FCC Unveils Draft Order to Combat New Access Stimulation Schemes

On March 30, the FCC released a draft order for consideration at its April 20 public meeting that is intended to foreclose a new method for evading the Commission's rules and arbitraging the access charge regime.

As the draft order recounts, some local exchange carriers (LECs) in areas with high access charges partner with "free" conference call or chat line services that significantly increase the volume of terminating calls to the LECs and thereby dramatically boost the access charges that the LECs can bill to interexchange carriers (IXCs). Access charges are supposed to cover the LECs' costs of providing service. But access stimulation schemes unnecessarily raise the costs for IXCs – as well as their customers – and such schemes unjustly enrich the LECs and their call service partners.  

 

The tactics employed by arbitragers change over time, requiring periodic updates of the rules to curb access stimulation. According to the draft order, certain LECs have inserted Internet Enabled Protocol Service (IPES) Providers into the call pathway for these conference call and call services. Apparently, some LECs have converted traditional competitive LEC numbers into IPES numbers in order to claim that the Commission's 2019 order does not apply to them. The Commission's draft order would address this. If adopted by the Commission, the draft order would provide that "when traffic is delivered to an IPES Provider by a LEC or an Intermediate Access Provider and the terminating-to-originating traffic ratios of the IPES Provider meet or exceed the triggers in the existing Access Stimulation Rules, the IPES Provider will be deemed to be engaged in access stimulation."

 

The Commission's draft order appears a reasonable and necessary step to halt further gaming of the access charge regime. (For further background, see my July 2022 blog post.)

FCC Proposes Rule Clarifications to Stop Gaming of the Access Charge System

On July 14, the FCC voted to adopt a Notice of Proposed Rulemaking to address a new form of access stimulation arbitrage of the intercarrier compensation system that allegedly involves involving call flow IP enabled (IPES) Providers. 

Access charges are a vestige of the legacy intercarrier compensation system. As the Commission's Notice points out, access charges were intended to compensate carriers for use of their networks by other carriers. Although the rates were once cost-based and tied to normal call traffic volumes, they have since been capped. Some local carriers have exploited this by artificially stimulating terminating calls through arrangements with high-volume calling services such as "free" conference calling services and chat lines. According to the Notice, the resulting high call volumes generate revenues far in excess of costs that the access charges were designed to cover.

In its 2011 USF/ICC Transformation Order, the Commission adopted rules to stop the problem of access stimulation (also called "traffic pumping") for those terminating tandem switching and transport services that have not transitioned to bill-and-keep. (The problem was subject of a December 2010 blog post). And in 2019, the Commission updated those rules to prevent new arbitrager tactics. The update to those rules was upheld by the D.C. Circuit in 2021.

Based on input from interexchange carriers (IXCs), the Commission's Notice suggests the rules need to be clarified once more to prohibit new forms of access stimulation involving call flow IP enabled (IPES) Providers. Apparently, some IPES Providers have claimed that the Commission's Access Stimulation Rules do not apply to voice traffic that terminates to "IPES numbers." 

 

To address this apparent problem, the Commission's Notice states: 

[W]e propose that when traffic is delivered to an IPES Provider by a LEC or an Intermediate Access Provider and the terminating-to-originating traffic ratios of the IPES Provider exceed the triggers in the Access Stimulation Rules, the IPES Provider will be deemed to be engaged in access stimulation. In such cases, we propose that the Intermediate Access Provider would be prohibited from imposing tariffed terminating tandem switching and transport access charges on IXCs sending traffic to the IPES Provider or the IPES Provider’s end-user customer. 

To be sure, access stimulation is a complicated and even arcane subject. But there is no justification for gaming the intercarrier compensation system and sticking interexchange carriers with bogus charges. If IPES Provider-related arbitrage is taking place as alleged, then some kind of clarification of the rules by the Commission is in order. To that end, the Commission's vote to approve the Notice makes good sense.  

Roundup of Recent FCC Reform Actions

At its October 25 public meeting, the FCC took a number of actions, including a vote to approve its Effective Competition Order. This order was discussed in My Perspectives from FSF Scholars paper, "FCC Action Would Finally Eliminate Local Cable Rate Regulation." Additionally, the order is the subject of Free State Foundation President Randolph May's Media Advisory from October 4. Given the choice of video services consumers have today, the Commission's grant of relief from the last remains of early 90s-era local cable rate regulation is welcome.

Also at its October 25 public meeting, the Commission voted to approve a declaratory ruling that provides parity and prohibits discriminatory fees on VoIP services. My October 17 blog post discussed that ruling.  

At its September 26 public meeting, the Commission approved an order eliminating forms of access arbitrage involving the intercarrier compensation system. Prior blog posts called attention to that order. 

FCC to Vote on Proposed Rules to Stop Access Arbitrage Schemes

At its September 26 public meeting, the FCC will vote on a proposed rulemaking to eliminate access stimulation arbitrage schemes. I called attention to this proposal in a May 2018 blog post. There is no good reason for the Commission to permit abuses of the intercarrier compensation system such as access stimulation. The Commission's proposed rule changes are sensibly targeted to the problem and deserve agency approval.

FCC Proposal Would Address New Forms of Access Arbitrage

One of the items on tap for the FCC’s June 7 public meeting is a draft proposed rulemaking that addresses access arbitrage abuse of the intercarrier compensation (IC) system. The IC system is premised on the basic idea that rural local exchange carriers have small customer bases and correspondingly small amounts of per-minute traffic that are terminated on their networks. As the Commission’s proposal observes:

Access stimulation (also known as traffic pumping) occurs when a local exchange carrier (LEC) with relatively-high switched access rates enters into an arrangement to terminate calls—often in a remote area—for an entity with a high call volume operation, such as a chat line, adult entertainment calls, and “free” conference calls, collectively high call volume services. 

Access stimulation thereby takes advantage of the IC system. Back in 2010, my blog post briefly explained: "FCC Needs Fast-Track Fix to Stop Traffic Pumping." The Commission made such fixes as part of its USF/ICC Transformation Order (2011). However, the Commission’s proposal points out that such arbitrage still takes place:

To circumvent the Commission’s rules, access-stimulating LECs have adjusted their practices, and now they support such services by interposing intermediate providers of switched access service not subject to the Commission’s existing access stimulation rules in the call route, thereby increasing the access charges interexchange carriers (IXCs) must pay. 

The Commission’s draft proposal seeks “to eliminate financial incentives to engage in access stimulation.” This draft proposal seeks a worthy end in eliminating new access arbitrage methods, and the Commission should approve its release for public comment. 

Supreme Court Denies Review of Narrow Ruling on State VoIP Regulation

On January 8, the U.S. Supreme Court denied a petition to review the 8th Circuit Court of Appeals' decision in Sprint Communications v. Lozier (2017). This leaves standing the 8th Circuit’s conclusion, based on Section 251(g) of the Telecommunications Act of 1996, that federal law did not preempt state authority to regulate nonnomadic, intrastate long-distance VoIP calls. The overall import of the case is decidedly narrow. As the 8th Circuit recognized in Lozier, the FCC's Connect American Fund Order (2011) explicitly superseded the pre-1996 Act access charge regime that was at issue in the case. Thus, the decision in Lozier was essentially limited to the matter of intrastate access charges incurred by Sprint between 2009 and 2011 – when the CAF Order was adopted.

My October 2017 blog post, "The Case for Keeping VoIP Free from Legacy Regulation" discusses a pending decision by the 8th Circuit that could be far more consequential for the future of IP-based services. For further background and insight, also see the April 2013 Perspectives from FSF Scholars paper by Professor and FSF Board of Academic Advisors member Daniel Lyons: "The Challenge of VoIP to Legacy Federal and State Regulatory Regimes."

ICC Reform: Another Subsidy System that Needs a Sunset

Anticipation is building for the FCC's upcoming public meeting on Thursday, October 26. The Commission is expected to finally vote on an order to comprehensively reform the universal service fund (USF) and intercarrier compensation (ICC) system. In a blog post from earlier this week, FSF President Randolph May restated the case for including a sunset date for all USF high-cost subsidies in the FCC's reforms. The outdated ICC system, for its part, deserves a sunset as well.

When FCC Chairman Julius Genachowski announced some of the basic components of the Commission's forthcoming reforms on October 6, he specifically mentioned three main elements for ICC reforms. One element is to phase down access charges over a multi-year period, "starting by bringing intrastate access rates to parity with interstate rates." This is a commendable reform proposal that, among other things, will help reduce direct transaction costs and reduce incentives for ICC-induced arbitrage. Establishing a low, uniform access charge rate would also establish a path to eventually sunset the ICC access charge regime.

In short, ICC is a system of payments between carriers to compensate each other for the origination, transport and termination of voice traffic. Professor Gerald W. Brock, a member of the Free State Foundation's Board of Academic Advisors, summarized the origins of the ICC/access charge regime in his September 6 FSF Perspectives paper "Abolish Access Charges Now":

Access charges were first implemented in 1984, and they were designed to maintain a portion of the pre-divestiture subsidy from long distance to local service for a temporary period while the industry adjusted to early competition. Access charges were created through a rigid cost allocation system for companies subject to rate of return regulation with an expected industry structure of competitive long distance companies and monopoly local exchange companies. Price discrimination was a fundamental feature of access charges from the beginning and the system has generated a long series of disputes and innovative ways to arbitrage between higher and lower rates for essentially the same service.

This system is supplemented by a system of differing and often high intrastate access charges over which state regulators have oversight. Another component of the ICC system is the subscriber line charge (SLC) that is assessed against consumers in their monthly phone bills.

But the nearly 30 year-old ICC system makes little sense in relation to today's advanced telecommunications market. American consumers no longer exclusively on the public switched telephone network (PSTN) to obtain plain old telephone service (POTS). Instead, consumers are increasingly subscribing to bundled services offering voice, text messaging, instant messaging, video, broadband Internet, and other data services—many of which are now delivered over IP-based networks.

One of those services is VoIP, typically offered by cable providers and over-the-top providers like Skype and Vonage. VoIP and other IP-enabled services are eroding the distinctions between local- and long-distance services and between intrastate and interstate telecommunications. The latter distinction historically relied on the ability to identify the two end points of every call. Yet as the FCC recognized in its Vonage Order (2004): "the inherent capability of IP-based services to enable subscribers to utilize multiple service features that access different websites or IP addresses during the same communication session and to perform different types of communications simultaneously, none of which the provider has a means to separately track or record."

Wireless services are flourishing when compared to wireline and have broken down the local/long-distance distinction, similarly making it more difficult to tell where a call starts and ends. And as Professor Brock pointed out, the FCC's rulings in the 1990s establishing wireless-wireline connection based on reciprocal compensation and prohibiting wireless carriers from filing access tariffs "made it feasible for cellular carriers to eliminate the earlier sharp distinction between rates charged for local and for long distance calls and to begin the now standard practice of distance insensitive rates for calls that begin on a wireless telephone."

Imposing interstate and intrastate access charges varying by technology or provider makes little sense in an increasingly data-centric, IP-based and wireless world. Calculating compensation payments according to the ICC system's per-minute rate structure – and based on whether the call is interstate or intrastate as well as on the type of technology used – create significant compliance costs.

Not surprisingly, the access charge regime is becoming an increasingly strained and poorly suited coping mechanism when it comes to dealing with the technological changes of the past 30 years. The growth of wireless and IP-enabled services such as VoIP has led to the steady decline in minutes of use (MOUs) for which local exchange carriers are to be compensated. This decline in MOUs has serious consequences because rate-of-return carriers' interstate access rates are designed to give such carriers opportunity to earn an 11.25% rate-of-return. Declining MOUs mean increasing access rates to offset demand reductions and help ensure their guaranteed rate-of-return.

Data cited in the Universal Service Monitoring Report (2010) show the steady but significant drop in MOUs over the last several years, with ILECs seeing the overall number of interstate access minutes declining every year since 2000. Those declines are roughly on the order of ten percent annually. Interstate access minutes for ILECs dropped from near 576 billion in 2000 down to approximately 401 billion in 2005, and down further to about 277 billion in 2009.

As the FCC's NPRM for comprehensive USF/ICC reform points out, "rate-of-return carriers' interstate switched access rates increased 9.4 percent in 2010, which follows similar increases during the last few years." High access rates have also inadvertently created incentives for arbitrage schemes such as phantom traffic and traffic pumping. The FCC is finally proposing to specifically address those abuses in its forthcoming reform order. A low, uniform access charge rate would also reduce arbitrage incentives.

Adoption of a low, uniform access charge rate amounts to a much more modest reform than the immediate abolition of all access charges that Professor Brock admirably urges. But streamlining and simplifying the ICC system could help reduce the misalignment between that system and today's technological realities. Meanwhile, the Chairman's reform proposal includes implementing a recovery mechanism to better ease carriers' transition away from ICC subsidies. And to the extent states find that local conditions require any further subsidies, they should address those concerns by enacting or reforming state USFs.

Reducing and bringing intrastate access charge rates into parity with interstate access charges could also help put us in a position to consider the next step: eventual sunset of the ICC regime. The ultimate end game should be an unregulated, free market in IP-based traffic exchange, similar to what prevails today with the Internet. The closer we can get to such a system and sooner we can get there the better.

New USF Tax Hike Adds Urgency to Reform Effort

On September 13 the FCC issued a public notice announcing that for the fourth quarter of 2011 the universal service contribution factor will be climbing back up to 15.3%. The contribution factor translates into the line-item surcharge amount that is added to the interstate long-distance portion of consumer’s monthly phone bills. So, in essence, for the last few months of this year consumers will get hit with a 15.3% surcharge (a tax, in effect) on the long-distance part of their bills.

The USF system subsidizes telephone companies in rural or high-cost areas, as well as schools, libraries, and some health care facilities. And, in some instances, it subsidizes providers serving qualified low-income consumers. The USF subsidy system has also grown exponentially over the last decade, with the program subsidies for telecommunications service in high-cost areas growing from $2.6 billion in 2001 to $4.3 billion in 2010.

Below is a chart that shows the decade-long trend of steady increases in the USF contribution factor that is resulting in surging surcharges hitting consumers to fund the system:

This dramatic growth of the USF system, as reflected above in the dramatic growth in the USF contribution factor, highlights the urgency of USF reform.

Earlier this year, FSF submitted comments and reply comments to the FCC in its comprehensive USF and intercarrier compensation reform proceeding. In those comments we emphasized the need to impose a cap on the overall size of the USF high-cost fund. We also urged the FCC to set a goal of eventually eliminating subsidies for telecommunications providers altogether by establishing a ten-year sunset on USF high-cost subsidies.

In comments submitted by FSF in the Lifeline and Link Up Reform and Modernization proceeding, we recommended the FCC implement reforms to control waste, fraud, and abuse. Just as important, we urged the FCC to treat Lifeline and Link Up as the exclusive, or at least the near-exclusive, mechanism for distributing USF support once the high-cost fund is sunset. Lifeline and Link Up are targeted to low-income individuals who can choose a communications service that best fits their needs. Such targeted subsidies are more efficient and can be more reliably monitored for accountability than subsidies targeted more broadly to service providers.

And in FSF's comments in response to the FCC's Further Inquiry regarding comprehensive USF and ICC reform, FSF President Randolph May commended the FCC for its urgency in finally undertaking such reforms. And he called the ABC plan offered by six price cap companies "a major step forward." But he also offered points for the FCC to consider for improving on the ABC plan. Reiterating the position FSF staked out in earlier comments, the FCC should "explicitly and immediately impose a hard cap on the high-cost fund at $4.5 billion per year, without any loopholes for overall subsidy increases above that cap." The FCC should also establish a sunset date for rate-of-return ("ROR") regulation.

As Mr. May further explained:

"Rate of return regulation provides all the wrong economic incentives – incentives that inevitably lead to an inefficient, wasteful allocation of societal resources. In most areas of the country, incumbent wireline telcos are subject increasingly to intense competition from wireless, cable, and satellite operators. Under these circumstances, it is difficult to understand why these providers are subject to ongoing rate regulation at all, much less ROR regulation. In any event, however, at this stage in the development of marketplace competition, it makes sense for the Commission to establish a firm – and not unduly long – transition for ending all ROR regulation. If any rate regulation is deemed necessary,it should be in the form of price cap (incentive-based) regulation."

Many of these USF and ICC reform issues were discussed and debated at FSF's July 13 seminar "Universal Service and Intercarrier Compensation Reform: Will the FCC Finally Bite the Reform Bullet?" And Professor Gerald Brock, a member of FSF's Board of Academic Advisors, recently wrote a Perspectives paper urging the FCC to "Abolish Access Charges Now."

By imposing a cap on the USF high-cost fund and eventually eliminating subsidies to carriers resulting from high-cost service, ROR, and outdated access charges, the FCC can reduce waste and inefficiencies, limit subsidies and target them to those who actually need them. And, of course, it would give consumers much-deserved relief from a USF surcharge now exceeding 15%.

And in so doing, the FCC can transform the outdated system we are still stuck with into a more disciplined system that fits the intermodal competition and broadband-centric world that exists today.

What Did The FCC Know And When?

Remember Senator Baker's famous Watergate question: "What did the President know, and when did he know it?"

Here's another: What did the FCC know about its broken intercarrier compensation regime, and when did it know it?

We don't need to find any missing 18 minutes of tape to know the answer to the above question. It's right in the FCC's official books.

Here's what the FCC said back in 2001:

“We believe it essential to re-evaluate these existing intercarrier compensation regimes in light of increasing competition and new technologies, such as the Internet and Internet-based services, and commercial mobile radio services (CMRS). We are particularly interested in identifying a unified approach to intercarrier compensation – one that would apply to interconnection arrangements between all types of carriers interconnecting with the local telephone network, and all types of traffic passing over the local telephone network.”

“The existing intercarrier compensation rules raise several pressing issues. First, and probably most important, are the opportunities for regulatory arbitrage created by the existing patchwork of intercarrier compensation rules.”

Of course, with the development of even more competition and the deployment of even newer technologies, the patchwork intercarrier compensation regime is even more problematically anachronistic today than it was a decade ago. In short, the regulatory arbitrage enabled by the current uneconomic regime creates significant inefficiencies in our telecom networks and increases consumer prices.

Well, ten years later it looks like the FCC may – in light of past inaction I emphasize "may" – shortly be prepared to finally address in a serious way intercarrier compensation reform, along with reform of the universal service subsidy regime.

That's why the Free State Foundation's seminar on Wednesday, July 13, at 8:45 AM, at the National Press Club is so important and timely. We have an excellent lineup of leading experts ready to explain what should be done, when, and how: Tom Tauke, Verizon; Jerry Ellig, Mercatus Center; James Assey, NCTA; Mike Romano, NTCA; and Deborah Taylor Tate, former FCC Commissioner and FSF Distinguished Adjunct Senior Fellow. Event details and RSVP information are in the sidebar to the right.

Now you know the answer to what the FCC knew and when it knew it. Please bring all your other USF/ICC questions and comments to the seminar to get all the skinny.

FCC Needs Fast-Track Fix to Stop Traffic Pumping

As 2010 draws to a close, among the important pieces of unfinished business at the FCC is the ongoing problem of "access stimulation" or "traffic pumping." The current intercarrier compensation system creates some unfortunate efficiency-killing arbitrage opportunities, and traffic pumping is one of them. Traffic pumping costs voice carriers millions of dollars each year. As long as rural voice services continue to be subsidized under the existing unreformed intercarrier compensation system, it is only sensible that the FCC immediately take narrow and targeted steps to prevent bad actors from taking advantage of the subsidy system it oversees.

Traffic pumping is a form of regulatory arbitrage arising out of the intercarrier compensation system's formula for assessing interstate access charges. To simplify, long-distance or interexchange carriers (IXCs) that originate interstate calls are required to make access charge payments to an end-user's local exchange carrier (LEC) that terminates such calls. Under the legacy intercarrier system, interstate access charges are particularly favorable to rural LECs. Rural competitive LECs, in particular, enjoy special exemptions that result in significant access charge revenues for those LECs. In other words, the current system subsidizes the cost of services provided by rural LECs through interstate access charges paid by IXCs that originate calls to LECs that terminate calls. The intercarrier compensation system is set up to transfer significant costs for voice services in rural areas onto voice services in urban areas--and thereby reduce the price of rural services for rural customers.

To simplify further, the current formula for assessing interstate access charges is premised on certain assumptions about the voice traffic history for rural LECs. Such rural LEC networks, it is assumed, have small customer bases and small associated amounts of per-minute interstate traffic that are terminated on their networks. But traffic pumping is a clever tactic for LECs to take advantage of interstate access charge regime, confounding the underlying assumptions of the system.

In recent years, some small LECs have entered into traffic pumping business arrangements with other entities to provide customers across the country a variety of "free" interstate and international conference call services or similar services that terminate on numbers in the LECs' networks. This results in surging amounts of interstate traffic being terminated on an LEC's network, despite the fact that no local customers are in any way associated with the terminating calls. LECs then bill IXCs for terminating the interstate calls they receive, reaping even larger above-cost interstate access charge revenues. And that means large interstate access costs incurred by IXCs. One recent study concluded that IXC losses due to traffic pumping amounted to some $2.3 billion.

The prevalence of traffic pumping practices eventually prompted the FCC to issue a Notice of Proposed Rulemaking to address the subject. As the FCC indicated in the NPRM,

We tentatively conclude that a rate-of-return carrier that shares revenue, or provides other compensation to an end user customer, or directly provides the stimulating activity, and bundles those costs with access is engaging in an unreasonable practice that violates section 201(b) and the prudent expenditure standard. On its face, the compensation paid by the exchange carrier to the entity stimulating the traffic is unrelated to the provision of exchange access.

That NPRM was issued in October 2008. Since then, however, the Commission has not acted on it. Instead, the Traffic Pumping NPRM docket has become a battlefield of ex parte filings. Meanwhile, traffic pumping practices continue, with numerous complaints filed by IXCs piling up at the FCC, at state public commissions, and at federal and state courts.

The National Broadband Plan sensibly acknowledges that "[m]ost ICC rates are above incremental cost, which creates opportunities for access stimulation, in which carriers artificially inflate the amount of minutes subject to ICC payments." As a prelude to long-term, comprehensive reforms of the intercarrier compensation system and universal service, the Plan recognizes the need for a quick fix to address regulatory arbitrage problems such as traffic pumping. Recommendation 8.7 in the Plan calls on the FCC to "adopt interim rules to reduce ICC arbitrage," which includes "rules to reduce access stimulation and to curtail business models that make a profit by artificially inflating the number of terminating minutes." In short, the Plan calls on the FCC, while it tackles intercarrier compensation reform more broadly, to make a band-aid fix for the problem it previously recognized in the Traffic Pumping NPRM.

The FCC should act fast to put an end to traffic pumping arbitrage activities. A clear problem exists. The Commission has already recognized the problem, and both the FCC and the National Broadband Plan have highlighted the need to address it. So what is the FCC waiting for? For starters, the FCC could set out some basic parameters defining the practice of traffic pumping and declare it impermissible for an LEC to apply its tariffed switched access rates to such conduct.

When it comes to traffic pumping, interim action by the FCC should be undeterred by any of the supposed complexities arising from the conceded necessary long-term, comprehensive reform of the intercarrier compensation system and universal service regime.

There is nothing that should be holding the FCC back from taking swift action against traffic pumping. Unfortunately, the FCC has been holding itself back and allowing arbitrage activity to continue. By 2011 it will be well past time for the FCC to have dealt with this problem. FCC efforts to tackle traffic pumping problems need not wait a day longer.

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.