$//MO&O; US West and Copper Valley Study Area Waiver, AAD 93-93, DA 95-133//$ $/Pt. 36 Appendix-Glossary Study Area Definition, 61.41(c) Mergers under Price Caps/$ "Record Only" Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. 20554 DA 95-133 In the Matter of ) ) US West Communications, Inc., ) AAD 93-93 Copper Valley Telephone, Inc., ) Midvale Telephone Exchange, and ) Table Top Telephone Company ) ) Joint Petition for Waiver of the ) Definition of "Study Area" Contained ) in Part 36, Appendix-Glossary ) of the Commission's Rules ) ) and ) ) Copper Valley Telephone, Inc., ) Midvale Telephone Exchange, and ) Table Top Telephone Company ) ) Petition for Waiver of Section 61.41(c) ) of the Commission's Rules ) MEMORANDUM OPINION AND ORDER Adopted: February 17, 1995 Released: February 21, 1995 By the Chief, Accounting and Audits Division: I. INTRODUCTION 1. On July 23, 1993, US West Communications, Inc. ("US West"), Copper Valley Telephone, Inc. ("Copper Valley"), Midvale Telephone Exchange ("Midvale"), and Table Top Telephone Company ("Table Top") (collectively, "Petitioners") filed a joint petition for waiver ("Joint Petition") of the definition of "study area" as set forth in the Appendix-Glossary of Part 36 of the Commission's rules. That definition constitutes a rule freezing all study area boundaries. The requested waiver would allow US West to consummate the sale of 11 telephone exchanges. US West proposes to sell four exchanges to Copper Valley, one exchange to Midvale and six exchanges to Table Top. In addition, Copper Valley, Midvale, and Table Top (collectively, "the Independents") seek a waiver of the Commission's price cap rules contained in Section 61.41(c) to exempt them from the requirement that non-price cap companies become subject to price cap regulation after acquiring a price cap company or any part thereof. 2. On August 4, 1993, the Common Carrier Bureau ("Bureau") released a public notice soliciting comments on the Joint Petition. The Bureau received comments from three parties and reply comments from three parties. At the request of Bureau staff, Petitioners provided additional information concerning the Joint Petition. On September 1, 1994, the Arizona Corporation Commission ("Arizona Commission") issued an order approving the transfer of ten of the 11 exchanges. With regard to the eleventh exchange, the Arizona Commission stated that it had issued a Procedural Order directing US West to delete from its application the request for approval of the sale of the San Carlos exchange to Table Top. US West states that it has not yet completed its negotiations with the San Carlos Apache Tribe for the transfer of that exchange and, thus, is withdrawing the request for Commission approval of that transfer. Accordingly, that transfer is excluded from consideration in this order. We find that allowing US West to consummate the three separate proposed sales of a total of ten Arizona exchanges to Copper Valley, Midvale, and Table Top will serve the public interest. We therefore grant the Petitioners' Joint Petition for waiver, as explained more fully herein. II. STUDY AREA WAIVER Background 3. A study area is a geographical segment of a carrier's telephone operations. Generally, a study area corresponds to a carrier's entire service territory within a state. Thus, carriers operating in more than one state typically have one study area for each state, and carriers operating in a single state typically have a single study area. Carriers perform jurisdictional separations at the study area level. For jurisdictional separations purposes, the Commission adopted a rule freezing study area boundaries effective November 15, 1984. The Commission took that action, in part, to ensure that local exchange carriers ("LECs") do not set up high-cost exchanges within their existing service territories as separate study areas to maximize high-cost support. The study area freeze also prevents LECs from decomposing, and recombining, study areas to increase interstate revenue requirements and exchange carrier compensation. A LEC must apply to the Commission for a waiver of that rule if the LEC wishes to sell an exchange to another carrier, because such a transaction would have the effect of changing the study area boundaries. 4. Waiver of commission rules is appropriate only if special circumstances warrant a deviation from the general rule and such deviation will serve the public interest. In evaluating petitions seeking a waiver of the rule freezing study area boundaries, the Commission employs a three-prong standard: first, that the change does not adversely affect the Universal Service Fund ("USF") support program; second, that the state commission(s) having regulatory authority does not object to the change; and third, that the public interest supports the change. In evaluating whether grant of a waiver request would adversely affect the USF, the Commission applies a "one percent" guideline to study area waiver requests filed after January 5, 1995. This guideline does not apply in the instant case because Petitioners filed before that date. Petition and Comments 5. US West seeks a waiver of the rule freezing study area boundaries to enable it to remove ten exchanges with approximately 12,000 access lines from its Arizona study area. Midvale, a LEC providing service in Arizona, seeks a similar waiver to add one exchange with approximately 200 access lines into its existing study area. Finally, Copper Valley and Table Top, which are new LECs that will be providing service in Arizona, seek a waiver to establish two new study areas for the acquired exchanges. Copper Valley would acquire four exchanges with approximately 4,000 access lines and Table Top would acquire five exchanges with approximately 7,700 access lines. 6. Petitioners claim their request is consistent with the original purposes of the USF and that the transfer of the ten exchanges will not adversely affect the USF in any material way. The ten sale exchanges currently receive no USF support, Petitioners state, because US West's average study area cost per loop in Arizona is below the established national eligibility threshold for USF support. Petitioners estimate that, if the waiver were granted, the transfer of the ten exchanges would not cause US West's remaining study area to draw USF support but would result in an initial net increase of $210,800 in USF support for the Independents. Specifically, Table Top estimates that the initial USF draw for its newly created study area would be $219,300 as a result of its acquisition and upgrade of the five exchanges. Midvale estimates that its annual USF draw would decrease by $8,500 (from $71,400 to $62,900) as a result of its acquisition and upgrade of the one exchange. Hence, the estimated initial increase of $210,800 in USF support for the Independents as a group is the net effect of an increase of $219,300 for Table Top and a decrease of $8,500 for Midvale. Petitioners submit that Table Top and Midvale would be entitled to USF support because they would be acquiring additional high-cost loops but that Copper Valley would not be eligible to receive such support. 7. Petitioners assert that the waiver would serve the public interest because service to the ten exchanges will be improved due to economies and resources available to the Independents. The Independents state that they are committed to providing customers with high quality service, including state-of-the-art telecommunications capabilities. In particular, the Independents state that they plan to replace central office switches with modern digital technology; upgrade multi-party service to one-party service; and provide service to areas not now served. 8. NECA and USTA support the Petitioners' request and urge the Bureau to grant the waivers expeditiously. AT&T, however, expresses concern regarding the increasing number and magnitude of LEC requests for study area waivers. AT&T states that waiver requests have been spurred by the aggressive efforts of price cap LECs to divest themselves of high-cost rural exchanges. It was this concern, AT&T explains, that led it to file a petition to establish additional standards for evaluating study area waiver requests. AT&T believes that, if the requested waiver is granted, it should be conditioned on the Independents' agreement to cap their added USF subsidies at 1994 levels, regardless of any planned service upgrades, through at least 1997. 9. In reply to AT&T's comments, the Independents state that the imposition of additional requirements on them, in exchange for the grant of a justified waiver request, would violate both fairness and due process. Petitioners submit that a cap on their levels of USF support, as AT&T proposes, would be anathema to the Commission's rules and would disserve the public. US West claims that AT&T's proposed conditions cannot be reconciled with the facts and current Commission rules and cannot be implemented without violating the Administrative Procedure Act. Discussion 10. Application of three-prong standard. Petitioners' proposals demonstrate that current and potential customers in the affected exchanges likely will be better served by the Independents than by US West. The Independents state that they intend to upgrade central office switches to digital technology and replace pole- mounted cables with buried cables. These changes should result in improved service and an extension of service to remote areas not currently served. We thus believe the transfer of the ten exchanges, which has been approved by the Arizona Commission, likely will serve the public interest. In addition, we believe the initial net increase of $210,800 in the Independents' draw from the USF fund will not, in the overall context of these transactions, have a significant adverse effect on the USF at this point in time. Offset against that increase in USF support is the reduction in interstate revenue requirements of US West's price cap indices that will result from its transfer of the ten exchanges to the Independents. We therefore find that the three existing criteria for granting a study area waiver have been met in this case and that the waiver request should be granted. 11. Although we find no reason to question Petitioners' estimates of the USF impact, we nonetheless are concerned that their estimates may later prove inaccurate. In several past cases, the actual USF impact has risen far above the amount petitioners estimated when seeking study area waivers. Moreover, we share AT&T's concern that these sales and a number of similar proposed transactions might, in the aggregate, have a substantial effect on the size of the USF and on those high- cost LECs that draw from the USF. 12. This concern has been mitigated, in the short term at least, by the Commission's recent adoption of the Joint Board's recommendation for an indexed cap on the USF for the next 12 months. Yet, even in the short term, unidentified errors contained in Petitioners' impact estimates may adversely affect the fund's distribution, if not its size. Under the indexed USF cap rules, any study area reconfiguration that increases the USF draw of one USF recipient reduces that of other USF recipients. Hence, if Petitioners' estimates prove to be too low, the support provided to other USF recipients could be lowered by an amount that does have a material impact. We therefore find that the waiver should be subject to the condition that the annual USF support provided to each of the study areas affected by the exchange transfers shall not exceed the estimates of the initial post-transfer amounts submitted by Petitioners in the Joint Petition and October 19 Supplement. 13. Another aspect of Petitioners' study area requests warrants discussion. Petitioners propose to establish a new study area for the four exchanges transferred to Copper Valley, a wholly-owned subsidiary of Valley Telephone Cooperative, Inc. ("Valley") which is already providing service in Arizona. Copper Valley argues that the exchanges should not be consolidated with Valley's existing study area because the exchanges are separated geographically and demographically from Valley's existing telephone operations. Copper Valley further argues that Valley considers this transaction a strategic business investment which is separate and distinct from its other telephone operations in Arizona. 14. We do not oppose Valley's plans to create a new, wholly-owned subsidiary for the acquired exchanges. Nor do we oppose Valley's plans to treat the acquisition as a strategic business investment that is separate and apart from its current Arizona operations. We do not agree, however, that such plans are precluded by a requirement that the acquired exchanges be added to the existing study area for purposes of jurisdictional separations. 15. We believe the proposed segmentation of Valley's planned telephone operations is at odds with the Commission's frozen study area policy. That policy was established, in part, to prevent the establishment of multiple study areas to gain an advantage under the USF and jurisdictional separations rules. In this case, the consolidation of the newly acquired exchanges with Valley's existing study area likely will result in a decline in USF assistance for the existing study area. Hence, the creation of a new study area likely would enable Valley to avoid such a reduction and thereby gain an advantage under the USF rules. The establishment of a second Valley study area in Arizona would also result in unnecessary increased regulatory costs and increased administrative burden on this Commission. We thus deny Petitioners' request that Copper Valley be permitted to create a new study area. 16. Conclusion. Petitioners have demonstrated that a waiver of the rule freezing study areas is warranted. We therefore grant the study area waiver petition, as conditioned below, to permit Midvale to consolidate its acquired exchange with its existing study area; to permit Table Top to create a new study area for its five acquired exchanges; and to permit US West to remove these six exchanges from its Arizona study area. We also grant the request that US West be permitted to remove four additional exchanges from its Arizona study area so they may be transferred to Copper Valley. This waiver is subject to the condition that the four exchanges being transferred to Copper Valley are consolidated with Valley's existing Arizona study area. This waiver also is subject to the condition that, absent explicit approval from us, future levels of annual USF support shall not exceed $219,292 for the new Table Top study area and the current levels of support for the Midvale and Valley study areas. The limits imposed by this condition are consistent with Petitioners' representations--in the Joint Petition and October 19 Supplement--that the transfers will not result in increased levels of USF support for Midvale or Copper Valley. Indeed, Midvale estimates that its annual USF draw will decrease by $8,500 and our calculations indicate that Valley's annual USF draw also will decrease when it consolidates Copper Valley with its existing Arizona study area. This condition therefore will ensure the study area waiver will not result in adverse effects on the USF that exceed the initial forecast representation made by Petitioners. III. PRICE CAPS WAIVER Background 17. Section 61.41(c) of the Commission's rules provides that, when a non- price cap company acquires a price cap company, the acquiring company shall become subject to price cap regulation within a year of the transaction. The Commission stated that this "all-or-nothing" rule applies not only to the acquisition of an entire LEC but also to the acquisition of part of a study area. Hence, under this rule, the Independents' acquisition of US West's ten rural exchanges obligates them to exit the NECA pools and become subject to price cap regulation instead of rate-of-return regulation. 18. The Commission explained that the all-or-nothing rule is intended to address two concerns it has regarding mergers and acquisitions involving price cap LECs. The first concern is that, in the absence of the rule, a company might attempt to shift costs from its price cap affiliate to its non-price cap affiliate, allowing the non- price cap affiliate to earn more--due to its increased revenue requirement--without affecting the earnings of the price cap affiliate, i.e., without triggering the sharing mechanism. The second concern is that, absent the rule, a LEC may attempt to "game the system" by switching back and forth between rate-of-return regulation and price cap regulation. The Commission cited, as an example, the incentive a LEC may have to raise rates by building up a large rate base under rate-of-return regulation and, then, after opting for price caps again, to increase earnings by cutting costs back to an efficient level. It would disserve the public interest, the Commission stated, to allow a LEC to alternately "fatten up" under rate-of-return regulation and "slim down" under price caps regulation, because rates would not fall in the manner intended under price cap regulation. The Commission nonetheless recognized that a narrow waiver of the all-or-nothing rule might be justified if efficiencies created by the purchase and sale of a few exchanges were to outweigh the threat that the system may be subject to gaming. Petition and Comments 19. The Independents seek waiver of Section 61.41(c) so they may operate as rate-of-return companies, rather than price cap companies, after acquiring the ten exchanges which currently are under price cap regulation. They submit that the rule's application in this instance is contrary to the public interest and does not serve the purposes for which the rule was adopted. They argue that the Commission's two concerns, the threat of cost shifting between affiliates and gaming of the system, are not at issue in this case. Both NECA and USTA support this waiver request. Discussion 20. We agree with the Independents that the Commission's first concern underlying the all-or-nothing rule is not applicable in this case. The Independents have no incentive to shift costs between price cap and rate-of-return affiliates, because they are not seeking to maintain separate affiliates under different systems of regulation. As to the Commission's second concern, we find it implausible that US West could game the system by moving the ten exchanges back and forth between price caps and rate-of-return regulation, because US West is selling these exchanges and a reacquisition would require a second study area waiver. Even so, the proposed sale could be a source of concern. After divesting itself of high-cost exchanges, US West might decide that rates in its remaining study area should not be adjusted to reflect the resulting decrease in the network costs on which its current price caps are based. US West has stated, however, that it will reduce its interstate revenue requirements to reflect the transfer of the ten exchanges to the Independents and then will adjust its price cap indices accordingly. 21. We therefore find there is good cause to grant the Independents a waiver of the all-or-nothing rule. For the present, we will continue to regulate the Independents as cost carriers. Because we are waiving Section 61.41(c), they need not withdraw from the NECA pools. We note that, as with any other rate-of-return carrier, the Independents may elect price cap regulation in the future if they decide to withdraw from the NECA pools. IV. ORDERING CLAUSES 22. Accordingly, IT IS ORDERED, pursuant to Section 4(i) and 5(c) of the Communications Act of 1934, as amended, 47 U.S.C.  154(i) and 155(c) and Sections 0.91 and 0.291 of the Commission's Rules, 47 C.F.R.  0.91, 0.291, that the Joint Petition of US West Communications, Inc., Copper Valley Telephone, Inc., Midvale Telephone Exchange, and Table Top Telephone Company for waiver of Part 36, Appendix-Glossary, of the Commission's Rules, 47 C.F.R. Part 36 Appendix- Glossary, IS GRANTED subject to the conditions set forth above. 23. IT IS FURTHER ORDERED that the Petition of Copper Valley Telephone, Inc., Midvale Telephone Exchange, and Table Top Telephone Company for waiver of Section 61.41(c) of the Commission's Rules, 47 C.F.R.  61.41(c), IS GRANTED. 24. IT IS FURTHER ORDERED that NECA shall not distribute USF assistance exceeding the limits imposed in paragraphs 12 and 16, supra. FEDERAL COMMUNICATIONS COMMISSION Kenneth P. Moran Chief, Accounting and Audits Division Common Carrier Bureau