**IN THE UNITED STATES COURT OF APPEALS**

**FOR THE FIFTH CIRCUIT**

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

98-60213

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

ALENCO COMMUNICATIONS, INC.;

AMANA SOCIETY SERVICE COMPANY;

ARROWHEAD COMMUNICATIONS CORPORATION;

AYERSVILLE TELEPHONE COMPANY;

BARAGA TELEPHONE COMPANY;

BARRY COUNTY TELEPHONE COMPANY;

BAY SPRINGS TELEPHONE COMPANY, INC.;

BENTLEYVILLE TELEPHONE COMPANY;

BENTON RIDGE TELEPHONE COMPANY;

BLOOMINGDALE HOME TELEPHONE COMPANY;

BLUE EARTH VALLEY TELEPHONE COMPANY;

BRUCE TELEPHONE COMPANY;

CASEY MUTUAL TELEPHONE COMPANY; CFW COMMUNICATIONS COMPANY; CITIZENS
TELEPHONE COMPANY OF KECKSBURG;

CITIZENS TELEPHONE COMPANY OF HAMMOND;

CITIZENS TELEPHONE CORPORATION;

CLEMENTS TELEPHONE COMPANY; CLIMAX TELEPHONE COMPANY; COMMUNITY SERVICE
TELEPHONE COMPANY;

CRAIGVILLE TELEPHONE COMPANY, INC.;

CROCKETT TELEPHONE COMPANY; DIXVILLE TELEPHONE COMPANY;

DOYLESTOWN TELEPHONE COMPANY;

DUNBARTON TELEPHONE COMPANY, INC.;

DUNKERTON TELEPHONE COOPERATIVE;

EAGLE VALLEY TELEPHONE COMPANY;

EASTON TELEPHONE COMPANY; ECKLES TELEPHONE COMPANY; ELKHART TELEPHONE
COMPANY;

EUSTIS TELEPHONE EXCHANGE;

FARMERS COOP TELEPHONE COMPANY;

FARMERS MUTUAL TELEPHONE COMPANY-OHIO;

FARMERS MUTUAL TELEPHONE COMPANY-MINNESOTA;

FLAT ROCK MUTUAL TELEPHONE COMPANY;

FORT JENNINGS TELEPHONE COMPANY;

FRONTIER COMMUNICATIONS OF DEPUE;

GEETINGSVILLE TELEPHONE COMPANY, INC.;

GERVAIS TELEPHONE COMPANY;

GRACEBA TOTAL COMMUNICATIONS, INC.;

GRANADA TELEPHONE COMPANY;

GRANBY TELEPHONE & TELEGRAPH COMPANY-MASSACHUSETTS; GULF TELEPHONE
COMPANY; HARTINGTON TELEPHONE COMPANY;HICKORY TELEPHONE COMPANY;

HINTON TELEPHONE COMPANY OF HINTON, OKLAHOMA, INC.; HOLLIS TELEPHONE
COMPANY;

HOME TELEPHONE COMPANY-NEBRASKA;

HOME TELEPHONE COMPANY-MINNESOTA;

HOT SPRINGS TELEPHONE COMPANY;

HUXLEY COOPERATIVE TELEPHONE COMPANY;

INDIANHEAD TELEPHONE COMPANY;

IRONTON TELEPHONE COMPANY;

JEFFERSON TELEPHONE COMPANY, INC.;

KADOKA TELEPHONE COMPANY; KALEVA TELEPHONE COMPANY; KALIDA TELEPHONE
COMPANY, INC.;

LAUREL HIGHLAND TELEPHONE COMPANY;

LIGONIER TELEPHONE COMPANY;

MANKATO CITIZENS TELEPHONE COMPANY;

MANTI TELEPHONE COMPANY;

MARIANNA & SCENERY HILL TELEPHONE COMPANY;

MARSEILLES TELEPHONE COMPANY;

MCCLURE TELEPHONE COMPANY;

MCDONOUGH TELEPHONE COOP, INC.; MEBTEL COMMUNICATIONS;

MERCHANTS & FARMERS TELEPHONE COMPANY;

METAMORA TELEPHONE COMPANY;

MID CENTURY TELEPHONE COOP, INC.;

MID COMMUNICATIONS TELEPHONE COMPANY;

MID-IOWA TELEPHONE COOP ASSOCIATION;

MIDDLE POINT HOME TELEPHONE COMPANY;

MIDSTATE TELEPHONE COMPANY-NORTH DAKOTA;

MIDWEST TELEPHONE COMPANY;

MILES COOPERATIVE TELEPHONE ASSOCIATION;

MILLRY TELEPHONE COMPANY, INC.;

MINFORD TELEPHONE COMPANY, INC.;

MINNESOTA LAKE TELEPHONE COMPANY;

MT. ANGEL TELEPHONE COMPANY;

NATIONAL TELEPHONE OF ALABAMA, INC.;

NEW LISBON TELEPHONE COMPANY;

NORTH-EASTERN PENNSYLVANIA TELEPHONE COMPANY;

NORTH ENGLISH COOP TELEPHONE COMPANY;

NORTHWESTERN INDIANA TELEPHONE COMPANY, INC.;

NOVA TELEPHONE COMPANY; ODIN TELEPHONE EXCHANGE, INC.; ORWELL TELEPHONE
COMPANY; OSAKIS TELEPHONE COMPANY;PALMERTON TELEPHONE COMPANY;

PANHANDLE TELEPHONE COOP, INC.;

PANORA COOPERATIVE TELEPHONE ASSOCIATION;

PATTERSONVILLE TELEPHONE COMPANY;

PENNSYLVANIA TELEPHONE COMPANY;

PEOPLES MUTUAL TELEPHONE COMPANY;

PEOPLES TELEPHONE COMPANY, INC.;

PIERCE TELEPHONE COMPANY, INC.;

PINE ISLAND TELEPHONE COMPANY; PINNACLE COMMUNICATIONS; PRAIRIE GROVE
TELEPHONE COMPANY;

PYMATUNING INDEPENDENT TELEPHONE COMPANY;

REDWOOD COUNTY TELEPHONE COMPANY;

ROANOKE TELEPHONE COMPANY, INC.;

ROBERTS COUNTY TELEPHONE COOP ASSOCIATION;

RONAN TELEPHONE COMPANY; SCHALLER TELEPHONE COMPANY; SEARSBORO TELEPHONE
COMPANY;

SHELL ROCK TELEPHONE COMPANY;

SOUTH CANAAN TELEPHONE COMPANY;

SOUTHERN MONTANA TELEPHONE COMPANY;

STATE LONG DISTANCE TELEPHONE COMPANY;

STATE TELEPHONE COMPANY;

STAYTON COOPERATIVE TELEPHONE COMPANY;

STOCKHOLM-STRANDBURG TELEPHONE COMPANY;

SUMMIT TELEPHONE COMPANY; SWAYZEE TELEPHONE COMPANY; SYCAMORE TELEPHONE
COMPANY;

TRI COUNTY TELEPHONE COMPANY, INDIANA;

TRI-COUNTY TELEPHONE MEMBERSHIP CORPORATION;

VALLEY TELEPHONE COOPERATIVE, INC.;

VAN HORNE COOPERATIVE TELEPHONE COMPANY;

VENUS TELEPHONE CORPORATION;

VOLCANO TELEPHONE COMPANY;

WEST IOWA TELEPHONE COMPANY;

WEST LIBERTY TELEPHONE COMPANY;

WEST SIDE TELEPHONE COMPANY;

WEST SIDE TELEPHONE COMPANY-PENNSYLVANIA;

WEST TENNESSEE TELEPHONE COMPANY, INC.;

WESTERN TELEPHONE COMPANY-SOUTH DAKOTA;

WIKSTROM TELEPHONE COMPANY, INC.;

WILTON TELEPHONE COMPANY-NEW HAMPSHIRE;

YADKIN VALLEY TELEPHONE MEMBERSHIP CORPORATION;

YUKON-WALTZ TELEPHONE COMPANY;

and

UNITED STATES TELEPHONE ASSOCIATION,

> Petitioners,

VERSUS

FEDERAL COMMUNICATIONS COMMISSION

and

UNITED STATES OF AMERICA,

> Respondents.

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

Petitions for Review of Orders

of the Federal Communications Commission

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

January 25, 2000

Before SMITH, WIENER, and EMILIO M. GARZA, Circuit Judges.

JERRY E. SMITH, Circuit Judge:

This is a consolidated challenge to two orders of the Federal
Communications Commission (the \"FCC,\" the \"Commission,\" or the
\"agency\")[[]{#txt1 .anchor}^(1)^](#N_1_) promulgated to satisfy the
twin Congressional mandates articulated in the Telecommunications Act of
1996 (the \"Act\")[[]{#txt2 .anchor}^(2)^](#N_2_) of providing universal
telecommunications service in the United States and injecting
competition into the market for local telephone service.
Petitioners\--local telephone service providers who serve predominantly
small towns and rural areas\--challenge the orders as inconsistent with
the statutory requirements of the Act; arbitrary and capricious in
violation of the Administrative Procedure Act, 5 U.S.C. § 706(2)(A);
violative of the Takings Clause, U.S. Const. amend. V; and in
noncompliance with the Regulatory Flexibility Act, 5 U.S.C. § 604.
Having jurisdiction to review the orders pursuant to 28 U.S.C. § 2342(1)
and 47 U.S.C. § 402(a), we deny the petitions for review.

I. The Statutory Mandates.

Universal service has been a fundamental goal of federal
telecommunications regulation since the passage of the Communications
Act of 1934. Indeed, the FCC\'s very purpose is \"to make available, so
far as possible, to all the people of the United States . . . a rapid,
efficient, Nation-wide, and world-wide wire and communication service
with adequate facilities at reasonable charges.\" 47 U.S.C. § 151 (as
amended). *See also Texas Office of Pub. Util. Counsel v. FCC*, 183 F.3d
393, 405-06 & n.2 (5th Cir. 1999) (\"*TOPUC*\"), *petition for cert.
filed* (Dec. 23, 1999) (No. 99-1072).

Specifically, the Act requires that universal service support be
\"explicit and sufficient,\" 47 U.S.C. § 254(e), and it articulates
several guiding principles to govern universal service\--including, for
example, that \"access . . . be provided in all regions of the Nation .
. . including low-income consumers and those in rural, insular, and high
cost areas,\" that services and rates be \"reasonably comparable\" to
those offered \"in urban areas,\" that \"\[a\]ll providers of
telecommunications services . . . make an equitable and
nondiscriminatory contribution to the preservation and advancement of
universal service,\" and that universal service support be \"specific\"
and \"predictable,\" *id.* § 254(b)(2)-(5); Order ¶ 21. While the FCC is
required to obey statutory commands, the guiding principles reflect
congressional intent to delegate difficult policy choices to the
Commission\'s discretion. *See TOPUC*, 183 F.3d at 411-12.[[]{#txt3
.anchor}^(3)^](#N_3_)

Alongside the universal service mandate is the directive that local
telephone markets be opened to competition. *See* 47 U.S.C. §§ 251-253;
*AT&T Corp. v. Iowa Utils. Bd.*, 525 U.S. 366, 371; *TOPUC*, 183 F.3d at
406, 412. The FCC must see to it that *both* universal service and local
competition are realized; one cannot be sacrificed in favor of the
other. The Commission therefore is responsible for making the changes
necessary to its universal service program to ensure that it survives in
the new world of competition.[[]{#txt4 .anchor}^(4)^](#N_4_) Because
Congress has conferred broad discretion on the agency to negotiate these
dual mandates, courts ought not lightly interfere with its reasoned
attempt to achieve both objectives. *See Chevron U.S.A., Inc. v. Natural
Resources Defense Council, Inc.,* 467 U.S. 837, 842-44 (1984); 5 U.S.C.
§ 706(2)(A).

II\. The Universal Service Orders.

The orders under review make various changes to universal service deemed
necessary achieve universal service within a competitive environment. We
describe the general principles guiding the Commission\'s judgment, then
detail the provisions specifically at issue in petitioners\' various
challenges.

A. Commission Principles.

To analyze the purpose and effect of the FCC\'s numerous regulatory
changes to its universal service program, we find it useful first to
articulate three principles the Commission has followed in making the
transition from monopolistic to competitive universal service. *First*,
rates must be based not on *historical, booked costs*, but rather on
*forward-looking costs*. After all, market prices respond to current
costs; historical investments, by contrast, are sunk costs and thus
ignored.

\[I\]t is current and anticipated cost, rather than historical cost\[,\]
that is relevant to business decisions to enter markets and price
products. The business manager makes a decision to enter a new market by
comparing anticipated additional revenues (at a particular price) with
anticipated additional costs. If the expected revenues cover all the
costs caused by the new product, then a rational business manager has
sound business reasons to enter the new market. The historical costs
associated with the plant already in place are essentially irrelevant to
this decision since those costs are \'sunk\' and unavoidable and are
unaffected by the new production decision. This factor may be
particularly significant in industries such as telecommunications which
depend heavily on technological innovation, and in which a firm\'s
accounting, or sunk, costs may have little relation to current pricing
decisions.

*MCI Communications Corp. v. American Tel. & Tel. Corp.*, 708 F.2d 1081,
1116-17 (7th Cir. 1983).[[]{#txt5 .anchor}^(5)^](#N_5_)

*Second*, the old regime of *implicit* subsidies\--that is, \"the
manipulation of rates for some customers to subsidize more affordable
rates for others\"\--must be phased out and replaced with *explicit*
universal service subsidies\--government grants that cause no distortion
to market prices\--because a competitive market can bear only the
latter.

*TOPUC*, 183 F.3d at 406.

For obvious reasons, this system of implicit subsidies can work well
only under regulated conditions. In a competitive environment, a carrier
that tries to subsidize below-cost rates to rural customers with
above-cost rates to urban customers is vulnerable to a competitor that
offers at-cost rates to urban customers. Because opening local telephone
markets to competition is a principal objective of the Act, Congress
recognized that the universal service system of implicit subsidies would
have to be re-examined.

*Id.* Indeed, the Act requires that all universal service support be
explicit. *See* 47 U.S.C. § 254(e).

*Finally*, the program must treat all market participants equally\--for
example, subsidies must be portable\--so that the market, and not local
or federal government regulators, determines who shall compete for and
deliver services to customers. Again, this principle is made necessary
not only by the economic realities of competitive markets but also by
statute. *See* 47 U.S.C. § 214(e)(1) (requiring that all \"eligible
telecommunications carrier\[s\] . . . shall be eligible to receive
universal service support\").

The FCC additionally defends the orders as reasonable *interim*
regulations. The shift from monopoly to competition is indeed dramatic.
Congress thus expressly contemplated that the Commission would adopt an
incremental approach to retooling universal service for a world of
competition.[[]{#txt6 .anchor}^(6)^](#N_6_) Because the provisions under
review are merely transitional, our review is especially
deferential.[[]{#txt7 .anchor}^(7)^](#N_7_)

B. Provisions.

Telephone service is jointly provided by two sets of carriers. Local
exchange carriers (\"LEC\'s\") provide local telephone service in a
given geographical calling area through monopoly networks, or
\"exchanges,\" each comprising a series of \"local loops\" allowing for
interconnection within the exchange.[[]{#txt8 .anchor}^(8)^](#N_8_)
Interexchange carriers (\"IXC\'s\") provide long distance service by
connecting callers served by different LEC\'s; such service is called
\"exchange access.\"[[]{#txt9 .anchor}^(9)^](#N_9_)

Petitioners are LEC\'s serving predominantly small towns and rural
areas.[[]{#txt10 .anchor}^(10)^](#N_10_) Intervenor Bell Atlantic,
supporting the FCC and opposing petitioners, is also an LEC. Intervenor
MCI is an IXC and also supports the FCC.

The FCC has established a number of universal service programs involving
LEC\'s and IXC\'s. The Order implements a myriad of amendments to bring
those programs into compliance with competition in the LEC market, but
petitioners object to amendments to two of them.

*First*, they oppose various changes to the universal service support
fund for high cost loops. *Second*, before issuing the Order, the FCC
allowed certain small, generally rural LEC\'s to weight specially the
amount of time spent by their telephone switching equipment on switching
long distance calls, for purposes of calculating the access charges
those LEC\'s may collect from IXC\'s. The Order would eliminate this
effective subsidy and replace it with a new, explicit support fund.

1\. High-cost Loops.

Rural LEC\'s face special obstacles. The cost of providing telephone
service varies with population density, because dispersed populations
require longer wires and permit lesser economies in installation,
service, and maintenance. Also relevant are geographic characteristics,
for climate and certain types of terrain make service calls and repairs
more costly. Rural areas where telephone customers are dispersed and
terrain is unaccommodating are therefore the most expensive to serve.

To meet its historic mandate of universal service, the FCC has
established a universal service fund to subsidize high-cost rural LEC\'s
to reduce the rates they must charge their customers. An LEC is eligible
for a subsidy if its operating expenses\--its \"loop costs\"\--are
fifteen percent or more above the national average. Loop costs include
the costs of the depreciated cable, wire, and circuit equipment used to
provide local service, the depreciation and maintenance expenses
associated with that local plant, and the corporate operations expenses
related to the provision of local service.

\"Corporate operations expenses\" include the costs incurred in
formulating corporate policy, providing overall administration and
management, and hiring accountants, consultants, and lawyers to
understand and comply with FCC, state, and local regulations. To
determine the amount of corporate operations expense that is properly
chargeable to the provision of local service (and therefore included in
total loop costs for purposes of determining eligibility for a subsidy),
an LEC must reduce its total corporate operations expenses to correspond
to the proportion of its entire plant that is local exchange plant.

Petitioners object to a variety of changes the Order effects to the
administration of the fund. *First*, they oppose the continued
imposition of a cap on growth in fund expenditures, which cap limits
total available support to the previous year\'s level, adjusted for
growth in the number of working loops. *See* Order ¶ 302. *Second*, they
object to a new cap on the amount of corporate operations expenses that
can be included in the loop cost calculation. The Order allows LEC\'s to
report corporate operations expenses only up to 115% of the industry
average for LEC\'s of like size. *See* Order ¶¶ 283-285, 307.

*Third*, the Order makes the subsidy portable, following the customer
who switches service from one LEC to another. Petitioners claim that
portability violates the principle of predictable funding. *See* Order ¶
311. *Fourth*, beginning January 1, 2000, the Order imposes an annual
inflation index on the loop cost eligibility benchmark\--the minimum
amount a loop must cost to be awarded a subsidy\--replacing the former
approach of recalculating a fresh benchmark periodically, based on
updated estimates of industry averages. *See* Order ¶¶ 300-301; 47
C.F.R. § 36.622(d) (1997). *Finally*, the Order disallows additional
universal service support when a rural LEC acquires and upgrades another
exchange, *see* Order ¶ 308, despite petitioners\' claim that such
mergers are efficient and should be encouraged.

The cumulative result of all these changes, petitioners say, is that the
Commission has rendered LEC\'s unable to earn a fair return and has
discouraged future investment in telecommunications, and thereby has
acted arbitrarily and capriciously and has violated the Act\'s
sufficient funding requirement and the Takings Clause.

2\. Switching Costs.

IXC\'s pay \"access charges\" to LEC\'s for the right to have access to
an LEC\'s local exchange to connect long-distance calls to and from that
exchange. Jurisdiction to regulate access charges is shared between
federal and state governments. To implement rate-of-return regulation,
state and federal regulators must allocate the costs of operating an LEC
between the delivery of intrastate, interexchange telephone service
(which is regulated by state entities) and the provision of interstate
service (which is subject to the FCC\'s jurisdiction). To determine how
the allocations are to be made, the agency has promulgated a number of
cost separation rules.

The separation rules for costs associated with connecting calls\--a
process known as \"switching\"\--are based on \"dial equipment minutes
of use\" (\"DEM\'s\"). Under the rules, an LEC divides its total DEM\'s
between those used to switch interstate calls and those used to switch
intrastate calls.

Before the orders under review, the FCC allowed certain small, generally
rural LEC\'s to weight their DEM totals with a \"toll weighting
factor,\" thereby providing LEC\'s with a higher cost basis on which
their federal access charge would be based. Petitioners maintain that
the practice of DEM weighting reflects the higher cost of switching a
long distance or \"toll\" call than that of switching a local call,
because certain network functions required by interexchange
carriers\--such as equal access, intra-LATA toll dialing parity, toll
screening, toll blocking, Signaling System 7 (SS7), expanded carrier
identification codes, and 800 number portability\--require additional
central processing hardware and software.

The FCC has long held, however, that the disparity between intrastate
and interstate call switching is a relic of old, electromechanical
technology and that modern digital switching equipment largely
eliminates the cost differential.[[]{#txt11 .anchor}^(11)^](#N_11_)
Toll-weighting continues today, not out of adherence to principles of
cost causation\--which provide that costs be charged to the source of
the cost\--but rather to provide an implicit subsidy for rural
LEC\'s.[[]{#txt12 .anchor}^(12)^](#N_12_)

The Order replaces toll-weighting with a new universal service fund
(separate from the fund for high-cost loops). *See* Order ¶¶ 303-304.
Petitioners object for three reasons.

*First*, they claim the Order arbitrarily and capriciously abandons
cost-causation principles. *Second,* because it would be financed by all
telecommunications carriers, including small LEC\'s such as petitioners,
the new fund constitutes an unlawful subsidy by small LEC\'s in favor of
IXC\'s because it effectively saves IXC\'s from having to pay for the
more expensive cost of switching their long-distance calls. *Finally*,
just as they do with respect to the high-cost loop fund, petitioners
object on the ground that portability violates the principle of
predictability and the statutory command of sufficient funding.
Specifically, they claim that if just 25% of the revenue that the FCC
has made portable is lost by a typical small LEC, the annual rate of
return for interstate access service will, in many cases, fall to minus
10.53%.

III\. Communications Act and Administrative Procedure Act Challenges.

Petitioners\' main challenge is that the orders are inconsistent with
the statutory mandates of the Act. Therefore, they claim, the orders
constitute arbitrary and capricious regulation.

A. Standard of Review.

Courts review agency conduct in two ways. First, we review agency
interpretation of their statutory authority under the familiar *Chevron*
two-step inquiry. *See Chevron*, 467 U.S. at 842-44.

Under step one, where \"Congress has directly spoken to the precise
question at issue,\" we must \"give effect to the unambiguously
expressed intent of Congress,\" reversing an agency\'s interpretation
that does not conform to the statute\'s plain meaning. *Id.* at 842-43.
Under step two, which addresses situations in which the statute is
either silent or ambiguous, \"the question for the court is whether the
agency\'s answer is based on a permissible construction of the
statute.\" *Id.* at 843. We reverse only if the agency\'s construction
is \"arbitrary, capricious or manifestly contrary to the statute.\"
*Id.* at 844. If, on the other hand, the interpretation \"is based on a
permissible construction of the statute,\" we defer to the agency\'s
construction.

In addition, the Administrative Procedure Act (\"APA\") empowers courts
to reverse agency action that is arbitrary and capricious. *See* 5
U.S.C. § 706(2)(A); *Harris v. United States*, 19 F.3d 1090 (5th Cir.
1994). *Chevron* step-two focuses on the agency\'s interpretation of its
statutory power, while APA arbitrary-and-capricious review focuses on
the reasonableness of the agency\'s decision-making process pursuant to
that interpretation. *See TOPUC*, 183 F.3d at 410. Like *Chevron*
step-two, APA arbitrary and capricious review is narrow and deferential,
requiring only that the agency \"articulate\[\] a rational relationship
between the facts found and the choice made.\" *Harris*, 19 F.3d at 1096
(quoting *Motor Vehicles Mfrs. Ass\'n of the United States v. State Farm
Mut. Auto. Ins. Co.*, 463 U.S. 29, 43 (1983)). \"\[T\]he agency\'s
decision need not be ideal.\" *Id.* Moreover, our review here is
especially deferential, because the provisions under review are merely
transitional, as expressly contemplated by the Act.[[]{#txt13
.anchor}^(13)^](#N_13_)

B. Analysis.

Petitioners assert two general themes. *First*, the challenges go
directly to the heart of FCC expertise\--whether the Commission has
sufficiently and explicitly supported universal service in an open,
competitive market\--and thus must overcome substantial judicial
deference. Examining the Act through the lens of *Chevron,* we note that
Congress obviously intended to rely primarily on FCC discretion, and not
vigorous judicial review, to ensure satisfaction of the Act\'s dual
mandates. As we noted in a prior challenge to an FCC universal service
regulation,

\[t\]o be sure, the FCC\'s reason for adopting this methodology is not
just to preserve universal service. Rather, it is also trying to
encourage local competition . . . . As long as it can reasonably argue
that the methodology will provide sufficient support for universal
service, however, it is free, under the deference we afford it under
*Chevron* step-two, to adopt a methodology that serves its other goal of
encouraging local competition.

*TOPUC*, 183 F.3d at 412. Petitioners do not satisfy the high
evidentiary standard necessary to establish that the Commission acted
arbitrarily and capriciously when it produced its interim rules.

*Second*, petitioners\' sufficiency challenge fundamentally misses the
goal of the Act. The Act does *not* guarantee all local telephone
service providers a sufficient return on investment; quite to the
contrary, it is intended to introduce competition into the market.
Competition necessarily brings the risk that some telephone service
providers will be unable to compete. The Act only promises universal
service, and that is a goal that requires sufficient funding of
*customers*, not *providers*. So long as there is sufficient and
competitively-neutral funding to enable all customers to receive basic
telecommunications services, the FCC has satisfied the Act and is not
further required to ensure sufficient funding of every local telephone
provider as well.

Moreover, excessive funding may itself violate the sufficiency
requirements of the Act. Because universal service is funded by a
general pool subsidized by all telecommunications providers\--and thus
indirectly by the customers\--excess subsidization in some cases may
detract from universal service by causing rates unnecessarily to rise,
thereby pricing some consumers out of the market.

1\. High-cost Loops.

Petitioners fail to show that the FCC\'s various changes to the
universal service support fund for high-cost loops unreasonably fails to
provide sufficient funding for universal service or otherwise
constitutes an arbitrary and capricious regulation under the Act.
*First,* they object to the agency\'s continuation of a cap on growth in
the fund, adjusted only for changes in the total number of working
loops. The cap\'s track record, however, reflects a reasonable balance
between the Commission\'s mandate to ensure sufficient support for
universal service and the need to combat wasteful spending. The
agency\'s broad discretion to provide sufficient universal service
funding includes the decision to impose cost controls to avoid excessive
expenditures that will detract from universal service. Petitioners do
not show how the FCC has abused that discretion.

*Second,* petitioners object to the introduction of a cap on the amount
of corporate operations expenses that may be reported to determine
eligibility for high-cost loop support. The Order limits LEC\'s to 115%
of the industry average for corporate operations expenses accrued by
carriers of like size. *See* Order ¶¶ 283-285, 307.

Petitioners claim that corporate operations expenses are already capped
and that there is no need for a second cap.[[]{#txt14
.anchor}^(14)^](#N_14_) It is true that, even before the Order, the
amount of reportable corporate operations expenses was determined by
multiplying an LEC\'s total corporate operations expenses by the
percentage of its total plant that is local exchange plant. This is no
cap, however, but rather a reasonable method of allocating costs. The
proposed 115% rule is thus a wholly reasonable exercise of the
Commission\'s legitimate power to combat abusive spending; absent the
proposed rule, the regulations provide no incentive to keep costs down.
Moreover, given its legitimate cost concerns, the agency was well within
its discretion to impose a cap rather than to undertake the more costly
alternative of intensive auditing.

Petitioners additionally claim that the cap on review is excessively
burdensome, driving interstate rates of return to 2.81% for rural
LEC\'s. Even assuming that this statistic proves that *customers* have
failed to receive sufficient universe service support, this statistic is
based on the experience of only a single provider\--the Bay Springs
Telephone Company\--and not a statistically valid sample. Petitioners\'
evidence therefore does not establish that the cap unreasonably fails to
provide sufficient service; at most it presents an anomaly that can be
addressed by a request for a waiver.[[]{#txt15 .anchor}^(15)^](#N_15_)

Moreover, the statistic ignores the Fourth Reconsideration Order, in
which the FCC responded to petitioners\' concerns by, *inter alia,*
establishing a minimum cap of \$300,000. *See* Fourth Reconsideration
Order ¶¶ 85-109. Petitioners present no evidence disputing the
sufficiency of the currently operative cap.

*Third*, the order provides that the universal service subsidy be
portable so that it moves with the customer, rather than stay with the
incumbent LEC, whenever a customer makes the decision to switch local
service providers. Petitioners claim that portability violates the
statutory principle of predictability, *see* 47 U.S.C. § 254(b)(5), and
the statutory command of sufficient funding.

We reiterate that predictability is only a principle, not a statutory
command. To satisfy a countervailing statutory principle, therefore, the
FCC may exercise reasoned discretion to ignore predictability. *See
TOPUC*, 183 F.3d at 411-12.

Moreover, petitioners cannot even show that portability violates
sufficiency or predictability. The purpose of universal service is to
benefit the customer, not the carrier.[[]{#txt16 .anchor}^(16)^](#N_16_)
\"Sufficient\" funding of the customer\'s right to adequate telephone
service can be achieved regardless of which carrier ultimately receives
the subsidy.[[]{#txt17 .anchor}^(17)^](#N_17_)

The methodology governing subsidy disbursements is plainly stated and
made available to LEC\'s. What petitioners seek is not merely
predictable funding mechanisms, but predictable market outcomes. Indeed,
what they wish is protection from competition, the very antithesis of
the Act.

To the extent petitioners argue that Congress recognized the precarious
competitive positions of rural LEC\'s, their concerns are addressed by
47 U.S.C. § 214(e), which empowers state commissions to regulate entry
into rural markets.[[]{#txt18 .anchor}^(18)^](#N_18_) Furthermore,
portability is not only consistent with predictability, but also is
dictated by principles of competitive neutrality and the statutory
command that universal service support be spent \"only for the
provision, maintenance, and upgrading of facilities and services for
which the \[universal service\] support is intended.\" 47 U.S.C.
§ 254(e).

*Fourth,* rather than continue to determine the eligibility threshold
for high-cost loop support by recalculating the national average loop
cost, the FCC now simply will adjust the previously-calculated national
average by an annual inflation index. Even assuming, as petitioners
contend, that inflation adjustments to historical averages in fact would
render fewer LEC\'s eligible for universal service subsidies than would
be the case under the former approach, petitioners nevertheless fail to
show how this interim approach is unreasonable. Given the eventual
transition from historic cost to forward-looking cost, as required by
competition, the FCC reasonably concluded that the effort of collecting
historic cost data no longer was justified.

*Finally*, petitioners claim that sales and transfers of exchanges by
rural providers are efficient and ought to be encouraged and subsidized.
The Order, by contrast, denies additional universal service support in
cases in which a rural LEC purchases another exchange.

When the permanent rules for universal access within the context of
local competition are in place, all exchanges will be governed by
uniform rules with respect to universal service support, without regard
to the rural or non-rural status of the LEC. In the interim, however,
the rules continue to treat rural and other LEC\'s differently, in
recognition of the continued greater need of rural LEC\'s. The
opportunity thus exists for gaming the different universal service
support regimes by transferring ownership to a rural LEC. The FCC acted
within its discretion to combat such gaming by keying regulatory
treatment to an exchange\'s original ownership status, without regard to
any subsequent transfer in ownership.

The Commission argues that, as a last resort, the availability of
waivers cures its orders of any deficiency with respect to sufficiency
and predictability.[[]{#txt19 .anchor}^(19)^](#N_19_) Even if the waiver
provisions were debatable as a policy matter, they are not an issue for
judicial review. For our purposes, a waiver provision is legitimate if
the underlying rule is rational, *see National Rural Telecomm. Ass\'n v.
FCC*, 988 F.2d 174, 181 (D.C. Cir. 1993), and cannot save a rule that on
its own has no rational basis, *see Alltel Corp*, 838 F.2d at 561-62. We
therefore can uphold these amendments relating to the high-cost loop
fund without addressing the wisdom of allowing waivers.

2\. Switching Costs.

Petitioners also fail to show that the FCC\'s various changes to the
treatment of switching equipment costs unreasonably fail to provide
sufficient and explicit funding for universal service or otherwise
constitute an arbitrary and capricious exercise of agency powers under
the Act. *First*, petitioners claim that the changes arbitrarily and
capriciously abandon cost-causation principles. They insist on retaining
special weighting on the assumption that it is in fact more costly to
switch long-distance calls than local calls. Therefore, under
cost-causative principles, IXC\'s should pay higher access charges,
because they are responsible for a greater proportion of switching
costs.

As we have said, however, the Commission has long abandoned this
assumption. Instead, special weighting has been allowed to continue
solely to provide an additional subsidy to rural LEC\'s, an interest
that would be equally served by the new universal service support fund.
Indeed, the Order makes plain that the new fund shall provide support
\"corresponding in amount to that generated formerly by DEM weighting.\"
Order ¶ 303. Moreover, by mandating that all universal service support
be \"explicit,\" 47 U.S.C. § 254(e) requires that this special weighting
be eliminated.

Petitioners\' second objection simply misconstrues the requirement of
\"explicit\" funding. They argue that, because the new fund would be
financed by all telecommunications carriers, including small LEC\'s such
as petitioners, the new fund constitutes an unlawful subsidy in favor
for IXC\'s.

Again, petitioners rest their argument on the same assumption deemed
obsolete by the FCC\--that long-distance switching is more costly than
local switching. Even so, we made clear in *TOPUC* that the
implicit/explicit distinction turns on the difference between direct
subsidies from support funds and recovery through access charges and
rate structures. \"The statute provides little guidance on whether
\'explicit\' means \'explicit to the consumer\' . . . or \'explicit to
the carrier\' . . . \[but it\] does state, however, that all universal
service support should be \'explicit.\' . . . By forcing GTE to recover
its universal service contributions from its access charges, the FCC\'s
interpretation maintains an implicit subsidy for ILEC\'s such as GTE.\"
183 F.3d at 425.

Petitioners thus misconstrue the meaning of the explicit funding
requirement. The fact that the fund is subsidized by contributions from
all telecommunications providers, including LEC\'s, does not make it an
implicit subsidy under § 254(e), even if it effectively redistributes
resources among telecommunications providers.

Moreover, § 254(b)(4) requires \"*\[a\]ll* providers of
telecommunications services \[to\] make an equitable and
nondiscriminatory contribution to the preservation and advancement of
universal service.\" 47 U.S.C. § 254(b)(4) (emphasis added); *see also*
47 U.S.C. § 254(d). The Commission reasonably applied the principle of
equitable and nondiscriminatory contribution by requiring contributions
from all telecommunications providers.

*Finally*, petitioners object on the ground that portability violates
the principle of predictability and the statutory command of sufficient
funding. Specifically, they claim that, if just 25% of the revenue that
the FCC has made portable is lost by a typical small LEC, the annual
rate of return for interstate access service will, in many cases, fall
to minus 10.53%.

As we have said, the Commission reasonably construed the predictability
principle to require only predictable *rules* that govern distribution
of the subsidies, and not to require predictable *funding amounts*.
Indeed, to construe the predictability principle to require the latter
would amount to protection from competition and thereby would run
contrary to one of the primary purposes of the Act.

Moreover, petitioners\' approach to the predictability principle would
prohibit also the *current* subsidy effect of weighting switching costs.
Under the current plan, LEC\'s receive the subsidy implicitly through
access charges\--costs that are realized only when customers make
telephone calls. The old system of implicit subsidies is no less
portable than is the explicit subsidies contemplated by the new fund,
for an LEC cannot assess access charges against IXC\'s for the costs of
a customer who has left that LEC for another provider. We therefore
uphold the Order over petitioners\' APA and *Chevron* challenges.

IV\. Takings Challenge.

Notwithstanding the above analysis, petitioners request us to read the
Act to avoid a violation of the Takings Clause. *See* *Edward J.
DeBartolo Corp. v. Florida Gulf Coast Building & Constr. Trades
Council*, 485 U.S. 568, 575 (1988). We see no reason to invoke the canon
of avoidance, however, because we are simply not presented with a
constitutional violation.

The Fifth Amendment protects utilities from regulations that are \"so
unjust as to be confiscatory.\" *Duquesne Light Co. v. Barasch*, 488
U.S. 299, 307 (1989). Petitioners therefore must show that a regulation
will \"jeopardize the financial integrity of the companies, either by
leaving them insufficient operating capital or by impeding their ability
to raise future capital,\" or they must demonstrate that the reduced
subsidies \"are inadequate to compensate current equity holders for the
risk associated with their investments under a modified prudent
investment scheme.\" *Duquesne*, 488 U.S. at 312.

It is not enough that a party merely speculates that a government action
will cause it harm. Rather, a taking must \"\'necessarily\' result from
the regulatory actions.\" *TOPUC*, 183 F.3d at 437 (*citing United
States v. Riverside Bayview Homes*, 474 U.S. 121, 128 n.5 (1985)). Such
a showing cannot be made here \"until the administrative agency has
arrived at a final, definitive position regarding how it will apply the
regulations at issue to the particular \[property right\] in question.\"
*Williamson County Regional Planning Comm\'n v. Hamilton Bank*, 473 U.S.
172, 191 (1985).

At the very least, therefore, petitioners must wait to experience the
actual consequences of the Order before a court may even begin to
consider whether the FCC has effected a constitutional taking. Until it
is known what level of universal service funding each petitioner will
receive under the Order, and under what circumstances the Commission
will grant a waiver, we cannot seriously entertain a Takings Clause
challenge.

Furthermore, petitioners do not present credible evidence that the Order
ever will cause the drastic consequences for rural LEC\'s articulated in
*Duquesne*. The mere fact that, \"\[f\]or many rural carriers, universal
service support provides a large share of the carriers\' revenues,\"
Order ¶ 294, is not enough to establish that the orders constitute a
taking. The Fifth Amendment protects against takings; it does not confer
a constitutional right to government-subsidized profits. The Takings
Clause thus erects no barrier to our *Chevron* and APA analysis.

V. Regulatory Flexibility Act Challenge.

Under the Regulatory Flexibility Act (\"RFA\"), final agency rules must
contain a \"final regulatory flexibility analysis\" (\"FRFA\"), 5 U.S.C.
§ 604(a), which must include

a description of the steps the agency has taken to minimize the
significant economic impact on small entities consistent with the stated
objectives of applicable statutes, including a statement of the factual,
policy, and legal reasons for selecting the alternative adopted in the
final rule and why each one of the other significant alternatives to the
rule considered by the agency which affect the impact on small entities
was rejected.

5 U.S.C. § 604(a)(5). In 1996, Congress provided for judicial review of
agency compliance with the RFA. *See* 5 U.S.C. § 611(a)(1). We review
only to determine whether an agency has made a \"reasonable, good-faith
effort\" to carry out the mandate of the RFA. *Associated Fisheries,
Inc. v. Daley*, 127 F.3d 104, 114 (1st Cir. 1997).

Petitioners\' RFA argument amounts to little more than a redressing of
its earlier *Chevron* and APA claims. The RFA is a procedural rather
than substantive agency mandate, to be sure,[[]{#txt20
.anchor}^(20)^](#N_20_) but petitioners fail to articulate specific
procedural flaws in the FCC\'s promulgation of the orders. In fact, both
orders are accompanied by substantial discussion and deliberation,
including consideration and reasoned rejection of significant
alternatives which, in the Commission\'s judgment, would not have
achieved with equivalent success its twin statutory mandates of
universal service and local competition. The RFA requires no
more.[[]{#txt21 .anchor}^(21)^](#N_21_)

Petitioners come closest to stating a meritorious procedural objection
when they assert that the FCC failed either to undertake or to present
economic analysis. Even assuming that that were so, the RFA plainly does
not require economic analysis, but mandates only that the agency
describe the steps it took \"to minimize the significant economic impact
on small entities consistent with the stated objectives of applicable
statutes.\" 5 U.S.C. § 604(a)(5).

The RFA specifically requires \"a statement of the factual, policy, and
legal reasons for selecting the alternative adopted in the final rule.\"
*Id.* Nowhere does it require, however, cost-benefit analysis or
economic modeling. Indeed, the RFA expressly states that, \"\[i\]n
complying with \[section 604\], an agency may provide either a
quantifiable or numerical description of the effects of a proposed rule
or alternatives to the proposed rule, or more general descriptive
statements if quantification is not practicable or reliable.\" 5 U.S.C.
§ 607.[[]{#txt22 .anchor}^(22)^](#N_22_) We therefore conclude that the
FCC reasonably complied with the requirements of the RFA.

Conclusion.

Petitioners\' various challenges fail because they fundamentally
misunderstand a primary purpose of the Communications Act\--to herald
and realize a new era of competition in the market for local telephone
service while continuing to pursue the goal of universal service. They
therefore confuse the requirement of sufficient support for universal
service within a market in which telephone service providers compete for
customers, which federal law mandates, with a guarantee of economic
success for all providers, a guarantee that conflicts with competition.

The FCC interim orders are reasonably tailored to achieving universal
service and competition in local markets. They do not effect a
cognizable, unconstitutional taking. And they were promulgated in
reasonable compliance with the requirements of the RFA. We therefore
DENY the petitions for review.

Judge WIENER concurs in the judgment only.

FOOTNOTES\
\
(Click footnote number to return to corresponding location in the text.)

[[]{#N_1_ .anchor}^1^](#txt1) *In re: Federal-State Joint Board on
Universal Serv.; Report and Order in CC Docket No. 96-45*, 12 FCC Rcd.
8776 (1997) (\"Order\"); *Fourth Order on Reconsideration in CC Docket
No. 96-45; Report and Order in CC Docket Nos. 96-45, 96-262, 94-1,
91-213, 95-72*, 13 FCC Rcd. 5318 (1997); *Errata*, 13 FCC Rcd. 2372
(1998) (\"Fourth Reconsideration Order\").

[[]{#N_2_ .anchor}^2^](#txt2) Telecommunications Act of 1996, Pub. L.
No. 104-104, 110 Stat. 56 (to be codified as amended in scattered
sections of title 47, United States Code).

[[]{#N_3_ .anchor}^3^](#txt3) The Act additionally states that \"\[i\]t
shall be the policy of the United States to encourage the provision of
new technologies and services to the public.\" 47 U.S.C. § 157(a). *Cf.*
47 U.S.C. § 254(b)(2) (providing that universal service programs be
guided by principle of providing access to advanced telecommunications
and information services in all regions). Petitioners argue that the
orders violate § 157(a).

Unlike the express statutory requirement of sufficient support of
universal service support imposed by 47 U.S.C. § 254(e), § 157(a) is
merely a broad statement of policy conferring substantial discretion on
the Commission to determine how best to provide for new technologies and
services. To our knowledge, § 157(a) has never been used to invalidate
an FCC action. We conclude, therefore, that a universal service program
that satisfies the specific statutory requirements of § 254(e)
necessarily satisfies the broad policy statement of § 157(a).

[[]{#N_4_ .anchor}^4^](#txt4) *See* Order ¶¶ 1-4, 20 (stating that it
\"ensure\[s\] that this system is sustainable in a competitive
marketplace, thus ensuring that universal service is available at rates
that are \'just, unreasonable, and affordable\' for all Americans\").

[[]{#N_5_ .anchor}^5^](#txt5) *See also TOPUC*, 183 F.3d at 407 (stating
that \"the FCC decided to use the \'forward-looking\' costs to calculate
the relevant costs of a carrier . . . . To encourage carriers to act
efficiently, the agency would base its calculation on the costs an
efficient carrier would incur (rather than the costs the incumbent
carriers historically have incurred)\").

[[]{#N_6_ .anchor}^6^](#txt6) It requires the Commission to adopt rules
opening the local services market to competition \"within 6 months.\" 47
U.S.C. § 251(d)(1). By contrast, the Commission need only adopt rules
establishing a \"specific timetable for implementation\" of universal
service, and even then, it has \"15 months\" to do so. 47 U.S.C. §
254(a)(2). *See also TOPUC*, 183 F.3d at 436 (\"By instructing the FCC
to establish a \'timetable for implementation\' by the statutory
deadline, Congress assumed the implementation process would occur over a
transition period after the fifteen-month deadline.\").

[[]{#N_7_ .anchor}^7^](#txt7) *See TOPUC*, 183 F.3d at 437 (\"Where the
statutory language does not explicitly command otherwise, we defer to
the agency\'s reasonable judgment about what will constitute
\'sufficient\' support during the transition period from one universal
service system to another.\"); *id.* at 440 n.85

(acknowledging that \"we extend the FCC greater discretion in deciding
what will be \'sufficient\' during the transition period\"); *MCI
Telecomm. Corp. v. FCC*, 750 F.2d 135, 140 (D.C. Cir. 1984) (noting that
\"substantial deference by courts is accorded to an agency when the
issue concerns interim relief\").

[[]{#N_8_ .anchor}^8^](#txt8) *See* 47 U.S.C. § 153(26) (defining
\"local exchange carrier\"); 47 U.S.C. § 153(47) (defining \"telephone
exchange service\").

[[]{#N_9_ .anchor}^9^](#txt9) *See* 47 U.S.C. § 153(16) (defining
\"exchange access\"); 47 U.S.C. § 153(48) (defining \"telephone toll
service\").

[[]{#N_10_ .anchor}^10^](#txt10) *See* 47 U.S.C. § 153(37) (defining
\"rural telephone company\").

[[]{#N_11_ .anchor}^11^](#txt11) As the Commission stated in 1987,

The Mountain States Telephone and Telegraph Company, Northwestern Bell
Telephone Company, Pacific Northwest Bell Telephone Company (US West),
which originally supported the use of weighted DEM in its comments,
changed its position to support measured DEM in reply comments because
it believes the ongoing process of replacing older technology with
digital switches will eliminate the need for any toll weighting. We
believe that modern digital switching equipment has greatly reduced, if
not eliminated, the additional cost of toll switching. . . . \[W\]e
believe that the need for toll weighting will continue to diminish and
will eventually be eliminated as the exchange carriers continue to
replace older technology equipment with digital switches.

*In the Matter of Amendment of Part 67 of the Commission\'s Rules and
Establishment of a Joint Board, Recommended Decision and Order in CC
Docket No. 80-286*, 2 FCC Rcd. 2551, ¶ 49 (1987). *See also In the
Matter of MTS and WATS Market Structure, Amendments of Part 67 (New Part
36) of the Commission\'s Rules and Establishment of a Federal-State
Joint Board, Report and Order in CC Docket Nos. 78-72, 80-286, 86-297*,
2 FCC Rcd. 2639, ¶ 5 (1987).

[[]{#N_12_ .anchor}^12^](#txt12) *See TOPUC*, 183 F.3d at 425 (noting
\"the sorts of implicit subsidies currently used by the FCC in its
\[DEM\] weighting program\").

[[]{#N_13_ .anchor}^13^](#txt13) *See* note 7, *supra*.

[[]{#N_14_ .anchor}^14^](#txt14) *See Alltel Corp. v. FCC*, 838 F.2d
551, 561 (D.C. Cir. 1988) (\"A regulation perfectly reasonable and
appropriate in the face of a given problem may be highly capricious if
that problem does not exist.\").

[[]{#N_15_ .anchor}^15^](#txt15) *See* 47 C.F.R. § 1.3; Fourth
Reconsideration Order ¶¶ 93, 102, 108.

[[]{#N_16_ .anchor}^16^](#txt16) *See, e.g.,* 47 U.S.C. § 254(b)(3)
(stating that \"Consumers in all regions of the Nation\" shall receive
comparable telephone service).

[[]{#N_17_ .anchor}^17^](#txt17) Petitioners estimate that the
introduction of competition will result in a loss of approximately 25%
of the customer base. The FCC counters with historical trends that would
predict market share losses of only 3%. Because we conclude that the
sufficiency requirement is intended to benefit the customer, not the
provider, we need not resolve this particular dispute.

[[]{#N_18_ .anchor}^18^](#txt18) *See* 47 U.S.C. § 254(e)(2) (\"Before
designating an additional eligible telecommunications carrier for an
area served by a rural telephone company, the State commission shall
find that the designation is in the public interest.\").

[[]{#N_19_ .anchor}^19^](#txt19) *See* 47 C.F.R. § 1.3 (general waiver
provision for all FCC regulations); Fourth Reconsideration Order ¶ 38
(providing for waiver of indexed cap on growth in high cost loop fund);
*Id.* at ¶¶ 93, 102, 108 (providing for waiver of cap on corporate
operations expenses).

[[]{#N_20_ .anchor}^20^](#txt20) *See Associated Fisheries*, 127 F.3d at
114

(stating that \"section 604 does not command an agency to take specific
substantive measures, but, rather, only to give explicit consideration
to less onerous options\").

[[]{#N_21_ .anchor}^21^](#txt21) *See Associated Fisheries*, 127 F.3d
at 115 (noting that \"section 604 does not require that an FRFA address
every alternative, but only that it address significant ones.\").

[[]{#N_22_ .anchor}^22^](#txt22) *See also Associated Fisheries*, 127
F.3d at 115 (\"Section 604 prescribes the content of an FRFA, but it
does not demand a particular mode of presentation.\").