telephone rates
low, and thus telephone penetration rates high.13
Federal and state telecommunications regulators previously
saddled long distance callers, especially ones making intrastate
calls, with higher rates than local telephone service consumers.
Over-priced long distance call revenues made it possible for local
exchange telephone companies ("LECs") to offer possibly below
cost local services and to tap into subsidies for achieving universal
service objectives including intentionally below cost service to
rural residents, the poor and residents of tribal lands.14
13B ill and Keep Carrier Compensation Proposal, supra note 5, at 9623.
14" The Universal Service Fund now encompasses four programs that support
telecommunications services nationwide. These include: Low-Income, High-
Cost, Schools and Libraries, and Rural Health Care. Link-Up America (Link-
Up) and the Lifeline Assistance Program (Lifeline) are part of the Fund's Low-
Income Program." Federal Communications Commission, Get Connected:
Afford-A-Phone, Background, availablea t http://www.fcc.gov/cgb/
getconnected/background.html (last modified Aug. 16, 2002) (on file with the
North Carolina Journal of Law & Technology).
Consumers qualifying for Link-Up America support are
eligible to save up to 50% on initial installation fees, not to
exceed $30 per household. In other words, up to $30 of the
first $60 of their initial hook-up bill. Participants may also
work with their telephone company to establish a deferred
payment schedule for remaining costs of up to $200.
Consumers living on American Indian or Alaskan Native
tribal lands may also qualify for an additional $70 to defray
initial connection charges.
The Lifeline Assistance Program enables eligible low-income
consumers to save from at least $6.75 to $9.50 on their basic
monthly telephone service fee depending on the state where
the consumer lives. Residents of tribal lands may be eligible
SPRING 20041 REGULATORY ARBITRAGE STRATEGIES 233
Distance insensitivity in telecommunications also
eliminates the rationale for having different charges for accessing
the same local exchange facilities on the basis of whether the call
crosses domestic or international borders, originates via a wireless
or wireline carrier, or traverses the Internet. Yet LECs continue
charging different rates largely because regulatory policies force
them to do so, or political factors favor their decision to over- or
under-price a particular service.
Set out below is a continuum of LEC access costs from
lowest to highest:
* the exchange of traffic between an ISP and a LEC typically
triggers no per minute access charge, because the ISP
qualifies as an information service provider exempt from
LEC access charge payment obligations making it possible
for the ISP to receive and terminate calls via metered
business telephone lines;15
• the exchange of traffic between LECs occurs on a
reciprocal basis using zero cost, (bill and keep);' 6
for an additional $25 in savings on their basic monthly phone
bill.
Id.
15 "Since 1983, the Commission has consistently and consciously permitted
enhanced service providers, a category that now includes Internet service
providers (ISPs) to connect to their customers using local business lines."
Implementation of the Local Competition Provisions in the Telecommunications
Act of 1996, 14 F.C.C.R. 3689, 3690 n.1 (1999); see also MTS and WATS
Market Structure, 97 F.C.C.2d 682, 715 (1983) (describing how the
implementation of high carrier rates would experience severe rate impacts).
"Enhanced service providers use interstate access but pay local business
exchange service rates." Implementation of the Local Provisions in the
Telecommunications Act of 1996, 14 F.C.C.R. at 3690 n. 1.
16 Bill and Keep, sometimes referred to as Sender Keep All refers to an
interconnection arrangement where a carrier agrees to accept traffic from
another carrier in exchange for a reciprocal agreement. The carriers make no
financial payments to each other. "The sharing of traffic over the interconnected
networks forming the Internet on a statistical and un-metered 'settlements' (or
'bill & keep') basis was a hallmark of early federal agency involvement in the
development of the Intemet. This system of traffic carriage free of charge
became known as 'peering."' BARBARA ESBIN, INTERNET OVER CABLE:
DEFINING THE FUTURE IN TERMS OF THE PAST 20 (F.C.C., O.P.P. Working
Paper No. 30, 1998), available at 1998 WL 567433.
234 N.C. J.L. & TECH. [VOL. 5
negotiated, or regulatory-agency prescribed rates typically
at a rate several decimal places below one cent;17
the exchange of traffic between long distance, i.e.,
interexchange carriers ("IXCs") and LECs occurs on a
uniformly tarriffed basis with rates that have declined
substantially, but still significantly exceed the reciprocal
rates paid by LECs; 18 New Competitive Local Exchange
Carriers ("CLECs") typically charge IXCs higher access
fees than Incumbent Local Exchange Carriers ("ILECs");19
Section 251 (b)(5) of the Telecommunications Act of 1996 requires all local
17
exchange carriers "the duty to establish reciprocal compensation arrangements
for the transport and termination of telecommunications." 47 U.S.C. § 251 (b)(5)
(2001). For examples of the quite small rates ILECs charge for local facilities,
see National Regulatory Research Institute, A Survey of UnbundledN etwork
Element Prices in the United States (July 2003), at http://nrri.org/documents/
Matrix0703all.pdf (comparing loop and port rates as well as tandem switching
and transport rates for state access lines) (on file with the North Carolina Journal
of Law & Technology); Jeffrey H. Rohlfs & J. Gregory Sidak, Exporting
Telecommunications Regulation: The UnitedS tates-JapanN egotiations on
InterconnectionP ricing,4 3 HARV. INT'L L.J. 317, 340 (2002) (listing the local
interconnection rates for selected states in 1999).
18 In 2000, the FCC adopted an industry proposed access charge regime that
increased user fees but reduced interexchange carrier access charge payments to
ILECs to a target range of 0.55 cents for the Regional Bell Operating
Companies and GTE, 0.65 cents for other LECs subject to price cap regulation,
and 0.95 cents LECs operating in areas with low subscriber densities. For
example, the Commission approved lower switching and transport access
services to a target range of 0.62. "We also adopt target rates of 0.55 cents for
the BOC price cap LECs and GTE, 0.95 cents for very low-density price cap
LECs, and 0.65 cents for other price cap LECs." See Matter of Access Charge
Reform, 15 F.C.C.R. 12,962, 13,029 162 (2000), rev'd in part by Texas Office
of Public Utility Counsel v. Fed. Communications Comm'n, 265 F.3d 313 (5th
Cir. 2001) (No. 00-60434), cert. denied by Nat'l Ass'n of State Util. Consumer
Advocates v. Fed. Communications Comm'n, 535 U.S. 986 (2002), on remand
to Cost Review Proceeding for Residential and Single-Line Business Subscriber
Line Charge (SLC) Caps, 17 F.C.C.R. 10,868 (F.C.C. Jun. 5, 2002), availablea t
2002 WL 1213038.
19" Our review of the record reveals that CLEC access rates vary quite
dramatically and, on the average, are well above the rates that ILECs charge for
similar service." Access Charge Reform, Reform of Access Charges Imposed
by Competitive Local Exchange Carriers, 2001 WL 431685, 22 (F.C.C. Apr.
7, 2001); see also Access Charge Reform Price Cap Performance Review for
Local Exchange Carriers, 15 F.C.C.R. 12,962, 13,028 (2000) (describing how
SPRING 20041 REGULATORY ARBITRAGE STRATEGIES 235
the exchange of traffic between a wireless carrier and a
wireline LEC carrier depends on whether the call appears
to be a local exchange of traffic (even if originated at a long
distance), or one involving a conventional long distance
20
call making the range variable;
the exchange of international long distance traffic on routes
lacking significant competition occurs on a per minute
accounting rate,21 ranging from a few cents to more than
the commission's current price cap plan allows price cap LECs flexibility to
determine tandem-switch rates), partially reverseds ub nom. Tex. Office of Pub.
Util. Counsel v. Fed. Communications Comm'n, 265 F.3d 313 (5th Cir. 2001),
cert. denied, 535 U.S. 986 (2002), on remand, Cost Review Proceeding for
Residential and Single-Line Business Subscriber Line Charge (SLC) Caps, 17
F.C.C.R. 10,868 (2002).
20 For example, in 2001 Sprint PCS charged AT&T 2.8 cents per minute to
deliver AT&T long distance calls to Sprint PCS subscribers. Petitions of Sprint
PCS and AT&T Corp. For Declaratory Ruling Regarding CMRS Access
Charges, WT Docket No. 01-316, Declaratory Ruling, 17 F.C.C.R. 13,192
(2001). This rate matched what major wireline LECs charged interexchange
carriers, but ran counter to the traditional access pricing mechanism for wireless
carriers where subscribers of the wireless carrier compensate it for the cost of
both sending and receiving calls:
CMRS carriers have never operated under the same calling
party's network pays (CPNP) compensation regime as wireline
LECs. Under a CPNP regime, LECs are compensated for
terminating calls by the carrier of the customer that originates
the call, not by the customer receiving the call. In contrast,
since the advent of commercial wireless service, and
continuing today, CMRS carriers have charged their end users
both to make and to receive calls. Until 1998, when Sprint
PCS first approached AT&T and other IXCs about payment
for terminating access service, all CMRS carriers recovered
the cost of terminating long distance calls from their end users,
and not from interexchange carriers.... The fact that the
industry practice for 15 years has been for CMRS carriers to
recover costs from their end users, together with the highly
competitive nature of the interexchange market, makes it
unlikely that an IXC that does not pay access charges to
CMRS carriers somehow "overcharges" its customers.
Id.a t 13,198.
21 For background on the international long distance telephone toll revenue
division process see ROB FRIEDEN, MANAGING INTERNET-DRIVEN CHANGE IN
INTERNATIONAL TELECOMMUNICATIONS ch. 9.1 (2001); Robert M. Frieden,