[Federal Register Volume 62, Number 128 (Thursday, July 3, 1997)]
[Rules and Regulations]
[Pages 35974-36018]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17407]


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FEDERAL COMMUNICATIONS COMMISSION

47 CFR Part 64

[CC Docket No. 96-149; FCC 97-142]


Regulatory Treatment of LEC Provision of Interexchange Services 
Originating in the LEC's Local Exchange Area

AGENCY: Federal Communications Commission.

ACTION: Final rule.

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SUMMARY: The Second Report and Order in CC Docket No. 96-149 and Third 
Report and Order in CC Docket No. 96-61 (Order) addresses issues 
concerning market definition, the regulatory treatment of Bell 
Operating Companies' (BOCs) and independent local exchange carriers' 
(LECs) provision of in-region long distance and international services, 
and separation requirements for the BOCs' and independent LECs' 
provision of out-of-region long distance services. This action taken by 
the Commission will further the pro-competitive, deregulatory 
objectives of the Telecommunications Act of 1996 (1996 Act) by 
eliminating unnecessary regulation that is currently imposed on BOCs 
and, in certain circumstances, on independent LECs.

EFFECTIVE DATE: This final rule, which contains information collection 
requirements, shall become effective September 11, 1997, following OMB 
approval, unless FCC publishes a timely document in the Federal 
Register changing the effective date of the rule.

FOR FURTHER INFORMATION CONTACT: Katherine Schroder, Attorney, Policy 
and Program Planning Division, Common Carrier Bureau, (202) 418-1580. 
For additional information concerning the information collections 
contained in this Order contact Dorothy Conway at (202) 418-0217, or 
via the Internet at [email protected].

SUPPLEMENTARY INFORMATION: This is a summary of the Commission's Order 
adopted April 17, 1997, and released April 18, 1997, as modified by 
Regulatory Treatment of LEC Provision of Interexchange Services 
Originating in the LEC's Local Exchange Area; Policy and Rules 
Concerning the Interstate, Interexchange Marketplace, CC Docket Nos. 
96-149, 96-61, Order on Reconsideration, FCC 97-229 (released June 26, 
1997) (Reconsideration Order).
    In the Reconsideration Order, the Commission makes the following 
minor modifications to the Order to clarify language and make minor 
corrections: (1) The Commission makes minor modifications to paragraphs 
173 and

[[Page 35975]]

188 of the Order to correct and clarify the meaning of these 
paragraphs; (2) the Commission amends 47 CFR 64.1903(c) adopted in the 
Order so that it is consistent with the text of the Order; (3) the 
Commission amends paragraph 226 of the Final Regulatory Analysis in the 
Order to be consistent with the changes made to paragraph 173; (4) the 
Commission extends the effective date of the Order in the ordering 
clauses to comply with the requirements of the Paperwork Reduction Act 
of 1995, Public Law 104-13, 109 Stat. 163 (1995); (5) in the ordering 
clauses and rules, the Commission redesignates subpart Q to subpart T 
in part 64 of title 47 of the Code of Federal Regulations; and (6) the 
Commission modifies the rules published in Appendix B of the Order to 
correct minor typographical and numbering errors.
    The full text of the Order (as released on April 18, 1997) and the 
Reconsideration Order is available for inspection and copying during 
normal business hours in the FCC Reference Center, 1919 M St., N.W., 
Room 239, Washington, D.C. The complete text of the Order (as released 
on April 18, 1997) may also be obtained through the World Wide Web at 
http://www.fcc.gov/Bureaus/Common Carrier/Orders/fcc97-142.wp, and the 
complete text of the Reconsideration Order may be obtained through the 
World Wide Web at http://www.fcc.gov/Bureaus/Common Carrier/Orders/
fcc97-229.wp. The complete text of the Order (as released on April 18, 
1997) and the Reconsideration Order may also be purchased from the 
Commission's copy contractor, International Transcription Service, 
Inc., (202) 857-3800, 2100 M St., N.W., Suite 140, Washington, D.C. 
20037.
    This Order contains new 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 Commission inadvertently omitted specifically 
including the collections and their burdens in the PRA portion of the 
notice of proposed rulemaking in CC Docket No. 96-149 (61 FR 39397 
(July 29, 1996)).

Regulatory Flexibility Analysis

    As required by the Regulatory Flexibility Act, this Order contains 
a Final Regulatory Flexibility Analysis which is set forth in Section 
VI. The Commission performed a comprehensive analysis of the Order with 
regard to small entities and small incumbent LECs. This analysis 
includes: (1) A statement of the need for and objectives of this Order 
and the regulations contained within; (2) a summary and analysis of the 
significant issues raised in response to the initial regulatory 
flexibility analysis; (3) description and estimates of the number of 
small entities and small incumbent LECs affected by this Order; (4) 
summary analysis of the projected reporting, recordkeeping, and other 
compliance requirements; and (5) description of the steps taken by the 
Commission to minimize the significant economic impact of this Order on 
small entities and small incumbent LECs, including the significant 
alternatives considered and rejected.
    The regulations adopted in this Order are necessary to implement 
the provisions of the 1996 Act.

Paperwork Reduction Act

    This Order contains new or modified information collection. The 
Commission, as part of its continuing effort to reduce paperwork 
burdens, invites the general public and OMB to comment on the 
information collections contained in this Order, as required by the 
Paperwork Reduction Act of 1995, Public Law 104-12. Written comments by 
the public on the information collections are due August 4, 1997. OMB 
notification of action is due September 2, 1997. Comments should 
address: (a) Whether the new or modified 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: Separate Affiliate Requirement for Independent Local 
Exchange Carrier (LEC) Provision of International, Interexchange 
Services (47 CFR 64.1901-64.1903).
    Form NO.: N/A.
    Type of Review: New collection.
    Respondents: Business or other for-profit.
    Public reporting burden for the collection of information is 
estimated as follows:

------------------------------------------------------------------------
                                                                 Annual 
                                                                  hour  
       Information collection            No. of respondents      burden 
                                             (approx.)             per  
                                                                response
------------------------------------------------------------------------
Maintaining books of account of      Approximately 10.........     6,056
 independent LEC's international,                                       
 interexchange affiliate separate                                       
 from LEC's local exchange and                                          
 other activities                                                       
------------------------------------------------------------------------

    Total annual Burden: 60,560 burden hours for all respondents.
    Estimated Costs Per Respondent: $100,300.
    Needs and Uses: The Commission imposes the recordkeeping collection 
to ensure that independent LECs providing international, interexchange 
services through a separate affiliate are in compliance with the 
Communications Act, as amended, and with Commission policies and 
regulations.

Synopsis of Order

I. Introduction

    1. In February 1996, the ``Telecommunications Act of 1996'' became 
law. Telecommunications Act of 1996, Public Law 104-104, 110 Stat. 56 
(1996 Act), codified at 47 U.S.C. Secs. 151 et seq. (Hereinafter, all 
citations to the 1996 Act will be to the 1996 Act as it is codified in 
the United States Code.) The 1996 Act amended the Communications Act of 
1934 (Communications Act). 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.'' 
In this rulemaking and related proceedings, the Commission is adopting 
policies necessary to achieve the pro-competitive, deregulatory goals 
of the 1996 Act.
    2.Upon enactment, the 1996 Act permitted the Bell Operating 
Companies (BOCs) (for purposes of this proceeding, we adopt the 
definition of the term ``Bell Operating Company'' contained in 47 
U.S.C. Sec. 153(4)) to provide interLATA services that originate 
outside of their regions. See 47 U.S.C. Sec. 271(b)(2). The 
Modification of Final Judgment (MFJ), which ended the government's 
antitrust suit against AT&T, and which resulted in the divestiture of 
the BOCs from AT&T,

[[Page 35976]]

prohibited the BOCs from providing interLATA services. See United 
States v. Western Elec. Co., 552 F. Supp. 131, 214 n.316 (D.D.C. 1982); 
United States v. Western Elec. Co., 552 F. Supp. 131 (D.D.C. 1982), 
aff'd sub nom. Maryland v. United States, 460 U.S. 1001 (1983); see 
also United States v. Western Elec. Co., Civil Action No. 82-0192 
(D.D.C. Apr. 11, 1996) (vacating the MFJ). For purposes of this 
proceeding, we adopt the definition of the term ``in-region state'' 
that is contained in 47 U.S.C. Sec. 271(i)(1). We note that section 
271(j) provides that a BOC's in-region services include 800 service, 
private line service, or their equivalents that terminate in an in-
region state of that BOC and that allow the called party to determine 
the interLATA carrier, even if such services originate out-of-region. 
Id. Sec. 271(j). The 1996 Act defines ``interLATA services'' as 
``telecommunications between a point located in a local access and 
transport area and a point located outside such area.'' 47 U.S.C. 
Sec. 153(21). Under the 1996 Act, a ``local access and transport area'' 
(LATA) is ``a contiguous geographic area (A) established before the 
date of enactment of the (1996 Act) by a (BOC) such that no exchange 
area includes points within more than 1 metropolitan statistical area, 
consolidated metropolitan statistical area, or State, except as 
expressly permitted under the AT&T Consent Decree; or (B) established 
or modified by a (BOC) after such date of enactment and approved by the 
Commission.'' 47 U.S.C. Sec. 153(25). LATAs were created as part of the 
MFJ's ``plan of reorganization.'' United States v. Western Elec. Co., 
569 F. Supp. 1057 (D.D.C. 1983), aff'd sub nom. California v. United 
States, 464 U.S. 1013 (1983). Pursuant to the MFJ, ``all BOC territory 
in the continental United States [was] divided into LATAs, generally 
centering upon a city or other identifiable community of interest.'' 
United States v. Western Elec. Co., 569 F. Supp. 990, 993 (D.D.C. 
1983). On March 25, 1996, the Commission released a Notice of Proposed 
Rulemaking (61 FR 14717 (April 3, 1996) initiating a review of its 
regulation of interstate, domestic, interexchange telecommunications 
services in light of the passage of the 1996 Act and the increasing 
competition in the interexchange market over the past decade. Among 
other things, the Commission asked whether it should modify or 
eliminate the separation requirements imposed on independent local 
exchange carriers (LECs) (exchange telephone companies other than the 
BOCs) as a condition for non-dominant treatment of their interstate, 
domestic, interexchange services originating outside their local 
exchange areas. We use the term ``independent LECs'' to refer to both 
the independent LECs and their affiliates. The Commission also sought 
comment on whether, if it modifies or eliminates these separation 
requirements for independent LECs, it should apply the same 
requirements to BOC provision of out-of-region interstate, domestic, 
interexchange services. In a recent order addressing BOC provision of 
interLATA services originating out-of-region, we considered whether, on 
an interim basis, BOC provision of out-of-region services should remain 
subject to dominant carrier regulation. See Bell Operating Company 
Provision of Out-of-Region Interstate, Interexchange Services, (61 FR 
35964 (July 9, 1996)) (Interim BOC Out-of-Region Order) recon. pending. 
We concluded, inter alia, that, on an interim basis, if a BOC provides 
out-of-region domestic, interstate, interexchange services offered 
through an affiliate that satisfies the separation requirements imposed 
on independent LECs in the Competitive Carrier Fifth Report and Order 
(49 FR 34824 (September 4, 1984)), we would remove dominant carrier 
regulation for such services. Id. at para. 2.
    Thus, we currently apply the same regulatory treatment to the BOCs' 
provision of out-of-region, domestic, interstate, interexchange 
services as we apply to the independent LECs' provision of those 
services. The Commission also proposed to revise the relevant product 
and geographic market definitions for purposes of determining whether a 
carrier should be regulated as dominant or non-dominant in the 
provision of interstate, domestic, interexchange services. 
Interexchange NPRM at Paras. 41-42. In the Interexchange NPRM, the 
Commission also raised issues relating to: implementation of the rate 
averaging and rate integration requirements in section 254(g) of the 
Communications Act; detariffing for domestic services of non-dominant 
interexchange carriers; and the current prohibition against bundling 
customer services equipment with the provision of interstate, 
interexchange services by non-dominant interexchange carriers. On 
August 7, 1996, we issued a Report and Order implementing the rate 
averaging and rate integration requirements. See Policy and Rules 
Concerning the Interstate, Interexchange Marketplace; Implementation of 
Section 254(g) of the Communications Act of 1934, as amended (61 FR 
42558 (August 16, 1996)) (Rate Integration Order). On October 31, 1996, 
we issued a Second Report and Order which eliminates Sec. 203 tariff 
filing requirements for interstate, domestic, interexchange services by 
nondominant interexchange carriers and orders all nondominant 
interexchange carriers to cancel their tariffs for those services 
within nine months from the effective date of the Order. Policy and 
Rules Concerning the Interstate, Interexchange Marketplace; 
Implementation of Section 254(g) of the Communications Act of 1934 (61 
FR 59340 (November 22, 1996)) (Tariff Forbearance Order), stayed 
pending judicial review, MCI Telecom. Corp. v. FCC, No. 96-1459 (D.C. 
Cir. Feb. 13, 1997). See also Policy and Rules Concerning the 
Interstate, Interexchange Marketplace: Guidance Concerning 
Implementation as a Result of the Stay Order of the U.S. Court of 
Appeals for the D.C. Circuit, CC Docket No. 96-61, Public Notice, DA 
97-493 (rel. March 6, 1997). In the Tariff Forbearance Order, we stated 
our intent to issue a Further Notice of Proposed Rulemaking that will 
address the continued applicability of the prohibitions against the 
bundling of both CPE and enhanced services with interstate, 
interexchange services by non-dominant interexchange carriers. Id. at 
para. 118.
    3. The 1996 Act conditions the BOCs' entry into in-region, 
interLATA service on their compliance with certain provisions of 
section 271 of the Act. Under section 271, we must determine, among 
other things, whether the BOC has complied with the safeguards imposed 
by section 272 and our rules promulgated thereunder. 47 U.S.C. 
Sec. 271(d)(3)(B). The Commission also must find that the 
interconnection agreements or statements approved by the appropriate 
state commission under section 252 satisfy the competitive checklist 
contained in section 271(c)(2)(B), and that the BOC's entry into the 
in-region interLATA market is ``consistent with the public interest, 
convenience and necessity.'' Id. Secs. 271(d)(3)(A), (d)(3)(C). For 
purposes of section 271, such interconnection agreements must be made 
with a facilities-based competitor that meets specified criteria. Id. 
Sec. 271(c)(1)(A). In acting on a BOC's application for authority to 
provide in-region interLATA services, the Commission must consult with 
the Attorney General and give substantial weight to the Attorney 
General's evaluation of the BOC's application. Id. Sec. 271(d)(2)(A). 
In addition, the Commission must consult with the applicable state 
commission to verify that the BOC complies with the requirements of 
section 271(c). Id. Sec. 271(d)(2)(B). Section 272 requires,

[[Page 35977]]

among other things, that a BOC provide in-region, interLATA service 
through a separate affiliate that meets the requirements of section 
272(b).
    4. On July 18, 1996, we released a Notice of Proposed Rulemaking 
(61 FR 39397 (July 29, 1996)) in which we sought comment on the non-
accounting separate affiliate and nondiscrimination safeguards in 
section 272. We also sought comment on whether we should alter the 
dominant carrier classification that under our current rules would 
apply to in-region, interstate, domestic, interLATA services provided 
by the BOCs' section 272 interLATA affiliates (BOC interLATA 
affiliates). For convenience, we use the term ``BOC interLATA 
affiliates'' to refer to the separate affiliates established by the 
BOCs, in conformance with section 272(a)(1), to provide in-region, 
interLATA services. Although we referred to these affiliates as ``BOC 
affiliates'' in the NPRM, our findings in this Order apply only to 
affiliates established in conformance with section 272(a)(1). Further, 
we sought comment on whether we should modify our existing rules for 
regulating the provision of in-region, interstate, domestic, 
interexchange services by an independent LEC. For purposes of this 
proceeding, we have defined an independent LEC's ``in-region services'' 
as telecommunications services originating in the independent LEC's 
local exchange areas or 800 service, private line service, or their 
equivalents that: (1) Terminate in the independent LEC's local exchange 
areas, and (2) allow the called party to determine the interexchange 
carrier, even if the service originates outside the independent LEC's 
local exchange areas. Id. at para. 4 n.12 Finally, we invited comment 
on whether we should apply the same regulatory treatment to the BOC 
interLATA affiliates' and independent LECs' provision of in-region, 
international services that we apply to their provision of in-region, 
interstate, domestic, interLATA services and in-region, interstate, 
domestic interexchange services, respectively. We recently adopted 
rules to implement the section 272 non-accounting separate affiliate 
and nondiscrimination safeguards. On the same day, we adopted rules to 
implement the accounting safeguards in sections 260 and 271 through 
276.
    5. This Order addresses the market definition and dominant/non-
dominant classification issues raised in the Interexchange NPRM and the 
Non-Accounting Safeguards NPRM. With respect to market definition, we 
adopt the approach proposed in the NPRMs. Specifically, we revise our 
current product and geographic market definitions in accordance with 
the 1992 Merger Guidelines. We conclude that we should define as a 
relevant product market any interstate, domestic, long distance service 
for which there are no close substitutes, or a group of services that 
are close demand substitutes (Demand substitutability identifies all of 
the products or services that consumers view as substitutes for each 
other, in response to changes in price. For example, if, in response to 
a price increase for orange juice, consumers instead purchase apple 
juice, apple juice would be considered a demand substitute for orange 
juice.) for each other, but for which there are no other close demand 
substitutes. In places where we use the term ``long distance 
services,'' we mean interstate, domestic or international, interLATA 
services provided by the BOC interLATA affiliates and interstate, 
domestic or international, interexchange services provided by 
independent LECs, respectively. We define the relevant geographic 
market for interstate, domestic, long distance services as all possible 
routes that allow for a connection from one particular location to 
another particular location (i.e., a point-to-point market). We 
conclude, however, that when a group of point-to-point markets exhibit 
sufficiently similar competitive characteristics (i.e., market 
structure), we can aggregate such markets, rather than examine each 
individual point-to-point market separately. Therefore, if we conclude 
that the conditions for a particular service in any point-to-point 
market are sufficiently representative of the conditions for that 
service in all other domestic point-to-point markets, then we will 
examine aggregate data, rather than data particular to each domestic 
point-to-point market. With respect to the BOC interLATA affiliates and 
independent LECs, however, we conclude that we should analyze point-to-
point markets that originate in-region separately from those point-to-
point markets that originate out-of-region to determine whether the BOC 
affiliates' or independent LECs' market power in local exchange and 
exchange access services results in market power in the interexchange 
market. We note that, in some cases, it may be necessary to focus 
specifically on the termination point because the local exchange 
carrier that serves the end-user customer will necessarily have market 
power with regard to that customer.
    6. We also conclude that a BOC interLATA affiliate should be 
classified as dominant only if we find that it has the ability 
profitably to raise and sustain prices of in-region, interstate, 
domestic, interLATA services significantly above competitive levels by 
restricting its own output. Dominant carriers are subject to more 
stringent regulation than non-dominant carriers, including price cap 
regulation, when specified by Commission order, and tariff filing 
notice periods of 14, 25 or 120 days. See supra para. 12 for more 
detail on the regulatory distinctions between dominant and non-dominant 
interexchange carriers. In light of the requirements established by, 
and pursuant to, sections 271 and 272, together with other existing 
Commission rules, we conclude that the BOCs will not be able to use, or 
leverage, their market power in the local exchange or exchange access 
markets to such an extent that their section 272 interLATA affiliates 
could profitably raise and sustain prices of in-region, interstate, 
domestic, interLATA services significantly above competitive levels by 
restricting the affiliate's own output. We also conclude that 
regulating BOC in-region interLATA affiliates as dominant carriers 
generally would not help to prevent improper allocations of costs, 
discrimination by the BOCs against rivals of their interLATA 
affiliates, or price squeezes by the BOCs or the BOC interLATA 
affiliates. Although certain aspects of dominant carrier regulation may 
address these concerns, we conclude that the burdens they would impose 
on competition, competitors, and the Commission outweigh any potential 
benefits. As a result, we classify the BOC interLATA affiliates as non-
dominant in the provision of in-region, interstate, domestic, interLATA 
services.
    7. We also classify the independent LECs as non-dominant in the 
provision of in-region, interstate, domestic, interexchange services, 
because the independent LECs do not have the ability profitably to 
raise and sustain prices of in-region, interstate, domestic, 
interexchange services above competitive levels by restricting their 
own output of these services. We conclude, however, that the 
independent LECs' control of local exchange and exchange access 
facilities potentially enables them to misallocate costs from their in-
region, interexchange services, discriminate against rivals of their 
interLATA affiliates, and engage in other anticompetitive conduct. We 
therefore require the independent LECs to provide their in-region, 
interstate, domestic, interexchange services through separate 
affiliates that satisfy

[[Page 35978]]

the separation requirements adopted in the Competitive Carrier Fifth 
Report and Order, para. 9 (1984). Nevertheless, we give companies 
providing in-region, interexchange services on an integrated basis one 
year from the date of release of this order to comply with the 
Competitive Carrier Fifth Report and Order separation requirements. See 
infra section II.B.
    8. In addition, we adopt the same regulatory treatment of the BOC 
interLATA affiliates' and independent LECs' provision of in-region, 
international services, as we adopt for their provision of in-region, 
interstate, domestic, interLATA and in-region, interstate, domestic, 
interexchange services, respectively. Accordingly, we will classify 
each BOC interLATA affiliate or independent LEC affiliate as non-
dominant in the provision of in-region, international services, unless 
it (or its parent) is affiliated within the meaning of 
Sec. 63.18(h)(1)(i) of the rules, with a foreign carrier that has the 
ability to discriminate against rivals of its U.S. affiliate through 
control of bottleneck services or facilities in a foreign market. In 
that case, we will apply section 63.10(a) of the rules to determine 
whether to regulate the BOC interLATA affiliate or independent LEC 
affiliate as a dominant carrier in its provision of service between the 
United States and that foreign market. In doing so, we emphasize that 
there is more than one basis for finding a U.S. carrier dominant in the 
provision of international services. The separate issue of whether a 
BOC interLATA affiliate, an independent LEC affiliate, or any other 
U.S. carrier should be regulated as dominant in the provision of 
international services because of the market power of an affiliated 
foreign carrier in a foreign destination market was addressed by the 
Commission last year in the Foreign Carrier Entry Order. Market Entry 
and Regulation of Foreign-affiliated Entities (60 FR 67332 (December 
29, 1995)) (Foreign Carrier Entry Order), recon. pending. See also 
Regulation of International Common Carrier Services (57 FR 57964 
(December 8, 1992)) Paras. 19-24 (1992) (International Services Order). 
The Foreign Carrier Entry Order maintained a separate framework adopted 
in the International Services Order for regulating U.S. international 
carriers (including BOCs or independent LECs ultimately authorized to 
provide in-region international services) as dominant on routes where 
an affiliated foreign carrier has the ability to discriminate in favor 
of its U.S. affiliate through control of bottleneck services or 
facilities in the foreign destination market. No carriers are exempt 
from this policy to the extent they have foreign affiliations. Section 
63.10(a) of the Commission's rules provides that: (1) carriers having 
no affiliation with a foreign carrier in the destination market are 
presumptively non-dominant for that route; (2) carriers affiliated with 
a foreign carrier that is a monopoly in the destination market are 
presumptively dominant for that route; (3) carriers affiliated with a 
foreign carrier that is not a monopoly on that route receive closer 
scrutiny by the Commission; and (4) carriers that serve an affiliated 
destination market solely through the resale of an unaffiliated U.S. 
facilities-based carrier's switched services are presumptively non-
dominant for that route. We will require the independent LECs to 
provide in-region international services through separate affiliates 
that satisfy the Competitive Carrier Fifth Report and Order separation 
requirements, consistent with the requirements we apply to their 
provision of in-region, interstate, domestic, interexchange services. 
In the Non-Accounting Safeguards Order, we concluded that the section 
272 safeguards apply to the BOCs' provision of in-region, international 
services. Non-Accounting Safeguards Order at para. 58.
    9. Finally, we consider whether we should modify or eliminate the 
separation requirements imposed on the BOCs and independent LECs as a 
condition for non-dominant treatment of their provision of out-of-
region interstate, domestic, interexchange services. We conclude that 
those requirements are unnecessary, and we therefore eliminate the 
separation requirements as a condition for non-dominant treatment of 
the BOCs' and independent LECs' provision of out-of-region, interstate, 
domestic, interexchange services.
    10. The actions we take in this proceeding will further the pro-
competitive, deregulatory objectives of the 1996 Act by eliminating 
unnecessary regulation that is currently imposed on interexchange 
carriers affiliated with BOCs and independent LECs. Although we are 
classifying these carriers as non-dominant with respect to their 
provision of in-region and out-of-region long distance services, as 
summarized above, we recognize that, as long as these carriers retain 
market power in providing local exchange and exchange access services, 
they will have some incentive and ability to misallocate costs to local 
exchange and exchange access services, to discriminate against their 
long distance competitors, and to engage in other anticompetitive 
conduct. We conclude, however, that the regulatory structure we adopt 
today will continue the process of enhancing competition in all 
telecommunications markets as envisioned by the 1996 Act.

II. Background

    11. Between 1979 and 1985, the Commission conducted the Competitive 
Carrier proceeding, in which it examined how its regulations should be 
adapted to reflect and promote increasing competition in 
telecommunications markets. In a series of orders, the Commission 
distinguished between two kinds of carriers--those with market power 
(dominant carriers) and those without market power (non-dominant 
carriers). In the Competitive Carrier Fourth Report and Order (48 FR 
52452 (November 18, 1983)), the Commission defined market power 
alternatively as ``the ability to raise prices by restricting output'' 
and as ``the ability to raise and maintain price above the competitive 
level without driving away so many customers as to make the increase 
unprofitable.'' The 1992 Department of Justice/Federal Trade Commission 
Merger Guidelines similarly define market power as ``the ability 
profitably to maintain prices above competitive levels for a 
significant period of time.'' 1992 Merger Guidelines, at 20,570. The 
Commission recognized that, in order to assess whether a carrier 
possesses market power, one must first define the relevant product and 
geographic markets. In the Competitive Carrier proceeding, the 
Commission relaxed its tariff filing and facilities authorization 
requirements for non-dominant carriers and focused its regulatory 
efforts on constraining the ability of dominant carriers to exercise 
market power.
    12. Our rules define a dominant carrier as one that possesses 
market power, and a non-dominant carrier as a carrier not found to be 
dominant (i.e., one that does not possess market power). Under our 
rules, non-dominant carriers are not subject to rate regulation, and 
currently may file tariffs that are presumed lawful on one day's notice 
and without cost support. Tariff Filing Requirements for Nondominant 
Carriers (60 FR 52865 (October 11, 1995)). As previously discussed, we 
adopted mandatory detariffing for nondominant interexchange carriers in 
the Tariff Forbearance Order, but that Order has been stayed pending 
judicial review. See supra n. 8. Non-dominant carriers are also subject 
to streamlined section 214 requirements. In contrast, dominant 
interexchange carriers are subject to price cap regulation, when

[[Page 35979]]

specified by Commission order, and must file tariffs on 14, 45, or 120 
days' notice, with cost support data for above-cap and out-of-band 
tariff filings, and with additional information for new service 
offerings. We note that effective February 1997, a local exchange 
carrier may file with the Commission a new or revised charge, 
classification, regulation, or practice on a streamlined basis. Unless 
the Commission takes action under 47 U.S.C. Sec. 204(a)(1), any charge, 
classification, regulation, or practice shall be deemed lawful and 
shall be effective 7 days (in the case of a rate reduction) or 15 days 
(in the case of a rate increase) after the date on which it is filed 
with the Commission. 47 U.S.C. Sec. 204(a)(3). See also Implementation 
of Section 402(b)(1)(A) of the Telecommunications Act of 1996 (62 FR 
5757 (February 7, 1997)). Dominant domestic carriers must also obtain 
specific prior Commission approval to construct a new line or to 
acquire, lease or operate any line, as well as to discontinue, reduce, 
or impair service. We note that the Commission has simplified this 
process to permit a carrier to file an annual ``blanket'' Section 214 
application for all construction planned for the year. See id. 
Sec. 63.06. Moreover, pursuant to section 402(b)(2)(A) of the 1996 Act, 
the Commission is required to ``permit any common carrier . . . to be 
exempt from the requirements of Section 214 of the 1934 Act for the 
extension of any line.'' We are addressing the implementation of 
section 402(b)(2)(A), including the issue of what constitutes an 
``extension of any line,'' in a separate proceeding. See Implementation 
of Section 402(b)(2)(A) of the Telecommunications Act of 1996 (62 FR 
4965 (February 3, 1997)). Finally, we note that the Commission has 
eliminated prior approval requirements to add, modify, or delete 
circuits on authorized international routes as they apply to U.S. 
international carriers that are regulated as dominant for reasons other 
than having foreign carrier affiliations. In addition, such dominant 
carriers are required to obtain prior Commission approval to 
discontinue, reduce, or impair service on a particular route and notify 
the Commission of the conveyance of international cable capacity. See 
Streamlining the International Section 214 Authorization Process and 
Tariff Requirements (61 FR 15724 (April 9, 1996)), Paras. 50, 77, 80-81 
(Streamlining Order).
    13. In the Competitive Carrier First Report and Order (45 FR 76148 
(November 18, 1980)), the Commission classified LECs and pre-
divestiture AT&T as dominant, with respect to both local exchange and 
interstate long distance services, and therefore subject to the ``full 
panoply'' of then-existing Title II regulation. In light of increasing 
competition in the interstate, domestic, interexchange 
telecommunications market, and evidence that AT&T no longer possessed 
the ability to control price unilaterally, the Commission reclassified 
AT&T as a non-dominant carrier in that market. Motion of AT&T Corp. to 
be Reclassified as a Non-Dominant Carrier, Order, 11 FCC Rcd 3271 
(1996) (AT&T Reclassification Order), recon. pending. In contrast, the 
Commission classified MCI, Sprint, and other ``specialized common 
carriers'' as non-dominant carriers.
    14. In the Competitive Carrier Fourth Report and Order, the 
Commission determined that interexchange carriers affiliated with 
independent LECs would be regulated as non-dominant interexchange 
carriers. In the Competitive Carrier Fifth Report and Order, the 
Commission clarified that an ``affiliate'' of an independent LEC was 
``a carrier that is owned (in whole or in part) or controlled by, or 
under common ownership (in whole or in part) or control with, an 
exchange telephone company.'' The Commission further clarified that, in 
order to qualify for non-dominant treatment, the affiliate providing 
interstate, interexchange services must: (1) Maintain separate books of 
account; (2) not jointly own transmission or switching facilities with 
its affiliated exchange telephone company; and (3) acquire any services 
from its affiliated exchange telephone company at tariffed rates, terms 
and conditions. Competitive Carrier Fifth Report and Order, 98 FCC 2d 
at 1198, para. 9. The Commission noted that ``[a]n affiliate qualifying 
for nondominant treatment is not necessarily structurally separated 
from an exchange telephone company in the sense ordered in the Second 
Computer Inquiry. . . .'' The Commission added that any interstate, 
interexchange services offered directly by an independent LEC (rather 
than through a separate affiliate) or through an affiliate that did not 
satisfy the specified conditions would be subject to dominant carrier 
regulation.
    15. In the Competitive Carrier Fifth Report and Order, the 
Commission also addressed the possible entry of the BOCs into 
interstate, interLATA services in the future:

    The BOCs currently are barred by the [MFJ] from providing 
interLATA services. . . . If this bar is lifted in the future, we 
would regulate the BOCs' interstate, interLATA services as dominant 
until we determined what degree of separation, if any, would be 
necessary for the BOCs or their affiliates to qualify for 
nondominant regulation.

    In this Order, we revisit the question of the appropriate 
regulatory treatment of BOCs and independent LECs in the provision of 
long distance services.

III. Market Definition

A. General Application

1. Background
    16. In order to determine that a particular carrier or group of 
carriers possesses market power, (The 1992 Merger Guidelines define 
market power as ``the ability profitably to maintain prices above 
competitive levels for a significant period of time.'' 1992 Merger 
Guidelines at 20,570-71. ``Sellers with market power also may lessen 
competition on dimensions other than price, such as product quality, 
service, or innovation.'' Id. at 20,571, note 6.) it is first necessary 
to define the relevant product and geographic markets. In the 
Competitive Carrier proceeding, the Commission found, for purposes of 
assessing the market power of interexchange carriers, that: ``(1) 
Interstate, domestic, interexchange telecommunications services 
comprise the relevant product market, and (2) the United States 
(including Alaska, Hawaii, Puerto Rico, U.S. Virgin Islands, and other 
U.S. offshore points) comprises the relevant geographic market for this 
product, with no other relevant submarkets.'' In the Interexchange 
NPRM, the Commission proposed to reexamine and refine the market 
definitions adopted in the Competitive Carrier proceeding. In the Non-
Accounting Safeguards NPRM, the Commission proposed to apply this new 
approach to market definition in assessing the market power of BOC 
interLATA affiliates and independent LECs in their provision of 
interstate, domestic, long distance services.
    17. In the Interexchange NPRM, the Commission asked whether it 
should adopt more sharply focused market definitions than those adopted 
in the Competitive Carrier proceeding to provide us with a more refined 
analytical tool for evaluating market power. To establish a more 
narrowly-focused approach that more accurately reflects the realities 
of the marketplace and is flexible enough to accommodate unique market 
situations, the Commission tentatively concluded that it should follow 
the approach for defining relevant markets contained in the 1992 Merger 
Guidelines. As the Commission noted in the Interexchange NPRM, the 
market definition approach taken in the 1992 Merger Guidelines has been 
recognized increasingly by courts

[[Page 35980]]

and scholars as an important tool in assessing market power.
2. Comments
    18. Several commenters agree with our proposal to reexamine the 
product and geographic market definitions adopted in the Competitive 
Carrier proceeding. Some emphasize that redefining the market would aid 
in determining whether BOC interLATA affiliates and independent LECs 
possess market power with respect to their provision of long distance 
services. Other commenters recognize the more general benefit in 
providing the Commission with a more refined and flexible analytical 
tool to evaluate whether any carrier possesses market power in the long 
distance marketplace.
    19. Although it generally supports a reexamination of the relevant 
market definitions, Sprint argues that it is not readily apparent 
whether more particularized definitions would represent an improvement 
over the broader definitions adopted in the Competitive Carrier 
proceeding. Sprint urges the Commission to continue to use the 
definitions adopted in the Competitive Carrier proceeding and to 
examine the issue, in light of the 1992 Merger Guidelines, on a case-
by-case basis only.
    20. In general, the BOCs oppose the Commission's proposal to 
redefine the product and geographic markets adopted in the Competitive 
Carrier proceeding. They argue that BOC entry into interLATA services 
should not serve as a basis to reconsider the relevant market 
definitions and that it would be unreasonable to isolate portions of 
the national market to analyze the market power of new entrants when a 
single national market has been used to assess the market power of 
incumbent interexchange carriers. BellSouth cautions that any change in 
the market definitions will also require the Commission to reconsider 
previous decisions based on the existing definitions. SBC and U S West 
assert that the fast-changing telecommunications marketplace may render 
modifications in the market definitions quickly obsolete. SBC claims 
that the 1992 Merger Guidelines were never intended to serve as a basis 
for determining whether or how to regulate a market or to establish a 
rationale for disparate regulation of market participants. USTA argues 
that a market definition based only on demand conditions, omitting 
supply factors and competitive conditions, could result in an 
inaccurate finding of significant market power.
    21. Although Ameritech does not disagree with the Commission's 
proposal to use the 1992 Merger Guidelines to define relevant markets, 
it claims that it would be impractical and unnecessary to define each 
and every product and geographic market. If the Commission adopts its 
proposed approach, however, Ameritech asks that the Commission clarify 
that the 1992 Merger Guidelines will be used to assess market power for 
other services, including interstate access services.
    22. AT&T argues that the definitions adopted in the Competitive 
Carrier proceeding are appropriate for determining whether carriers, 
other than those that control the local bottleneck, possess market 
power in interexchange services because supply substitutability and the 
widespread pervasiveness of ubiquitous calling plans demonstrate that 
there is a single, national market for such services. AT&T emphasizes 
that the 1992 Merger Guidelines provide support for the existing market 
definitions, rather than the Commission's proposed new approach, 
because the 1992 Merger Guidelines recognize the importance of supply 
substitutability in defining relevant markets and advocate aggregate 
market descriptions where production substitution among a group of 
products is nearly universal among the firms selling one or more of 
those products, as is the case in the telecommunications industry.
    23. The Department of Justice (DOJ) contends that it is not 
necessary for the Commission to adopt a precise definition of the 
relevant markets involved in the provision of a BOC interLATA 
affiliate's interLATA services and that the Commission should refrain 
from doing so at this time. To the extent the Commission chooses to 
define markets in this proceeding, however, DOJ urges the Commission to 
be mindful of the different objectives of defining markets for purposes 
of regulation and antitrust enforcement. DOJ asserts that, while the 
approach proposed by the Commission in the Interexchange NPRM for 
defining relevant markets is ``not unreasonable,'' changes in the 
telecommunications industry may require the Commission to define 
markets more precisely in the future and that it may be inappropriate 
to address this issue at this time. DOJ Aug. 30, 1996 Reply at 20. 
Although DOJ, like AT&T, believes that the market definition is 
irrelevant in assessing the market power of BOC interLATA affiliates, 
its conclusion is based on its assessment that the BOC interLATA 
affiliates will not be able to exercise, at least in the near term, the 
type of market power targeted by dominant carrier regulation. Id. at 
16-17.
    24. MFS argues that the 1992 Merger Guidelines are too generic to 
apply to the telecommunications industry and should not be used to 
redefine the appropriate product and geographic markets. MFS argues, 
for example, that while the 1992 Merger Guidelines contemplate 
industries in which goods are substitutable, the telecommunications 
services market is made up of services that are not substitutes, but 
rather essential inputs used by competitors. In addition, MFS claims 
that the 1992 Merger Guidelines are not well-suited to highly segmented 
industries, such as the telecommunications industry, which is segmented 
into residential, business, peak, off-peak, local, toll and access 
services. This market segmentation, MFS claims, makes it possible for 
dominant firms to engage in predatory cross-subsidization between 
market segments. MFS further contends that, while the 1992 Merger 
Guidelines focus on geographic factors and pricing issues, measuring 
market power in the telecommunications industry requires consideration 
of such non-pricing issues as physical collocation, interconnection, 
and the allocation of telephone numbers. Finally, MFS argues that the 
focus on demand substitutability in the 1992 Merger Guidelines results 
in an inaccurate measurement of market power in the telecommunications 
industry because the monopolists or near-monopolists that control the 
local exchange and exchange access market may foreclose competition by 
raising the price of an essential facility they provide to competitors 
without also raising the price of the service they sell to end-users.
3. Discussion
    25. We conclude that the 1992 Merger Guidelines provide an 
appropriate analytical framework for defining relevant markets in order 
to assess market power in the interstate, domestic, long distance 
marketplace. We disagree with those commenters that claim that the 1992 
Merger Guidelines are inapplicable in a regulatory setting or are based 
on generalized market concepts that are inapplicable to the 
telecommunications industry. We find that the 1992 Merger Guidelines 
are based on fundamental and widely-applicable economic principles, 
such as principles of demand and supply substitution. Supply 
substitutability identifies all productive capacity that can be used to 
produce a particular good, whether it is currently being used to 
produce that good or to produce some

[[Page 35981]]

other, even unrelated, good. For example, if a factory that is 
producing desks could be converted quickly and inexpensively to the 
production of wheelbarrows, then the owner of that factory should be 
considered a potential producer of wheelbarrows. That does not mean, 
however, that desks and wheelbarrows are in the same relevant product 
market. As previously noted, demand substitutability identifies all of 
the products or services that consumers view as substitutes for each 
other, in response to changes in price. For example, if, in response to 
a price increase for orange juice, consumers instead purchase apple 
juice, apple juice would be considered a demand substitute for orange 
juice. Accordingly, we reject MFS's contention that the 
telecommunications industry is so unique that the 1992 Merger 
Guidelines are inapplicable. MFS's concern that, by relying on the 1992 
Merger Guidelines, the Commission will only consider demand-based 
factors in assessing market power is unfounded. As discussed supra, 
although we will rely on demand substitutability in defining relevant 
markets, market definition is only one component in assessing market 
power. The 1992 Merger Guidelines are intended to guide DOJ and the FTC 
in their analysis of mergers taking place in any industry, not only 
mergers in particular industries.'' These guidelines outline the 
present enforcement policy of the Department of Justice and the Federal 
Trade Commission (the ``Agency'') concerning horizontal acquisitions 
and mergers (``mergers'') subject to section 7 of the Clayton Act, to 
section 1 of the Sherman Act, or to section 5 of the FTC Act.'' 1992 
Merger Guidelines at p. 20,569-3. The economic principles contained in 
the 1992 Merger Guidelines are not limited to an analysis of particular 
types of markets, but rather are broadly drawn to accommodate virtually 
all marketplace characteristics.We note that there is a recognition in 
the 1992 Merger Guidelines that they will be applied to ``a broad range 
of possible factual circumstances.'' 1992 Merger Guidelines at p. 
20,569-3. In fact, DOJ agrees that ``[t]he Commission's market 
definition, like market definition under the antitrust laws, should be 
guided by the basic economic principles that inform competitive 
analysis and market definitions under the DOJ Merger Guidelines.'' We 
acknowledge that, in its comments, DOJ notes that the different 
objectives of regulation and antitrust enforcement may affect the 
application of the market definition in those contexts. We agree and 
realize that the markets defined in a particular antitrust suit may 
reach different results. DOJ does not argue, however, that the 
fundamental concepts and principles espoused in the 1992 Merger 
Guidelines apply only in the merger context.
    26. We conclude that we should revise our product and geographic 
market definitions to follow the approach taken in the 1992 Merger 
Guidelines. Most commenters do not appear to articulate serious 
disagreements with the fundamental economic principles on which we base 
our revised approach to defining the relevant product and geographic 
markets. Rather, they appear to focus their concerns on the impact that 
this new approach may have on specific assessments of market power. We 
believe that our market power analysis, including our approach to 
defining the relevant product and geographic markets, should not be 
formulated by focusing on end-results, but instead should be focused on 
the application of sound economic principles and analysis. As a result, 
we conclude that the product and geographic market definitions defined 
in the Competitive Carrier proceeding should be refined to follow the 
approach taken in the 1992 Merger Guidelines in order to ensure that 
our market power assessments are based on the most accurate, up-to-
date, and generally accepted economic principles relating to market 
analysis. As new carriers enter the long distance marketplace and as 
the telecommunications marketplace changes in the face of increased 
competition, the flexibility inherent in our new approach to defining 
the relevant product and geographic markets enables us to make a more 
accurate measurement of market power than before by accounting for 
unique carrier characteristics that could impact the dynamics of the 
marketplace. For example, potential new entrants to the long distance 
marketplace, such as BOCs, utility companies, and cable companies, 
possess different characteristics that could impact, inter alia, the 
types of services offered in the long distance marketplace and the 
method in which long distance services are priced. For example, many 
new carriers have begun entering the long distance market by targeting 
particular types of customers or by targeting customers in particular 
areas, suggesting that carriers do not view the interstate, domestic, 
long distance market as a single national market or as a single market 
of interchangeable and substitutable services.
    27. In contrast to some commenters, we find that supply 
substitutability (As previously noted, supply substitutability 
identifies all productive capacity that can be used to produce a 
particular good, whether it is currently being used to produce that 
good or to produce some other, even unrelated, good.) should not be 
used to define relevant markets, but rather should be used to determine 
which providers are currently serving, or potentially could be serving, 
a relevant market only after that market has been identified. As the 
1992 Merger Guidelines note, ``[o]nce defined, a relevant market must 
be measured in terms of its participants and concentration. 
Participants include firms currently producing or selling the market's 
products in the market's geographic area. In addition, participants may 
include other firms depending on their likely supply responses to a 
`small but significant and nontransitory' price increase. A firm is 
viewed as a participant if, in response to a `small but significant and 
nontransitory' price increase, it likely would enter rapidly into 
production or sale of a market product in the market's area, without 
incurring significant sunk costs of entry and exit. Firms likely to 
make any of these supply responses are considered to be `uncommitted' 
entrants because their supply response would create new production or 
sale in the relevant market and because that production or sale could 
be quickly terminated without significant loss.'' 1992 Merger 
Guidelines at p. 20,572. We conclude that our market definitions should 
be based solely on demand substitutability considerations. As 
previously noted, demand substitutability identifies all of the 
products or services that consumers view as substitutes for each other, 
in response to changes in price. This conclusion accords with the 1992 
Merger Guidelines, which state that, ``market definition focuses solely 
on demand substitution factors--i.e., possible consumer responses. 
Supply substitution factors--i.e., possible production responses--are 
considered elsewhere in the Guidelines in the identification of firms 
that participate in the relevant market and the analysis of entry.''
    28. Under the 1992 Merger Guidelines, market power is determined by 
delineating both the product and geographic market in which power may 
be exercised and, then, identifying those firms that are current 
suppliers and those firms that are potential suppliers in that 
particular market. Therefore, in determining whether a carrier is able 
to

[[Page 35982]]

exercise market power in the provision of a particular service or group 
of services or within a particular area, we must consider two issues. 
First, in the case of the relevant product market, we must consider 
whether, if all carriers raised the price of a particular service or 
group of services, customers would be able to switch to a substitute 
service offered at a lower price. With respect to the relevant 
geographic market, we must consider whether, if all carriers in a 
specified area raised the price of a particular service or group of 
services, customers would be able to switch to the same service offered 
at a lower price in a different area. Second, with respect to supply 
substitutability, we must consider whether, if a carrier raised the 
price of a particular service or group of services, other carriers, 
currently not offering that service or group of services, would have 
the incentive and the ability to begin provisioning a substitute 
service quickly and easily. For example, if we were assessing the 
market power of a carrier providing long distance service from Miami, 
and determined that another carrier currently providing service in Los 
Angeles would also begin providing service from Miami if the price of 
the service in Miami were to increase, we would consider the impact of 
the Los Angeles carrier's potential entry into Miami in assessing the 
market power of the Miami carrier. This does not mean, however, that 
customers in Miami consider long distance service offered in Los 
Angeles as a substitute for service offered in Miami. Therefore, long 
distance service offered in Miami and long distance service offered in 
Los Angeles would not be considered as services in the same relevant 
geographic market. By following the approach taken in the 1992 Merger 
Guidelines, we will continue to weigh supply substitutability as an 
important factor in assessing market power, but we will not use it as a 
factor in defining the relevant product and geographic markets.
    29. We acknowledge that the approach to defining relevant markets 
that we adopt in this proceeding departs from the approach adopted in 
the Competitive Carrier proceeding and applied in the AT&T 
Reclassification Order. For the reasons discussed herein, we believe 
these more refined definitions are now necessary. To the extent that 
various parties argue that our new approach is contrary to our decision 
in the AT&T Reclassification Order, it is well-established that the 
Commission may change approaches as long as it provides a reasoned 
explanation for doing so. Should any modifications be necessary to 
decisions reached in the AT&T Reclassification Order, they will be 
addressed, as necessary, in further proceedings. We emphasize, however, 
that, because market definition is only one step in assessing market 
power, changes made in the approach to defining relevant markets will 
not necessarily produce different assessments of market power.
    30. We also reject the argument that we should not revise the 
product and geographic market definitions because of the dynamic 
changes taking place in the long distance marketplace. To the contrary, 
we believe that these changes in the long distance marketplace provide 
a compelling reason to modify our approach to defining the relevant 
product and geographic markets. Our new approach to defining relevant 
markets will be consistently applied, yet contain inherent 
flexibilities, so that our assessment of market power will always be 
based on a particular carrier's or group of carriers' unique market 
situation. For example, in recognition that certain carriers may 
control discrete facilities in specific geographic areas, target 
particular types of customers, or provide specialized services, our new 
market definitions allow us to examine the relevant product and 
geographic markets at the level of detail necessary to make a more 
accurate assessment of market power than under the Competitive Carrier 
definitions. We find that the definitions developed in the Competitive 
Carrier proceeding would not provide us with sufficient flexibility to 
account for the impact such unique market situations may have on 
assessing market power because these definitions are too broad to 
analyze markets at the necessary level of detail. At the time the 
Commission defined the relevant product and geographic markets in the 
Competitive Carrier proceeding, telecommunications services were 
provided primarily by a single national carrier. Under such a 
regulatory model, the use of a simplified definition of relevant 
markets did not significantly hinder our analysis of market power. 
Today, in light of the dramatic changes that have been occurring in the 
long distance marketplace, particularly those brought on by the passage 
of the Telecommunications Act of 1996, with many firms competing to 
provide more specialized and regionalized long distance services to 
different types of customers, more detailed market definitions are 
needed to assess market power more accurately and to pinpoint the 
particular markets where that power is or could be exercised.

B. Product Market Definition

1. General Approach to Product Market Definition

a. Background

    31. In the Competitive Carrier proceeding, the Commission defined 
the relevant product market as ``all interstate, domestic, 
interexchange telecommunications services . . . with no relevant 
submarkets.'' In the Interexchange NPRM, we tentatively concluded that 
we should refine our analysis and define as a relevant product market 
any domestic, interstate, interexchange service for which there are no 
close demand substitutes or any group of services that are close 
substitutes for each other but for which there are no other close 
demand substitutes. Recognizing, however, that delineating all relevant 
product markets would be administratively burdensome and that the 
Commission has previously found that there is substantial competition 
with respect to most interstate, domestic, interexchange services, the 
Commission tentatively concluded that we generally should address the 
question of whether a specific domestic, interstate, interexchange 
service, or group of services, constitutes a separate product market 
only where there is credible evidence suggesting that there is or could 
be a lack of competitive performance with respect to a particular 
service or group of services. We asked commenters to evaluate this new 
approach and to suggest any other possible approaches.

b. Comments

    32. Several commenters support the proposed approach to redefining 
the relevant product market. Many commenters agree that the Commission 
should rely on demand substitutability in defining relevant product 
markets. A number of commenters argue, however, that the Commission 
should continue to recognize supply substitutability in defining the 
relevant product market and, therefore, should not modify the relevant 
product market definition adopted in the Competitive Carrier 
proceeding.
    33. GTE concedes that the definition proposed in the Interexchange 
NPRM would provide the Commission with the flexibility to accommodate a 
rapidly-evolving, technology-driven environment and would enable the 
Commission to assess a particular service provider's ability to exert 
market power over new products. GTE claims, however, that the certainty 
of the Commission's standard would diminish

[[Page 35983]]

if different market evaluations were applied to particular carriers or 
groups of carriers absent a relatively strong basis for distinguishing 
them. Although it generally supports the revised approach to defining 
the relevant product market, the Florida Public Service Commission 
warns that logical sets of substitutable services will likely intersect 
with one another, which could render the Commission's approach to 
defining relevant product markets unworkable in practice.
    34. AT&T opposes the approach proposed in the Interexchange NPRM. 
It emphasizes that the 1992 Merger Guidelines support an aggregate 
product market definition where ``production substitution among a group 
of products is nearly universal among the firms selling one or more of 
the products,'' as in the telecommunications industry. AT&T claims 
that, due to pervasive supply substitutability, a product market 
defined by a single service would yield the same market share and 
market power results as the single product market approach adopted in 
the Competitive Carrier proceeding. Because there is no difference 
between the facilities used to provide different services, AT&T argues 
that there is ample capacity for carriers to attract customers from any 
carrier that attempts to exercise market power with respect to a 
particular service. AT&T further claims that the Commission's recent 
analysis of AT&T's 800 directory assistance and analog private line 
offerings provide no basis to abandon the single product market 
definition. AT&T contends that the Commission recognized that AT&T's 
pricing of 800 directory assistance is constrained by supply 
substitutability principles, and that the migration of analog private 
line customers to digital and virtual private line services 
demonstrates that these services are substitutable and, therefore, in 
the same market.
    35. The BOCs generally oppose the product market definition 
proposed in the Interexchange NPRM. BellSouth supports retention of the 
current product market definition on the grounds that there is high 
cross-elasticity of demand among virtually all interexchange services, 
most of which are interchangeable services that are packaged 
differently, and that the distinctions between services can be easily 
erased by entities such as resellers. For example, BellSouth argues 
that, if a sole supplier of any particular interexchange service raised 
its prices by five percent or more, most customers would turn to a 
different service as an alternative. BellSouth disputes the 
Commission's suggestion that market power over discrete fringe services 
may warrant redefinition of the relevant product market. It further 
asserts that delineating relevant product markets would be 
administratively burdensome and might cause carriers without market 
power to be regulated as dominant carriers. BellSouth claims that the 
Commission's proposed approach would be inconsistent with the 
Commission's decision in the AT&T Reclassification Order, in which AT&T 
was classified as nondominant even though it was found to control two 
discrete services in the overall product market. BellSouth also 
contends that the Commission's proposed approach seems to signal a 
return to the ``all-services'' methodology of assessing dominance, 
which was expressly rejected in the AT&T Reclassification Order.
    36. PacTel agrees that the product market definition turns on 
whether there are sufficiently close substitutes for a product or group 
of products. PacTel contends, however, that because services, such as 
MTS, discount plans, WATS, 800 service, foreign exchange service, 
wireless and even ``carrier'' access services, are highly substitutable 
options for consumers to place or receive long distance calls, the 
relevant product market should include all interstate, long distance 
services. USTA questions the Commission's use of a demand-elasticity 
methodology to define the relevant domestic product market, especially 
when the Commission proposes to continue to emphasize supply 
substitutability in defining the international product market. USTA 
asserts that the Commission has consistently and continually recognized 
a single relevant product market, and contends that the Commission 
should not abandon this long-settled definition in favor of numerous, 
fragmented submarkets.
    37. A number of commenters support our proposal in the 
Interexchange NPRM to delineate separate product markets only if there 
is credible evidence demonstrating that there is or could be a lack of 
competitive performance with respect to a particular service or group 
of services. MCI claims that, although some interexchange services may 
have characteristics indicative of discrete product markets, there is 
no lack of competitive performance with respect to a particular service 
or group of services that would warrant the Commission's delineating 
the boundaries of specific product markets. The Pennsylvania Commission 
cautions that state commissions and consumer advocacy groups may not 
have access to the information necessary to determine whether credible 
evidence exists, especially if the Commission detariffs non-dominant 
carriers. Sprint states that the Commission should reexamine various 
product markets if circumstances require.
    38. ACTA suggests that a separate relevant market should be 
established where the Commission finds that a carrier possesses market 
power over a particular market segment. In delineating product markets, 
ACTA believes that the Commission should consider many factors 
including such customer classifications as residential, small/medium 
businesses, and large businesses, but cautions that product markets 
based on discrete offerings may not adequately account for products 
offered as a package of services.
    39. Two commenters identify particular services that, they contend, 
should be classified as separate product markets. The Pennsylvania 
Commission recommends that the Commission define three separate product 
markets: (1) MTS or residential long distance; (2) WATS/800 service; 
and (3) virtual network-type services (all services provided within 
software defined networks). SNET argues that the Commission should 
treat interstate toll free directory assistance as a separate product 
market because there are no substitutes and structural barriers make 
entry impossible.

c. Discussion

    40. We conclude that the product market definition adopted in the 
Competitive Carrier proceeding should be revised to reflect the 1992 
Merger Guidelines' approach to defining relevant markets. The 1992 
Merger Guidelines define the relevant product market as ``a product or 
group of products such that a hypothetical profit maximizing firm that 
was the only present and future seller of those products (`monopolist') 
likely would impose at least a `small but significant and 
nontransitory' increase in price.'' Accordingly, in defining the 
relevant product market, one must examine whether a ``small but 
significant and nontransitory'' increase in the price of the relevant 
product would cause enough buyers to shift their purchases to a second 
product, so as to make the price increase unprofitable. If so, the two 
products should be considered in the same product market. 1992 Merger 
Guidelines at p. 20,572. As explained above, we find that this new 
approach to defining the relevant product market will provide us with a 
more refined and narrowly-focused tool that more accurately reflects 
marketplace realities. We, therefore, adopt our tentative conclusion in 
the Interexchange NPRM

[[Page 35984]]

that we should define as a relevant product market any interstate, 
domestic, long distance service for which there are no close demand 
substitutes, or a group of services that are close substitutes for each 
other, but for which there are no other close demand substitutes. As 
previously noted, demand substitutability identifies all of the 
products or services that consumers view as substitutes for each other, 
in response to changes in price. We also adopt our tentative conclusion 
that we need not delineate the boundaries of specific product markets, 
except where there is credible evidence suggesting that there is or 
could be a lack of competitive performance with respect to a particular 
service or group of services.
    41. Unlike the approach to product market definition adopted in the 
Competitive Carrier proceeding, our new approach will rely exclusively 
on demand considerations to define the relevant product market, rather 
than supply substitutability. As previously noted, supply 
substitutability identifies all productive capacity that can be used to 
produce a particular good, whether it is currently being used to 
produce that good or to produce some other, even unrelated, good. As 
discussed above, supply substitutability will continue to be a relevant 
factor in assessing market power, but will not be used as a factor in 
defining the relevant market. We disagree with USTA that our approach 
to defining the relevant market in the international services market is 
inconsistent with our approach in the domestic context. See discussion 
infra at Paras.  53,80. Although this distinction may be subtle, we 
believe that it is important in order to ensure that each step we take 
in assessing market power is grounded in fundamental economic 
principles and marketplace realities. Our new approach, however, does 
not reflect an ``all-services'' methodology of assessing dominance, in 
which a carrier must be deemed dominant with respect to all services if 
it is found to have market power over any single service. Rather, our 
new approach allows us, where warranted, to focus our analysis on 
particular services and limit our assessment of market power with 
regard to only those particular services.
    42. We further adopt our tentative conclusion that we need not 
delineate any particular product markets to analyze the market power of 
a particular carrier or group of carriers unless there is credible 
evidence suggesting that there is or could be a lack of competitive 
performance with respect to a particular service or group of services. 
For example, if the price/cost ratio for a particular interexchange 
service is four times that of the price/cost ratio for all other 
interexchange services, that may constitute credible evidence of a lack 
of competitive performance. We recognize that the various services 
available in the interstate, domestic, long distance marketplace are 
changing. For example, we noted in the Interexchange NPRM that ``our 
finding (in the AT&T Reclassification Order) that the prices of 800 
directory assistance and analog private line services could profitably 
be raised above competitive levels may imply these services constitute 
distinct relevant product markets.'' Interexchange NPRM, 11 FCC Rcd at 
7166, para. 44. Patterns of consumer demand and the forces of 
competition spur continual innovation and force carriers constantly to 
reevaluate current services, remove outdated services, and add new 
services to the marketplace. In light of these marketplace dynamics, we 
conclude it is best to establish a consistent approach to defining the 
relevant product market that maintains the flexibility to recognize 
separate product markets only when there is credible evidence 
indicating that there is or could be a lack of competitive performance 
with respect to a particular service or group of services.
    43. Despite two commenters' recommendations that we identify for 
all purposes, in this proceeding, particular services as separate 
product markets, we decline to do so at this time. We conclude that 
such a determination should only be made in the context of assessing 
the market power of a particular carrier or group of carriers. In this 
proceeding, we only assess the market power of BOC interLATA affiliates 
and independent LECs. As noted supra at para. 29, any modifications 
that we may make to decisions reached in the AT&T Reclassification 
Order will be addressed, as necessary, in further proceedings. We 
emphasize, however, that because market definition is only one step in 
assessing market power, changes made in the approach to defining 
relevant markets will not necessarily produce different assessments of 
market power. Unless there is credible evidence suggesting that there 
is or could be a lack of competitive performance with respect to a 
particular service or group of services, we will treat these services 
together, by analyzing aggregate data that encompasses all long 
distance services, rather than information particular to specific 
services. Such data may include, but not be limited to, price level of 
services, the number of competitors, the share of sales by competitors, 
and the ease with which potential entrants can provide these services. 
Recognizing that we have previously found that there is substantial 
competition with respect to most interstate, long distance services, 
such an approach allows us to avoid the burdensome task of delineating 
separate product markets when there is no other credible evidence 
suggesting that a particular carrier or group of carriers is exercising 
or has the ability to exercise market power, with respect to a 
particular service or group of services. Therefore, we will refrain 
from examining narrower relevant product markets except when such 
credible evidence has come to our attention. As we conclude infra at 
para. 50, for purposes of assessing the market power of BOC interLATA 
affiliates and independent LECs in their provision of domestic, 
interstate, long distance services, we need not delineate separate 
product markets because there is no credible evidence in the record 
that indicates that there is or will be a lack of competitive 
performance associated with any particular long distance service 
offered by BOC interLATA affiliates or independent LECs.
    44. We conclude that the approach we adopt here will not impose an 
undue burden on parties seeking to have the Commission define narrower 
relevant product markets in order to assess the market power of a 
particular carrier or group of carriers. Such parties will not have to 
prove that there is an actual lack of competitive performance with 
respect to a particular service or group of services. Rather, they must 
only present credible evidence that there is or could be a lack of 
competitive performance. Credible evidence should include information 
sufficient to identify services that are likely substitutes and the 
carrier or group of carriers that allegedly possesses market power. 
Contrary to the concerns of the Pennsylvania Public Utilities 
Commission, because information suggesting a lack of competitive 
performance, such as availability of service from a single provider, is 
easily observable, we need not require data from proprietary sources 
for this purpose. Moreover, as we recognized in the Tariff Forbearance 
Order, even in the absence of tariffs for interstate, domestic, 
interexchange services offered by non-dominant carriers, we conclude 
that information concerning the rates, terms and conditions for such 
services will still be readily accessible to consumers and other 
interested parties because customers will continue to receive this 
information through, inter

[[Page 35985]]

alia, the billing process, notifications required by service contracts 
or state consumer protection laws, and marketing materials, such as 
advertisements.
2. Product Market Definition for BOC InterLATA Affiliates and 
Independent LECs

a. Background

    45. In the Non-Accounting Safeguards NPRM, we tentatively concluded 
that if we adopt the market definition approach proposed in the 
Interexchange NPRM, we should treat all interstate, domestic, long 
distance services as the relevant product market for purposes of 
determining whether BOC interLATA affiliates have market power in their 
provision of in-region domestic, interstate, interLATA services and 
whether independent LECs have market power in their provision of in-
region domestic, interstate, interexchange services.

b. Comments

    46. Although commenters disagree over whether the Commission should 
adopt the approach to the product market definition proposed in the 
Interexchange NPRM, most commenters agree with the Commission's 
tentative conclusion in the Non-Accounting Safeguards NPRM that 
interstate, domestic, long distance services should be treated as a 
single product market for purposes of assessing whether BOC interLATA 
affiliates and independent LECs have market power.
    47. AT&T argues that the interexchange product market definition is 
irrelevant to whether the BOCs could abuse their power in the local 
market to impede interexchange competition. Instead, AT&T contends that 
the proper markets to analyze are the local exchange and exchange 
access service markets, rather than the interexchange market. DOJ also 
argues that the product market definition is irrelevant to whether BOC 
interLATA affiliates could exercise market power in the interLATA 
marketplace because BOC interLATA affiliates clearly do not have the 
ability to raise prices by restricting output.
    48. BellSouth contends that since the Commission did not redefine 
the product market in order to evaluate whether AT&T was a dominant 
carrier, it need not reconsider the definition in order to evaluate the 
competitive effects of BOC entry into the interexchange market. USTA 
and GTE agree with the Commission's tentative conclusion that all 
interstate, domestic, interexchange services should be considered the 
relevant product market for independent LECs.
    49. The Independent Telephone Telecommunications Alliance (ITTA) 
contends that the Commission should adopt a product market defined as 
``all telecommunications services,'' that encompasses such services as 
interexchange, local, access and wireless services, in recognition of 
the new market structure envisioned by the 1996 Act in which firms will 
be providing a broad range of services. The Competitive 
Telecommunications Association (CTA) contends that the relevant product 
market should include those services that rely on or utilize the BOCs' 
local network.

c. Discussion

    50. We are aware of no evidence, nor has any commenter presented 
any such evidence in the record, that suggests that there is a 
particular interexchange service or group of services that will be 
provided by BOC interLATA affiliates or independent LECs with respect 
to which there is or could be a lack of competitive performance. 
Moreover, we have found previously that there is substantial 
competition with respect to most interstate, domestic, interexchange 
service offerings. As a result, we conclude that we need not conduct 
any particularized product market inquiry in order to evaluate the 
market power of BOC interLATA affiliates and independent LECs for 
interexchange services. We conclude that, at this time and for purposes 
of determining whether BOC interLATA affiliates or independent LECs 
have market power in the provision of domestic, interstate, long 
distance services, our assessment of market power will remain the same, 
regardless of whether we examine each individual long distance service, 
different groupings of long distance services, or aggregate data that 
encompasses all long distance services. Therefore, in assessing the 
market power of BOC interLATA affiliates and independent LECs in the 
provision of domestic, interstate, long distance services, we find it 
is appropriate at this time to evaluate their market power with respect 
to all interstate, domestic, long distance services, rather than 
conducting a separate analysis of each individual service.
    51. We disagree with AT&T's assertion that the product market 
definition is irrelevant in assessing whether BOC interLATA affiliates 
or independent LECs possess market power in the domestic, interstate, 
long distance market. As discussed above, we believe that a relevant 
product market must be defined before we can evaluate whether a 
particular carrier or group of carriers possesses market power. While 
we agree with AT&T that other factors are important in making our 
overall assessment of market power, we conclude that we must define the 
relevant product market in order to reach an accurate assessment of 
whether BOC interLATA affiliates or independent LECs possess market 
power in the domestic, interstate, long distance marketplace.
3. International Product Market for BOC InterLATA Affiliates and 
Independent LECs
    52. In the Non-Accounting Safeguards NPRM, we tentatively concluded 
that we should apply the current international product market 
definition, which recognizes international message telephone service 
(IMTS) and non-IMTS as separate product markets, for purposes of 
determining whether BOC interLATA affiliates and independent LECs 
possess market power in the provision of international long distance 
services.
    53. MCI and NYNEX generally agree with the Commission's tentative 
conclusion that IMTS and non-IMTS should be treated as the relevant 
product markets for international services. USTA supports treating 
international services as a product market separate from domestic 
services, because international agreements and regulation create 
different conditions than exist for domestic interexchange services. 
Questioning the wisdom of dividing international services into two 
distinct product markets, Sprint argues that the Commission should 
retain flexibility to reflect the rapid changes taking place in the 
product market for international communications. Sprint asserts, for 
example, that, where providers engage in the resale of international 
private lines interconnected to the public switched network at both 
ends, the distinctions between IMTS and non-IMTS are blurred.
    54. We conclude that, for purposes of determining whether BOC 
interLATA affiliates and independent LECs possess market power in the 
provision of international long distance services, we will modify our 
tentative conclusion and examine aggregate data that encompasses all 
international long distance services. Because our approach to defining 
relevant markets is based on fundamental economic principles, we find 
that it is applicable for assessing market power in both the domestic 
and international long distance markets. Although we recognize that 
international agreements and regulation

[[Page 35986]]

distinguish international long distance service from domestic long 
distance service, we conclude that, while these distinctions may affect 
our assessments of market power, they do not change our approach to 
defining relevant markets. Therefore, we find that we should define the 
relevant product market, in the international context, as any 
international long distance service for which there are no close 
substitutes or a group of services that are close substitutes for each 
other, but for which there are no other close substitutes. We need only 
delineate specific product markets, however, when there is credible 
evidence suggesting that there is or could be a lack of competitive 
performance with respect to a particular service or group of services.
    55. Although traditionally we have recognized IMTS and non-IMTS as 
separate international long distance product markets, we conclude, 
similar to our conclusion in the domestic context, that this 
distinction is not necessary for purposes of assessing whether BOC 
interLATA affiliates and independent LECs possess market power in the 
international long distance marketplace in this Order because our 
assessment of market power will not change whether we examine IMTS and 
non-IMTS separately as individual product markets or analyze aggregate 
data that encompasses both IMTS and non-IMTS. Our decision to analyze 
aggregate data that encompasses IMTS and non-IMTS, in this particular 
context, does not modify our treatment of IMTS and non-IMTS as separate 
product markets under the existing framework for regulating U.S. 
carriers as dominant in the provision of international services because 
of the market power of an affiliated foreign carrier.

C. Geographic Market

1. Geographic Market in General

a. Background

    56. In the Competitive Carrier proceeding, the Commission defined 
the relevant geographic market as ``the United States (including 
Alaska, Hawaii, Puerto Rico, U.S. Virgin Islands, and other U.S. 
offshore points) . . . with no relevant submarkets.'' In the 
Interexchange NPRM, the Commission tentatively concluded that we should 
refine this analysis and define a relevant geographic market for 
interstate, domestic, interexchange services as all calls, in the 
relevant product market, between two particular points. For purposes of 
market power analysis, however, the Commission tentatively concluded 
that, in general, we should treat domestic, interstate, interexchange 
calling as a single, national market because geographic rate averaging, 
in conjunction with the pervasiveness of ubiquitous calling plans, 
should reduce the likelihood that a carrier could exercise market power 
in a single point-to-point market, and because price regulation of 
access services and excess capacity in interstate transport should 
reduce the likelihood that an interexchange carrier could exercise 
market power in most point-to-point markets. If there is credible 
evidence suggesting that there is or could be a lack of competition in 
a particular point-to-point market or group of point-to-point markets 
and there is a showing that geographic rate averaging will not 
sufficiently mitigate the exercise of market power in that market or 
group of markets, we proposed to examine the individual market or group 
of markets for the presence of market power. We asked commenters to 
evaluate this new approach and to suggest any other possible 
approaches.

b. Comments

    57. Many commenters oppose the Commission's proposal to define a 
relevant geographic market for interstate, domestic, interexchange 
services as all calls between two points, although some commenters 
concede its conceptual validity. Those parties opposing the point-to-
point market definition generally advocate the retention of the single 
national market definition adopted in the Competitive Carrier 
proceeding. Several commenters claim that demand patterns based on the 
widespread use of ubiquitous calling plans favor a national market. 
Other commenters indicate that it may be too early to define relevant 
geographic markets with lasting precision and that point-to-point 
markets would not be administrably viable because of the impracticality 
of conducting a market power analysis in each point-to-point market. A 
number of parties support our proposal to treat interstate, 
interexchange calling as a single national market unless there is 
credible evidence suggesting that there is or could be a lack of 
competition in a particular point-to-point or group of point-to-point 
markets, and there is a showing that geographic rate averaging will not 
sufficiently mitigate the exercise of market power.
    58. AT&T disagrees with the Commission's point-to-point market 
analysis and argues that a single national market definition reflects 
the way that competitors have built and conducted their business. AT&T 
also notes that the Commission has rejected point-to-point markets on 
several previous occasions. AT&T, BellSouth, USTA and NYNEX emphasize 
that supply substitutability demonstrates that the market is national 
because several carriers have national networks with capacity to 
provide alternate routing and the ease of constructing new facilities 
or to resell services allows carriers to enter the market and expand 
service rapidly.
    59. Several commenters contend that the geographic rate averaging 
and rate integration requirements in the 1996 Act and the regulatory 
regime overseeing access rates point to the existence of a single, 
national market because together they ensure that the benefits of 
competition in one market will be passed on to customers in other 
markets. Bell Atlantic supports a single national market because, as 
long as customers select a carrier for nationwide coverage, national 
pricing schemes will drive the market, whether or not certain carriers 
offer services originating only in a particular region. PacTel claims 
that the trend toward uniform, distance-insensitive pricing 
demonstrates that the interexchange market remains a national one. USTA 
asserts that if point-to-point markets are appropriate, AT&T should not 
have been classified as a non-dominant interexchange carrier because it 
is the sole carrier serving a number of different cities.
    60. PacTel and GTE submit that a single nationwide geographic 
market is supported by economic theory, Commission precedent, the AT&T 
Reclassification Order, and the 1996 Act. GTE acknowledges, however, 
that certain service providers may be able to take advantage of their 
market power in some point-to-point markets, despite geographic rate 
averaging, regulated access pricing and excess transmission capacity. 
In such situations, GTE recognizes that a narrower geographic market 
may be appropriate to measure market power if there is credible 
evidence of a lack of competition in a particular market. GTE adds 
that, if the Commission does adopt a point-to-point approach, this 
analysis should apply to IXCs as well as LECs.
    61. Ameritech does not oppose the possibility of identifying 
smaller markets than the national market, but claims that it is unable 
to identify any such markets at this time. DOJ acknowledges that the 
relevant geographic market theoretically could be defined as all calls 
between two particular points, but argues that examining markets at 
such a level of detail would be impractical.
    62. LDDS claims that, although, for most purposes, the appropriate 
relevant

[[Page 35987]]

geographic market for interstate, interexchange services is national, 
the division between local and long distance will blur as competition 
develops in the local market and the Commission must be able to employ 
an appropriate geographic market definition to reflect these changes. 
ACTA and GCI oppose the Commission's proposal to treat interstate, 
interexchange services generally as a single national market. According 
to ACTA, such a definition would overlook route-specific pricing 
schemes designed to defeat competitive entry. GCI argues that certain 
obvious characteristics, such as a de facto or de jure monopoly in the 
provision of a service or a shortage of capacity in interstate 
transport, should provide adequate justification for examining a 
particular market for the presence of market power. GCI cites AT&T/
Alascom's facilities monopoly in rural Alaska and the limited fiber 
optic capacity linking Alaska to the continental United States as such 
examples.
    63. A few commenters propose alternative approaches for defining 
relevant geographic markets, including markets based on state 
boundaries or local exchange boundaries and markets based on 
Metropolitan Statistical Areas (MSAs), Basic Trading Areas (BTAs) or 
Major Trading Areas (MTAs). See, e.g., Frontier April 19, 1996 Comments 
at 1-2; PaPUC April 19, 1996 Comments at 10-11; Missouri Public Counsel 
May 3, 1996 Reply at 3. We note that Rand McNally & Company is the 
copyright owner of the Basic Trading and Major Trading Area Listings, 
which list the counties contained in each BTA, as embodied in Rand 
McNally's Trading Area System Diskette and Atlas & Marketing Guide. 
Rand McNally has licensed the use of its copyrighted MTA/BTA listings 
and maps for certain wireless telecommunications services. See 
Amendment of Parts 2 and 90 of the Commission's Rules to Provide for 
the Use of 200 Channels Outside the Designated Filing Areas in the 896-
901 MHz and the 935-940 MHz Bands Allotted to the Specialized Mobile 
Radio Pool (60 FR 21987 (May 4, 1995)). GCI asserts that, because 
market power does not follow any preestablished lines, the Commission 
should conduct a market power analysis for any area for which there is 
a nonfrivolous allegation of market power.

c. Discussion

    64. We conclude that the geographic market definition adopted in 
the Competitive Carrier proceeding should be revised to reflect the 
approach to defining relevant markets contained in the 1992 Merger 
Guidelines. The 1992 Merger Guidelines define the relevant geographic 
market as the ``region such that a hypothetical monopolist that was the 
only present or future producer of the relevant product at locations in 
that region would profitably impose at least a `small but significant 
and nontransitory' increase in price, holding constant the terms of 
sale for all products produced elsewhere.'' Accordingly, in defining 
the relevant geographic market, one must examine whether a ``small but 
significant and nontransitory'' increase in the price of the relevant 
product at a particular location would cause a buyer to shift his 
purchase to a second location, so as to make the price increase 
unprofitable. If so, the two locations should be considered to be in 
the same geographic market. 1992 Merger Guidelines at pp. 20,573-
20,573-3. In accordance with the principles enunciated in the 1992 
Merger Guidelines, we believe that long distance calling, at its most 
fundamental level, involves a customer making a connection from one 
specific location to another specific location. As we stated in the 
Interexchange NPRM, ``[w]e believe that most telephone customers do not 
view interexchange calls originating in different locations to be close 
substitutes for each other.'' Therefore, we further conclude that we 
will follow the revised approach to the geographic market definition 
proposed in the Interexchange NPRM and define a relevant geographic 
market for interstate, domestic, long distance services as all possible 
routes that allow for a connection from one particular location to 
another particular location (i.e., a point-to-point market).
    65. Contrary to a number of commenters, we find that defining the 
relevant geographic market as a point-to-point market, rather than as a 
single national market, more accurately reflects the fact that most 
customers use long distance services by purchasing ubiquitous calling 
plans. A point-to-point connection is a constituent element of all 
types of interstate, domestic, long distance services, (As we described 
in the Interexchange NPRM, ``residential interexchange services can be 
thought of as a bundle of all possible interexchange calls originating 
from a single point and terminating anywhere, and 800 service as a 
bundle of interstate, interexchange calls originating from a certain 
geographic region and terminating at a specific point.'' Interexchange 
NPRM, 11 FCC Rcd at 7168, para.50.) including purely point-to-point 
services, (private line service is an example of a point-to-point 
service) as well as point-to-all-points services (Residential long 
distance service is an example of a point-to-all-points service. Point-
to-all-points services can be viewed as a bundle of point-to-point 
connections all originating at the same point.) and all-points-to-point 
services. (Toll free 800 or 888 numbers that are accessible from all 
domestic geographic locations would be examples of an all points-to-
point service. An all-points-to-point service can be viewed as a bundle 
of point-to-point connections that all terminate at the same point.) 
Ubiquitous calling plans encompass point-to-all-points services or all-
points-to-point services, which are essentially a bundle of point-to-
point connections serving a common point. Although ubiquitous calling 
allows customers to make multiple point-to-point connections from or to 
a common point via a single source, it does not change the nature of 
interstate, domestic, long distance calling. From the customer's 
perspective, while the calling plan itself may be ``ubiquitous'' in 
that it offers nationwide coverage from or to a common point, the 
market to purchase that plan is a localized market, not a national one. 
For example, customers located in Miami generally purchase calling 
plans that offer long distance service originating from Miami. Any 
calling plan that provides service originating from Los Angeles, even 
if it is ``ubiquitous'' service, would not be a viable substitute for 
customers located in Miami. Accordingly, we believe that defining the 
relevant geographic market as a point-to-point market is a more 
accurate approach to assessing market power than a single national 
market definition, even assuming that most long distance customers 
purchase ubiquitous calling plans.
    66. We recognize, however, that assessing market power in each 
individual point-to-point market would be administratively impractical 
and inefficient. Therefore, we clarify our proposal in the 
Interexchange NPRM to treat, in general, interstate, long distance 
calling as a single national market unless there is credible evidence 
indicating that there is or could be a lack of competition in a 
particular point-to-point market, and there is a showing that 
geographic rate averaging will not sufficiently mitigate the exercise 
of market power. We conclude that when a group of point-to-point 
markets exhibit sufficiently similar competitive characteristics (i.e., 
market structure), we will examine that group of markets using 
aggregate data that encompasses all point-to-point markets

[[Page 35988]]

in the relevant area, rather than examine each individual point-to-
point market separately. Therefore, if we conclude that the competitive 
conditions for a particular service in any point-to-point market are 
sufficiently representative of the competitive conditions for that 
service in all other domestic point-to-point markets, then we will 
examine aggregate data, rather than data particular to each domestic 
point-to-point market. For example, we could analyze national market 
share data, rather than market share data for particular point-to-point 
markets. Such a finding would require that there be no credible 
evidence that there is or could be a lack of competitive performance in 
any point-to-point market for that service. As noted in the 
Interexchange NPRM, we believe that geographic rate averaging, price 
regulation of exchange access services, and the excess capacity in 
interstate transport currently cause carriers to behave similarly in 
each domestic point-to-point market and reduce the likelihood that 
carriers could exercise market power in most point-to-point markets.
    67. Unless there is credible evidence suggesting that there is or 
could be a lack of competition in a particular point-to-point market or 
group of point-to-point markets, and there is a showing that geographic 
rate averaging will not sufficiently mitigate the exercise of market 
power, we will refrain from employing the more burdensome approach of 
analyzing separate data from each point-to-point market. We believe 
that, in most cases, statistics, such as market shares, are most 
usefully calculated based on aggregate data covering all domestic 
point-to-point markets. In many point-to-point markets (e.g., one home 
to another home), one long distance carrier will have 100 percent 
market share. This does not imply, however, that this particular long 
distance carrier has market power. Therefore, in using market share as 
one factor in assessing market power, it is important that we examine 
market share in the broadest geographic group of point-to-point markets 
in which competitive conditions are reasonably homogeneous.
    68. In the Interexchange NPRM, we also sought comment on how 
narrowly we should define the points of origination and termination 
when examining a point-to-point market. The relevant point in a point-
to-point market is the location of a particular telephone or other 
telecommunications device. For example, with regard to residential long 
distance service, the relevant point is each individual customer's 
residence. We recognize that assessing market power at such a level of 
detail would be administratively impractical. We conclude, however, 
that there is no need to define larger points because, when assessing 
the market power of a particular carrier or group of carriers, we will 
treat together all point-to-point markets within a boundary such that 
all transactions carried out within that boundary are subject to the 
same competitive conditions. Therefore, for all practical purposes, we 
fully expect that the relevant geographic area for assessing market 
power will usually consist of multiple point-to-point connections that 
exhibit the same competitive conditions. Because we will invariably 
analyze a group of point-to-point markets, there is no practical need 
to also redefine the individual points.
    69. Although GCI has suggested that we treat Alaska as a separate 
geographic market in assessing the market power of AT&T/Alascom, we do 
not do so in this proceeding. As noted supra at notes 170, 171, GCI 
identified the Alaska market as a separate geographic market. We also 
note that GCI has filed a petition seeking reconsideration of the AT&T 
Reclassification Order, in which it argues that the reclassification of 
AT&T does not apply to AT&T/Alascom, Inc. because AT&T/Alascom is still 
dominant in the Alaska market. See GCI petition for reconsideration or 
clarification of AT&T Reclassification Order (filed Nov. 22, 1995). As 
noted above, any modifications to decisions reached in the AT&T 
Reclassification Order that may be necessary as a result of our 
decision here will be addressed, as necessary, in further proceedings. 
We emphasize, however, that, because market definition is only one step 
in assessing market power, changes made in the approach to defining 
relevant markets will not necessarily produce different assessments of 
market power.
2. Geographic Market for BOC InterLATA Affiliates and Independent LECs

a. Background

    70. In the Non-Accounting Safeguards NPRM, we tentatively concluded 
that, if we adopt the approach proposed in the Interexchange NPRM, we 
should evaluate a BOC's point-to-point markets in which calls originate 
in-region separately from its point-to-point markets in which calls 
originate out-of-region, for purposes of determining whether BOC 
interLATA affiliates have market power in the provision of interstate, 
domestic, interLATA services. Similarly, we tentatively concluded that 
we should evaluate an independent LEC's point-to-point markets in which 
calls originate in its local exchange areas separately from its markets 
in which calls originate outside those areas, for the purpose of 
determining whether an independent LEC possesses market power in the 
provision of interstate, domestic, interexchange services.

b. Comments

    71. Several commenters support the Commission's tentative 
conclusion that it should evaluate a BOC's point-to-point markets in 
which calls originate in-region separately from its point-to-point 
markets in which calls originate out-of-region in order to determine 
whether a BOC interLATA affiliate possesses market power in-region. CTA 
and LDDS argue that this approach is supported by the fact that 
Congress legislated different treatment for in-region and out-of-region 
BOC services. Although LDDS agrees with the Commission's proposal to 
identify particular markets only where credible evidence of a lack of 
competition and a failure of geographic rate averaging to mitigate 
market power exists, LDDS argues that the Commission should find that, 
in light of BOC control over the origination and termination ends of 
nearly all interstate, long distance calls, the relevant geographic 
market for a BOC interLATA affiliate will be the entire region from 
which it provides long distance services, regardless of whether it is 
part of the region in which the BOC provides local exchange and 
exchange access service. MCI contends that the approach proposed in the 
Non-Accounting Safeguards NPRM recognizes that there are greater 
opportunities for cross-subsidization and anticompetitive conduct for 
interLATA service originating in a BOC's service region. Regardless of 
the market definition, DOJ states that it is ``not unreasonable'' in 
this proceeding for the Commission to distinguish a BOC's provision of 
interexchange service outside its region from provision of such service 
within its region. Sprint and the New York Public Service Department 
urge the Commission to recognize that mergers, acquisitions, and 
similar combinations by BOCs may require consideration of geographic 
markets more extensive than a BOC's own region.
    72. The BOCs generally oppose the approach proposed in the Non-
Accounting Safeguards NPRM and contend that the Commission should treat 
domestic, interstate, interexchange services as a single national 
market for purposes of determining whether a BOC interLATA affiliate 
possesses in-region market power. BellSouth and USTA

[[Page 35989]]

contend that all competing carriers should be subject to the same 
standards, including the same relevant market definitions, absent 
compelling reasons for disparate treatment. BellSouth and USTA argue 
that, given the BOCs' zero market share, the structural separation 
requirements and regulatory safeguards that apply to a BOC's provision 
of long distance services, and the comprehensive regulation of the 
BOCs' bottleneck facilities, the Commission's assumption that BOC 
interLATA affiliates may have market power over in-region interexchange 
services and therefore those services may need to be examined 
separately from out-of-region services is flawed.
    73. NYNEX contends that the fact that the BOCs are not likely to 
begin offering interexchange services with nationwide networks does not 
justify redefining the geographic market because many interexchange 
carriers also concentrate their offerings in particular regions. NYNEX 
also asserts that the 1992 Merger Guidelines support a single, 
nationwide geographic market definition regardless of whether 
interexchange services provided by BOC interLATA affiliates originate 
in-region or out-of-region. Bell Atlantic, BellSouth, and NYNEX argue 
that geographic rate averaging will prevent the BOCs from being able to 
raise prices selectively in targeted areas. Moreover, these parties 
allege that even if a BOC attempted to raise rates on any given route, 
other carriers would respond by offering lower rates because they would 
have sufficient capacity available on their existing networks to be 
able to carry the BOC customers that they would attract through lower 
prices.
    74. USTA argues that the Commission should not change the single, 
national geographic market definition in assessing the market power of 
independent LECs because: (1) The national scope of major 
telecommunications companies has increased over the years, not 
lessened, with the four largest IXCs controlling over 85 percent of the 
market; and (2) the national market is the relevant market for 
independent LECs, their competitors and the public, because 
interexchange service offerings are generally ubiquitous, not local or 
regional, and pricing, marketing, and networks are all national in 
scope. USTA adds that customers generally purchase interexchange 
services under ubiquitous calling plans, not on a point-to-point basis. 
According to USTA, although independent LECs provide local exchange 
services that are regional or local in scope, this does not change the 
national nature of the interexchange market because customers can 
choose from national, regional or local providers of long distance 
service.
    75. As noted above, AT&T asserts that the geographic market 
definition is irrelevant in determining whether the BOCs or independent 
LECs could abuse their power in the local market to impede 
interexchange competition. AT&T contends that market definitions and 
market share analyses are unnecessary when the presence of market power 
can be proven directly, as it can here because of the BOCs' control of 
the local bottleneck, or where undisputed power in one market (i.e., 
local services) can be leveraged to impede competition in a second 
market (i.e., long distance). AT&T also asserts, however, that ``while 
interexchange services originating in a particular BOC's service area 
generally could not be a separate geographic market, a determination of 
the appropriate regulatory treatment of a BOC's (or independent LEC's) 
in-region interLATA services should focus on these areas.''

c. Discussion

    76. In evaluating whether BOC interLATA affiliates and independent 
LECs possess market power in the interstate, domestic, long distance 
market, we conclude that we generally will follow the approach proposed 
in the Non-Accounting Safeguards NPRM. As discussed above, we disagree 
with those commenters that advocate using a single national geographic 
market definition. We conclude that a local exchange carrier's control 
of the local bottleneck constitutes credible evidence that there could 
be a lack of competitive performance in point-to-point markets that 
originate in-region. Because we expect that competitive conditions will 
be different for those point-to-point markets that originate in-region 
than for those point-to-point markets that originate out-of-region, we 
find that our analysis of market power should reflect this expectation. 
In-region, a BOC's control over the local bottleneck may give it a 
competitive advantage that it does not have out-of-region, causing the 
BOC to compete differently in-region than out-of-region. Therefore, the 
competitive conditions in-region are likely to be different in-region 
than out-of-region. Therefore, in determining whether BOC interLATA 
affiliates have market power in the provision of interstate, domestic, 
interLATA services, we conclude that calls originating from in-region 
point-to-point markets should be analyzed separately from calls 
originating from out-of-region point-to-point markets. Similarly, in 
determining whether independent LECs have market power in the provision 
of interstate, domestic, interexchange services, we conclude that calls 
originating in point-to-point markets within their local service areas 
should be analyzed separately from calls originating in point-to-point 
markets outside those areas.
    77. We adopt this bifurcated analysis to determine whether a BOC or 
independent LEC, through improper cost allocation or discrimination, 
could use its market power in local exchange and exchange access 
services to disadvantage long-distance rivals of the BOC interLATA 
affiliate or independent LEC. Such improper cost allocation or 
discrimination might enable a BOC interLATA affiliate or independent 
LEC to obtain the ability profitably to raise and sustain its price for 
in-region, interstate, domestic, long distance services above 
competitive levels by restricting its output of long distance services. 
We are not persuaded, moreover, that geographic rate averaging of 
interstate long distance services alone will necessarily suffice to 
offset the potential anticompetitive effects of a BOC's or independent 
LEC's use of the market power resulting from its control over local 
access facilities because if a BOC interLATA affiliate's or independent 
LEC's long distance customers are concentrated in one region, it may be 
profitable to raise prices above competitive levels, even if geographic 
rate averaging might cause it to lose market share outside that region.
    78. We reject AT&T's contention that the geographic market 
definition is irrelevant in assessing whether BOC interLATA affiliates 
or independent LECs possess market power. As discussed above, we 
conclude that a relevant geographic market must be defined in order to 
conduct an accurate assessment of market power. While we agree with 
AT&T that other factors are important in making our overall assessment 
of market power, we do not agree that we can avoid defining the 
relevant geographic market if we wish to achieve an accurate assessment 
of whether BOC interLATA affiliates or independent LECs possess market 
power in the long distance marketplace. Moreover, we further note that, 
in some cases, it may be necessary to focus specifically on the 
termination point because the local exchange carrier that serves the 
end-user customer will necessarily have market power with regard to 
that customer.

[[Page 35990]]

3. International Geographic Market for BOC InterLATA Affiliates and 
Independent LECs
    79. In the Non-Accounting Safeguards NPRM, we tentatively concluded 
that, for purposes of assessing whether BOC interLATA affiliates or 
independent LECs could exercise market power in the international long 
distance marketplace, market power should be measured on a worldwide, 
rather than route-by-route, basis, except for routes on which the 
carriers are affiliated with foreign carriers in the destination 
market. MCI, NYNEX and USTA agree with the Commission's tentative 
conclusion.
    80. In assessing whether BOC interLATA affiliates and independent 
LECs possess market power in the international long distance 
marketplace, we adopt our tentative conclusion, but clarify that we 
will examine aggregate data that encompasses all international point-
to-point markets, unless there is credible evidence suggesting that 
there is or could be a lack of competition in one or more international 
point-to-point markets. Of course, as discussed above, we will examine 
international point-to-point markets that originate in-region 
separately from international point-to-point markets that originate 
out-of-region. We acknowledge that myriad factors, including whether a 
carrier controls 100 percent of the capacity of the U.S. half of a 
particular international point-to-point market, may affect our 
determination of whether each international point-to-point market has 
competitive characteristics that are sufficiently similar to other 
point-to-point markets in the international marketplace. In classifying 
AT&T as non-dominant in the provision of IMTS, we generally analyzed 
AT&T's market power on a worldwide basis as a surrogate for a route-by-
route analysis, except a route-by-route analysis was employed to 
scrutinize those markets that have not supported entry by competing 
U.S. carriers. A route-by-route approach also was used to analyze the 
competitive impact of AT&T's affiliations and alliances with foreign 
carriers on particular U.S. international routes. In the Matter of 
Motion of AT&T Corp. to be Declared Non-Dominant for International 
Service, Order, FCC 96-209, at para. 32 (rel. May 14, 1996). In such 
cases, it may be necessary to conduct a more particularized analysis 
and examine certain individual international point-to-point markets or 
groups of point-to-point markets separately. Because no such factors 
currently apply or, we believe, are likely to apply to any BOC 
interLATA affiliate or independent LEC, however, we find that each 
individual international point-to-point market exhibits similar 
competitive characteristics to all other international point-to-point 
markets. Therefore, it is unnecessary for us to conduct a separate 
analysis for each international point-to-point market, given the 
administrative burdens associated with such an inquiry. Our decision 
here to examine aggregate data that encompasses all international 
point-to-point markets does not modify our existing route-by-route 
approach to consider whether U.S. carriers affiliated with a foreign 
carrier should be regulated as dominant in the provision of 
international services because they are affiliated with a foreign 
carrier that exercises market power in a foreign market.

IV. Classification of BOC Interlata Affiliates and Independent LECS 
as Dominant or Non-Dominant Carriers in the Provision of in-Region 
Long Distance Services

    81. In this section, we consider whether we should continue the 
dominant carrier classification that under our rules would apply to the 
BOC interLATA affiliates in the provision of in-region, interstate, 
domestic, interLATA services. As previously discussed, for convenience, 
we use the term ``BOC interLATA affiliates'' to refer to the separate 
affiliates established by the BOCs, in conformance with section 
272(a)(1), to provide in-region, interLATA services. See supra n. 12. 
In order to reclassify the BOC interLATA affiliates as non-dominant, 
our rules require us to conclude that they will not possess market 
power in the provision of those interLATA services in the relevant 
product and geographic markets. Our analysis of whether the BOC 
interLATA affiliates should be classified as dominant or non-dominant 
in the provision of in-region, interstate, domestic, interLATA services 
has no bearing on the determination of whether a BOC interLATA 
affiliate has satisfied the requirements of section 271(d)(3), and it 
should not to be interpreted as prejudging such determinations in any 
way. We also consider whether we should modify the regulatory regime 
adopted in the Competitive Carrier Fifth Report and Order for the 
regulation of in-region, interstate, domestic, interexchange services 
provided by independent LECs. Finally, we consider whether we should 
apply the same regulatory classification to the BOC interLATA 
affiliates' and independent LECs' provision of in-region, international 
services as we adopt in this proceeding for their provision of in-
region, interstate, domestic, long distance services. This proceeding 
does not modify the Commission's separate framework, adopted in the 
International Services Order and Foreign Carrier Entry Order, for 
regulating United States international carriers (including BOC 
interLATA affiliates or independent LECs) as dominant on routes where 
an affiliated foreign carrier has the ability to discriminate in favor 
of its U.S. affiliate through control of bottleneck services or 
facilities in the foreign destination market. See infra para. 139.

A. Classification of BOC InterLATA Affiliates

    82. We conclude that the requirements established by, and the rules 
implemented pursuant to, sections 271 and 272, together with other 
existing rules, sufficiently limit a BOC's ability to use its market 
power in the local exchange or exchange access markets to enable its 
interLATA affiliate profitably to raise and sustain prices of in-
region, interstate, domestic, interLATA services significantly above 
competitive levels by restricting the affiliate's own output. We 
therefore classify the BOCs' section 272 interLATA affiliates as non-
dominant in the provision of these services. We also conclude that we 
should apply the same regulatory classification to the BOC interLATA 
affiliates' provision of in-region, international services as we adopt 
for their provision of in-region, interstate, domestic, interLATA 
services.
1. Definition of Market Power and the Limits of Dominant Carrier 
Regulation

a. Background

    83. In the Non-Accounting Safeguards NPRM, we noted that there are 
two ways in which a carrier can profitably raise and sustain prices 
above competitive levels and thereby exercise market power. Non-
Accounting Safeguards NPRM at para. 131. For convenience, we refer, as 
we did in the Notice, to a carrier's ability to engage in such a 
strategy as the ability to ``raise prices.'' First, a carrier may be 
able to raise prices by restricting its own output (which usually 
requires a large market share); second, a carrier may be able to raise 
prices by increasing its rivals' costs or by restricting its rivals' 
output through the carrier's control of an essential input, such as 
access to bottleneck facilities, that its rivals need to offer their 
services. Id. We also noted that economists have recognized these 
different ways to exercise market power by distinguishing between 
``Stiglerian'' market power, which is the ability of a firm profitably 
to raise and sustain its

[[Page 35991]]

price significantly above the competitive level by restricting its own 
output, and ``Bainian'' market power, which is the ability of a firm 
profitably to raise and sustain its price significantly above the 
competitive level by raising its rivals' costs and thereby causing the 
rivals to restrain their output. T.G. Krattenmaker, R.H. Lande, and 
S.C. Salop, Monopoly Power and Market Power in Antitrust Law, 76 Geo. 
L.J. 241, 249-53 (1987). We sought comment on whether the BOC interLATA 
affiliates should be classified as dominant carriers in the provision 
of in-region, interstate, domestic, interLATA services under our rules 
only if we find that the affiliates have the ability to raise prices of 
those services by restricting their own output, or whether we should 
also classify the affiliates as dominant if the BOCs have the ability 
to raise prices by raising the costs of their affiliates' interLATA 
rivals.

b. Comments

    84. Most commenters that address this issue, including DOJ, argue 
that the BOC interLATA affiliates should be classified as dominant only 
if they have the ability to raise the prices of interLATA services by 
restricting their own output. MCI and AT&T contend, however, that we 
should also classify a BOC interLATA affiliate as dominant if it (or 
its BOC parent) has the ability to raise the costs or restrict the 
output of the affiliate's rivals through control of an essential input, 
such as exchange access, or the ability to raise the prices paid by the 
affiliate and its rivals for exchange access. MCI claims that, even if 
consumer prices are not raised immediately, a BOC's ability to impose 
excessive costs on or to restrict essential inputs to its interexchange 
rivals presents a long-run harm to competition because it will make the 
BOC's rivals weaker competitors, and thereby reduce their output and 
make consumer price increases inevitable. MCI asserts that raising 
rivals' costs is, in fact, likely to result in an increase in the BOC 
interLATA affiliate's rates, which could be prevented by dominant 
carrier regulation.

c. Discussion

    85. We conclude that the BOC interLATA affiliates should be 
classified as dominant carriers in the provision of in-region, 
interstate, domestic, interLATA services only if the affiliates have 
the ability to raise prices of those services by restricting their own 
output of those services. As we stated in the NPRM, we believe that our 
dominant carrier regulations are generally designed to prevent a 
carrier from raising prices by restricting its output rather than to 
prevent a carrier from raising its prices by raising its rivals' costs. 
Non-Accounting Safeguards NPRM at para. 132. Accord NYNEX Aug. 15, 1996 
Comments at 51; USTA Aug. 15, 1996 Comments at 47; DOJ Aug. 30, 1996 
Reply at 16. As noted in the NPRM, the definitions of market power 
cited by the Commission in the Competitive Carrier Fourth Report and 
Order referred to the concept of a carrier raising price by restricting 
its own output. Non-Accounting Safeguards NPRM at para. 132 (citing 
Competitive Carrier Fourth Report and Order, 95 FCC 2d at 558, 
Paras. 7, 8). In fact, these regulations were adopted at a time when 
AT&T was essentially a monopoly provider of domestic long distance 
services. As discussed below, application of these regulations to a 
carrier that does not have the ability to raise long distance prices by 
restricting its own output could lead to incongruous results.
    86. Even AT&T acknowledges that at least some of the dominant 
carrier regulations, such as price ceilings and more stringent section 
214 requirements, are not designed to address the potential problems 
associated with BOC entry into competitive markets. For example, 
although we recognize, as discussed below, that there are circumstances 
in which price cap regulation (including price floors) of a BOC 
interLATA affiliate's rates might decrease a BOC's ability to engage in 
anticompetitive conduct, (We also conclude below that price cap 
regulation of the BOCs' exchange access services will reduce the BOCs' 
incentive to misallocate the costs of their affiliates' interLATA 
services. See infra para. 106.) we believe that in this situation the 
disadvantages of price cap regulation outweigh its benefits. Similarly, 
we question whether more stringent section 214 requirements would be an 
efficient means of addressing the concerns raised by BOC entry. 
Congress enacted the facilities-authorization requirements in section 
214 and subsequent amendments primarily to prevent investment in 
unnecessary new plant by rate-base regulated common carriers and to bar 
service discontinuance in areas served by a single carrier. See 
Competitive Carrier First Report and Order, 85 FCC 2d at 39, para. 114. 
See also H. Averch and L. L. Johnson, Behavior of the Firm under 
Regulatory Constraint, 52 Amer. Econ. Rev. 1053 (1962) (a firm under 
rate of return regulation has an incentive to invest in more than the 
efficient amount of plant in order to increase the value of its rate 
base). Because we previously have found that markets for long distance 
services are substantially competitive in most areas, marketplace 
forces should effectively deter carriers that face competition from 
engaging in the practices that Congress sought to address through the 
section 214 requirements. For example, a carrier facing competition 
lacks the incentive to invest in unneeded facilities, because it cannot 
extract additional revenue from its long distance customers to recoup 
the cost of those facilities. If such a carrier discontinues service in 
an area where it faces competition, its customers could turn to the 
carrier's competitors for service. Because marketplace forces generally 
eliminate the need for regulatory requirements imposed by section 214, 
we have granted a blanket section 214 authorization to non-dominant 
carriers such that they no longer must obtain prior approval to provide 
domestic long distance service or add new facilities and we impose less 
stringent requirements on non-dominant carriers that are discontinuing 
service. 47 CFR Secs. 63.07, 63.71. Section 63.07 requires non-dominant 
carriers to report the acquisition or construction of initial or 
additional circuits to the Commission on a semi-annual basis, while 
section 63.71 imposes certain notification requirements on non-dominant 
carriers that plan to reduce, impair, or discontinue service. We 
recognize that, for certain areas, such as those served by a single 
interexchange carrier or where equal access has not been implemented, 
it may still be appropriate for the Commission to review a carrier's 
proposal to discontinue service.
    87. We recognize that certain aspects of dominant carrier 
regulation might constrain a BOC's ability to raise the costs of its 
affiliate's interLATA rivals or engage in other anticompetitive 
conduct. For example, requiring a BOC interLATA affiliate to file its 
tariffs with advance notice and cost support data might help to detect 
and prevent predatory pricing, particularly if coupled with a price 
floor on the affiliate's interLATA services. Price cap regulation of a 
BOC interLATA affiliate's interLATA services may deter a BOC from 
raising the costs of its affiliate's rivals through discrimination or 
other anticompetitive conduct by limiting the profit the affiliate 
could earn as a result of the anticompetitive conduct. As we stated in 
the Notice, however, price cap regulation of a BOC interLATA 
affiliate's interLATA services generally would not prevent a

[[Page 35992]]

BOC from raising its affiliate's rivals costs through discrimination or 
other anticompetitive conduct. Non-Accounting Safeguards NPRM at para. 
132. It also would not prevent the affiliate from profiting from the 
BOC's raising rivals' costs through increased market share. Id. See 
also DOJ Aug. 30, 1996 Reply at 28 (impact of price cap regulation on 
affiliate pricing, and therefore its deterrence effect, is not so 
clear). Nevertheless, the fact that these measures might help to deter 
a BOC or its interLATA affiliate from engaging in certain types of 
anticompetitive conduct is not, by itself, a sufficient basis for 
imposing dominant carrier regulations on the BOC interLATA affiliates. 
We should also consider whether and to what extent these regulations 
would dampen competition and whether other statutory and regulatory 
provisions would accomplish the same objectives while imposing fewer 
burdens on the carriers and the Commission. Dominant carrier regulation 
should be imposed on the BOC interLATA affiliates only if the benefits 
of such regulation outweigh the burdens that would be imposed on 
competition, service providers, and the Commission.
    88. The Commission has long recognized that the regulations 
associated with dominant carrier classification can dampen competition. 
For example, advance notice periods for tariff filings can stifle price 
competition and marketing innovation when applied to a competitive 
industry. In the Tariff Forbearance Order, we eliminated tariff filing 
requirements for non-dominant carriers pursuant to our forbearance 
authority under the Communications Act and ordered all non-dominant 
interexchange carriers to cancel their tariffs for interstate, 
domestic, interexchange services within nine months from the effective 
date of the Order. Tariff Forbearance Order at para. 3. As previously 
noted, the Tariff Forbearance Order is currently subject to a judicial 
stay. We concluded that a regime without non-dominant interexchange 
carrier tariffs for interstate, domestic, interexchange services will 
be the most pro-competitive, deregulatory system. We also found that 
not permitting non-dominant interexchange carriers to file tariffs with 
respect to interstate, domestic, interexchange services will enhance 
competition among providers of such services, promote competitive 
market conditions, and achieve other objectives that are in the public 
interest. We further concluded that continuing to require non-dominant 
interexchange carriers to file tariffs for interstate, domestic, 
interexchange services would reduce incentives for competitive price 
discounting, constrain carriers' ability to make rapid, efficient 
responses to changes in demand and cost, impose costs on carriers that 
attempt to make new offerings, and prevent customers from seeking out 
or obtaining service arrangements specifically tailored to their needs.
    89. Requiring the BOC interLATA affiliates to file tariffs on 
advance notice and with cost support data would impose even more 
significant costs and burdens on the interLATA affiliates than the one-
day notice period formerly required of non-dominant carriers and would 
adversely affect competition. Moreover, these requirements could 
undermine at least some of the benefits otherwise gained by eliminating 
tariff filing by non-dominant domestic interexchange carriers. In the 
Tariff Forbearance Order, we found that tacit coordination of prices 
for interstate, domestic, interexchange services, to the extent it 
exists, would be more difficult if we eliminate tariffs, because price 
and service information about such services provided by non-dominant 
interexchange carriers would no longer be collected and available in 
one central location. Upon full implementation of that Order, no 
interexchange carrier will be obligated (or permitted) to file tariffs 
for interstate, domestic, interexchange services. Upon full 
implementation of this Order, all domestic interexchange carriers will 
be regulated as non-dominant carriers. See infra section IV.B. If we 
were to require BOC interLATA affiliates to file tariffs for 
interstate, domestic, interexchange services, the ready availability of 
that information might facilitate tacit coordination of prices. We also 
believe that such requirements would impose significant administrative 
burdens on the Commission and the BOC interLATA affiliates, 
particularly to the extent they encourage the affiliates' interLATA 
competitors to challenge the affiliates' interLATA rates in order to 
impede the affiliates' ability to compete.
    90. We find that the other regulations associated with dominant 
carrier classification can also have undesirable effects on 
competition. Although a price floor might help prevent a BOC interLATA 
affiliate from pricing below its cost, a price floor, if set too high, 
could prevent consumers from enjoying lower prices resulting from real 
efficiencies. The required cost support data can also discourage the 
introduction of innovative new service offerings, because it requires a 
carrier to reveal its financial information to its competitors.
    91. As we discussed in the NPRM, we believe that other regulations 
applicable to the BOCs and their interLATA affiliates will address the 
anticompetitive concerns raised in the NPRM in a less burdensome 
manner. For example, a BOC's ability to engage in a ``price squeeze'' 
by raising its prices for access services (Under this scenario, a BOC 
would raise the price of access to all interexchange carriers, 
including its affiliate. This would cause competing interLATA carriers 
either to raise their retail interLATA rates in order to maintain the 
same profit margins or to attempt to preserve their market share by not 
raising their prices to reflect the increase in access charges, thereby 
reducing their profit margins. If the competing in-region interLATA 
service providers raised their prices to recover the increased access 
charges, the BOC interLATA affiliate could seek to expand its market 
share by not matching the price increase. See infra para. 125.) (as 
opposed to a BOC affiliate's lowering its long distance prices even 
when the BOC has not lowered its access prices) is limited by price cap 
regulation of those services. The nondiscrimination and structural 
separation requirements set forth in section 272 and our rules 
thereunder, price cap regulation of the BOCs' exchange access services, 
and the Commission's affiliate transaction rules sufficiently reduce 
the risk of successful anticompetitive discrimination and improper 
allocation of costs. We agree with DOJ that applying dominant carrier 
regulation to an affiliate in a downstream market would be ``at best a 
clumsy tool for controlling vertical leveraging of market power by the 
parent, if the parent can be directly regulated instead.'' In the Non-
Accounting Safeguards Order (62 FR 2927 (January 21, 1997)) and 
Accounting Safeguards Order (62 FR 10220 (March 6, 1997)), we adopted 
regulations to constrain the BOCs' ability to use their market power in 
local exchange and exchange access services to engage in 
anticompetitive conduct in competitive markets. We therefore reject 
AT&T and MCI's contention that a BOC's ability to engage in such 
conduct would provide a legitimate basis for classifying its affiliate 
as dominant in the provision of in-region, interstate, domestic, 
interLATA services.
    92. We find that the entry of the BOC interLATA affiliates into the 
provision of interLATA services has the potential to increase price 
competition and lead to innovative new services and marketing 
efficiencies. We see no reason to saddle the BOC interLATA affiliates

[[Page 35993]]

with regulations that are not well-suited to prevent the risks 
associated with BOC entry into in-region, interstate, domestic, 
interLATA services. We, therefore, conclude that the BOC interLATA 
affiliates should be classified as dominant carriers only if they have 
the ability to raise prices by restricting their own output.
2. Classification of BOC InterLATA Affiliates in the Provision of In-
Region, Interstate, Domestic, InterLATA Services

a. Traditional Market Power Factors (other than control of bottleneck 
facilities)

i. Background
    93. In the Non-Accounting Safeguards NPRM, we noted that, in 
determining whether a firm possesses market power, the Commission has 
previously focused on certain well-established market features, 
including market share, supply and demand substitutability, the cost 
structure, size or resources of the firm, and control of bottleneck 
facilities. We sought comment on the application of these factors in 
determining whether the BOC interLATA affiliates should be classified 
as dominant or non-dominant.
ii. Comments
    94. Most commenters that address the issue agree that each of the 
traditional market factors weighs in favor of classifying the BOC 
interLATA affiliates as non-dominant. According to Ameritech, it is 
inconceivable that a BOC interLATA affiliate ``could bring AT&T to its 
knees quickly'' because the affiliates will enter the long-distance 
market with no customers, no traffic, no revenues, and no presubscribed 
lines and will be competing against some 500 incumbent carriers, 
including AT&T, MCI and Sprint, all of which are well-established in 
the market. Ameritech and U S West also claim that, in considering 
whether to classify the BOC interLATA affiliates as dominant, the 
Commission should consider only whether the BOC interLATA affiliates 
will have market power upon entry, not whether they will ``quickly 
gain'' such market power.
    95. The California Cable Television Association (CCTA) contends, 
however, that a BOC interLATA affiliate's initial zero market share 
should not dissuade the Commission from retaining dominant carrier 
regulation because, as an entity affiliated with the dominant provider 
in the state, it will have enormous advantages particularly in terms of 
brand identification. CCTA further argues that it is likely that these 
affiliates will seek to capitalize on their parental lineage by using 
some or all of the BOCs' logos or other branding mechanisms. LDDS 
asserts that market share in and of itself is not a measure of market 
power, but rather is one of many possible indications that market power 
may exist in a certain market.
iii. Discussion
    96. We find that each of the traditional market factors (excluding 
bottleneck control) supports a conclusion that the BOC interLATA 
affiliates will not have the ability to raise price by restricting 
their output upon entry or soon thereafter. As stated in the NPRM, the 
fact that each BOC interLATA affiliate initially will have zero market 
share in the provision of in-region, interstate, domestic, interLATA 
services suggests that the affiliate will not initially be able to 
raise price by restricting its output. As discussed in the NPRM, 
however, we find that this factor is not conclusive in determining 
whether a BOC interLATA affiliate should be classified as dominant, 
because the affiliate's zero market share results from its exclusion 
from the market until now, and, the affiliate potentially could gain 
significant market share upon entry or shortly thereafter, because of 
its brand identification with in-region customers, possible 
efficiencies of integration, and the BOC's ability potentially to raise 
the costs of its affiliate's interLATA rivals.
    97. As to supply substitutability, we note that the Commission has 
previously found that the excess capacity of AT&T's competitors is 
sufficient to constrain AT&T's exercise of market power. In light of 
that finding, we conclude that AT&T and its competitors, which 
currently serve all interLATA customers, should be able to expand their 
capacity sufficiently to attract a BOC interLATA affiliate's customers 
if the affiliate attempts to raise its interLATA prices. As we 
discussed in the NPRM, the Commission also recently found that the 
purchasing decisions of most customers of domestic interexchange 
services are sensitive to changes in price, and customers would be 
willing to shift their traffic to an interexchange carrier's rival if 
the carrier raises its prices. The existence of such demand 
substitutability supports the conclusion that the BOC interLATA 
affiliates will not have the ability to raise prices by restricting 
their output. Finally, given the presence of existing interexchange 
carriers, including such large well established carriers as AT&T, MCI, 
Sprint, and LDDS, we find that the cost structure, size, and resources 
of the BOC interLATA affiliates are not likely to enable them to raise 
prices above the competitive level for their domestic interLATA 
services. Although the BOCs' brand identification and possible 
efficiencies of integration may give the BOC interLATA affiliates 
certain cost advantages in attracting customers, their lack of 
nationwide facilities-based networks would appear to put them at a 
disadvantage relative to the four largest interexchange carriers, as 
noted by Ameritech, particularly because the cost of resold long 
distances services will generally exceed the marginal cost of providing 
those services.

b. BOC Control of Bottleneck Access Facilities

i. Background
    98. In the Non-Accounting Safeguards NPRM, we noted that, in 
assessing whether a BOC interLATA affiliate would possess market power 
in the provision of in-region, interstate, domestic, interLATA 
services, we must also consider the significance of the BOCs' current 
control of bottleneck exchange access facilities. We noted the concern 
that a BOC's control of bottleneck access facilities would enable it to 
allocate costs improperly from its affiliate's interLATA services to 
the BOC's regulated exchange or exchange access services, discriminate 
against its affiliate's interLATA competitors, and potentially engage 
in a price squeeze against those competitors. We therefore sought 
comment on whether the statutory and regulatory safeguards currently 
imposed on the BOCs and their affiliates are sufficient to prevent a 
BOC from engaging in such activities to such an extent that the BOC 
interLATA affiliates would quickly gain the ability to raise price by 
restricting output.
ii. Comments
    99. Some of the BOCs dispute the Commission's assumption that the 
BOCs have and will maintain control of bottleneck access facilities. 
These commenters argue that any control the BOCs may have once had in 
the exchange access market has been dissipated by the Commission's 
expanded interconnection initiatives, the 1996 Act and the Commission's 
implementing regulations, and the actions of various states. In 
contrast, AT&T contends that the BOCs' monopoly control over local 
bottleneck facilities gives them market power in the interexchange 
market. Similarly, LDDS asserts that the BOCs will continue to possess 
market power in both the local exchange and exchange access markets, 
which translates into

[[Page 35994]]

market power in the in-region interLATA market. Many commenters also 
specifically address the three types of anticompetitive conduct listed 
above.
iii. Discussion
    100. As noted in the Non-Accounting Safeguards NPRM, BOCs currently 
provide an overwhelming share of local exchange and exchange access 
services in areas where they provide such services--approximately 99.1 
percent of the market as measured by revenues. Industry Analysis 
Division, Telecommunications Industry Revenue: TRS Worksheet Data, 
(Common Carrier Bureau December 1996). Tables 18 and 15 show that BOC 
local and access revenues in 1995 were $65.6 billion, while CAPs and 
Competitive LECs local and access revenues both in and out of BOC 
regions were only $595 million. Although the 1996 Act establishes a 
framework for eliminating entry barriers and thereby fostering local 
competition, the evidence to date indicates that such competition is 
still in its infancy. As a result, we conclude, solely for purposes of 
this proceeding, that the BOCs currently possess market power in the 
provision of local exchange and exchange access services in their 
respective regions, and we therefore must consider whether they can use 
that market power to give their interLATA affiliates the ability to 
raise the prices of in-region, interstate, domestic, interLATA services 
by restricting their own output of those services.

c. Improper Allocation of Costs

i. Comments
    101. The BOCs and USTA assert that statutory and regulatory 
safeguards should prevent any improper cost allocations from occurring, 
particularly because all BOCs are subject to price-cap regulation, and 
a majority have adopted the no-sharing option. PacTel asserts that the 
concern over improper cost allocation ignores current regulation of the 
BOCs and presumes the incompetence of both state and federal 
regulators. AT&T counters that price cap regulation cannot eliminate 
the incentive to allocate costs improperly because both the initial 
caps and subsequent adjustments are generally set at least in part on 
the basis of the BOCs' profits during the preceding years. The Economic 
Strategy Institute asserts that cost accounting methodologies and 
models leave room for manipulation and interpretation. It also claims 
that improper cost allocation can lead to substantial cost advantages 
and facilitate a price squeeze.
    102. The BOCs and USTA contend that it defies economic sense to 
expect any of the BOC interLATA affiliates to drive AT&T, MCI, or 
Sprint from the long-distance market. Even if they could, these 
commenters assert, the facilities of that carrier would remain intact, 
ready for another firm to buy at distress sale prices. AT&T, CTA, and 
DOJ argue, however, that the concerns expressed in the NPRM regarding 
improper cost allocation are too narrow. In addition to raising the 
possibility of predatory pricing, improper cost allocation may cause 
substantial harm to consumers, competition, and production efficiency. 
For example, improper cost allocation could lead to higher prices for 
local exchange and exchange access services and could shift market 
share and profits to a BOC interLATA affiliate, even if the affiliate 
is less efficient than its competitors, thereby resulting in a loss of 
production efficiency. AT&T asserts that such a strategy would be 
costless to the BOC, for it would recover its losses in the competitive 
market through contemporaneous higher rates in the non-competitive 
market. As a result, no subsequent recoupment would be necessary. 
According to DOJ, the Commission must consider whether applicable 
regulation would prevent improper cost allocation that would result in 
these adverse effects on consumers, competition, and production 
efficiency. DOJ argues that regulation alone will not prevent 
competitively significant improper cost allocations. The incentives to 
engage in such practices, according to DOJ, will be eliminated only 
when the local exchange market is subject to robust competition.
ii. Discussion
    103. As noted in the Non-Accounting Safeguards NPRM, improper 
allocation of costs by a BOC is of concern because such action may 
allow a BOC to recover costs from subscribers to its regulated services 
that were incurred by its interLATA affiliate in providing competitive 
interLATA services. In addition to the direct harm to regulated 
ratepayers, this practice can distort price signals in those markets 
and may, under certain circumstances, give the affiliate an unfair 
advantage over its competitors. Recognizing this concern, Congress 
established safeguards in section 272, which we have implemented in the 
Non-Accounting Safeguards Order and Accounting Safeguards Order. For 
purposes of determining whether the BOC interLATA affiliates should be 
classified as dominant, however, we must consider only whether the BOCs 
could improperly allocate costs to such an extent that it would give 
the BOC interLATA affiliates, upon entry or soon thereafter, the 
ability to raise prices by restricting their own output. We conclude 
that, in reality, such a situation could occur only if a BOC's improper 
allocation enabled a BOC interLATA affiliate to set retail interLATA 
prices at predatory levels (i.e., below the costs incurred to provide 
those services), drive out its interLATA competitors, and then raise 
and sustain retail interLATA prices significantly above competitive 
levels. In so concluding, we do not dismiss cost misallocation as a 
potential problem. We recognize that the BOCs may have an incentive to 
misallocate the costs of their interLATA affiliates' interLATA 
services.
    104. We conclude that applicable statutory and regulatory 
safeguards are likely to be sufficient to prevent the BOCs from 
improperly allocating costs between their monopoly local exchange and 
exchange access services and their affiliates' competitive interLATA 
services to such an extent that their interLATA affiliates would be 
able to eliminate other interLATA service providers and subsequently 
earn supra-competitive profits by charging monopoly prices. Section 
272(b) includes a number of structural safeguards that constrain a 
BOC's ability to allocate costs improperly. For example, the provision 
requires a BOC interLATA affiliate to ``operate independently'' from 
the BOC, maintain separate books, records, and accounts from the BOC, 
and have separate officers, directors, and employees. Section 272 also 
requires each BOC ``to obtain and pay for a joint Federal/State audit 
every 2 years conducted by an independent auditor to determine whether 
such company has complied with [section 272] and the regulations 
promulgated under this section. . . .'' 47 U.S.C. Sec. 272(d)(1). The 
results of such audits must be submitted to the Commission and the 
state commissions in each State in which the BOC provides services, 
which shall make such results available for public inspection. Id. 
Sec. 272(d)(2). As noted by Ameritech and Bell Atlantic, the structural 
separation and audit requirements mandated in section 272 should reduce 
the risk of improper allocation of costs by minimizing the amount of 
joint costs that could be improperly allocated. In the Non-Accounting 
Safeguards Order, we adopted rules to implement and clarify these 
provisions. For example, we concluded that the requirement that

[[Page 35995]]

the BOC and its affiliate operate independently precludes the joint 
ownership of transmission and switching facilities by a BOC and its 
interLATA affiliate, as well as the joint ownership of the land and 
buildings where those facilities are located. Non-Accounting Safeguards 
Order at para.158. We noted that prohibiting joint ownership of 
transmission and switching facilities would ensure that an affiliate 
must obtain any such facilities pursuant to the arm's length 
requirements of section 272(b)(5), thereby facilitating monitoring and 
enforcement of the section 272 requirements. Id. at para.160. We also 
concluded that operational independence precludes a section 272 
affiliate from performing operating, installation, and maintenance 
functions associated with the BOC's facilities. Likewise, it bars a BOC 
or any BOC affiliate, other than the section 272 affiliate itself, from 
performing operating, installation, or maintenance functions associated 
with the facilities that the section 272 affiliate owns or leases from 
a provider other than the BOC with which it is affiliated. Id. at 
para.158. We concluded, however, consistent with these requirements and 
those established pursuant to sections 272(b)(5) and 272(c)(1), a 
section 272 affiliate may negotiate with an affiliated BOC on an arm's 
length and nondiscriminatory basis to obtain transmission and switching 
facilities, to arrange for collocation of facilities, and to provide or 
to obtain services such as administrative and marketing services. Id. 
We also clarified that section 272(b)(1) does not preclude a BOC or a 
section 272 affiliate from providing telecommunications services to one 
another, so long as each entity performs itself, or obtains from an 
unaffiliated third party, the operating, installation, and maintenance 
functions associated with the facilities that it owns or leases from an 
entity unaffiliated with the BOC. Id. at para.164. As noted by 
BellSouth, the separate employee requirement should ensure that the 
cost of each employee will be attributed directly to the appropriate 
entity.
    105. Section 272 also requires a BOC interLATA affiliate to conduct 
all transactions with the BOC on an arm's length basis, and all such 
transactions must be reduced to writing and made available for public 
inspection. In the Accounting Safeguards Order, we concluded that, to 
satisfy this requirement, a section 272 affiliate must, at a minimum, 
provide a detailed written description of the asset or service 
transferred and the terms and conditions of the transaction on the 
Internet within 10 days of the transaction through the company's 
Internet home page. Accounting Safeguards Order at para.122. This 
information also must be made available for public inspection at the 
principal place of business of the BOC. Id. We conclude that these 
safeguards will constrain a BOC's ability to allocate costs improperly 
and make it easier to detect any improper allocation of costs that may 
occur.
    106. We further find that price cap regulation of the BOCs' access 
services reduces the BOCs' incentive to allocate improperly the costs 
of their affiliates' interLATA services. As the Commission previously 
explained, ``[b]ecause price cap regulation severs the direct link 
between regulated costs and prices, a carrier is not able automatically 
to recoup improperly allocated nonregulated costs by raising basic 
service rates, thus reducing the incentive for the BOCs to shift 
nonregulated costs to regulated services.'' We recognize that under our 
current interim LEC price cap rules, a BOC can select an X-factor 
option that requires it to share interstate earnings with its customers 
that exceed specified benchmarks and permit the BOC to make a low-end 
adjustment if interstate earnings fall below a specified threshold. The 
X-factor is a component of the price cap formula that is used to adjust 
the price cap index for a LEC's access services each year to account 
for changes in telephone companies' costs per unit of output. 
Consequently, in certain circumstances, a BOC may have an incentive to 
allocate costs from interLATA services to access services in order to 
reduce the amount of profits the BOC is required to share with its 
interstate access service customers or become eligible for a low-end 
adjustment. Time Warner Aug. 15, 1996 Comments at 12-13. Similarly, the 
possibility of future re-calibration of price cap levels or out-of-band 
filings also implies that price cap regulation does not fully sever the 
link between regulated costs and prices. See 47 CFR Sec. 61.49(e), (f). 
We note, however, that only one of the BOCs currently has adopted a 
sharing option. U S West is the only BOC currently subject to a sharing 
option. Data based on 1996 Annual Access Tariff Filings filed on April 
2, 1996. See also USTA Aug. 15, 1996 Comments, Hausman Aff. at 8. We 
also note that the Commission has sought comment on whether the sharing 
option should be eliminated. Price Cap Performance Review for Local 
Exchange Carriers (60 FR 52362 (October 6, 1995)). Also, in the Access 
Charge Reform NPRM, we sought comment on whether we should reinitialize 
price cap indices and increase the X-factor. See Access Charge Reform; 
Price Cap Performance Review for Local Exchange Carriers; Transport 
Rate Structure and Pricing; Usage of the Public Switched Network by 
Information Service and Internet Access Providers (62 FR 4657 (January 
31, 1997)) at Paras. 223-35 (Access Charge Reform NPRM). Our affiliate 
transaction rules, which apply to transactions between the BOCs and 
their interLATA affiliates, should make it more difficult for a BOC to 
allocate improperly the costs of its affiliates' interLATA services. We 
also recognize that, if a state does not impose price cap regulation on 
a BOC's local exchange services, the BOC may have an incentive to 
allocate costs from interLATA services to its local exchange services. 
It appears, however, that many states have adopted price cap regulation 
or some other alternative form of regulation for the BOCs' local 
exchange services. Moreover, we are not persuaded that dominant carrier 
regulation of the BOC interLATA affiliates' interLATA services would 
prevent such improper cost allocation.
    107. Furthermore, even if a BOC were able to allocate improperly 
the costs of its affiliate's interLATA services, we conclude that it is 
unlikely that a BOC interLATA affiliate could engage successfully in 
predation. At least four interexchange carriers--AT&T, MCI, Sprint, and 
LDDS WorldCom--have nationwide, or near-nationwide, network facilities 
that cover every BOC region. These are large well-established companies 
with millions of customers throughout the nation. It is unlikely, 
therefore, that a BOC interLATA affiliate, whose customers are likely 
to be concentrated in the BOC's local service region, (We recognize 
that action taken in concert by two or more BOCs could have a more 
significant impact on interLATA competitors, but believe that the 
antitrust laws and our enforcement process will sufficiently limit the 
risk of such concerted activity. Non-Accounting Safeguards Order at 
para.70.) could drive one or more of these national companies from the 
market.
    Even if it could do so, it is doubtful that the BOC interLATA 
affiliate would later be able to raise prices in order to recoup lost 
revenues. As Professor Spulber has observed, ``[e]ven in the unlikely 
event that [a BOC interLATA affiliate] could drive one of the three 
large interexchange carriers into bankruptcy, the fiber-optic 
transmission capacity of that carrier would remain intact, ready for 
another firm to buy the

[[Page 35996]]

capacity at distress sale and immediately undercut the (affiliate's) 
noncompetitive prices.''
    108. We acknowledge that improper cost allocation may raise 
concerns beyond the risk of predatory pricing. As AT&T and DOJ assert, 
exploiting improper cost allocation to divert business to BOC interLATA 
affiliates from other, more efficient suppliers would be 
anticompetitive even if the latter suppliers remained in the market. 
DOJ contends that this strategy would produce inefficiencies and wasted 
resources and reduce future investment by competitors to improve or 
expand their networks and to develop innovative technologies and 
services. AT&T claims that such a strategy would be costless to the 
BOC, for it would recover its losses in the competitive market through 
contemporaneous higher rates in the non-competitive market, and, 
consequently, subsequent recoupment would be unnecessary. As previously 
stated, although we agree that these are serious concerns, we find that 
they do not establish a persuasive basis for classifying the BOC 
interLATA affiliates as dominant in the provision of in-region, 
interstate, domestic, interLATA services. Rather, such concerns are 
best addressed through enforcement of the section 272 requirements. We 
also note that DOJ contends that dominant carrier regulation will not 
prevent the BOCs from improperly allocating their affiliates' interLATA 
costs. In fact, DOJ asserts that the incentives to engage in such 
practices will be eliminated only when the local exchange market is 
subject to robust competition. As previously discussed, we conclude 
that dominant carrier regulation generally would not help prevent a BOC 
from improperly allocating costs.

d. Unlawful Discrimination

i. Comments
    109. The BOCs suggest that concerns over the BOCs' incentives to 
discriminate are grossly exaggerated, given increasing competition in 
exchange and exchange access services (particularly after a BOC has 
satisfied the competitive checklist and other requirements in section 
271) and the potential problem that customers would attribute 
degradation in service quality to the BOCs, rather than their interLATA 
affiliates' competitors. The BOCs further contend that, even if they 
did have the incentive to discriminate, they lack the ability to do so 
because of the nondiscrimination requirements in the 1996 Act and 
because of engineering obstacles to such selective degradation of 
service quality. Several BOCs also argue that discrimination is 
unlikely to be effective unless it is apparent to customers. According 
to the BOCs, if it is apparent to customers, however, it also is likely 
to be apparent to their long distance carrier and regulators that have 
the authority to enjoin any illegal practices. BellSouth and SBC 
contend that BOCs have a significant disincentive to provide inferior 
access to IXCs or otherwise jeopardize their relationship because the 
access charges paid by IXCs are a major source of revenue for the BOCs, 
and the IXCs increasingly will have the option of moving their exchange 
access traffic to alternative LECs and CAPs. Bell Atlantic and USTA 
claim that the BOCs have a long history of operating in other markets 
related to their local exchange and exchange access services without 
any adverse economic effects. They claim that, in each of the 
businesses that the BOCs have been allowed to enter since divestiture--
cellular, voice messaging, customer premises equipment, and limited 
interLATA services--output has grown, prices have fallen and 
competitors have thrived. PacTel asserts that, if such discriminatory 
behavior could happen, it would already have happened.
    110. A number of parties contend that, despite passage of the 1996 
Act, BOCs have the incentive and ability to discriminate against their 
interLATA affiliates' long distance competitors. AT&T argues that the 
BOCs can discriminate against interexchange competitors in numerous and 
subtle ways that would be difficult to police. According to DOJ and 
Time Warner, the BOCs will retain the incentive and ability to 
discriminate against competitors until they are subject to actual, 
sustained competition in local telephone markets.
ii. Discussion
    111. In the Non-Accounting Safeguards NPRM, we noted that a BOC 
potentially could use its market power in the provision of local 
exchange and exchange access services to discriminate against its 
interLATA affiliate's interLATA competitors to gain an advantage for 
its interLATA affiliate. We noted that there are various ways in which 
a BOC could attempt to discriminate against unaffiliated interLATA 
carriers, such as through poorer quality interconnection arrangements 
or unnecessary delays in satisfying its competitors' requests to 
connect to the BOC's network. Certain forms of discrimination may be 
difficult to police, particularly in situations where the level of the 
BOC's ``cooperation'' with unaffiliated interLATA carriers is difficult 
to quantify. To the extent customers value ``one-stop shopping,'' 
degrading a rival's interexchange service may also undermine the 
attractiveness of the rival's interexchange/local exchange package and 
thereby strengthen the BOC's dominant position in the provision of 
local exchange services. We continue to be concerned that a BOC could 
attempt to discriminate against unaffiliated interLATA carriers. For 
purposes of determining whether the BOC interLATA affiliates should be 
classified as dominant, however, we need to consider only whether a BOC 
could discriminate against its affiliate's interLATA competitors to 
such an extent that the affiliate would gain the ability to raise 
prices by restricting its own output upon entry or shortly thereafter.
    112. The 1996 Act contains a number of nondiscrimination 
safeguards, which we have implemented in the Non-Accounting Safeguards 
Order and Accounting Safeguards Order. For example, section 272(c)(1) 
prohibits a BOC, in its dealings with its section 272 affiliate, from 
``discriminat[ing] between that company or affiliate and any other 
entity in the provision or procurement of goods, services, facilities, 
and information, or in the establishment of standards.'' In the Non-
Accounting Safeguards Order, we concluded that section 272(c)(1) 
requires a BOC to provide unaffiliated entities the same goods, 
services, facilities, and information that it provides to its section 
272 affiliate at the same rates, terms, and conditions. We also 
concluded that a prima facie case of discrimination would exist under 
section 272(c)(1) if a BOC does not provide unaffiliated entities the 
same goods, services, facilities, and information that it provides to 
its section 272 affiliate at the same rates, terms, and conditions.Non-
Accounting Safeguards Order at para. 212. To rebut the complainant's 
case, the BOC may demonstrate, among other things, that rate 
differentials between the section 272 affiliate and unaffiliated entity 
reflect differences in cost, or that the unaffiliated entity expressly 
requested superior or less favorable treatment in exchange for paying a 
higher or lower price to the BOC. Id. In addition, we concluded that, 
to the extent a BOC develops new services for or with its section 272 
affiliate, it must develop new services for or with unaffiliated 
entities in the same manner.
    113. Section 272(e) also includes a number of specific 
nondiscrimination requirements. For example, section

[[Page 35997]]

272(e)(1) requires a BOC to ``fulfill any requests from an unaffiliated 
entity for telephone exchange service and exchange access within a 
period no longer than the period in which it provides such telephone 
exchange service and exchange access to itself or its affiliates.'' In 
the Non-Accounting Safeguards Order, we concluded that the term 
``requests'' includes, but is not limited to, initial installation 
requests, subsequent requests for improvement, upgrades or 
modifications of service, or repair and maintenance of these services. 
We also concluded that BOCs must disclose to unaffiliated entities 
information regarding service intervals in which BOCs provide service 
to themselves or their affiliates. Non-Accounting Safeguards Order at 
para. 241. In the Order, we sought further comment on specific 
information disclosure requirements that were proposed by AT&T in an ex 
parte letter filed after the official pleading cycle closed. Id. at 
para. 244. This disclosure requirement should promote compliance with 
section 272(e)(1) and allow competitors to resolve disputes informally 
rather than using the Commission's formal complaint process.
    114. Section 272(e)(2) restricts the ability of a BOC to provide 
``facilities, services, or information concerning its provision of 
exchange access to [its affiliate,] unless [it makes] such facilities, 
services, or information * * * available to other providers of 
interLATA services in that market on the same terms and conditions.'' 
Coupled with existing equal access and network disclosure requirements, 
this provision will limit the BOCs' ability to discriminate in the 
provision of such facilities, services, and information.
    115. Section 272(e)(3) requires that a BOC charge its affiliate 
``an amount for access to its telephone exchange service and exchange 
access that is no less than the amount [that the BOC charges] any 
unaffiliated interexchange carriers for such service.'' In the Non-
Accounting Safeguards Order, we recognized that this provision serves 
to constrain a BOC's ability to engage in discriminatory pricing of its 
exchange and exchange access service.
    116. We also find that the structural separation requirements of 
section 272(b) will constrain a BOC's ability to discriminate against 
its affiliate's interLATA competitors. As previously noted, we have 
interpreted the section 272(b)(1) requirement that a section 272 
affiliate ``operate independently'' from the BOC to prohibit the joint 
ownership of transmission and switching facilities by the BOC and its 
affiliate. This requirement ensures that an affiliate must obtain any 
such facilities on an arm's length basis pursuant to section 272(b)(5), 
thereby increasing the transparency of transactions between a BOC and 
its affiliates. As we observed in the Non-Accounting Safeguards Order, 
``[t]ogether, the prohibition on joint ownership of facilities and the 
nondiscrimination requirements should ensure that competitors can 
obtain access to transmission and switching facilities equivalent to 
that which section 272 affiliates receive.''
    117. We recognize that the nondiscrimination requirements in the 
Communications Act are effective only to the extent that they are 
enforced. To this end, the 1996 Act gives the Commission specific 
authority to enforce the requirements of section 272 and the other 
conditions for in-region, interLATA entry incorporated in section 
271(d)(3). Section 271(d)(6) provides that ``[i]f at any time after the 
approval of a [BOC application under section 271(d)(3)], the Commission 
determines that a [BOC] has ceased to meet any of the conditions 
required for such approval, the Commission may, after notice and 
opportunity for a hearing--(i) issue an order to such company to 
correct the deficiency; (ii) impose a penalty on such company pursuant 
to title V; or (iii) suspend or revoke such approval.'' In the Non-
Accounting Safeguards Order, we concluded that this authority augments 
the Commission's existing enforcement authority. Section 271(d)(6) also 
specifies that the Commission must act within 90 days on a complaint 
alleging that a BOC has failed to meet a condition required for in-
region, interLATA approval under section 271(d)(3).
    118. In light of the 90-day deadline to act upon a 271(d)(6) 
complaint, we adopted certain measures in the Non-Accounting Safeguards 
Order to expedite the processing of these complaints. We also recently 
initiated a separate proceeding addressing the expedited complaint 
procedures mandated by this subsection as well as those mandated by 
other provisions of the 1996 Act. See Amendment of Rules Governing 
Procedures to be Followed When Formal Complaints are Filed Against 
Common Carriers (61 FR 67978 (December 26, 1990)). For example, once a 
complainant has demonstrated a prima facie case that a defendant BOC 
has ceased to meet the conditions of entry, the burden of production 
(i.e., coming forward with evidence) will shift to the BOC defendant. 
By shifting this burden of production, we have placed on the BOC an 
affirmative obligation to produce evidence and arguments necessary to 
rebut the complainant's prima facie case or face an adverse ruling. The 
complainant, however, will have the ultimate burden of persuasion 
throughout the proceeding; that is, to show that the ``preponderance of 
the evidence'' produced in the proceeding weighs in its favor. Non-
Accounting Safeguards Order at para. 345. In the Non-Accounting 
Safeguards Order, we also concluded that, in addressing complaints 
alleging that a BOC has ceased to meet the conditions required for the 
provision of in-region interLATA services, we will not employ a 
presumption of reasonableness in favor of the BOC interLATA affiliate, 
regardless of whether the BOC or BOC interLATA affiliate is regulated 
as a dominant or non-dominant carrier. Id. at para. 351. The 
presumption of lawfulness given to nondominant carrier rates and 
practices is employed in the context of complaints alleging violations 
of sections 201(b) and 202(b), where the complaint must demonstrate 
that the defendant's rates and practices are ``unjust and 
unreasonable.'' We found that a presumption of reasonableness is an 
irrelevant concept in the context of complaints alleging violations of 
the conditions of interLATA approval in section 271(d)(3), particularly 
given our interpretation of section 272(c)(1) as an unqualified 
prohibition on discrimination. Id. We believe that these enforcement 
mechanisms will allow us to adjudicate complaints against the BOCs and 
BOC interLATA affiliates in a timely manner.
    119. We conclude that the statutory and regulatory safeguards 
discussed above will prevent a BOC from discriminating to such an 
extent that its interLATA affiliate would have the ability, upon entry 
or shortly thereafter, to raise the price of in-region, interstate, 
domestic, interLATA services by restricting its output. We also 
conclude that imposing dominant carrier regulation on the BOC interLATA 
affiliates would not significantly aid in the prevention of most types 
of discrimination. Although the advance tariff filing requirement might 
help detect certain types of price discrimination, the marginal benefit 
of such regulation would be outweighed by the burdens such regulation 
would impose, as discussed above. See supra Paras.  88-90. Although 
AT&T expresses concern about the risk of discrimination, it suggests 
that the Commission should impose stringent non-discrimination 
requirements and reporting obligations in order to combat this problem. 
It does not contend that

[[Page 35998]]

dominant carrier regulation would help to prevent discrimination. We 
are not persuaded by Time Warner's assertion that dominant carrier 
regulation is necessary to ensure that the BOCs comply with their 
statutory obligation to charge affiliates rates equal to those charged 
unaffiliated carriers for telephone exchange and exchange access 
services. Rather, as discussed above, we conclude that the section 272 
safeguards, coupled with the expedited enforcement mechanism, should 
provide an adequate means of ensuring that the BOCs comply with this 
requirement.

e. Price Squeeze

i. Comments
    120. The BOCs generally argue that they do not have the ability to 
engage in a price squeeze by raising prices because their access prices 
are regulated. They also note that section 272(e)(3) requires BOCs to 
charge their affiliates the same access rates they charge unaffiliated 
carriers. PacTel claims that a true price squeeze would occur only if 
the price charged by the BOC interLATA affiliate was less than the 
BOC's marginal cost of access, plus the foregone contribution from that 
access, plus the affiliate's cost of providing the long distance 
service. PacTel contends that it would be irrational for a BOC 
interLATA affiliate to price below this level unless its object was 
predation, which is not a plausible strategy. On the other hand, 
according to PacTel, a BOC interLATA affiliate's acceptance of little 
or no profit in order to expand its market share, by itself, would not 
be a price squeeze and would not be anticompetitive. NYNEX claims that 
significant changes to local exchange service and access markets 
initiated by the Local Competition First Report and Order (61 FR 45476 
(August 29, 1996)) make it unreasonable to fear that BOC access pricing 
could result in its affiliate's attaining long distance market power, 
particularly in light of the Commission's commitment to undertake and 
complete access reform within the next year.
    121. Non-BOC commenters generally contend that the BOCs will have 
the incentive and ability to engage in a price squeeze, despite price 
cap regulation of the BOCs' access services and other applicable 
safeguards. The Economic Strategy Institute asserts that antitrust and 
economic literature generally supports the need for regulatory 
intervention in cases of price squeezes. MCI contends that the BOCs are 
most likely to exercise market power by assessing excessive prices for 
exchange access services for all carriers (including the BOCs' 
interLATA affiliates), and price cap regulation will not prevent this 
tactic because access rates are already excessive. MFS argues that, as 
long as a BOC is allowed to provide both essential services and 
competitive services, and as long as those essential services are 
priced above cost, a ``vertically integrated'' BOC can drive even more 
efficient rivals out of the market. MFS and MCI further assert that a 
price squeeze would not be limited to price increases in access 
services, but could also arise from the contribution BOCs earn on 
stimulated demand for access services created by competitors' forced 
price reductions to match a BOC interLATA affiliate price reduction. 
MCI claims that such a strategy could seriously harm competition. 
According to MCI, even if rivals remain in the market, they will be 
weakened by the cost increases they are forced to absorb, thereby 
reducing their output and the ``vigors of competition.''
    122. LDDS asserts that the structural separation, accounting, and 
imputation requirements in the Communications Act do not adequately 
address the BOCs' access cost advantage because: (1) There is no way to 
ensure that a BOC interLATA affiliate's costs, other than for access, 
are reflected in its prices; (2) to the extent customers buy bundled 
local exchange, long distance, and other services from a BOC interLATA 
affiliate, the BOC interLATA affiliate could effectively evade 
imputation requirements by passing on its access cost advantage in 
reduced prices for services not subject to the Commission's direct 
jurisdiction, such as local exchange and information services; (3) a 
BOC will have the incentive and ability to favor its interLATA 
affiliate over its competitors in the provision of bundled local 
exchange and interLATA services; and (4) a BOC has the ability to 
discriminate against its affiliate's interLATA competitors on terms 
other than price.
    123. MCI and AT&T argue that requiring cost support data and 
advance notice periods for tariff filings is important to ensure that 
the BOC interLATA affiliates are pricing their services above their 
costs. MFS, however, questions whether regulating BOC interLATA 
affiliates as dominant firms would be effective in preventing price 
squeezes. It contends that the only effective mechanisms for preventing 
this behavior are pricing BOC essential services at economic cost and 
developing competitive alternatives to the BOCs' essential services.
    124. Ameritech disputes arguments that access charges are priced 
above economic costs and therefore will enable BOC interLATA affiliates 
to set interLATA rates below cost without incurring a loss. According 
to Ameritech, any subsidies in access are real costs that the BOC must 
recover in some manner in order to remain ``whole.'' Ameritech also 
claims that price squeeze arguments ignore the fact that BOC interLATA 
affiliates will pay access charges to unaffiliated carriers when they 
originate or terminate long distance calls out-of-region and that 
facilities-based incumbent carriers actually have significant cost 
advantages. Finally, Ameritech disputes the relevance of the price 
squeeze arguments. According to Ameritech, a BOC interLATA affiliate's 
ability to gain market share by setting rates below the cost of access 
would not constitute a basis for classifying the BOC interLATA 
affiliate as dominant. Ameritech is aware of no legal theory under 
which such a practice could be considered unreasonable or otherwise 
unlawful, since consumers would suffer no harm unless the BOC interLATA 
affiliate could somehow acquire market power from its action. Bell 
Atlantic and NYNEX claim that advance notice periods for tariff filings 
and cost support requirements are unnecessary to ensure compliance with 
the section 272 imputation requirement because the 1996 Act already 
provides for a biennial audit, which is intended to serve specifically 
as a check on compliance with the section 272 separation requirements, 
including the imputation requirement.
ii. Discussion
    125. In the Non-Accounting Safeguards NPRM, we noted that, absent 
appropriate safeguards, a BOC potentially could raise the price of 
access to all interexchange carriers, including its affiliate. This 
would cause competing interLATA carriers either to raise their retail 
interLATA rates in order to maintain the same profit margins or to 
attempt to preserve their market share by not raising their prices to 
reflect the increase in access charges, thereby reducing their profit 
margins. If the competing in-region interLATA service providers raised 
their prices to recover the increased access charges, the BOC interLATA 
affiliate could seek to expand its market share by not matching the 
price increase. In that event, although the BOC interLATA affiliate 
would achieve lower profit margins than its rivals, all other things 
being equal, the BOC corporate entity as a whole would receive 
additional access revenues from unaffiliated carriers due to the access 
price increase and greater

[[Page 35999]]

revenues from the affiliate's interLATA services caused by its 
increased share of interLATA traffic. If the BOC were to raise its 
access rates high enough, it would be impossible for interexchange 
competitors to compete effectively. Thus, the entry of a BOC's 
affiliate into the provision of in-region, interstate, domestic, 
interLATA services might give the BOC an incentive to raise its price 
for access services in order to disadvantage its affiliate's rivals, 
increase its affiliate's market share, and increase the profits of the 
BOC overall. Non-Accounting Safeguards NPRM at para.141. In the Notice, 
we recognized that the same situation could occur if a BOC failed to 
pass through to interexchange carriers a reduction in the cost of 
providing access services, and that price cap regulation would not be 
effective in eliminating the effect of a price squeeze initiated under 
these circumstances. Id. at para.141 n.272.
    126. We conclude, as discussed in the NPRM, that price cap 
regulation of the BOCs' access services sufficiently constrains a BOC's 
ability to raise access prices to such an extent that the BOC affiliate 
would gain, upon entry or soon thereafter, the ability to raise prices 
of interLATA services above competitive levels by restricting its own 
output of those services. See NYNEX comments at 57. We also note that 
the emergence of competition in the provision of exchange access 
service may also constrain a BOC's ability to raise access prices. See 
id.; SBC Aug. 30, 1996 Reply at 27. Although a BOC may be able to raise 
its access rates to some extent if those rates are currently below the 
applicable price cap and could fail to pass along reductions in the 
cost of access if the productivity factor is too low, we conclude that 
such an increase would not give a BOC affiliate the ability to raise 
prices of interLATA services above competitive levels by restricting 
its own output of those services. We will consider the impact of such a 
potential increase on competition in the pending access charge reform 
proceeding. We also note that the ability of competing carriers to 
acquire access through the purchase of unbundled elements enables them 
to avoid originating access charges and thus partially protect 
themselves against a price squeeze. See 47 U.S.C. Sec. 252(d)(1)(A)(i). 
The Commission's pricing rules interpreting section 252(d)(1)(A)(i) are 
currently under stay by the 8th Circuit Court of Appeals. Iowa 
Utilities Board v. FCC, No. 96-3321, 1996 WL 589284 (8th Cir. Oct. 15, 
1996) (order granting stay pending judicial review). To the extent that 
access charges are reformed to more closely reflect economic cost, as 
is being considered in the access charge reform proceeding, the 
potential for a price squeeze should be further mitigated.
    127. Some commenters assert, however, that a BOC could engage in a 
price squeeze without raising the price of its access services. These 
commenters suggest that, because access services are currently priced 
above economic cost, a BOC interLATA affiliate could set its interLATA 
prices at or below the BOC's access prices and still be profitable. The 
affiliate's interLATA competitors would then be faced with the choice 
of setting their prices at unprofitable levels or losing market share. 
Several BOCs respond that this would not be a profit-maximizing 
strategy because the increased revenues they would receive from the 
affiliate's interLATA services would be offset by a reduction in the 
access revenues received from unaffiliated carriers. If the affiliate's 
reduction in interLATA rates sufficiently increased demand, however, it 
is possible the BOC interLATA affiliate's higher interLATA revenues 
would more than offset lost access revenues, assuming the affiliate's 
interLATA competitors do not match the affiliate's price reduction. If, 
in the alternative, the competitors reduce their interLATA rates to 
match the BOC interLATA affiliate's reductions, the BOC would receive 
increased access revenues. In the extreme, such a situation could drive 
the affiliate's rivals from the market. MCI claims that, even if such a 
predatory strategy is not successful, the rivals would be weakened by 
the cost increases they absorb, thereby reducing their output and their 
ability to compete effectively.
    128. We conclude that imposing advance tariffing and cost support 
data requirements on the BOC interLATA affiliates would not be an 
efficient means of preventing the BOCs from engaging in such a 
predatory price squeeze strategy. As previously discussed, advance 
notice periods for tariff filings could reduce the BOC interLATA 
affiliates' incentives to reduce their interLATA rates. Furthermore, 
requiring the BOC interLATA affiliates to file cost support data could 
discourage them from introducing innovative new service offerings. We 
also conclude that imposing advance tariff filing and cost support data 
requirements on the BOC interLATA affiliates would not address LDDS' 
concern that the BOC interLATA affiliates could effectively evade 
imputation requirements by passing on their access cost advantage in 
reduced prices for services not subject to the Commission's 
jurisdiction, such as local exchange and information services. In 
addition, we believe that, if the predatory behavior described above 
were to occur, it could be adequately addressed through our complaint 
process and enforcement of the antitrust laws, coupled with the 
biennial audits required by section 272(d), such that the benefits of 
any protections offered by advance tariffing and cost support data 
requirements would be outweighed by the enormous administrative burden 
those requirements would impose on the Commission. A BOC interLATA 
affiliate that charges a rate for its interLATA services below its 
incremental cost to provide service would be in violation of sections 
201 and 202 of the Communications Act, if such a rate were sustained 
for an extended period.
    129. We also note that other factors constrain the ability of a BOC 
or BOC interLATA affiliate to engage in a predatory price squeeze. For 
example, a BOC interLATA affiliate's apparent cost advantage resulting 
from its avoidance of access charges may be offset by other costs it 
must incur, such as the cost of interLATA transport, which, at least 
initially, may be greater than the true marginal cost of interLATA 
transport for facilities-based interLATA carriers. In addition, a BOC 
interLATA affiliate will have to pay terminating access charges to LECs 
other than its BOC parent for calls terminating outside the BOC's 
region and to competing LECs in the BOC's in-region states. Having to 
pay such access charges reduces the cost disparity between the BOC 
interLATA affiliate and competing interexchange carriers. Finally, we 
note that a price squeeze strategy would give a BOC interLATA affiliate 
the ability to raise price by restricting its own output only if it is 
able to drive competitors from the market. As discussed previously, the 
existence of four nationwide, or near-nationwide, network facilities 
makes it unlikely that a BOC interLATA affiliate could successfully 
engage in a predatory strategy. As a result, we conclude that the BOCs 
or BOC interLATA affiliates will not be able to engage in a price 
squeeze to such an extent that the BOC interLATA affiliates will have 
the ability, upon entry or soon thereafter, to raise price by 
restricting their own output. Thus we do not believe that classifying a 
BOC's interLATA affiliate as a dominant carrier is necessary or 
appropriate to constrain the BOC and its affiliate from attempting to 
execute a predatory price squeeze.
    130. We agree with commenters that assert that the risk of the BOCs 
engaging in a price squeeze will be greatly

[[Page 36000]]

reduced when interLATA competitors gain the ability to purchase access 
to the BOCs' networks at or near cost, and as competition develops in 
the provision of exchange access services. As noted, we believe that 
the ability of competing carriers to acquire access through the 
purchase of unbundled elements enables them to avoid originating access 
charges and thus partially protect themselves against a price squeeze. 
Moreover, to the extent that access charges are reformed to more 
closely reflect economic cost, as is being considered in the access 
charge reform proceeding, the potential for a price squeeze should be 
further mitigated.

f. Mergers or Joint Ventures Between Two or More BOCs

i. Background and Comments
    131. In the Non-Accounting Safeguards NPRM, we sought comment on 
what effect, if any, a merger of or joint venture between two or more 
BOCs should have on our determination whether to classify the interLATA 
affiliate of one of those BOCs as dominant or non-dominant. Bell 
Atlantic, contends that the prospect of mergers between BOCs should not 
have any impact on whether the BOCs are treated as dominant because 
both parties to such a merger would be entering the long distance 
market with zero market share and in competition with well established 
competitors and because the merged company's access business would 
remain subject to all the same market and regulatory constraints as 
nonmerged BOCs. Sprint and the New York State Department of Public 
Service (NYPDS) contend that mergers, acquisitions, and similar 
combinations by BOCs may require consideration of geographic markets 
more expansive than a particular BOC's region.
ii. Discussion
    132.We conclude that a merger of or joint venture between two or 
more BOCs should have no direct effect on our determination of whether 
to classify the interLATA affiliates of one of those BOCs as dominant 
or non-dominant. Bell Atlantic notes that, even though a merged 
company's territory would grow, it would continue to be subject to the 
same regulation currently imposed on the individual companies prior to 
the merger or joint venture. In the Non-Accounting Safeguards Order, we 
concluded that, upon completion of a merger between or among BOCs, the 
in-region states of a merged entity shall include all of the in-region 
states of each of the BOCs involved in the merger. Non-Accounting 
Safeguards Order at para. 69. We declined, however, to adopt a general 
rule that would treat the regions of merging BOCs as combined prior to 
completion of the merger, for the purposes of applying the section 272 
separate affiliate and nondiscrimination safeguards. We found that 
adequate protections against discriminatory and anticompetitive conduct 
already applied to mergers, acquisitions, and joint ventures among 
BOCs. Id. Thus, the merged entity would be required to satisfy the 
requirements of sections 271 and 272 in providing interLATA services 
originating in those in-region states. We also note that DOJ is 
currently considering the implications of such mergers and joint 
ventures from an antitrust perspective.

g. Conclusion

    133. Based on the preceding analysis, we conclude that the BOCs' 
interLATA affiliates will not have the ability, upon entry or soon 
thereafter, to raise the price of in-region, interstate, domestic, 
interLATA services by restricting their own output, and, therefore, 
that the BOC interLATA affiliates should be classified as non-dominant 
in the provision of those services. We note, however, that we retain 
the ability to impose some or all of the dominant carrier regulations 
on one or more of the BOC interLATA affiliates if this proves necessary 
in the future. As discussed in the NPRM, our experience with regulating 
the independent LECs' provision of interstate, domestic, interexchange 
services and the BOCs' provision of enhanced services suggests that our 
existing safeguards have worked reasonably well and generally have been 
effective, in conjunction with our regular audits, in deterring the 
improper allocation of costs and unlawful discrimination. Non-
Accounting Safeguards NPRM at para. 146; PacTel Aug. 15, 1996 Comments 
at 65-66 (noting that PacTel has lost significant market share in 
intraLATA toll services and that Bell Atlantic and NYNEX have not 
gained significant market share in the provision of interLATA corridor 
services). We acknowledge, however, that there have been instances in 
which individual BOCs may have not complied with our non-structural 
safeguards in providing non-regulated services. See id. n. 284. See 
also MCI Aug. 15, 1996 Comments at 67 (referring to the MemoryCall 
case). We are not persuaded by MCI's argument that the Ninth Circuit's 
decision in California III (California v. FCC, 39 F.3d 919, 923 (9th 
Cir. 1994) (California III). In its Computer III decisions, the 
Commission removed the separate affiliate requirements applicable to 
AT&T and the BOCs, provided that they complied with certain 
nonstructural safeguards intended to guarantee that they offered their 
regulated network services to competing enhanced service providers on 
an equal and nondiscriminatory basis. The U.S. Court of Appeals for the 
Ninth Circuit vacated portions of the Commission's Computer III 
decisions in three separate decisions leads to the conclusion that we 
should impose dominant carrier regulation on the BOC interLATA 
affiliates. As discussed above, section 272 requires the BOCs to 
provide in-region, interLATA services through structurally separate 
affiliates. Since section 272's structural separation requirements are 
akin to those in Computer II, the Ninth Circuit's discussion of whether 
the Commission had adequately justified its elimination of the Computer 
II structural separation requirements for BOC enhanced services is not 
relevant here.
    134. We believe that the entry of the BOC interLATA affiliates into 
the provision of in-region, interLATA services has the potential to 
increase price competition and lead to innovative new services and 
market efficiencies. We recognize that, as long as the BOCs retain 
control of local bottleneck facilities, they could potentially engage 
in improper cost allocation, discrimination, and other anticompetitive 
conduct to favor their affiliates' in-region, interLATA services. We 
conclude, however, that, to the extent dominant carrier regulation 
addresses such anticompetitive conduct, the burdens imposed by such 
regulation outweighs its benefits. We therefore see no reason to impose 
dominant carrier regulation on the BOC interLATA affiliates, given that 
section 272 contains numerous safeguards designed to prevent the BOCs 
from engaging in improper cost allocation, discrimination, and other 
anticompetitive conduct. Section 272(f)(1) of the Communications Act 
provides that the BOC safeguards set out in section 272, other than 
those prescribed in section 272(e), shall sunset three years after the 
date that the BOC affiliate is authorized to provide interLATA 
telecommunications services unless the Commission extends such three-
year period by rule or order. We cannot now predict how competition 
will develop in local exchange markets nor can we determine at this 
time what accounting and non-accounting safeguards, if any, will be 
needed at that time. Accordingly, we recognize that it will be 
necessary for the Commission to determine what accounting and non-

[[Page 36001]]

accounting safeguards, if any, are necessary and appropriate upon 
expiration of those section 272 safeguards subject to sunset, and 
whether BOC interLATA affiliates should be classified as dominant or 
non-dominant in the provision of in-region, interstate, domestic, 
interLATA services. We emphasize that our decision to accord non-
dominant treatment to the BOCs' provision of in-region, interLATA 
services is predicated upon their full compliance with the structural, 
transactional, and nondiscrimination requirements of section 272 and 
our implementing rules. We believe that these safeguards, coupled with 
other statutory and regulatory safeguards, are sufficient to prevent 
the BOC interLATA affiliates from gaining the ability, upon entry or 
shortly thereafter, to raise prices by restricting their output.
3. Classification of BOC InterLATA Affiliates in the Provision of In-
Region, International Services

a. Background

    135. In the Non-Accounting Safeguards NPRM, we tentatively 
concluded that we should apply the same regulatory treatment to a BOC 
interLATA affiliate's provision of in-region, international services as 
we apply to its provision of in-region, interstate, domestic, interLATA 
services, assuming the BOC or BOC interLATA affiliate does not have an 
affiliation with a foreign carrier that has the ability to discriminate 
against the rivals of the BOC or its affiliate through control of 
bottleneck facilities in a foreign destination market. Under this 
proposal, our current framework for addressing issues raised by foreign 
carrier affiliations would apply to the BOCs' provision of U.S. 
international services.

b. Comments

    136. Most commenters support the Commission's proposal to apply the 
same regulatory treatment to the BOC interLATA affiliates' provision of 
in-region, international services as it applies to in-region, 
interstate, domestic interLATA services. PacTel and US West agree that 
if the BOC interLATA affiliates should be non-dominant for in-region 
domestic services, they should be non-dominant for in-region 
international services, but they further claim that differences in the 
domestic and international markets suggest that BOC interLATA 
affiliates should be classified as nondominant for international 
interLATA services regardless of their classification for domestic 
services. PacTel agrees that the existing rules governing dominance 
based on foreign market affiliations should apply to BOC interLATA 
affiliates as they do to all other international carriers. PacTel 
suggests, however, that the Commission should ensure that route-by-
route dominance filings, based on foreign affiliations, be concluded no 
later than the grant of a section 271 entry petition.
    137. MCI generally agrees with the Commission that a BOC's in-
region international service should be treated in a manner similar to 
its in-region domestic interLATA service. It contends, however, that 
the BOCs have unique advantages in the international services market as 
a result of their ``regional focus.'' MCI expresses concern that the 
BOCs will enter into special arrangements with foreign carriers under 
which return traffic would be ``groomed''--i.e., the foreign carrier 
would give the BOC's interLATA affiliate the return traffic that 
terminates in the BOC's region. MCI contends that, by contrast, non-BOC 
interexchange carriers would be required to take return traffic to 
destinations all over the United States and thereby incur higher costs 
in terminating such traffic. MCI notes that a disproportionate amount 
of international traffic terminates in the NYNEX and Pacific Bell 
regions and argues that these BOCs would have an especially lucrative 
opportunity to obtain groomed traffic. MCI notes that such arrangements 
may result in lower costs for terminating U.S. inbound traffic, but 
characterizes these arrangements as ``anticompetitive.'' It urges the 
Commission, at a minimum, to impose on the BOC interLATA affiliates the 
same safeguards that it imposed on MCI in the order approving British 
Telecom's (BT's) initial 20 percent investment in MCI. A number of the 
BOCs respond that such additional requirements are unnecessary and 
inappropriate.

c. Discussion

    138. We adopt our tentative conclusion that we should apply the 
same regulatory treatment to a BOC interLATA affiliate's provision of 
in-region, international services as we apply to its provision of in-
region, interstate, domestic, interLATA services. As discussed in the 
NPRM, the relevant issue in both contexts is whether the BOC interLATA 
affiliate can exploit its market power in local exchange and exchange 
access services to raise prices by restricting its own output in 
another market (the domestic interLATA or international market). We 
also note that the section 272 safeguards apply equally to the BOCs' 
in-region, domestic, interLATA and in-region, international services. 
We find no practical distinctions between a BOC's ability and incentive 
to use its market power in the provision of local exchange and access 
services to improperly allocate costs, discriminate against, or 
otherwise disadvantage unaffiliated domestic interexchange competitors 
as opposed to international service competitors.
    139. In light of our classification of the BOC interLATA affiliates 
as non-dominant in the provision of in-region, interstate, domestic, 
interLATA services, we accordingly will classify each BOC interLATA 
affiliate as non-dominant in the provision of in-region, international 
services, unless it is affiliated, within the meaning of section 
63.18(h)(1)(i) of our rules, with a foreign carrier that has the 
ability to discriminate against the rivals of the BOC or its affiliate 
through control of bottleneck services or facilities in a foreign 
destination market. We will apply section 63.10(a) of our rules to 
determine whether to regulate a BOC interLATA affiliate as dominant on 
those U.S. international routes where an affiliated foreign carrier has 
the ability to discriminate against unaffiliated U.S. international 
carriers through control of bottleneck services or facilities in the 
foreign destination market. The safeguards that we apply to carriers 
that we classify as dominant based on a foreign carrier affiliation are 
contained in Section 63.10(c) of our rules and are designed to address 
the incentive and ability of the foreign carrier to discriminate 
against the rivals of its U.S. affiliate in the provision of services 
or facilities necessary to terminate U.S. international traffic. 
Section 63.10(a) of the Commission's rules provides that: (1) Carriers 
having no affiliation with a foreign carrier in the destination market 
are presumptively non-dominant for that route; (2) carriers affiliated 
with a foreign carrier that is a monopoly in the destination market are 
presumptively dominant for that route; (3) carriers affiliated with a 
foreign carrier that is not a monopoly on that route receive closer 
scrutiny by the Commission; and (4) carriers that serve an affiliated 
destination market solely through the resale of an unaffiliated U.S. 
facilities-based carrier's switched services are presumptively 
nondominant for that route. See also Regulation of International Common 
Carrier Services, Paras. 19-24. This framework for addressing issues 
raised by foreign carrier affiliations will apply to the BOCs' 
provision of U.S. international

[[Page 36002]]

services as an additional component of our regulation of the U.S. 
international services market.
    140. We reject MCI's suggestion that we should impose additional 
safeguards on the BOC's in-region, international services. We observe, 
as an initial matter, that all U.S. international carriers are subject 
to the same prohibition against accepting ``special concessions'' from 
foreign carriers that we imposed on MCI in the order approving BT's 
initial 20 percent investment in MCI. The grooming described by MCI 
would constitute a special concession prohibited by the terms of 
Section 63.14 of the Commission's rules to the extent the U.S. carrier 
entered into a grooming arrangement that the foreign carrier did not 
offer to similarly situated U.S. carriers. See 47 CFR Section 63.14 
(``[a]ny carrier authorized to provide international communications 
service * * * shall be prohibited from agreeing to accept special 
concessions directly or indirectly from any foreign carrier or 
administration with respect to traffic or revenue flows between the 
United States and any foreign country served * * * and from agreeing to 
enter into such agreements in the future * * *.'' ). A U.S. carrier 
that negotiates a grooming arrangement with a foreign carrier on a 
particular route would be required to submit the arrangement to the 
Commission for public comment and review in circumstances where the 
arrangement deviates from existing arrangements with other U.S. 
carriers for the routing and/or settlement of traffic on that route.
    141. We are not prepared to rule on this record, however, that the 
grooming of return traffic (i.e., giving a U.S. carrier the return 
traffic that terminates in a particular region) in a manner that may 
ultimately reduce U.S. carrier costs and rates is anticompetitive per 
se. We recently adopted guidelines for permitting in certain 
circumstances flexible settlement arrangements between U.S. and foreign 
carriers that do not comply with the International Settlements Policy 
(ISP). Regulation of International Accounting Rates (62 FR 5535 
(February 6, 1997)) (Accounting Rate Flexibility Order). The ISP 
requires: (1) The equal division of accounting rates; (2) non-
discriminatory treatment of U.S. carriers; and (3) proportionate return 
of U.S.-bound traffic. The ISP is designed to prevent foreign carriers 
with market power from obtaining discriminatory accounting rate 
concessions from competing U.S. carriers. See generally Policy 
Statement on International Accounting Rate Reform (61 FR 11163 (March 
19, 1996)). MCI will have ample opportunity to make its arguments, with 
proper economic support, in the event a BOC interLATA affiliate or any 
other U.S. international carrier seeks to establish an arrangement for 
grooming return traffic.
    142. We are also unpersuaded that the other conditions imposed in 
the 20 percent BT investment in MCI are useful or necessary in this 
case. MCI has not explained how those conditions are relevant to the 
BOC interLATA affiliates' provision of in-region international service 
on routes where they have no investment interest in or by a foreign 
carrier. The conditions imposed on MCI apply to its operations only on 
the U.S.-U.K. route, where we found that BT controlled bottleneck local 
exchange and exchange access facilities on the U.K. end, and they were 
targeted to limiting the potential risks of undue discrimination 
between a U.S. carrier (MCI) and a foreign carrier with which the U.S. 
carrier has an equity relationship (BT). We note that MCI and BT have 
requested Commission approval of the transfer of control to BT of 
licenses and authorization held by MCI subsidiaries, which would occur 
as a result of the proposed merger of MCI and BT. See MCI 
Communications Corporation and British Telecommunications PLC Seek FCC 
Consent for Proposed Transfer of Control, GN Docket No. 96-245, Public 
Notice, DA 96-2079 (rel. Dec. 10, 1996). To the extent a BOC has an 
equity interest in a foreign carrier or the foreign carrier has such an 
interest in a BOC on a particular U.S. international route, it is of 
course subject to Section 63.10 of our rules. This rule sets forth the 
framework for imposing certain safeguards on U.S. carriers that are 
affiliated with foreign carriers that have the ability to discriminate 
in the favor of their U.S. affiliate through the control of bottleneck 
services or facilities.

B. Classification of Independent LECs

    143. For the reasons discussed below, we conclude that the 
requirements established in the Fifth Report and Order, together with 
other existing rules, sufficiently limit an independent LEC's ability 
to exercise its market power in the local exchange and exchange access 
markets so that the LEC cannot profitably raise and sustain the price 
of in-region, interstate, domestic, interexchange services by 
restricting its own output. We, therefore, classify independent LECs as 
non-dominant in the provision of these services. We recognize, however, 
that an independent LEC conceivably could use its control over local 
bottleneck facilities to allocate costs improperly, engage in unlawful 
discrimination, or attempt to price squeeze. We, therefore, impose the 
Fifth Report and Order separation requirements on all incumbent 
independent LECs that provide in-region, interstate, domestic, 
interexchange services. We further conclude that we should apply the 
same regulatory classification to the independent LECs' provision of 
in-region, international services that we adopt for their provision of 
in-region, interstate, domestic, interexchange services.
1. Classification of Independent LECs in the Provision of In-Region, 
Interstate, Domestic, Interexchange Services

a. Background

    144. In the Competitive Carrier Fourth Report and Order, the 
Commission determined that interexchange carriers affiliated with 
independent LECs would be regulated as non-dominant carriers. In the 
Competitive Carrier Fifth Report and Order, the Commission clarified 
the definition of ``affiliate'' (The Commission defined a carrier 
affiliated with an independent LEC as ``a carrier that is owned (in 
whole or in part) or controlled by, or under common ownership (in whole 
or in part) or control with, an exchange telephone company.'' Fifth 
Report and Order, 98 FCC 2d at 1198, para. 9.) and identified three 
separation requirements that the affiliate must meet in order to 
qualify for non-dominant treatment. These requirements are that the 
affiliate: (1) Maintain separate books of account; (2) not jointly own 
transmission or switching facilities with the LEC; and (3) acquire any 
services from its affiliated exchange company at tariffed rates, terms, 
and conditions. The Commission further concluded that, if the LEC 
provides interstate, interexchange service directly, rather than 
through an affiliate, or if the affiliate fails to satisfy the three 
requirements, those services would be subject to dominant carrier 
regulation. The Commission observed that these separation requirements 
would provide some ``protection against cost-shifting and 
anticompetitive conduct'' by an independent LEC that could result from 
its control of local bottleneck facilities.
    145. In the Non-Accounting Safeguards NPRM, we sought comment on 
how we should classify independent LECs' provision of in-region, 
interstate, interexchange services. We also sought comment on whether, 
absent the Fifth Report and Order separation requirements, an 
independent LEC would be able to use its market power

[[Page 36003]]

in local exchange and exchange access services to disadvantage its 
interexchange competitors to such an extent that it would quickly gain 
the ability profitably to raise and sustain the price of in-region, 
interstate, domestic interexchange service significantly above 
competitive levels by restricting its output. We suggested that, 
regardless of our determination of whether independent LECs should be 
classified as dominant or non-dominant, some level of separation may be 
necessary between an independent LEC's interstate, domestic, 
interexchange operations and its local exchange operations to guard 
against cost misallocation, unlawful discrimination, or a price 
squeeze. In addition, we sought comment on whether the existing Fifth 
Report and Order requirements are sufficient safeguards to apply to 
independent LECs to address these concerns.

b. Comments

    146. Commenters generally suggest two different schemes for 
regulating independent LECs' provision of in-region, interstate, 
interexchange services. First, independent LECs and others argue that 
the Commission should find that independent LECS are non-dominant in 
their provision of in-region, interstate, interexchange services, and 
that the Fifth Report and Order requirements are no longer necessary. 
According to these commenters, the Commission should eliminate the 
existing Fifth Report and Order separate affiliate requirement as a 
precondition for non-dominant classification. In support of their 
contention that independent LECs should be regulated as non-dominant in 
their provision of in-region, interstate, interexchange services, these 
commenters argue that: (1) independent LECs do not have market power in 
the in-region, interstate, interexchange market based on the market 
power factors that the Commission applied in reclassifying AT&T as a 
non-dominant interexchange carrier; (2) dominant carrier regulation 
would reduce competition in the long distance market; (3) imposition of 
the Fifth Report and Order separations requirements on independent 
LECs' provision of in-region, interstate, interexchange service is 
inconsistent with the 1996 Act; and (4) the real costs of requiring any 
level of separation for independent LECs far outweighs the speculative 
benefits of separation.
    147. In addition, these commenters assert that independent LECs 
have neither the ability nor the incentive to leverage the market power 
resulting from their control over local facilities to impede 
competition in the interexchange market. These commenters argue that 
their inability to leverage control over local facilities is 
attributable to several factors, including provisions of the 1996 Act 
that are designed to open the local market to competition; the 
geographic dispersion and largely rural nature of independent LEC 
service territories; cost accounting safeguards, price caps on access 
services, and regulations to prevent non-price discrimination in the 
quality of access services provided; and the interexchange carriers' 
increasing emphasis on constructing their own facilities.
    148. GTE contends that the Commission is legally prohibited from 
imposing separation requirements on independent LECs in general, and 
specifically on GTE. GTE argues that section 601(a)(2) of the 1996 Act, 
which removes the restrictions and obligations imposed by the GTE 
Consent Decree, prohibits the Commission from imposing any separate 
affiliate requirements on GTE. In addition, GTE asserts that section 
271 and 272 added by the 1996 Act, apply only to BOCs, therefore, these 
sections reflect Congress' determination that there is no need to 
extend the separation requirements of section 272 to independent LECs 
or GTE. Moreover, GTE maintains that, if the Commission continues to 
require separate affiliates, it should modify the Fifth Report and 
Order requirements to allow the affiliate to take exchange access 
services not only by tariff, but also on the same basis as other 
carriers that have negotiated interconnection agreements pursuant to 
section 251.
    149. Sprint argues that the Fifth Report and Order separation 
requirements are no longer necessary because those requirements have 
been incorporated into the Commission's cost allocation rules.
    150. In contrast, interexchange carriers, except Sprint, and 
competing access providers generally argue that the Commission not only 
should retain the Fifth Report and Order separation requirements as a 
condition for non-dominant treatment of independent LEC provision of 
in-region, interstate, interexchange services, but also should impose 
additional safeguards to prevent independent LECs from engaging in 
anticompetitive behavior by virtue of their control over bottleneck 
facilities.
    151. Teleport argues that the Commission should impose quarterly 
reporting requirements that will enable competitors and the Commission 
to analyze objectively the independent LEC's service record and to 
compare service to competitors with service to itself or its 
affiliates. Teleport also recommends that the Commission implement an 
expedited complaint process to address service quality complaints by 
competing carriers.
    152. AT&T argues that the Fifth Report and Order and our dominant 
carrier requirements are inadequate to address independent LECs' 
potential abuse of market power. AT&T contends that the Commission 
should, therefore, impose the same structural separation and non-
discrimination requirements on independent LECs that we impose on BOCs, 
as well as a modified form of dominant carrier regulation. AT&T also 
asks the Commission to make clear that equal access requirements apply 
to independent LECs, including the requirement that a customer seeking 
local service from such carriers be offered the options for 
interexchange service in a neutral fashion. AT&T asserts that the Fifth 
Report and Order allows joint and integrated design, planning, and 
provisioning of exchange and interexchange services, which inherently 
discriminates against other carriers and permits the costs of long 
distance operations to be misallocated to monopoly ratepayers. In 
addition, AT&T, challenging SNET's claim that geographic rate averaging 
would mitigate the effects of any unilateral increase in access 
charges, asserts that access charges are far above cost, and that this 
enables LECs to impose a price squeeze in the interexchange market.
    153. MCI asserts that, given the types of abuses that control over 
bottleneck facilities allows, it is necessary to review independent 
LECs' in-region, interexchange rates to ensure that they fully cover 
independent LEC tariffed access and other costs. MCI further contends 
that enforcement of the imputation requirement is necessary to protect 
against an independent LEC's adopting a price squeeze strategy, and 
maintains that the Commission's cost accounting rules and after-the-
fact audits are insufficient to ensure that LEC interLATA rates cover 
imputed access costs. Like AT&T, MCI claims that, because an 
independent LEC's actual access costs are much lower than the tariffed 
rates, an independent LEC could adopt a successful price-squeeze 
strategy against its interexchange rivals. MCI adds that an independent 
LEC may be able to increase its total profits by reducing the price of 
its interLATA service, thereby increasing the demand for its switched 
access service.
    154. The Commonwealth of the Northern Mariana Islands (CNMI) 
asserts that GTE-owned Micronesian

[[Page 36004]]

Telecommunications Corporation (MTC), which is the sole provider of 
both local exchange and exchange access services and a major provider 
of domestic and international off-island services in the Commonwealth, 
currently provides domestic, interexchange services on a nondominant 
basis, even though it lacks a separate subsidiary. CNMI asks the 
Commission to recognize explicitly that MTC must comply with the Fifth 
Report and Order separation requirements or comply with the 
Commission's dominant carrier requirements. CNMI also asks the 
Commission to devise specific safeguards applicable to MTC's monopoly 
operations in the Commonwealth, such as a strengthened form of the 
Fifth Report and Order separation requirements. GTE disputes CNMI's 
claims that MTC is providing domestic interexchange services directly 
as a non-dominant carrier contrary to the requirements of the 
Commission's Fifth Report and Order and 1985 International Competitive 
Carrier Order (50 FR 48191 (November 22, 1985)). GTE asserts that, 
although MTC provides domestic exchange, exchange access and 
interexchange services on an integrated basis, its domestic 
interexchange services are provided on a dominant basis. GTE emphasizes 
that neither the Commission nor any court has found that MTC has 
engaged in any misconduct of the nature alleged by CNMI. GTE also 
asserts that imposing additional regulatory requirements on MTC, which 
serves 16,000 access lines in a rural location, is clearly contrary to 
the deregulatory spirit and intent of the 1996 Act.
    155. CNMI also asks the Commission to clarify that MTC's service 
between the Commonwealth and the U.S. mainland and other U.S. points is 
a domestic service, and thus requires domestic tariffing and compliance 
with the strengthened form of the Fifth Report and Order separation 
requirements. GTE responds that, because the Northern Mariana Islands 
have long been considered an international point for service to and 
from the United States, MTC currently tariffs its service to the U.S. 
mainland and other U.S. points in its international tariff. GTE 
contends that, pursuant to the Commission's Rate Integration Order, the 
integration of the Islands into domestic rate schedules is not required 
to occur until August 1, 1997. GTE states that these offshore locations 
will continue to be tariffed as international points for rate purposes 
until that time.

c. Discussion

i. Traditional Market Power Factors (Other Than Control of Bottleneck 
Facilities)
    156. As we noted above, dominant carrier regulation is generally 
designed to prevent a carrier from raising prices by restricting its 
own output of interexchange services. An independent LEC, therefore, 
should be classified as dominant in the provision of in-region, 
interstate, interexchange services only if it has the ability to raise 
prices by restricting its output of these services.
    157. We find that the traditional market power factors (excluding 
bottleneck control) suggest that independent LECs do not have the 
ability profitably to raise and sustain prices above competitive levels 
by restricting their output. Based on an analysis of these traditional 
market power factors--market share, supply and demand substitutability, 
cost structure, size, and resources--we conclude that independent LECs 
do not have the ability to raise prices by restricting their own 
output. First, independent LECs generally have minimal market share, 
compared with the major interexchange carriers, which suggests they 
could not profitably raise and sustain interexchange prices above 
competitive levels. Second, the same high supply and demand 
elasticities that the Commission found constrained AT&T's pricing 
behavior also apply to independent LECs. Finally, we find that low 
entry barriers in the interexchange market and widespread resale of 
interexchange services constrain independent LECs from exercising 
market power. We conclude, therefore, that in light of the Fifth Report 
and Order requirements independent LECs do not have the ability to 
raise prices above competitive levels by restricting their output of 
interexchange services.
ii. Control of Bottleneck Access Facilities
    158. As we previously found with regard to the BOCs, traditional 
market power factors are not conclusive in determining whether 
independent LECs should be classified as dominant in the provision of 
in-region, interstate, interexchange services. We noted in the Non-
Accounting Safeguards NPRM that an independent LEC may be able to use 
its control over local exchange and exchange access services to 
disadvantage its interexchange competitors to such an extent that it 
will quickly gain the ability profitably to raise the price of in-
region, interstate, interexchange services above competitive levels. We 
therefore must examine whether an independent LEC could improperly 
allocate costs, discriminate against its in-region competitors, or 
engage in a price squeeze to such an extent that the independent LEC 
would have the ability to raise prices for interstate, interexchange 
services by restricting its output. We find, as we did with regard to 
BOCs, that independent LECs providing in-region, interstate, 
interexchange services do not have the ability to engage in these 
actions to such an extent that they would have the ability to raise 
prices by restricting output. For the reasons discussed with regard to 
the BOCs, we thus conclude that dominant carrier regulation of 
independent LEC provision of in-region, interstate, interexchange 
services is inappropriate.
    159. We disagree, however, with those commenters that assert that 
independent LECs have no ability to use their bottleneck facilities to 
harm interexchange competition. We believe that, absent appropriate and 
effective regulation, independent LECs have the ability and incentive 
to misallocate costs from their in-region, interstate, interexchange 
services to their monopoly local exchange and exchange access services 
within their local service region. Improper allocation of costs by an 
independent LEC is a concern because such action may allow the 
independent LEC to recover costs incurred by its affiliate in providing 
in-region, interexchange services from subscribers to the independent 
LEC's local exchange and exchange access services. As we stated 
previously, this can distort price signals in those markets and, under 
certain circumstances, may give the affiliate an unfair advantage over 
its competitors. We believe that the improper allocation of costs may 
cause substantial harm to consumers, competition, and production 
efficiency. Such cost misallocations may be difficult to detect and are 
not necessarily deterred by price cap regulation.
    160. Furthermore, an independent LEC, like a BOC, potentially could 
use its market power in the provision of exchange access service to 
advantage its interexchange affiliate by discriminating against the 
affiliate's interexchange competitors with respect to the provision of 
exchange and exchange access services. This discrimination could take 
the form of poorer quality interconnection or unnecessary delays in 
satisfying a competitors' request to connect to the independent LEC's 
network.
    161. We are also concerned that an independent LEC could 
potentially

[[Page 36005]]

initiate a price squeeze to gain additional market share. Absent 
appropriate regulation, an independent LEC could potentially raise the 
price of access to all interexchange carriers which would cause 
competing in-region carriers to either raise their retail rates to 
maintain the same profit margins or attempt to maintain their market 
share by not raising their prices to reflect the increase in access 
charges, thereby reducing their profit margins. If the competing in-
region, interexchange providers raised their prices to recover the 
increased access charges, the independent LEC could seek to expand its 
market share by not matching the price increase. The independent LEC 
could also set its in-region, interexchange prices at or below its 
access prices. The independent LEC's in-region competitors would then 
be faced with the choice of lowering their retail rates, thereby 
reducing their profit margins, or maintaining their retail rates at the 
higher price and risk losing market share.
    162. As we explained earlier, the Fifth Report and Order identified 
three separation requirements with which an independent LEC must comply 
in order to qualify for non-dominant treatment. These requirements are 
that the affiliate providing in-region, interstate, interexchange 
services must: (1) maintain separate books of account; (2) not jointly 
own transmission or switching facilities with the LEC; and (3) acquire 
any services from its affiliated exchange companies at tariffed rates, 
terms, and conditions.
    163. We conclude that, although an independent LEC's control of 
exchange and exchange access facilities may give it the incentive and 
ability to engage in cost misallocation, unlawful discrimination, or a 
price squeeze, the Fifth Report and Order requirements aid in the 
prevention and detection of such anticompetitive conduct. We, 
therefore, conclude that we should retain the Fifth Report and Order 
separation requirements. More specifically, separate books of account 
are necessary to trace and document improper allocations of costs or 
assets between a LEC and its long-distance affiliate as well as 
discriminatory conduct. In addition, the prohibition on jointly-owned 
facilities will reduce the risk of improper cost allocations of common 
facilities between the independent LEC and its interexchange affiliate. 
The prohibition on jointly owned facilities also helps to deter any 
discrimination in access to the LEC's transmission and switching 
facilities by requiring the affiliates to follow the same procedures as 
competing interexchange carriers to obtain access to those facilities. 
Finally, we conclude that requiring services to be taken at tariffed 
rates, or as discussed below, on the same basis as requesting carriers 
that have negotiated interconnection agreements pursuant to section 
251, aids in preventing a LEC from discriminating in favor of its long 
distance affiliate, and reduces somewhat the risk of a price squeeze to 
the extent that an affiliate's long distance prices are required to 
exceed their costs for tariffed services.
    164. We agree that we should modify the third Fifth Report and 
Order requirement to allow independent LECs to take exchange services 
not only by tariff, but also on the same basis as requesting carriers 
that have negotiated interconnection agreements pursuant to section 
251. GTE contends that, because under the Commission's current rules, 
LECs must make interconnection agreements available to other carriers, 
affiliated carriers should be able to obtain services under such terms 
as well. 47 CFR 51.809. Section 252(i) states as follows:

    (i) Availability to Other Telecommunications Carriers.--A local 
exchange carrier shall make available any interconnection, service, 
or network element provided under an agreement approved under this 
section to which it is a party to any other requesting 
telecommunications carrier upon the same terms and conditions as 
those provided in the agreement. 47 U.S.C 252(i).

    The Commission's pricing rules and interpretation of section 252(i) 
are currently under stay by the 8th Circuit Court of Appeals. Iowa 
Utilities Board v. FCC, No. 96-3321 (8th Cir. October 15, 1996) (Order 
granting stay pending judicial review). In the Non-Accounting 
Safeguards Order, we concluded that section 272 does not prohibit a BOC 
interLATA affiliate from providing local exchange services in addition 
to interLATA services. We also found in that Order that section 251 
does not place any restrictions on which telecommunications carriers 
may qualify as requesting carriers. We concluded in the Non-Accounting 
Safeguards Order, therefore, that BOC section 272 affiliates should be 
permitted to purchase unbundled elements under section 251(c)(3) of the 
Communications Act and telecommunications services at wholesale rates 
under section 251(c)(4) from the BOC on the same terms and conditions 
as other competing local exchange carriers. We find no basis for 
concluding that Congress intended to treat an incumbent LEC differently 
from any other requesting telecommunications carrier. Accordingly, in 
addition to taking exchange services by tariff, the LEC may 
alternatively take unbundled network elements or exchange services for 
the provision of a telecommunications service, subject to the same 
terms and conditions as provided in an agreement approved under section 
252 to which the independent LEC is a party.
    165. As argued by many commenters, independent LECs have been 
providing in-region, interstate, interexchange services on a separated 
basis with no substantiated complaints of denial of access or 
discrimination. The Fifth Report and Order separation requirements have 
been in place for over ten years. During that time, we have received 
few complaints from independent LECs about the requirements themselves. 
Moreover, we previously determined that the Fifth Report and Order 
requirements are not overly burdensome. As we stated in the Interim BOC 
Out-of-Region Order, the separation requirements of the Fifth Report 
and Order require that the LEC interexchange affiliate be a separate 
legal entity. We do not, however, require actual ``structural 
separation.'' Thus, as we stated in the Interim BOC Out-of-Region 
Order, ``except for the ban on joint ownership of transmission and 
switching facilities,'' the LEC and the interexchange affiliate ``will 
be able to share personnel and other resources or assets.''
    166. We are not persuaded by the arguments made by Citizens and 
USTA that the separate affiliate requirement prevents independent LECs 
from realizing efficiency gains though the use of joint resources. 
While joint ownership of transmission and switching facilities by a LEC 
and its affiliate is not permitted by our rules, the use of 
transmission and switching facilities by the other is permitted. The 
affiliate can contract for use of the LEC's transmission and switching 
facilities at tariffed rates or on the same basis as requesting 
carriers that have negotiated interconnection agreements pursuant to 
section 251, and thereby continue to benefit from economies of scope. 
Furthermore, we conclude that the separate books of account requirement 
and the requirement that the affiliate obtain LEC services at tariffed 
rates are not overly burdensome. As we explained in the Interim BOC 
Out-of-Region Order, ``the separate books of account requirement refers 
to the fact that, as a separate legal entity, the affiliate must 
maintain its own books of account as a matter of course.'' Moreover, as 
we stated previously, in addition to taking exchange services by 
tariff, to the extent that the independent

[[Page 36006]]

LEC affiliate meets the requirements of 251, the LEC affiliate may 
alternatively take unbundled network elements or exchange services 
subject to the same terms and conditions as provided in an agreement 
approved under section 252 to which the independent LEC is a party.
    167. While we recognize that the Fifth Report and Order 
requirements impose some regulatory burdens, we find that these burdens 
are not unreasonable in light of the benefits these requirements yield 
in terms of protection against improper cost allocation, unlawful 
discrimination, and price squeezes. We conclude that continued 
imposition of the Fifth Report and Order separation requirements is 
necessary to prevent and detect any anticompetitive conduct that may 
arise as a result of an independent LEC's control of bottleneck 
facilities.
    168. We reject GTE's contention that the 1996 Act prohibits the 
Commission from imposing structural safeguards on GTE, or on any other 
independent LEC. We find no reasonable basis for inferring from section 
601, or any other provision in the 1996 Act, that Congress intended to 
eliminate the Fifth Report and Order requirements or to repeal by 
implication our authority to impose on independent LECs separation 
requirements that we deem necessary to protect the public interest 
consistent with our statutory mandates. To the contrary, section 
601(c)(1) of the 1996 Act provides that we are not to presume that 
Congress intended to supersede our existing regulations unless 
expressly so provided. Section 601(c) provides as follows:

    (c) Federal, State and Local Law.--
    (1) No Implied Effect.--This Act and the amendments made by this 
Act shall not be construed to modify, impair, or supersede Federal, 
State, or local law unless expressly so provided in such Act or 
amendments. Telecommunications Act of 1996, Public Law 104-104, sec. 
601(c), 110 Stat. 56, 143 (to be codified as a note following 47 
U.S.C. Sec. 152).

    Furthermore, section 601(a)(2) of the 1996 Act deals solely with a 
judicial decree, not the Commission's regulations; therefore, GTE's 
argument is frivolous.
    169. We are also not persuaded by Sprint's arguments that the Fifth 
Report and Order requirements are no longer necessary because other 
Commission requirements, such as the Commission's access charge rules, 
imputation requirements, and cost allocation and affiliate transaction 
rules, prevent anticompetitive conduct by an independent LEC in 
providing in-region, interstate, interexchange services. While these 
other requirements have significant beneficial effects, we find that 
these regulations alone are not an adequate substitute for the Fifth 
Report and Order separation requirements. As previously discussed, the 
prohibition against jointly owned transmission and switching facilities 
ensures that the affiliate obtains such facilities on an arm's length 
basis. This requirement also helps to ensure that all competing in-
region providers have the same access to provisioning of transmission 
and switching as that provided to the independent LEC's affiliate. 
There is nothing in the Commission's rules that otherwise prohibits 
joint ownership of switching and transmission facilities. Although 
Sprint contends that we should impose this prohibition by modifying the 
cost allocation rules, such a prohibition is possible only if a LEC 
provides interexchange service through a separate affiliate, as 
required by the Fifth Report and Order requirements. In addition, as 
stated previously, the Fifth Report and Order requirement that the 
affiliate maintain separate books of account is necessary to trace and 
document improper allocations of costs or assets between a LEC and its 
long distance affiliate and to detect unlawful discrimination in favor 
of the affiliate. The historical purpose for the requirement that the 
affiliate acquire any services from its affiliated exchange companies 
at tariffed rates, terms, and conditions was to prevent the LEC from 
discriminating in favor of its long distance affiliate. The Commission 
recently reconfirmed the need for such a requirement when it applied 
the affiliate transaction rules to all transactions between incumbent 
LECs and their affiliates. We believe that the Commission's access 
charge rules, imputation requirements, and cost allocation and 
affiliate transaction rules continue to serve important purposes. We 
conclude, however, that the Fifth Report and Order requirements are 
also necessary under these circumstances to safeguard further 
ratepayers against cost-shifting, discrimination, and price squeezes.
    170. We reject the arguments that we should impose additional 
requirements on independent LECs, including section 272 requirements, 
certain aspects of dominant carrier regulation, or any other 
requirements. Independent LECs tend to be more geographically dispersed 
and their service territories are largely rural in nature, therefore, 
they generally serve areas that are less densely populated than BOC 
services areas. In addition, because the service areas of independent 
LECs tend to be smaller than the service areas of the BOCs, on average, 
independent LECs have fewer access lines per switch than BOCs and 
provide relatively little interexchange traffic that both originates 
and terminates in their region. We conclude, therefore, that 
independent LECs are less likely to be able to engage in 
anticompetitive conduct than the BOCs and that applying the section 272 
requirements to independent LECs would be overly burdensome. The Fifth 
Report and Order requirements appear to balance these competing 
concerns; they address cost shifting and discrimination, but do not 
appear to be overly burdensome. Although the independent LECs assert 
that these requirements increase their costs, none of them has provided 
specific evidence to support this claim, much less to demonstrate that 
these additional costs outweigh the benefits.
    171. As previously stated, we conclude that we should not apply 
dominant carrier regulation to independent LECs. The dominant carrier 
regulation that AT&T and MCI recommend is not necessary to prevent, nor 
effective in detecting improper cost allocation, unlawful 
discrimination, price squeezes, or other anticompetitive conduct. The 
benefits of dominant carrier regulation are outweighed by the burdens 
imposed on independent LECs. We also reject MCI's argument that we 
should maintain full dominant carrier regulation in order to enforce 
effectively the Commission's imputation requirements and to prevent 
independent LECs from engaging in a price squeeze strategy. As we 
stated previously, we believe that such predatory behavior can be 
adequately addressed through our complaint process and enforcement of 
the antitrust laws. Moreover, we note that the potential for a price 
squeeze will be further mitigated as access charges are reformed to 
reflect cost.
    172. Furthermore, we confirm that the equal access restrictions 
apply to independent LECs. Under the MFJ the BOCs were required to 
``provide to all interexchange carriers and information service 
providers exchange access, information access and exchange services for 
such access on an unbundled, tariffed basis, that is equal in type, 
quality, and price to that provided to AT&T and its affiliates.'' Equal 
access includes the nondiscriminatory provision of exchange access 
services, dialing parity, and presubscription of interexchange 
carriers. Exchange access services included, but were not limited to, 
``provision of network control signalling, answer supervision,

[[Page 36007]]

automatic calling number identification, carrier access codes, 
directory services, testing and maintenance of facilities, and the 
provision of information necessary to bill customers.'' GTE became 
subject to similar requirements in 1984, and in 1985 the Commission 
imposed requirements on independent LECs similar to those imposed on 
GTE. As we stated in the Non-Accounting Safeguards Order, section 
251(g) added by the 1996 Act preserves the equal access requirements in 
place prior to the passage of the Act, including obligations imposed by 
the MFJ and any commission rules. We do not decide at this time, 
however, whether the allegations AT&T raises regarding SNET's alleged 
pre-subscribed interexchange carrier (PIC) freeze constitutes a 
violation of the Commission's equal access requirements. AT&T or any 
other carrier, if it deems appropriate, can file a complaint with the 
Commission raising this allegation in the proper context. We note that 
on July 24, 1996, MCI filed an informal complaint with the Commission 
against SNET regarding PIC-freeze disputes. Letter from MCI to John 
Muleta, Chief, Enforcement Division, Common Carrier Bureau (July 24, 
1996), Informal Complaint No. IC96-09734 (requesting the Commission to 
conclude that SNET's solicitations authorizing SNET to protect long 
distance customers from being switched without express consent violate 
section 201(b) and 251 of the 1996 Act.) In addition, on September 27, 
1996, AT&T filed a letter with the Enforcement Division requesting the 
Commission to establish procedures under which neutral third parties 
administer PIC protection. Letter from AT&T to John Muleta, Chief, 
Enforcement Division, Common Carrier Bureau (Sept. 27, 1996).
    173. Based on the foregoing, we conclude that we should require 
independent LECs to provide in-region, interstate, interexchange 
services through a separate affiliate that satisfies the Fifth Report 
and Order separation requirements. We further conclude that, in light 
of our finding that independent LECs do not have the power to raise and 
sustain interexchange rates above competitive levels, it would be 
inconsistent with our analysis to allow independent LECs to choose 
whether to be regulated as a dominant carrier when providing in-region, 
interstate, domestic interexchange services. We are aware, however, of 
three independent LECs, Union Telephone Company (of Wyoming) (Union), 
GTE Hawaiian Tel., and MTC, that currently provide interexchange 
services on an integrated basis subject to dominant carrier regulation.
    We recognize that the costs of complying with the Fifth Report and 
Order separation requirements faced by a going concern could be greater 
than the costs of complying with these requirements for independent 
LECs that are currently providing these services on a separated basis. 
Accordingly, Union, GTE Hawaiian Tel., MTC, and any other independent 
LEC that is currently providing interexchange service on an integrated 
basis subject to dominant carrier regulation shall have one year from 
the date of release of this Order to comply with the Fifth Report and 
Order separation requirements. This does not affect the requirement 
that these providers integrate rates across their affiliates. See Rate 
Integration Order, 11 FCC Rcd 9598 (para. 69). Until that time, the 
Commission will continue to regulate these independent LECs as dominant 
carriers. The record in this proceeding does not reflect special 
circumstances necessary for a waiver of one or more of these 
requirements. To the extent that special circumstances exist, however, 
independent LECs may petition us to establish the necessity of a waiver 
of the Fifth Report and Order requirements.
    174. Because section 3(40) of the Communications Act defines a 
state to include the ``Territories and possessions'' of the United 
States, CNMI is a state for purposes of domestic telecommunications 
regulation. In our Rate Integration Order, we stated that, in making 
the section 254(g) of the Communications Act rate integration provision 
applicable to interstate interexchange services provided between the 
``states,'' as defined by section 153(40) of the Communications Act, 
Congress made rate integration applicable to interexchange services 
provided between the contiguous forty-eight states and U.S. possessions 
and territories, including CNMI. In the Rate Integration Order, we 
required providers of interexchange services between the Northern 
Mariana Islands and the contiguous forty-eight states to do so on an 
integrated basis with other interexchange services they provide by 
August 1, 1997. MTC and all other carriers providing off-island 
services between CNMI and other states are required to comply with 
these requirements. We find no basis in the record of this proceeding 
to amend these requirements. We further note that, although our Rate 
Integration Order does not require providers of interexchange service 
to integrate services offered to subscribers in the Commonwealth until 
August 1, 1997, this does not affect our finding that, if MTC continues 
to provide in-region, interstate, interexchange service directly, it 
must continue to comply with our dominant carrier requirements prior to 
that date.
    175. We find no basis on the record in this proceeding to impose 
additional requirements on MTC's provision of in-region, interstate, 
domestic, interexchange service, beyond those applied in this Order. To 
the extent that CNMI or any other petitioner can demonstrate that MTC 
has violated our rules, we encourage parties to file a petition asking 
the Commission to impose additional requirements through a petition for 
declaratory ruling or a complaint filed pursuant to section 208 of the 
Communications Act.
2. Application of Fifth Report and Order Separation Requirements to 
Incumbent Independent LECs

a. Background

    176. In the Non-Accounting Safeguards NPRM, we tentatively 
concluded that, because an independent LEC's control of local exchange 
and exchange access facilities is our primary rationale for imposing a 
separate affiliate requirement on independent LECs, we should limit 
application of any separation requirements that we adopt in this 
proceeding to incumbent LECs that control local exchange and exchange 
access facilities. For purposes of determining which independent LECs 
are ``incumbent,'' we proposed to use the definition of ``incumbent 
local exchange carrier'' contained in section 251(h) of the 
Communications Act. Section 251(h) provides that a LEC is an incumbent 
LEC, with respect to a particular area, if: (1) the LEC provided 
telephone exchange service in that area on the date of enactment of the 
1996 Act (February 8, 1996), and (2) the LEC was deemed to be a member 
of NECA on the date of enactment or the LEC became a successor or 
assign of a NECA member after the date of enactment.

b. Comments

    177. AT&T agrees with the tentative conclusion that only those 
independent LECs that control local exchange or exchange access 
facilities should be subject to the requirements adopted in this 
proceeding and that the Commission should rely on the definition of 
``incumbent local exchange carrier'' provided in 47 U.S.C. 251(h).
    178. NTCA, on the other hand, contends that the Commission should 
treat new entrants no differently than it treats small incumbent LECs 
because

[[Page 36008]]

new LEC entrants that provide in-region interexchange services are free 
to, and have in fact, built or acquired control of local exchange 
access facilities.

c. Discussion

    179. We adopt our tentative conclusion that the Fifth Report and 
Order separation requirements should be imposed only on incumbent 
independent LECs that control local exchange and exchange access 
facilities. We believe this conclusion is consistent with the 1996 Act, 
which provides different regulatory treatment for incumbent and non-
incumbent LECs. This different treatment generally imposes fewer 
regulatory requirements on non-incumbent LECs, which we believe 
indicates Congress's view that such carriers are unable, at this time, 
to affect competition adversely, and therefore, are unable to generally 
harm consumers through unreasonable rates. We also believe that it 
would be premature to impose such regulation on competitive LECs when 
they possess little, if any, market power in the local exchange at this 
time. By limiting application of the separation requirements to 
incumbent independent LECs that control local exchange and exchange 
access facilities, we avoid imposing unnecessary regulation on new 
entrants in the local exchange market, such as neighboring LECs, 
interexchange carriers, cable television companies, and commercial 
mobile radio service providers, some of which may be small entities, 
thus facilitating market entry and the development of competition in 
the in-region, interstate, domestic, interexchange market.
3. Application of Fifth Report and Order Separation Requirements to 
Small or Rural Incumbent Independent LECs

a. Background

    180. In the Non-Accounting Safeguards NPRM, we sought comment on 
whether there is some minimum size of independent LECs below which the 
separation requirements should not apply. We noted that, in principle, 
the size of a LEC will not affect its incentives to improperly allocate 
costs between its monopoly services and its competitive services, but 
that for small or rural independent LECs, the benefits to ratepayers of 
a separate affiliate requirement may be less than the costs imposed by 
such a requirement.

b. Comments

    181. Several commenters contend that we should exempt certain small 
or rural independent LECs (e.g., non-Class A LECs or LECs serving less 
than two percent of the nation's access lines) from any separation 
requirements that are retained, because the costs of imposing the 
separations requirements on small carriers may outweigh the likely 
benefits. Several commenters argue that small incumbent LECs lack the 
market power to engage in anticompetitive conduct that is harmful to 
their interexchange rivals. Sprint argues that its local operations 
have little ability and incentive to engage in anticompetitive conduct, 
since its service territories are widely dispersed and largely rural.
    182. GTE and Bell Atlantic argue that there is no economic basis 
for exempting small or rural independent LECs from the separation 
requirements imposed in this Order, especially given the increasing 
competition in local exchange and exchange access markets throughout 
the country. GTE argues that all independent LECs, small and large, 
generally serve areas that are less densely populated than BOC service 
areas, have fewer access lines per switch on average, and provide 
relatively small volumes of interexchange traffic that originates and 
terminates in their region.

c. Discussion

    183. We conclude that we should not exempt any independent LECs 
from the Fifth Report and Order requirements based on their size or 
rural service territory because neither a carrier's size nor the 
geographic characteristics of its service area will affect its 
incentives or ability to improperly allocate costs or discriminate 
against rival interexchange carriers. Commenters favoring such an 
exemption provide no persuasive evidence that small or rural 
independent LECs that are not currently providing in-region 
interexchange service on an integrated basis subject to dominant 
carrier regulation would be adversely affected by continuation of the 
Fifth Report and Order separation requirements or that the safeguards 
are unnecessary for such carriers. Although suggested by several 
commenters, a rule that exempted all LECs with less than 2 percent of 
the nation's access lines would essentially eviscerate our regulation 
of independent LECs because it would exempt all 1100 independent LECs 
except the GTE companies (approximately 12 percent) and the Sprint/
United companies (approximately 4 percent). Industry Analysis Division, 
Statistics of Communications Common Carriers 1996/96, (Com. Car. Bur. 
Dec. 1996), Tables 1.1, 2.3, and 2.10. Accordingly, we will continue to 
apply the Fifth Report and Order separation requirements to all 
independent LECs, regardless of size. As previously noted, an 
independent LEC may seek a waiver of the Fifth Report and Order 
requirements on the basis of special circumstances. See supra para. 
173. We note, however, that a petitioner will face a heavy burden in 
demonstrating the need for such a waiver. Finally, we note that, 
although NTCA argues that the separation requirements may cause small 
companies to lose benefits in the form of name recognition and good 
will, the Fifth Report and Order requirements do not preclude an 
independent LEC from taking advantage of its good will by providing 
interexchange services under the same or a similar name.
4. Classification of Independent LECs' Provision of In-Region, 
International Services

a. Background

    184. In the Non-Accounting Safeguards NPRM we tentatively concluded 
that we should apply the same regulatory treatment to an independent 
LEC's provision of international services originating within its local 
service area as we adopt for independent LEC provision of interstate, 
domestic, interexchange services originating within its local service 
area.

b. Comments

    185. Most commenters support our proposal to apply the same 
regulatory treatment that we adopt for an independent LEC's provision 
of in-region interstate, domestic, interexchange services to an 
independent LEC's provision of in-region international services. GTE 
argues that the Commission should not impose the Fifth Report and Order 
requirements on independent LECs providing either in-region domestic or 
international interexchange services because independent LECs do not 
have market power in the provision of domestic or international in-
region interexchange services. GTE notes that it, and some other 
carriers, may be subject to dominant classification on particular 
routes pursuant to the Foreign Carrier Entry Order due to foreign 
carrier affiliations.
    186. MCI, on the other hand, argues that the Commission should 
generally apply the same regulatory treatment to independent LECs' 
provision of in-region, international services, but impose additional 
requirements where the LEC has a foreign affiliation or other 
commercial relationship with a foreign carrier. MCI urges the 
Commission, at a minimum, to impose on the independent LECs in such

[[Page 36009]]

circumstances the same safeguards that it imposed on MCI in the Order 
approving British Telecom's (BT's) initial 20 percent investment in 
MCI.
    187. In addition, CNMI asks the Commission to clarify that MTC is a 
dominant carrier under the terms of the International Competitive 
Carrier Order. CNMI states that in the International Competitive 
Carrier Order, the Commission ruled that MTC's parent company, GTE 
Hawaii, and similarly situated carriers were dominant. CNMI claims, 
however, that MTC was not covered by these policies when the Commission 
issued this Order because CNMI did not become a U.S. commonwealth until 
November 3, 1986. CNMI asserts that, now that MTC is a domestic carrier 
with significant market power and a lack of effective competition in 
exchange and exchange access markets, the Commission should declare MTC 
dominant in its provision of in-region, interstate, international, 
interexchange service. GTE replies that imposing dominant regulation on 
MTC's provision of in-region, interstate, international, interexchange 
service now, when MTC has operated as non-dominant for years, would be 
contrary to the deregulatory goals of the 1996 Act. In any case, GTE 
asserts that independent LEC international and domestic interexchange 
services should be regulated in the same manner and that independent 
LECs have no market power in the international service market. GTE 
further claims that MTC's exchange access service in the Northern 
Mariana Islands cannot give it market power in the international 
services market.

c. Discussion

    188. We confirm our tentative conclusion that we should adopt the 
same rules in this proceeding for an independent LEC's provision of in-
region, international, interexchange services as we adopt for its 
provision of in-region, interstate, domestic, interexchange services. 
As discussed above with regard to BOC provision of in-region, 
international services, the relevant issue, with respect to both 
domestic interexchange and international services, is whether an 
independent LEC can exercise its market power in local exchange and 
exchange access services to raise and sustain prices of interexchange 
or international services above competitive levels by restricting its 
own output. We find no practical distinctions between an independent 
LEC's ability and incentive to use its control over bottleneck 
facilities in the provision of local exchange and exchange access 
services to improperly allocate costs, unreasonably discriminate 
against, or otherwise engage in anticompetitive conduct against 
unaffiliated domestic interexchange competitors as opposed to 
international services competitors. Consistent with our conclusion to 
limit application of the Fifth Report and Order requirements to 
incumbent independent LECs that control local exchange and exchange 
access facilities, for independent LECs providing in-region, 
international, interexchange services, we also limit application of the 
Fifth Report and Order separation requirements to incumbent independent 
LECs that control local exchange and exchange access facilities.
    189. In light of our decision to classify independent LECs as non-
dominant in the provision of in-region, interstate, domestic, 
interexchange services and to impose the Fifth Report and Order 
requirements, we will classify an independent LEC as non-dominant in 
the provision of in-region, international services, unless it is 
affiliated with a foreign carrier that has the ability to discriminate 
in favor of the independent LEC through control of bottleneck services 
or facilities in a foreign destination market. We will apply section 
63.10(a) of our rules to determine whether to regulate a independent 
LECs as dominant on those U.S. international routes where an affiliated 
foreign carrier has the ability to discriminate against unaffiliated 
U.S. international carriers through control of bottleneck services or 
facilities in the foreign destination market. The safeguards that we 
apply to carriers that we classify as dominant based on a foreign 
carrier affiliation are contained in Section 63.10(c) of the rules and 
are designed to address the incentive and ability of the foreign 
carrier to discriminate in favor of its U.S. affiliate in the provision 
of services or facilities necessary to terminate U.S. international 
traffic. As previously noted, section 63.10(a) of the Commission's 
rules provides that: (1) Carriers having no affiliation with a foreign 
carrier in the destination market are presumptively non-dominant for 
that route; (2) carriers affiliated with a foreign carrier that is a 
monopoly in the destination market are presumptively dominant for that 
route; (3) carriers affiliated with a foreign carrier that is not a 
monopoly on that route receive closer scrutiny by the Commission; and 
(4) carriers that serve an affiliated destination market solely through 
the resale of an unaffiliated U.S. facilities-based carrier's switched 
services are presumptively nondominant for that route. See also 
Regulation of International Common Carrier Services, 7 FCC Rcd at 7334, 
Paras. 19-24. This framework for addressing issues raised by foreign 
carrier affiliations will apply to independent LECs' provision of U.S. 
international services as an additional component of our regulation of 
the U.S. international services market.
    190. We reject MCI's suggestion that we should impose additional 
safeguards on the independent LEC's in-region, international services. 
As we stated with regard to the BOCs, all U.S. international carriers 
are subject to the same prohibition against accepting ``special 
concessions'' from foreign carriers that we imposed on MCI in the Order 
approving BT's initial 20 percent investment in MCI. The grooming 
described by MCI would constitute a special concession prohibited by 
the terms of Section 63.14 of the Commission's rules to the extent the 
U.S. carrier entered into a grooming arrangement that the foreign 
carrier did not offer to similarly situated U.S. carriers. See 47 CFR 
Section 63.14 (``[a]ny carrier authorized to provide international 
communications service * * * shall be prohibited from agreeing to 
accept special concessions directly or indirectly from any foreign 
carrier or administration with respect to traffic or revenue flows 
between the United States and any foreign country served * * * and from 
agreeing to enter into such agreements in the future * * * .''). A U.S. 
carrier that negotiates a grooming arrangement with a foreign carrier 
on a particular route would be required to submit the arrangement to 
the Commission for public comment and review in circumstances where the 
arrangement deviates from existing arrangements with other U.S. 
carriers for the routing and/or settlement of traffic on that route.
    191. We believe our decision will benefit small incumbent LECs and 
small entities, for many of the same reasons enumerated in our analysis 
of independent LEC provision of in-region, interstate, domestic, 
interexchange services. For instance, by establishing a regulatory 
regime for provision of international services that is less stringent 
for incumbent independent LECs than for BOCs, independent LECs, some of 
which may be small incumbent LECs, will benefit by not being subjected 
to regulations that may be burdensome and may hamper competition in the 
international market. In addition, by limiting application of the Fifth 
Report and Order separations requirements to incumbent independent 
LECs, new entrants, some of which may

[[Page 36010]]

be small entities, will benefit from lower market entry costs.
    192. We decline to address whether MTC should be regulated as a 
dominant carrier for the provision of international services because of 
the inadequate record in this proceeding. We note that CNMI or any 
other petitioner may petition us to initiate a proceeding regarding 
MTC's regulatory status. We reiterate, however, our conclusion that all 
independent LECs that are providing international interexchange service 
through an affiliate that satisfies the Fifth Report and Order 
separation requirements as of the date of release of this Order must 
continue to do so, and all other independent LECs providing 
international interexchange service must comply with the Fifth Report 
and Order separation requirements no later than one year from the date 
of release of this Order. The Commission's International Bureau 
recently granted GTE Hawaiian Tel.'s petition for reclassification as a 
non-dominant carrier in the Hawaiian market for international message 
telephone service (IMTS), subject to implementation by GTE Hawaiian 
Tel. of the Fifth Report and Order separation requirements which the 
Bureau imposed on an interim basis pending the outcome of this 
proceeding. Petition of GTE Hawaiian Telephone Company, Inc. for 
Reclassification as a Non-dominant IMTS Carrier, Order, DA 96-1748 
(Int'l Bur. released Oct. 22, 1996). Our decision here does not modify 
the International Bureau's determination that GTE Hawaiian Tel. will 
remain a dominant IMTS carrier until it certifies to the Chief, 
International Bureau, that it is in compliance with the conditions of 
that Order. GTE Hawaiian Tel., must comply with the Fifth Report and 
Order separation requirements, however, within one year from January 1, 
1997.
5. Sunset of Separation Requirements for Independent LECs

a. Background

    193. Section 272(f)(1) of the Communications Act provides that the 
BOC safeguards set out in section 272 shall sunset three years after 
the date that the BOC affiliate is authorized to provide interLATA 
telecommunications services, unless the Commission extends such three-
year period by rule or order. In the NPRM we requested comment on 
whether any regulation of independent LECs should be subject to some 
type of sunset.

b. Comments

    194. Frontier contends that we should eliminate any separation 
requirements applicable to independent LECs' provision of in-region, 
interstate, interexchange services no later than such time as section 
272 requirements sunset.
    195. Excel and CNMI oppose the removal of the separate affiliate 
requirements applicable to independent LECs. CNMI notes that the sunset 
provision in section 272 has no application to independent LECs. 
Moreover, CNMI states that in insular areas such as the Commonwealth, 
there is no evidence to suggest that effective local competition will 
develop in the near future.

c. Discussion

    196. We intend to commence a proceeding three years from the date 
of adoption of this Order to determine whether the emergence of 
competition in the local exchange and exchange access marketplace 
justifies removal of the Fifth Report and Order requirements. We 
believe that three years should be a reasonable period of time in which 
to evaluate whether effective competition has developed sufficiently to 
reduce or eliminate an independent LEC's bottleneck control of exchange 
and exchange access facilities.

V. Classification of BOCS and Independent LECS as Dominant or Non-
Dominant in the Provision of Out-of-Region Interstate, Domestic, 
Interexchange Services

    197. In this section, we consider whether the Competitive Carrier 
Fifth Report and Order separation requirements that were applied to the 
provision of out-of-region, interstate, domestic, interexchange 
services by independent LECs in the Competitive Carrier proceeding and 
to the provision of such services by the BOCs in the Interim BOC Out-
of-Region Order are necessary as a condition for non-dominant 
regulatory treatment. As discussed below, we conclude that BOCs and 
independent LECs do not have and will not gain the ability in the near 
term to use their market power in the provision of local exchange 
service in their in-region markets to such an extent that the BOCs or 
independent LECs could profitably raise and sustain prices for out-of-
region, interstate, domestic, interexchange services significantly 
above competitive levels by restricting their own output. We therefore 
classify the BOCs and independent LECs as non-dominant in the provision 
of these services. We also conclude that, at this time, a BOC or an 
independent LEC will not be able to raise significantly its 
interexchange rivals' costs by improperly allocating costs from its 
out-of-region interexchange services to its regulated exchange and 
exchange access services, unlawfully discriminating against its rivals, 
or engaging in a price squeeze in its provision of out-of-region, 
interstate, domestic, interexchange services. We therefore eliminate 
the separation requirements imposed in the Fifth Report and Order as a 
condition for non-dominant regulatory treatment of the BOCs and 
independent LECs in the provision of these out-of-region services.

A. Background

    198. As previously noted, the Commission determined in the 
Competitive Carrier proceeding that interexchange carriers affiliated 
with independent LECs would be regulated as non-dominant carriers if 
they satisfied the three separation requirements identified in the 
Competitive Carrier Fifth Report and Order. See supra para. 144. The 
three requirements are that an affiliate: (1) Maintain separate books 
of account; (2) not jointly own transmission or switching facilities 
with the LEC; and (3) acquire any services from its affiliated exchange 
company at tariffed rates, terms, and conditions. Competitive Carrier 
Fifth Report and Order, 98 FCC 2d at 1198, para. 9. The Commission 
further concluded that, if the LEC provided the interstate, 
interexchange services directly, rather than through an affiliate, 
those services would be subject to dominant carrier regulation. Upon 
enactment of the 1996 Act, the BOCs were authorized to provide 
interLATA telecommunications services outside of their regions. In the 
Interim BOC Out-of-Region Order, the Commission determined that, on an 
interim basis, the BOCs' out-of-region, interstate, domestic, 
interexchange services would be subject to the same regulatory 
treatment as the Commission applied to the independent LECs' 
interstate, domestic, interexchange services in the Fifth Report and 
Order. Interim BOC Out-of-Region Order at Paras. 15-25. In other words, 
a BOC would be subject to non-dominant treatment in the provision of 
out-of-region, interstate, domestic, interexchange services if it 
provided these services through a separate affiliate that satisfied the 
Fifth Report and Order separations requirements, but would be regulated 
as dominant if it provided these services directly. Id. at Paras. 19-
25. In the Interexchange NPRM, the Commission sought comment on whether 
it should modify or eliminate the separation requirements that are 
currently imposed on independent LECs and BOCs, in order to qualify for 
non-dominant

[[Page 36011]]

treatment in the provision of out-of-region interstate, interexchange 
services.

B. Comments

    199. The BOCs and independent LECs generally argue that they cannot 
exercise market power if they provide directly out-of-region, domestic, 
interstate, interexchange services. Specifically, Ameritech asserts 
that the Commission may impose requirements as a condition of non-
dominant treatment, such as a separate affiliate requirement, only if 
it can show that such a requirement is necessary to prevent the 
exercise of market power. Ameritech further argues that the Commission 
cannot possibly show that a separate affiliate requirement is necessary 
to prevent the exercise of market power in out-of-region interexchange 
services, and thus cannot link this requirement to non-dominant status. 
SBC argues that neither independent LECs nor new-entrant BOCs have 
market power in the provision of out-of-region interexchange services 
based on the market power factors listed in AT&T Reclassification 
Order. Furthermore, SNET asserts that the Competitive Carrier Fifth 
Report and Order separation requirements are not necessary for small 
independent LECs. The Ohio Consumer Counsel argues, however, that rural 
carriers without a national presence should be subject to separation 
requirements if they receive suspensions or modification of section 
251(b) or (c) of the 1996 Act.
    200. In addition, the BOCs and independent LECs generally claim 
that they no longer retain bottleneck control over exchange access 
services and that the Fifth Report and Order separation requirements 
are not necessary to prevent cross-subsidization and discrimination. 
Ameritech notes that the Commission has found that a firm or group of 
firms has ``bottleneck control'' when it has sufficient command over 
some essential commodity or facility in its industry or trade to be 
able to impede new entrants. Ameritech asserts that no BOC could impede 
long-distance entry because any such effort would be a blatant 
violation of equal access obligations and the Communications Act, and 
such an attempt would surely be discovered and punished. Furthermore, 
several LECs argue that to the extent bottleneck control previously 
existed, the 1996 Act eliminates it by requiring interconnection and 
access to unbundled elements and resale, and by creating incentives for 
BOCs to implement these provisions in order to enter in-region long-
distance. Several BOCs further respond that they have neither the 
incentive nor the opportunity to cross subsidize their long distance 
services. NYNEX, BellSouth and GTE contend that separation requirements 
are unnecessary because the BOCs' rates for access services are subject 
to price caps. NYNEX asserts that Commission's rules control the 
allocation of costs between interexchange and access services and 
require LECs to impute to their interexchange services the same access 
rates they charge to other carriers for in-region services. Ameritech 
and Bell Atlantic argue that price caps (particularly without sharing) 
and cost allocation rules will prevent cross subsidization. Bell 
Atlantic also contends that geographic separation between a BOC's local 
exchange operations and out-of-region long distance services eliminates 
the potential for cost shifting.
    201. Numerous non-LEC commenters, on the other hand, contend that 
the Commission should treat BOCs and independent LECs as non-dominant 
for out-of-region, interexchange services only so long as they satisfy 
the separation requirements in the Fifth Report and Order. CompTel 
argues that the focal point of any decision to classify a BOC as 
dominant or non-dominant in interexchange services will not be the 
level of competition in the interexchange market, but the extent to 
which the BOC has lost its monopoly power in local exchange and 
exchange access services. In addition, numerous commenters argue that 
the separation requirements are necessary to prevent cross-
subsidization, unreasonable discrimination or other anticompetitive 
conduct. Sprint contends that the Fifth Report and Order requirements 
are the most, and perhaps the only, reliable tool at hand for detecting 
and preventing cross-subsidization and discrimination. The Missouri 
Commission claims that, unless LECs are required to maintain separate 
records for their LEC and IXC operations, it will be difficult, if not 
impossible, to determine whether any improper discrimination or cross 
subsidization has occurred. The Alabama Commission asserts that the 
separation requirements ensure that carriers can compete on an equal 
basis in the interexchange market. MCI argues that the continuing need 
for separate affiliate requirements is underscored by recent federal 
and state audits of BOC and LEC affiliate transactions, which uncovered 
improper cost allocations and demonstrated the ineffectiveness of the 
cost allocation regulations in preventing LEC cross-subsidies between 
regulated and unregulated services.
    202. In addition, several commenters claim that the BOCs and 
independent LECs have significant incentives to engage in improper cost 
allocation, discrimination, and other anti-competitive behavior, and 
are able to engage in such behavior due to their control of bottleneck 
facilities. For example, MCI contends that the independent LECs' and 
BOCs' local bottleneck power can be exploited beyond their service 
areas by discriminating against an IXC dependent on the BOC or 
independent LEC for access in its region, thereby damaging the IXC's 
reputation on a national basis. MCI further asserts that the 
similarity, and in some cases identity, of facilities used for monopoly 
and interexchange services would greatly aggravate the risks of cross-
subsidization and discrimination on the terminating end of such calls. 
Vanguard claims that, as suppliers of an essential input, BOCs are in a 
position to affect the cost structures of their competitors. More 
specifically, Vanguard argues that any increase in charges for 
terminating traffic will raise the costs of non-affiliated 
interexchange providers that terminate calls over the same route. 
Vanguard notes that these increases must be absorbed by competitors, 
but will not injure the BOC because raising access charges to its 
affiliate will merely result in an intracompany transfer. Commenters 
further contend that BOCs and independent LECs can discriminate in a 
variety of ways, such as slow service provisioning, delayed information 
about or roll-out of new technologies, less responsive maintenance and 
customer service, and poorer connections. MCI asserts that LECs also 
can exploit information obtained in their capacity as local service 
providers to gain an advantage in out-of-region interexchange 
marketing, including such information as validation databases, and that 
they can manipulate the price or other terms and conditions of 
terminating traffic, including limiting access to certain signalling 
information.
    203. Several commenters contend that the cost and asset shifting 
techniques available to incumbent LECs are hard to detect and are not 
deterred by price caps. MFS disputes BOC arguments that geographical 
separation between the BOCs' in-region exchange access and out-of-
region interexchange facilities and price cap regulation moot concerns 
about cost shifting. MFS asserts that a BOC's ability to fund 
anticompetitive pricing schemes in the interexchange market from local 
exchange market profits is not impeded just because these markets are 
not contiguous or because the BOC performs artificial cost

[[Page 36012]]

allocations. MFS argues that price cap mechanisms do not perfectly 
reflect actual cost changes and can yield windfall unintended profits 
for BOCs which could be used to subsidize interexchange services. AT&T 
contends that the BOCs' assertions that price cap regulation removes 
exchange carriers' ability and incentive to allocate costs improperly 
ignores the fact that not all LECs have elected price caps, and those 
that have may periodically elect a ``sharing'' option. MCI asserts that 
``pure'' price caps do not deter cross subsidization because the 
conferring of monopoly-derived benefits upon a BOC's or independent 
LEC's interexchange operations at less than their economic value 
unfairly subsidizes those operations whether or not the BOC or LEC can 
raise its monopoly rates to absorb additional costs.
    204. In addition, numerous commenters contend that even if the 
Fifth Report and Order separation requirements for independent LECs are 
modified or eliminated, the Commission should maintain these 
requirements as a condition for non-dominant treatment of the BOCs' 
provision of out-of-region, interexchange services. Vanguard and GSA 
contend that the BOCs have greater opportunity to allocate costs 
improperly than the independent LECs because of their greater number of 
services, larger service territories, and more extensive interoffice 
facilities. Vanguard notes, for example, that each BOC serves about 
one-eighth of all U.S. telephone subscribers in largely contiguous 
service territories, which means that the BOCs receive more calls than 
other LECs and have more opportunities to manipulate the price and 
quality of terminating access than other companies. Vanguard argues 
that the proposed BOC mergers would further widen the size 
differentials between the BOCs and independent LECs.
    205. Several non-LECs contend that the Competitive Carrier Fifth 
Report and Order separation requirements are insufficient to protect 
against abuses by BOCs and independent LECs, and, therefore, propose 
additional safeguards. These commenters urge the Commission to: (1) 
Impose full structural separation on the out-of-region affiliate; (2) 
prohibit joint marketing of local and out-of-region, interexchange 
services; (3) require that a LEC's out-of-region affiliate have no 
preferential access to non-Title II services offered by the LEC; (4) 
require that the LEC's affiliate transaction practices and cost 
allocation procedures be subject to annual independent audit; and (5) 
prohibit the affiliate from receiving proprietary information unless it 
is made available to competitors on the same basis.

C. Discussion

    206. In Section IV, we concluded that a BOC affiliate or 
independent LEC should be classified as dominant in the provision of 
in-region, interstate, domestic, long distance services only if it has 
the ability to raise prices by restricting its output of those in-
region services. We found that each of the traditional market factors 
(excluding bottleneck control) suggest that the BOC interLATA 
affiliates and independent LECs do not have the ability to raise the 
price of in-region, interstate, long distance services by restricting 
their output of these services. We recognized that a BOC's or 
independent LEC's control of local exchange and exchange access 
facilities potentially gives the BOC or independent LEC an incentive to 
disadvantage its interexchange competitor through improper allocations 
of costs, discrimination or other anticompetitive conduct. We 
concluded, however, that the statutory and regulatory safeguards 
currently imposed on the BOCs and independent LECs will prevent them 
from engaging in such anticompetitive conduct to such an extent that 
the BOC interLATA affiliates or independent LECs have, or will have 
upon entry or shortly thereafter, the ability to raise the price of in-
region, interstate, domestic, long distance services by restricting 
their output of these services. Accordingly, we classified the BOC 
interLATA affiliates and independent LECs as non-dominant in the 
provision of these in-region services.
    207. We conclude that we should apply a similar analysis in 
assessing whether to classify the BOCs and independent LECs as dominant 
in the provision of out-of-region, interstate, domestic, interexchange 
services. We conclude that the traditional market power factors 
(excluding bottleneck facilities)--market share, supply and demand 
substitutability, cost structure, size, and resources--support a 
finding that the BOCs and independent LECs do not have, and will not 
gain the ability in the near term, to raise prices of out-of-region 
interexchange services by restricting their output of these services. 
More specifically, we find, first, that the BOCs begin with an 
interexchange market share of zero while the market shares of the 
independent LECs are negligible when compared to the major 
interexchange carriers. Second, we find that the same high supply and 
demand elasticities that the Commission found constrained AT&T's price 
behavior also apply to the provision of out-of-region interexchange 
services by the BOCs and independent LECs. Finally, we find that the 
presence of existing interexchange carriers, including AT&T, MCI, 
Sprint, and LDDS, prevents the BOCs and independent LECs from using 
their cost structure, size, and resources to raise prices above the 
competitive level for their out-of-region interstate, domestic, 
interexchange services.
    208. With respect to discrimination concerns related to the 
provision of out-of-region, interstate, interexchange services by the 
BOCs and independent LECs, we note that these carriers are not the 
dominant providers of originating exchange access services in out-of-
region areas. We also note that majority of the discrimination concerns 
raised by commenters focus on inferior interconnection to a LEC's 
network for originating exchange access. We therefore find that the 
BOCs' and independent LECs' lack of control over originating access for 
its competitors' calls originating outside its region significantly 
limits their ability to discriminate against their interexchange 
competitors and to engage in other anticompetitive conduct. Although it 
is possible that a LEC could damage an interexchange competitor's 
reputation on a national basis by discriminating against an 
interexchange carrier dependent on it for access in its region, we 
believe this is unlikely because the BOCs and independent LECs are 
subject to our equal access requirements. In addition, as discussed in 
Section IV, we believe that the safeguards in place for the provision 
of in-region, interstate, interexchange services by BOCs and 
independent LECs further protect against originating exchange access 
discrimination. We therefore conclude that our equal access provisions 
and safeguards established for in-region interstate, interexchange 
services provide sufficient protection to interexchange carriers for 
the provision of originating exchange access as well as for the quality 
of these services. Similarly, although a BOC or an independent LEC may 
control the facilities used to terminate its interexchange competitors 
calls in its in-region service area, we believe it has less opportunity 
to discriminate against competitors through its control of these 
facilities. In order to discriminate effectively through control of 
terminating exchange access, the BOCs and independent LECs would have 
to convince consumers that an inferior termination connection was the 
fault of their interexchange carrier, and that the only way to obtain 
efficient termination arrangements to this region would be

[[Page 36013]]

through the BOCs' or independent LECs' interexchange services. In 
addition, to the extent such quality degradation is apparent to 
consumers, it is also likely to be apparent to regulators and 
interexchange competitors. We also note that the record in the 
Interexchange proceeding does not demonstrate that the BOCs and LECs 
have the technical ability to degrade selectively the quality of the 
interconnection for their interexchange competitors through their 
control of terminating exchange access. In addition, Section 222 of the 
Communications Act provides all telecommunications carriers with 
protection from the misuse of customer proprietary network information. 
We, therefore, conclude that discrimination by a BOC or an independent 
LEC is unlikely in the context of out-of-region, interstate, 
interexchange services.
    209. In addition, we agree with Bell Atlantic that the geographic 
separation between a LEC's in-region local exchange and exchange access 
operations and out-of region long distance operations mitigates the 
potential for undetected improper allocation of costs. Because of this 
geographic separation, it is unlikely that the out-of-region operation 
will be able to share any transmission or switching facilities, many 
employees, or other common costs with the in-region operation. 
Consequently, improper allocation of costs is less problematic with 
respect to a BOC's or independent LEC's provision of out-of-region long 
distance services. We further conclude that statutory and regulatory 
safeguards, including our Part 64 rules, imposed on the BOCs and 
independent LECs sufficiently limit any residual ability to 
disadvantage their rivals by improperly allocating costs between their 
regulated local exchange and exchange access services and their out-of-
region interexchange services. Our cost allocation rules control the 
allocation of cost between interexchange and local services and require 
a BOC or an independent LEC to impute to its interexchange services the 
same access rates it charges other carriers. Furthermore, in the 
Accounting Safeguards Order, the Commission determined, solely for 
federal accounting purposes, that out-of-region interLATA services 
provided by incumbent LECs on an integrated basis should be treated 
like nonregulated activities for purposes of our cost allocation rules. 
We find that the existing statutory and regulatory safeguards, coupled 
with the geographical separation between the BOCs' and LECs' in-region 
and out-of-region operations, are sufficient to prevent the BOCs and 
independent LECs from improperly allocating costs. We therefore 
disagree with MFS' assertion that a LEC's ability to fund 
anticompetitive pricing schemes in the interexchange market from local 
exchange market profits exists even thought these markets are not 
contiguous or because the BOC performs artificial cost allocations. 
Furthermore, we note that the exchange access services for all of the 
BOCs and most of the largest independent LECs are subject to our price 
cap regulations. As discussed in Section IV, price cap regulation 
further serves to reduce the potential that the BOCs and independent 
LECs will improperly allocate the costs of their interexchange 
services. Consequently, we conclude that the risk that the BOCs and 
independent LECs would be able to allocate improperly substantial costs 
from their out-of-region interLATA services to their monopoly local 
exchange and exchange access services is not sufficient to warrant 
imposing separation requirements.
    210. We also conclude that the BOCs and independent LECs will not 
be able to engage in a price squeeze with respect to their out-of-
region, interstate, domestic, interexchange services to such an extent 
that they will gain the ability to raise prices of long distance 
services by restricting their output of those services. We are not 
persuaded by arguments that, because BOCs and independent LECs have 
control over terminating exchange access, they will be able to effect a 
price squeeze to gain market share by raising the price of terminating 
access. We note that, because the BOCs and independent LECs do not have 
control over originating exchange access for out-of-region, interstate, 
interexchange services, they will incur the same cost for originating 
access as their interexchange competitors. In addition, to the extent 
that a BOC or independent LEC offers out-of-region long distance 
services on an integrated basis, our rules require the carrier to 
impute to itself its tariffed terminating exchange access rate. Under 
section 64.901(b)(1) of our rules, tariffed services, such as exchange 
access services, provided to a nonregulated activity must be charged to 
the nonregulated activity at the tariffed rates and credited to the 
regulated revenue account for that service. 47 CFR Sec. 64.901(b)(1). 
See also 47 CFR Sec. 32.5280 (explaining how carriers must account for 
the provision of tariffed services to nonregulated activities). As 
previously noted, out-of-region interLATA services provided by 
incumbent LECs on an integrated basis are treated as nonregulated 
activities for federal accounting purposes. Accounting Safeguards Order 
at para. 75. If a BOC or independent LEC offers out-of-region long 
distance services through an affiliate, the affiliate will have to pay 
the tariffed exchange access rate for long distance calls it terminates 
on the BOC's or independent LEC's in-region network. We also note that 
section 272(e)(3) of the Communications Act requires a BOC to ``charge 
[its section 272 interLATA affiliate], or impute to itself (if using 
the access for its provision of its own services), an amount for access 
to its telephone exchange service and exchange access that is no less 
than the amount charged to any unaffiliated interexchange carriers for 
such service.'' 47 U.S.C. Sec. 272(e)(3). See also Non-Accounting 
Safeguards Order at Paras. 256-58 (implementing section 272(e)(3)). 
Also, price cap regulation of exchange access services mitigates the 
ability of a BOC or independent LEC to effect a price squeeze by 
increasing terminating exchange access rates. All BOCs and most of the 
largest independent LECs are subject to price cap regulation. 1996 
Annual Access Tariff Filings, DA 96-1022, para. 2 n.2 (rel. June 24, 
1996). All but one BOC is subject to price caps without sharing. Data 
based on 1996 Annual Access Tariff Filings filed on April 2, 1996. 
Moreover, we believe an attempted price squeeze would be less likely to 
be effective, because it appears that typically a BOC's originating 
out-of-region calls that terminate in-region will account for a small 
percentage of the BOC's total out-of-region originating traffic. We 
acknowledge, however, that some BOCs and independent LECs may market 
their out-of-region interexchange services to customers who routinely 
terminate in the BOC's or independent LEC's in-region local exchange 
and exchange access area. See, e.g., AT&T Sept. 13 Reply, Appendix B. 
Finally, we note that there are other adequate mechanisms to address 
such behavior. More specifically, a BOC or an independent LEC that 
charges a rate for interstate services below its incremental costs of 
providing service in the long term would be in violation of sections 
201 and 202 of the Act. In addition, Federal antitrust law also would 
apply to the predatory pricing of interstate services.
    211. Based on the foregoing, we conclude that the BOCs and 
independent LECs do not have, upon entry or soon thereafter, the 
ability to raise the price of out-of-region,

[[Page 36014]]

interstate, interexchange services by restricting their own output even 
if they are permitted to provide these services on an integrated basis. 
We therefore conclude that it is not necessary to require the BOCs or 
independent LECs to maintain the Competitive Carrier Fifth Report and 
Order separation requirements as a condition for non-dominant 
regulatory treatment for the provision of out-of-region, interstate, 
interexchange services. We note, however, that because BOCs and 
independent LECs are required to offer in-region, interstate, 
interexchange services through a separate affiliate, some may provide 
their out-of-region, interstate, interexchange services through the 
same affiliate rather than directly. We further note that, in the 
Accounting Safeguards Order, the Commission determined that affiliate 
transactions rules apply to all transactions between incumbent local 
exchange carriers and their affiliates providing any of the competitive 
services of the types permitted under sections 260 and 271 through 276. 
Accounting Safeguards Order at para. 256. Upon the effective date of 
this Order, the requirements established herein for the provision of 
out-of-region, interstate, interexchange services by BOCs will 
supersede any conflicting requirements established in the Interim BOC 
Out-Of-Region Order.
    212. Contrary to the comments of GSA and Vanguard, we find that the 
record in this proceeding does not demonstrate that a BOC is in a 
better position than an independent LEC to leverage its in-region 
monopoly power arising from its control of the local exchange to 
benefit its provision of out-of-region long distance services. We 
therefore conclude that there is no persuasive reason to implement 
different regulatory schemes for the BOCs and independent LECs in the 
context of their provision of out-of-region long distance services.
    213. We also conclude that the Fifth Report and Order separation 
requirements and the additional safeguards suggested in the record, are 
not necessary to prevent the BOCs and independent LECs from raising the 
costs of their interexchange rivals' services originating outside the 
BOC's or independent LEC's region. As discussed above, we believe that 
other applicable safeguards, coupled with the geographic separation 
between the BOCs' and independent LECs' in-region and out-of-region 
operations will prevent a BOC or independent LEC from favoring its out-
of-region interexchange services through improper allocation of costs, 
discrimination, or other anticompetitive conduct. Further, we found in 
the Interim BOC Out-of-Region Order that the commenters presented no 
persuasive evidence that showed additional safeguards were warranted to 
prevent improper allocation of costs and discrimination. In Section 
IV.B., we found that no party presented persuasive evidence in this 
proceeding that shows that it is necessary to impose additional 
safeguards on the independent LECs as a condition for non-dominant 
regulatory treatment for the provision of in-region, interstate, 
interexchange service. Consequently, we conclude that the Fifth Report 
and Order separation requirements and the proposed additional 
safeguards are unnecessary in this context, and should therefore be 
eliminated. With respect to small independent LECs, we note that this 
decision may promote their expansion into new telecommunications 
services and information services consistent with section 257 of the 
Act. See 47 U.S.C. Sec. 257.

VI. Final Regulatory Flexibility Analysis

    214. As required by Section 603 of the Regulatory Flexibility Act 
(RFA), 5 U.S.C. Sec. 603, an Initial Regulatory Flexibility Analysis 
(IRFA) was incorporated in each of the two Notices of Proposed 
Rulemaking from which this Order issues. The Commission sought written 
public comment on the proposals in the NPRMs. The Commission's Final 
Regulatory Flexibility Analysis (FRFA) in this Order conforms to the 
RFA, as amended by the Contract With America Advancement Act of 1996 
(CWAAA).

A. Need for and Objectives of This Report and Order and the Regulations 
Adopted Herein

    215. In the 1996 Act, Congress sought to establish ``a pro-
competitive, de-regulatory national policy framework'' for the United 
States telecommunications industry. Three principal goals of the 
telephony provisions of the 1996 Act are: (1) Opening local exchange 
and exchange access markets to competition; (2) promoting increased 
competition in telecommunications markets that are already open to 
competition, particularly long distance services markets; and (3) 
reforming our system of universal service so that universal service is 
preserved and advanced as local exchange and exchange access markets 
move from monopoly to competition.
    216. The regulations adopted in this Order implement the second of 
these goals--promoting increased competition in the interexchange 
market. The objective of the regulations adopted in this Order is to 
implement as quickly and effectively as possible the national 
telecommunications policies embodied in the 1996 Act and to promote the 
development of competitive, deregulated markets envisioned by Congress. 
In doing so, we are mindful of the balance that Congress struck between 
this goal of bringing the benefits of competition to all consumers and 
its concern for the impact of the 1996 Act on small incumbent local 
exchange carriers.

B. Analysis of Significant Issues Raised in Response to the IRFA

    217. As noted above, this Order issues from two separate Notices of 
Proposed Rulemaking. In March 1996, the Commission released an NPRM 
asking, among other things, whether we should modify or eliminate the 
separation requirements imposed on independent LECs as a condition for 
non-dominant treatment of their out-of-region, interstate, domestic, 
interexchange services. In July 1996, we released an NPRM seeking 
comment on, in addition to other issues, whether to modify our existing 
regulations governing independent LECs' provision of in-region, 
interstate, domestic, interexchange services, and whether to apply the 
same regulatory treatment to their provision of in-region, 
international services.
    218. Summary of the Initial Regulatory Flexibility Analyses 
(IRFAs). In each of the NPRMs, the Commission performed an IRFA. In the 
IRFA for the Interexchange NPRM, the Commission did not find that any 
of the issues that are addressed in this Order would have a significant 
economic impact on a substantial number of small businesses as defined 
by section 601(3) of the RFA. In the IRFA for the Non-Accounting 
Safeguards NPRM, the Commission certified that its proposed regulations 
would not, if promulgated, have a significant economic impact on a 
substantial number of small businesses as defined by section 601(3) of 
the RFA. We stated that our regulatory flexibility analysis was 
inapplicable to BOCs and other incumbent LECs because these entities 
are dominant in their field of operation.
1. Treatment of Small LECs
    219. Comments. NTCA claims that its membership includes companies 
that constitute ``small business concerns'' under the RFA. NTCA argues 
that our IRFA in the Non-Accounting Safeguards NPRM incorrectly 
certifies that our proposed regulations will not have a significant 
economic impact on a

[[Page 36015]]

substantial number of small entities. NTCA states that the Small 
Business Administration (SBA) establishes size standards for small 
businesses that ``seek to ensure that a concern that meets a specific 
size standard is not dominant in its field of operation.'' NTCA states 
that the Commission cannot ignore SBA definitions and conclude that all 
incumbent LECs are dominant for purposes of the Regulatory Flexibility 
Analysis. NTCA recommends that we ``consider flexible regulatory 
proposals and analyze any significant alternatives that would minimize 
significant economic impacts'' of our regulations on its members that 
are small companies.
    220. Discussion. NTCA essentially argues that we exceeded our 
authority under the RFA by certifying all incumbent LECs as dominant in 
their field of operation, and concluding on that basis that they are 
not small businesses under the RFA. We have found incumbent LECs to be 
``dominant in their field of operation'' since the early 1980s, and we 
consistently have certified under the RFA that incumbent LECs are not 
subject to regulatory flexibility analyses because they are not small 
businesses. We have made similar determinations in other areas. While 
we recognize SBA's special role and expertise with regard to the RFA, 
we are not fully persuaded on the basis of this record that our prior 
practice has been incorrect. Nevertheless, in light of NTCA's concerns, 
we will conduct an analysis on the impact of our regulations in this 
Order on small incumbent LECs, in order to remove any possible issue of 
RFA compliance. We therefore need not address NTCA's argument that many 
of its members are ``small business concerns'' for purposes of the RFA.

C. Description and Estimates of the Number of Small Entities Affected 
by This Report and Order

    221. In this FRFA, we consider the impact of this Order on two 
categories of entities, ``small incumbent LECs'' and ``small non-
incumbent LECs.'' Consistent with our prior practice, we shall continue 
to exclude small incumbent LECs from the definition of a small entity 
for the purpose of this FRFA. Accordingly, our use of the terms ``small 
entities'' and ``small businesses'' does not encompass ``small 
incumbent LECs.'' We use the term ``small incumbent LECs'' to refer to 
any incumbent LECs that arguably might be defined by SBA as ``small 
business concerns.'' We include ``small non-incumbent LECs'' in our 
analysis, even though we believe that we are not required to do so.
    222. For the purposes of this Order, the RFA defines a ``small 
business'' to be the same as a ``small business concern'' under the 
Small Business Act, 15 U.S.C. Sec. 632, unless the Commission has 
developed one or more definitions that are appropriate to its 
activities. Under the Small Business Act, a ``small business concern'' 
is one that: (1) is independently owned and operated; (2) is not 
dominant in its field of operation; and (3) meets any additional 
criteria established by the SBA. SBA has defined a small business for 
Standard Industrial Classification (SIC) category 4813 (Telephone 
Communications, Except Radiotelephone) to be a small entity when it has 
fewer than 1,500 employees.
    223. Incumbent LECs. SBA has not developed a definition of small 
incumbent LECs. The closest applicable definition under SBA rules is 
for telephone communications companies other than radiotelephone 
(wireless) companies. The most reliable source of information regarding 
the number of LECs nationwide of which we are aware appears to be the 
data that we collect annually in connection with the Telecommunications 
Relay Service (TRS). According to our most recent data, 1,347 companies 
reported that they were engaged in the provision of local exchange 
services. Although it seems certain that some of these carriers are not 
independently owned and operated, or have more than 1,500 employees, we 
are unable at this time to estimate with greater precision the number 
of LECs that would qualify as small business concerns under SBA's 
definition. Consequently, we estimate that there are fewer than 1,347 
small incumbent LECs that may be affected by the decisions and 
regulations adopted in this Order.
    224. Non-Incumbent LECs. SBA has not developed a definition of 
small non-incumbent LECs. For purposes of this Order, we define the 
category of ``small non-incumbent LECs'' to include small entities 
providing local exchange services which do not fall within the 
statutory definition in section 251(h), including potential LECs, LECs 
which have entered the market since the 1996 Act was passed, and LECs 
which were not members of the exchange carrier association pursuant to 
section 69.601(b) of the Commission's regulations. We believe it is 
impracticable to estimate the number of small entities in this 
category. We are unaware of any data on the number of LECs which have 
entered the market since the 1996 Act was passed, and we believe it is 
impossible to estimate the number of entities which may enter the local 
exchange market in the near future. Nonetheless, we will estimate the 
number of small entities in a subgroup of the category of ``small non-
incumbent LECs.'' According to our most recent data, 57 companies 
identify themselves in the category ``Competitive Access Providers 
(CAPs) & Competitive LECs (CLECs).'' A CLEC is a provider of local 
exchange services which does not fall within the definition of 
``incumbent LEC'' in section 251(h). Although it seems certain that 
some of the carriers in this category are CAPs, (While the Commission 
has not prescribed a definition for the term ``CAP,'' it is generally 
not used to refer to companies that provide local exchange services.) 
are not independently owned and operated, or have more than 1,500 
employees, we are unable at this time to estimate with greater 
precision the number of non-incumbent LECs that would qualify as small 
business concerns under SBA's definition.

D. Summary Analysis of the Projected Reporting, Recordkeeping, and 
Other Compliance Requirements

    225. Under our current regulations, independent LECs are classified 
as non-dominant interexchange carriers if they provide interstate, 
domestic, interexchange services through an affiliate that satisfies 
the separation requirements established in the Fifth Report and Order. 
Independent LECs offering interstate, domestic, interexchange services 
directly (rather than through a separate affiliate), or through an 
affiliate that does not satisfy the specified conditions, are subject 
to dominant carrier regulation. Independent LECs are permitted to 
provide international, interexchange services subject to non-dominant 
or dominant regulation, as determined on a case-by-case basis. Non-
dominant interexchange carriers are not subject to rate regulation, and 
currently may file tariffs that are presumed lawful on one day's notice 
and without cost support. Tariff Filing Requirements for Non-Dominant 
Carriers. As discussed in note 8 supra, the Commission recently 
determined, pursuant to section 10 of the Communications Act, to 
forbear from requiring non-dominant interexchange carriers to file 
tariffs for interstate, domestic, interexchange services. The 
Commission therefore ordered, inter alia, non-dominant interexchange 
carriers to cancel their tariffs for interstate, domestic, 
interexchange services on file with the Commission within a nine-month 
transition period and not to file any

[[Page 36016]]

such tariffs thereafter. Tariff Forbearance Order at Paras. 89-93, 
stayed pending judicial review, MCI Telecom. Corp. v. FCC, No. 96-1459 
(D.C. Cir. Feb. 13, 1997). See also Policy and Rules Concerning the 
Interstate, Interexchange Marketplace; Guidance Concerning 
Implementation as a Result of the Stay Order of the U.S. Court of 
Appeals for the D.C. Circuit, CC Docket No. 96-61, Public Notice, DA 
97-493 (rel. March 6, 1997). Non-dominant carriers are also subject to 
streamlined section 214 requirements. Compliance with these 
requirements may require small incumbent LECs to use accounting, 
economic, technical, legal, and clerical skills.
    226. In this Order, we have found that all incumbent independent 
LECs, including small incumbent independent LECs, must provide in-
region, interstate, domestic, interexchange services through a separate 
affiliate that satisfies the Fifth Report and Order requirements. We 
are aware of three companies currently providing interexchange services 
directly on dominant basis, Union Telephone Company (of Wyoming), GTE 
Hawaiian Tel., and MTC. We direct companies that are not currently 
providing interexchange services through a separate affiliate that 
satisfies the Fifth Report and Order requirements to comply with the 
Fifth Report and Order separation requirements no later than one year 
from the date of release of this Order. We also extend this regulatory 
regime, which applies to domestic services, to international, 
interexchange services as well. Pursuant to this Order, all incumbent 
independent LECs, including small incumbent independent LECs, must 
provide in-region, interstate, domestic, interexchange services and 
international, interexchange services through a separate affiliate that 
satisfies the Fifth Report and Order separation requirements. 
Specifically, incumbent independent LECs must provide these services 
through a separate affiliate that must: (1) Maintain separate books of 
account; (2) not jointly own transmission or switching facilities with 
its affiliated exchange companies; and (3) obtain any services from its 
affiliated exchange companies at tariffed rates and conditions. Fifth 
Report and Order, 98 FCC 2d at 1198, para. 9. For purposes of these 
requirements, an ``affiliate'' of an independent LEC is ``a carrier 
that is owned (in whole or in part) or controlled by, or under common 
control with, an exchange telephone company.'' Id. In this Order, we 
have also eliminated the Fifth Report and Order separation requirements 
as a condition for non-dominant treatment of incumbent independent 
LECs' provision of out-of-region, interstate, domestic, interexchange 
services.

E. Steps Taken to Minimize the Significant Economic Impact of this 
Report and Order on Small Entities and Small Incumbent LECs, Including 
the Significant Alternatives Considered and Rejected

    227. We believe that our actions eliminating dominant carrier 
regulation of independent LEC provision of in-region, interstate, 
domestic, interexchange services, yet maintaining all of the Fifth 
Report and Order separation requirements to guard against 
anticompetitive conduct in the form of cost misallocation or 
unreasonable discrimination, will facilitate the provision of in-
region, interstate, domestic, interexchange services by independent 
LECs, many of which may be small incumbent LECs. We reject proposals to 
remove the Fifth Report and Order requirements, for reasons set forth 
in Section IV.B.1.
    228. Our actions seem likely to benefit all incumbent independent 
LECs providing in-region, interstate, domestic, interexchange services 
on a non-dominant basis, some of which may be small incumbent LECs, 
because any increase in costs of regulatory compliance can be amortized 
over a period of one year. As noted in Section IV.B.1, incumbent LECs 
that currently provide these services on an integrated basis subject to 
dominant carrier regulation are given one year from the date of release 
of this Order to comply with the Fifth Report and Order separation 
requirements.
    229. We decline to impose section 272 requirements, aspects of 
dominant carrier regulation, or any additional requirements on 
independent LECs' provision of in-region, interstate, domestic, 
interexchange services. Consistent with our belief that independent 
LECs are less likely to be able to engage in anticompetitive conduct 
than the BOCs, we therefore establish a less stringent regulatory 
regime for the independent LECs. This seems likely to benefit 
independent LECs, including small incumbent LECs, by not subjecting 
them to burdensome regulations that may serve only to hamper 
competition in the interexchange market. For the reasons set forth in 
Section IV.B.1, we reject alternatives to impose additional 
requirements on independent LECs' provision of in-region, interstate, 
domestic, interexchange services.
    230. We limit the scope of the separation requirements to incumbent 
independent LECs. By not imposing the Fifth Report and Order 
requirements on non incumbent LECs, we avoid imposing unnecessary 
regulation on new entrants into the local exchange market that wish to 
provide in-region, interstate, domestic, interexchange services, and 
will not have control of incumbent local exchange and exchange access 
facilities. This seems likely to benefit all of these new entrants, 
some of which may be small entities, by lowering entry costs, lowering 
the disparity in market power between new entrants and incumbent LECs, 
minimizing the risk of being subjected to legal action, and decreasing 
administrative costs. We reject proposals to subject non-incumbent LECs 
to the same requirements as incumbent LECs, for the reasons set forth 
in Section IV.B.2.
    231. We apply our regulations equally to all incumbent independent 
LECs, in view of our conclusion that the size of an independent LEC 
will not affect its incentives to engage in cost misallocation between 
its monopoly services and its competitive services. Our action is 
intended to foster competition in the in-region, interstate, domestic, 
interexchange marketplace nationwide by preventing all incumbent 
independent LECs, regardless of size, from using their control of 
bottleneck local exchange and exchange access facilities to thwart new 
entry. This seems likely to benefit all new entrants into the local 
exchange market that wish to provide in-region, interstate, domestic, 
interexchange services, some of which may be small entities, by helping 
to reduce entry costs and lower the disparity in market power between 
new entrants and other incumbent LECs. Moreover, our action will likely 
help to establish these favorable entry conditions uniformly 
nationwide, fostering increased certainty which will benefit all new 
entrants, including any small entities. We reject alternatives to 
exempt all incumbent LECs with less than two percent of the nation's 
access lines from our regulations, for the reasons stated in Section 
IV.B.3.
    232. We extend the regulatory regime described above, which governs 
independent LECs' provision of in-region, interstate, domestic, 
interexchange services, to independent LECs' provision of in-region, 
international services. We believe that this action will benefit 
incumbent LECs and non-incumbent LECs, some of which may be small 
incumbent LECs or small entities, for the same reasons enumerated in 
our analysis for in-region, interstate, domestic, interexchange 
services, such as helping

[[Page 36017]]

to reduce market entry costs, decreasing the disparity in market power 
between new entrants and other incumbent LECs, and lowering 
administrative costs. We decline to treat independent LECs' provision 
of in-region, interstate, domestic, interexchange services and in-
region, international services differently, for the reasons stated in 
Section IV.B.4.
    233. As stated in Section IV.B.5, we intend to commence a 
proceeding three years from the date of adoption of this Order to 
determine whether the emergence of competition in the local exchange 
and exchange access marketplace justifies removal of the Fifth Report 
and Order requirements. We believe that three years should be a 
reasonable period of time in which to expect effective competition to 
develop in local exchange and exchange access markets. We reject 
proposals to decide in this proceeding whether to sunset separate 
affiliate requirements for independent LECs, for the reasons stated in 
Section IV.B.5.
    234. Report to Congress: The Commission shall send a copy of this 
FRFA, along with this Report and Order, in a report to Congress 
pursuant to the SBREFA, 5 U.S.C. Sec. 801(a)(1)(A). A copy of this 
analysis will also be provided to the Chief Counsel for Advocacy of the 
Small Business Administration, and will be published in the Federal 
Register.

VII. Final Paperwork Reduction Analysis

    235. Each of the two Notices of Proposed Rulemaking from which this 
Order issues proposed changes to the Commission's information 
collection requirements. As required by the Paperwork Reduction Act of 
1995, Public Law 104-13, the Commission sought written comment from the 
public and from the Office of Management and Budget (OMB) on the 
proposed changes. The collections described therein, however, are 
addressed in other proceedings.
    236. In this Order, we have decided to require independent LECs to 
comply with Fifth Report and Order separation requirements in order to 
provide international, interexchange services. Pursuant to the 
separation requirements, an independent LEC and its international, 
interexchange affiliate must maintain separate books of account. This 
requirement constitutes a new ``collection of information'' within the 
meaning of the Paperwork Reduction Act of 1995, 44 U.S.C. Secs. 3501-
3520. Implementation of this requirement is subject to approval by the 
Office of Management and Budget as prescribed by the Paperwork 
Reduction Act.

VIII. Ordering Clauses

    237. Accordingly, it is ordered that, pursuant to sections 1, 2, 4, 
201, 202, 251, 271, 272 and 303(r) of the Communications Act of 1934, 
as amended, 47 U.S.C. Secs. 151, 152, 154, 201, 202, 251, 271, 272, and 
303(r), the Report and Order is adopted.
    238. It is further Ordered that the Report and Order, which imposes 
new or modified information or collection requirements, shall become 
effective 70 days after publication in the Federal Register, following 
approval by the Office of Management and Budget, unless a notice is 
published in the Federal Register stating otherwise.
    239. It is further Ordered that part 64, subpart T of the 
Commission's rules, 47 CFR part 64 subpart T, is added as set forth in 
rule changes attached hereto.
    240. It is further Ordered that the Secretary shall send a copy of 
this Report and Order, including the final regulatory flexibility 
analysis, to the Chief Counsel for Advocacy of the Small Business 
Administration, in accordance with paragraph 605(b) of the Regulatory 
Flexibility Act, 5 U.S.C. Secs. 601 et seq.

List of Subjects in 47 CFR Part 64

    Communications common carriers, Reporting and recordkeeping 
requirements.

Federal Communications Commission.
William F. Caton,
Acting Secretary.

Rule Changes

    Part 64 of title 47 is amended as follows:

PART 64--MISCELLANEOUS RULES RELATING TO COMMON CARRIERS

    1. The authority citation for part 64 continues to read as follows:

    Authority: 47 U.S.C. 154.

    2. Part 64 is amended by adding new subpart T to read as follows:

Subpart T--Separate Affiliate Requirements for Incumbent 
Independent Local Exchange Carriers That Provide In-Region, 
Interstate Domestic Interexchange Services or In-Region 
International Interexchange Services

Sec.
64.1901  Basis and purpose.
64.1902  Terms and definitions.
64.1903  Obligations of all incumbent independent local exchange 
carriers.


Sec. 64.1901  Basis and purpose.

    (a) Basis. These rules are issued pursuant to the Communications 
Act of 1934, as amended.
    (b) Purpose. The purpose of these rules is to regulate the 
provision of in-region, interstate, domestic, interexchange services 
and in-region international interexchange services by incumbent 
independent local exchange carriers.


Sec. 64.1902  Terms and definitions.

Terms used in this part have the following meanings:

    Books of Account. Books of account refer to the financial 
accounting system a company uses to record, in monetary terms the basic 
transactions of a company. These books of account reflect the company's 
assets, liabilities, and equity, and the revenues and expenses from 
operations. Each company has its own separate books of account.
    Incumbent Independent Local Exchange Carrier (Incumbent Independent 
LEC). The term incumbent independent local exchange carrier means, with 
respect to an area, the independent local exchange carrier that:
    (1) On February 8, 1996, provided telephone exchange service in 
such area; and
    (2) (i) On February 8, 1996, was deemed to be a member of the 
exchange carrier association pursuant to Sec. 69.601(b) of this title; 
or
    (ii) is a person or entity that, on or after February 8, 1996, 
became a successor or assign of a member described in paragraph (2) (i) 
of this definition. The Commission may also, by rule, treat an 
independent local exchange carrier as an incumbent independent local 
exchange carrier pursuant to section 251(h)(2) of the Communications 
Act of 1934, as amended.
    Independent Local Exchange Carrier (Independent LEC). Independent 
local exchange carriers are local exchange carriers, including GTE, 
other than the BOCs.
    Independent Local Exchange Carrier Affiliate (Independent LEC 
Affiliate). An independent local exchange carrier affiliate is a 
carrier that is owned (in whole or in part) or controlled by, or under 
common ownership (in whole or in part) or control with, an independent 
local exchange carrier.
    In-Region Service. In-region service means telecommunications 
service originating in an independent local exchange carrier's local 
service areas or 800 service, private line service, or their 
equivalents that:
    (1) Terminate in the independent LEC's local exchange areas; and

[[Page 36018]]

    (2) Allow the called party to determine the interexchange carrier, 
even if the service originates outside the independent LEC's local 
exchange areas.
    Local Exchange Carrier. The term local exchange carrier means any 
person that is engaged in the provision of telephone exchange service 
or exchange access. Such term does not include a person insofar as such 
person is engaged in the provision of a commercial mobile service under 
section 332(c), except to the extent that the Commission finds that 
such service should be included in the definition of that term.


Sec. 64.1903  Obligations of all incumbent independent local exchange 
carriers.

    (a) Except as provided in paragraph (c) of this section, an 
incumbent independent LEC providing in-region, interstate, 
interexchange services or in-region international interexchange 
services shall provide such services through an affiliate that 
satisfies the following requirements:
    (1) The affiliate shall maintain separate books of account from its 
affiliated exchange companies. Nothing in this section requires the 
affiliate to maintain separate books of account that comply with Part 
32 of this title;
    (2) The affiliate shall not jointly own transmission or switching 
facilities with its affiliated exchange companies. Nothing in this 
section prohibits an affiliate from sharing personnel or other 
resources or assets with an affiliated exchange company; and
    (3) The affiliate shall acquire any services from its affiliated 
exchange companies for which the affiliated exchange companies are 
required to file a tariff at tariffed rates, terms, and conditions. 
Nothing in this section shall prohibit the affiliate from acquiring any 
unbundled network elements or exchange services for the provision of a 
telecommunications service from its affiliated exchange companies, 
subject to the same terms and conditions as provided in an agreement 
approved under section 252 of the Communications Act of 1934, as 
amended.
    (b) The affiliate required in paragraph (a) of this section shall 
be a separate legal entity from its affiliated exchange companies. The 
affiliate may be staffed by personnel of its affiliated exchange 
companies, housed in existing offices of its affiliated exchange 
companies, and use its affiliated exchange companies' marketing and 
other services, subject to paragraph (a)(3) of this section.
    (c) An incumbent independent LEC that is providing in-region, 
interstate, domestic interexchange services or in-region international 
interexchange services prior to April 18, 1997, but is not providing 
such services through an affiliate that satisfies paragraph (a) of this 
section as of April 18, 1997, shall comply with the requirements of 
this section no later than April 18, 1998.
[FR Doc. 97-17407 Filed 7-2-97; 8:45 am]
BILLING CODE 6712-01-P