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In the Matter of the Board's

June 21, 2012

IN THE MATTER OF THE BOARD'S INVESTIGATION AND REVIEW OF LOCAL EXCHANGE CARRIER INTRASTATE EXCHANGE ACCESS RATES.


On appeal from the New Jersey Board of Public Utilities, Docket No. TX08090830.

Per curiam.

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

Argued: May 11, 2011

Before Judges Axelrad, R. B. Coleman, and Lihotz.

This appeal involves the Board of Public Utility's (the BPU) reduction of switched access service rates, which telephone companies pay each other when calls by their customers either originate or terminate, or both, on another company's rented, leased, or owned landline network.

Appellants, various competitive local exchange carriers (CLECs), challenge the BPU's order gradually reducing the rates they can charge incumbent local exchange carriers (ILECs), such as respondents, Verizon and CenturyLink, and interexchange carriers (IXCs), such as respondents Sprint and American Telephone and Telegraph Corp. (AT&T), for intrastate switched access service, that is, connections for toll calls originating and terminating in New Jersey. The BPU historically set intrastate switched access rates much higher than the actual cost of providing switched access service, reflecting the agency's historical goals: (1) to subsidize costs incurred by the ILECs to operate their local landline networks, and (2) to provide the ILECs with the ability to offer artificially cheaper local telephone service to their own customers. However, the telecommunications industry is constantly changing, and the BPU maintains that its elimination of those subsidies and the uniform reduction of intrastate switched access rates for all local exchange carriers (LECs)*fn1 to the lowest level set by the Federal Communications Commission (FCC) for interstate access is reasonable and supported by the record. Appellants challenge the BPU's order as unreasonable and unconstitutionally confiscatory, and argue the BPU made no findings of fact sufficiently explaining its decisions. We affirm.

I.

We provide a brief historical perspective of the telecommunications markets to place this appeal in context. Telecommunications markets in the United States were monopolistically controlled first by AT&T, and then later by its "Baby Bell" offspring. Until 1982, AT&T dominated both the local-exchange and long-distance telephone service markets. AT&T Corp. v. Iowa Utils. Bd., 525 U.S. 366, 413, 119 S. Ct. 721, 746, 142 L. Ed. 2d 834, 870 (1999) (Breyer, J., concurring in part and dissenting in part). Because of that monopoly, there were no access fees or switched access service. In 1982, facing an antitrust suit by the federal government, AT&T agreed to a settlement whereby it retained its long-distance operations in one IXC, and split that IXC from its local-exchange or intrastate services, which it then bestowed to various LECs, the Baby Bells. Verizon Commc'ns Inc. v. Fed. Commc'ns Comm'n, 535 U.S. 467, 475, 122 S. Ct. 1646, 1654, 152 L. Ed. 2d 701, 715 (2002).

States then granted one LEC, called the incumbent LEC or ILEC, an exclusive franchise to provide local telephone service within a designated area in that state. AT&T Corp. v. Iowa Utils. Bd., supra, 525 U.S. at 371, 119 S. Ct. at 726, 142 L. Ed. 2d at 844. These areas were called Local Access and Transport Areas, or "LATAs." In re MCI Telecomms. Corp., 263 N.J. Super. 313, 316 (App. Div. 1993). A LATA was identified by a three-digit number (area code). Ibid. "IntraLATA" referred to connections made within the same LATA, while "interLATA" referred to connections between a carrier in one LATA and a carrier in another LATA, i.e., toll calls. Ibid.

The ILECs typically built and owned "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[d] a local exchange network." Iowa Utils. Bd., supra, 525 U.S. at 371, 119 S. Ct. at 726, 142 L. Ed. 2d at 844. IXCs, such as AT&T and Sprint, made no investment in those local loops; they merely used that network for their customers' toll calls.

As explained by Verizon's experts,

An exchange access line is composed of a local loop from the NID [(network interface device)] at the customer's location to a switch termination point at a central office. The primary [physical] components of the local loop are the NID, drop, distribution plant, feeder plant, terminal equipment, and electronic equipment.

In addition to the loop cost, the cost of an exchange access line includes the costs associated with the main distribution frame [] or digital cross-connect [] bay and the termination, or port, on the central office switch.

Accordingly, each ILEC was considered the carrier of last resort (COLR) in its own LATA. An ILEC is still "required to provide service on demand to all customers throughout its service territory," "to maintain a ubiquitous, fully operational telecommunications network that stands ready to serve any customer that requests service regardless of the costs of serving that customer," and to implement and pay for programs to provide subsidized services, such as, for elderly and lower income residents.

Respondent Verizon NJ is the largest ILEC and COLR in New Jersey, serving up to ninety-five percent of the State. It has an average of 839 loops per square mile in its LATA. CenturyLink is also an ILEC and COLR, serving approximately 154,000 customers in largely rural and suburban sections of northern and western New Jersey. It has an average of 182 loops per square mile in its LATA.

After AT&T's split in 1982, state legislatures and administrative agencies set the rates that ILECs could charge consumers, both at the wholesale and retail levels, in order to prevent monopolies from leading to exorbitant local prices. Verizon Commc'ns Inc., supra, 535 U.S. at 477-78, 122 S. Ct. at 1654-55, 152 L. Ed. 2d at 716-17. Regulation of retail prices focused on balancing the ILEC's interest in a fair return on investment against the public's interest in a fair price for services. Id. at 480-81, 122 S. Ct. at 1656-57, 152 L. Ed. 2d at 718-19. Nevertheless, regulators set toll call rates above the actual service costs so the ILEC's local service rates could be kept artificially low. Those rates were set to ensure that the ILEC in each LATA had the chance to recover its costs plus a reasonable rate of return.

Additionally at that time, because the ILEC networks carried both intrastate and interstate calls, charges for switched access services were created. In theory, switched access rates are not paid directly by telephone company customers, considered "end users"; these rates are charged between the companies and apply when a call either originates or terminates beyond the customer's local calling area, as it then is carried on wires controlled, owned, or leased by different companies. That is, an IXC is required to pay a fee, the switched access charge, to the ILEC serving the calling and called customers of a long distance call for the functionality of handling the call at the originating and terminating ends.

Technically, switched access is "a two point electrical communications path between a [calling] customer's premises and an end [answering] user's premises. It provides for the use of common terminating, switching and transport facilities, and both common subscriber plant and unshared subscriber plant, i.e., entrance facilities, of the Telephone Company." This "switching" accommodates calls to and from end users throughout the country, and occurs over the public telephone network, which consists of multiple carriers' interconnecting networks, as contrasted with special access lines dedicated to a private line circuit. The record contains various examples of switched access routes; each appears to involve: (1) a customer making or receiving a call from another customer, with one of them using a landline or wired network, and (2) an actual electric "switch" in the central or satellite office of the "wired" customer's LEC switching that call to or from the customer's IXC or another LEC.

Interstate switched access service crossed state boundaries, while intrastate switched access service stayed within state boundaries, and the FCC governed switched access charges associated with interstate calls, while the BPU regulated the intrastate access rates. Like the ILECs' other rates, these governmental agencies initially and purposely set switched access charges well above the costs of the actual service, with the primary policy objective of promoting universal low-cost basic service across the region.

At that time, the "three most significant" elements of a switched access rate were: (1) the carrier common line charge, a per minute usage charge applied equally to both originating and terminating minutes, which was used to recover a portion of the costs of non-traffic sensitive network elements used to provide access service, and which had a quarterly and annual revenue cap based on a carrier's proportionate use of originating and terminating minutes (i.e., Verizon NJ's current annual cap is $12.8 million); (2) the local switching charge, which was a per minute charge applied to both originating and terminating minutes, and represented an inherent component of the facilities activating switched access service; and (3) the market share line charge, which was a monthly rate assessed against all access lines and trunks, with revenues being apportioned to each carrier customer connecting to the switched access network, the apportionment based on that carrier customer's market share of the local switching minutes of use.

However, despite all of this governmental regulation, local service became a monopoly held by the ILECs, primarily due to the expense of any new carrier having to duplicate the infrastructure of the existing ILEC, including its lines, telephone poles, and switching terminals, before entering the local market. Verizon Commc'ns Inc., supra, 535 U.S. at 490, 122 S. Ct. at 1662, 152 L. Ed. 2d at 724-25.

Consequently, fourteen years later in 1996, Congress opened up the local markets by enacting the Telecommunications Act of 1996 (TCA), Pub. L. 104-104, 110 Stat. 56 (1996) (codified in scattered sections of 15 U.S.C.A., 18 U.S.C.A., and 47 U.S.C.A.). AT&T Corp. v. Fed. Commc'ns Comm'n, 220 F.3d 607, 611 (D.C. Cir. 2000). The TCA restructured and deregulated local service markets by requiring ILECs to share their facilities and networks with aspiring competitors, the CLECs. 47 U.S.C.A. § 253.

These "sharing" arrangements were effectuated through interconnection agreements establishing, among other things, how much a CLEC had to compensate the ILEC for the use, (rent, lease, or sale) of its equipment and networks. 47 U.S.C.A. §§ 251 and 252. If a voluntary agreement could not be negotiated between a CLEC and the ILEC, the TCA provided the CLEC could petition the governing state commission to compel arbitration to produce an interconnection agreement. 47 U.S.C.A. § 252(b). However, unlike the ILECs, the CLECs had no COLR obligations or related costs. The record shows they were "not burdened with legacy technologies and legacy network architectures, and . . . can choose the specific geographic areas in which to build and serve, can service other areas without building a network . . . , or can choose not to serve some areas at all."

Appellants, Level 3 Communications, L.L.C., CTC Communications Corp., Conversent Communications of New Jersey, L.L.C., PAETEC Communications, Inc., US LEC of Pennsylvania, L.L.C., RNK, Inc., Cavalier Telephone Mid-Atlantic, L.L.C., and XO Communications Services, Inc., who are various CLECs, provide retail telecommunications services over facilities they individually own or lease from the ILEC in their region. They are "billion dollar, multi-state and often multi-national corporations," serving "primarily medium to large businesses, government, wholesale markets, and content markets in metropolitan areas." The record reflects that "none serves any substantial number of residential customers in New Jersey." Appellants' witnesses testified they: (1) have incurred and often continue to incur higher capital and operating costs than an ILEC, and (2) do not have the large and stable customer bases enjoyed by the ILECs.

Despite this new deregulation within the industry, the BPU continued its historic practice of setting intrastate access rates above the cost of providing that service in order to maintain affordable basic exchange service rates and to promote universal service.

In 2000, the FCC reduced the interstate switched access rates that all ILECs could charge IXCs, and in 2001, it capped the interstate switched access rates that all CLECs could charge at the interstate rate of the ILEC with which the CLEC competed. That cap was "intended to prevent CLECs from imposing excessive access charges on [IXCs] and their customers." Simultaneously, the FCC increased the LECs' subscriber line charges and established a universal service fund to help LECs offset revenue losses from the switched access rate reductions.

Since 2000, at least seventeen states have reduced their intrastate switched access rates for all LECs to the interstate levels. Some of those states, however, had express policies to mirror the FCC rates, either established by their legislatures, such as Texas and Maine, or by the administrative agencies regulating telecommunication companies, such as in West Virginia and Ohio.

In New Jersey, the BPU began adopting plans of alternative regulation, including service reclassifications, for the LECs in this state. The BPU has "the authority to approve alternative forms of regulation in order to address changes in technology and the structure of the telecommunications industry; to modify the regulation of competitive services; and to promote economic development." N.J.S.A. 48:2-21.16(a)(5). See N.J.S.A. 48:2-21.17 ("'Competitive service' means . . . any telecommunications service not regulated by the [BPU]."). Thus, while an IXC's services are always competitive, N.J.S.A. 48:2-21.20, the BPU could determine, based on evidence of ease of market entry, the presence of competitors, and the availability of substitute services, whether the services of any LEC were competitive/unregulated or noncompetitive/regulated. N.J.S.A. 48:2-21.19(b).

For example, in 2007, pursuant to N.J.S.A. 48:2-21.19, the BPU granted the ILECs pricing freedom by reclassifying all of their retail services as competitive/unregulated, except for the following four, which remained noncompetitive/regulated:

(1) residential basic exchange service; (2) single line business basic exchange service; (3) installation of residential service; and (4) residential directory assistance. In re Bd. Investigation Regarding the Reclassification of Incumbent Local Exch. Carrier (ILEC) Servs. as Competitive, In re Application of United Tel. Co. of N.J., Inc., BPU TX07110873 and TO08060451 (August 20, 2008) (ILEC Reclassification Proceeding). Expressly excluded from the BPU's order were switched access service and rates, which remained noncompetitive/regulated.

Also in 2007, and more important here, the BPU issued an order deregulating all CLECs' retail services and deeming them competitive/unregulated. In re Bd. Investigation Regarding the Reclassification of Competitive Local Exch. Carrier (CLEC) Servs. as Competitive, BPU TX06120841 (June 29, 2007) (CLEC Reclassification Proceeding). While the BPU's order did not extend to any CLEC's wholesale services, including switched access services, it allowed CLECs to increase their rates for retail services without the BPU's review or permission.

II.

At its agenda meeting on October 6, 2008, the BPU sua sponte "open[ed] an investigation into the appropriate level" of the intrastate access rates charged by LECs. The agency invited and granted intervention and pro hac vice motions.

On December 17, 2008, the BPU issued a "Prehearing Order," declaring that "[t]his investigation [was] designed to set rates which all entities will be required to charge, including default rates where entities have failed to participate in this proceeding." The agency explained there were "two basic positions" at the core of its investigation: (1) "one group believes that access rates should be immediately reduced, ideally to the interstate level set by the [FCC]," with other issues being resolved, "if necessary, after the setting of the appropriate access rates"; and (2) "[t]he other group accepts the [BPU's] ability to review access rates, but calls upon the [BPU] to engage in a deliberate and intensive review prior to any modifications in the access rate, and . . . does not concede that the FCC's interstate rate is necessarily reasonable."

The BPU viewed "this as an investigation as to the entire industry," which "require[d] a comprehensive review of costs as well as other relevant information in order for the [BPU] to make its determination." Thus, it ordered "that cost studies, to the extent requested or otherwise used in this matter, shall be forward-looking." Additionally, the BPU announced that "[t]he question of revenue recovery is not an appropriate area of review in this docket and shall be considered, if necessary, in a separate matter, as appropriate, following the conclusion of this matter. This approach reflects the commitment set forth in the ILEC stipulations."

Thereafter, before the BPU held evidentiary hearings on September 15, and 17, and October 19, and 20, 2009, most of the parties here filed initial and reply testimony from their experts, and appellants filed cost studies and other summary models, with explanations, claiming they would lose millions of dollars in revenue if the BPU reduced those rates by eliminating the historical subsidies in switched access rates. Appellants Level 3 Communications, L.L.C., and XO Communications Services, Inc., requested additional time to file their own cost studies, but never submitted them. The parties then filed initial and reply briefs.

The CLECs presented only two "New Jersey-specific studies and models estimating costs incurred in providing switched usage service" -- one from appellant PAETEC and one from appellant One Communications or ONE COMM. They argued the studies demonstrated it was "clear" that "CLEC access costs are: (1) higher than Verizon's costs required to produce the same services, and (2) substantially higher than both Verizon's and [CenturyLink]'s interstate access rates." However, appellants' witnesses testified that PAETEC's results were "unique for a CLEC" and its "network" was "unique in relation to networks operated by other CLECs." They also pointed to other differences between PAETEC and the other CLECs, such as the size of the switching office.

Nevertheless, based on those studies, appellants argued their rates should not be changed. They claimed that it would be unfair if the BPU capped their intrastate switched access rates at the level of an ILEC's interstate rate because of the considerable economic and market differences between them and the ILECs, such as in their operating costs and lower margins. They pointed out: (1) CLECs were "smaller companies"; (2) "investors and creditors view [CLECs] very differently from AT&T when attributing necessary returns on their capital," and "CLEC investors require greater levels of return on their investment to mitigate this increased level of risk"; (3) "CLECs face greater risk due to their lack of size and scale"; and (4) "CLECs lack any regulatory protection related to their revenue stream should they lose customers and/or usage volumes on their networks." They further claimed CLECs do not have the ability to raise their unregulated retail rates because the market was so competitive and they could not rely on regulated rates as a source of revenue.

Appellants further asserted that while ILECs served more of the local customers in an exchange, CLECs had significantly smaller customer bases and smaller economies of scale and scope. Appellants urged that CLEC switches served more geographic area than an ILEC's switches, requiring CLECs to build or purchase transport capacity between their switches and various ILECs' central offices, and use third parties to connect to some However, appellants' witnesses admitted that although "the CLEC networks are designed somewhat differently," "they predominately provide the same general functionality as an ILEC network." In fact, they answered in their written testimony:

Q. THOUGH DIFFERENTLY CONFIGURED, DO CLEC NETWORKS PROVIDE THE SAME TYPE OF SWITCHED ACCESS SERVICE AS A MORE CLASSICALLY CONFIGURED NETWORK?

A. Yes, in the sense that functionally, there are no differences for either the end user customer, or the IXC with regard to the access service provided by CLECs versus access service provided by a more traditional network.

Sprint's witnesses argued that "CLECs have absolutely no incentive to limit the level of their switched access rates." They explained that "[t]o ensure and promote full competition, carriers cannot be expected to subsidize LEC retail services through inflated intrastate switched access rates." They elaborated:

The higher that CLECs set their switched access rates, the more their cost of service is recovered from the CLECs' competitors instead of the CLECs' own customers. Inflated access rates allow the CLECs to offer lower retail rates that competitors paying those access rates cannot match. Competitors subsidize the CLEC offerings through high switched access rates that other carriers must pay to complete their non-local calls to the CLECs' customers. High switched access rates, regardless of the entity imposing those rates, distort the retail market.

CLECs' switched access should be set at levels that do not distort the retail market. To accomplish that, Sprint believes the [BPU] should prevent the aggregate CLEC access rate from exceeding the aggregate rate of the ILEC the CLEC is competing against. If the CLEC is competing with more than one ILEC in New Jersey, the CLEC should be permitted to charge an aggregate rate equal to incumbent's aggregate rate in each ILEC territory served. As it does with ILEC rates, Sprint advocates an immediate change to the CLEC rates so each CLEC's aggregate rate equals the ILECs' interstate rates-which will also be the new intrastate aggregate levels.

Verizon NJ's witnesses testified that its intrastate rates should be "the benchmark" for all LECs, since those rates "have been subject to the greatest regulatory scrutiny and they are near the median intrastate access rate charged by all carriers in the state." The other parties criticized Verizon NJ's cost study, but Verizon NJ submitted rebuttal testimony, demonstrating that its low basic exchange service rates did not cover its costs for providing local service, and it was already suffering a shortfall for its regulated service.

The other respondents' witnesses testified that "subsidies embedded in access rates harm competition and consumers," because they "inflate the price for all retail voice telecommunications services that require those access services as an essential input." Switched access is a monopoly service, because there can only be one provider of switched access for calls to and from a local service customer, and that is the customer's local service provider. They further testified the only time carriers are not impacted by high intrastate access rates is "[w]hen a competing carrier exchanges traffic with its affiliated LEC," such as the traffic between Verizon Corporation, Verizon Wireless, and Verizon NJ. Moreover, LECs can recover revenue for lower access rates using price schedules of other services. The witnesses concluded, "[i]f the switched access rates are reduced, consumers will benefit" because "service providers will have more resources to expand service coverage, enhance service quality, develop new and innovative service offerings, and provide better pricing in the market."

Various witnesses pointed out that the cost of switching and transporting a call on both Verizon NJ's networks is significantly less than each ILEC's compatible intrastate switched access rate, because "[t]he same ILEC network elements are used to complete a call on the ILEC network regardless of where that call originated. Therefore, the economic cost to terminate a local call should be the same as the cost to terminate interstate or intrastate switched access traffic." In ...


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