NOTICE ************************************************************************* NOTICE ************************************************************************* This document was originally prepared in Word Perfect. If the original document contained-- * Footnotes * Boldface & Italics --this information is missing in this version The document format (spacing, margins, tabs, etc.) is changed too. If you need the complete document, download the Word Perfect version. For information about downloading documents (FTP) see file pnmc5021. File pnmc5021 (.txt & .wp) is in directory \pub\Public_Notices\Miscellaneous. ************************************************************************* Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of ) AAD 95-174 Petitions for Waivers Filed by ) ) J.B.N. Telephone Company, Inc. and ) United Telephone Company of Eastern Kansas) ) Concerning Section 61.41(c)(2) and the) Definition of "Study Area" Contained in the) Part 36 Appendix-Glossary of the ) Commission's Rules ) MEMORANDUM OPINION AND ORDER Adopted: July 17, 1996 Released: July 17, 1996 By the Chief, Accounting and Audits Division: I. INTRODUCTION 1. On December 13, 1995, J.B.N. Telephone Company, Inc. ("JBN") and United Telephone Company of Eastern Kansas ("United") filed a petition for waiver of two Commission rules. JBN and United seek waivers of the definition of "Study Area" contained in the Part 36 Appendix-Glossary of the Commission's rules. That definition constitutes a rule freezing all study area boundaries. The requested waivers would allow petitioners to alter the boundaries of their existing Kansas study areas when transferring two rural telephone exchanges from United to JBN. 2. In addition, JBN seeks a waiver of the price cap rule contained in Section 61.41(c)(2) of the Commission's rules. That rule requires non-price cap companies, and the telephone companies with which they are affiliated, to become subject to price cap regulation after acquiring a price cap company or any part thereof. The requested waiver would permit JBN to remain under rate-of-return regulation after acquiring the exchanges, which currently are under price cap regulation. 3. On February 16, 1996, the Common Carrier Bureau ("Bureau") released a Public Notice soliciting comments on the petition. On March 18, 1996, the Bureau received comments supporting the petition from the National Exchange Carrier Association, Inc. ("NECA"). In this Order, we find that the public interest would be served by allowing petitioners to alter their study area boundaries and allowing JBN to continue operating under rate-of-return regulation after acquiring the exchanges. We therefore grant the petition, as explained more fully below. II. STUDY AREA WAIVERS A. Background 4. 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. Study area boundaries are important primarily because carriers perform jurisdictional separations at the study area level. For jurisdictional separations purposes, the Commission froze all study area boundaries effective November 15, 1984. The Commission took that action primarily 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 payments. The study area freeze also prevents LECs from transferring exchanges among existing study areas for the purpose of increasing interstate revenue requirements and compensation. A LEC must apply to the Commission for a waiver of the frozen study area rule if the LEC wishes to sell an exchange to another carrier and if that transaction would have the effect of changing the study area boundaries of either carrier. 5. Waiver of Commission rules is appropriate only if special circumstances warrant deviation from the general rule and such a 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, the change in study area boundaries does not adversely affect the Universal Service Fund ("USF") support program; second, the state commission(s) having regulatory authority over the exchange(s) to be transferred does not object to the change; and third, the public interest supports such a change. 6. The Commission's concern about adverse USF impacts was mitigated, in the short term at least, by its adoption of the Joint Board's recommendation for an indexed cap on the USF. The Commission nonetheless recognized that, even in the short term, the granting of a study area waiver 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 often reduces that of other USF recipients. Consequently, in evaluating whether a study area change would have an adverse impact on the distribution or level of the USF, the Commission applies a "one-percent" guideline to study area waiver requests filed after January 5, 1995. Under this guideline, no study area waiver is granted if it would result in an annual aggregate shift in USF assistance in an amount equal to or greater than one percent of the total USF, unless the parties can demonstrate extraordinary public interest benefit. To prevent carriers from evading this limitation by disaggregating a single large sale of exchanges into a series of smaller transactions that in the aggregate have the same effect on the USF, the Commission further requires that the guideline be applied to all study area waivers granted to either carrier, as a purchaser or seller, pending completion of the current review of the USF program. B. Pleadings 7. Petition. United seeks a waiver of the rule freezing study area boundaries to enable it to remove two exchanges, serving 354 access lines, from its Kansas study area. JBN also seeks a waiver of that rule to permit it to consolidate the acquired exchanges with its existing Kansas study area, which is comprised of 13 exchanges serving approximately 2,315 access lines. 8. Petitioners state that the proposed changes would serve the public interest because JBN will comply with the modernization requirements previously imposed on United by the Kansas Corporation Commission ("KCC"). Those requirements include providing digital dialtone and modern features by the end of 1997. Further, JBN states that these upgrades will give the new customers equal access to interstate and intrastate long distance carriers, as well as access to custom local area signalling service features such as automatic callback, automatic recall, selective call forwarding and call rejection. Finally, JBN states that it will provide the new customers with more localized management and maintenance. 9. Based on 1994 cost data, petitioners state that the transfer of the two exchanges out of United's study area and into JBN's study area would initially decrease United's annual USF draw by $149,625 (from $8,982,230 to $8,832,605) and decrease JBN's by $71,073 (from $312,983 to $241,910), for a net decrease of $220,698. JBN states that prior to the end of 1997 it plans to complete substantial upgrades to the proposed new exchanges, as well as to its 13 existing exchanges. Therefore, JBN estimates, based on projected 1997 costs, that the proposed new consolidated study area will receive an additional $871,197 (from $312,983 to $1,184,180). C. Discussion 10. Request for waivers. We have reviewed the data the petitioners filed with NECA and the estimates filed with this proceeding and have determined that the combined increase in USF draws will not have a substantial adverse impact on the USF total or on individual carrier draws. In addition, the KCC states that it does not object to these requested waivers. JBN states that it will upgrade existing equipment with digital dialtone and modern features. Finally, the modernization and upgrade proposals as stated by the petitioners, demonstrate that current and potential customers in the affected exchanges will likely be better served by JBN than United. The requested study area waivers thus are likely to serve the public interest. We therefore find that the three criteria for granting a study area waiver have been met in this instance and that the waiver requests should be granted. 11. Need for imposed limits on USF draws. Although we find no reason to question JBN's estimates of the USF impact, we nonetheless are concerned that those estimates may later prove inaccurate when the planned upgrades are completed. We have found that, even in a period of a few years, the USF payments for some LECs have risen by unexpected amounts. These LECs generally had undertaken substantial upgrades or expansions of the local network in difficult-to-serve, sparsely populated exchanges that are similar to the exchanges being acquired by JBN. 12. We therefore find that the waiver should be subject to the condition that, absent explicit approval from the Bureau, the annual USF support provided to JBN's study area shall not exceed the post-upgrade USF amount estimated in the petition for the three-year period following the transfer, which is $1,184,180. This limit ensures that the study area waiver will not, due to errors or unforeseen circumstances, result in adverse USF impacts which substantially exceed JBN's forecast. We note that the Telecommunications Act of 1996, which became effective on February 8, 1996, requires the reform of many mechanisms the Commission uses to support its universal service goals, including the USF, by May 8, 1997. It is likely that any new universal service rules will alter the method used to determine the distribution of USF support to high-cost areas, thereby changing the projected level of support to the buyer's study area. This, in turn, may require us to revisit these issues, and the related waiver conditions that we have established herein. III. PRICE CAPS WAIVER A. Background 13. Section 61.41(c)(2) of the Commission's rules provides that, when a non-price cap LEC acquires a price cap LEC, the acquiring company, and any LEC with which it is affiliated, 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, JBN's acquisition of United's two exchanges would obligate JBN to become subject to price cap regulation instead of rate-of- return regulation. 14. The Commission explained that the all-or-nothing rule is intended to address two concerns regarding mergers and acquisitions involving price cap LECs. The first concern is that, in the absence of the rule, a LEC 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 price cap LEC may have to increase earnings by opting out of price cap regulation, building up a large rate base under rate-of-return regulation so as to raise rates and, then, after returning to price caps, 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 cap regulation, because rates would not fall in the manner intended under price cap regulation. 15. 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. Such a waiver would not be granted unconditionally, however. Rather, waivers of the all-or-nothing rule would be granted subject to the condition that the selling price cap LEC shall make a downward exogenous adjustment to its price cap indices to reflect the change in its study area. That adjustment is needed to remove the effects of the transferred exchanges from price-capped rates that have been based, in whole or in part, upon the inclusion of those exchanges in the study areas subject to price cap regulation. B. Pleadings 16. Petition. JBN seeks waiver of Section 61.41(c)(2) so it may operate as a rate-of- return LEC, rather than a price cap LEC, after acquiring the two exchanges which currently are under price cap regulation. Petitioners argue 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. Petitioners further 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. C. Discussion 17. We agree with petitioners that the Commission's first concern underlying the all-or- nothing rule is not applicable in this case. JBN has no incentive to shift costs between price cap and rate-of-return affiliates, because JBN is not seeking to maintain separate affiliates under different systems of regulation. As to the Commission's second concern, we find it implausible that United could game the system by moving the two exchanges back and forth between price caps and rate-of-return regulation, because United is selling these exchanges and a reacquisition would require a second study area waiver. Moreover, United cannot transfer the exchanges without removing the rate-increasing effects of these exchanges from the price-capped rates that have been based, in part, upon the inclusion of these exchanges in its Kansas study area. 18. We therefore find there is good cause to grant JBN a waiver of the all-or-nothing rule to permit it to remain under rate-of-return regulation after acquiring the two exchanges which currently are under price cap regulation. As noted above, these waivers are subject to the condition that United shall make a downward exogenous adjustment to its price cap indices to reflect the removal of these generally high-cost exchanges from its Kansas study area. For the present, we will continue to regulate JBN as a rate-of-return carrier. Because we are waiving Section 61.41(c)(2), it need not withdraw from the NECA pools. We note that, as with any other rate-of-return carriers, JBN may elect price cap regulation in the future if it decides to withdraw from the NECA pools. IV. ORDERING CLAUSES 19. Accordingly, IT IS ORDERED, pursuant to Sections 1, 4(i), 5(c), 201-202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201-202, and Sections 0.91, 0.291, and 1.3 of the Commission's rules, 47 C.F.R.  0.91, 0.291, 1.3, that the petition of J.B.N. Telephone Company, Inc. and United Telephone Company of Eastern Kansas, 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 condition stated in paragraph 12 of the Order. 20. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201-202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201-202, and Sections 0.91, 0.291, and 1.3 of the Commission's rules, 47 C.F.R.  0.91, 0.291, 1.3, that the petition of J.B.N. Telephone Company, Inc. and United Telephone Company of Eastern Kansas, for waiver of Section 61.41(c)(2) of the Commission's rules, 47 C.F.R.  61.41(c)(2), IS GRANTED subject to the condition stated in paragraph 18 of this Order. 21. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201-202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201-202, and Sections 0.91 and 0.291 of the Commission's rules, 47 C.F.R.  0.91, 0.291, that the National Exchange Carrier Association shall not distribute USF assistance exceeding the limit imposed in paragraph 12 of this Order. 22. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201-202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201-202, and Sections 0.91 and 0.291 of the Commission's rules, 47 C.F.R.  0.91, 0.291, that this Order IS EFFECTIVE IMMEDIATELY UPON RELEASE. FEDERAL COMMUNICATIONS COMMISSION Kenneth P. Moran Chief, Accounting and Audits Division Common Carrier Bureau