[Federal Register Volume 61, Number 149 (Thursday, August 1, 1996)]
[Proposed Rules]
[Pages 40161-40181]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19563]


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FEDERAL COMMUNICATIONS COMMISSION

47 CFR Parts 32 and 64

[CC Docket No. 96-150, FCC 96-309]


Implementation of the Telecommunications Act of 1996: Accounting 
Safeguards Under the Telecommunications Act of 1996

AGENCY: Federal Communications Commission.

ACTION: Proposed rule.

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SUMMARY: The Commission is issuing this Notice of Proposed Rulemaking 
which seeks comment on proposed measures to satisfy the accounting 
safeguards requirements, including those for affiliate transactions, of 
Sections 260 and 271 through 276 of the Telecommunications Act of 1996 
(``1996 Act''). These sections outline the conditions under which 
incumbent local exchange carriers may offer telemessaging and alarm 
monitoring services and under which the Bell Operating Companies 
(``BOCs'') may manufacture and sell telecommunications equipment, 
manufacture customer premises equipment, offer interLATA 
telecommunications, information, electronic publishing and payphone 
services. Sections 271 through 274 and 276 of the 1996 Act generally 
prohibit the BOCs from subsidizing services permitted under those 
sections with revenues from regulated telecommunications services. 
Sections 260 and 275 generally prohibit incumbent local exchange 
carriers, including the BOCs, from subsidizing their telemessaging and 
alarm monitoring services with revenues from regulated 
telecommunications services. This action was intended to implement the 
accounting safeguards provision of the 1996 Act.

DATES: Comments are due on or before August 26, 1996 and Reply Comments 
are due on or before September 10, 1996. Written comments must be 
submitted by the Office of Management and Budget (OMB) on the proposed 
and/or modified information collections on or before September 30, 
1996.

ADDRESSES:  Comments and Reply Comments should be sent to Office of the 
Secretary, Federal Communications Commission, 1919 M Street, N.W., Room 
222, Washington, D.C. 20554, with a copy to Ernestine Creech of the 
Common Carrier Bureau's Accounting and Audits Division, 2000 L Street, 
N.W., Suite 257, Washington, D.C. 20554. Parties should also file one 
copy of any documents filed in this docket with the Commission's copy 
contractor, International Transcription Services, Inc., 2100 M Street, 
N.W., Suite 140, Washington, D.C. 20037. In addition to filing comments 
with the Secretary, a copy of any comments on the information 
collections contained herein should be submitted to Dorothy Conway, 
Federal Communications Commission, Room 234, 1919 M Street, N.W., 
Washington, D.C. 20554, or via the Internet to [email protected], and to 
Timothy Fain, OMB Desk Officer, 10236 NEOB, 725-17th Street, N.W., 
Washington, D.C. 20503 or via the Internet to [email protected].

FOR FURTHER INFORMATION CONTACT:
 John V. Giusti, Attorney, Common Carrier Bureau, Accounting and Audits 
Division, (202) 418-0850, or Mark B.

[[Page 40162]]

Ehrlich, Attorney, Common Carrier Bureau, Accounting and Audits 
Division, (202) 418-0850. For additional information concerning the 
information collections contained in this NPRM contact Dorothy Conway 
at 202-418-0217, or via the Internet at [email protected].

SUPPLEMENTARY INFORMATION: This is a summary of the Commission's Notice 
of Proposed Rulemaking adopted July 17, 1996 and released July 18, 
1996, 1996 (FCC 96-309). This NPRM contains proposed or modified 
information collections subject to the Paperwork Reduction Act of 1995 
(PRA). It has been submitted to the Office of Management and Budget 
(OMB) for review under the PRA. OMB, the general public, and other 
Federal agencies are invited to comment on the proposed or modified 
information collections contained in this proceeding. The full text of 
this Notice of Proposed Rulemaking is available for inspection and 
copying during normal business hours in the FCC Reference Center (Room 
239), 1919 M St., NW., Washington, D.C. The complete text also may be 
purchased from the Commission's copy contractor, International 
Transcription Service, Inc., (202) 857-3800, 2100 M St., NW., Suite 
140, Washington D.C. 20037.

Paperwork Reduction Act

    This NPRM contains either a proposed or modified information 
collection. The Commission, as part of its continuing effort to reduce 
paperwork burdens, invites the general public and the Office of 
Management and Budget (OMB) to comment on the information collections 
contained in this NPRM, as required by the Paperwork Reduction Act of 
1995, Public Law No. 104-13. Public and agency comments are due at the 
same time as other comments on this NPRM; OMB notification of action is 
due September 30, 1996. Comments should address: (a) whether the 
proposed collection of information is necessary for the proper 
performance of the functions of the Commission, including whether the 
information shall have practical utility; (b) the accuracy of the 
Commission's burden estimates; (c) ways to enhance the quality, 
utility, and clarity of the information collected; and (d) ways to 
minimize the burden of the collection of information on the 
respondents, including the use of automated collection techniques or 
other forms of information technology.
    OMB Approval Number: None.
    Title: Implementation of the Telecommunications Act of 1996: 
Accounting Safeguards Under the Telecommunications Act of 1996.
    Form No.: N/A.
    Type of Review: New collection.

------------------------------------------------------------------------
                                                 Estimated              
                                      No. of      time per      Total   
      Information collection       respondents    response      annual  
                                    (approx.)     (hours/       burden  
                                                   hour)       (hours)  
------------------------------------------------------------------------
Affiliate Company Books, Records                                        
 and Accounts....................           20     6,056.25      121,125
Biennial Federal/State Audit.....           20       250.00        5,000
Filing Written Contract..........        \1\ 7         1.00            7
Compliance Audit.................        \1\ 7       250.00        1,750
Report of Exceptions.............        \1\ 7        80.00          560
10-K Requirement.................        \1\ 7     1,711.00       11,977
------------------------------------------------------------------------
\1\ BOCS.                                                               

    Total Annual Burden: 140,419 hours.
    Respondents: Bell Operating Companies and/or incumbent local 
exchange carriers and/or affiliated companies.
    Estimated cost per respondent: $632,500. This cost represents the 
total annual/startup costs associated with the annual and biennial 
audits and does not include the burden hour cost of the information 
collection. Of the $632,500, $316,250 represents our estimate of the 
biennial Federal/State audit. By definition, this cost will only be 
incurred once every two years. The total cost also includes a cost of 
$316,250 which represents our estimate of the annual compliance audit 
requirement. The $316,250 figure was derived by averaging the range of 
audit costs ($32,500--$600,000). We expect the actual cost of the 
audits to vary considerably.
    Needs and Uses: The NPRM seeks comments on a number of issues, the 
resolution of which may lead to the imposition of information 
collections subject to the Paperwork Reduction Act. the NPRM seeks 
comment on certain reporting requirements to implement the accounting 
safeguards provisions of Sections 260 and 271 through 276 of the 1996 
Act.

SYNOPSIS OF NOTICE OF PROPOSED RULEMAKING

I. Introduction

    1. In February 1996, Congress passed and the President signed the 
``Telecommunications Act of 1996.'' This legislation makes sweeping 
changes affecting all consumers and telecommunications service 
providers. The intent of this legislation is ``to provide for a pro-
competitive, de-regulatory national policy framework designed to 
accelerate rapidly private sector deployment of advanced 
telecommunications and information technologies and services to all 
Americans by opening all telecommunications markets to competition.''
    2. In this Notice of Proposed Rulemaking (``NPRM''), we consider 
rules to implement the accounting safeguards provisions of Sections 260 
and 271 through 276 of the 1996 Act. Those sections address Bell 
Operating Company (``BOC'') and, in some cases, incumbent local 
exchange carrier provision of particular telecommunications and 
information services.
    3. This proceeding is one of a series of interrelated rulemakings 
that collectively will implement the 1996 Act. Certain of these 
proceedings focus on opening markets to entry by new competitors. Other 
proceedings will establish rules for fair competition in the markets 
that are opened to competitive entry by the 1996 Act.
    4. This NPRM focuses on the accounting safeguards that Congress 
adopted in the 1996 Act to foster the development of robust competition 
in all telecommunications markets. As discussed more fully below, these 
safeguards are intended both to protect subscribers to regulated 
monopoly services provided by the BOCs and, in some cases, other 
incumbent local exchange carriers against the risk of being forced to 
``foot the bill'' for the carriers' entry into, or continued 
participation in, competitive services, and to promote competition in 
new markets by preventing carriers from using their existing market 
power in

[[Page 40163]]

local exchange services to obtain an anticompetive advantage in those 
new markets the carriers seek to enter.

A. Background

    5. the 1996 Act permits the BOCs to engage in previously proscribed 
activities if the BOCs satisfy certain conditions that are intended to 
prevent them from misallocating costs of their new ventures to 
subscribers to local exchange access services and from discriminating 
against their competitors in these new markets. Other incumbent local 
exchange carriers are subject to similar conditions if they elect to 
enter or continue to participate in certain markets.
    6. In lifting or modifying the restrictions on the BOCs, we believe 
Congress also recognized that BOC entry into in-region interLATA 
services, manufacturing and other areas raises serious concerns for 
consumers and competition, even after a BOC has satisfied the 
requirements for entry. BOCs currently possess market share for local 
exchange and exchange access in areas where they provide such services 
of approximately 99.5 percent as measured by revenues. Other incumbent 
local exchange carriers have similar market shares within their local 
exchange and exchange access service areas. Under rate-of-return 
regulation, price caps with sharing (either for interstate or 
intrastate services), or price caps that may be adjusted in the future, 
or if its entitlement to any revenues may be affected by the costs that 
it classifies as regulated, an incumbent local exchange carrier may 
have an incentive to misallocate to its regulated core business costs 
that would be properly allocated to its competitive ventures. While the 
1996 Act promotes competition and encourages BOC entry, it also 
prescribes a judicious mix of structural and non-structural safeguards 
that are intended to protect ratepayers, consumers and competitors 
against potential cost misallocation and discrimination. Where BOCs 
already participate in a market, as with alarm monitoring services and 
payphone services, or where the Act addresses services other incumbent 
local exchange carriers may provide, the Act requires compliance with 
similar safeguards. The purpose of this proceeding is to establish 
accounting safeguards to constrain potential cost misallocation and 
discrimination against competitors.
    7. Although we could prescribe rules that would completely prevent 
improper cost allocations by enforcing complete separation between 
regulated telecommunications operations and new activities, we 
recognize that it would be difficult, if not impossible, to enforce 
such rules. Moreover, our success might destroy the potential 
competitive benefits of the economies of scope that BOCs and other 
incumbent local exchange carriers could realize, benefits that 
constitute a major incentive for the BOCs and other incumbent local 
exchange carriers to enter or continue to participate in these markets. 
Our task in this proceeding is to protect against improper cost 
allocations, while allowing the BOCs and other incumbent local exchange 
carriers to realize their reasonable competitive advantages and 
ensuring that the consumers of those carriers' regulated 
telecommunications services are able to share in the carriers' 
economies of scope.
    8. We expect that once competition exists in the local exchange and 
exchange access services markets and incumbent local exchange carrier 
revenues are not dependent on costs, the need for the accounting 
safeguards proposed in this NPRM may vanish. With the advent of 
competition, we can and will act to eliminate any unnecessary rules. 
With our adoption of the Notice of Proposed Rulemaking to implement 
Section 251, 61 FR 18311 (April 25, 1996), we have taken a major step 
to achieve that goal. Reform of other regulations, like price cap 
rules, jurisdictional separations rules, and the access charge regime, 
will also move us more quickly toward that goal. In the meantime, while 
we continue to seek to minimize the burden our rules impose those 
subject to them, we also will ensure that ratepayers and competition 
remain protected from cost misallocation and anticompetitive 
discrimination.

B. Specific Considerations

    9. The challenge in setting cost allocation rules that prevent 
subsidization without eliminating legitimate economies of scope arises 
because there are some costs that cannot be allocated based on economic 
cost-causation principles. The greater the economies of scope between 
or among services, the greater the share of costs that cannot be 
allocated among them on economic cost-causation principles. Given these 
circumstances, we believe that the rules we develop for allocating 
these costs should be clear, consistent, and predictable. They should 
also assure that subscribers to the BOCs' and other incumbent local 
exchange carriers' core services share in any economies of scope 
realized when entering those markets from which they were previously 
barred or continuing to participate in other markets addressed in the 
1996 Act. We believe, for example, that a policy that would permit the 
BOCs to allocate all common costs of shared facilities to regulated 
services would pose a risk that subscribers to the BOCs' regulated 
telecommunications services would pay more than the stand-alone costs 
of the services they receive, and would thus be subsidizing the BOCs' 
competitive activities rather than sharing the economies of scope 
realized because of the BOCs' diversification.
    10. It is also essential that the affiliate transactions rules 
discourage, and facilitate detection of, cost misallocations. Statutory 
structural separation requirements, like the prohibition on sharing 
employees or the obligation that all affiliate transactions be ``on an 
arm's length basis,'' reduce the risk that cost misallocations will 
accompany BOC entry into manufacturing and interLATA service markets. 
This protection of ratepayer interests, however, is not cost free. 
Structural separation restrictions that protect ratepayers also make it 
more difficult for a BOC or other incumbent local exchange carrier to 
capture the economies of scope that benefit both regulated and 
nonregulated service subscribers. Only our success in removing barriers 
to competition in the BOCs' and other incumbent local exchange 
carriers' regulated services markets will enable us to remove these 
restrictions.
    11. A threshold question is to what extent, if any, we should rely 
upon our existing accounting safeguards to achieve our twin goals of 
protecting subscribers to BOCs' and other incumbent local exchange 
carriers' regulated telecommunications services against improper cost 
allocations and competitors against unreasonable discrimination. Those 
safeguards are found in Parts 32 and 64 of our rules. They consist of 
cost allocation and affiliate transactions rules that were designed to 
keep incumbent local exchange carriers from imposing the costs and 
risks of their competitive ventures on interstate telephone ratepayers, 
and to ensure that interstate ratepayers share in the economies of 
scope incumbent local exchange carriers realize when they expand into 
additional enterprises. As we implement the accounting safeguards 
provisions of Sections 260 and 271 through 276 of the 1996 Act, for 
each of these sections, we seek comment on whether our current rules 
can or should be applied as they are, with some modification, or 
eliminated. We tentatively conclude that our rules, with the 
modifications we describe below, will best meet the statutory

[[Page 40164]]

requirements of these sections and their underlying goals. We invite 
comment on this tentative conclusion.
    12. In reaching this tentative conclusion, we note our belief that 
the accounting safeguards this NPRM proposes are no more detailed than 
those in our current rules except where the 1996 Act requires more 
detailed safeguards or where our experience with current rules has made 
clear that more detailed safeguards are necessary to prevent improper 
subsidization. We invite comment on whether less detailed accounting 
safeguards would suffice to achieve the aims of Sections 260 and 271 
through 276 of the 1996 Act. We note that those urging that we adopt 
more detailed accounting safeguards than those in our current rules or 
those specifically mandated by the 1996 Act bear a heavy burden of 
persuading us to adopt such safeguards.
    13. The 1996 Act creates opportunities for competitive entry in the 
local exchange, exchange access, and interLATA telecommunications 
markets, among others. These opportunities may affect which accounting 
safeguards we adopt in two apparently countervailing ways. The 
incumbent local exchange carrier may be reluctant to increase rates for 
local exchange and exchange access service if the increases would 
induce competitive entry in the markets in which it would otherwise 
continue to have market power. This would militate against the adoption 
of stringent accounting safeguards. On the other hand, a carrier 
entering or continuing to participate in a nonregulated market will 
have an increased incentive to shift the costs and risks of its 
competitive activities to these regulated services if such shifting 
permits the carrier to increase the rates for these regulated services. 
The increased rates would not reduce substantially the carrier's market 
share for local exchange and exchange access service.
    14. Several provisions of the 1996 Act prohibit BOCs, or, in some 
cases, all incumbent local exchange carriers from using their telephone 
exchange service and exchange access operations to subsidize their 
competitive ventures. We believe that Congress's primary intent in 
prohibiting this subsidization was to protect subscribers to these 
services from increased rates, and seek commenters' help in determining 
how best to fulfill that intent. We propose that the accounting 
safeguards we adopt in this proceeding apply to all services for which 
Section 260 and 271 through 276 require accounting safeguards.
    15. Control over the bottleneck facility may enable a BOC or other 
incumbent local exchange carrier to engage in predatory behavior. For 
example, the ability to discriminate in favor of its interexchange 
affiliate with respect to the price of access (i.e.,) charging the 
affiliate a lower access rate than it charges competing IXCs) could 
facilitate an incumbent local exchange carrier's engaging in a ``price 
squeeze,'' In such a situation if the incumbent local exchange 
carrier's interexchange affiliate lowers its retail rate to reflect its 
unfair cost advantage, competing IXCs would be forced either to match 
the price reduction and decrease their profit margins, or to maintain 
their retail prices at preexisting levels and lose market share (and 
therefore profits). As a practical matter, an incumbent local exchange 
carrier can achieve the same result by charging the same price for 
access to all interexchange providers, while providing a higher quality 
of service to its affiliate than to competing IXCs. In this case, an 
IXC that attempted to match the incumbent local exchange carrier 
affiliate's retail price would lose market share since its lower 
quality of access would mean that it would be offering a lower quality 
of interexchange service. A third type of potentially anticompetitive, 
discriminatory behavior occurs when an incumbent local exchange carrier 
discriminates in favor of its affiliates when purchasing goods or 
services. For example, to the extent that the incumbent local exchange 
carrier is the predominant purchaser of telecommunications equipment 
that is used in the local exchange network, purchasing such equipment 
only from its affiliate manufacturing entity could adversely effect the 
ability of a competitor to operate profitably.
    16. We also note that a carrier subject to rate-of-return 
regulation may have an incentive to engage in predatory pricing, if 
losses from below-cost pricing in the competitive market can be shifted 
to its regulated cost of service. We expect, however, that such 
predatory pricing by a BOC or other incumbent local exchange carrier is 
unlikely to occur. First, while an incumbent local exchange carrier may 
possess the legal ability to raise rates in the regulated market to 
subsidize its competitive activities, the threat of entry into the 
regulated market may prevent it from doing so. Even if such 
subsidization were to allow a BOC or other incumbent local exchange 
carrier to sustain prices below cost for a period of time sufficient to 
drive out competing IXCs, the local exchange carrier would be unlikely 
to raise prices above the competitive level, since each IXC's network 
represents an embedded facility which could be purchased in a 
bankruptcy proceeding and used if the local exchange carrier affiliates 
subsequently attempted to raise prices above the competitive level. We 
invite comment on the extent to which the opportunities to engage in 
predatory behavior should affect our decisions in this proceeding.

C. Overview of Sections 260 and 271 Through 276

    17. In Section 260 and 271 through 276, Congress delineated the 
conditions under which incumbent local exchange carriers would be 
permitted to offer telemessaging and alarm monitoring services and 
under which BOCs would be permitted to manufacture and sell 
telecommunications equipment, to manufacture customer premises 
equipment, and to offer interLATA telecommunications, information, 
alarm monitoring and payphone services. In some cases, separate 
affiliates are required. In other cases, integrated operation is 
permitted.
    18. Section 260 provides that an incumbent local exchange carrier, 
including a BOC, the provides telemessaging service ``shall not 
subsidize its telemessaging service directly or indirectly from its 
telephone exchange service or its exchange access,'' but does not 
require a separate affiliate.
    19. Section 271(b) authorizes the BOCs to provide ``out-of-region'' 
interLATA services as of February 8, 1996, even if the services 
terminate within the BOC's region, and ``in-region'' interLATA services 
upon Commission approval. Section 271(g) lists specific ``incidental 
interLATA services'' that BOCs and their affiliates may provide after 
February 8, 1996. Section 271(h) states that ``[t]he Commission shall 
ensure that the provision of services authorized under [Section 271(g)] 
by a Bell operating company or its affiliate will not adversely affect 
telephone exchange service ratepayers or competition in any 
telecommunications market.''
    20. Section 272 permits a BOC (including any affiliate) that is an 
incumbent local exchange carrier to manufacture equipment (as defined 
in the AT&T consent decree), originate in-region interLATA 
telecommunications services, other than incidental and previously 
authorized interLATA services, and provide certain interLATA 
information services only if it does so through one or more separate 
affiliates. Each of the separate affiliates must ``maintain [separate] 
books, records, and accounts in the manner prescribed by the 
Commission'' and ``shall conduct all

[[Page 40165]]

transactions with the Bell operating company of which it is an 
affiliate on an arm's length basis.'' In its dealings with the separate 
affiliate, each BOC must ``account for all transactions * * * in 
accordance with accounting principles designated or approved by the 
Commission.''
    21. Section 273(d)(3) sets forth an additional separate affiliate 
requirement for manufacturing of telecommunications equipment and 
customer premises equipment by entities that certify the same class of 
telecommunication equipment and customer premises equipment produced by 
unaffiliated entities.
    22. Section 274(a) prohibits any ``Bell operating Company or any 
affiliate [from] engag[ing] in the provision of electronic publishing 
that is disseminated by means of such Bell operating company's or any 
of its affiliates' basic telephone service,''other than through ``a 
separated affiliate or electronic publishing joint venture.'' This 
separated affiliate or electronic publishing joint venture must, among 
other requirements, ``maintain separate book, records, and accounts and 
prepare separate financial statements.''
    23. Section 275(b)(2) bars an incumbent local exchange carrier that 
provides alarm monitoring services from ``subsidiz[ing] its alarm 
monitoring services either directly or indirectly from telephone 
exchange service operations,'' but does not require a separate 
affiliate.
    24. Section 276(b)(1)(C) directs the Commission to prescribe rules 
for BOC payphone service that, ``at a minimum, include the 
nonstructural safeguards equal to those adopted in the Computer 
Inquiry-III (CC Docket No. 90-623) proceeding.'' Section 276(a)(1) 
provides that, after the effective date of those rules, any BOC that 
provides payphone service ``shall not subsidize its payphone service 
directly or indirectly from its telephone exchange service operations 
or its exchange access operations.''
    25. Section 254(k) prohibits a telecommunications carrier from 
``us[ing] services that are not competitive to subsidize services that 
are subject to competition.'' Section 254(k) further states that `` 
[t]he Commission, with respect to interstate services, and the States, 
with respect to intrastate services, shall establish any necessary cost 
allocation rules, accounting safeguards, and guidelines to ensure that 
services included in the definition of universal service bear no more 
than a reasonable share of the joint and common costs of facilities 
used to provide those services.''

D. Structure of This NPRM

    26. Section II of this NPRM discusses accounting safeguards that 
would apply when an incumbent local exchange carrier, including a BOC, 
provides a service addressed in Sections 260 and 271 through 276 of the 
1996 Act on an integrated, or in-house, basis. For the provision of 
services on an integrated basis, we tentatively conclude in Section II 
that our existing Part 64 cost allocation rules generally satisfy the 
1996 Act's accounting safeguards requirements. Section III discusses 
accounting safeguards that would apply when an incumbent local exchange 
carrier, including a BOC, uses an affiliate to provide a service 
addressed in Sections 260 and 271 through 276 of the 1996. In Section 
III, we tentatively conclude that, except where the 1996 Act imposes 
specific additional requirements, our current affiliate transactions 
rules generally satisfy the statue's requirement of accounting 
safeguards when an incumbent local exchange carrier conducts 
transactions with its affiliate. In that section, we do propose several 
modifications to the affiliate transactions rules to provide greater 
protection against improper subsidization. Within Sections II and III, 
subsections discuss issues related to the application of the individual 
statutory sections. In Section IV of this NPRM, we seek comment on 
whether and, if so, how price cap regulation alters the need for 
accounting safeguards to ensure against the subsidization of services 
permitted under Sections 260 and 271 through 276 of the 1996 Act with 
revenues from regulated telecommunications services to subsidize other 
services. In that same section, we seek comment on whether our 
proposals in this NPRM satisfy the requirements of Section 254(k).

II. Safeguards For Integrated Operations

A. General

    27. In this section, we discuss the provisions in Sections 260, 
271, 275, and 276 of the 1996 Act relating to accounting safeguards for 
telemessaging, certain interLATA telecommunications and information, 
alarm monitoring, and payphone services that the BOCs and other 
incumbent local exchange carriers might be permitted to provide on an 
integrated basis (i.e., within the telephone operating companies). We 
tentatively conclude that our existing Part 64 cost allocation rules 
generally satisfy the statute's requirement of safeguards to ensure 
that these services are not subsidized by subscribers to regulated 
telecommunications services. We invite comment on this tentative 
conclusion.
    28. We developed the cost allocation rules in our Joint Cost and 
Computer II Proceedings to help ensure that interstate ratepayers do 
not bear the costs and risks of the telephone companies' nonregulated 
activities. These rules prescribe how carriers separate the costs of 
activities regulated under Title II of the Communications Act of 1934, 
as amended, from the costs of nonregulated activities, where the 
nonregulated activities are performed directly by the carrier rather 
than through an affiliate. Under these rules, incumbent local exchange 
carriers may not assign the costs of nonregulated activities to 
regulated products and services. Incumbent local exchange carriers have 
implemented internal cost allocation systems to help ensure their 
compliance with these rules. Redesigning these internal systems to 
accommodate a fundamentally different cost allocation approach might 
impose substantial administrative and financial costs on the carriers. 
We seek comment on whether the benefits of a fundamentally different 
approach to cost allocation would be outweighed by the costs that 
implementation of such a system would entail. Alternatively, we invite 
comment on whether, and how, we might adapt the existing cost 
allocation system to accommodate any or all of the services we address 
in Section II.B, below.

B. Specific Services

1. Section 260--Telemessaging Service
a. Statutory Language
    29. Section 260(a)(1) of the 1996 Act prohibits each ``local 
exchange carrier subject to the requirements of section 251(c) that 
provides telemessaging service [from] subsidiz[ing] its telemessaging 
service directly or indirectly from its telephone exchange service or 
its exchange access.'' Section 251(c), in turn, applies to every 
``incumbent local exchange carrier.'' Section 260(c) defines 
``telemessaging service'' as ``voice mail and voice storage and 
retrieval services, any live operator services used to record, 
transcribe, or relay messages (other than telecommunications relay 
services), and any ancillary services offered in combination with these 
services.'' The principal goal of the prohibition against subsidization 
in Section 260(a)(1) appears to be to ensure that the telemessaging 
service operations of incumbent local exchange carriers do not result 
in increased rates for telephone exchange service and exchange access. 
Section 260(b) also

[[Page 40166]]

requires the Commission to establish procedures for expedited 
consideration of any complaint alleging ``material financial harm to a 
provider of telemessaging service.'' In providing for this expedited 
consideration, Congress intended to protect providers of telemessaging 
service that are not themselves, or affiliated with, incumbent local 
exchange carriers against subsidization.
    30. Our present Part 64 rules classify telemessaging service as a 
nonregulated activity for Title II accounting purposes. Consequently, 
provision of telemessaging services is already governed by our Part 64 
rules and, to the extent telemessaging is provided through affiliates, 
our affiliate transactions rules also apply. Our Part 64 rules require 
carriers to use a cost allocation methodology based on fully 
distributed costs (``FDC''). This methodology establishes a hierarchy 
of cost apportionment rules designed to prevent subsidies. These rules 
are applied to costs recorded in the accounts specified in the Uniform 
System of Accounts (``USOA'') set out in Part 32 of our rules. The 
methodology requires carriers to assign costs directly, wherever 
possible, to regulated or nonregulated activities. If costs cannot be 
directly assigned, they are considered ``common costs'' and must be 
placed in homogeneous cost pools. The carrier must then divide the 
costs in each pool between regulated and nonregulated activities using 
formulas or factors known as ``allocators.'' Depending upon the 
information available, carriers must apply these allocators in the 
following order. Whenever possible, common costs must be directly 
attributed based upon a direct analysis of the origins of those costs. 
Common costs that cannot be directly attributed must be indirectly 
attributed based on an indirect, but cost-causative, linkage to another 
cost pool or pools for which a direct assignment or attribution is 
possible. Only if direct or indirect attribution factors are not 
available may the carrier allocate a pool of common costs using what is 
known as a ``general allocator.'' For regulated activities, the general 
allocator is expressed as the ratio of all expenses directly assigned 
or attributed to regulated activities (numerator) to all expenses 
directly assigned or attributed to both regulated and nonregulated 
activities (denominator).
    31. Our Part 64 cost allocation rules also require incumbent local 
exchange carriers to allocate their network investment plant between 
activities that we regulate under Title II and nonregulated activities. 
This allocation must be based on the peak ``relative regulated and 
nonregulated usage'' projected for the network plant over a three-year 
period. BOC provision of telemessaging service may result in the 
reallocation of this plant from regulated to nonregulated activities. 
In the Joint Cost Proceeding, we determined that, absent waiver, any 
such reallocation ``must be made at undepreciated baseline cost and 
must include interest calculated at the authorized interstate rate of 
return.''
    32. Section 64.901(b)(4) of our rules requires a carrier at the 
beginning of each calendar year to forecast peak relative nonregulated 
use of jointly-used network plant over a three-year period. The 
relative split between usage for activities regulated under Title II 
and nonregulated usage at the point in time when nonregulated usage is 
greatest in comparison to regulated defines the allocation factor to be 
applied. If application of this method would increase the allocation to 
nonregulated activities for any account from the previous year, the 
carrier must make the reallocation. If application of this method would 
decrease the allocation to nonregulated activities for that account 
from the previous year, the carrier must obtain a waiver to make the 
reallocation. At the end of the year, the carriers compare their 
forecasts with actual usage. If the actual usage of nonregulated 
activities is greater, they must adjust the allocation to nonregulated 
services based on that actual usage.
    33. We tentatively conclude that applying our Part 64 rules to 
telemessaging will safeguard against the subsidies prohibited by 
Section 260(a)(1). Section 260 appears to allow telemessaging service 
to be provided on an integrated basis, at least for most incumbent 
local exchange carriers. However, we tentatively conclude, as we do in 
our companion item, BOC In-Region NPRM, that telemessaging is an 
information service. We also tentatively conclude in that NPRM, that 
our authority under Sections 271 and 272 over interLATA information 
services applies to intrastate, interLATA information services provided 
by BOCs or their affiliates. BOC provision of telemessaging service on 
an interLATA basis would therefore be subject to the separate affiliate 
and other requirements of Section 272. We invite comment on these 
tentative conclusions.
b. Scope of Commission's Authority
    34. Section 260 of the Act imposes additional safeguards regarding 
the provision of telemessaging services, not only on the BOCs, but on 
all incumbent on whether, in light of our tentatilocal exchange 
carriers. We seek commenve conclusion that Sections 271 and 272 give 
the Commission jurisdiction over intrastate interLATA information 
services including telemessaging, Section 260 should also be read to 
give us jurisdiction over intrastate information services in 
implementing and enforcing Section 260. We note, however, that unlike 
Sections 271 and 272, the scope of Section 260 is not limited to 
interLATA services, nor is it limited to the BOCs. We seek comment, 
therefore, on whether any such intrastate jurisdiction would extend 
only to the BOCs, as only BOCs are covered by Sections 271 and 272, or 
to all incumbent local exchange carriers.
    35. We further seek comment on what role States might have in 
implementing Section 260(a)(1)'s prohibition against subsidization of 
``telemessaging service directly or indirectly from * * * telephone 
exchange service or * * * exchange access.'' Prior to the enactment of 
the 1996 Act, we did not preempt States from using their own cost 
allocation procedures for intrastate purposes. We ask commenters to 
address whether we must change this policy in order to effectuate 
Section 260.
    36. To ensure a complete record, if Section 260 does not itself 
apply to intrastate services, we also seek comment on whether we have 
authority to preempt State regulation with respect to the accounting 
matters addressed by Section 260 pursuant to Louisiana PSC and, if so, 
whether we should exercise that authority. We tentatively conclude that 
if Section 260 does not apply to intrastate services and if we have 
authority to preempt pursuant to Louisiana PSC, we should refrain from 
exercising that authority in this area and instead retain our prior 
policy of not preempting States from using their own cost allocation 
procedures for intrastate purposes. We invite comment on this tentative 
conclusion. We ask the commenters to address, in particular whether 
preemption pursuant to Louisiana PSC in this area would be necessary to 
achieve the intent behind Section 260(a)(1) or whether less intrusive 
measures would be sufficient.
2. Section 271--InterLATA Telecommunications Services
a. Incidental InterLATA Services
    37. Section 271(h) states that ``[t]he Commission shall ensure that 
the provision of services authorized under [Section 271(g)] by a Bell 
operating company or its affiliate will not adversely affect telephone 
exchange service ratepayers or competition in any telecommunications 
market.'' Section

[[Page 40167]]

271(g) lists specific incidental interLATA services that he BOCs and 
their affiliates may provide after the date of enactment of the 1996 
Act. Those services are:

    The interLATA provision by a Bell operating company or its 
affiliate--
    (1)(A) of audio programming, video programming, or other 
programming services to subscribers to such services of such company 
or affiliate;
    (B) of the capability for interaction by such subscribers to 
select or respond to such audio programming, video programming, or 
other programming services;
    (C) to distributors of audio programming or video programming that 
such company or affiliate owns or controls, or is licensed by the 
copyright owner of such programming (or by an assignee of such owner) 
to distribute; or
    (D) of alarm monitoring services;
    (2) of two-way interactive video services or Internet services over 
dedicated facilities to or for elementary and secondary schools as 
defined in section 254(h)(5);
    (3) of commercial mobile services in accordance with section 332(c) 
of this Act and with the regulations prescribed by the Commission 
pursuant to paragraph (8) of such section;
    (4) of a service that permits a customer that is located in one 
LATA to retrieve stored information from, or file information for 
storage in, information storage facilities of such company that are 
located in another LATA;
    (5) of signaling information used in connection with the provision 
of telephone exchange services or exchange access by a local exchange 
carrier; or
    (6) of network control signaling information to, and receipt of 
such signaling information from, common carriers offering interLATA 
services at any location within the area in which such Bell operating 
company provides telephone exchange services or exchange access.

Section 271(h) states that ``[t]he provision of [Section 271(g)] are to 
be narrowly construed. The interLATA services provided under 
subparagraph (A), (B), or (C) of [Section 271(g)(1)] are limited to 
those interLATA transmissions incidental to the provision by a Bell 
operating company or its affiliate of video, audio, and other 
programming services that the company or its affiliate is engaged in 
providing to the public.''
    38. Section 271(h) states that ``[t]he Commission shall ensure that 
the provision of services authorized under [Section 271(g)] by a Bell 
operating company or its affiliate will not adversely affect telephone 
exchange service ratepayers or competition in any telecommunications 
market.'' We invite comment on whether our present cost allocation 
rules in Part 64 are adequate to prevent the adverse effects proscribed 
by Section 271(h) or whether alternative solutions, if any, would be 
more appropriate. We ask commenters asserting that the rules require 
modifications to describe in detail the modifications they believe 
necessary, to explain how these modifications or additions to our Part 
64 rules would better enable the Commission to fulfill its obligations 
under Section 271(h), and to identify the category of ratepayers or 
competitive markets the proposed modifications or additions would 
protect.
b. Integrated Provision of InterLATA Services
    39. We note that BOCs are permitted to provide certain regulated, 
interLATA telecommunications services on an integrated basis, including 
out-of-region services and certain types of incidental services. In our 
BOC Out-of-Region Order, 61 FR 35964 (July 9, 1996), we determined that 
the BOCs must provide out-of-region interstate, interexchange services 
(including interLATA and intraLATA services) through separate 
affiliates, at least on an interim basis, in order to qualify for 
nondominant regulatory treatment in the provision of those services. 
Under that Order, however, a BOC could still choose to provide these 
services on an integrated basis, subject to dominant carrier 
regulation. To ensure against improper subsidization in the event of 
such operations, we tentatively conclude that we should apply our cost 
allocation rules to regulated services other than local exchange and 
exchange access services provided on an integrated basis. We seek 
comment on this tentative conclusion and on whether we should develop 
modified cost allocation rules for these other regulated services that 
the BOCs may provide on an integrated basis to prevent allocation of 
the costs of these other regulated services to local exchange and 
exchange access customers and, if so, what these modifications should 
be. One possible solution would be to require BOCs to create a separate 
category for regulated services other than local exchange and exchange 
access services within their internal cost allocation systems. This 
category would be in addition to the regulated and nonregulated 
categories our existing rules require and would parallel the approach 
we took with respect to video dialtone. Alternatively, we could require 
BOCs to classify any regulated services other than local exchange and 
exchange access services they provide on an integrated basis as 
nonregulated activities for Title II accounting purposes. This would 
parallel the approach we took in the BOC out-of-Region Order and would 
result in the carriers' allocating the costs of these services to the 
nonregulated category. We invite comment on the relative costs and 
benefits of these approaches.
    40. In our Interexchange Notice, 61 FR 14717 (April 3, 1996), we 
addressed whether we should modify or eliminate the separation 
requirements independent local exchange carriers must currently meet in 
order to qualify for non-dominant treatment when they offer interstate, 
interexchange services originating outside the areas in which they 
control local access facilities. We also sought comment on whether, if 
we modified or eliminated these separation requirements for non-
dominant treatment of independent local exchange carriers, we should 
apply the same requirements to BOC provision of out-of-region 
interstate, interexchange services. If independent local exchange 
carriers are allowed to, and choose to, provide out-of-region 
interstate interexchange services on an integrated basis, we seek 
comment on whether our regulatory treatment for such incumbent local 
exchange carriers should be similar to the regulatory treatment we 
adopt for the BOCs.
c. Other Matters
    41. Section 272(e)(3) requires that ``[a] Bell operating company * 
* * impute to itself (if using [exchange] access for its provision of 
its own services), an amount for access that is no less than the amount 
charged to any unaffiliated interexchange carriers for such service.'' 
In our BOC In-Region NPRM, we seek comment on how to determine the 
imputed exchange access charges under Section 272(e)(3). We now invite 
comment on how the BOCs should account for these imputed access 
charges. One possible approach would be for the BOCs to record these 
imputed exchange access charges as an expense that would be directly 
assigned to nonregulated activities with a credit to the regulated 
exchange access revenue account. We seek comment on this approach as 
well as suggested alternatives.
    42. Section 272(e)(4) states that ``[a] Bell operating company and 
an affiliate that is subject to the requirements of section 251(c) * * 
* may provide any interLATA or intraLATA facilities or services to its 
interLATA affiliate if such services or facilities are made available 
to all carriers at the same rates and on

[[Page 40168]]

the same terms and conditions, and so long as the costs are 
appropriately allocated.'' Although Sections 272(e)(3) and (e)(4) do 
not address activities performed on an integrated basis, we invite 
comment on whether and, if so, how these requirements should affect our 
rules for allocating costs between activities regulated under Title II 
and nonregulated activities for those BOCs that provide interLATA 
services on an integrated basis. We request comment on whether, in view 
of Section 272(e)(4), we may require BOCs that provide interLATA or 
intraLATA facilities or services on an integrated basis to provide them 
to their own internal operation only at the same rates as those 
facilities or services are made available to all carriers. When those 
rates differ for different carriers, we seek comment on which rate 
should be the one that applies to BOC affiliate transactions. We also 
invite comment on whether we should adopt specific accounting 
procedures to address the difference, if any, between those rates and 
``the costs [that would be] appropriately allocated'' for the 
underlying facilities or services.
d. Scope of Commission's Authority
    43. In the BOC In-Region NPRM, we tentatively conclude that this 
Commission has jurisdiction under Sections 271 and 272 over both 
interstate and intrastate interLATA services and interLATA information 
services. That tentative conclusion leads us also to conclude 
tentatively that we have jurisdiction with respect to accounting 
matters under those same sections of the 1996 Act. We base our 
tentative conclusions in the BOC In-Region NPRM and in this Notice on 
the following analysis. Sections 271 and 272 by their terms address BOC 
provision of ``interLATA'' services and information services. Many 
States contain more than one LATA, and thus, interLATA traffic may be 
either interstate or intrastate. Accordingly, we must determine whether 
Sections 271 and 272, and our authority pursuant to those sections, 
apply only to interstate interLATA services and interLATA information 
services, or to both interstate and intrastate interLATA services and 
interLATA information services.
    44.The MFJ, when it was in effect, governed BOC provision of both 
interstate and intrastate services. The 1996 Act provides:

    Any conduct or activity that was, before the date of enactment 
of this Act, subject to any restriction or obligation imposed by the 
[MFJ] shall, on and after such date, be subject to the restrictions 
and obligations imposed by the Communications Act of 1934 as amended 
by this Act and shall not be subject to the restrictions and the 
obligations imposed by [the MFJ].

This section supersedes the MFJ, and explains that the Communications 
Act is to serve as its replacement. In the BOC In-Region NPRM, we find 
that Sections 271 and 272 of the Act were intended to replace the MFJ 
as to both interstate and intrastate interLATA services and interLATA 
information services.
    45. Although Sections 271 and 272 make no explicit reference to 
interstate and intrastate services, they do refer to a different 
geographic boundary--the LATA, as originally defined by the MFJ and now 
by the 1996 Act. In the BOC In-Region NPRM, we tentatively conclude 
that the interLATA/intraLATA distinction appears to have supplanted the 
traditional interstate/intrastate distinction for purposes of these 
sections.
    46. As to interLATA services, the MFJ prohibited the BOCs and their 
affiliates from providing any interLATA services, interstate or 
intrastate, unless specifically authorized by the MFJ or a waiver 
thereunder. Reading Sections 271 and 272 as applying to all interLATA 
services fits well with the structure of the statute as a whole. 
Sections 251 and 252 of the Act establish rules and procedures for 
competitive entry into local exchange markets. In the Interconnection 
NPRM, 61 FR 18311, we tentatively concluded that Congress intended 
these sections to apply to both interstate and intrastate aspects of 
interconnection. These new obligations imposed on BOCs (as well as 
other incumbent local exchange carriers), and enacted at the same time 
as Sections 271 and 272, clearly are part of the process for entry into 
the interLATA marketplace. Indeed, BOCs are permitted to provide in-
region interLATA services only after they have met the requirements of 
Section 271, including a competitive checklist requiring compliance 
with certain provisions in Sections 251 and 252.
    47. In the BOC In-Region NPRM, we note also that the structure of 
Sections 271 and 272 themselves indicates that these sections were 
intended to address both interstate and intrastate interLATA services. 
For instance, BOCs are directed to apply for interLATA entry on a 
state-by-state basis, and the Commission is directed to consult with 
the relevant State Commission before making any determination with 
respect to an application in order to verify the BOC's compliance with 
the requirements for providing in-region interLATA services. As we 
believe it did in Sections 251 and 252, Congress appears to have put in 
place rules to govern both interstate and intrastate services, and to 
have provided a role for both the Commission and the States in 
implementing those rules.
    48. We also note in the BOC In-Region NPRM that, by contrast, 
reading Sections 271 and 272 as limited to the provision of interstate 
services would mean that the BOCs would have been permitted to provide 
in-region, intrastate, interLATA services upon enactment and without 
any guidance from Congress as to entry requirements or safeguards, 
subject only to any pre-existing State rules on interexchange entry. 
Any such rules, presumably, would not have been directed at BOC entry, 
which had for many years been prohibited. Concerns about BOC control of 
bottleneck facilities over the provision of in-region interLATA 
services are equally important for both interstate and intrastate 
services. Thus, the reasons for imposing the procedures and safeguards 
of Sections 271 and 272 apply equally to the BOCs' provision of both 
intrastate and interstate, in-region, interLATA services. We found it 
implausible that Congress could have intended to lift the MFJ's ban on 
BOC provision of interLATA services without making any provision for 
orderly entry into intrastate interLATA services, which constitute 
approximately 30 percent of interLATA traffic. Based on the preceding 
analysis, we tentatively conclude that our authority under Sections 271 
and 272 applies to both intrastate and interstate interLATA services 
and interstate and intrastate interLATA information services provided 
by the BOCs or their affiliates. We also stated our belief that Section 
2(b) of the Communications Act did not require a contrary result 
because Congress enacted Sections 271 and 272 after Section 2(b) and 
squarely addressed the issues presented here. We reach the same 
tentative conclusion here as to accounting safeguards and seek comment 
on it.
    49. We also invite comment on what role States might play in 
implementing the accounting safeguards provisions of Sections 271 and 
272, given this tentative conclusion. We ask commenters to address 
whether we must change our policy, adopted prior to the enactment of 
the 1996 Act, of not preempting States from using their own cost 
allocation procedures for intrastate purposes. We also invite comment 
on whether, in enacting the accounting safeguards provisions of 
Sections 271 and 272, Congress intended to eliminate our ability to 
allow the States to depart from the federal cost allocation

[[Page 40169]]

procedures in their regulation of ``charges . . . for or in connection 
with intrastate communications service[s].''
    50. To the extent commenters disagree with the above analysis, we 
also seek comment on whether we have authority to preempt state 
regulation with respect to the accounting matters addressed by Sections 
271 and 272 pursuant to Louisiana PSC and, if so, whether we should 
exercise that authority. We tentatively conclude that if Sections 271 
and 272 do not provide authority over intrastate interLATA services and 
intrastate interLATA information services and if we have authority to 
preempt pursuant to Louisiana PSC, we should refrain from exercising it 
in this area and instead retain our prior policy of not preempting 
States from using their own cost allocation procedures for intrastate 
purposes. We invite comment on this tentative conclusion. We ask the 
commenters to address, in particular, whether preemption in this area 
would be necessary to achieve the intent behind the accounting 
safeguards provisions of Sections 271 and 272, or whether less 
intrusive measures would be sufficient.
3. Section 275--Alarm Monitoring Services
    51. Section 275(e) defines ``alarm monitoring service'' as ``a 
service that uses a device located at a residence, place of business, 
or other fixed premises (1) to receive signals from other devices 
located at or about such premises regarding a possible threat at such 
premises to life, safety, or property, from burglary, fire, vandalism, 
bodily injury, or other emergency, and (2) to transmit a signal 
regarding such threat by means of transmission facilities of a local 
exchange carrier or one of its affiliates to a remote monitoring center 
to alert a person . . .'' about the emergency. Section 275(a)(1) delays 
entry by the BOCs not already providing alarm monitoring services until 
five years from the date of enactment of the 1996 Act. If a BOC or BOC 
affiliate provided alarm monitoring services as of November 30, 1995, 
it may continue to do so, but cannot expand its alarm monitoring 
business by acquiring ``any equity interest in, or obtain financial 
control of, any unaffiliated alarm monitoring service entity'' during 
the five-year period.
    52. Section 275(b)(2) specifies that an incumbent local exchange 
carrier engaged in the provision of alarm monitoring services ``not 
subsidize its alarm monitoring services either directly or indirectly 
from telephone exchange service operations.'' As with the prohibition 
against subsidizing telemessaging services, this prohibition against 
subsidizing alarm monitoring services specifically applies to incumbent 
local exchange carriers.
    53. We currently require carriers to treat alarm monitoring 
services as nonregulated activities for Title II accounting purposes. 
Accordingly, the Part 64 cost allocation rules require incumbent local 
exchange carriers to allocate the costs of those services to 
nonregulated activities. We invite comment on whether our present rules 
are necessary or sufficient to prevent subsidization of alarm 
monitoring services as defined in Section 275(e). Commenters asserting 
that our existing rules would not meet this objective should identify 
with specificity any deficiency in our rules, explain the nature of the 
deficiency, and describe, in detail, how the rules can be modified to 
remove that deficiency. We ask commenters asserting that rules are not 
necessary to identify which rules are not necessary and why they are 
not necessary.
    54. Alarm monitoring, as defined in Section 275(e), appears to fall 
within the definition of ``information service'' in Section 3(20) of 
the Act. Alarm monitoring services, however, are specifically exempted 
from the separate affiliate and nondiscrimination requirements of 
Section 272. We seek comment on the extent of our authority, if any, 
under Section 275 over intrastate alarm monitoring services.
    55. We further seek comment on what role States might have in 
implementing Section 275(b)(2)'s prohibition against subsidization of 
``alarm monitoring services either directly or indirectly from . . . 
telephone exchange service operations.'' We ask commenters to address 
whether we must change our policy, adopted prior to the enactment of 
the 1996 Act, of not preempting States from using their own cost 
allocation procedures for intrastate purposes. We also invite comment 
on whether, in enacting Section 275(b)(2), Congress intended to 
eliminate our ability to allow the States to depart from the federal 
cost allocation procedures for alarm monitoring services in the States' 
regulation of ``charges . . . for or in connection with intrastate 
communications service[s].''
    56. We also seek comment on whether, if Section 275 does not itself 
preempt, we have authority to preempt State regulation with respect to 
the accounting matters addressed by Section 275(b)(2) pursuant to 
Louisiana PSC and, if so, whether we should exercise that authority. We 
tentatively conclude that even if Section 275 does not itself preempt 
and if we have that authority pursuant to Louisiana PSC, we should 
refrain from exercising it in this area and instead retain our prior 
policy of not preempting States from using their own cost allocation 
procedures for intrastate purposes. We invite comment on this tentative 
conclusion. We ask the commenters to address, in particular, whether 
preemption in this area would be necessary to achieve the intent behind 
Section 275(b)(2) or whether less intrusive measures would be 
sufficient.
4. Section 276--Payphone Services
    57. Section 276(a)(1) states that ``any Bell operating company that 
provides payphone service shall not subsidize its payphone service 
directly or indirectly from its telephone exchange service operations 
or its exchange access operations.'' This prohibition against 
subsidization is an integral part of Congress's plan ``to promote 
competition among payphone providers and promote the widespread 
deployment of payphone services to the benefit of the general public.'' 
To implement the prohibition, Section 276(b)(1)(C) directs the 
Commission to prescribe nonstructural safeguards for BOC payphone 
service that, ``at a minimum, include the nonstructural safeguards 
equal to those adopted in the Computer Inquiry-III (CC Docket No. 90-
623) proceeding.'' The Act defines the term ``payphone service'' as 
``the provision of public or semi-public pay telephones, the provision 
of inmate telephone service in correctional institutions, and any 
ancillary services.''
    58. We tentatively conclude that we should apply accounting 
safeguards identical to those safeguards adopted in Computer Inquiry-
III to prevent the subsidization of payphone services by BOC telephone 
exchange service or exchange access operations. We seek comment on this 
tentative conclusion. Commenters asserting that additional accounting 
safeguards are necessary to fulfill our responsibilities under Sections 
276(a)(1) and (b)(1)(C) should identify the alternative safeguards and 
explain why they would better prevent the subsidies referred to in 
Section 276(a)(1).
    59. All of the BOCs provide payphone service. In the past, we have 
treated payphone service as a regulated activity with applicable Part 
32 plant, expense, and revenue accounts. This classification appears 
inconsistent with the mandate in Section 276(b)(1)(C) that we prescribe 
nonstructural safeguards for payphone service because this past 
treatment allows payphone investment and expenses to be recorded as 
costs of the regulated service. We tentatively conclude that the new 
rules required by

[[Page 40170]]

that section should reclassify payphone service as a nonregulated 
activity so that its costs should be separated from the telephone 
exchange service and exchange access operations that would continue to 
be regulated activities. Under this approach, the BOCs would continue 
to use the Commission's Part 32 accounts to record their payphone 
service activities, but would classify their payphone investment, 
expenses and revenues as nonregulated for Title II accounting purposes. 
We seek comment on this tentative conclusion and overall approach and, 
in particular, ask whether this proposal would comply with the 1996 
Act's mandate to prescribe nonstructural accounting safeguards for the 
BOCs' payphone services at least equal to those adopted in the Computer 
Inquire-III proceeding. We also invite comment on whether this approach 
would prevent the subsidization of ``payphone service'' as defined in 
Section 276(d) by BOC telephone exchange service or exchange access 
operations.
    60. Section 276 does not prescribe or direct the Commission to 
prescribe accounting safeguards to govern the provision of payphone 
service by incumbent local exchange carriers other than the BOCs. We 
seek comment on whether we can and should require these other incumbent 
local exchange carriers to reclassify their payphone service operations 
as a nonregulated activity for Title II accounting purposes.
    61. Section 276(c) states that ``[t]o the extend that any State 
requirements are inconsistent with the Commission's regulations, the 
Commission's regulations on such matters shall preempt such State 
requirements.'' Thus, it is clear that the statute itself preempts any 
State regulations that may be inconsistent with our own. We invite 
comment on what role States might have in implementing Section 
276(a)(1)'s prohibition against subsidization of ``payphone service 
directly or indirectly from * * * telephone exchange service operations 
or * * * exchange access operations,'' given this clear statutory 
language and, in particular, whether in enacting Section 276(c), 
Congress intended to eliminate our ability to allow the States to 
depart from the Federal cost allocation procedures in their regulation 
of ``charges * * * for or in connection with intrastate communications 
service[s].''

III. Safeguards For Separated Operations

A. General

    62. Section 272(a)(2) of the 1996 Act allows BOCs to provide the 
following services only through a separate subsidiary: manufacturing of 
telecommunications equipment and customer premises equipment; 
origination of interLATA telecommunications services, other than 
incidental, out-of-region, and previously authorized services; and 
interLATA information services other than electronic publishing and 
alarm monitoring services. Section 273(d)(3) requires ``any entity 
which certifies telecommunications equipment or customer premises 
equipment manufactured by an unaffiliated entity * * * only [to] 
manufacture a particular class of telecommunications equipment or 
customer premises equipment for which it is undertaking or has 
undertaken, during the previous eighteen months, certification activity 
for such class of equipment through a separate affiliate.'' Section 
274(a) requires that BOCs providing electronic publishing must do so 
only through a ``separated affiliate'' or electronic publishing joint 
venture. These requirements for ``separate'' or ``separated'' 
affiliates or joint ventures implicitly assume that structural 
safeguards limit the carrier's ability to engage in subsidization.
    63. In this section, we discuss the accounting safeguards needed to 
prevent subsidization where telephone operating companies do business 
with their nonregulated and regulated affiliates. In the Joint Cost 
Order, 52 FR 6557, we adopted rules to govern the way costs are 
recorded, for Title II accounting purposes, when a regulated carrier 
does business with nonregulated affiliates. The affiliate transactions 
rules are designed to protect interstate ratepayers from subsidizing 
the competitive ventures of incumbent local exchange carrier 
affiliates. The affiliate transactions rules do not require carriers or 
their affiliates to charge any particular prices for assets transferred 
or services provided; rather, the rules require carriers to use certain 
specified valuation methods in determining the amounts to record in 
their Part 32 accounts, regardless of the prices charged.
    64. We tentatively conclude that, except where the 1996 Act imposes 
specific additional requirements, our current affiliate transactions 
rules generally satisfy the statute's requirement of safeguards to 
ensure that these services are not subsidized by subscribers to 
regulated telecommunications services. We invite comment on this 
tentative conclusion. We have previously concluded that these rules 
provide effective safeguards against subsidization. Incumbent local 
exchange carriers have implemented internal accounting systems for 
affiliate transactions to help ensure their compliance with these 
rules. Redesigning these internal systems to accommodate a 
fundamentally different approach to affiliate transactions accounting 
systems would impose substantial costs on the carriers. We seek comment 
on these matters and, in particular, on whether the benefits of any 
fundamentally different approach to affiliate transactions would be 
outweighed by the costs that implementation of such a system might 
entail.
    65. Although we do not propose an approach for affiliate 
transactions that is fundamentally different from our existing rules, 
we seek comment on whether we should modify our affiliate transactions 
rules in certain respects. The Commission and the telephone industry 
have had more than eight years experience with the cost allocation 
regime created by the Joint Cost Order, 52 FR 6557 (March 4, 1987). 
This experience has made us aware that amending certain aspects of the 
affiliate transactions rules might provide more optimal protection 
against subsidization. In 1993, we released an Affiliate Transactions 
Notice, 58 FR 62080 (November 24, 1993), proposing such rule changes, 
including changes in how subject carriers would value for Title II 
accounting purposes services they provide, or receive from, 
nonregulated affiliates. We invite comment on whether, in implementing 
the 1996 Act's provisions regarding subsidization, we should amend the 
current affiliate transactions rules to incorporate certain of the 
modifications proposed in the Affiliate Transactions Notice. We discuss 
these modifications below. We also invite comment on whether any 
additional changes to those rules might be necessary or appropriate to 
implement the requirements of the 1996 Act.
    66. As a general matter, we solicit comment on how and to whom the 
affiliate transactions rules should be applied. For example, we could 
apply the accounting safeguards for affiliate transactions discussed in 
this NPRM only to those entities that engage in activities for which 
the 1996 Act requires the use of a separate or separated subsidiary. We 
could also extend application of these safeguards to those incumbent 
local exchange

[[Page 40171]]

carriers that engage in activities for which the 1996 Act allows, but 
does not require, the use of a separate subsidiary. We discuss these 
approaches below. Finally, we invite comment on whether we should also 
apply any modifications to our affiliate transactions rules that we 
make in this proceeding to all transactions between incumbent local 
exchange carriers and their affiliates.

B. Specific Services

1. Section 272--Manufacturing and InterLATA Services
a. Statutory Language
    67. Section 272(a) prohibits a ``Bell operating company (including 
any affiliate) which is a local exchange carrier that is subject to the 
requirements of section 251(c)'' from ``provid[ing] any service 
described in [Section 272(a)(2)] unless it provides that service 
through one or more affiliates that (A) are separate from any operating 
company entity that is subject to the requirements of section 251(c); 
and (B) meet the requirements of [Section 272(b)].'' Section 272(a)(2) 
states that:

    [T]he services for which a separate affiliate is required by 
[Section 272(a)(1)] are: (A) [m]anufacturing activities (as defined 
in section 273(h); (B) [o]rigination of interLATA telecommunications 
services, other than (i) incidental interLATA services described in 
[Section 271(g)(1)-(3) and (5)-(6)]; (ii) out-of-region services 
described in section 271(b)(2); or (iii) previously authorized 
activities described in section 271(f); [and] (C) [i]nterLATA 
information services, other than electronic publishing (as defined 
in section 274(h)) and alarm monitoring services (as defined in 
section 275(e)).

Section 272(b)(2) requires each of these separate affiliates to 
``maintain books, records, and accounts in the manner prescribed by the 
Commission which shall be separate from the books, records, and 
accounts maintained by the [BOC] of which it is an affiliate.'' Under 
Section 272(b)(5), each of these separate affiliates must ``conduct all 
transactions with the [BOC] of which it is an affiliate on an arm's 
length basis with any such transactions reduced to writing and 
available for public inspection.'' Pursuant to Section 272(c)(2), BOCs 
must account for all transactions with these affiliates ``in accordance 
with accounting principles designated or approved by the Commission.''
b. Accounting Requirements of Sections 272 (b)(2) and (c)(2)
    68. Section 272(b)(2) requires the separate affiliates prescribed 
under Section 272(a)(2) to ``maintain books, records, and accounts in 
the manner prescribed by the Commission which shall be separate from 
the books, records, and accounts maintained by the [BOC] of which it is 
an affiliate.'' We invite comment on the steps we should take to 
implement this provision and, in particular, whether we should mandate 
that the separate affiliates required under Section 272(a)(2) maintain 
their books, records, and accounts in accordance with generally 
accepted accounting principles (``GAAP''). We ask the commenters to 
address whether it is necessary to adopt any additional accounting, 
bookkeeping, or record keeping requirements for these affiliates and, 
if so, what those additional requirements should be.
    69. Pursuant to Section 272(c)(2), BOCs must account for all 
transactions with their separate affiliates required under Section 
272(a)(2) ``in accordance with accounting principles designated or 
approved by the Commission.'' We invite comment on how we should 
implement this provision. To ensure that the amounts recorded in Part 
32 accounts are based on reliable financial data, the Affilitate 
Transactions Notice proposed that, except as otherwise ordered by this 
Commission, all accounting related to affiliate transactions must 
comply with GAAP. We invite comment on whether requiring such 
accounting would assist us in fulfilling our statutory obligation to 
ensure that each affiliate required under Section 272(a)(2) will 
``conduct all transactions with the [BOC] of which it is an affiliate 
on an arm's length basis'' and, if so, whether we should adopt such a 
requirement.
c. ``Arm's Length'' Requirement of Section 272(b)(5)
    70. Section 272(b)(5) of the 1996 Act requires that transactions 
between the BOC and its affiliate engaged in the manufacturing 
activities, origination of interLATA telecommunications services, and 
interLATA information services described in Section 272(a)(2) be 
conducted on ``an arm's length'' basis. In the Computer II Final 
Decision, 45 FR 24694, we required AT&T to provide enhanced services 
and customer premises equipment only through a ``separate corporate 
entity'' that would ``deal with any affiliated manufacturing entity 
only on an arm's length'' basis. We stated that ``the transfer of any 
products'' between this separate corporate entity and ``any affiliated 
equipment manufacturer must be done at a price that is compensatory.'' 
We also stated that, ``[t]o police this requirement, we [would] require 
that any transaction between the enhanced services subsidiary and any 
other affiliate which involves the transfer (either directly or by 
accounting or other record entries) of money, personnel, resources or 
other assets be recorded in auditable form.'' We invite comment on 
whether we should adopt similar requirements to implement Section 
272(b)(5). We also invite comment on whether a requirement that prices 
be compensatory would be consistent with the Congressional intent 
behind Section 272(b)(5) and, in particular, any intent that ratepayers 
of regulated services benefit from the economies of scope from BOC 
manufacturing, origination of interLATA telecommunications services, 
and interLATA information services activities.
    71. In Computer III, we reexamined our regulatory regime for the 
provision of enhanced services and replaced the Computer II 
requirements with a series of nonstructural safeguards. These 
safeguards included the Part 64 cost allocation rules and the affiliate 
transactions rules that we developed in the Joint Cost Order. The 
latter prescribe how incumbent local exchange carriers other than 
average schedule companies must value their affiliate transactions for 
Title II accounting purposes. These rules direct subject carriers to 
use different methods for valuing assets transferred and services 
provided. For asset transfers, the rules require that they us one of 
four methods: (1) tariffed rates; (2) prevailing company prices; (3) 
net book cost; and (4) estimated fair market value. Carriers must 
record each asset transferred to an affiliate pursuant to tariff at the 
tariffed rate. If an affiliate that sells a non-tariffed asset to its 
regulated carrier also sells the same kind of asset to third parties at 
a generally available price, the carrier must record the asset transfer 
at that prevailing company price. All other asset transfers must be 
recorded at the higher of net book cost and estimated fair market value 
when the carrier is the buyer (i.e., from the affiliate). The United 
States Court of Appeals for the District of Columbia Circuit affirmed 
the valuation methods for asset transfers, finding them ``reasonably 
designed to prevent systematic abuse of ratepayers.''
    72. The affiliate transactions rules authorize three valuation 
methods for determining the amounts carriers should record in their 
Part 32 accounts for services they provide to or obtain from 
affiliates: (1) tariffed rates; (2) prevailing company prices; and (3) 
fully distributed costs. Carriers must record services provided to an 
affiliate pursuant to tariff at the tariffed rate. If an affiliate 
provides a non-tariffed service to its regulated carrier that it also 
provides to third parties, the carrier

[[Page 40172]]

must record the transaction at the prevailing company price. All other 
affiliate services must be recorded at the service provider's fully 
distributed costs.
    73. As stated above, the Commission has released an Affiliate 
Transactions Notice that proposes certain rule changes to provide 
greater protection against subsidization. We discuss certain of these 
proposed changes below. We solicit comment concerning whether our 
affiliate transactions rules, with the proposed changes, would be 
necessary or sufficient to ensure compliance with the ``arm's length'' 
requirement of Section 272(b)(5).
    74. We also seek comment on whether and, if so, how we should amend 
our rules to address Section 272(b)(5)'s requirement that all 
transactions be ``reduced to writing and available for public 
inspection.'' We ask the commenters to address in particular whether 
Internet access to information about these transactions would be 
sufficient to comply with this requirement ``for public inspection.'' 
We also invite commenters to suggest any other methods we could 
implement to comply with Section 272(b)(5). We seek further comment 
about whether we need to adopt safeguards to protect any sensitive or 
confidential information that these publicly available documents may 
contain.
    75. We note that Section 272(e)(1) requires a ``Bell operating 
company and an affiliate that is subject to the requirements of section 
251(c)'' to ``fulfill any requests from an unaffiliated entity for 
telephone exchange service and exchange access service within a period 
no longer than the period in which it provides such telephone exchange 
service and exchange access to itself or to its affiliates.'' We 
interpret ``transactions'' under Section 272(b)(5) to include requests 
by an affiliate to its BOC for telephone exchange service or exchange 
access. We seek comment on this interpretation. We also seek comment on 
whether we should require information about such transactions to be 
made publicly available and, if so, whether we need to adopt safeguards 
to protect any sensitive or confidential information related to such 
transactions.
i. Identical Valuation Methods for Assets and Services
    76. In the Joint Cost Order, we did not prescribe uniform valuation 
methods for all affiliate transactions. In particular, if an asset 
transfer was neither tariffed nor subject to prevailing company prices, 
we required carriers to record the transfer at the higher of net book 
cost and estimated fair market value when it is the seller, and at the 
lower of net book cost and estimated fair market value when the carrier 
is the purchaser. In contrast, the Commission required carriers to 
record all non-tariffed services other than those having prevailing 
company prices at the providers' fully distributed costs.
    77. If we apply our affiliate transactions rules, with the changes 
proposed in this Notice, to transactions between the BOC and its 
affiliates engaged in the manufacturing, origination of interLATA 
telecommunications services and interLATA information services 
described in Section 272(a)(2) of the 1996 Act, we believe we should 
consider prescribing uniform valuation methods for all affiliate 
transactions. In the Affiliate Transactions Notice, we tentatively 
concluded that our treatment of the provision of services that are 
neither tariffed nor subject to prevailing company prices may reward a 
carrier's imprudent acts of buying services for more than, and selling 
services for less than, fair market value. By requiring carriers to 
record services they sell to nonregulated affiliates at the carriers' 
fully distributed costs even when those costs are less than what non-
affiliates would pay the carriers, the rules motivate carriers to sell 
services for less than fair market value. Similarly, by permitting 
carriers to record services purchased from nonregulated affiliates at 
the affiliates' fully distributed costs, even when those costs exceed 
what the carriers would pay non-affiliates, the rules motivate carriers 
to pay more than fair market value for services. If these increased 
costs are reflected in rates for regulated telecommunications services, 
ratepayers may be harmed. Ratepayers and service providers not 
affiliated with carriers may also be harmed if the valuation methods 
for affiliate transactions induce carriers and their affiliates to 
``use services that are not competitive to subsidize services that are 
subject to competition,'' thereby putting service providers not 
affiliated with the carrier at a competitive disadvantage.
    78. Because of the concerns identified in the preceding paragraph, 
we believe that the current rules regarding the valuation of affiliate 
services may not be consistent with the requirement of Section 
272(b)(5) for ``transactions * * * on an arm's length basis.'' 
Requiring that affiliate transactions that do not involve tariffed 
assets or services be recorded at the higher of cost and estimated fair 
market value when the carrier is the seller or transferor, and at the 
lower of cost and estimated fair market value when the carrier is the 
buyer or transferee appears more likely to achieve these statutory 
objectives. We propose to continue to define the applicable cost 
benchmarks as net book cost for asset transfers and fully distributed 
costs for service transfers. Our proposed rule, viewed in light of 
other changes detailed below, would form part of a rational and 
streamlined approach to affiliate transactions. This proposed rule 
would also reduce the incentive to record an affiliate transaction as a 
provision of a service, rather than an asset transfer, especially in 
the context of procurement activities. We seek comment on whether these 
modifications would better meet the objectives of Section 272. We also 
ask commenters to discuss whether, and under what circumstances, we 
should allow carriers and their affiliates to use any alternative 
valuation methods. We also seek comment on how the elimination of a 
sharing obligation from our price cap rules would affect the validity 
of our tentative conclusion in the Affiliate Transactions Notice that 
our treatment of the provision of services that are neither tariffed 
nor subject to prevailing company prices may reward a carrier's 
imprudent acts of buying services for more than, and selling services 
for less than, fair market value.
    79. Section 272(e)(3) requires that ``[a] Bell operating company 
and an affiliate that is subject to the requirements of section 251(c) 
* * * shall charge the affiliate described in subsection (a) or impute 
to itself (if using the access for its provision of its own services), 
an amount for access that is no less than the amount charged to any 
unaffiliated interexchange carriers for such service.'' Section 
272(e)(4) states that ``[a] Bell operating company and an affiliate 
that is subject to the requirements of section 251(c) * * * may provide 
any interLATA or intraLATA facilities or services to its interLATA 
affiliate if such services or facilities are made available to all 
carriers at the same rates and on the same terms and conditions, and so 
long as the costs are appropriately allocated.'' We invite comment on 
how these requirements should affect our rules for implementing the 
``arm's length'' requirement of Section 272(b)(5). We also invite 
comment on whether we should adopt specific accounting procedures to 
address the difference, if any, between the rates charged by BOCs when 
they provide interLATA or intraLATA facilities or services on a 
separated basis and ``the costs [that would be] appropriately 
allocated'' for the underlying facilities or services.

[[Page 40173]]

ii. Prevailing Company Prices
    80. The prevailing price method describes the use of the price at 
which a company offers an asset or service to the general public to 
establish the value of the affiliate transaction. Generally, when a 
carrier transfers assets or provides services to an affiliate or the 
affiliate transfers assets or provides services to the carrier and 
either the carrier or affiliate conducts similar transactions with the 
non-affiliates, the transfer or service price with non-affiliates 
should become the benchmark price for defining the value of the 
transaction. Although the prevailing price appears to represent the 
price that would be paid in an arm's length transaction, prevailing 
price in affiliate transactions may not reflect fair market value 
primarily because of the different nature of affiliate and non-
affiliate transactions. In competitive markets, companies devote 
significant resources to retaining and attracting customers including 
sales presentations, advertising campaigns, discounts for volume 
purchases, or long-term commitments. Most affiliate transactions, 
however, take place in an entirely different environment. Sales between 
affiliates generally do not require extensive marketing efforts and 
involve lower transactional costs than sales to non-affiliates. We 
invite comment on whether affiliate transactions conducted ``on an 
arms's length basis'' will necessarily entail the same marketing 
efforts and transactional costs as sales to non-affiliates. We also 
invite comment on what, if any, effect any differences in those efforts 
and costs should have on our decision regarding the use of the 
prevailing price method for recording affiliate transactions between 
BOCs and their affiliates engaged in manufacturing, interLATA 
telecommunications origination and interLATA information services as 
described in Section 272(a)(2).
    81. Our experience with the prevailing price method has revealed 
the difficulty of defining what constitutes a prevailing price. When a 
nonregulated affiliate transfers assets or provides services to the 
carrier and non-affiliates, the question becomes what percentage of an 
affiliate's overall business must be provided to non-affiliates in 
order to establish a prevailing company price. If the percentage of 
third-party business is small, there may not be enough participants in 
the market to ensure that the price equals the price the carrier and 
the affiliate would have negotiated ``on an arm's length basis.'' In 
such situations, using prevailing prices to value asset transfers could 
permit affiliates to charge inflated prices to the BOC. This would 
allow nonregulated affiliates to receive added revenue that could 
permit the nonregulated affiliate to price other competitive assets and 
services lower to the detriment of fair competition. An additional 
problem in determining a prevailing price arises because of the nature 
of the products and services that an affiliate may transfer. 
``[R]egulatory requirements that [BOCs] buy equipment competitively 
crumble quickly when the product being purchased is technically complex 
and readily differentiated.''
    82. We, therefore, seek comment on the benefits of our proposal to 
amend our affiliate transactions rules to eliminate the valuation of 
affiliate transactions based on prevailing prices for transactions 
between a BOC and its affiliates engaged in the manufacturing, 
interLATA telecommunications origination and interLATA information 
services described in Section 272(a)(2). Under this proposal, 
transactions from the carrier to the nonregulated affiliate would be 
recorded at tariffed rates, if applicable, or at the higher of fair 
market value or fully distributed cost. Transactions from the 
nonregulated affiliate to the carrier would be recorded at the lower of 
fully distributed cost or fair market value.
iii. Estimates of Fair Market Value
    83. In prior portions of this NPRM, we propose to adopt identical 
valuation methodologies for assets and services which would require the 
carrier to record most affiliate transactions at the higher of net book 
cost and estimated fair market value when the carrier is the seller, 
and at the lower of net book cost and estimated fair market value when 
the carrier is the buyer. These proposals implicitly assume that there 
is an observable fair market value for any assets and services that a 
carrier and its nonregulated affiliates might provide each other, and 
that reasonable efforts will enable the carrier to discover that value. 
We believe that the procedures carriers use in estimating fair market 
value should vary with the circumstances of the transaction and 
consequently that we should not specify the methodologies that carriers 
must follow to estimate fair market value. We instead propose to 
require carriers to make good faith determinations of the fair market 
value, where such a valuation is required under the affiliate 
transactions rules. While this methodology will limit appraisals to 
transactions, such as building sales and other transfers of major 
assets, for which nonregulated companies obtain appraisals in the 
normal course of business, we believe a more stringent approach would 
impose unnecessary burdens and costs on the BOCs and other incumbent 
local exchange carriers. We believe that a good faith requirement would 
help ensure that affiliates covered by Section 272 ``conduct all 
transactions with the [BOC] of which it is an affiliate on an arm's 
length basis.''
    84. While we propose not to prescribe methodologies for estimating 
fair market value, we seek comment on whether we should set criteria 
for determining what constitutes a good faith estimate of fair market 
value. For example, if a transaction is subject to reasonable 
independent valuation methods, we believe that carriers should continue 
to ascertain fair market value by applying these methods to demonstrate 
their good faith. If companies making certain purchases routinely 
solicit competitive bids, survey potential suppliers, or obtain 
independent appraisals, companies should continue to employ these 
methods to determine fair market value. Thus, carriers could support 
affiliate transactions involving real estate transfers by means of 
independent appraisals.
    85. In situations involving transactions that are not easily 
valued, we seek comment on whether we should still require carriers to 
support their valuations by reasonable and appropriate methods. For 
example, for some assets or services a carrier might determine that an 
independent appraisal would be difficult, if not impossible, to obtain 
or be prohibitively expensive. In this case, a good faith attempt to 
ascertain fair market value might include supporting the transaction 
with computations or studies that utilize methods and principles that 
an independent appraiser would apply. This could mean, if possible, 
obtaining comparable sales information, computing values by applying a 
responsible capitalization rate on cash flow, or determining 
replacement value. We note that nothing discussed in this Notice would 
exempt carriers from their statutory obligation under Section 220(c) to 
justify their accounting entries. We invite comment on our proposal to 
allow good faith attempts to determine fair market value in affiliate 
transactions.
iv. Tariffed-based Valuation
    86. Finally, we seek comment about the status of tariff-based 
valuation if incumbent local exchange carriers are not required to 
provide interconnection and collocation services and network elements 
pursuant to tariffs. Under Section 252, it may be that the BOC

[[Page 40174]]

would submit agreements adopted by negotiations or arbitration to State 
commissions for approval or rejection without ever filing a tariff. 
Alternatively, the BOCs may file statements of generally available 
terms pursuant to Section 252(f) that would state the terms on which 
these LECs would provide services to all customers who desire them. We 
seek comment on whether, and the extent to which, our affiliate 
transactions rules should be amended to substitute rates appearing in 
such publicly filed agreements and statements for tariffed rates where 
affiliates could subscribe to services under such generally available 
terms. We also seek comment on whether such amendments would be 
consistent with, or required by, Sections 272(e)(3) and 272(e)(4).
v. Return Component for Allowable Costs
    87. In the Joint Cost Proceeding, the Commission determined that 
fully distributed costs should include a return on investment, but no 
``profit'' in excess of the return then prescribed for the carrier's 
interstate regulated activities. Consequently, carriers that utilize 
fully distributed cost to value affiliate transactions include in their 
cost computations a component for rate of return. We believe we should 
consider allowing all carriers providing directly, or indirectly 
through an affiliate, the services that are the subject of Section 272 
to use a uniform rate of return to value affiliate transactions. 
Adopting numerous rates of return would impose a significant compliance 
burden on the industry. In addition, the use of various rates of return 
could favor certain telecommunications service providers and 
disadvantage others. Moreover, allowing carriers to determine their own 
rate of return would increase the likelihood that an affiliate will 
fail to ``conduct all transactions with the [BOC] of which it is an 
affiliate an arm's length basis[,]'' as required by Section 272(b)(5). 
From a regulatory standpoint, the Commission would have a difficult, if 
not impossible, burden if it had to engage in numerous prescription 
proceedings and then monitor compliance with each.
    88. The Commission has prescribed a unitary, overall rate of return 
for those incumbent local exchange carriers still subject to rate-of-
return regulation to use in computing interstate revenue requirements, 
unless a carrier can show that such use would be confiscatory. The 
current prescribed rate of return on interstate services is 11.25 
percent. Because the rate-of-return represcription will not affect 
either the price cap indices or the sharing zones for carriers subject 
to price cap regulation, the impact of any represcription of this rate 
of return on price cap LECs would be limited. In addition to affecting 
cost calculations for affiliate transactions, as we propose above, a 
represcription may change the amounts that price cap LECs receive from 
the universal service fund or pay for long-term support of NECA's 
common line pool and the amounts those LECs pay the telecommunications 
relay services fund to give persons with hearing or speech impairments 
full access to the voice communications network. We seek comment on 
whether we should require the BOCs to use the prescribed interstate 
rate of return for valuing their transactions with their affiliates 
engaged in the manufacturing activities, in-region telecommunications 
services origination and interLATA information services described in 
Section 272(a)(2).
d. Application to InterLATA Telecommunications Affiliates
    89. We propose to apply our affiliate transactions rules to 
transactions between a BOC and any affiliates it establishes under 
Section 272(a) Under that provision, a BOC, including any affiliate, 
``which is a local exchange carrier that is subject to the requirements 
of section 251(c)'' may not provide in-region interLATA 
telecommunications services, interLATA information services, or 
manufacturing unless it provides those services through one or more 
affiliate. Any transactions between a BOC and its interLATA information 
services or manufacturing affiliates would be subject to our existing 
affiliate transactions rules, because neither interLATA information 
services nor manufacturing are regulated activities under Title II. 
InterLATA telecommunications services, however, are regulated under 
Title II, and, absent a Commission requirement to the contrary, the 
affiliates that offer those services would therefore classify interLATA 
telecommunications services as regulated for Title II accounting 
purposes. Our existing affiliate transactions rules are solely designed 
for transactions between regulated carriers and their nonregulated 
affiliates. To help protect against improper subsidization, we have 
already determined that out-of-region interstate, interexchange 
services provided by BOC affiliates should be treated as nonregulated 
for accounting purposes. Thus, our affiliate transactions rules apply 
to transactions between the BOCs and those affiliates. Because BOC in-
region interLATA telecommunications services also present a potential 
for improper subsidization, we tentatively conclude that we should 
apply our affiliate transactions rules to transactions between each BOC 
and any interLATA telecommunications services affiliate it establishes 
under Section 272(a). We invite comment on this tentative conclusion. 
We also invite comment on whether and how we should adapt our affiliate 
transactions rules if applied to such transactions and, in particular, 
whether we should adopt special valuation methodologies for these 
transactions to recognize the regulated status of the affiliates on 
both sides of the transactions.
    90. Section 272 does not prohibit a BOC from providing 
manufacturing and interLATA information services described in Section 
272(a)(2) through the same affiliate by which it provides origination 
of interLATA telecommunications services described in the same section. 
It also does not prohibit that affiliate from engaging in other 
activities not regulated under Title II. We seek comment on whether in 
this context we should apply our cost allocation rules to prevent 
subsidization of nonregulated activities, including manufacturing and 
interLATA information services, by subscribers to interLATA 
telecommunication services. In particular, we seek comment on what, if 
any, authority Section 254(k) extends to our application of our cost 
allocation rules to affiliates engaged in regulated and nonregulated 
activities.
e. Application to Joint Marketing
    91. Although Section 272(b)(3) requires [the affiliate] to ``have 
separate officers, directors, and employees from the Bell operating 
company of which it is an affiliate,'' Section 272(g)(2) allows the BOC 
to ``market or sell interLATA service provided by an affiliate required 
by [Section 272] . . . [after] such company is authorized to provide 
interLATA services in such State under section 271(d).'' In our 
companion BOC In-Region NPRM, we seek comment on whether an affiliate 
may share marketing personnel with a BOC, and if so, what corporate and 
financial arrangements are necessary to comply with sections 272(b)(3), 
272(b)(5) and 272(g)(2). If an affiliate may share marketing personnel 
with a BOC, we tentatively conclude that we should apply our cost 
allocation and affiliate transactions rules, as we propose to modify 
them in this Notice, to any joint marketing on interLATA and local 
exchange services. We seek comment whether and the extent to which any

[[Page 40175]]

additional accounting safeguards may be necessary.
f. Audit Requirements
    92. Section 272(d) states that companies required to maintain a 
separate affiliate under Section 272 ``shall obtain and pay for a 
Federal/State audit every 2 years conducted by an independent auditor 
to determine whether such company complied with this section and the 
regulations promulgated under this section, and particularly whether 
such company has complied with the separate accounting requirements 
under [Section 272(b)].'' The independent auditor ``shall submit the 
results of the audit to the Commission and to the State commission of 
each State in which the company audited provides service, which shall 
make such results available for public inspection.'' Interested persons 
may then submit comment on the final audit report.
    93. We tentatively conclude that the independent auditor's report 
should be filed with the Commission and each relevant State commission 
and should include a discussion of: (1) the scope of the work 
conducted, with a description of how the affiliate's or joint venture's 
books were examined and the extent of the examination; (2) the 
auditor's conclusion whether examination of the books has revealed 
compliance or non-compliance with the affiliate transactions rules and 
any non-discrimination requirements in the Commission rules; (3) any 
limitations imposed on the auditor in the course of its review by the 
affiliate or joint venture or other circumstances that might affect the 
auditor's opinion; and (4) a statement by the auditor that the 
carrier's cost allocation methodologies conform to the Communications 
Act of 1934, as amended, and the Commission's rules and that the 
carrier has accurately applied the methodologies described in those 
rules. We seek comment on the necessity or desirability of using such 
an approach to satisfy the requirements of Section 272(d). We also seek 
comment on whether the independent auditor's report should address 
whether the carrier has complied with Sections 272(e)(3) and 272(e)(4).
g. Scope of Commission's Authority
    94. Section 272 of the 1996 Act, by its terms, covers transactions 
between a BOC and its affiliates engaged in the manufacturing 
activities, origination of interLATA telecommunications services, and 
interLATA information services described in Section 272(a)(2). As we 
have done in the BOC In-Region NPRM, we believe that each of these 
activities requires a different analysis. We state elsewhere in this 
Notice our tentative conclusions and analysis regarding telemessaging, 
interLATA telecommunications services, and manufacturing activities. We 
also tentatively conclude that we should apply our analysis for 
telemessaging to other interLATA information services covered by 
Section 272. We seek comment on this tentative conclusion.
2. Section 273--Manufacturing by Certifying Entities
a. Statutory Language
    95. Section 273(d) of the 1996 Act requires certain standard-
setting organizations to maintain separate affiliates in order to 
engage in certain types of manufacturing. Under Section 273(d)(3), when 
such a standard-setting organization certifies telecommunications 
equipment or customer premises equipment manufactured by an 
unaffiliated entity, the certifying entity ``shall only manufacture a 
particular class of telecommunications equipment or customer premises 
equipment for which it is undertaking or has undertaken, during the 
previous eighteen months, certification activity * * * through a 
separate affiliate.'' [N]otwithstanding [Section 273(d)(3)],'' Section 
273(d)(1)(B) prohibits ``Bell Communications Research, Inc., or any 
successor entity or affiliate'' from ``engag[ing] in manufacturing 
telecommunications equipment or customer premises equipment as long as 
it is an affiliate of more than 1 otherwise unaffiliated [BOC] or 
successor or assign of any such company.''
    96. Section 273(d)(3)(B) requires the separate affiliate to 
``maintain books, records, and accounts separate from those of the 
entity that certifies such equipment, consistent with generally 
acceptable accounting principles[,]'' and to ``have segregated 
facilities and separate employees'' from the certifying entity. Section 
273(g) permits ``[t]he Commission [to] prescribe such additional rules 
and regulations as the Commission determines necessary to carry out the 
provisions of this section, and otherwise to prevent discrimination and 
cross-subsidization in a [BOC's] dealings with its affiliates and with 
third parties.''
b. Comparison of Sections 273 and 272
    97. Both Sections 272 and 273 require the use of a separate 
affiliate to engage in different specified activities. We have already 
proposed accounting safeguards to govern transactions between a BOC and 
its affiliate engaged in the manufacturing, origination of interLATA 
telecommunications services and interLATA information services 
described in Section 272(a)(2). Section 273 requires a standard-setting 
organization that certifies telecommunications equipment or customer 
premises equipment manufactured by an unaffiliated entity to ``only 
manufacture a particular class of telecommunications equipment or 
customer premises equipment for which it is undertaking or has 
undertaken, during the previous eighteen months, certification activity 
* * * through a separate affiliate.'' Section 273(d)(3)(B) requires 
that the separate affiliate of the standard-setting organization 
``maintain books, records, and accounts separate from those of the 
entity that certifies such equipment, consistent with generally 
acceptable accounting principles[,]'' and to ``have segregated 
facilities and separate employees'' from the certifying entity. As a 
threshold question, we seek comment on whether and, if so, how Section 
273's different statutory language requires or permits different 
accounting treatment from that required or permitted for BOCs under 
Section 272. Specifically, we seek comment whether we should apply our 
affiliate transactions rules, as we propose to modify them, to 
transactions between a certifying entity and the affiliate it must 
maintain under Section 273(d). We note that our existing rules would 
not cover transactions between a certifying entity and its affiliate 
where that certifying entity is not also a regulated carrier. We, 
therefore, seek comment on whether, and to what extent, we should 
modify our affiliate transactions rules to govern such transactions.
    98. In addition to the accounting safeguards for BOC entry into 
manufacturing set forth in Section 272 as discussed above, we note that 
Section 273(g) specifically authorizes ``[t]he Commission [to] 
prescribe such additional rules and regulations as the Commission 
determines necessary * * * to prevent cross-subsidization in a [BOC's] 
dealings with its affiliates and with third parties.'' We tentatively 
conclude that application of our affiliate transactions rules, as we 
propose to modify them, to BOCs engaged in activities under Section 273 
would be sufficient to satisfy this provision of the 1996 Act. We seek 
comment on this tentative conclusion.
c. Scope of Commission's Authority
    99. Section 273 provides that a BOC may manufacture and provide 
telecommunications equipment and

[[Page 40176]]

customer premises equipment if the Commission authorizes that BOC to 
provide interLATA services under Section 271(d). Section 273 also sets 
out safeguards for BOC manufacturing activities. We tentatively 
conclude that the provisions of this section apply to all BOC 
manufacturing activities, irrespective of any jurisdictional 
distinction. First, much like Sections 271 and 272, Section 273 sets 
the conditions for BOC entry into manufacturing. Thus, as with Sections 
271 and 272, we believe that Section 273 was meant to supersede the 
MFJ, and to replace it for both interstate and intrastate activities, 
to the extent that such a jurisdiction division makes sense in the 
context of manufacturing. Section 273 conditions entry into 
manufacturing on the BOC's obtaining Commission approval for interLATA 
entry under Section 272. This relationship between Sections 272 and 273 
further suggests that they should both be read to have the same 
jurisdictional reach.
    100. Moreover, we tentatively conclude that although Section 2(b) 
of the Communication Acts limits the Commission's authority over 
``charges, classifications, practices, services, facilities, or 
regulation for or in connection with intrastate communications 
service,'' we tentatively conclude the manufacturing activities 
addressed by Section 273 are not within the scope of Section 2(b). Even 
if Section 2(b) applies with respect to BOC manufacturing under Section 
273, we tentatively find that such manufacturing activities plainly 
cannot be segregated into interstate and intrastate portions. We invite 
comment on what role States might have in implementing Section 273's 
accounting safeguards provisions, assuming the correctness of these 
beliefs, and, in particular, whether in enacting Section 273, Congress 
intended to eliminate our ability to allow the States to depart from 
the federal cost allocation procedures in their regulation of ``charges 
* * * for or in connection with intrastate communications service[s].'' 
We ask the commenters also to address whether preemption in this area 
would be necessary to achieve the intent behind Section 273 or whether 
less intrusive measures would be sufficient.
3. Section 274--Electronic Publishing
    101. Section 274 of the 1996 Act prescribes the terms under which a 
BOC may offer electronic publishing. Section 274(a) permits a BOC or 
its affiliate to provide electronic publishing over its or its 
affiliate's basic telephone service only through a ``separated 
affiliate'' or an ``electronic publishing joint venture.'' Section 
274(i)(9) defines ``separated affiliate'' as ``a corporation under 
common ownership or control with a Bell operating company that does not 
own or control a Bell operating company and is not owned or controlled 
by a Bell operating company and that engages in the provision of 
electronic publishing which is disseminated by means of such Bell 
operating company's or any of its affiliate's basic telephone 
service.'' Section 274(i)(8), in turn defines ``own'' as having ``a 
direct or indirect equity interest (or the equivalent thereof) of more 
than 10 percent of an entity, or the right to more than 10 percent of 
the gross revenues of an entity under a revenue sharing or royalty 
agreement.'' Section 274(i)(4) states that ``control'' has the meaning 
that it has in 17 CFR 240.12b-2, the regulations promulgated by the 
Securities and Exchange Commission pursuant to the Securities Exchange 
Act of 1934 (15 U.S.C. 78a et seq.) or any successor provision to such 
section.'' Section 274(i)(5) defines an ``electronic publishing joint 
venture'' as `` a joint venture owned by a Bell operating company or 
affiliate that engages in the provision of electronic publishing which 
is disseminated by means of such Bell operating company's or any of its 
affiliates' basic telephone service.''
    102. Under Section 274(b), the ``separated affiliate'' or joint 
venture ``shall be operated independently from the [BOC].'' The 
``separated affiliate'' or joint venture and the BOC with which it is 
affiliated must ``carry out transactions (i) in a manner consistent 
with such independence, (ii) pursuant to written contracts or tariffs 
that are filed with the Commission and made publicly available, and 
(iii) in a manner that is auditable in accordance with generally 
accepted auditing standards.'' The ``separated affiliate'' or joint 
venture must also ``value any assets that are transferred directly or 
indirectly from the [BOC] to a separated affiliate or joint venture, 
and record any transactions by which such assets are transferred, in 
accordance with such regulations as may be prescribed by the Commission 
or a State commission to prevent improper cross-subsidies.''
    103. Section 274(c)(2) discusses the joint activities permitted 
under Section 274. Section 274(c)(2)(A) provides that ``[a] Bell 
operating company may provide inbound telemarketing or referral 
services related to the provision of electronic publishing for a 
separated affiliate, electronic publishing joint venture, affiliate, or 
unaffiliated electronic publisher, provided that if such services are 
provided to a separated affiliate, electronic publishing joint venture, 
or affiliate, such services shall be made available to all electronic 
publishers on request, on nondiscriminatory terms.'' Section 
274(c)(2)(B) states that ``[a] Bell operating company may engage in 
nondiscriminatory teaming or business arrangements to engage in 
electronic publishing with any separated affiliate or with any other 
electronic publisher if (i) the Bell operating company only provides 
facilities, services, and basic telephone service information as 
authorized by [Section 274], and (ii) the Bell operating company does 
not own such teaming or business arrangement.'' Lastly, Section 
274(c)(2)(C) permits ``[a] Bell operating company or affiliate [to] 
participat[e] on a nonexclusive basis in electronic publishing joint 
ventures with entities that are not a Bell operating company, 
affiliate, or separated affiliate to provide electronic publishing 
services, if the Bell operating company or affiliate has not more than 
a 50 percent direct or indirect equity interest (or the equivalent 
thereof) or the right to more than 50 percent of the gross revenues 
under a revenue sharing arrangement or royalty agreement in any 
electronic publishing joint venture.'' Under Section 274(c)(2)(C), 
``[o]fficers and employees of a Bell operating company or affiliate 
participating in an electronic publishing joint venture may not have 
more than 50 percent of the voting control over the electronic 
publishing joint venture.'' ``In the case of joint ventures with small, 
local electronic publishers, the Commission for good cause shown may 
authorize the Bell operating company or affiliate to have a larger 
equity interest, revenue share, or voting control but not to exceed 80 
percent.'' A BOC participating in an electronic publishing joint 
venture ``may provide promotion, marketing, sales, or advertising 
personnel and services to such joint venture.''
    104. Section 274(d) requires a ``Bell operating company under 
common ownership or control with a separated affiliate or electronic 
publishing joint * * * [to] provide network access and interconnections 
for basic telephone service to electronic publishers at just and 
reasonable rates that are tariffed (so long as rates for such services 
are subject to regulation).'' Those rates cannot be ``higher on a per-
unit basis than those charges for such services to any other electronic 
publisher or any separated affiliate engaged in electronic 
publishing.''
a. Comparison of Sections 274 and 272
    105. The language of Section 274's structural and transactional

[[Page 40177]]

requirements differs from the structural and transactional requirements 
of Section 272. We invite comment on whether the distinction between a 
``separated affiliate'' under Section 274 and a ``separate affiliate'' 
under Section 272 requires or permits different accounting treatment 
for affiliate transactions pursuant to Sections 272 and 274. 
Specifically, we seek comment whether we should apply our affiliate 
transactions rules, as we propose to modify them, to transactions 
between a BOC and its electronic publishing joint venture or 
``separated affiliate.'' We seek comment on whether application of 
these rules would provide adequate accounting safeguards for the joint 
activities permitted under Section 274(c)(2). Because Section 274 
allows a BOC to provide electronic publishing through either a 
``separated affiliate'' or a joint venture, we also seek comment on 
whether we should distinguish, for Title II accounting purposes, 
between transactions involving a BOC and its ``separated affiliate'' 
and those involving a BOC and its electronic publishing joint venture.
b. Audit Requirements
    106. Section 274(b)(8) requires electronic publishing ``separated 
affiliates'' or joint ventures and the BOC with which they are 
affiliated to have performed an annual compliance review ``conducted by 
an independent entity for the purpose of determining compliance during 
the preceding calendar year with any provision of [Section 274].'' The 
results of such a review must be maintained by the ``separated 
affiliate'' or the joint venture for a five-year period. We seek 
comment regarding how such compliance reviews should be conducted. We 
ask commenters to address specifically what matters the annual 
compliance review should encompass. We propose to require the 
independent entity to prepare and file with the Commission reports 
describing: (1) the scope of its compliance review, with a description 
of how the affiliate's or joint venture's books were examined and the 
extent of the examination; (2) the independent entity's conclusion 
whether examination of the books has revealed compliance or non-
compliance with the affiliate transactions rules and any other non-
discrimination requirements imposed by Commission rules; (3) any 
limitations imposed on the independent entity in the course of its 
review by the affiliate or joint venture or other circumstances that 
might affect the entity's opinion; and (4) statements by the 
independent entity as to whether the carrier's accounting and affiliate 
transactions methodologies conform to the Communications Act of 1934, 
as amended, and the Commission's rules and whether the carrier has 
accurately applied the methodologies. We seek comment on the necessity 
or desirability of this approach.
    107. Section 274(b)(9) states a separated affiliate or joint 
venture and the BOC with which it is affiliated shall ``within 90 days 
of receiving a review described in [Section 274(b)(8)], file a report 
of any exceptions and corrective action with the Commission and allow 
any person to inspect and copy such review subject to reasonable 
safeguards to protect any proprietary information contained in such 
report from being used for purposes other than to enforce or pursue 
remedies under [Section 274].'' We seek comment regarding what 
``reasonable safeguards'' may be necessary to protect proprietary 
information in the compliance review report ``from being used for 
purposes other than to enforce or pursue remedies under [Section 
274].''
c. Section 274(f)'s Reporting Requirement
    108. Section 274(f) requires ``[a]ny separated affiliate under 
[Section 274 to] file with the Commission annual reports in a form 
substantially equivalent to the Form 10-K required by regulations of 
the Securities and Exchange Commission.'' The Form 10-K contains a 
description of the company filing the report and its operations, 
financial statements with supporting financial data, and major legal 
and financial disclosures concerning the company. We tentatively 
conclude that, to minimize burdens on the filing companies, we should 
require the separated affiliate to file the Form 10-K with us as well 
as the Securities and Exchange Commission. We recognize, however, that 
not all separated affiliates providing electronic publishing services 
would be subject to the Security and Exchange Commission's Form 10-K 
requirement. With regard to these separated affiliates, we seek comment 
on what ``substantially equivalent to the Form 10-K'' means under 
Section 274(f).
d. Section 274 Transactional Requirements
    109. Section 274(b)(1) requires the ``separated affiliate'' or 
joint venture to ``maintain books, records, and accounts and prepare 
separate financial statements.'' We invite comment on the steps we 
should take to implement this provision. We ask the commenters to 
address whether it is necessary for the Commission to adopt any 
additional accounting, bookkeeping, or record keeping requirements for 
these affiliates and joint ventures, and, if so, what those additional 
requirements should be.
    110. Under Section 274(b), the ``separated affiliate'' or joint 
venture ``shall be operated independently from the [BOC].'' The 
``separated affiliate'' or joint venture and the BOC with which it is 
affiliated must ``carry out transactions (i) in a manner consistent 
with such independence, (ii) pursuant to written contracts or tariffs 
that are filed with the Commission and made publicly available, and 
(iii) in a manner that is auditable in accordance with generally 
accepted auditing standards.'' We seek comment on the meaning of ``in a 
manner consistent with such independence.'' We also seek comment as to 
whether any regulations are necessary to implement Sections 274 
(b)(3)(A) and (b)(3)(B).
    111. We further seek comment on whether and, if so, how we should 
amend our rules to implement the requirement that transactions under 
Section 274(b)(3)(C) be ``auditable in accordance with generally 
accepted auditing standards.'' Generally accepted auditing standards 
refer to standards and guidelines promulgated by the American Institute 
of Certified Public Accountants that an independent auditor must follow 
when preparing for and conducting an audit of a company's financial 
statements. These standards generally require that the auditor review a 
company's internal controls and determine whether adequate 
documentation exists to verify that the company has recorded 
transactions on its books in a manner consistent with generally 
accepted accounting principles.
    112. According to Section 274(b)(4), the ``separated affiliate'' or 
joint venture must also ``value any assets that are transferred 
directly or indirectly from the [BOC] to a separated affiliate or joint 
venture, and record any transactions by which such assets are 
transferred, in accordance with such regulations as may be prescribed 
by the Commission or a State commission to prevent improper cross-
subsidies.'' We have proposed in this Notice to conform our valuation 
methods under the affiliate transactions rules for the provision of 
services to those governing asset transfers. Regardless of how we 
resolve that issue, because Section 274 specifically addresses asset 
transfers between a BOC and its ``separated affiliate'' or joint 
venture, we seek comment on whether in this case we should distinguish 
between the asset transfers and the provision of services in

[[Page 40178]]

the context of electronic publishing affiliate transactions.
e. Scope of Commission's Authority
    113. Although electronic publishing is specifically included within 
the definition of information service in Section 3(20), it is 
specifically exempted from the separate affiliate and nondiscrimination 
requirements of Section 272. Section 274,which applies only to BOCs, 
requires the use of a ``separated affiliate'' or ``electronic 
publishing joint venture'' in order for a BOC to engage in the 
provision of electronic publishing services via basic telephone 
services.
    114. Section 274 imposes a number of safeguards on the provision by 
BOCs of electronic publishing through a separated affiliate or 
electronic publishing joint venture. Unlike Sections 260 and 275, 
however, Section 274 specifically refers to State commission 
jurisdiction regarding one of these safeguards. Section 274(b)(4) 
provides that a separated affiliate or joint venture and the BOC with 
which it is affiliated shall:

value any assets that are transferred directly or indirectly from 
the Bell operating company to a separated affiliate or joint 
venture, and record any transactions by which such assets are 
transferred, in accordance with such regulations as may be 
prescribed by the Commission or a State commission to prevent 
improper cross subsidies.

This explicit reference to State commission regulations indicates that 
the requirements of this section apply to both interstate and 
intrastate electronic publishing services, and at the same time 
suggests that the Commission may not have exclusive jurisdiction over 
all aspects of intrastate services pursuant to Section 274. In light of 
this subsection, we seek comment on the extent of our authority, if 
any, under Section 274 over intrastate electronic publishing services.
    115. Section 274(e) also provides that any person claiming a 
violation of this section may file a complaint with the Commission, or 
may bring suit pursuant to Section 207. It also provides that an 
application for a cease and desist order may be made to the Commission, 
or in any district court. No reference is made to complaints being 
filed with State commissions. We seek comment on the extent to which 
the Commission has jurisdiction under Section 274 over intrastate 
electronic publishing, particularly in light of the specific provisions 
of Sections 274(b)(4) and 274(e). We ask that commenters clearly 
identify whether specific subsections of Section 274 confer intrastate 
authority with respect to accounting matters addressed by Section 274 
on the Commission.
    116. To ensure a complete record, we also seek comment on whether, 
apart from any intrastate jurisdiction conferred by Section 274 itself, 
we have authority to preempt State regulation with respect to the 
accounting matters addressed by Section 260 pursuant to Louisiana PSC 
and, if so, whether we should exercise that authority. We tentatively 
conclude that if Section 274 does not apply to intrastate services and 
if we have authority to preempt pursuant to Louisiana PSC, we should 
refrain from exercising it in this area and instead retain our prior 
policy of not preempting States from using their own cost allocation 
procedures for intrastate purposes. We invite comment on this tentative 
conclusion. We also invite comment on what role states might have in 
implementing Section 274's accounting safeguards provisions, given the 
above analysis. We ask commenters to address whether in enacting 
Section 274, Congress intended to foreclose the states from departing 
from the federal cost allocation procedures for electronic publishing 
in their regulation of ``charges . . . for or in connection with 
intrastate communications service[s].'' We also ask the commenters also 
to address whether preemption in this area would be necessary to 
achieve the intent behind Section 274 or whether less intrusive 
measures would be sufficient.
f. Miscellaneous
    117. Section 274(d) also requires a ``Bell operating company under 
common ownership or control with a separated affiliate or electronic 
publishing joint venture . . . [to] provide network access and 
interconnections for basic telephone service to electronic publishers 
at just and reasonable rates that are tariffed (so long as rates for 
such services are subject to regulation) and that are not higher on a 
per-unit basis than those charges for such services to any other 
electronic publisher or any separated affiliate engaged in electronic 
publishing.'' We tentatively conclude that we should apply our 
affiliate transactions rules, as we propose to modify them, to the 
provision of ``network access and interconnections for basic telephone 
service'' by a BOC under common ownership or control to ensure 
compliance with Section 274(d). We seek comment on this tentative 
conclusion.
4. Separated Operations Under Sections 260, 271, 275 and 276
    118. While Sections 260, 271, 275 and 276 of the 1996 Act define 
categories of services that BOCs and, in some cases, incumbent local 
exchange carriers may not necessarily have to offer through a separate 
affiliate, a BOC or other incumbent local exchange carrier might, even 
if not required to do so, choose to perform these activities through an 
affiliate. We note that these sections do not explicitly impose 
regulatory requirements for transactions between a regulated company 
and its nonregulated affiliate. Sections 260, 275 and 276 bar the 
subsidization of the competitive businesses permitted under those 
sections by subscribers of either exchange access services. Section 
260(a)(1) states that ``[a]ny local exchange carrier subject to the 
requirements of section 251(c) . . . shall not subsidize its 
telemessaging service directly or indirectly from its telephone 
exchange service or its exchange access.'' Section 275(b)(2) prohibits 
the subsidization of alarm monitoring services ``either directly or 
indirectly from telephone exchange service operations.'' Section 
276(a)(1) bars any BOC that provides payphone service from 
``subsidiz[ing] its payphone service directly or indirectly from its 
telephone exchange service operations or its exchange access 
operations.'' We believe that application of our affiliate transactions 
rules, as we propose to modify them, to transactions between an 
incumbent local exchange carrier and any of its affiliates engaged in 
activities that Sections 260, 275 and 276 of the 1996 Act might permit 
or require the carrier to offer through a separate affiliate would be 
consistent with these statutory mandates. We therefore seek comment on 
whether we should apply the affiliate transactions rules, with the 
proposed modifications, to transactions between an incumbent local 
exchange carrier and any of its affiliates engaged in activities that 
Sections 260, 275 and 276 might permit or require the carrier to offer 
through a separate affiliate. It is important to note, that we 
tentatively conclude in a companion item, BOC In-Region NPRM, that 
telemessaging, as defined in Section 260, is an information service. 
BOC provision of telemessaging on an interLATA basis would therefore be 
subject to the separate affiliate and other requirements of Section 
272.
    119. We also ask commenters to identify any interLATA 
telecommunications services, other than the interLATA 
telecommunications services that Section 272 requires BOCs

[[Page 40179]]

to provide through a separate affiliate, that the BOCs may choose to 
provide on a separated basis and for which we should develop 
appropriate affiliate transactions rules. In the case of such services, 
the 1996 Act does not explicitly impose or require specific regulatory 
safeguards to prevent subsidies. All of these interLATA 
telecommunications services would currently be considered regulated 
services for Title II accounting purposes, and, absent a Commission 
requirement to the contrary, the affiliates that offer these services 
would therefore classify them as regulated for Title II accounting 
purposes. Our existing affiliate transactions rules are solely designed 
to govern transactions between regulated carriers and their 
nonregulated affiliates. Because interLATA telecommunications services 
present a potential for improper subsidization, we tentatively conclude 
that we should apply our affiliate transactions rules to transactions 
between each BOC and any interLATA telecommunications services 
affiliate it establishes. We invite comment on this tentative 
conclusion. We also invite comment on whether and how we should adapt 
our affiliate transactions rules if applied to such transactions and, 
in particular, whether we should adopt special valuation methodologies 
for these transactions to recognize the regulated status of the 
affiliates on both sides of the transactions.

IV. Other Matters

A. Price Caps

1. General
    120. Our existing Part 64 cost allocation rules were developed when 
all local exchange carriers were subject to cost-based, rate-of-return 
regulation. Today, we rely upon price cap, rather than rate-of-return, 
regulation to ensure that rates for the interstate services of the 
largest incumbent local exchange carriers, including the BOCs, are 
reasonable. Many States also have moved away from the traditional rate-
of-return regulation by establishing temporary rate freezes or other 
price cap-like plans. Several State plans that were implemented before 
the Commission adopted price caps helped to guide us in developing the 
federal plan. Under the Commission's plan, price cap indices limit the 
prices that incumbent local exchange carriers may charge for their 
regulated interstate services. The indices are adjusted each year in 
accordance with a formula that accounts for changes in inflation and 
industry-wide changes in productivity.
    121. The rules we adopt to prevent the subsidies prohibited by 
Sections 260 and 271 through 276 of the 1996 will shaped by our price 
cap regulations. A ``pure'' price cap system would permanently 
eliminate sharing, claims for exogenous treatment, and the need for the 
Commission to consider adjustments to productivity factors. Under pure 
price cap regulation, there would be few incentives to subsidize 
nonregulated services with revenues from regulated telecommunications 
services and the need for accounting safeguards to ensure against 
subsidies would be greatly diminished, unless, of course, there are 
other ways in which the carrier's entitlement to any revenues is 
dependent upon the costs the carrier classifies as regulated.
2. Exogenous Costs and Part 64
    122. Under our price cap rules for incumbent local exchange 
carriers, most changes in a carrier's costs of providing regulated 
services are treated as ``endogenous,'' which means they do not result 
in adjustments to the carrier's price cap indices. Certain cost 
changes, however, triggered by administrative, legislative, or judicial 
action that are beyond the control of the carriers may result in 
adjustments to those indices. The Commission concluded that failing to 
recognize these cost changes by adjusting price cap indices would 
either unjustly punish or reward the carrier. Price cap carriers may 
claim adjustments to their indices based on costs that are beyond the 
carriers' control if they are not otherwise accounted for in the price 
cap formula. Such costs are defined as ``exogenous.'' Accordingly, the 
Commission has found that those types of cost changes should be treated 
``exogenously'' to ensure that price cap regulation does not lead to 
unreasonably high or unreasonably low rates.
    123. Our price cap rules for incumbent local exchange carriers 
specify that ``[s]ubject to further order of the Commission, those 
exogenous cost changes shall include cost changes caused by * * * [t]he 
reallocation of investment from regulated to nonregulated activities 
pursuant to [Section 64.901 of the Commission's rules].'' Under a 
strict reading of this rule, cost reallocations due to changes in the 
Part 64 cost allocation process would result in exogenous treatment 
only to the extent amounts are reallocated ``from regulated to 
nonregulated activities.'' We seek comment on this interpretation and 
whether all such reallocations to nonregulated activities that may 
result from the provision of telemessaging service should trigger an 
adjustment to lower price cap indices. We also seek comment on the 
potential exogenous treatment of new investment in network plant, some 
of which will be used for telemessaging service. As noted above, this 
investment may later require reallocation under part 64 if the 
proportion of regulated usage to nonregulatred usage changes over time.
3. Part 64 and Sharing
    124. Under our price cap rules, incumbent local exchange carriers 
can select the productivity factor they will use to determine annual 
adjustments to their price cap indices. If they choose not to select 
the highest productivity factor permitted under our rules, they are 
required to ``share.'' Under sharing, incumbent local exchange carriers 
earning in excess of prescribed earnings levels must refund a portion 
of the excess earnings in subsequent rate periods by reducing their 
price cap indices. Those earnings are equal to the incumbent local 
exchange carrier's interstate revenues less the regulated interstate 
costs. Improper cost allocation can increase the incumbent local 
exchange carrier's regulated interstate costs and, therefore, can 
reduce the carrier's sharing obligations. We note, however, that in 
their most recent annual tariff filings all but four price cap local 
exchange carriers elected the highest interim productivity factor we 
had prescribed,which exempts them from sharing obligations for the 
1995-96 access year. We seek comment on whether our eliminating sharing 
obligations permanently for price cap carriers would eliminate the need 
for Part 64 processes in our regulation of these companies. We also 
seek comment on how the relationship of our cost allocation rules to 
price cap local exchange carriers should influence the outcome of this 
proceeding.

B. Section 254(k)

    125. Section 254(k) prohibits a telecommunications carrier from 
``us[ing] services that are not competitive to subsidize services that 
are subject to competition.'' Section 254(k) further states that 
``[t]he Commission, with respect to interstate services, and the 
States, with respect to intrastate services, shall establish any 
necessary cost allocation rules, accounting safeguards, and guidelines 
to ensure that services included in the definition of universal service 
bear no more than a reasonable share of the joint and common costs of 
facilities used to provide those services.'' We seek comment on whether 
our proposals related to Sections 260 and 271 through

[[Page 40180]]

276 of the 1996 Act are sufficient to implement Section 254(k)'s 
requirements that carriers not ``use services that are not competitive 
to subsidize services that are subject to competition'' and that the 
Commission, ``with respect to interstate services,'' establish rules 
necessary to ensure that regulated universal services ``bear no more 
than a reasonable share of the joint and common costs of facilities 
used to provide those services.''

V. Procedural Issues

A. Ex Parte Presentations

    126. This is a non-restricted notice-and-comment rulemaking 
proceeding. Ex parte presentations are permitted, except during the 
Sunshine Agenda period, provided that they are disclosed as provided in 
the Commission's rules.

B. Regulatory Flexibility Analysis

    127. Section 603 of the Regulatory Flexibility Act, as amended, 
requires an initial regulatory flexibility analysis in notice and 
comment rulemaking proceedings, unless we certify that ``the rule will 
not, if promulgated, have a significant economic impact on a 
significant number of small entities.'' The Regulatory Flexibility Act 
generally defines the term ``small entity'' as having the same meaning 
as ``small-business concern'' under the Small Business Act, which 
defines ``small-business concern'' as ``one which is independently 
owned and operated and which is not dominant in its field of operation 
* * *.'' This proceeding pertains to the Bell Operating Companies and 
other incumbent local exchange carriers which, because they are 
dominant in their field of operations, are by definition not small 
entities under the Regulatory Flexibility Act. We therefore certify, 
pursuant to Section 605(b) of the Regulatory Flexibility act, that the 
rules will not, if promulgated, have a significant economic impact on a 
substantial number of small entities. The Secretary shall send a copy 
of this NPRM, including this certification and statement, to the Chief 
Counsel for Advocacy of the Small Business Administration. A copy of 
this certification will also be published in the Federal Register 
notice.

C. Paperwork Reduction Act

    128. This NPRM contains either a proposed or modified information 
collection. The Commission, as part of its continuing effort to reduce 
paperwork burdens, invites the general public and the Office of 
Management and Budget (OMB) to comment on the information collections 
contained in this NPRM, as required by the Paperwork Reduction Act of 
1995, Public Law No. 104-13. Public and agency comments are due on 
August 26, 1996 and reply comments are due on September 10, 1996; OMB 
comments are due September 30, 1996. Comments should address: (a) 
whether the proposed collection of information is necessary for the 
proper performance of the functions of the Commission, including 
whether the information shall have practical utility; (b) the accuracy 
of the Commission's burden estimates; (c) ways to enhance the quality, 
utility, and clarity of the information collected; and (d) ways to 
minimize the burden of the collection of information on the 
respondents, including the use of automated collection techniques or 
other forms of information technology.
    129. Written comments by the public on the proposed or modified 
information collection are due on or before August 26, 1996 and reply 
comments on or before September 10, 1996. Written comments must be 
submitted by the Office of Management and Budget (OMB) on the proposed 
or modified information collections on or before [insert date 60 days 
after publication in the Federal Register.] In addition to filing 
comments with the Secretary, a copy of any comments on the information 
collection contained herein should be submitted to Dorothy Conway, 
Federal Communications Commission, Room 234, 1919 M Street, N.W., 
Washington, DC 20554, or via the Internet to [email protected] and to 
Timothy Fain, OMB Desk Officer, 10236 NEOB, 725 17th Street, N.W., 
Washington, DC 20503 or via the Internet to [email protected].

D. Comment Filing Procedures

    130. Pursuant to applicable procedures set forth Sections 1.415 and 
1.419 of the Commission's rules, 47 CFR Secs. 1.415 and 1.419, 
interested parties may file comments on or before August 26, 1996, and 
reply comments on or before September 10, 1996. To file formally in 
this proceeding, you must file an original and six copies of all 
comments, reply comments, and supporting comments. If you want each 
Commissioner to receive a personal copy of your comments, you must file 
an original and eleven copies. Comments and reply comments should be 
sent to Office of the Secretary, Federal Communications Commission, 
1919 M Street, N.W., Room 222, Washington, D.C. 20554, with a copy to 
Ernestine Creech of the Common Carrier Bureau's Accounting and Audits 
Division, 2000 L Street, N.W., Suite 257, Washington, D.C. 20554. 
Parties should also file one copy of any documents filed in this docket 
with the Commission's copy contractor, International Transcription 
Services, Inc. (``ITS''), 2100 M Street, N.W., Suite 140, Washington, 
D.C. 20037. Interested parties can reach ITS by telephone at (202) 857-
3800. Comments and reply comments will be available for public 
inspection during regular business hours in the FCC Reference Center, 
1919 M Street, N.W., Room 239, Washington, D.C. 20554.
    131. In order to facilitate review of comments and reply comments, 
both by parties and by Commission staff, we require that comments and 
reply comments include a short and concise summary of the substantive 
arguments raised in the pleading. Comments, exclusive of appendices and 
summaries of substantive arguments, shall be no longer than sixty (60) 
pages and reply comments no longer than thirty (30) pages.
    132. Parties are also asked to submit comments and reply comments 
on diskette. Such diskette submissions would be in addition to and not 
a substitute for the formal filing requirements addressed above. 
Parties submitting diskettes should submit them to Ernestine Creech of 
the Common Carrier Bureau's Accounting and Audits Division, 2000 L 
Street, N.W., Suite 257, Washington, D.C. 20554. Such a submission 
should be on a 3.5 inch diskette formatted in a IBM compatible form 
using WordPerfect 5.1 for Windows software. The diskette should be 
submitted in ``read only'' mode. The diskette should be clearly 
labelled with the party's name, proceeding, type of pleading (comment 
or reply comments) and date of submission. The diskette should be 
accompanied by a cover letter.

E. Additional Information

    133. For further information concerning this proceeding, contact 
John V. Giusti or Mark B. Ehrlich, Accounting and Audits Division, 
Common Carrier Bureau at (202) 418-0850.

VI. Ordering Clauses

    134. Accordingly, it is ordered that, pursuant to Sections 260 and 
271-276 of the 1996 Act and Sections 1, 2, 4, 201-205, 215, 218, 220 of 
the Communications Act of 1934, as amended, 47 U.S.C. Secs. 151(a), 
152(b), 154, 201-205, 215, 218, 220, 260 and 271-276, that Notice is 
hereby given of proposed amendments to Parts 32 and

[[Page 40181]]

64 of the Commission's rules, 47 CFR Part 32 and 64, as described in 
this Notice of proposed rulemaking.
    135. It is further ordered that, the Secretary shall send a copy of 
this Notice of proposed rulemaking, including the regulatory 
flexibility certification, to the Chief Counsel for Advocacy of the 
Small Business Administration, in accordance with Section 603(a) of the 
Regulatory Flexibility Act, 5 U.S.C. Secs. 601 et seq. (1981).

List of Subjects

47 CFR Part 32

    Transactions with affiliates, Regulated accounts.

47 CFR Part 64

    Allocation of costs, transactions with affiliates, cost allocation 
manuals, Independent audits.

Federal Communications Commission
William F. Caton,
Acting Secretary.
[FR Doc. 96-19563 Filed 7-31-96; 8:45 am]
BILLING CODE 6712-01-M