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If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** Before the Federa l Communications Commission Wash ington, D.C. 20554 In the Matter of) ) NebCom, Inc. ) AAD 97-50 ) Petition For Waiver of Sections 61.41(c)(2) and ) 69.605(c) of the Commission's Rules ) ORDER Adopted: February 25, 1998 Released: February 25, 1998 By the Chief, Accounting and Audits Division: I. INTRODUCTION 1. On March 25, 1997, NebCom, Inc. ("NebCom") filed a petition ("Petition") requesting a waiver of Sections 61.41(c)(2) and 69.605(c) of the Commission's rules to enable it to operate under rate-of-return regulation and to enable it to become an average schedule company. On April 3, 1997, the Common Carrier Bureau ("Bureau") released a public notice soliciting comment on the petition for waiver. The United States Telephone Association ("USTA") filed comments. In this Order, we grant in part and deny in part NebCom's Petition. II. BACKGROUND 2. Section 61.41(c)(2) of the Commission's rules provides that, when a cost company acquires a price-cap company, the acquiring company, and any incumbent local exchange carrier ("incumbent 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 incumbent LEC but also to the acquisition of part of a study area. As a result, NebCom's acquisition of exchanges from US West Communications, Inc. ("US West"), a carrier subject to price-cap regulation, obligates NebCom, in the absence of the grant of a waiver, to become subject to price-cap regulation instead of rate- of return regulation. 3. The Commission's all-or-nothing rule is intended to address two concerns it has regarding mergers and acquisitions involving price-cap companies. 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 rate-of-return affiliate, thus allowing the rate-of-return affiliate to earn more, due to its increased revenue requirement, without affecting the earnings of the price-cap affiliate. The second concern is that, absent the rule, an incumbent LEC may attempt to "game the system" by switching back and forth between rate-of-return regulation and price-cap regulation. The Commission noted that a price-cap company may have an incentive 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-cap regulation, cutting costs back to an efficient level. It would not serve the public interest, the Commission stated, to allow an incumbent 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. 4. Incumbent LECs that participate in the National Exchange Carrier Association ("NECA") pool collect interexchange access charges at the rates contained in the access tariff filed by NECA. In the settlement process, each pool participant receives revenues from the pool to cover its cost of providing service plus a pro rata share of the pool's earnings. NECA pool participants' costs are determined either on the basis of cost studies or average schedule formulas. Although less exact than cost studies, the average schedule procedure provides the advantage of reducing the costs imposed on incumbent LECs and borne, in part, by interstate ratepayers. 5. The determination of which incumbent LECs may use the average schedule formulas is governed by the definition of "average schedule company" found in section 69.605(c) of the Commission's rules. Section 69.605(c) provides, in pertinent part, that "a telephone company that was participating in average schedule settlements on December 1, 1982, shall be deemed to be an average schedule company." This definition of average schedule company essentially "grandfathered" existing average schedule incumbent LECs but neither allowed the creation of new average schedule companies nor conversion of cost-based carriers to average schedule status. This policy reflected the Commission's finding that "cost studies produce the most accurate financial information, and consequently, the most accurate interstate telephone rates." Although average schedule companies may elect, at any time, to convert to cost-study status, the average schedule definition precludes cost companies from converting to average schedule status absent a waiver of section 69.605(c). The definition thus was designed to limit the use of average schedule formulas to companies that operated as average schedule companies prior to adoption of the rule or that are able to demonstrate compelling circumstances sufficient to warrant a special exception. III. PETITION AND COMMENTS 6. Petition. NebCom is a Nebraska corporation newly formed to acquire and operate nine exchanges recently purchased from US West. On January 1, 1997, NebCom purchased the subject exchanges which consist of approximately 2,979 access lines throughout Nebraska. NebCom is a wholly-owned subsidiary of Northeast Nebraska Telephone Company ("NE Nebraska"), an average schedule company serving other local exchanges within Nebraska. Because NebCom purchased the exchanges from a carrier subject to price-cap regulation, the Commission's rules require NebCom to also be subject to price-cap regulation. 7. In its Petition, NebCom asserts that it would be contrary to the purpose underlying price-cap regulation and contrary to the public interest for the Commission to subject NebCom to price-cap regulation. NebCom notes that price-cap regulation is applied on a mandatory basis to only the Regional Bell Operating Companies and GTE, in recognition of certain characteristics: geographic diversity; enormous subscriber bases; high activity levels in both regulated and nonregulated markets; and access to national and international markets. NebCom argues, therefore, that application of the price-cap framework to a small, rural company, like NebCom, would result in a situation in which incentives to upgrade services and facilities would be diminished because small companies would not be able to recover the costs of capital. NebCom also states that requiring it to operate under price-cap regulation would require it to undertake costly economic and administrative burdens. Finally, NebCom maintains that it has neither the opportunity nor motive to "game the system." 8. NebCom also seeks a waiver of Section 69.605(c) of the Commission's rules in order to allow it to operate under the same settlement method as its parent company, an average schedule company with whom it shares a single study area. In its Petition, NebCom argues that a denial of its request for a waiver "would have the unintended effect of requiring [its] parent company, which now has average schedule status, to convert to cost-based status." NebCom further asserts that "[o]perating as an average schedule company would . . . permit NebCom to avoid the significant burdens and costs of settling on a cost basis, which are usually imposed only on large LECs with significant revenues." NebCom estimates that the non-recurring cost of performing cost studies would be approximately $55,000 and the recurring cost would be approximately $38,500. NebCom argues that "[v]iewed in the light of NebCom's projected net loss of $83,645 for its 1997 fiscal year of operation, these amounts are significant and impose a tremendous burden." Finally, NebCom asserts that it "does not maintain individualized information to treat its exchanges on a stand-alone basis in order to develop adequate supporting records." 9. Comments. USTA supports NebCom's request for a waiver of Section 61.41(c)(2), stating that it had no opportunity to "game the system" and supports NebCom's request to operate as an average schedule company, stating that because NebCom seeks to operate the acquired exchanges as a portion of the existing Nebraska study area of its affiliate, an average schedule company, the public interest would be served by allowing the waiver of 69.605(c) to be granted. IV. DISCUSSION 10. Under Section 1.3 of our rules, we are required to grant waivers "if good cause therefor is shown." As interpreted by the courts, this requires that a petitioner demonstrate that "special circumstances warrant a deviation from the general rule and such a deviation will serve the public interest." According to the courts, special circumstances include demonstration of individualized hardship or inequity. A. Waiver of Section 61.41(c)(2) 11. The Commission has 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 are granted subject to the condition that the selling price-cap company makes a downward 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 study areas subject to price-cap regulation. 12. We agree with NebCom that the Commission's first concern underlying the all-or- nothing rule is not applicable in this case. NebCom and its affiliate seek to continue as average schedule NECA pooling companies under rate-of-return regulation. In addition, since NebCom has no affiliated price-cap companies, there is no incentive to shift costs. As to the Commission's second concern, we find it implausible that the petitioners could game the system by moving the subject exchanges back and forth between price-cap and rate-of-return regulation, because the petitioners would require a second study area waiver. We therefore find good cause to grant NebCom a waiver of the all-or-nothing rule to permit it to operate under rate-of-return regulation. B. Waiver of Section 69.605(c) 13. The Commission has explained that the definition of "average schedule" in Section 69.605 was premised upon a policy determination "that exchange carriers which have the financial resources and expertise to conduct cost studies without undue hardship should be required to measure the actual costs they incur in providing interstate service." In addition, the definition contained in section 69.605(c) also serves to prevent an increase in the number of lines subject to average schedule treatment. Our actions on NebCom's request shall, therefore, be guided by a policy preference that incumbent LECs settle on a cost basis whenever possible without undue hardship. 14. As a result of its acquisition from US West, NE Nebraska's study area in Nebraska increased from 3,940 to 6,919. At 6,919 lines, the study area is larger than 57 percent of the study areas that operate on a cost basis. NebCom thus is incorrect in its assertion that only large LECs settle on a cost basis. This study area is not so small that it would, on the basis of its size alone, experience undue difficulty in preparing annual cost studies. In addition, granting NebCom's requested waiver would increase the number of lines that settle on an average schedule basis. In this case, more than 40 percent of the 6,919 lines in the new study area were previously part of a cost study area. We believe that this effect is a significant concern in light of the Commission's policy preference for cost studies rather than average schedule settlements. 15. We are further troubled by the absence of any itemization or explanation that could establish the credibility of NebCom's cost study expense estimates. NebCom does not explain whether its estimates are based upon the time that company personnel would spend annually on preparing cost studies, or whether it reflects the use of an outside consultant and, if so, whether more than one consultant was approached to prepare estimates. Further, NebCom provides neither a description of the tasks that would need to be performed nor a breakdown of the time that would be spent on each task. 16. The absence of contrary cost information on the record does not compel us to accept NebCom's estimates. In seeking a waiver, NebCom assumed the burden of presenting credible evidence of special circumstances, and mere allegations, absent convincing documentation and support, do not suffice. As stated above, study areas the size of NE Nebraska's study area cannot be assumed to lack the resources to operate on a cost basis. Moreover, it is likely that a great deal of the requisite cost information already exists, because nearly 43 percent of its access lines were, prior to their acquisition, part of US West's cost- based study area in Nebraska. 17. NebCom has not presented well-documented, credible evidence that it would incur unduly burdensome expense in preparing cost studies for its new study area, as a result of specific problems or circumstances that differ from those of other study areas with a similar number of access lines that operate on a cost basis. We therefore do not find that NebCom has demonstrated special circumstances warranting waiver of section 69.605(c) of the Commission's rules, and we are unwilling to grant a permanent waiver of that rule. 18. We are, however, inclined to grant a temporary waiver in order to allow NebCom to accomplish a transition to cost-study status. We base this determination, in part, upon NebCom's representation of a projected net loss of $83,645 in its 1997 fiscal year of operation. Although we find NebCom's assertions regarding its projected 1997 losses deficient in detail and documentation, we are nonetheless inclined to grant a temporary waiver in this instance, in light of the potentially serious implications of a net loss for NebCom's subscribers. We therefore shall afford NebCom a temporary waiver of section 69.605(c) of our rules, commencing in 1998 and terminating on December 31, 1999. By the beginning of 2000, NebCom must settle on a cost basis. We also shall condition this temporary waiver on the provision of additional information by NebCom. Within 90 days from the release of this order, NebCom must file with the Commission a statement of income and expenses for 1997, which indicates the actual net profit or loss for that year. Assuming that NebCom complies with this requirement, the temporary waiver will continue in effect until December 31, 1999. V. ORDERING CLAUSES 19. Accordingly, IT IS ORDERED, pursuant to Sections 1, 4(i), 5(c), 201, 202, 205, and 218-220, of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201, 202, 205, and 218-220, and Sections 1.3, 0.91, and 0.291 of the Commission's rules, 47 C.F.R.  1.3, 0.91, and 0.291 that the Petition of NebCom, Inc. for Waiver of Section 61.41(c)(2) of the Commission's rules, 47 C.F.R.  61.41(c)(2) IS GRANTED. 20. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201, 202, 205, and 218-220, of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201, 202, 205, and 218-220, and Sections 1.3, 0.91, and 0.291 of the Commission's rules, 47 C.F.R.  1.3, 0.91, and 0.291 that the Petition of NebCom for Waiver of Section 69.605(c) of the Commission's rules, 47 C.F.R.  69.605(c) IS GRANTED until December 31, 1999 subject to the conditions stated in paragraph 18 of this Order and is otherwise DENIED. FEDERAL COMMUNICATIONS COMMISSION Kenneth P. Moran Chief, Accounting and Audits Division