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. ***************************************************************** ******** FOR FCC RECORD ONLY! $// NYNEX Telephone Operating Companies, FCC 95-75 //$ Before the FEDERAL COMMUNICATIONS COMMISSION FCC 95-75 Washington, D.C. 20554 In the Matter of ) ) NYNEX Telephone ) AAD 93-149 Operating Companies ) ORDER TO SHOW CAUSE Adopted: February 24, 1995 Released: March 3, 1995 By the Commission: 1. At the direction of this Commission, the National Exchange Carriers' Association, Inc. ("NECA") hired Ernst and Young to conduct an independent audit of carrier-reported adjustments to the Common Line ("CL") revenue pool for 1988 and the first quarter of 1989. Our subsequent review of that Commission-mandated audit revealed apparent violations of our accounting rules and reporting requirements by the NYNEX Telephone Companies ("NYNEX") during the audit period. These apparent violations may have continued beyond the period covered by the audit. This Order to Show Cause sets forth those apparent violations and directs NYNEX to show cause why this Commission should not: (1) issue a Notice of Apparent Liability for Forfeiture ("NAL") for apparent violation of Section 220(d) of the Communications Act of 1934, as amended; (2) require NYNEX to adjust its price cap indexes; and (3) require NYNEX to improve its internal processes to bring them into compliance with Commission rules and orders. 2. Enforcing our accounting rules and reporting requirements is essential for the Commission to carry out its statutory obligations to ensure that rates for telecommunications services remain just and reasonable. Our ability to carry out these obligations is impaired if we cannot rely upon the information that carriers are required to submit about the costs of their operations and their allocations of those costs, or if those allocations are made improperly. As the telecommunications marketplace continues to diversify, with carriers providing more and more nonregulated services, our enforcement of accounting safeguards will become even more important if we are to continue to protect ratepayers from being overcharged for interstate services. I. Background 3. Our rules requires the LECs, on a monthly basis, to report to NECA their revenue, expense and investment data. NECA then uses these data to compute each LEC's monthly pool shares. Because LECs do not have complete data available when they first report to NECA, the LECs initially report estimated data. In the following months, the LECs are required to reconcile their estimates with actual results. To ensure the accuracy of the reconciliation process, and because even the best accounting systems sometimes fail to prevent errors, NECA procedures allow the LECs twenty-four months to reconcile and correct previously submitted data. Thus, in each monthly "settlement cycle," LECs report estimated data for the current month as well as adjusted data for the preceding twenty-four months. 4. In the December 1988 settlement cycle, certain LECs reported unusually large adjustments to the CL pool. Commission staff audited the larger of these adjustments and found that they appeared to have been encouraged by NECA Board members representing the BOCs and further found them apparently inconsistent with the Commission's rules. As a result, the Commission issued Notices of Apparent Liability for Forfeiture and Orders to Show Cause against the BOCs that filed these adjustments. The Commission also issued a letter of reprimand to the NECA Board of Directors and required, inter alia, that NECA hire an independent auditor to perform a comprehensive audit of significant adjustments the BOCs reported to the CL pool for 1988 and 1989. 5. NECA hired the public accounting firm of Ernst & Young to conduct the independent audit. Ernst & Young issued its report which NECA submitted to the Commission. That report included numerous audit findings against the BOCs, including the NYNEX carriers. The conduct noted by Ernst & Young has had a substantial impact on the CL pool as well as on the carriers' interstate telecommunications services customers. This is because NECA distributes access tariff revenue based on reported data. Moreover, since the reported adjustments to the CL pool involve misstatements or miscalculations of interstate costs and revenues historically used to develop the reporting carrier's access charges, and, after 1988, its price cap indexes, the reporting carrier's interstate access customers, as well as end users, are affected. Although the independent auditor's report addressed the effects of the BOCs' conduct only on the CL pool, Commission auditors are examining the effect on all interstate telecommunications services. Those of the independent auditor's findings that were directed against NYNEX and that warrant Commission action are the subject of this Order to Show Cause. These findings are summarized below. Attachment A provides the specific details of each finding, the Commission rules that were apparently violated, and the companies' responses to those findings. Attachment B presents, in tabular form, a summary of the apparent violations and their revenue impacts as revealed by the record to date. II. The Findings 6. Section 220(a) of the Communications Act grants to the Commission specific authority to "prescribe the forms of any and all accounts, records, and memoranda to be kept by carriers subject [to the Act]...." In turn, Section 220(d) authorizes the Commission to impose forfeitures on carriers who do not keep such accounts, records, and memoranda in the manner prescribed by the Commission. The findings in Attachment A appear to reveal conduct by the NYNEX carriers that violates Section 220 for the period that is the subject of the audit, namely, the period beginning January 1, 1988, and ending March 31, 1989. 7. The findings that we address here involve the misstatement or miscalculation of $37.8 million of interstate costs and revenues for the period from January 1988 through March 1989. In the aggregate, these misstatements or miscalculations apparently benefited NYNEX to the detriment of the users of NYNEX's interstate services. The misstatements or miscalculations shifted costs between or among access elements, thus apparently distorting NYNEX's interstate revenue requirements for particular services. The seriousness of the misstatements is compounded here not only because of the net impact and the extent of understatements and overstatements, but also because of the scope and number of the errors or apparent violations and the fact that some apparently have continued to the date of this Order to Show Cause. The findings reveal the NYNEX carriers' apparent failure to maintain their accounts, records, and memoranda in the manner prescribed by the Commission. To the extent that this conduct has continued, it must seriously undermine the Commission's confidence that NYNEX's accounts accurately reflect Commission-mandated accounting practices and reveal the true and lawful costs of NYNEX's interstate services. Moreover, as explained more fully below, even where the conduct may have been discontinued, the apparent rule violations and misstatements may very well have led NYNEX to compute price cap indexes that likely would require correction. 8. In the following paragraphs we describe the accounting irregularities that have led us to issue this Order to Show Cause. A. Apparent Cash Working Capital Violations 9. The independent auditor found five instances in which NYNEX's calculation of cash working capital allowances appeared to violate Commission requirements. These allowances are supposed to reflect the average amount of investor-supplied capital needed to fund carriers' day-to-day operations. The cash working capital allowance is added to the carrier's rate base, thereby increasing the earnings the carrier is allowed. NYNEX's development of cash working capital included faulty calculations based on improper lead-lag studies, and resulted in NYNEX reporting incorrect information to NECA as well as to the Commission's Automated Reporting Management Information System (ARMIS) database. B. Allowance for Funds Used During Construction 10. NYNEX also apparently violated Commission rules when it calculated its allowance for funds used during construction ("AFUDC"). AFUDC is a regulatory tool used to compensate investors for funds used in construction projects. In the Docket 19129 proceeding, the Commission required AT&T and the Bell System to use the prime rate to compute AFUDC for ratemaking purposes. According to the independent auditor, NYNEX used a rate other than prime to calculate its rate base, despite the ruling in Docket 19129. C. Apparent Jurisdictional Separations Violations 11. Responsibility for regulating telephone services is shared between this Commission, which regulates interstate service, and state commissions, which regulate intrastate service. Carriers must use a process called jurisdictional separations to apportion their costs and revenues between the state and interstate jurisdictions. The separations procedures are set forth in Part 36 of our rules. The independent auditor found that in separating its regulated costs NYNEX used an unsupported allocator and incorrectly used direct assignment, in apparent violation of Commission rules. D. Lack of Documentation and Other Apparent Errors 12. The independent auditor also found a number of other apparent rule violations arising from NYNEX's failure to ensure that its employees and software operate properly. While we recognize that even the best accounting system will experience errors, an accumulation of errors strongly suggests a faulty system. As such, errors and other violations accumulate, the data carriers report to NECA under Section 69.605 of our rules and to us under Parts 43 and 65 of our rules become increasingly unreliable. Although these errors may have no current impact on NYNEX's interstate rates, their number and scope persuade us to order NYNEX to show cause why its internal accounting and accounting-related practices should not generally be brought into compliance with Commission rules and orders. III. Discussion and Conclusion A. NALs 13. We find that the NYNEX carriers' conduct appears to be inconsistent with their statutory obligation to maintain their accounts, records, and memoranda as prescribed by the Commission. Carriers must accumulate, process, and report their financial and operating data in accordance with very specific Commission requirements because we rely on those data to help us ensure that interstate telephone rates are just and reasonable. Moreover, we cannot evaluate how well our accounting rules work if carriers disregard or misinterpret these rules. Therefore, where, as appears to be the case with NYNEX, carriers either violate our rules or fail to maintain the internal systems necessary to ensure compliance with those rules, we believe forfeitures may be appropriate under Section 220(d) of the Act. 14. Section 220(d) of the Act authorizes us to impose forfeitures of up to $6000 per carrier per day for accounting-related violations. Obviously, any violations that continued throughout the audit period and to the present could trigger substantial sums for the two NYNEX companies based on appropriate application of the statute of limitations. In order to make a determination about the amount of any forfeitures that may lie, we direct NYNEX to state when the conduct described in paragraphs 8 through 11 and detailed in Attachment A ceased, if ever, and otherwise show cause why notices of apparent liability pursuant to Section 1.80 of the Commission's rules should not issue. NYNEX's response should include a discussion of the appropriate application of the prescribed limitations period. NYNEX's response should also identify any mitigating circumstances we should consider in determining forfeiture amounts. B. Adjustment to Price Cap Indexes 15. As indicated above, NYNEX did not provide estimates of the impact on interstate service rates and revenue requirements of the conduct described in certain of the independent auditor's findings. So that we may assess the full impact of NYNEX's conduct, we order the NYNEX carriers to estimate the interstate impact of each of these findings, and to file those estimates with the Commission. This filing shall include estimates of the annual effect of each of the additional findings on NYNEX's CL, TS, special access, billing and collection, and interexchange costs and revenues for the period from January 1, 1988 to the public release date of this Order to Show Cause. We also order NYNEX to provide that information related to NYNEX's development of lag factors and lead-lag studies specifically requested in paragraphs 7, 9 and 14 of Attachment A, infra. We also direct NYNEX to provide estimates of the impact on the operating companies' interstate revenue requirements attributable to all conduct discussed in this Order and in Attachment A that continued beyond the period of the audit, and to file these estimates with its response. We specifically order NYNEX to provide a revised estimate of the impact of calculating AFUDC at rates other than the prime rate. 16. Since January 1, 1991, the Commission has regulated NYNEX's interstate access charges using the LEC price cap rules. Under these rules, NYNEX's initial price cap indexes were established based upon its projected interstate access revenue requirements for the period July 1, 1990 to June 30, 1991. NYNEX's calculation of those revenue requirements may have reflected the practices detailed in Attachment A. Because, under price cap regulation, each succeeding price cap index for a basket of services is a function of an initial price cap index for that basket, NYNEX's price cap indexes for its interstate services (and, by definition, its interstate rates) would have continued to reflect the impact of any improper practices. Absent Commission action, NYNEX's future indexes would reflect any overstatement as well. Therefore, we order NYNEX to show cause why we should not require it to reduce its current price cap indexes to remove any overstatement. C. Corrective Action 17. Finally, we tentatively conclude that we should direct the NYNEX carriers to improve their internal processes to bring them into compliance with Commission rules and orders, and we order those carriers to show cause why such action should not be required. We will take any additional actions we believe appropriate, including issuing a further Order to Show Cause, based on NYNEX's response. IV. Ordering Clauses 18. Accordingly, IT IS ORDERED, pursuant to Sections 4(i), 4(j), 220(d), and 504(b) of the Communications Act of 1934, as amended, 47 U.S.C. 154(i), 154(j), 220(d), & 504(b), and Section 1.701 of the Commission's rules, 47 C.F.R. 1.701, that the NYNEX Telephone Operating Companies SHALL SHOW CAUSE within sixty (60) days of the release date of this Order to Show Cause why the Commission should not issue Notices of Apparent Liability for Forfeiture against these companies for failure to keep their accounts, records, and memoranda on the books and in the manner prescribed by the Commission as set out in this Order to Show Cause, including Attachments A and B which are hereby incorporated by reference, and therewith SHALL FILE any and all data and other information required by this Order to Show Cause, including information requested in Attachment A. 19. IT IS FURTHER ORDERED, pursuant to Sections 4(i), 4(j), 201-203, 205, 215, 217-219, and 220 of the Communications Act of 1934, as amended, 47 U.S.C. 154(i), 154(j), 201-03, 205, 215, 217-19, & 220, and Section 1.701 of the Commission's rules, 47 C.F.R. 1.701, that the NYNEX Companies SHALL FILE within sixty (60) days of the release date of this Order to Show Cause interstate cost and revenue impact estimates, and such other information as specified in paragraph 14, supra. 20. IT IS FURTHER ORDERED, pursuant to Sections 4(i), 4(j), 201-203, 205, 215, 217-219, and 220 of the Communications Act of 1934, as amended, 47 U.S.C. 154(i), 154(j), 201-03, 205, 215, 217-19, & 220, and Section 1.701 of the Commission's rules, 47 C.F.R. 1.701, that the NYNEX Companies SHALL SHOW CAUSE within sixty (60) days of the release date of this Order to Show Cause why they should not be required to adjust their price cap indexes as specified in paragraph 15, supra. 21. IT IS FURTHER ORDERED, pursuant to Sections 4(i), 4(j), 201-203, 205, 215, 217-219, and 220 of the Communications Act of 1934, as amended, 47 U.S.C. 154(i), 154(j), 201-03, 205, 215, 217-19, and 220, and Section 1.701 of the Commission's rules, 47 C.F.R. 1.701, that the NYNEX Companies SHALL SHOW CAUSE within sixty (60) days of the release date of this Order to Show Cause why they should not be required to improve their internal processes to bring them into compliance with Commission rules and orders. 22. IT IS FURTHER ORDERED that the Secretary shall send by certified mail a copy of this Order to Show Cause to New England Telephone and Telegraph Co., 185 Franklin Street, Boston, Massachusetts 02107 and to New York Telephone Co., 1095 Avenue of the Americas, New York, New York 10036. FEDERAL COMMUNICATIONS COMMISSION William F. Caton Acting Secretary ATTACHMENT A 1. We present below the apparent violations of the NYNEX carriers based on the findings in the Ernst & Young report that prompt us to issue the accompanying Order to Show Cause. For each apparent violation, we summarize the independent auditor's finding and any NYNEX reply. We also present our preliminary evaluation of the record. In general, the violations are categorized according to the ratemaking component affected, including, inta alia, cash working capital, allowance for funds used during construction, and jurisdictional separations. In attachment B, we present the information in the record that describes the impact of these apparent violations on the NYNEX carriers' interstate revenue requirements for the fifteen-month audit period. A. Cash Working Capital 2. We find five instances in which NYNEX's calculation of cash working capital allowances may have violated Commission requirements. Specifically, NYNEX's development of those allowances apparently violated Sections 65.800 and 65.820(d) and (e) of the Commission's rules, which instruct carriers on how to calculate the interstate rate base. As a result of its cash working capital calculations, NYNEX reported incorrect information to NECA in apparent violation of Section 69.605 of the rules and to the Commission in apparent violation of Section 65.600 of the rules. Finally, to the extent this information has been reported in the Commission's automated database, Automated Reporting Management Information System (ARMIS), NYNEX also appears to have violated Section 43.21 of the rules, which requires that data filed in ARMIS be accurate, complete, and responsive, and certified as such by a senior carrier officer. 3. The elements of lead-lag studies to calculate cash working capital were set forth in Docket No. 19129 and reaffirmed in Docket No. 86-497. Lead-lag studies measure cash inflows and outflows in relation to the time service is rendered. Revenue and expense items that are received or paid before a service is rendered are considered "lead" items, and revenue and expense items that are received or paid after service is rendered are considered "lag" items. Lead-lag studies determine the number of days between receipt of revenues and payment of expenses. The net number of revenue lag days is then multiplied by the average daily cash expenses to determine cash working capital. A positive net lag results in a positive cash working capital allowance, which increases the rate base; a negative one results in a negative allowance, which reduces the rate base. In previous orders, we have set forth the specific criteria for the inclusion and exclusion of various items in cash working capital calculations, but the general rule is that the net lead or lag is applied to the average daily cash expenses. The specifics of these five instances in which NYNEX failed to observe these criteria are discussed below. 4. Apparent Violation No. 1: Minimum bank balance are balances "maintained in an account to compensate banks, in lieu of fees, for services provided to that account." In Docket 19129, the Administrative Law Judge (ALJ) made clear that minimum bank balances and working cash advances were to be included in the cash working capital allowance. The independent auditor found that NYNEX instead used average daily cash balances to compute cash working capital. This practice resulted in a $2,091,000 overstatement in NYNEX's interstate revenue requirements for January 1988 through March 1989, according to the independent auditor. 5. Both NYNEX carriers took their average daily cash balances from Account 1130, Cash. NET asserts that it "uses Account 1130 as a proxy for minimum bank balances," a practice it contends is reasonable. NYT states that its bank balances reflect efforts to minimize the amount of working capital kept in banks. NYT states further that it compensates banks for their services either by direct fees or by maintaining bank balances. NYT maintains that this practice is fairly common among corporate treasury departments. According to NYT, "[i]t is reasonable to conclude that the banks would receive approximately the same amount of fees under either all direct charges or all compensating balances and for any combinations in between." Thus, NYT concludes that a reduction for minimum bank balances would be offset by an increase in direct fees. In addition, NYT argues that the 86-497 Order was silent on the treatment of minimum bank balances and that the Commission's treatment of this area was not clarified until the release of the 86-497 Reconsideration Order on February 22, 1989. 6. It is true that the 86-497 Order was silent on this issue. That Order did not discuss this matter because it had been resolved in Docket 19129 some ten years earlier. In Docket 19129, the Commission determined that minimum bank balances and working cash advances, rather than actual cash balances, were to be used in cash working capital calculations. We include minimum bank balances in cash working capital calculations to protect carriers from loss if their money is encumbered because of a bank requirement. We do not allow carriers to earn a return on whatever additional money they may have in the bank. 7. Apparent Violation No. 2: The independent auditor found that, in its lead-lag study, NET used one revenue lag factor that was based only on customer revenue and applied it to all revenue categories. In addition, the independent auditor found that NET used one expense lag factor based on a sampling of expenses and did not separately analyze salaries and wages, benefits, rents, and other expenses. Subsequently, NET corrected these lag factors, but applied the updated factors only prospectively, according to the independent auditor. The independent auditor stated that this lack of retroactivity resulted in a $888,000 overstatement in NET's interstate revenue requirements for January 1988 through March 1989. NET maintains that it used the best lag study data available and argues that its practices are reasonable. 8. The reasonableness of NET's lag factors are, we believe, dependent on whether they were based on representative samples of NET's revenues and expenses. We reserve judgment on this issue pending NYNEX's response to the accompanying Order. NYNEX's response should state in detail NET's reasons for apparently believing that customer revenue was representative of all NET revenue for purposes of determining a revenue lag factor. That response should also describe in detail the sampling criteria NET used in developing its expense lag factor. 9. Apparent Violation No. 3: The independent auditor found that NYT applied its customer revenue lag factor to other revenues in computing its overall revenue lag. Because other revenues are generated by carrier access services, the independent auditor stated that, for these revenues, NYT should have used its carrier lag factor instead. This factor would have increased the lag for other revenues from 28.26 to 50.57 days. If, as the independent auditor stated, the "other revenues" category contains revenues related to carrier access services, then it would appear that NYT should have applied the carrier lag factor to this category in computing the overall revenue lag. We reserve judgment on this issue, however, pending NYT's full explanation of this matter in its response to the accompanying Order. 10. NYT stated, without explanation, that the 28.26 lag factor was correct for other revenues. NYT only acknowledged that it should have excluded billing and collection revenues from other revenues before calculating the cash working capital allowance. The independent auditor stated that NYT's failure to exclude this revenue caused its interstate revenue requirements for January 1988 through March 1989 to be overstated by $927,000. 11. Apparent Violation No. 4: The independent auditor found that NYT did not compute the federal income tax component of cash working capital using actual cash payments to the Internal Revenue Service (IRS). The independent auditor also found that NYT's federal income tax computations did not separate book to tax timing differences for items such as depreciation that are excluded from cash working capital as non-cash items. Although NYT admits to these practices, it contends that it should not have been expected to exclude non-cash items from cash working capital prior to the release of the 86-497 Reconsideration Order on February 22, 1989. Including these non-cash items in the cash working capital calculation understated NYT's interstate revenue requirements for January 1988 through March 1989 by $770,000. 12. We do not agree with NYT's position. The Commission has always excluded non-cash items from lead-lag studies. If NYT wanted to change this policy, it should have filed a timely petition for waiver or a petition for rulemaking to include non-cash timing differences in cash working capital. Without such a change, however, NYT was bound to exclude these items, even before the Commission was asked to consider the issue in Docket No. 86-497. 13. In addition, NYNEX admits that NYT was fully aware of the Commission's policy with regard to non-cash items well within NECA's twenty-four month adjustment period for January 1988 through January 1989. NYT should have reported a retroactive adjustment to NECA to bring itself into compliance with this policy. 14. Apparent Violation No. 5: The independent auditor found that NYT's lead-lag study for 1988 did not reflect changes between Part 31 and Part 32. The independent auditor stated that NYT had developed a 1988 study, but did not use it in 1988. Instead, it used a 1987 study, according to the independent auditor. NYNEX argues that the 1987 study was an actual study, not an estimate and that it gave the independent auditor substantial support for that study. NYNEX also states that this study was the basic study available in 1988 and that it introduces basic studies on a prospective basis only. According to the independent auditor, NYT's use of the 1987 study understated its interstate revenue requirements for 1988 by $5,603,000. 15. We reserve judgment on this issue pending our review of the information NYNEX gave the independent auditor regarding the 1987 study. We direct NYNEX to provide that information in its response to the accompanying Order. B. Allowance for Funds Used During Construction 16. Apparent Violation No. 6: In the Docket 19129 proceeding, the Commission specified that, for ratemaking purposes, AT&T and the Bell System use the prime rate to compute the allowance for funds used during construction (AFUDC) of long-term projects. The independent auditor found that NYNEX failed to calculate AFUDC based on that rate, but instead used an overall cost of capital rate. The use of rates other than prime resulted in a $953,000 overstatement in NYNEX's interstate revenue requirements for January 1988 through March 1989, according to the independent auditor. 17. NYNEX does not agree with this finding. According to NYNEX, Section 32.2000(c)(2)(x) of the Commission's rules clearly states that AFUDC includes the cost of debt and equity funds used in the construction of telecommunication property. NYNEX states that its Form M filings have annually notified the Commission of its AFUDC rate. NYNEX maintains that there is an inconsistency between the Part 65 ratemaking requirements and the Part 32 accounting requirements of the Commission. NYNEX is undoubtedly referring to the fact that the BOCs are required to use the prime rate for ratemaking purposes, but can use other rates for accounting purposes. 18. We find that NYNEX's approach to calculating AFUDC was unauthorized. In Docket 19129, the Commission required the Bell System to use the prime rate in calculating AFUDC for ratemaking purposes. That requirement applies until changed. NYNEX's decision that the requirement should no longer apply to NYNEX should have led to a timely petition for waiver or a petition for rulemaking to produce a ratemaking policy that more accurately reflects how NYNEX funds its construction program. Absent a change in Commission policy, NYNEX was obligated to use the applicable prime rate in its AFUDC calculations for ratemaking purposes. Instead, the NYNEX carriers used another rate, and thus apparently violated a Commission requirement. We note that NYNEX failed to correct its AFUDC practices, even though it was advised of our requirements long before the end of the two-year NECA adjustment period. 19. The independent auditor's interstate revenue requirement estimate of $953,000 was based on information provided by NYNEX. We question whether this estimate of the revenue requirement impact is correct. The prime rate rarely ever exceeds rates based on sources of funds that include both debt and equity, and calculating AFUDC at rates higher than the prime rate would overstate the carriers' ratebases, depreciation expenses, and consequently interstate revenue requirements. A $953,000 revenue requirement overstatement appears too low to capture the impact of NYNEX's use of AFUDC rates higher than prime prior to the audit period. Therefore, NYNEX is instructed to calculate the impact of its practices on its interstate revenue requirement for the period from January 1988 to the present. C. Jurisdictional Separations 20. Apparent Violation No. 7: The independent auditor found that NYNEX changed its separations process by discontinuing its practice of offsetting rent revenues against associated expenses. Instead NYNEX assigned the rent revenues to the intrastate jurisdiction, but separated the associated expenses between the intrastate and interstate jurisdictions, according to the independent auditor. As a result, NYNEX's total interstate revenue requirement for January 1988 through March 1989 was overstated by $15,935,000. 21. NYNEX does not believe this should be considered a finding, because the 1988 NECA Cost Procedures do not directly address rent revenues. It also contends that there were annual audits of NYT's data submissions to NECA and this issue was not cited. It further states that the need for additional adjustment to the pool is unclear. 22. We do not agree. The effect of offsetting the revenues against expenses before entering them into the separations process was to apportion revenues on the same basis as expenses. NYNEX apparently discontinued this practice and assigned all rent revenues to the intrastate jurisdiction while allocating all rent expenses between the interstate and intrastate jurisdictions. NYNEX offered no justification for changing its jurisdictional separation of rent revenues to create a mismatch between rent revenues and the associated expenses. Therefore, we find an apparent violation of Section 36.215(c) of the Commission's rules, which requires that rent revenues be apportioned on the basis of analysis. 23. Apparent Violation No. 8: NYT maintains a trunk integrated record keeping system (TIRKS) to track its cable and wire facilities. The independent auditor stated that NYT changed this system to include exchange trunks and that this change produced erroneous results that could no longer reasonably be used as input into ISAACS for separation purposes. The independent auditor also stated that, to overcome this problem, the company applied an average monthly growth factor to TIRKS data from a prior period. This procedure was apparently intended to reflect changes in NYT's operations that occurred after that prior period. This remedy proved fallible, because the growth factor, according to the independent auditor, did not recognize a new regional calling plan that had become effective in 1987 and was not reflected in the data from the prior period. This plan caused a significant shift in trunk counts from interexchange to exchange, increasing the exchange trunk count by 150%, according to the independent auditor. The independent auditor states that excluding the impact of the regional calling plan from the growth factor overstated NYT's CL revenue requirements by $1,488,000, understated its TS revenue requirements by $5,163,000, overstated its special access revenue requirements by $3,477,000, and overstated its interexchange revenue requirements by $39,000 for January 1988 through March 1989. The net impact on NYT's interstate revenue requirements was a $159,000 understatement. 24. NYT admits to this finding. We find an apparent violation of Section 36.152 of our rules, which requires cable and wire facilities to be properly divided between exchange and interexchange categories. 25. Apparent Violation No. 9: NYT performed a basic study that revised its conversation minutes and conversation minute miles based on 1987 data. The independent auditor found that this study contained mathematical errors that NYT entered into ISAACS. The independent auditor stated that NYT eventually discovered the errors after it withdrew from the CL pool in April 1989, but did not make a retroactive adjustment to correct them. The independent auditor also stated that these errors overstated NYT's interstate revenue requirements for January 1988 through March 1989 by $5,297,000. We find that NYT apparently violated Sections 36.126(e) and 36.156(b) of our rules, which specify the proper allocation between jurisdictions of interexchange circuit equipment and cable and wire facilities. D. Lack of Documentation 26. Apparent Violation No. 10: In order to maintain a reliable accounting system, a carrier's records must support its accounting entries. Section 220(c) of the Communications Act recognizes this by authorizing the Commission to have access to and the right of inspection and examination of "all accounts, records, and memoranda, including all documents, papers, and correspondence . . . kept or required to be kept" by the NYNEX carriers. Section 220(c) also places "[t]he burden of proof to justify every accounting entry questioned by the Commission . . . on the person making, authorizing, or requiring such entry . . ." In addition, Section 32.12(b) of our rules requires the NYNEX carriers to keep their accounting records "with sufficient particularity to show fully the facts pertaining to all accounting entries" and to file "[t]he detail records in such manner as to be readily accessible for examination" by Commission representatives. 27. The independent auditor found numerous instances where revenue, cost, basic study or tax adjustments were unsupported by adequate documentation. NYNEX admits to these instances. NYT reported revenue adjustments of $1,400,000 to NECA reflecting corrections to AT&T minutes of use, but failed to provide adequate support for the adjustments. The independent auditor stated that parts of the basic studies supporting the adjustments were missing. NYT reported adjustments to NECA for March 1988 to reflect changes to the ISAACS allocator and CL pooling process for that month. NYT could not support differences between the output from its cost allocation manual and the input amounts entered into ISAACS for four factors and two balances. NYT reported adjustments for terminating underbillings that are not supported by its workpapers. NYT reported $610,287 more in revenues to NECA than its workpapers would support. NYT was unable to support a data entry that changed one of its basic separations studies. The independent auditor stated that CL revenue requirements of approximately $100,000 for the 11 months of 1988 were unsupported. As part of its jurisdictional separations procedures, NYT periodically updates the data input programs that it uses to develop balances for use in ISAACS. One of these programs is for expenses, taxes, and investments. While implementing a new version of this program, NYT inadvertently erased the original version of the program which it had used during the November 1988 settlement cycle. Because of this error, the independent auditor could draw no conclusions as to the number or the accuracy of the adjustments NYT reported for that cycle. NYT inadvertently erased the expense, tax, and investment data input program it used for the December 1988 settlement cycle. Because of this, the independent auditor could not determine whether NYT provided the auditor with all of the adjustments NYT reported to NECA for that cycle. 28. These errors suggest that NYNEX's internal controls apparently failed to function properly in these instances. Therefore, we tentatively find that NYNEX's admitted documentation failures would support a conclusion that NYNEX fails to keep its accounts, records, and memoranda as prescribed by the Commission. E. Other Errors 29. The independent auditor identified other clerical and computer errors that caused NYNEX to violate particular Commission rules. In this regard, NYNEX admits to the following errors. 30. Apparent Violation No. 11: The independent auditor found that NET erroneously omitted a subledger account balance used to develop an allocation factor for Account 6610, Marketing, for the July through November 1988 data months. The independent auditor stated that this error understated NET's interstate revenue requirements by $1,300,000. 31. Apparent Violation No. 12: The independent auditor found errors in the NET's balances in Account 4100, Net current deferred operating income taxes, and in Account 4340, Net noncurrent operating income taxes, for all the data months under review. Collectively, these errors overstated NET's interstate revenue requirements by $267,000. 32. Apparent Violation No. 13: In 1989, NYT revised its cost allocation manual and related model. The independent auditor found that, when processing new cost manual data for 1988, NYT failed to revise the data for April 1988. According to the independent auditor this error overstated NYT's interstate revenue requirements for that month by $2,215,000. 33. Apparent Violation No. 14: The independent auditor found that NYT overstated non-management, nonmedical expenses in its ISAACS process. The independent auditor stated that this error overstated NYT's CL total revenue requirement for January 1988 through March 1989 by $174,000. 34. Apparent Violation No. 15: The independent auditor found that NET overstated its CL revenues for January through November 1988. NET stated that an erroneous spreadsheet caused this overstatement. The independent auditor stated that this error understated NET's CL and total interstate revenue requirements for those months by $105,000. 35. Apparent Violation No. 16: The independent auditor found that NYT excluded the FCC taxable income adjustment from the amount it reported to the CL pool for federal income adjustments. This error understated NYT's CL revenue requirement by $745,000, according to the independent auditor. 36. Apparent Violation No. 17: The state of Vermont instituted a state income tax that took effect July 1, 1988. NET initially thought that the tax was retroactive to January 1, 1988 and made a entry to accrue the tax liability for the seven-month period from January to July 1988. NET later reversed this entry, when it learned the tax was not retroactive. The independent auditor found that the reversal included taxes for July 1988, even though the tax had become effective July 1, 1988. Thus, the independent auditor concluded that the tax expense NET reported to the CL pool for July 1988 was understated by $125,000 and that NET's total interstate revenue requirements for that month were understated by $312,000. 37. These errors suggest that NYNEX's internal controls apparently failed to function properly in multiple instances. As a result of such errors, it may be necessary to require adjustments to NYNEX's price cap indexes and take other remedial action depending upon our review of the additional information we have directed NYNEX to submit. Attachment B Page 1 of 2 NYNEX - Summary of Apparent Violations INTERSTATE REVENUE REQUIREMENT OVERSTATEMENT FOR THE AUDIT PERIOD (See Note) ($000) OTHER COMMISSION COMMON INTERSTATE FINDING CARRIER TOTAL LINE ACCESS ELEMENTS ============================================================================== 1. Used average New York 1,547 608 939 balances instead of minimum bank balances to compute CWC. 1. Used average New England 544 210 334 balances instead of minimum bank balances to compute CWC. 2. Inadequate revenue New England 888 341 547 and expense analysis in lead/lag studies. 3. Used an inappro- New York 927 367 560 priate revenue lag factor for "Other" revenue. 4. Inadequate income New York (770) (231) (539) tax analysis in CWC study. 5. Lag-study did not New York (5,603) (2,201) (3,402) reflect new accounting system (Part 32). 6. Did not use prime New York 929 335 594 rate in calculating AFUDC. 6. Did not use prime New England 24 11 13 rate in calculating AFUDC. 7. Directly assigned New York 12,439 4,444 7,995 rent revenue to state, but allo- cated related expense to inter- state. 7. Directly assigned New England 3,496 1,249 2,247 rent revenue to state, but allo- cated related expense to inter- state. Attachment B Page 2 of 2 NYNEX - Summary of Apparent Violations INTERSTATE REVENUE REQUIREMENT OVERSTATEMENT FOR THE AUDIT PERIOD (See Note) ($000) OTHER COMMISSION COMMON INTERSTATE FINDING CARRIER TOTAL LINE ACCESS ELEMENTS ============================================================================== 8. Used obsolete New York (159) 1,488 (1,647) studies to determine trunk counts. 9. Used erroneous con- New York 5,297 (360) 5,657 versation-minutes and conversation- minute-mile data. 10. Lack of document- New York Unknown ation for numerous adjustments. 11. Omission of New England (1,300) (446) (854) Marketing expense. 12. Errors in deferred New England 267 101 166 operating income tax balances. 13. Failed to revise New England 2,215 381 1,834 April 1988 data to reflect new cost allocation manual. 14. Overstated non- New York 174 174 0 management non- medical expenses. 15. Overstated CL New England (105) (105) 0 revenue. 16. Used erroneous New York (745) (745) 0 income tax amount. 17. Used erroneous New England (312) (125) (187) Vermont state income tax amount for July 1988. Note: Overstated expenses are indicated by positive amounts. Understated expenses are indicated by negative (parentheses) amounts. Overstated revenues are indicated by negative (parentheses) amounts. Understated revenues are indicated by positive amounts.