Tuesday, January 26, 2010

The Slow Winding Road to Intercarrier Compensation Reform

The intercarrier compensation system is outdated, complex, and in need of reform. But due to political pressures, analysis paralysis, or whatever other reasons, the Federal Communications Commission has persistently resisted real reform for a decade or more. Occasional regulatory patches to the intercarrier compensation system only nibble at the edge of hoped-for comprehensive reform. This month brings yet another reminder of the need for the newly constituted FCC to unify the intercarrier compensation system.

The U.S. Court of Appeals for the District of Columbia Circuit upheld the rate cap system for calls from an originating local exchange carrier (LEC) to an Internet Service Provider's (ISP) LEC. Originally established by a 1999 order by the FCC, the rate cap system for inter-LEC ISP-bound traffic has undergone a repeated back-and-forth between the D.C. Circuit and the FCC. Core Communications v. FCC is the latest and probably last round in the bounce-back mini-saga. The D.C. Circuit rejected claims that the FCC's 2008 order rearticulating the statutory basis for the rate cap system was "arbitrary and capricious."

The FCC's 2008 order relied primarily on Section 201 of the Communications Act for authority to regulate inter-LEC ISP-bound traffic. That section prohibits carriers engaged in delivering interstate communications from charging rates that are not "just and reasonable," and it gives the FCC authority to adopt implementing regulations. The D.C. Circuit concluded the FCC provided a solid foundation for treating inter-LEC ISP-bound traffic (i.e., under the rate cap system) differently than it generally treats inter-LEC compensation (i.e., reciprocal compensation through private negotiation and arbitration by state regulators). As Senior Judge Stephen Williams described the rationale of the FCC's order:

In the context to which reciprocal compensation is ordinarily applied, it noted, outgoing calls are generally balanced by incoming ones, so that it matters relatively little how accurately rates reflect costs….Such balance is utterly absent from ISP-bound traffic. Moreover, it found that in fact the rates for such traffic were so distorted that CLECs were in effect paying ISPs to become their customers…To the extent that ILECs simply passed the costs on to their customers generally (rather than having a separate charge for those making ISP-bound calls), they would force their non-internet customers to subsidize those making ISP-bound calls, and the system would send inaccurate price signals to those using their facilities for internet access (in effect the ISPs and their customers) and to those not doing so…the Commission believed that its "failure to act …would led to higher rates for Internet access, as ILECs seek to recover their reciprocal compensation liability from their customers to call ISPs,"…presumably meaning rates "higher" than cost, correctly computed. Thus the continued application of the reciprocal compensation regime to ISP-bound traffic would "undermine[] the operation of competitive markets."
The result of the D.C. Circuit's ruling was hardly surprising given the deferential "arbitrary and capricious" standard being applied. This result was also foreshadowed by last month's ruling by the D.C. Circuit in Rural Cellular Association v. FCC, upholding the "interim, emergency" rate cap system for the high-cost universal service fund (USF) for non-rural telecommunications carriers. (I blogged about the earlier case and related USF issues last month's post: "Reform USF Now: Two New Data Points").

The D.C. Circuit ultimately found persuasive the FCC's concern for arbitrage opportunities that inter-LEC ISP-bound traffic creates under the general reciprocal compensation system. Professor Gerald W. Brock, a member of the FSF Board of Academic Advisors, likewise acknowledged the incentives for such behavior in "Unifying Intercarrier Compensation," an essay published in New Directions in Communications Policy. Writes Brock:

In the late 1990s, the favorable treatment of interconnection among [LECs] created a form of arbitrage in which companies attempted to transform themselves from customers into LECs...If a dial-up ISP could create a CLEC "front" so that the traffic coming to it was treated as incoming reciprocal compensation traffic, then the ILEC would make net payments to the ISP instead of the ISP paying the ILEC.
Thus, the rate cap system makes sense given the broken intercarrier compensation system we have. But even this small "fix" points to the pressing need for comprehensive reform to create a unified intercarrier compensation system that FSF President Randolph May has urged in several blog posts.

As Brock writes in New Directions, "Now, access charges should be abolished and subsidies for universal service should be separated from intercarrier compensation." A meaningful overhaul toward a unified intercarrier compensation system should lean more heavily on private negotiation between parties, with arbitration as a backdrop. An FCC-established framework of presumptions and default arrangements could guide negotiating parties and reduce transaction costs. And expert arbitrators can take stock of regulation-induced arbitragers. Essentially, this kind of reform means a qualified expansion of the reciprocal compensation system, and a clear separation of any subsidies from intercarrier arrangements.

Of course, on the intercarrier compensation side, the FCC has dragged its heels to bring about a unified system since at least 2001. But even though the rate cap system just upheld by the D.C. Circuit hardly constitutes the straight path to badly needed comprehensive reforms, the very resolution of the litigation over inter-LEC ISP-bound traffic now leaves the FCC with one less excuse for delaying those reforms. Little more could be said for the FCC's progress on the comprehensive USF reform side. However, the FCC has been taking public comments on a petition for rulemaking by the National Cable & Telecommunications Association (NCTA) that seeks to reduce universal service subsidies in geographic areas experiencing facilities-based competition that is not subsidized. Now is the time for the FCC to take positive steps forward on intercarrier compensation reform and USF reform.