**UNITED STATES COURT OF APPEALS**

**FIFTH CIRCUIT**

\_\_\_\_\_\_\_\_\_\_\_\_

No. 00-60434

\_\_\_\_\_\_\_\_\_\_\_\_

TEXAS OFFICE OF PUBLIC UTILITY COUNSEL;

NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES,

Petitioners,

versus

FEDERAL COMMUNICATIONS COMMISSION;UNITED STATES OF AMERICA,

Respondents.

On Petition for Review of a Final Order of

the Federal Communications Commission

September 10, 2001

Before EMILIO M. GARZA, PARKER, Circuit Judges, and ELLISON[^1],
District Judge.

EMILIO M. GARZA, Circuit Judge:

This petition for review of the CALLS Order[[^2]](#N_2_) represents the
latest challenge to the Federal Communication Commission\'s
implementation of the Telecommunications Act of 1996, Pub.L. No. 104-04,
110 Stat. 56 (codified as amended in scattered sections of title 47,
United States Code) (\"1996 Act\"). The Texas Office of Public Utility
Counsel (\"TOPUC\") and the National Association of State Utility
Consumer Advocates (\"NASUCA\"), along with intervenor Consumer
Federation of America (\"CFA\") (collectively, \"Petitioners\"), claim
that the CALLS Order violates the procedural requirements of the
Administrative Procedure Act, 5 U.S.C. § 706(2)(A) as well as the
substantive provisions of the 1996 Act. We affirm the CALLS Order in
most respects, but we remand for further analysis the portions regarding
the \$650 million Universal Service Fund and the X-Factor.

**I**

We must briefly review the regulatory regime of the telephone industry
to better understand the issues presented in this petition. The
telephone industry is comprised of two sets of carriers. Local exchange
carriers (\"LECs\") provide local basic telephone service, while
interexchange carriers (\"IXCs\") offer long-distance service. Since the
divestiture of AT&T in 1984, robust competition has existed in the
long-distance market with IXCs trying to recruit new customers and lure
subscribers from each other. On the other hand, LECs until recently had
natural monopolies on local service in their respective regions, because
they own the network infrastructure necessary to make telephone calls.
The prohibitive capital costs involved in laying out a separate
infrastructure deterred potential competitors from entering the local
service market. The 1996 Act made competition in the local basic service
market as one of its main goals. Congress prodded incumbent local
exchange carriers (\"ILECs\")\--that is, LECs like the Baby Bells which
own the infrastructure\--to provide cost-based use of their network to
companies that wanted to enter the local service market. In return,
Congress allowed ILECs, which had previously been barred from offering
long-distance service in their home regions, to enter that market.

The 1996 Act\'s provision of allowing LECs to use ILECs\' infrastructure
resembled an arrangement already shared by IXCs and ILECs: IXCs rely on
ILECs\' network to originate and terminate long-distance calls. More
technically, the IXCs use the \"local loop,\" which refers to telephone
wires running from a person\'s telephone to the local telephone switch.
Whenever someone makes a long-distance phone call, he or she taps into
the local network, where the call is then routed between a LEC local
switch and an IXC switch. The costs incurred by the ILECs in providing
the use of this infrastructure are called \"loop costs.\"

Two sources of revenues allow the ILECs to recover the loop costs.
First, all end-users of basic local service pay a flat Subscriber Line
Charge (\"SLC\") that appears in their monthly telephone bills. Prior to
the CALLS Order, the FCC capped the SLC at \$3.50 per month: ILECs can
charge less than \$3.50 per month, but it cannot levy an access charge
above that amount. The SLC alone is insufficient to defray the loop
costs entirely. Thus, the FCC assesses an access charge against IXCs,
which in turn usually pass down these costs to end-users. At first, the
FCC levied a traffic-sensitive fee called the Common Carrier Line Charge
(\"CCL\") against IXCs. The FCC later replaced the CCL with the
flat-rate Presubscribed Interexchange Carrier Charge (\"PICC\"). *See*
*Access Charge Reform Order, Price Cap Reform Performance Review for
Local Exchange Carriers, Transport Structure and Pricing, End User
Common Line Charges*, CC Docket Nos. 96-262, 94-1, 91-213 and 95-72,
First Report and Order, FCC 97-158, 62 Fed. Reg. 31867 (released May 16,
1997) (\"Access Charge Reform Order\"). The FCC determined that
high-volume long-distance callers did not financially burden the network
more than low-volume callers, but were nevertheless being penalized by a
traffic-sensitive CCL charge. The FCC believed that the flat-rate PICC
more accurately represented the true costs incurred by long-distance
callers.

In addition to fostering competition in the local telephone service
market, the 1996 Act had another key goal of continuing the provision of
affordable universal service to all Americans. Traditionally, the phone
bills of poor and rural customers have been implicitly subsidized by
rate manipulation. High-volume long-distance callers and urban residents
pay artificially higher phone bills to subsidize and support universal
service for others. Congress recognized that these implicit subsidies
could not continue under a market-based regime ushered in by the 1996
Act. In a competitive market, a carrier that subsidizes rural or poor
customers by charging below-cost rates while billing above-cost rates to
urban customers will be undercut by a competitor offering at-cost rates
to urban end-users. Congress wanted to continue subsidizing universal
service, but in a way more consistent with the market-oriented reforms.
The 1996 Act thus required that the implicit subsidy system of rate
manipulation be replaced with explicit subsidies for universal service.
To implement the goals of the 1996 Act, the FCC issued a series of
orders.

The FCC first issued its Access Charge Reform Order. As noted before,
the order abolished the traffic-sensitive CCL fees assessed against
IXCs, and replaced them with the flat-rate PICC. By ensuring that access
charges more accurately reflected the actual costs incurred, the FCC
hoped that it would facilitate the shift to a competitive market. The
order also increased the SLC cap for multi-line business customers on
the assumption that they could afford such a price increase. It,
however, did not increase the SLC cap for primary residences and
single-line businesses. Several IXCs petitioned for review of the Access
Charge Reform Order, alleging, among other things, that the failure to
increase the SLC cap on primary residential and single-line businesses
amounted to new implicit subsidies. The Eighth Circuit upheld the Access
Charge Reform Order in part on the ground that the 1996 Act\'s
commitment to universal access constrained the FCC from raising the SLC
price-cap on other lines. *See Southwestern Bell Tel. Co. v. FCC*, 153
F.2d 523 (8th Cir. 1998) (citing 47 U.S.C. § 254(b)\'s statement of
affordable universal access). Noting that the order was a transitional
plan only, the court further upheld the FCC\'s decision to rely on
market forces rather than on comprehensive cost analysis in changing its
access charge policy.

The FCC also issued *In re Federal-State Joint Board on Universal
Service*, CC Docket No. 96-45, Report and Order, 12 FCC Rcd. 8776 (1997)
(\"Universal Service Order\"). This order emphasized that implicit
subsidies for universal service should be gradually removed from
interstate access charges, and replaced with an explicit universal
service fund derived from percentage-based fees levied against
telecommunications carriers. This Circuit remanded parts of the order,
but we upheld the requirement that LECs must reduce access charges by an
amount commensurate with the money received for the explicit universal
service fund. *See Tex. Office of Pub.Util. Counsel v. FCC*, 183 F.3d
393 (5th Cir. 1999) (\"*TOPUC I*\").

Finally, the FCC addressed the issue of the \"X-Factor\" in its *In the
Matter of Price Cap Performance Review for Local Exchange Carriers*, CC
Docket 96-262, Fourth Report and Order, 12 FCC Rcd 16,642 (1997)
(\"Price Cap Review\"). FCC had annually reduced LECs\' price-caps by
imposing what it dubbed the X-Factor, a percentage number that
represented the LECs\' increase in productivity minus the rate of
inflation. By lowering the price-caps (and hence the amount that LECs
could charge consumers), the X-Factor pressured LECs to become more
efficient and to lower their costs. In effect, the X-Factor passed down
the savings from the LECs\' increased productivity to the consumers. In
its Price Cap Review, the FCC raised the X-Factor to 6.5 percent. On
petition for review, the D.C. Circuit found the increase to be arbitrary
and capricious because the FCC did not provide sufficient evidence of
increased productivity by the LECs to warrant the 6.5 percent figure.
*See United States Tel. Ass\'n v. FCC*, 188 F.3d 521 (D.C. Cir. 1999)
(\"*USTA*\"). It remanded this issue back to the FCC.

While revisiting the two remanded orders from *USTA* and *TOPUC I*, the
FCC considered and adopted the CALLS Order, a five-year transitional
plan intended to help resolve the thorny issues of access charges. This
order originates from the work of the Coalition for Affordable Local and
Long Distance Service (\"CALLS\"), a group of major IXCs and ILECs.
Although ILECs and IXCs traditionally have held opposing views on
telecommunications reform, they worked together in jointly presenting
the CALLS proposal. The FCC conducted a notice-and-comment proceeding
pursuant to the Administrative Procedure Act (\"APA\") by soliciting
public comments on the proposal and receiving dozens of comments. After
making some changes, the FCC submitted a modified CALLS proposal, and
again solicited comments but on an abbreviated schedule. Several weeks
later, the FCC issued the final CALLS Order.

The CALLS Order promulgates four key changes, all of which are
challenged in this petition for review. First, the FCC abolishes the
PICC fees assessed against IXCs. Second, to compensate for the loss of
revenues from the elimination of the PICC, the order raises the SLC
price cap for primary residential lines. It will increase from \$3.50 to
\$6.50 over a period of several years. The FCC changed the fee
structure, believing that it would encourage more competition and lead
to lower rates overall for consumers. Third, the FCC reintroduces a 6.5
percent X-Factor, but switches it from a productivity proxy to a
non-productivity-based mechanism for rate reduction. Fourth, it
establishes a transitional \$650 million Universal Service Fund to
provide explicit subsidies for poor and rural customers.

The parties challenging the CALLS Order include the Texas Office of
Public Utility Counsel, as well as the National Association of State
Utility Consumer Advocates and the intervenor Consumer Federation of
America, both of which are consumer advocacy groups.[^3] In their
petition, they make two broad challenges against the order. The
Petitioners first contend that the CALLS Order did not comport with the
APA requirements. They characterize the CALLS Order as the product of a
surreptitious political deal between the respondent FCC and the
respondent-intervenor CALLS Coalition. The Petitioners also challenge
the order on substantive grounds, claiming that it betrays, among other
things, the 1996 Act\'s requirement of affordable universal access. We
first address the substantive statutory challenge, and then the
procedural objections to the CALLS Order.

**II**

In reviewing the Petitioners\' substantive claims, we apply the two-step
analysis set forth in *Chevron U.S.A. Inc. v. Natural Res. Def.
Council*, 467 U.S. 837, 842-43, 104 S.Ct. 2778, 2781-2783, 81 L.Ed.2d
694 (1984). In step one, we look to see whether Congress has spoken
directly on the precise question at issue. *See id.* at 843, 104 S.Ct.
at 2781. If Congress has done so, we must \"give effect to
\[Congress\'\] unambiguously expressed intent.\" *Id.* at 843, 104 S.Ct.
at 2781. If the statute is ambiguous as to the question at issue, we
move to the second step of the *Chevron* analysis to determine \"whether
the agency\'s answer is based upon a permissible construction.\" *Id.*
at 843, 104 S.Ct. at 2782. Under this second step, we can reverse the
agency\'s decision only if it was arbitrary, capricious or manifestly
contrary to the statute. *See id.* at 844, 104 S.Ct. at 2782. The
question is not whether we might have preferred another way to interpret
the statute, but whether the agency\'s decision was a reasonable one.
*See MCI Telecomm. Corp. v. FCC*, 675 F.2d 408, 413 (D.C. Cir. 1982).

We address in order the Petitioners\' three main objections to the CALLS
Order: whether the SLC price cap increase violates § 254(b)(1) and
§ 254(i)\'s purported affordability mandate; whether it contravenes
§ 254(k)\'s prohibition against unreasonable allocation of joint and
common costs; and whether the 1996 Act requires the FCC to conduct a
comprehensive, forward-looking study.

**A**

The Petitioners object to the increase in the SLC caps for residential
and single-line business customers, alleging that it violates the
affordability mandate of 47 U.S.C. § 254 and arbitrarily reverses the
long-settled agency policy of ensuring affordable universal service. We
hold that the increase in the SLC price cap does neither: the FCC has
reasonably interpreted § 254 under step-two of the *Chevron* analysis,
and has provided sufficient justification for its change in price cap
policy.

The Petitioners point to two statutory provisions that allegedly
preclude the FCC from increasing the SLC cap. Section 254(b)(1) states
that \"\[q\]uality services should be available at just, reasonable, and
affordable rates,\" and § 254(i) declares that \"\[t\]he Commission and
the States should ensure that universal service is available at rates
that are just, reasonable and affordable.\" 47 U.S.C. § 254(i),
254(b)(1). The FCC acknowledges the importance of affordability under
the 1996 Act, but states that it is only an aspirational guideline that
must be carefully balanced with other statutory objectives. In response,
the Petitioners imply that the FCC must make affordability paramount in
formulating access charge policy, even if it comes at the expense of
other statutory goals.

We hold that the FCC\'s interpretation § § 254(b)(1) and 254(i) as
merely aspirational is permissible under step-two of the *Chevron*
analysis. Accordingly, the two provisions cannot serve as a basis to
invalidate the SLC price cap increase (assuming that the increase
endangers affordability, which the FCC denies).

We first discuss § 254(b)(1). Under the heading of \"\[u\]niversal
service principles,\" § 254(b) lists seven factors that the FCC should
follow in implementing the 1996 Act.[^4] One of the principles is that
\"\[q\]uality service should be at . . . affordable rates.\" 47 U.S.C. §
254(b)(1). We have previously analyzed § 254(b) under *Chevron* step-two
because the listed principles use \"vague, general language,\" rendering
the section ambiguous. *TOPUC I*, 183 F.3d at 421 (analyzing
§ 254(b)(3)). Under this deferential review, we have approved the FCC\'s
interpretation of the statutory principles as aspirational only. *See
id*, 183 F.3d at 421 (refusing to \"rely\[\] on the aspirational
language in § 254(b) to bind the FCC to adopt certain cost methodologies
for calculating universal service support\"); *see also Chevron* at 843,
104 S.Ct. at 2778 (holding that courts must defer to an agency\'s
reasonable reading of an ambiguous provision). Indeed, the lofty and
expansive language of § 254(b) \"hardly constitute\[\] a series of
specific statutory commands.\" *TOPUC I*, 183 F.3d at 421. Rather, they
\"reflect congressional intent to delegate difficult policy choices to
the Commission\'s discretion.\" *See Alenco*, 201 F.3d 608, 615 (5th
Cir. 2000); *cf. Nat\'l Ass\'n of Regulatory Util. Comm\'r v. FCC*, 737
F.2d 1095, 1134 (D.C. Cir. 1984) (noting the \"breadth of the
Commission\'s statutory discretion to balance the multiple goals
embodied in the Communications Act.\").

Similarly, we hold that the FCC\'s reading of § 254(i) as aspirational
is a \"permissible construction of the statute.\" *Chevron* at 843, 104
S.Ct. at 2778. Section 254(i) states that the FCC \"*should* ensure that
universal service is . . . affordable.\" Generally, courts have \"read
\'shall\' as a more direct statutory command than words such as
\'should\' or \'may.\'\" *TOPUC I*, 184 F.3d at 418. The Petitioners
counter that courts nevertheless sometimes read \"should\" as a direct
statutory command. *See, e.g., Alenco*, 201 F.3d at 614-15. While that
may be true, the Petitioners do not provide any convincing reasons why
the word \"should\" in this context must be read to rebut the general
presumption. The Petitioners\' argument shows only that, at best, the
meaning of § 254(i) is unclear. If a statutory provision is ambiguous,
we must uphold the FCC\'s interpretation as long as it is a reasonable
reading. *See* *Chevron* at 843, 104 S.Ct. at 2778.

Thus, while the FCC cannot flatly ignore or contravene the goal of
affordability, Congress gave it the latitude to formulate a policy that
considers affordability, along with other policy goals of the 1996 Act.
We cannot arrogate to ourselves this policy-making function, merely
because we (or the Petitioners) believe that the FCC is not maximizing
the affordability goal at the expense of other objectives. As we explain
later, the increase in the SLC cap represents FCC\'s reasoned attempt to
maintain the difficult balance between the principles of ensuring
affordability and encouraging competition.

Notwithstanding the statutory provisions, we cannot uphold FCC\'s
decision to increase the SLC caps if it represents an unexplained
reversal of past FCC policy. \"While the agency is entitled to change
its views on the acceptability of \[a prior policy\], it is obligated to
explain its reasons for doing so.\" *Motor Vehicle Mfrs. Ass\'n v. State
Farm Mut. Auto. Ins. Co.*, 463 U.S. 29, 56, 103 S.Ct. 2856, 2873, 77
L.Ed.2d. 443 (1983). The Petitioners allege that FCC has reversed itself
from its earlier decisions not to raise the SLC cap on residences and
single-line businesses due to affordability concerns. *See, e.g.,*
Access Charge Reform Order, ¶ 73 (increasing the SLC cap only on
multi-line businesses).

The FCC has articulated rational reasons to the degree that it has
changed prior policies.[^5] Simply put, the telecommunications market
has undergone dramatic changes in the past few years, and it continues
to do so. In light of this dynamic market, the FCC has walked a delicate
tightrope between the 1996 Act\'s twin goals of ensuring affordability
and promoting local service competition. We have implicitly recognized
that an uneasy tension exists between these two goals: although
increased competition will ultimately make phone service more
affordable, the transition from a highly-regulated industry to a
market-oriented regime can bring some growing pains. *See Alenco*, 201
F.3d at 615. As a consequence, while the \"FCC must see to it that
*both* universal service and local competition are realized,\" we have
also recognized that \"Congress has conferred broad discretion on the
agency to negotiate these dual mandates \[and that\] courts ought not
\[to\] lightly interfere with its reasoned attempt to achieve both
objectives.\" *Id.* at 615 (emphasis in original).

Citing several factors and changes in the market, the FCC believed that
its prior concerns about affordability were \"sufficiently mitigated to
allow an increase in the SLC\" from \$3.50 to \$6.50 over the course of
several years. CALLS Order, ¶ 86. First, the FCC noted that the prior
SLC limit of \$3.50 was established in 1984; if adjusted for inflation,
it would stand at \$4.94. *See* *id.* at ¶ 85. In light of this, the FCC
did not find that an increase in the SLC cap would raise affordability
concerns. Second, it cited empirical evidence suggesting that telephone
subscribership would not be \"negatively impacted\" by such an increase.
*See id.* at ¶ 86. The FCC also noted that increased funding for the
Lifeline support program allayed prior fears of unaffordability.
Finally, the FCC promised to conduct a cost-study before the SLC is
scheduled to rise above \$5.00.

In addition, the FCC believed that pro-competitive benefits from the
abolition of the PICC would offset any increase in the SLC. Although the
PICC is technically assessed against the IXCs, they usually pass it
down, with added costs, to the end-users. *See id.* Eliminating the PICC
would remove such unnecessary transaction costs. The FCC further
reasoned that consumers would benefit because the PICC, as an external
cost imposed on all IXCs, is relatively resistant to competitive
pressures. *See* CALLS Order, ¶ 89. Consequently, the FCC believed that
it would be difficult for the IXCs to reduce and compete away this fee.
*See id.* On the other hand, only the ILECs assess the SLC, which is
imposed directly against the consumers. The newly entering LECs are not
required to charge the SLC. Thus, the FCC held that competitive pressure
could force ILECs to reduce the SLC through efficiency gains. *See id.*

The Petitioners strongly dispute the FCC\'s reasoning. For example, they
reply that the FCC\'s logic about the PICC is counterintuitive because
the long-distance market is currently more competitive than the local
service market. Under our standard of review, we are not required to
concur wholeheartedly with the policy analysis of the FCC. Rather, we
only examine whether \"prior policies and standards are being
deliberately changed\" and \"not casually ignored.\" *Bush-Quayle \'92
Primary Campaign Comm., Inc. v. FEC*, 104 F.3d 448, 453 (D.C. Cir.
1997). After reviewing the record, we are satisfied that the FCC has
sufficiently explained its reasons for increasing the SLC for
residential and single-line business customers. The Petitioners may not
agree with the FCC\'s reasoning, but we cannot usurp the FCC\'s role in
making the difficult policy decisions regarding affordability and
competition. *See* *Alenco*, 201 F.3d at 615.

**B**

The Petitioners also challenge the CALLS Order on the ground that it
recovers an unreasonably disproportionate amount of joint and common
costs of universal service from end-users. At dispute is the meaning of
§ 254(k), which states that the FCC \"shall establish any necessary cost
allocation rules, accounting safeguards, and guidelines to ensure that
services included in the definition of universal service bear no more
than a reasonable share of the joint and common costs of facilities used
to provide these services.\" 47 U.S.C. § 254(k). By abolishing the PICC
fee assessed against IXCs and increasing the SLC cap on end-users, the
FCC unreasonably recovers 100 percent of joint and common costs of
universal service from end-users, according to the Petitioners.

One of the Petitioners, TOPUC, had presented this very same argument in
challenging the Access Charge Reform Order, which had increased the SLC
price cap on multi-line businesses. The Eighth Circuit wholly rejected
that argument in *Southwestern Bell*. It noted that \"\[b\]ecause the
SLC is a method of recovering loop costs, not an allocation of those
costs between supported and unsupported services, § 254(k) is not
implicated.\" *Southwestern Bell*, 153 F.3d at 559. We agree with the
Eighth Circuit. Section 254(k) concerns cost allocation of joint and
common costs, while the SLC and the PICC involve the recovery of such
costs. Thus, § 254(k) does not implicate the SLC or the PICC: cost
recovery involves how and from whom the funds are collected, while cost
allocation refers to how the costs are disbursed.[^6]

**C**

In enacting the 1996 Act, Congress established the goal that network
access charges should eventually reflect the actual costs of providing
and administering the particular network service. To meet this
objective, the FCC has primarily relied on market forces to restructure
the access charges. The Petitioners maintain that the FCC has failed to
conduct a comprehensive, forward-looking cost-study in violation of the
1996 Act. We reject this argument.

The 1996 Act does not compel the FCC to conduct forward-looking
cost-studies because the cost-study requirements of § § 251(c)(1) and
252(d)(1) do not apply to the interstate access services at issue in
this petition. *See Competitive Telecomm. Ass\'n v. FCC*, 117 F.3d 1068,
1072 (8th Cir. 1997) (\"\[I\]t is clear from the Act that Congress did
not intend all access charges to move to cost-based pricing, at least
not immediately. The Act plainly preserves certain rate regimes already
in place.\"). Instead, § § 201(b) and 202(a)\'s broader standard that
interstate service rates be \"just and reasonable\" without
\"unreasonable discrimination\" applies here. *See* 47 U.S.C. §
§ 201(b), 202(a). This \"just and reasonable\" standard gives the FCC
discretion in structuring the access charges. The FCC accordingly has
delayed conducting a forward-looking cost-study because of time
constraints and the technical uncertainty involved in carrying out a
reliable cost study. In lieu of cost-studies, the FCC has primarily
relied on competitive pressures to lower costs.

The Eighth Circuit earlier upheld the FCC\'s reliance on the market to
restructure rates. *See Southwestern Bell*, 153 F.2d at 547 (noting that
\"\[d\]ue to the difficulty in creating a reliable forward-looking cost
model for interstate access services, a prescriptive plan would not be
feasible at the present time.\"). The Petitioners remind the court that
nearly three years have passed since the Eighth Circuit\'s decision.
Although we recognize that the FCC has not acted as quickly as the
Petitioners would want, we cannot say that the FCC has acted arbitrarily
or capriciously, given the transitional nature of the CALLS Order. *See
Alenco*, 201 F.3d at 616 (giving special deference to transitional
rules). We are further assured by the FCC\'s promise to conduct a
cost-study before the SLC cap is set to rise over five dollars. In sum,
we believe that the Eighth Circuit\'s analysis in *Southwestern Bell* is
apropos here:

The FCC has reasonably exercised its predictive judgment in concluding
that competition in the local telephone services market will effectively
drive interstate access charges to economic costs. If, in light of the
actual market developments, the Commission determines that competition
is not having the anticipated effect on access charges, the agency
presumably will revisit the issue. We cannot conclude at this time that
the FCC\'s decision to adopt a market-based approach was arbitrary . . .
in light of the broad discretion Congress has given the Commission in
setting interstate rates.

*Southwestern Bell*, 153 F.3d at 547.

**III**

The Petitioners allege that the FCC\'s procedures in formulating the
CALLS Order was fatally defective and in violation of the APA. *See* 5
U.S.C. § 706(2)(a). They claim that the FCC failed to follow appropriate
notice-and-comment procedures; that it acted arbitrarily and
capriciously in establishing the \$650 million figure for the Universal
Service Fund, and that it provided no rational basis to support a 6.5
percent X-Factor.

In reviewing an agency\'s procedures under the APA, we apply the
arbitrary and capricious standard, recognizing that particular deference
is accorded to transitional rules. *See Alenco*, 201 F.3d at 616. We
cannot \"substitute \[our\] judgment for that of the agency.\" *State
Farm* at 43, 103 S.Ct. at 2866. Our role is \"to review the agency
action to determine whether the decision \'was based on a consideration
of the relevant factors and whether there was a clear error of
judgment.\'\" *State of Louisiana v. Verity*, 853 F.2d 322, 327 (5th
Cir. 1988) (quoting *State Farm*).

**A**

The Petitioners characterize the CALLS Order as a tainted political
compromise between the FCC and the CALLS Coalition. Specifically, the
abbreviated second round of notice-and-comment and the *ex parte*
contact between the FCC and the CALLS Coalition suggest that the FCC had
given approval to the proposed order before considering public comment,
according to the Petitioners. We hold that the CALLS Order is the
product of a valid, if not perfect, informal notice-and-comment
rulemaking proceeding. The APA requires federal agencies that conduct
informal rulemaking to give notice of a proposed rule and consider
public comment on it. *See* 5 U.S.C. § 553. This process allows
\"interested persons an opportunity to participate\" in the rulemaking
process through the submission of written comments. *See* 5 U.S.C. §
553(c). An agency\'s failure to comply with the APA requirements \"leads
in the direction of arbitrary decision-making.\" *United States v. Nova
Scotia Food Prod. Corp*., 568 F.2d 240, 250 (2d Cir. 1976).

Before it promulgated the final CALLS Order, the FCC held a round of
notice-and-comment proceedings for each of its two drafts of the
proposed order. The FCC released the original CALLS proposal for public
comment on September 15, 1999. Over the course of the next few months,
the FCC solicited and received written submissions from dozens of
interested parties. In all, the FCC received comments from 36 parties,
and reply comments from 29 parties. The Petitioners apparently do not
dispute that this first round of notice-and-comment met the APA
requirements.

After receiving and considering these comments, the FCC revised the
proposed order and released a modified CALLS proposal which took into
account concerns about the affordability of the increase in the SLC
price cap. The FCC held an abbreviated notice-and-comment period for the
revised draft of the proposed order, and issued the final CALLS Order
about two months later. The Petitioners complain that this shortened
second round of notice-and-comment violated the APA. Furthermore, they
point to several *ex parte* contacts between the FCC and the CALLS
Coalition. According to the Petitioners, the abbreviated schedule for
the revised draft of the proposed order, along with the *ex parte*
communication, suggests that the FCC gave \"at least tacit approval \[of
the revised proposed order\] . . . long before initiation of the second
comment period.\" In short, they accuse the FCC of flouting the
procedural safeguards that ensure meaningful participation by the public
in the rulemaking process.

We find the Petitioners\' objections without merit. Even if we assume
that the abbreviated second round of notice-and-comment did not fully
meet the APA requirements, it would not undermine the validity of the
CALLS Order because the FCC was not legally required to offer an
additional period of notice-and-comment. We have held that \"\[i\]f,
after notice and comment, the agency alters the proposed rule, a new
comment period will not be required so long as the modified rule is a
\'logical outgrowth of the published proceedings.\'\" *United
Steelworkers of Amer., AFL-CIO-CLC v. Schuykill Metals Corp.*, 828 F.2d
314, 317-18 (5th Cir. 1987).

The revised version of the proposed order was a \"logical outgrowth\" of
the original proposal, which the Petitioners concede met the APA
requirements. The modified proposal retained the essential framework of
the original proposal, but it added a few provisions to allay
affordability concerns (e.g., requiring a cost-study before increasing
the SLC cap over five dollars). In other words, had the FCC not even
held a second notice-and-comment period, the Petitioners would have no
grounds for complaint. We believe that the FCC\'s second
notice-and-comment period, even if it was abbreviated, went above and
beyond what the APA legally requires.

Moreover, while interested parties should be able to participate
meaningfully in the rulemaking process, the public \"need not have an
opportunity to comment on every bit of information influencing an
agency\'s decision.\" *See State of Tex. v. Lyng*, 868 F.2d 795, 800
(5th Cir. 1989) (allowing an agency to withdraw regulations and announce
modified ones without taking additional comments). Accordingly, the
petitioners must show how they were prejudiced by the FCC\'s failure to
solicit additional comments, and how they would have responded had they
been given the opportunity to submit additional responses.[^7] *See
id.* at 799. The Petitioners fail to meet this burden.

We also reject the Petitioners\' speculative and perhaps sinister
scenario imputed to the *ex parte* communication between the FCC and the
interested parties. The APA permits *ex parte* contact between an agency
and private parties as long as the agency adequately gives notice of
such contact. *See* 47 C.F.R. § 1.1206(a) (stating that \"*ex parte*
presentations . . . to or from Commission decision-making personnel are
permissible . . . provided that \[they\] . . . are disclosed\"). The
Petitioners initially charged the FCC of failing to file such notices,
but later retracted that accusation. The record reflects that the FCC
properly disclosed the *ex parte* contacts.

Generally, *ex parte* contact is not shunned in the administrative
agency arena as it is in the judicial context. In fact, agency action
often demands it. As the D.C. Circuit explained, \"Under our system of
government, the very legitimacy of general policymaking performed by
unelected administrators depends in no small part upon the openness,
accessibility and amenability of these officials to the needs and ideas
of the public from whom their ultimate authority derives, and upon whom
their commands must fall.\" *Sierra Club v. Costle*, 657 F.2d 298,
400-401 (D.C. Cir. 1981).

Finally, we do not agree with the Petitioners that the FCC\'s private
contact with interested parties triggered the procedural mandates of the
Negotiated Rulemaking Act of 1990 (\"NRA\"). *See* 5 U.S.C. § 561. The
plain language of the statute undermines the notion that the NRA\'s
procedures are mandatory. The preface of the statute states that,
\"Nothing in this subchapter should be construed as an attempt to limit
innovation and experimentation with the negotiated rulemaking process or
with other innovative rulemaking procedures otherwise authorized by
law.\" 5 U.S.C. § 561. The substantive provisions of the statute further
reinforce the permissive nature of the NRA. *See, e.g.,* 5 U.S.C. §
563(a) (\"An agency *may* establish a negotiated rulemaking committee .
. .\") (emphasis added); 5 U.S.C. § 563(b) (\"An agency *may* use the
services of a convener . . .\") (emphasis added). The Petitioners fail
to cite (and we do not find) any cases contravening the plain language
interpretation of the statute.

**B**

We hold that the FCC acted arbitrarily and capriciously in establishing
the \$650 million amount for the Universal Service Fund. As a part of
its goal to replace the implicit subsidy system of rate-manipulation,
the FCC promulgated the Universal Service Fund, a five-year transitional
plan designed to provide explicit subsidies to poor and rural end-users.
In trying to determine the appropriate amount for the Universal Service
Fund, the FCC considered six studies, whose estimates ranged from \$250
million to \$3.9 billion. The Petitioners accuse the FCC of arbitrarily
averaging the estimates of the six cost-studies without exercising any
independent judgment of its own. *See Laclede Gas Co. v. FERC*, 997 F.2d
936, 947 (D.C. Cir. 1993) (holding that FERC failed to exercise
independent judgment in approving a settlement amount merely because it
fell within the range of amounts in the record).

Although we do not agree with the Petitioners\' contention that the FCC
merely averaged the estimates, we find that the FCC failed to exercise
sufficiently independent judgment in establishing the \$650 million
amount. *See id.* The FCC does not explain how it actually derived that
figure, and instead seems to invoke the Goldilocks approach to
rulemaking: noting that \"\[s\]ome commentators argue that the size of
the interstate access universal service mechanism is too large \[while\]
\[o\]ther commentators argue that the size . . . is too small,\" the FCC
apparently believes that its approach is just right because it falls
reasonably within the range of estimates. CALLS Order, ¶ 204. The FCC
also relies heavily on the fact that both the IXCs and LECs, which
traditionally have had opposing interests, agree on the amount. *See
id.* at ¶ 202 (\"Because of the divergent interests of these parties, we
believe that the \$650 million represents a sufficient amount . . .\").
An agency abdicates its role as a rational decision-maker if it does not
exercise its own judgment, and instead cedes near-total deference to
private parties\' estimates\--even if the parties agree unanimously as
to the estimated amount. *Cf. Laclede*, 997 F.2d at 946 (\"Even when the
customer support is unanimous, however, FERC retains the responsibility
of making an \'independent judgment\' as to whether the settlement
amount constitutes a reasonable remedy.\").

We recognize that identifying a specific amount is an \"imprecise
exercise,\" and that our review of the Universal Service Fund is
especially deferential due to its transitional nature. *See id.* at
¶ 201. However, the FCC must provide some explanation as to why it found
one study more persuasive than the other, even if it does not determine
a precise amount as the only \"correct\" figure. The CALLS Order hints
at some reasoned analysis, suggesting that the AT&T study applied the
FCC\'s synthesis model, while the ALTS and Time Warner studies made
unwarranted assumptions. *See* CALLS Order at ¶ ¶ 202, 204. But the
CALLS Order fails to address other studies. *See Natural Res. Def.
Council v. EPA*, 859 F.2d 156, 194 (D.C. Cir. 1988) (requiring some
independent analysis by the agency prior to adoption of a rule).

We remand to the FCC for further analysis and explanation in regards to
the \$650 million Universal Service Fund.[^8]

**C**

We also remand the X-Factor issue, finding that the FCC lacked a
rational basis in the record to support the 6.5 percent figure. Prior to
the CALLS Order, the FCC had designated the X-Factor as a proxy for the
increase in the LECs\' productivity minus the rate of inflation. The
price caps for local services were reduced each year by the percentage
represented by the X-Factor. The X-Factor thus had the effect of passing
down to consumers the savings from increased productivity. In 1997, the
FCC set the X-Factor at 6.5 percent. On a petition for review, the D.C.
Circuit reversed and remanded the X-Factor issue, holding that there was
no rational relationship between the 6.5 percent figure and the alleged
increase in productivity. *See USTA*, 188 F.3d at 525.

In its CALLS Order, the FCC reintroduced the same 6.5 percent X-Factor,
but stated that the revamped X-Factor serves a different function as a
\"transitional mechanism that operates to reduce rates at a certain
pace, and \[is no longer\] . . . linked to a specific measure of
productivity.\" CALLS Order, ¶ 140. Therefore, the FCC argues that the
CALLS Order does not conflict with the D.C. Circuit\'s remand order in
*USTA*, because the court had only required further justification of the
6.5% figure in light of its role as a productivity proxy. Now that the
X-Factor no longer is tied to productivity, the FCC claims that the 6.5
percent figure is acceptable. We disagree.

The new X-Factor suffers from the same infirmity as the prior one: the
FCC has failed to show a rational basis as to how it derived the 6.5
percent figure.[^9] *See State Farm* at 56, 103 S.Ct. at 2873. Even if
the X-Factor is no longer tethered to any productivity measure, the FCC
still needs to provide a rational explanation of how it derived the
precise percentage. Otherwise, the FCC would have free reign to set the
X-Factor arbitrarily and capriciously. It must justify why a 6.5 percent
X-Factor is a more appropriate rate reduction measure, than, say, a .065
percent or 65 percent X-factor.

**IV**

We uphold most parts of the CALLS Order, but remand to the FCC for
further analysis and explanation of two portions of the CALLS Order: the
\$650 million Universal Service Fund and the 6.5% X-Factor.

The petition for review is DENIED IN PART and GRANTED IN PART. The CALLS
Order is AFFIRMED IN PART, REVERSED IN PART, and REMANDED IN PART, in
accordance with this opinion.

[^1]: District Judge of the Southern District of Texas, sitting by
    designation.

[^2]: The CALLS Order is officially named *In the Matter of Deployment
    of Access Charge Reform, Price Cap Performance Review for Local
    Exchange Carriers, Low-Volume Distance Users, and Federal-State
    Joint Board on Universal Service*, Sixth Report and Order in CC
    Docket No. 96-262 and 94-1, and Report and Order in CC Docket
    99-249, and Eleventh Report and Order in CC Docket 96-56, 15 FCC
    Rcd. 12962 (released May 31, 2000). The order derives its
    appellation from the Coalition of Affordable Local and Long Distance
    Service (\"CALLS\"), a group of local and long-distance providers
    that helped draft the initial proposal.

[^3]: The Petitioners have filed two opening briefs: TOPUC and CFA
    jointly filed a brief, while NASUCA filed separately. For the
    purpose of brevity, this opinion will not attempt to identify the
    specific arguments made by each brief, and will instead refer to
    them collectively as the Petitioners\' argument or brief. Similarly,
    the respondents in the case, the FCC and the CALLS Coalition have
    filed separate briefs, but we will not individually identify the
    arguments made by each respondent.

[^4]: The headings of the seven principles are: \"Quality and rates\";
    \"Access to advanced services\"; \"Access in rural and high cost
    areas\"; \"Equitable and nondiscriminatory contributions\";
    \"Specific and predictable support mechanisms\"; \"Access to
    advanced telecommunications services for schools, health care, and
    libraries\"; and a catch-call \"Additional principles.\" 47 U.S.C. §
    254(b)(1)-(7).

[^5]: As an initial point, the Petitioners err in intimating that the
    FCC refused to increase the SLC cap on residential and single-line
    business customers solely because of affordability. The FCC did not
    increase the SLC cap for several reasons, including the prudential
    rationale of not altering the rate structure at a time of rapid
    reform. For example, in the Access Charge Reform Order, the FCC
    explained: \"Because of concerns about affordability, *and* in light
    of the significant changes that are still underway in this
    proceeding, in the federal universal service support proceeding,
    *and* possible future changes to the separations process, we
    conclude that the SLC for \[residential and single-line business\]
    lines should not e raised.\" *Id.* (emphasis added). Likewise, the
    FCC explained in its Universal Service Order that it would not raise
    \"at this time\" the SLC caps \"in light of significant changes that
    are still underway.\" Universal Service Report, ¶ 763.

[^6]: In any case, as a practical matter, the Petitioners\' fears of
    anti-consumer effects are exaggerated. Both sides apparently agree
    that most customers have a presubscribed long-distance carrier, and
    that IXCs pass down the PICC charge, along with transaction costs,
    to their customers. Moreover, even \"\[i\]f an end-user customer
    does not have a presubscribed interexchange carrier,\" he may not be
    able to avoid the PICC because \"the local exchange carrier may
    collect the PICC directly from the end user.\" 47 C.F.R. § 69.153
    (2000). Hence, from a policy perspective, end-users will be assessed
    access charges, whether directly through the SLC or indirectly
    through the PICC or through a combination of both; thus, a more
    appropriate question, at least in terms of impact on consumers, is
    whether the net burden on consumers will be lower or higher.

[^7]: Similarly, the Petitioners\' complaint that they did not have an
    opportunity to comment on the late-filed Industry Analysis Division
    study lacks merit. They do not explain how they would have responded
    to the IAD study, and how the lack of opportunity to comment
    prejudiced them. *See Lyng*, 868 F.2d at 799. They also do not
    respond to the FCC\'s assertion that the study relied on publicly
    available data.

[^8]: We find little merit as to the Petitioners\' two other arguments
    regarding the Universal Service Fund. First, the FCC\'s failure to
    consider the TOPUC\'s cost-study is not a ground for remand. An
    agency need not respond to every study, and only has to address
    \"significant comments.\" *See United States Satellite Broad. Co.,
    Inc. v. FCC*, 740 F.2d 1177, 1188 (D.C. Cir. 1984). Second, we
    reject the Petitioners\' argument that the FCC improperly failed to
    consult with and receive certification from the Federal-State Joint
    Board. The statute requires consultation with the Joint Board for
    only the initial implementation of § 254\'s universal service
    requirement. *See* 47 U.S.C. § 254(a)(1). Any consultation
    afterwards is permissive. *See* 47 U.S.C. § 254(c)(2) (\"The Joint
    Board *may*, from time to time, recommend to the Commission
    modifications . . .\") (emphasis added).

[^9]: We reject the FCC\'s claim that the Petitioners lack standing to
    raise the X-Factor issue. An organization has standing to bring a
    suit if its members suffer an actual or threatened injury. *See
    Texans United for a Safe Economy Educ. Fund v. Crown Central
    Petroleum Corp.*, 207 F.3d 789 (5th Cir. 2000). As groups
    representing consumers, the Petitioners allege, among other things,
    that a non-productivity-based X-Factor will harm consumers because
    it will no longer pass down the efficiency savings to consumers, and
    indeed will eventually only offset inflation. The FCC counters that
    there is no nexus between the new X-Factor and the supposed harm to
    consumers caused by the 6.5% figure, because the D.C. Circuit had
    earlier rejected the consumer organizations\' argument that the 6.5%
    figure was too high. The alleged harm here is not the 6.5% figure
    *per se*, but rather the revamped X-Factor\'s failure to pass down
    efficiency savings to consumers.