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SBC Inc. v. Federal Communications Commission

July 14, 2005


Petition for Review of an Order of the Federal Communications Commission

The opinion of the court was delivered by: McKEE, Circuit Judge.


Argued: November 16, 2004

Before: McKEE and CHERTOFF,*fn1 Circuit Judges, and BUCKWALTER, Senior District Judge*fn2


SBC Communications, Inc., petitions for review of an order of the Federal Communications Commission captioned, "Cost-Based Terminating Compensation for CMRS Providers, 18 FCC Rcd 18441, released on September 3, 2003 (the "Order Under Review"). SBC contends that the Order Under Review violated the Administrative Procedure Act by improperly revising an FCC rule without first affording notice and an opportunity for comment as required by the APA. SBC also argues that the Order Under Review cannot be upheld because it is arbitrary and capricious. For the reasons explained below, we will deny the petition for review.


The technological sea change that has occurred in the telecommunications industry has revolutionized the manner in which local telephone service is provided. It has also resulted in dramatic changes in federal and state regulations of the industry. Prior to the passage of the Telecommunications Act of 1996 (the "1996 Act"), Pub. L. 104-104, 110 Stat. 56, "[s]tates typically granted an exclusive franchise in each local service area to a local exchange carrier ("LEC")." AT&T Corp. v. Iowa Utilities Board, 525 U.S. 366, 371 (1999). The LEC typically owned, "among other things, the local loops (wires connecting telephones to switches), the switches (equipment directing calls to their destinations), and the transport trunks (wires carrying calls between switches) that constitute a local exchange network."*fn3 Id. The 1996 Act restructured local telephone markets by preempting state and local franchise arrangements, 47 U.S.C. § 253, and by requiring "incumbent local exchange carriers (ILECs) to share their networks and services with competitors seeking entry into the local service market." MCI Telecommunication Corp. v. Bell Atlantic-Pennsylvania, 271 F.3d 491, 498 (3d Cir. 2001).

Congress recognized that without allowing new entrants to use the incumbents' local exchange networks and other technology and services, the incumbents would maintain a stranglehold on local telephone service: no new entrant could realistically afford to build from the ground up the massive communications grid the incumbents had developed through years of monopolistic advantage.

Indiana Bell v. McCarty, 362 F.3d 378, 382 (7th Cir., 2004) (footnote omitted).

Among other things, the 1996 Act required that ILECs allow competitors to "interconnect" to their networks. See 47 U.S.C. § 251(c)(2). Interconnection is critically important to a competitive local exchange market. Without it, customers of one carrier -- e.g., the ILEC, that has historically served that area -- would not be able to call customers of another carrier -- e.g., a competitive LEC ("CLEC"), that has recently initiated service in that same area.

When local carriers establish interconnection arrangements, the 1996 Act requires them to include compensation terms, known as "reciprocal compensation arrangements," for delivery of the traffic they exchange. 47 U.S.C. § 251(b)(5). When a customer of carrier A makes a local call to a customer of carrier B, and carrier B uses its facilities to connect, or "terminate," that call to its own customer, the "originating" carrier A is ordinarily required to compensate the "terminating" carrier B for the use of carrier B's facilities. See Global NAPS, Inc. v. FCC, 247 F.3d 252, 254 (D.C. Cir. 2001) (Reciprocal compensation arrangement "means that when a customer of Carrier X calls a customer of Carrier Y who is within the same local calling area, Carrier X pays Carrier Y for completing or 'terminating' the call."). With respect to the compensation a carrier may recover for the transport and termination of traffic that originates with another carrier, the 1996 Act requires just and reasonable rates that provide for "the mutual and reciprocal recovery by each carrier of costs associated with the transport and termination on each carrier's network facilities of calls that originate on the network facilities of the other carrier." 47 U.S.C. § 252(d)(2)(A)(I). The 1996 Act effectively defines a reasonable rate as one that is "a reasonable approximation of the additional cost of terminating such calls," and prohibits any regulatory proceeding to establish such costs "with particularity." 47 U.S.C. §§ 252(d)(2)(A)(ii), 252(d)(2)(B)(ii).

The 1996 Act directs competing LECs to address "reciprocal compensation" terms in the first instance through voluntary negotiations. See 47 U.S.C. §§ 251(b)(5), 252(a); MCI Telecommunications, 271 F.3d at 500. When they are unable to do so, the 1996 Act permits either party to petition the appropriate state utilities commission to arbitrate the dispute in accordance with the terms of the 1996 Act and the FCC's implementing regulations. See 47 U.S.C. § 252(b)(1). The 1996 Act also required the FCC to adopt regulations to implement the Act, including its reciprocal compensation provisions. See generally Iowa Utilities Board, 525 U.S. at 377-78, 384. Within six months of the adoption of the 1996 Act, the FCC issued a comprehensive rulemaking decision to satisfy that requirement. See First Report and Order, Implementation of the Local Competition Provisions in the Telecommunications Act of 1996, 11 FCC Rcd 15499 (1996) (the "Local Competition Order").*fn4

In the Local Competition Order, the FCC established a presumption that the reciprocal compensation rates that two interconnecting carriers may charge each other are symmetrical.

Accordingly, the ILECs' rates generally serve as the proxy for other telecommunications carriers' additional costs of transport and termination. Local Competition Order, 11 FCC Rcd at 16031-44 (¶¶ 1069-1093); see also 47 C.F.R. § 51.71(a) (symmetrical reciprocal compensation rules). The FCC adopted symmetric rates because, among other things, they are easy to administer, can prevent ILECs' from taking advantage of their "unequal bargaining position," and do not discourage carriers' incentives to reduce costs. 11 FCC rcd at 16040-41 (¶¶ 1086, 1087, 1088); see also Id. at 16040 (¶ 1086). The FCC explained that it adopted the ILECs' rates as a proxy for the rates of other carriers because "[b]oth the incumbent LEC and the interconnecting carriers will be providing service in the same geographic area, so the[ir] forward-looking economic costs should be similar in most areas." Local Competition Order, 11 FCC Rcd at 16040 (para. 1085). This ratemaking scheme thus allows carriers to recover, through reciprocal compensation, "a reasonable approximation" of their costs. See 47 U.S.C. § 252(d)(2)(A)(ii).

The older, established telephone networks that traditionally have been built by ILECs utilize a hub-and-spoke design. The outside of the network -- the ends of the spoke -- are switches,*fn5 known as "end-office" switches, that directly serve customers in a particular local calling area. These end-office switches may be connected directly, one to another. In addition (or alternatively), the end-office switches are connected to a "tandem" switch -- the hub of the wheel. These tandem switches do not directly serve customers, but instead route calls to the appropriate end-office switch (sometimes via another tandem switch) and, therefore, serve a number of local calling areas. See MCI Telecommunications, 271 F.3d at 502. When a call goes through the ILEC's tandem switch, the ILEC incurs additional costs because it then has to transport the call from the tandem switch to the end-office switch. Local Competition Order, 11 FCC Rcd at 16042 (¶ 1090). See also Indiana Bell Tel. Co. Inc. v. McCarty, 362 F.3d at 384. Moreover, interconnecting carriers do not always have identical networks and therefore must sometimes terminate calls over different types of facilities.

The FCC recognized that "[n]ew entrants cannot hope to replicate the incumbents' network switch for switch" and would instead deploy "new technology" to terminate calls on their network. Local Competition Order, 11 FCC Rcd at 16042 (¶ 1090). Nevertheless, the FCC's Local Competition Order adopted a general regime of symmetrical reciprocal compensation rates and directed the states to establish "presumptive symmetrical rates based on the incumbent LEC's costs for transport and termination of traffic. . . ." 11 FCC Rcd at 16042 (¶ 1089). Given the advantages it perceived from using symmetrical rates, the FCC found that the ILECs' costs "serve as reasonable proxies for other carriers' costs of transportation and termination for the purpose of reciprocal compensation." Id. at 16041 (¶ 1088).

The FCC separately addressed the special situation that occurs when a competing carrier's newer technology does not precisely replicate the traditional "tandem switch" routing typically employed by the ILEC. The FCC offered the following explanation of its resolution of that problem:

We find that the "additional costs" incurred by a LEC when transporting and terminating a call on a competing carrier's network are likely to vary depending on whether tandem switching is involved. We, therefore, concluded that states may establish transport and termination rates in the arbitration process that vary according to whether the traffic is routed through a tandem switch or directly to the end-office switch. In such event, states shall also consider whether new technologies (e.g., fiber ring or wireless networks) perform functions similar to those performed by an incumbent LEC's tandem switch and thus, whether some or all calls terminating on the new entrant's network should be priced the same as the sum of transport and termination via the incumbent LEC's tandem switch. Where the interconnecting carrier's switch serves a geographic area comparable to that served by the incumbent LEC's tandem switch, the appropriate proxy for the interconnecting carrier's additional costs is the LEC tandem interconnection rate.

11 FCC Rcd at 16042 (¶ 1090).

The FCC thus mandated an inquiry into the geographic area served in determining the appropriate compensation rate in some circumstances that may involve tandem switching even though the state of the competing carrier's technology might not use tandem switching to complete a given call.

The substance of this rule is set forth in the final sentence of ¶ 1090 of the Local Competition Order. That text is nearly identical to the text of Rule 51.711 (a)(3). Pursuant to ¶ 1090 and Rule 51.711(a)(3), a non-ILEC carrier is entitled to recover the tandem interconnection rate for terminating traffic on its network upon a showing that its switch serves a geographical area comparable to that served by the ILEC's tandem switch. According to the FCC, there is no need for the non-ILEC to also show that its switch is "functionally equivalent" to the ILEC's tandem switch.

The FCC claims that the initial reciprocal compensation rules inadvertently encouraged some competitive carriers to "game the system" by such practices as soliciting business only from internet service providers ("ISPs"). See generally WorldCom, Inc. v. FCC, 288 F.3d 429 (D.C.Cir. 2002), cert. denied sub nom. Core Communications, Inc v. FCC, 538 U.S. 1012 (2003). An ISP's dial-up customers call the ISP to connect to the internet and typically remain on the line for an extended period of time. When the ISP subscribes to a CLEC for its local service and the ISP's dial-up customers are local telephone customers of an ILEC, the CLEC's transport and termination services are used to connect the caller to the internet. However, the exaggerated duration of the connected calls meant that the CLEC recorded protracted use for purposes of reciprocal compensation calculations. As the Court of Appeals for the D.C. Circuit recently found, the FCC's initial reciprocal compensation regime was "flaw[ed]" because "ISPs typically generate large volumes of one-way traffic in their direction." WorldCom, Inc. v. FCC, 288 F.3d at 431. According to the FCC, some competitive carriers were able to earn substantial parts of their revenues by delivering traffic that originated on the ILEC network to the ISPs on the competitive carriers' own networks. CLECs would therefore receive compensation for completing lengthy calls made by an ILEC's customers yet never have to pay an ILEC for completing traffic in the other direction. This system attracted some competitive LECs "that entered the business simply to serve ISPs, making enough money from reciprocal compensation to pay their ISP customers for the privilege of completing the calls." Id.

According to the FCC, this practice by some CLECs was partly responsible for causing some state utility commissioners to try to reduce what they perceived as excessive payments to competitive carriers that were solely in the business of terminating calls to ISPs. See Intercarrier Compensation Regime, 16 FCC Rcd at 9649 n.173. In arbitration proceedings before state utility commissions after the Local Competition Order became effective, some state commissioners interpreted ¶ 1090 of the Local Competition Order as imposing upon a non-ILEC carrier two separate conditions precedent to recovering the tandem interconnection rate. Id. Such a carrier would have to establish both that its switch served a geographic area comparable to the ILEC's, and that its switch functioned in a manner equivalent to the ILEC's tandem switch. See, e.g., Arbitration Award, Proceeding to Examine Reciprocal Compensation Pursuant to Section 252 of the Federal Telecommunications Act of 1996, Docket No. 21982, 2000 Tex. PUC Lexis 95 (Tex. PUC July 13, 2003) at *45-47; see also Opinion and Order Concerning Reciprocal Compensation, Proceeding on Motion of the Commissioner to Reexamine Reciprocal Compensation, N. Y. PUC LEXIS 398 at *96-97 (N.Y. PSC Aug. 26 1999).

This two prong test resulted in some CLECs receiving the lower non-tandem rate for reciprocal compensation and thus receiving smaller amounts of compensation. According to the FCC, some federal district courts affirmed some of those state commission decisions. FCC's Br. at 11 (citing, e.g., U. S. West Communications, Inc. v. Public Serv. Comm'n, 75 F.Supp.2d 1284, 1289 (D.Utah 1999)).

In addition to these specific rules regarding the tandem interconnection rate, the FCC also adopted two more general rules relating to reciprocal compensation rates. First, the FCC adopted a rule that mirrored the "additional costs" language of § 252(d)(2)(A)(ii) requiring that reciprocal compensation rates be "structured consistently with the manner that carriers incur th[e] costs" of terminating local calls. 47 C.F.R. § 51.709(a); see also id. § 51.507(a) (requiring rates to be "structured consistently within the manner in which the costs of providing the elements are incurred"). Second, the FCC stressed that reciprocal compensation rates must be crafted consistently with "rate structure rules" that require distinct rates for different functions, including (I) "tandem switching," (2) "local switching," and (iii) the use of "transmission facilities between tandem switches and end offices." Id. §§ 51.509, 51.709(a).


On February 2, 2000, Sprint PCS wrote a letter to the chiefs of the FCC's Common Carrier Bureau (now known as the "Wireline Competition Bureau") and Wireless Telecommunications Bureau seeking guidance on whether a wireless telephone service provider may "recover in reciprocal compensation all the additional costs it incurs in terminating local traffic originated on other networks." See Letter from Jonathan M. Chambers, Sprint PCS, January 26, 2000. The letter was prompted by state commissioner decisions on reciprocal compensation that Sprint PCS claimed were inconsistent with the 1996 Act and the Local Competition Order. Id. at 18, 19-20.

The FCC issued a public notice requesting comments on the Sprint letter, and numerous parties responded. Attwood Letter, 16 FCC Rcd at 9598. Many of the responses also asked the FCC to clarify the rule governing payment of the tandem interconnection rate for terminating traffic to commercial mobile radio service providers ("CMRS" or "wireless" or "mobile carriers"). See, e.g., Comments of Western Wireless Corporation, June 1, 2000 (App. 48-49); see also Reply Comments of US West Communications, Inc., June 13, 2000 (App. 62).

On April 27, 2001, while Sprint's letter request was pending, the FCC released a Notice of Proposed Rulemaking ("NPRM"), in which it undertook to reexamine the general subject of intercarrier compensation. See Intercarrier Compensation NPRM, 16 FCC Rcd 9610. The NPRM addressed many subjects, including the question of when an interconnecting carrier is entitled to recover the tandem rate for reciprocal compensation.

The FCC acknowledged that there had been some disagreement over the availability of the tandem interconnection rate -- specifically, whether a competitive carrier must demonstrate functional equivalency as a separate requirement independent of, and in addition to, comparable geographic area coverage in order to recover the tandem rate. Intercarrier Compensation NPRM, 16 FCC Rcd at 9647, 9648 (¶¶ 103, 105). The FCC noted that "in dealing with problems presented by ISP-bound traffic, some states have incorporated a functional equivalency test into their interpretations of section 51.711(a)(3)." Id. at 9649 n.173. For example, both "the Texas PUC and the New York PCS concluded that large imbalances in traffic flows strongly suggest that a carrier is serving a higher proportion of convergent customers rather than a large distribution of customers similar to those served by an ILEC tandem switch." Id.

The FCC stated that the state commission decisions imposing a separate functional equivalency requirement in addition to the geographic area test were "inconsistent with our rule." Intercarrier Compensation NPRM, 16 FCC Rcd at 9649 n.173. The Commission pointed out that Rule 51.711(a)(3) requires only that a carrier demonstrate that its switch serve "a geographic area comparable to that served by the incumbent LEC's tandem switch" in order to receive the tandem rate. Id. at 9648 (¶ 105). Nevertheless, the FCC acknowledged the problems addressed in those state decisions and it undertook to "consider whether to amend the rule to give states greater flexibility in applying a tandem interconnection rate to networks using newer, more efficient technologies." Id. at 9649 n.173. It also invited comment, including comment on whether it should amend its rule to include "the 'functional equivalency' concept. . . ." Id. at 9649 (¶ 107).*fn6

On May 9, 2001, the chiefs of the Common Carrier Bureau and the Wireless Telecommunications Bureau, acting on delegated authority, released the Attwood Letter addressing the issues raised in Sprint's letter as well as the responsive comments. 16 FCC Rcd 9597. The Attwood Letter was an opinion letter of the FCC staff. Although it primarily addressed Sprint's inquiry regarding wireless carriers' incurring asymmetrical, "additional costs" in terminating telephone traffic, it also addressed "when a carrier is entitled to the tandem interconnection rate." Id. at 9599. The Letter noted that the FCC had recently confirmed that, "[w]ith respect to when a carrier is entitled to the tandem interconnection rate, . . . section 51.711(a)(3) requires only a geographic area test." Id.*fn7 The opinion Letter concluded: "Therefore, a carrier demonstrating ...

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