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                           Before the
               Federal Communications Commission
                     Washington, D.C. 20554


     In the Matter of)
      )
    Implementation of the )
    Telecommunications Act of 1996:)CC Docket No. 96-150
      )
   Accounting Safeguards Under the)
   Telecommunications Act of 1996 )


                        REPORT AND ORDER
                                
Adopted:  December 23, 1996                 Released:  December 24, 1996   
                                
By the Commission:

                       TABLE OF CONTENTS

I.  INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . .  1

II.  BACKGROUND AND OVERALL GOALS. . . . . . . . . . . . . . .  3
     A.  Summary of the Relevant Statutory Provisions. . . . .  3
     B.  Goals of the Proceeding . . . . . . . . . . . . . .   13
     C.  Scope of Commission's Authority . . . . . . . . . . . 29
     D.  Structure of this Order . . . . . . . . . . . . . . . 47

III.  SAFEGUARDS FOR INTEGRATED OPERATIONS . . . . . . . . . . 48
     A.  General . . . . . . . . . . . . . . . . . . . . . . . 48
     B.  Specific Services . . . . . . . . . . . . . . . . . . 51
          1.  Section 260 - Telemessaging Service. . . . . . . 51
          2.  Section 271 - InterLATA Telecommunications Services 61
               a.  Incidental InterLATA Services . . . . . . . 62
               b.  Integrated Provision of InterLATA Services. 66
               c.  Other Matters . . . . . . . . . . . . . . . 77
          3.  Section 275 - Alarm Monitoring Services. . . . . 88
                         4.  Section 276 - Payphone Services. . . . . . . . . 93IV.  SAFEGUARDS FOR SEPARATED OPERATIONS . . . . . . . . . .  101
     A. General. . . . . . . . . . . . . . . . . . . . . . .  101
     B.  Specific Services . . . . . . . . . . . . . . . . .  110
          1.  Section 272 - Manufacturing and InterLATA Services 110
               a.  Statutory Language. . . . . . . . . . . .  110
               b.  "Arm's Length" Requirement of Section 272(b)(5) 111
                    i.  Prevailing Company Prices. . . . . .  125
                    ii.  Valuation Methods for Assets and Services. 138
                    iii.  Fair Market Value. . . . . . . . .  149
                    iv.  Tariffed-based Valuation. . . . . .  155
                    v.  Return Component for Allowable Costs  160
               c.  Accounting Requirements of Sections 272(b)(2) and (c)(2) 167
               d.  Application to InterLATA Telecommunications Affiliates 171
               e.  Application to Sharing of Services. . . .  179
               f.  Audit Requirements. . . . . . . . . . . .  184
          2.  Section 273 - Manufacturing by Certifying Entities 206
               a.  Statutory Language. . . . . . . . . . . .  206
               b.  Comparison of Sections 273 and 272. . . .  208
          3.  Section 274 - Electronic Publishing. . . . . .  213
               a.  Statutory Language. . . . . . . . . . . .  213
               b.  Comparison of Sections 274 and 272. . . .  214
               c.  Compliance Review . . . . . . . . . . . .  220
               d.  Section 274(f)'s Reporting Requirement. .  227
               e.  Section 274 Transactional Requirements. .  231
               f.  Miscellaneous . . . . . . . . . . . . . . .245
          4.  Separated Operations under Sections 260 and 271 through 276248

V.  OTHER MATTERS. . . . . . . . . . . . . . . . . . . . . . .259
     A.  Price Caps. . . . . . . . . . . . . . . . . . . . . .259
          1.  General. . . . . . . . . . . . . . . . . . . . .259
          2.  Exogenous Costs and Part 64. . . . . . . . . . .260
          3.  Part 64 and Sharing. . . . . . . . . . . . . . .267
     B.  Section 254(k). . . . . . . . . . . . . . . . . . . .272

VI.  FINAL REGULATORY FLEXIBILITY ACT ANALYSIS . . . . . . . .277

VII.  FINAL PAPERWORK REDUCTION ACT ANALYSIS . . . . . . . . .284

VIII.  ORDERING CLAUSES. . . . . . . . . . . . . . . . . . . .285

                        I.  INTRODUCTION

      1.In this Report and Order ("Order") we address the accounting safeguards
necessary to satisfy the requirements of sections 260 and 271 through 276 of the
Communications Act of 1934, as amended by the Telecommunications Act of 1996.  This
Order prescribes the way incumbent local exchange carriers, including the Bell Operating
Companies ("BOCs"), must account for transactions with affiliates involving, and allocate
costs incurred in the provision of, both regulated telecommunications services and
nonregulated services, including telemessaging, interLATA telecommunications, information,
manufacturing, electronic publishing, alarm monitoring and payphone services, to ensure
compliance with the Act.  In particular, the Order adopts the tentative conclusion in the Notice
of Proposed Rulemaking ("NPRM") in this proceeding that our current cost allocation rules
generally satisfy the Act's accounting safeguards requirements when incumbent local exchange
carriers, including the BOCs, provide services permitted under sections 260 and 271 through
276 on an integrated basis (i.e., within the telephone operating companies).  The Order also
adopts the tentative conclusion in the NPRM that our current affiliate transactions rules
generally satisfy the Act's accounting safeguards requirements when incumbent local exchange
carriers, including the BOCs, are required to, or choose to, use an affiliate to provide services
permitted under sections 260 and 271 through 276.  The Order adopts most of the NPRM's
proposed modifications to the affiliate transactions rules to provide greater protection against
subsidization of competitive activities by subscribers to regulated telecommunications
services.

      2.By applying our current cost allocation rules and modified affiliate transactions
rules to incumbent local exchange carriers, including the BOCs, that provide services
permitted under sections 260 and 271 through 276, we seek to protect regulated service
ratepayers from bearing the risks and costs of carriers' nonregulated ventures.  We also seek to
promote competition by preventing carriers from using their market power in local exchange
services to obtain an anti-competitive advantage in the markets that they seek to enter.  We will
monitor the development of competition to determine whether further changes to these
accounting safeguards are needed to achieve the objectives of the Act.

               II.  BACKGROUND AND OVERALL GOALS

A.  Summary of the Relevant Statutory Provisions

      3.The Act permits the BOCs to engage in previously proscribed activities if the
BOCs satisfy certain conditions that are intended to prevent them from recovering costs of
their new ventures from subscribers to local exchange and exchange access services and from
discriminating against their competitors in these new markets.  The Act places similar
conditions on other incumbent local exchange carriers electing to enter or continue to
participate in certain markets.

      4.The Act prescribes structural and nonstructural safeguards that are intended to
protect ratepayers, consumers, and competitors against the effects of potential improper cost
allocation and discrimination.  These structural and nonstructural safeguards apply to activities
such as payphone services that BOCs are currently permitted to provide and to activities such
as alarm monitoring services that BOCs are currently permitted to provide in certain markets. 
In addition, these safeguards apply to other activities that incumbent local exchange carriers
may now provide as a result of the Act.

      5.Sections 260 and 271 through 276 outline the conditions under which incumbent
local exchange carriers may offer telemessaging and alarm monitoring services and under
which the BOCs may manufacture and provide telecommunications equipment, may
manufacture customer premises equipment ("CPE"), and may offer interLATA
telecommunications, information, electronic publishing and payphone services.  While the Act
requires that many of these services must be provided through separate affiliates, it also
permits some to be offered on an integrated basis.

      6.Sections 260 and 275 generally prohibit an incumbent local exchange carrier,
including the BOCs, from subsidizing its telemessaging and alarm monitoring services with
revenues from regulated telecommunications services.  Section 260 provides that an incumbent
local exchange carrier, including a BOC, that provides telemessaging service "shall not
subsidize its telemessaging service directly or indirectly from its telephone exchange service or
its exchange access," but does not require a separate affiliate.  Section 275(b)(2) bars an
incumbent local exchange carrier, including a BOC, that provides alarm monitoring services
from "subsidiz[ing] its alarm monitoring services either directly or indirectly from telephone
exchange service operations," but does not require a separate affiliate.

      7.Section 271(b) authorizes the BOCs to immediately provide "out-of-region"
interLATA services but requires the BOCs to obtain Commission approval before providing
"in-region" interLATA services.  Section 271(g) lists specific "incidental interLATA
services" that BOCs and their affiliates may provide after February 8, 1996.  Section 271(h)
states that "[t]he Commission shall ensure that the provision of services authorized under
[section 271(g)] by a Bell operating company or its affiliate will not adversely affect telephone
exchange service ratepayers or competition in any telecommunications market."  

      8.Section 272 permits a BOC (including any affiliate) that is subject to section
251(c) to manufacture equipment (as defined in the AT&T consent decree), originate in-
region interLATA telecommunications services, other than incidental and previously
authorized interLATA services, and provide certain interLATA information services only if it
does so through one or more separate affiliates.  Each of the separate affiliates must "maintain
[separate] books, records, and accounts in the manner prescribed by the Commission" and
"shall conduct all transactions with the Bell operating company of which it is an affiliate on an
arm's length basis."  In its dealings with the separate affiliate, each BOC must "account for
all transactions . . . in accordance with accounting principles designated or approved by the
Commission."  

      9.Section 273(d)(3) imposes separate affiliate requirements for the manufacture of
telecommunications equipment and customer premises equipment upon entities that certify the
same class of telecommunication equipment and customer premises equipment produced by
unaffiliated entities.

      10.Section 274(a) prohibits any "Bell operating company or any affiliate [from]
engag[ing] in the provision of electronic publishing that is disseminated by means of such Bell
operating company's or any of its affiliates' basic telephone service," other than through "a
separated affiliate or electronic publishing joint venture."  This separated affiliate or
electronic publishing joint venture must, among other requirements, "maintain separate books,
records, and accounts and prepare separate financial statements."  

      11.Section 276(b)(1)(C) directs the Commission to prescribe rules for BOC
provision of payphone service that, "at a minimum, include the nonstructural safeguards equal
to those adopted in the Computer Inquiry-III (CC Docket No. 90-623) proceeding."  Section
276(a)(1) states that any BOC that provides payphone service after the effective date of those
rules "shall not subsidize its payphone service directly or indirectly from its telephone
exchange service operations or its exchange access operations."

      12.Finally, section 254(k) imposes a more general prohibition against cross-
subsidization by barring telecommunications carriers from "us[ing] services that are not
competitive to subsidize services that are subject to competition."

B.  Goals of the Proceeding

      13.In our NPRM, we set forth two goals for this proceeding: (1) preserving for the
benefit of interstate telephone ratepayers legitimate economies of scope that could be realized
by BOCs and other incumbent local exchange carriers when entering markets from which they
were previously barred or in which they continue to participate; and (2) discouraging, and
facilitating detection of, improper cost allocations in order to prevent incumbent local exchange
carriers from imposing the costs of their competitive ventures on interstate telephone
ratepayers.  In the NPRM, we asked the threshold question: to what, if any, extent should we
rely on our existing accounting safeguards in Parts 32 and 64 of our rules to achieve these
two goals.  We tentatively concluded that our existing accounting safeguards, with the
modifications described in the NPRM, would best meet the requirements and underlying goals
of sections 260 and 271 through 276.  We invited comment on this tentative conclusion.  We
also sought comment on whether less detailed accounting safeguards would suffice to achieve
the objectives of the Act.  
     
     14.  To the extent that BOCs or other incumbent local exchange carriers maintain
control over the bottleneck facility, these BOCs or other incumbent local exchange carriers
could potentially engage in predatory behavior.  In the NPRM, we also sought comment on
how the extent to which a BOC or other incumbent local exchange carrier has the opportunities
to engage in predatory behavior should affect our decisions in this proceeding.

Comments:

      15.Worldcom contends that the Act does not support the Commission's statement in
the NPRM concerning the need to preserve "economies of scope" for the BOCs.  SBC,
however, maintains that, except to the extent Congress imposed temporary separation
requirements as well as other restrictions such as the nondiscrimination provisions on
incumbent local exchange carriers, Congress did not deny incumbent local exchange carriers
the benefits of their own efficiencies.

      16.Several parties, including NYNEX, contend that existing accounting safeguards
are more than adequate to meet the requirements of sections 260 and 271 through 276 and no
additional safeguards are required.  In particular, Cincinnati Bell argues that incumbent local
exchange carriers will not be able to raise prices based upon improperly allocated costs given
the choices that will be available to customers in a competitive market.  Many parties,
including States, interexchange carriers, and trade associations, generally support our proposal
to use current Part 32 and Part 64 accounting rules, with some modifications.  USTA and
SBC argue that given the pro-competitive, deregulatory goals of the Act and the increase in
competition since the adoption of the accounting safeguards in the Joint Cost and Computer III
Proceedings, we should not impose more stringent rules.  Ameritech contends that we should
adopt less detailed accounting rules consistent with the Act's mandate to foster a national
deregulatory policy framework.

      17.Sprint, GSA, Puerto Rico Telephone and several BOCs argue that a new system
of accounting safeguards would require the BOCs to develop new systems and retrain
employees, requiring substantial investments of time and resources without any assurance that
a new system will be more effective.  Ameritech adds that the substantial costs associated
with the adoption of a different accounting safeguards approach would not be justified by the
benefit.  

      18.USTA maintains that where we determine that current accounting safeguards
will continue to apply to incumbent local exchange carriers, we should streamline those
safeguards to the extent possible to ensure fair competition and to make the rules clear and
predictable.    USTA recommends streamlining our current rules as follows:  (1) modify the
shared forecast investment rules; (2) modify the affiliate transactions valuation standards; (3)
simplify the Part 64 administrative process; and, (4) modify the frequency of the independent
audit.  Ameritech and SBC recommend adoption of USTA's streamlining proposals to
implement provisions under the Act related to both separated and integrated operations. 
Several parties, including USTA, allege that competition and a number of existing safeguards,
most notably price cap regulation, provide the most effective constraints on the ability of
incumbent local exchange carriers to cross-subsidize.

      19.In contrast, APCC argues that existing safeguards have not adequately prevented
cross-subsidization.  In particular, APCC suggests that we should make extensive changes to
the cost allocation manuals, impose additional requirements to annual attestation audits, and
reconsider the allocation methodology presently employed by incumbent local exchange
carriers.  ESI recommends that we adopt rules that ensure that vertically integrated
telecommunications carriers with proven market power be more strictly regulated than carriers
without the potential to price squeeze.

      20.MCI maintains that the Act clearly recognizes the incentives for incumbent local
exchange carriers to shift costs between their new competitive activities and their monopoly
local exchange and exchange access operations.  Accordingly, MCI asserts that we must
adopt safeguards stricter than our existing accounting safeguards to account for the increased
opportunities for BOCs to enter new lines of nonregulated businesses and for the increased
incentives and opportunities for incumbent local exchange carriers to shift costs following
passage of the 1996 Act.  In particular, MCI suggests that we adopt a rule requiring carriers
to maintain a complete audit trail of all cost allocations and affiliate transactions. 

      21.GTE agrees with our contention that any commenter urging us to adopt more
detailed accounting safeguards than those in our current rules or those specifically mandated by
the Act bears a heavy burden of persuading us to adopt such safeguards.  Ameritech alleges,
however, that we have not satisfied this heavy burden of persuasion test with regard to the
more detailed accounting safeguards proposed in the NPRM.

      22.With respect to our concerns regarding opportunities for incumbent local
exchange carriers to engage in predatory behavior, Worldcom argues that "the very act of
competing head-on with the BOCs creates a heightened degree of reliance on the BOCs'
bottleneck facilities that did not exist before."  AT&T alleges that the BOCs still control
bottleneck facilities and that as long as their control continues, the BOCs will be able to engage
in predatory behavior, forcing non-affiliated interexchange carriers to absorb high access
charges as a real cost and allowing the BOCs and their interexchange affiliates to underprice
these non-affiliated carriers.

      23.Ameritech and USTA, however, contend that predatory behavior is not likely to
occur.  In particular, USTA argues that given the difference in resources between incumbent
local exchange carriers and competitors, such as AT&T and MCI in the interexchange market,
it is more likely that incumbent local exchange carriers will be the victims of predatory
behavior, not the perpetrators of it.  SBC maintains that predatory behavior concerns prices
in competitive markets and has no place in an accounting safeguards proceeding. 

Discussion:

      24.In addressing the issues in this proceeding, we adopt and follow the two
fundamental goals for this proceeding articulated in the NPRM and discussed above.  We are
committed to facilitating the development of competitive telecommunications service offerings
and, in particular, to giving effect to the provisions relating to incumbent local exchange
carrier entry into, or expansion within, the markets covered by sections 260 and 271 through
276.  We affirm that protecting ratepayers from cross-subsidizing competitive ventures is a
primary goal behind all our cost allocation and affiliate transactions rules.  The 1996 Act
clarifies the meaning of what constitutes just and reasonable rates by adding to the
Communications Act of 1934 section 254(k), which provides that incumbent local exchange
carriers may "not use services that are not competitive to subsidize services that are subject to
competition."  

      25.Many commenters endorse adoption of the goals we set forth in the NPRM.  The
primary objective of this proceeding is to examine whether our existing accounting safeguards
adequately respond to new competitive opportunities created by the 1996 Act.  These
accounting safeguards consist of cost allocation and affiliate transactions rules that were
designed to keep incumbent local exchange carriers from imposing the costs and risks of their
competitive ventures on interstate telephone ratepayers, and to ensure that interstate ratepayers
share in the economies of scope realized by incumbent local exchange carriers when they
expand into additional enterprises.  Our cost allocation and affiliate transactions rules, in
combination with audits, tariff review, and the complaint process, have proven successful at
protecting regulated ratepayers from bearing the risks and costs of incumbent local exchange
carriers' competitive ventures.  

     26.  With respect to affiliate transactions, we note that the Act requires BOCs to
create a separate affiliate for certain services.  While the volume of affiliate transactions may
increase as the result of this requirement, we do not believe that the nature and type of such
transactions will raise any accounting concerns that our current rules do not already address. 
Similarly, the 1996 Act will also likely increase the scope of nonregulated activities in which
BOCs participate because they may now provide, on an integrated basis, services that they
were previously prohibited from providing.  Since the inception of our Part 64 cost allocation
rules, the type and level of nonregulated activities have continued to grow.  We designed our
cost allocation rules to accommodate the growth of these nonregulated activities and affiliate
transactions.  We conclude that our existing cost allocation and affiliate transactions rules, as
modified herein, are appropriate for any of the new activities described in Sections 260 and
271 through 276.  Where we find that our accounting safeguards should be strengthened, we
do so in this Order.  We therefore find that adoption of the existing cost allocation rules and
the affiliate transactions rules, as modified herein, will successfully achieve our goals.

      27.We noted in the NPRM that any commenter urging us to adopt more detailed
accounting safeguards than those in our current rules or those specifically mandated by the Act
bears a heavy burden in demonstrating the necessity to adopt such safeguards.  The
imposition of this burden is consistent with the requirement of the Administrative Procedure
Act that our actions be supported by the language of the Act as well as substantial evidence in
the record.

      28.Finally, we see no need for additional accounting safeguards designed
specifically to prevent predatory behavior by incumbent local exchange carriers.  We believe
that the accounting rules we adopt here will effectively prevent predatory behavior that might
result from cross-subsidization.  None of the commenters proposed any additional accounting
rules to guard against predatory behavior.

C.  Scope of Commission's Authority

      29. In the NPRM, we asked whether the Act grants the Commission authority to
establish accounting safeguards for the intrastate services described in sections 260 and 271
through 276.  With respect to interLATA services of the types described in sections 271 and
272, we tentatively concluded, in accordance with the analysis developed and discussed in the
BOC In-Region NPRM, that the Commission has authority to set the accounting safeguards for
both interstate and intrastate interLATA services and interLATA information services
governed by these sections.  With respect to payphone service, we tentatively concluded that
the language of section 276 specifically grants the Commission jurisdiction to preempt any
State regulations that may be inconsistent with the Commission's regulations.  With respect to
manufacturing by certifying entities, we tentatively concluded that the provisions of section
273 apply to all BOC manufacturing activities, irrespective of any jurisdictional distinctions.

      30.We sought comment in the NPRM on the role the states might have in
implementing the accounting safeguards provisions of sections 260 and 271 through 276.  We
also sought comment on whether, if these sections do not specifically grant the Commission
jurisdiction over intrastate services, the Commission has the authority to preempt State
regulation with respect to accounting matters addressed by these sections pursuant to Louisiana
Public Service Commission v. F.C.C. ("Louisiana PSC").  We tentatively concluded that if
the Commission has the authority to preempt pursuant to Louisiana PSC, we should refrain
from exercising that authority and retain our policy of not preempting States from using their
own accounting safeguards for intrastate purposes.  

Comments:

      31.Sprint asserts that the Act grants the Commission jurisdiction over section 260
telemessaging services without regard to either State or LATA boundaries.  Voice-Tel
maintains that the inherent interstate nature of telemessaging services permits the Commission
to preempt States even with respect to an individual local exchange carrier operating in a single
state.  BellSouth, however, argues that there is no basis for the Commission to preempt State
Commission actions that are consistent with section 260 and the Part 64 rules.

      32.In general, interexchange carriers contend that sections 271 and 272 grant the
Commission authority to regulate all interLATA services including intrastate, interLATA
services because sections 271 and 272 expressly address BOC provision of interLATA
services, making no distinction between interstate and intrastate aspects of those services. 
NARUC and the States generally disagree.  CTA and Sprint contend that the Commission
should preempt the States with regard to intrastate, intraLATA telecommunications services
and information services if the lack of sufficient cross-subsidization safeguards by a State will
hinder the development of competition and allow the BOCs to abuse their market power in the
intraLATA market.  California and Wisconsin PSC allege that the Commission has no
authority to preempt States from using their own accounting safeguards unless individual State
rules compromise the goals and intent of the Act.  US West argues that we should consider
the necessity of preemption on a case-by-case basis because there is no record to justify a
blanket preemption of State accounting safeguards procedures for intrastate purposes.

      33.Sprint and AICC argue that the Act grants the Commission jurisdiction over
alarm monitoring under section 275 without regard to either State or LATA boundaries. 
AICC argues that even if section 275 does not, by its terms, grant the Commission jurisdiction
over all alarm monitoring services, the Commission has the power to preempt State regulation
in order to ensure that alarm monitoring services are not subsidized by exchange and exchange
access ratepayers.  Florida PSC contends, however, that the Commission has no authority to
preempt the States from applying their own cost allocation systems for intrastate alarm
monitoring services.

      34.BellSouth and NYNEX contend that section 276 contains express language that,
with respect to payphone service, specifically grants the Commission authority to preempt any
State regulations that may be inconsistent with the Commission's regulations.  California and
NYDPS contend that the Act does not authorize the Commission to preempt States from
imposing accounting safeguards on payphone service.

      35.Sprint and TIA maintain that the Commission has jurisdiction over all
manufacturing activities under section 273 because manufacturing cannot be segregated into
interstate and intrastate portions.  NYDPS, however, argues that the Act does not limit States
from exercising jurisdiction over manufacturing.

      36.All commenters that addressed the Commission's scope of authority over
electronic publishing services agree that section 274 covers both interLATA and intraLATA
electronic publishing.  YPPA contends that if Congress had intended to distinguish between
interLATA and intraLATA electronic publishing, it would have done so, as it did in section
272.  NYDPS argues that the Act does not preclude States from exercising jurisdiction over
electronic publishing.  NAA maintains that the requirements of section 274 apply when the
electronic publishing is disseminated by means of a BOC's "basic telephone service."  Thus, 
NAA argues that the Commission's authority with respect to complaints and cease and desist
orders applies to interstate and intrastate electronic publishing.  NAA contends, however, that
Congress has manifested no intent to preclude the States from also enforcing section 274.  

      37.AT&T contends that the role of the States in implementing the Act's various
prohibitions against cross-subsidization arises in the auditing process.  According to AT&T,
States will also continue to have authority to use their own accounting methods for intrastate
services that have not been preemptively deregulated by the Commission or for which
jurisdiction has not been expressly vested in the Commission under the Act.  

      38.With respect to the Commission's authority to preempt State accounting
regulations pursuant to Louisiana PSC, NYDPS contends that because two sets of accounting
regulations can co-exist and have co-existed in the past, the Commission's tentative conclusion
to refrain from preempting States under Louisiana PSC is correct as a matter of law.  TIA
contends that any State regulation with respect to BOC manufacturing that is inconsistent with
the requirements of section 272 or 273 would necessarily "thwart or impede" federal policies
and should therefore be preempted.

Discussion:

      39. Sections 260, 271, 274, 275 and 276 of the Communications Act of 1934 all
expressly prohibit BOCs and, in some cases, other incumbent local exchange carriers from
subsidizing services permitted under those sections from their "telephone exchange service"
or their "basic telephone service."  The term "telephone exchange service" as defined under
section 3(47) of the Act is a primarily intrastate service.  Moreover, the term "basic
telephone service" as defined under section 274(i)(2) is a primarily intrastate service. 
Therefore, by barring BOCs and, in some cases, other incumbent local exchange carriers from
subsidizing activities permitted pursuant to sections 260, 271, 274, 275 and 276 from their
"telephone exchange service" or their "basic telephone service," these sections of the Act
expressly reach intrastate services.  In addition, section 273(g) states that the Commission may
prescribe such additional rules and regulations as may be necessary to prevent cross-
subsidization.

      40. The relevant statutory references to intrastate services are extensive.  Section
260(a)(1) provides that "[a]ny local exchange carrier subject to the requirements of section
251(c) that provides telemessaging service . . . (1) shall not subsidize its telemessaging service
directly or indirectly from its telephone exchange service or its exchange access."  Section
274(a) provides that "[n]o Bell operating company or any affiliate may engage in the provision
of electronic publishing that is disseminated by means of such Bell operating company's or any
of its affiliates' basic telephone service."  Similarly, section 275(b)(2) provides that an
incumbent local exchange carrier shall "not subsidize its alarm monitoring services either
directly or indirectly from telephone exchange service operations," while section 276(a)(1)
prohibits any BOC that provides payphone service from subsidizing its payphone service
"directly or indirectly from its telephone exchange service operations or its exchange access
operations."  Further, section 271(h), pertaining to BOC entry into interLATA services,
states that the "Commission shall ensure that the provision of services authorized under
subsection (g) by a Bell operating company or its affiliate will not adversely affect telephone
exchange service ratepayers or competition in any telecommunications market."

      41. In addition, we note that in the companion Non-Accounting Safeguards Order,
we conclude that sections 271 and 272 give us jurisdiction over all interLATA services
covered by those sections, including intrastate, interLATA services.  The Act defines
"interLATA services" as "telecommunications between a point located in a [LATA] and a
point located outside such area."  The definition does not distinguish between domestic and
international interLATA services.  Further, international telecommunications services, which
originate in a LATA and terminate in a country other than the United States, or vice versa, fit
within the statutory definition of interLATA services.  Thus, we conclude, as we do in the
Non-Accounting Safeguards Order that Congress intended the section 272 safeguards to apply
to all domestic and international interLATA services.  Because the scope of sections 271 and
272 extends to both interstate and intrastate services, carriers must comply with the
requirements of those sections for both interstate and intrastate services.  We emphasize,
however, that the scope of the Commission's authority under sections 271 and 272 extends
only to matters covered by those sections.  Those sections do not alter the jurisdictional
division of authority with respect to matters falling outside their scope.  For example, rates
charged to end users for intrastate interLATA service have traditionally been subject to state
authority, and will continue to be.

      42. Based on the express statutory language prohibiting cross-subsidization, as well
as our interpretation of the term "interLATA," as discussed in the Non-Accounting Safeguards
Order, and our interpretation of the terms "telephone exchange service" and "basic telephone
service," as discussed above, we conclude that the reach of sections 260, 271, 272 and 274
through 276 extends to intrastate services, and that the Commission has jurisdiction, under the
cross-subsidization prohibitions contained in these sections, to adopt regulations governing
intrastate services.  Again, we emphasize that the scope of the Commission's authority under
sections 260, 271, 272, and 274 through 276 extends only to matters covered by those
sections.  Those sections do not alter the jurisdictional division of authority with respect to
matters falling outside their scope, including rates charged to end users for intrastate
interLATA service. 

      43.We also find, as discussed in the Non-Accounting Safeguards Order, that section
2(b) of the Communications Act of 1934 does not limit the Commission's authority to establish
regulations governing intrastate matters under these sections.  For the reasons explained
below, however, we decline to impose any additional accounting rules on carriers' intrastate
services.  We note that the language of sections 260, 271, 272 and 274 through 276 that
extends our jurisdiction to include certain intrastate activities is both more recent and more
specific than section 2(b).  As a result, the language of these more recent provisions is
controlling.

      44. As we discuss in section II.B. above, we already have an accounting safeguards
system in place that prevents incumbent local exchange carriers from imposing the costs and
risks of their competitive ventures on interstate telephone ratepayers and ensures that interstate
ratepayers share in the economies of scope that incumbent local exchange carriers may realize
upon expansion into additional enterprises.  In this Order, we apply our existing accounting
safeguards system, consisting of our cost allocation and modified affiliate transactions rules in
Parts 32 and 64 of our rules, to the services permitted by sections 260, 271, 272 and 274
through 276.  Our experience with these safeguards has demonstrated their ability to protect
interstate ratepayers from improper cross-subsidization.  The cross-subsidization prohibitions
of sections 260, 271, 272 and 274 through 276, however, cover certain intrastate services, as
noted in the previous paragraph.  Neither the information contained in the record nor our
experience provides us with any basis to conclude that existing state accounting systems that
differ from our federal system will result in the type of subsidization of competitive activities
prohibited by sections 260, 271, 272 and 274 through 276.  Therefore, we decline to impose
any additional accounting rules on intrastate services.

      45. Regardless of whether we or the States adopt accounting rules to prevent
subsidies flowing from regulated services within our respective jurisdictions to the services
permitted under sections 260, 271, 272 and 274 through 276, carriers must comply with the
cross-subsidization prohibitions in those sections of the Act.  Any ratepayer or other person
alleging a violation of these provisions by a carrier may file a complaint with the Commission
pursuant to section 208 of the Communications Act.  In the event that a carrier or customer
believes that any State has imposed accounting rules that may force a carrier to violate the
cross-subsidization prohibitions of sections 260, 271, 272 and 274 through 276, then the
carrier or customer may seek declaratory relief from the Commission pursuant to section 1.2
of the Commission rules on a case-by-base basis.

      46. With regard to the manufacturing activities covered by section 273, we conclude
that States are preempted from implementing any part of that section, including its accounting
safeguards provisions.  We base this conclusion on the fact that such manufacturing activities
cannot be separated between the interstate and intrastate jurisdictions, rendering any separation
between interstate and intrastate jurisdictions infeasible.  As a result, we must preempt States
from implementing accounting safeguards related to manufacturing activities.  Moreover, while
section 2(b) of the Communications Act of 1934 limits the Commission's authority over
"charges, classifications, practices, services, facilities, or regulation for or in connection with
intrastate communications service," we find that the manufacturing activities addressed by
section 273 do not fit within any of these categories and therefore are not within the scope of
section 2(b).  We therefore conclude that section 2(b) does not preclude our assertion of
jurisdiction over manufacturing activities, as required by section 273.

D.  Structure of this Order

      47.Section III of this Order addresses accounting safeguards that apply when an
incumbent local exchange carrier, including a BOC, provides on an integrated basis a service
within the ambit of sections 260 and 271 through 276.  Section IV discusses the accounting
safeguards that apply when an incumbent local exchange carrier, including a BOC, uses an
affiliate to provide a service within the ambit of sections 260 and 271 through 276.  Within
sections III and IV, we address the application of accounting safeguards to meet the individual
requirements of each statutory section addressed in this Order.  Section V of this Order
presents our analysis as to why price cap regulation does not obviate the need for accounting
safeguards to ensure against the subsidization of services permitted under sections 260 and 271
through 276 with revenues from regulated telecommunications services.  

           III.  SAFEGUARDS FOR INTEGRATED OPERATIONS
                                
A.  General

      48.In this section of the Order, we discuss the provisions in sections 260, 271, 275,
and 276 relating to accounting safeguards for telemessaging, certain interLATA
telecommunications and information, alarm monitoring, and payphone services that the BOCs
and other incumbent local exchange carriers may provide on an integrated basis.   In the
NPRM, we tentatively concluded that our existing Part 64 cost allocation rules, developed in
our Joint Cost and Computer III proceedings, satisfy the requirements of these sections of the
Act that certain competitive telecommunications and information services not be subsidized by
subscribers to regulated telecommunications services.  We invited comment on this tentative
conclusion.  In the NPRM, we asked whether the benefits of a fundamentally different
approach to cost allocation would be outweighed by the costs that implementation of such a
change would impose.  Alternatively, we asked commenters to discuss how, if necessary, we
might adapt the existing cost allocation system to accommodate the services discussed in
section III of the NPRM.

Comments:

      49.Most parties, including several BOCs, support the Commission's tentative
conclusion that our existing Part 64 cost allocation rules generally satisfy the requirements of
the Act that certain competitive and information services not be subsidized by subscribers to
regulated telecommunications services.  In particular, Puerto Rico Telephone contends that
we need not modify our cost allocation rules because competition in the local exchange and
exchange access markets will ensure that local exchange carriers do not shift costs of
nonregulated services to regulated ratepayers.  In contrast, MCI maintains that additional
safeguards for integrated operations are necessary to protect the public interest.  Ameritech
argues that our current cost allocation rules exceed the statutory requirements of the Act.

Discussion:

      50.We developed our cost allocation rules in the Joint Cost and Computer III
Proceedings to help ensure that interstate ratepayers do not bear the costs and risks of the
telephone companies' nonregulated activities.  These rules prescribe how subject carriers
must separate the costs of activities regulated under Title II from the costs of nonregulated
activities when the nonregulated activities are performed directly by the carrier rather than
through an affiliate.  Under these rules, incumbent local exchange carriers may not apportion
the costs of nonregulated activities to regulated products and services.  We adopt our tentative
conclusion that our existing Part 64 cost allocation rules satisfy the requirements of sections
260, 271, 275, and 276 that certain competitive telecommunications and information services
not be subsidized by subscribers to regulated telecommunications services.  Incumbent local
exchange carriers have implemented internal cost allocation systems to help ensure their
compliance with these rules.  No commenter has presented a plan for redesigning these internal
systems to accommodate a fundamentally different cost allocation approach.  We discuss below
the application of our cost allocation rules to services permitted under sections 260, 271, 275,
and 276.

B.  Specific Services

     1.  Section 260 - Telemessaging Service

      51.Section 260(a)(1) provides that each "local exchange carrier subject to the
requirements of section 251(c) that provides telemessaging service . . . shall not subsidize its
telemessaging service directly or indirectly from its telephone exchange service or its exchange
access."  Section 251(c), in turn, applies to every "incumbent local exchange carrier." 
Section 260(c) defines "telemessaging service" as "voice mail and voice storage and retrieval
services, any live operator services used to record, transcribe, or relay messages (other than
telecommunications relay services), and any ancillary services offered in combination with
these services."

      52.In the NPRM, we tentatively concluded that applying our Part 64 rules to
telemessaging will safeguard against the cross-subsidies prohibited by section 260(a)(1).  We
also tentatively concluded, as we did in a companion NPRM, the BOC In-Region NPRM, that
telemessaging is an information service and that our authority under sections 271 and 272 over
interLATA information services extends to intrastate, interLATA information services
provided by BOCs or their affiliates.  Therefore, BOC provision of telemessaging service on
an interLATA basis would be subject to the separate affiliate requirements of section 272. 
We invited comment on these tentative conclusions.

Comments:

      53.In general, incumbent local exchange carriers assert that the existing Part 64
rules will effectively prevent cross-subsidization of telemessaging services.  ATSI contends
that existing rules applicable to telemessaging are not sufficient to safeguard against the
subsidies prohibited by section 260 because they fall short of equalizing cost attributions.

      54.Voice-Tel maintains that existing accounting safeguards in Parts 32 and 64
cannot ensure that telemessaging services that are marketed and provided by incumbent local
exchange carriers on an in-house basis will not be subsidized by ratepayers.  Voice-Tel
argues that because telemessaging is part of basic service offered by a local exchange carrier
and is marketed by customer service representatives at the same time that other basic service
options are presented, there are no easily identifiable separate marketing activities that can be
isolated and separately costed.  Telemessaging often uses the same facilities that are used for
other basic and optional services provided by the local exchange carrier, and the switch is not
necessarily partitioned in a manner that permits direct allocation.  Voice-Tel contends that
even if the switch can be partitioned, it is questionable whether the use of lines and trunks can
be properly allocated because most telemessaging services permit access to a mailbox by
dialing either a special number or by dialing one's own number.  In both cases, there is no
separate trunk or line cost to allocate.  Accordingly, Voice-Tel's advocates that we should
require all incumbent local exchange carriers that wish to offer telemessaging services to do so
through a separate affiliate in order to meet the goals of section 260.  

      55.MCI and Voice-Tel contend that telemessaging is an information service, and
that when a BOC provides telemessaging on an interLATA basis, it must do so in accordance
with the section 272 separate affiliate requirements.  Certain local exchange carriers argue
that section 272 only requires that interLATA information services, not intraLATA
information services such as many existing telemessaging services, be offered through a
separate affiliate.  BellSouth asserts that the requirement of a separate subsidiary for the
provision of interLATA information services facially violates incumbent local exchange
carriers' First Amendment right to freedom of speech.

Discussion:

      56.We concur with the incumbent local exchange carriers that assert that our
existing accounting safeguards will effectively prevent cross-subsidization of telemessaging
services in accordance with section 260(a)(1).  We presently classify telemessaging service as a
nonregulated activity for Title II accounting purposes.  Consequently, costs associated with
the provision of telemessaging services are already addressed by our Part 64 cost allocation
rules and, to the extent telemessaging is provided through affiliates, our affiliate transactions
rules also apply.  Our Part 64 rules require carriers to allocate a portion of their network
investment plant used to provide telemessaging services to nonregulated accounts.

      57.We find unpersuasive Voice-Tel's assertion that existing accounting safeguards
in Parts 32 and 64 cannot ensure that telemessaging services that are marketed and provided by
incumbent local exchange carriers on an in-house basis will not be subsidized by ratepayers. 
Our Part 64 cost allocation rules require local exchange carriers providing services in addition
to local exchange service to use a cost allocation methodology based on fully distributed costs
("FDC").  This methodology establishes a hierarchy of cost apportionment rules designed to
prevent cross-subsidies.  These rules are applied to costs recorded in the accounts specified in
the Uniform System of Accounts ("USOA") set out in Part 32 of our rules.  The
methodology requires carriers to assign costs directly, wherever possible, to regulated or
nonregulated activities.  If costs cannot be directly assigned, they are considered "common
costs" and must be placed in homogenous cost pools.  The carrier must then divide the costs
in each pool between regulated and nonregulated activities using formulas or factors known as
"allocators."  Depending upon the information available, carriers must apply these allocators in
the following order.  Whenever possible, common costs must be directly attributed based upon
a direct analysis of the origins of those costs.  Common costs that cannot be directly attributed
must be indirectly attributed based on an indirect, but cost-causative, linkage to another cost
pool or pools for which a direct assignment or attribution is possible.  Only if direct or
indirect attribution factors are not available may the carrier allocate a pool of common costs
using what is known as a "general allocator."  Our Part 64 cost allocation rules are designed to
prevent cross-subsidization of nonregulated activities such as telemarketing by establishing a
methodology for allocating joint and common costs such as those described by Voice-Tel
between regulated and nonregulated activities.

     58.  Our cost allocation and affiliate transactions rules have been in place for
approximately ten years.  As already observed, these rules and procedures, in combination
with audits, tariff review, and the complaint process, have proven successful at protecting
regulated ratepayers from bearing the risks and costs of incumbent local exchange carriers'
competitive ventures.  Since the inception of our Part 64 cost allocation rules, the types of
nonregulated activities have continued to grow.  The Commission designed the cost allocation
system in such a way that it can accommodate the evolving nature of nonregulated activities,
such as telemessaging services.  Thus, we conclude that our current rules protect local
exchange service subscribers from subsidizing telemessaging services that are marketed and
provided by incumbent local exchange carriers on an integrated basis.

      59.Based upon the analysis set forth in our companion item, the Non-Accounting
Safeguards Order, we adopt our tentative conclusion that telemessaging is an information
service.  We also adopt, as we do in our companion item, our tentative conclusion that BOCs
providing telemessaging services that meet the definition of interLATA information services
must comply with the section 272 separate affiliate requirements, in addition to the section 260
requirements.

      60.BellSouth has argued that requiring BOCs to provide out-of-region interLATA
information services through a section 272 separate affiliate violates the First Amendment. 
As noted above, we find that this result is required by the Act.  Although the courts have
ultimate authority to determine the constitutionality of this and other statutes, we find it
appropriate to state that we find BellSouth's argument to be without merit.  BellSouth bases
its argument on an assertion that information services are commercial speech entitled to First
Amendment protections.  We conclude, first, that with respect to certain information
services, a BOC neither provides, nor exercises editorial discretion over, the content of the
information associated with those particular services, and therefore provision of those
information services does not constitute speech subject to First Amendment protections. 
Second, to the extent that BOC provision of other interLATA information services constitutes
speech for First Amendment purposes, the section 272 separate affiliate requirement neither
prohibits the BOCs from providing such services, nor places any restrictions on the content of
the information the BOCs may provide.  Instead, the section 272 separate affiliate
requirement is a content-neutral restriction on the manner in which BOCs may provide
interLATA information services, intended by Congress to protect against improper cost
allocation and discrimination concerns.  Thus, we conclude that the separate affiliate
requirement imposed by section 272 of the Communications Act on BOC provision of
interLATA information services does not violate the First Amendment.

     2.  Section 271 - InterLATA Telecommunications Services 
     
      61.The NPRM noted that section 272(a)(2)(B) permits BOCs to provide on an
integrated basis certain regulated, interLATA telecommunications services, including out-of-
region services and certain types of incidental services.  In our Interim BOC Out-of-Region
Order, we determined that the BOCs must provide out-of-region interstate, interexchange
services (including interLATA and intraLATA services) through separate affiliates, at least on
an interim basis, in order to qualify for non-dominant regulatory treatment in the provision of
those services.  Under the Interim BOC Out-of-Region Order, however, a BOC could still
choose to provide these services on an integrated basis, subject to dominant carrier
regulation.  Accordingly, this Order addresses the cost allocation rules that should be applied
to BOCs that choose to provide certain regulated, interLATA telecommunications services,
including out-of-region services and certain types of incidental services, on an integrated basis.

     a.  Incidental InterLATA Services

      62.Section 271(h) states that "[t]he Commission shall ensure that the provision of
services authorized under [section 271(g)] by a Bell operating company or its affiliate will not
adversely affect telephone exchange service ratepayers or competition in any
telecommunications market."  In the NPRM, we sought comment on whether our present
Part 64 cost allocation rules are adequate to prevent the adverse effects proscribed by section
271(h) with respect to incidental interLATA services.  We asked commenters to describe in
detail the modifications or additions to Part 64 they believe necessary, to explain how these
modifications or additions would better enable the Commission to fulfill its obligations under
section 271(h), and to identify the category of ratepayers or markets the proposed
modifications or additions would protect.

Comments:

      63.Incumbent local exchange carriers generally assert that our current cost
allocation rules are adequate to "ensure that the provision of services authorized under [section
271(g)] by a Bell operating company or its affiliate will not adversely affect telephone
exchange service ratepayers or competition in any telecommunications market" in accordance
with section 271(h).

      64.Worldcom contends that the language of section 271(h) strongly implies that the
Commission's current cost allocation rules are not adequate to ensure that the BOC's provision
of incidental interLATA services would not adversely affect ratepayers and competitors. 
Worldcom asserts that at a minimum we should apply the same cost allocation requirements to
incidental interLATA services as are applied to other interLATA services provided by the
BOCs on an integrated basis.

Discussion:

      65.We incorporate our conclusions regarding the accounting safeguards necessary
to prevent the adverse effects proscribed by section 271(h) with respect to the integrated
provision of incidental interLATA services by the BOCs in our discussion of accounting
safeguards to be applied to BOC provision of interLATA services.  That discussion appears in
Section III.B.2.b. below.
 
     b.  Integrated Provision of InterLATA Services

      66.The NPRM tentatively concluded that we should apply our Part 64 cost
allocation rules to regulated services other than local exchange and exchange access services,
including out-of-region services and certain types of incidental services, provided by BOCs on
an integrated basis in accordance with section 272(a)(2)(B).  We invited comment on this
tentative conclusion.  We also asked whether we needed to develop different cost allocation
rules for these regulated services other than local exchange and exchange access to prevent
allocation of the costs of such regulated services to local exchange and exchange access
customers.  We suggested two possible solutions:  (1) the creation of a separate category for
Title II accounting purposes to include regulated services other than local exchange and
exchange access services, or (2) the classification of any regulated services other than local
exchange and exchange access services that are provided on an integrated basis as nonregulated
activities for Title II accounting purposes.  We invited comment on these solutions.

      67.In the NPRM, we asked whether, if incumbent local exchange carriers provide
out-of-region interstate interexchange services on an integrated basis, our accounting rules for
such incumbent local exchange carriers should be similar to those we adopt for the BOCs.

Comments:

      68.Many parties support our proposal to apply our Part 64 cost allocation rules to
regulated interLATA telecommunications services, including out-of-region services and certain
types of incidental services, that may be provided by BOCs on an integrated basis and contend
that such services should be treated like nonregulated activities for federal accounting
purposes.  In particular, TRA maintains that treating such services like nonregulated
activities for federal accounting purposes will lessen the chance that costs associated with such
services are inadvertently assigned to a local exchange or exchange access category. 
Worldcom asserts that the potential for improper cost allocation is greater between two
regulated categories than between regulated and nonregulated activities. 
 
      69.SBC argues that it would be improper to treat all incidental interLATA services
like nonregulated activities for federal accounting purposes because a number of the activities
that these incidental interLATA services support would be regulated Title II activities.  SBC
contends that the costs of such incidental services are supposed to flow through the Part 36
process to separate integrated plant serving state and interstate jurisdictions.

      70.MCI proposes that, as in the Video Dialtone Proceeding, we should create a
separate category for Title II accounting purposes to include regulated services other than local
exchange and exchange access services in order to clearly identify the allocation of costs
between a BOC's local and interLATA operations.  In contrast, the BOCs generally argue
that no separate regulated category is needed for interLATA telecommunications services
provided on an integrated basis, such as out-of-region services and certain types of incidental
services, because our current accounting safeguards rules ensure that ratepayers do not
subsidize interexchange operations.  In particular, several of the BOCs assert that Part 36
will separate the costs of these services into state and interstate portions, and Part 69 will
allocate the costs of all regulated, interLATA telecommunications services to the interexchange
basket separate from local exchange and exchange access costs.  BellSouth and PacTel argue
that there is also no need to treat these services like nonregulated activities for federal
accounting purposes because the Commission can review the costs of providing such services,
including the allocation of overhead, during the tariff review process.

      71.Several parties contend that we should require all incumbent local exchange
carriers, including non-BOCs, to treat any regulated services other than local exchange and
exchange access like nonregulated services for Title II accounting purposes to ensure the
prevention of subsidies flowing from the latter services to the former.

      72.Cincinnati Bell and USTA argue that sections 271 through 276 apply solely to
BOCs and the Commission has no authority to apply additional accounting safeguards to non-
BOC incumbent local exchange carriers.

Discussion:

      73.Section 254(k) prohibits a "telecommunications carrier" from using "services
that are not competitive to subsidize services that are subject to competition."  We conclude
that section 254(k) bars all incumbent local exchange carriers, including BOCs, from
subsidizing competitive interLATA telecommunications services, such as out-of-region
services and certain types of incidental interLATA services, with revenues from exchange
services and exchange access that are not subject to competition.  Section 271(h) specifically
requires the Commission to ensure that the provision of incidental interLATA
telecommunications services by a BOC or its affiliate "will not adversely affect telephone
exchange service ratepayers or competition in any telecommunications market." 
Accordingly, we concur with the parties that assert that our Part 64 cost allocation rules should
apply to interLATA telecommunications services, including out-of-region services and certain
types of incidental services, that may be provided by incumbent local exchange carriers on an
integrated basis.  

      74.Our Part 64 cost allocation rules require a carrier to assign costs directly,
wherever possible, to regulated or nonregulated activities.  These rules protect subscribers to
interstate exchange and exchange access services from bearing the costs and risks of the
carrier's nonregulated activities provided on an integrated basis.  These rules do not, however,
protect against improper cost allocations from one regulated activity to another regulated
activity.  Therefore, if interLATA telecommunications services, including out-of-region
services and certain types of incidental services, that may be provided by incumbent local
exchange carriers on an integrated basis, were treated as regulated for accounting purposes,
our Part 64 rules would not prevent any improper cost allocations that may occur between local
exchange and exchange access services and these interLATA telecommunication services.

      75.For these reasons, we agree with TRA, GSA and AT&T that under our current
cost allocation rules we can most efficiently and comprehensively satisfy sections 254(k) and
271(h) if, solely for federal accounting purposes, we treat like nonregulated activities both out-
of-region and certain types of incidental interLATA services that may be provided by
incumbent local exchange carriers on an integrated basis.  We believe that this should
sufficiently safeguard against cross-subsidization without imposing additional accounting
requirements on carriers.  This would parallel the approach taken in the Interim BOC Out-of-
Region Order that classified out-of-region interstate, interexchange services provided by BOC
affiliates as nonregulated activity for accounting purposes.  Because incumbent local
exchange carriers currently have internal accounting systems in place to allocate costs fairly
between nonregulated activities and regulated services provided on an integrated basis, such a
requirement will not impose extensive expense upon incumbent local exchange carriers.

      76.We agree with several of the BOCs that assert that Part 36 will jurisdictionally
separate the costs of regulated, interLATA telecommunications services into state and interstate
portions, and Part 69 will allocate the costs of all regulated interstate, interLATA
telecommunications services to the interexchange basket separate from local exchange and
exchange access costs.  We conclude, however, that the Part 36 jurisdictional separations
process and the Part 69 access charge process were not designed to prevent subsidization of
competitive telecommunications services by subscribers to exchange and exchange access
services.  Although the Part 36 and Part 69 processes produce the secondary effect of assigning
the costs of regulated interstate, interLATA telecommunications services to the interexchange
basket, classifying both out-of-region and certain types of incidental interLATA services as
nonregulated activities for federal accounting purposes will achieve greater accuracy in
safeguarding against cross-subsidization.  Classifying such services as nonregulated activities
allows the allocation of costs for these activities to occur immediately after such costs are
assigned to Part 32 accounts.  Such treatment avoids the necessary imprecisions inherent in the
Part 36 jurisdictional separations process, the Part 69 access charge process, and our Part 61
price cap rules.  Moreover, we concur with TRA that treating such services like nonregulated
activities for federal accounting purposes will lessen the chance that costs associated with such
services are inadvertently assigned to a local exchange or exchange access category. 

     c.  Other Matters

      77.Section 272(e)(3) requires that "[a] Bell operating company . . . impute to itself
(if using [exchange] access for its provision of its own services), an amount for access that is
no less than the amount charged to any unaffiliated interexchange carriers for such service." 
In the NPRM, we invited comment on how BOCs should account for these access charges. 
The NPRM suggested that one possible approach would be for BOCs to record these imputed
exchange access charges as an expense that would be directly assigned to nonregulated
activities with a credit to the regulated access revenue account.  We invited comment on this
approach as well as alternative approaches.

      78.Section 272(e)(4) states that "[a] Bell operating company and an affiliate that is
subject to the requirements of section 251(c) . . . may provide any interLATA or intraLATA
facilities or services to its interLATA affiliate if such services or facilities are made available
to all carriers at the same rates and on the same terms and conditions, and so long as the costs
are appropriately allocated."  In the NPRM, we invited comment on whether and, if so, how
the requirements of sections 272(e)(3) and (4) should affect our rules for allocating costs
between activities regulated under Title II and nonregulated activities for those BOCs that
provide interLATA services on an integrated basis.  We also requested comment on
whether, in light of section 272(e)(4), we may require BOCs that provide interLATA or
intraLATA facilities or services on an integrated basis to provide these facilities or services to
their own internal operation only at the same rates as those facilities or services are made
available to all carriers.  When those rates differ for different carriers, we sought comment on
which rate should be applicable to BOC affiliate transactions.  We also invited comment on
whether we should adopt specific accounting procedures to address the difference, if any,
between those rates and the costs that would be appropriately allocated for the underlying
facilities or services.  

Comments:

      79.AT&T and Worldcom agree with the tentative conclusion in the NPRM that
BOCs should record imputed exchange access charges as an expense that would be directly
assigned to nonregulated activities with a credit to the regulated access revenue account.  In
general, incumbent local exchange carriers disagree with the tentative conclusion stated in the
NPRM.  In particular, PacTel contends that the approach suggested in the NPRM is only
workable for structurally separate affiliates where revenues and expenses of the BOC and its
affiliate are each stated correctly for regulated reporting purposes (each entity separately
reports the results of its own operations).  US West and GSA argue that recording imputed
access charges as a nonregulated expense might result in a doubling of overhead costs allocated
to the nonregulated activity because the imputed charge would already contain an element of
overhead.

      80.Several incumbent local exchange carriers argue that we should require imputed
access charges to be recorded as debits to nonregulated revenues and credits to regulated access
charge revenues.  In general, incumbent local exchange carriers maintain that section
32.5280 of our rules defines the accounting treatment for regulated services provided on an
integrated basis: "[the nonregulated operating revenue] account shall be debited, and regulated
revenue accounts credited at tariffed rates when tariffed services are provided to nonregulated
activities."

      81.NYNEX contends that imputing exchange access charges is not necessary
because treating interexchange service as nonregulated would trigger the application of the Part
64 requirement that nonregulated services record the use of the underlying tariffed services at
tariff rates, satisfying section 272(e)(3)'s requirements and ensuring against cross-
subsidization.

      82.AT&T and Worldcom assert that we must ensure that the full access charge is
reflected in a BOC's end-user rates, and is not merely a book entry in the case of a BOC that
uses exchange access for the provision of its own services.  AT&T argues that in order to
ensure that the full access charge is reflected in a BOC's end-user rates, we should establish
price floors at a level equal to the amount of the access charge plus the incremental cost of the
non-access portions of the service.  Wisconsin PSC states that it presently makes use of price
floors such that when a carrier subject to Wisconsin PSC's regulations uses a noncompetitive
service in the provision of its own competitive service, the competitive service must be priced
to exceed total service long-run incremental cost ("TSLRIC").  Accordingly, like AT&T,
Wisconsin PSC argues that we should adopt a price floor to prevent cross-subsidization.

      83.With respect to whether the requirements in sections 272(e)(3) and (e)(4) should
affect our rules for allocating costs between activities regulated under Title II and nonregulated
activities for those BOCs that provide interLATA services on an integrated basis, SBC argues
that sections 272(e)(3) and (e)(4) relate solely to in-region interLATA services that BOCs are
required to provide through an affiliate and are not relevant to the interLATA services that the
BOCs are permitted to provide on an integrated basis. 

      84.TRA and Worldcom argue that when a BOC charges different rates to different
unaffiliated carriers for facilities or services, the BOC must impute the highest rate paid for the
same facilities or services to the BOC's integrated operations.  USTA, however, alleges that
an approach requiring the BOC's integrated operations to pay the highest rate paid for the same
facilities or services by unaffiliated carriers would unnecessarily constrain a BOC from volume
discount purchases.

      85.Bell Atlantic and US West assert that what local exchange carriers charge for
interLATA services is not an accounting issue, but rather a pricing issue and has no place in
this proceeding.

Discussion:

      86.We conclude that we should not require BOCs to record imputed exchange
access charges required under section 272(e)(3) as an expense that would be directly assigned
to nonregulated activities with a credit to the regulated access revenue account.  We conclude
that the approach suggested in the NPRM would result in an overstatement of operating
revenues.  Instead, we concur with the BOCs that the logic of section 32.5280 of our rules
provides the proper framework for recording imputed exchange access charges. 
Accordingly, to record imputed exchange access charges required under section 272(e)(3),
BOCs should debit the nonregulated operating revenue account by the amount of the imputed
exchange access charges and credit the regulated revenue account by the amount of the imputed
exchange access charges.  By requiring BOCs to account for imputed exchange access charges
in this manner, the accounting for this imputed revenue will be consistent with our current
accounting rules adopted in the Joint Cost Proceeding for imputing revenues derived from
services provided to nonregulated affiliates.

      87.Section 272(e)(3) requires a BOC to impute to itself an amount for access it
provides to its telephone exchange service "that is no less than the amount charged to any
unaffiliated interexchange carriers for such service."  Accordingly, where a BOC charges
different rates to different unaffiliated carriers for access to its telephone exchange service, the
BOC must impute to its integrated operations the highest rate paid for such access by
unaffiliated carriers.  In determining the highest rate paid by unaffiliated carriers, the BOC
may consider the comparability of the service provided.  If, for example, rates charged
unaffiliated carriers vary based on the volume purchased, the BOC may consider comparable
volume in determining the highest rate to impute to its integrated operations.  Accordingly, a
BOC's integrated operations may take advantage of the same volume discount purchases
offered to its interLATA affiliate and other unaffiliated carriers.  As for AT&T's and
Worldcom's concerns regarding the reflection of the full access charge in a BOC's end-user
rates, we agree with Bell Atlantic and US West that those concerns involve pricing issues,
rather than accounting issues, and therefore lie beyond the scope of this proceeding.

     3.  Section 275 - Alarm Monitoring Services

      88.Section 275(e) defines "alarm monitoring service" as "a service that uses a
device located at a residence, place of business, or other fixed premises (1) to receive signals
from other devices located at or about such premises regarding a possible threat at such
premises to life, safety, or property, from burglary, fire, vandalism, bodily injury, or other
emergency, and (2) to transmit a signal regarding such threat by means of transmission
facilities of a local exchange carrier or one of its affiliates to a remote monitoring center to
alert a person" about the emergency.  Section 275(a)(1) delays entry by the BOCs not
already providing alarm monitoring services until five years from the date of enactment of the
1996 Act.  If a BOC or BOC affiliate provided alarm monitoring services as of November
30, 1995, it may continue to do so, but cannot expand its alarm monitoring business by
acquiring "any equity interest in, or obtain financial control of, any unaffiliated alarm
monitoring service entity" during the five-year period after the date of enactment of the 1996
Act.

      89.Section 275(b)(2) specifies that an incumbent local exchange carrier engaged in
the provision of alarm monitoring services "not subsidize its alarm monitoring services either
directly or indirectly from telephone exchange service operations."  As with the prohibition
against subsidizing telemessaging services, this prohibition against subsidizing alarm
monitoring services specifically applies to incumbent local exchange carriers.

      90.In the NPRM, we asked whether our present Part 64 cost allocation rules are
necessary or sufficient to prevent subsidization of alarm monitoring services either directly or
indirectly from telephone exchange service operations in accordance with section 275(b)(2).

Comments:

      91.Commenters generally agree that the Commission's present Part 64 cost
allocation rules are sufficient to prevent subsidization of alarm monitoring services from
telephone exchange service operations because alarm monitoring services are presently treated
as nonregulated activities for Title II accounting purposes and the Commission's Part 64 cost
allocation rules require carriers to allocate the costs of alarm monitoring services to
nonregulated activities.  SBC believes that the language of section 275 does not require the
imposition of any accounting safeguards with respect to alarm monitoring services.

Discussion:

      92.We concur with the numerous commenters that assert that application of our
present Part 64 cost allocation rules to alarm monitoring services will adequately safeguard
against the subsidies prohibited by section 275(b)(2) because our rules require that the fully
distributed cost of providing alarm monitoring service be removed from the carrier's regulated
activities.  We presently classify alarm monitoring services as nonregulated activities for Title
II accounting purposes.  Consequently, our cost allocation rules and affiliate transaction rules
apply to alarm monitoring services.  Carriers are required to allocate a portion of their network
investment plant used to provide alarm monitoring services to these nonregulated activities. 
We already have experience with the application of our existing rules to alarm monitoring
services because some companies already provide alarm monitoring services on a nonregulated
basis.  

     4.  Section 276 - Payphone Services

      93.Section 276(a)(1) states that "any Bell operating company that provides
payphone service shall not subsidize its payphone service directly or indirectly from its
telephone exchange service operations or its exchange access operations."  This prohibition
against cross-subsidization is an integral part of the statutory plan "to promote competition
among payphone providers and promote the widespread deployment of payphone services to
the benefit of the general public."  To implement the prohibition, section 276(b)(1)(C)
directs the Commission to prescribe nonstructural safeguards for BOC payphone service that,
"at a minimum, include the nonstructural safeguards equal to those adopted in the Computer
Inquiry-III (CC Docket No. 90-623) proceeding."  In Computer III, we examined our
regulatory regime for the provision of enhanced services and replaced the Computer II
requirements with a series of nonstructural safeguards.  These safeguards included the Part 64
cost allocation rules and the affiliate transactions rules that we developed in the Joint Cost
Order.

      94.In the NPRM, we tentatively concluded that we should apply accounting
safeguards identical to those adopted in the Computer III proceedings to prevent the cross-
subsidization of payphone services by BOC telephone exchange service or exchange access
operations in accordance with sections 276(a)(1) and (b)(1)(C).  We invited comment on this
tentative conclusion.

      95.The provision of payphone service by local exchange carriers has traditionally
been treated as a regulated activity for Title II accounting purposes.  In the NPRM, we
tentatively concluded that we should reclassify payphone service as a nonregulated activity for
accounting purposes so that its costs will be separated from telephone exchange service and
exchange access operations.  Under this proposal, BOCs would classify their payphone
investment, expenses and revenues as nonregulated for Title II accounting purposes while
continuing to use the Commission's Part 32 accounts to record their payphone service
activities.  We invited comment on this tentative conclusion and asked whether this proposal
would provide nonstructural accounting safeguards equivalent to those adopted in the
Computer III proceeding and whether such changes would prevent subsidization of payphone
services by BOC telephone exchange service or exchange access operations. 

      96.Section 276 does not prescribe accounting safeguards to govern the provision of
payphone service by incumbent local exchange carriers other than the BOCs.  We also asked in
NPRM whether we should require non-BOC incumbent local exchange carriers to reclassify
their payphone service operations as a nonregulated activity for Title II accounting purposes.

Comments:

      97.In general, BOCs and interexchange carriers contend that payphone service
should be treated like a nonregulated activity for federal accounting purposes.  Several BOCs
assert that adoption of the Computer III safeguards is sufficient to prevent cross-subsidization
of payphone services.  Coalition argues that section 276(b) specifically identifies the
nonstructural safeguards in Computer III as an appropriate standard.  MCI maintains that any
new safeguards or revisions adopted pursuant to our reconsideration of Computer III on
remand should also apply to the provision of payphone service. 

      98.Worldcom, CTA and APCC argue that Computer III safeguards are insufficient
to satisfy section 276. APCC asserts that our Computer III safeguards were devised to
incorporate concerns regarding efficiency that are outside the realm of section 276.  APCC
also contends that incumbent local exchange carriers have dominated the payphone industry for
some time and their payphone operations have traditionally benefitted from cross-
subsidization.  Accordingly, APCC concludes that stronger safeguards are needed in the
payphone context.

      99.Several parties maintain that the Computer III safeguards should be applied to all
incumbent local exchange carriers providing payphone service.  APCC contends that any
proposed accounting safeguard should apply, at a minimum, to all incumbent local exchange
carriers with greater than $100 million in annual revenues, as well as local exchange carriers
serving island territories such as Puerto Rico and the Virgin Islands.

Discussion:

      100.The Commission reclassified pay telephone service as a nonregulated service in
the Pay Telephone Reclassification Order.  As a result, carriers must apportion payphone
service costs to nonregulated and common cost pools, ensuring that subscribers to interstate
exchange services and exchange access do not bear the costs and risks of the carrier's
payphone service.  Our Pay Telephone Reclassification Order also requires that BOCs and
incumbent local exchange carriers providing payphone service on an integrated basis follow the
nonstructural safeguards described in Computer III in order to provide sufficient protection
against the possibility that payphone service could be subsidized by local exchange service or
exchange access operations.  The nonstructural safeguards in Computer III include our Part
64 cost allocation rules and our Part 32 affiliate transactions rules adopted in the Joint Cost
Order.  This requirement satisfies both the prohibition against cross-subsidization in section
276(a)(1) and the requirement in section 276(b)(1)(C) that we adopt a set of nonstructural
safeguards at least equal to those adopted in Computer III.  Although Worldcom, CTA and
APCC argue that Computer III safeguards are insufficient to satisfy section 276, these parties
offer no substitute safeguards to implement the requirements of section 276.  Our experience
with accounting safeguards in Computer III has demonstrated that these safeguards can
effectively guard against the subsidization of competitive activities by regulated ratepayers,
which section 276 prohibits.  In fact, section 276(b) specifically identifies the Computer III
safeguards as the appropriate standard for nonstructural safeguards regarding payphone
service.  Accordingly, we adopt our tentative conclusion that we should apply accounting
safeguards identical to those adopted in Computer III  to BOCs and incumbent local exchange
carriers providing payphone service on an integrated basis.
                                
            IV.  SAFEGUARDS FOR SEPARATED OPERATIONS
                                
A. General

      101.Section 272(a)(2) allows BOCs to provide the following services only through a
separate subsidiary:  the sale of telecommunications equipment and manufacturing of
telecommunications equipment and customer premises equipment; origination of interLATA
telecommunications services, other than incidental, out-of-region, and previously authorized
services; and interLATA information services other than electronic publishing and alarm
monitoring services.  Section 273(d)(3) requires "any entity which certifies
telecommunications equipment or customer premises equipment manufactured by an
unaffiliated entity . . . only [to] manufacture a particular class of telecommunications
equipment or customer premises equipment for which it is undertaking or has undertaken,
during the previous eighteen months, certification activity for such class of equipment through
a separate affiliate."  Section 274(a) requires that BOCs providing electronic publishing must
do so only through a "separated affiliate" or electronic publishing joint venture.  These
requirements for "separate" or "separated" affiliates or joint ventures implicitly assume that
structural safeguards limit the carrier's ability to engage in cross-subsidization and
discrimination, and enhance the ability of the Commission or a State to detect cross-
subsidization and discrimination.

      102.In the NPRM, we tentatively concluded that, except where the Act imposes
specific additional requirements, our current affiliate transactions rules generally satisfy the
Act's requirements on safeguards to ensure that the services that section 272, 273 and 274
require BOCs to provide through a separate or "separated" affiliate are not subsidized by
subscribers to regulated telecommunications services.  We invited comment on this tentative
conclusion as well as whether the benefits of any fundamentally different approach to affiliate
transactions would be outweighed by the costs that implementation of such a system would
entail.  

      103.We also sought comment in the NPRM on whether we should modify our
affiliate transactions rules in certain respects.  In 1993, we released an Affiliate Transactions
Notice proposing certain rule changes, including changes in how subject carriers would value
for Title II accounting purposes services they provide, or receive from, nonregulated affiliates
in order to provide more complete protection against cross-subsidization.  In the NPRM, we
invited comment on whether, in implementing the Act's provisions regarding cross-
subsidization, we should amend the current affiliate transactions rules to incorporate certain of
the modifications proposed in the Affiliate Transactions Notice or any other changes.  We also
sought comment on whether the affiliate transactions rules we adopt in this proceeding should
apply to all transactions between incumbent local exchange carriers and their affiliates, or
simply to entities that engage in activities for which the Act requires the use of a separate or
separated subsidiary.

Comments:

      104.Most parties support our tentative conclusions that our current affiliate
transactions rules generally satisfy the Act's requirements except where amendments made by
the 1996 Act impose specific additional requirements.  In particular, AT&T contends that
existing accounting rules could be extended to new separated operations with a minimum of
disruption because incumbent local exchange carriers have already implemented internal
accounting systems designed to ensure compliance with the Commission's existing accounting
rules.  MCI, however, maintains that we must adopt more stringent affiliate transactions
rules to account for the increased opportunities for BOCs to enter new lines of nonregulated
businesses and for the increased incentives and opportunities for incumbent local exchange
carriers to shift costs.  Specifically, MCI argues that we should adopt a rule requiring
carriers to maintain a complete audit trail for all cost allocations and affiliate transactions.

      105.TIA sets forth three justifications for strengthening the affiliate transactions
rules in the manner described in the NPRM.  First, TIA contends that the Commission has had
almost a decade of experience with the existing affiliate transactions rules and that the
Commission found the current rules to be inadequate as far back as 1993 in its Affiliate
Transactions NPRM.  Second, TIA alleges that a number of recent State and federal audits
have indicated improper allocations of costs by the BOCs under the current rules.  Finally,
TIA contends that the removal of the MFJ's restrictions on BOC entry into competitive
markets has increased the risk of cross-subsidization.

      106.The BOCs generally oppose the modifications to the affiliate transactions rules
that we proposed in the NPRM.  They assert that any benefits of new or modified affiliate
transactions rules would be outweighed by the costs of implementing these new or modified
rules.  In particular, SBC maintains that parties advocating additional and more detailed
affiliate transactions rules have not provided sufficient justification to outweigh the increased
burden that would result.  SBC and US West contend that, if we decide to modify our
affiliate transactions rules, we should apply those modifications only to transactions involving
BOCs and their section 272 separate affiliates.  

Discussion:

      107.In the Joint Cost Order, we adopted rules to govern how costs are recorded, for
Title II accounting purposes, when a regulated carrier does business with nonregulated
affiliates.  These affiliate transactions rules were designed to protect ratepayers from
subsidizing the competitive ventures of incumbent local exchange carriers' affiliates.  The
affiliate transactions rules do not require carriers or their affiliates to charge any particular
price for assets transferred or services provided; rather, the rules require carriers to use certain
specified valuation methods in determining the amounts to record in their Part 32 accounts,
regardless of the prices charged.
     
      108.In agreement with most commenters, we adopt our tentative conclusion that,
except where the 1996 Act imposes specific additional requirements, our current affiliate
transactions rules generally satisfy the statute's requirement of safeguards to ensure that these
services are not subsidized by subscribers to regulated telecommunications services.  We
have previously concluded that these rules provide effective safeguards against cross-
subsidization.  Moreover, incumbent local exchange carriers have already implemented
internal accounting systems for affiliate transactions to help ensure compliance with these
rules.  These systems have proven generally effective and we see no reason to require a change
to a different system.
          
      109.While we decline to alter our prescribed accounting treatment of affiliate
transactions, we do adopt several of the modifications to the affiliate transactions rules initially
proposed in the NPRM.  We now have had approximately ten years experience with the cost
allocation and affiliate transactions regime created by the Joint Cost Order.  This experience
has convinced us that amending certain aspects of the affiliate transactions rules would provide
more complete protection against cross-subsidization.  We first presented in the 1993
Affiliate Transaction Notice some of the proposed modifications incorporated in our NPRM.
We discuss these modifications and present our rationale for adopting or rejecting them below. 
We note that modifications that we make to improve the affiliate transactions rules will apply
to all transactions between incumbent local exchange carriers currently subject to these rules
and their affiliates, not just to transactions between a BOC and an affiliate required under the
Act.

B.  Specific Services

     1.  Section 272 - Manufacturing and InterLATA Services

     a.  Statutory Language

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

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

Section 272(b)(2) requires each of these separate affiliates to "maintain books, records, and
accounts in the manner prescribed by the Commission which shall be separate from the books,
records, and accounts maintained by the [BOC] of which it is an affiliate."  Under section
272(b)(5), each of these separate affiliates must "conduct all transactions with the [BOC] of
which it is an affiliate on an arm's length basis with any such transactions reduced to writing
and available for public inspection."  Pursuant to section 272(c)(2), BOCs must account for
all transactions with these affiliates "in accordance with accounting principles designated or
approved by the Commission."

     b.  "Arm's Length" Requirement of Section 272(b)(5)

      111.Section 272(b)(5) requires that transactions between the BOC and its affiliates
engaged in the manufacturing activities, origination of interLATA telecommunications
services, and offering of interLATA information services described in section 272(a)(2) be
conducted on "an arm's length basis."  In the Computer II Final Decision, we required
AT&T to provide enhanced services and customer premises equipment only through a
"separate corporate entity" that would "deal with any affiliated manufacturing entity only on an
'arm's length'" basis.  We stated that "the transfer of any products" between this separate
corporate entity and "any affiliated equipment manufacturer must be done at a price that is
compensatory."  In the NPRM, we asked commenters to address whether we should adopt
requirements similar to those in the Computer II Final Decision in order to implement section
272(b)(5).  We also asked whether a requirement that all transfers of products between the
BOC and its affiliates be done at a price that is compensatory would be consistent with the
congressional intent behind section 272(b)(5).  In Computer III and the Joint Cost Proceeding,
we re-examined our regulatory regime for the provision of enhanced services and replaced the
Computer II requirements with a series of nonstructural safeguards, including affiliate
transactions rules.  In the NPRM, we invited comment on whether our affiliate transactions
rules, incorporating some of the changes proposed in the Commission's Affiliate Transactions
NPRM to provide greater protection against cross-subsidization, would be necessary or
sufficient to ensure compliance with the "arm's length" requirement of section 272(b)(5).

      112.In the NPRM, we sought comment on whether and, if so, how we should amend
our rules to address section 272(b)(5)'s requirement that all transactions be "reduced to writing
and available for public inspection."  We also asked whether Internet access to information
about these transactions would be sufficient to comply with the "public inspection" requirement
and whether we need to adopt safeguards to protect any confidential or sensitive information
contained in these publicly available documents.

      113.In the NPRM, we tentatively concluded that a "request" by an affiliate to its
BOC for telephone exchange service or exchange access constitutes a "transaction" within the
meaning of section 272(b)(5) which must be "reduced to writing and available for public
inspection."  We invited comment on this tentative conclusion and asked whether we need to
adopt safeguards to protect any confidential or sensitive information related to these types of
transactions.

Comments:

      114.The BOCs generally contend that we need not prescribe any particular
accounting methods to ensure that the "arm's length" requirement of section 272(b)(5) is
met.  In contrast, MCI argues that our existing affiliate transaction rules, without
modification, do not satisfy the "arm's length" requirement because the existing rules give the
BOCs too much latitude in valuing their affiliate transactions.  MCI and AT&T assert that
we should adopt the modifications to the existing affiliate transactions rules proposed in the
Affiliate Transactions NPRM.  TRA maintains that in order to successfully demonstrate
satisfaction of the "arm's length" requirement of section 272(b)(5), a BOC must be able to
provide evidence that the terms and conditions of its transactions with affiliates are comparable
to the terms and conditions that would have been secured from non-affiliates.  Accordingly,
TRA suggests that we should require each BOC to accumulate and retain information regarding
affiliate transactions.

      115.TIA contends that section 272(b)(5)'s requirement that affiliate transactions be
conducted on an "arm's length basis" requires that all transfers of assets or services between a
BOC and its affiliate required under section 272(a) must occur at a price that is
"compensatory."  TIA and TRA argue that the affiliate transactions rules, with the
modifications proposed in the NPRM, would help ensure that BOCs are fully compensated for
any goods or services provided to an affiliate and that BOCs pay reasonable prices for any
goods or services procured from an affiliate.  Several of the BOCs assert that because the
Commission, in its Computer III decision, retained the notion of compensatory pricing in Parts
32 and 64, existing affiliate transactions rules already ensure that such transactions are
conducted at compensatory prices.

      116.MCI argues that section 272(b)(5)'s requirement that transactions be "reduced to
writing and available for public inspection" indicates that Congress contemplated vigorous
involvement by interested third parties in deterring cross-subsidization and discriminatory
activity by BOCs.  Accordingly, MCI suggests that BOCs should be required to provide to
the Commission and make publicly available a complete list of transaction activities with their
interLATA and manufacturing affiliates on a periodic basis, at least quarterly, specifying all
contracts, arrangements, and other agreements between the BOC and its affiliates, providing a
description of the asset or service transferred, the transfer price, and the method of
valuation.

     117. The BOCs generally argue that there is no need for the Commission to amend its
rules to address section 272(b)(5)'s requirement that transactions be "reduced to writing and
available for public inspection" because the Commission's rules already require carriers to
disclose certain information regarding affiliate transactions in section V of their cost allocation
manuals.  MCI, however, asserts that the "reduced to writing and available for public
inspection" requirement of section 272(b)(5) cannot be satisfied by the Commission's existing
cost allocation manual filing requirements because the information in the BOCs' cost allocation
manuals is not sufficiently detailed.

      118.MCI and Worldcom contend that Internet access to information about
transactions between BOCs and their affiliates required under section 272(a) would be
sufficient to comply with section 272(b)(5)'s requirement that transactions be "reduced to
writing and available for public inspection."  Although US West agrees that Internet access
would meet the obligations of section 272(b)(5), US West maintains that we should not require
companies to post internal documents on the Internet because the companies could not monitor
who was inspecting the documents.  In contrast, TRA and APCC argue that, while the
Commission should encourage Internet access to information concerning affiliate transactions,
Internet access alone does not satisfy section 272(b)(5)'s "available for public inspection"
requirement because Internet access is still unavailable to many.  USTA asserts that we
should simply require that documents related to affiliate transactions be available at a location
designated by the carrier.  Several parties oppose a rule that would allow BOCs to choose a
single location where documents concerning affiliate transactions are available to the public
and contend that such a rule would severely limit a third party's ability to gain access to such
information.

      119.With regard to concerns about the protection of confidential or sensitive
information contained in any documents that BOCs make "available for public inspection" in
accordance with section 272(b)(5), APCC contends that pricing information based upon
tariffed rates, prevailing market prices, or fair market value should not involve proprietary
information.  According to APCC, only pricing based upon fully distributed costs might be
considered proprietary, and, for the sake of ensuring arm's length transactions, the
Commission should impose a heavy burden on BOCs and independent local exchange carriers
of demonstrating that such information warrants proprietary status.  TIA asserts that to the
extent that relevant documents contain proprietary information, the Commission should use
reasonable non-disclosure agreements to ensure that such information is not misused.  The
BOCs urge the Commission to adopt and apply the standards for the protection of confidential
information are contained in the Comments of the Joint Parties in response to the
Commission's Confidential Information Notice.

      120.Several interexchange carriers support our tentative conclusion that a request by
an affiliate to its BOC for telephone exchange service or exchange access constitutes a
"transaction" within the meaning of section 272(b)(5) which must be "reduced to writing and
available for public inspection."  TRA asserts that only by requiring all requests by affiliates
to their BOCs for telephone exchange service or exchange access to be available for public
inspection will the public and the Commission be able to evaluate the BOCs' compliance with
section 272(e)(1).  US West disagrees with our tentative conclusion and contends that only
once the BOC and its affiliate have agreed upon the terms and conditions for telephone
exchange and exchange access does the agreement constitute a "transaction."

Discussion:

      121.We decline to adopt Computer II type requirements in order to implement
section 272(b)(5).  We agree with several of the BOCs that because our Computer III decision
retained the concept of compensatory pricing in Parts 32 and 64, our existing affiliate
transactions rules already ensure that affiliate transactions are conducted at compensatory
prices.  We conclude that our affiliate transactions rules, developed in Computer III and the
Joint Cost Proceeding, with some of the changes proposed in the Commission's Affiliate
Transactions NPRM, will ensure compliance with the "arm's length" requirement of section
272(b)(5).  We discuss the requirements of these rules in section IV.B.1.b.ii. below.  

      122.To satisfy section 272(b)(5)'s requirement that transactions between section 272
affiliates and the BOC of which they are an affiliate be "reduced to writing and available for
public inspection," we require the separate affiliate, at a minimum, to provide a detailed
written description of the asset or service transferred and the terms and conditions of the
transaction on the Internet within 10 days of the transaction through the company's home page. 
The broad access of the Internet will increase the availability and accessibility of this
information to interested parties, while imposing a minimal burden on the BOCs.  We require
that the description of the asset or service and the terms and conditions of the transaction
should be sufficiently detailed to allow us to evaluate compliance with our accounting rules. 
This information must also be made available for public inspection at the principal place of
business of the BOC.  The information made available at the principal place of business of
the BOC must include a certification statement identical to the certification statement currently
required to be included with all Automated Reporting and Management Information System
("ARMIS") reports.  Such certification statement declares that an officer of the BOC has
examined the submission and that to the best of the officer's knowledge all statements of fact
contained in the submission are true and the submission is an accurate statement of the affairs
of the BOC for the relevant period.  Information contained in a BOC's cost allocation
manual is not sufficiently detailed to satisfy section 272(b) because the BOC's cost allocation
manual contains only a general description of the asset or service and does not describe all of
the terms and conditions of each transaction.  While section 272(b)(5) requires BOCs to reduce
their transactions to writing and make them "available for public inspection," we will continue
to protect the confidential information of BOCs, as well as other incumbent local exchange
carriers.

      123.We recognize a need to clarify how the requirements of section 273(e)(5) relate
to the full scope of a BOC's reporting obligations under section 272(b)(5) of the Act.  Section
273(e)(5)'s general mandate that BOCs "shall protect the proprietary information submitted for
procurement decisions from release not specifically authorized by the owner of such
information" neither curtails nor obviates section 272(b)(5)'s requirement that transactions
between BOCs and their manufacturing affiliates be reduced to writing and made available for
public inspection.  Section 273(e)(5) addresses a BOC's duties solely with regard to
submissions for procurement decisions, either by an affiliate or a third party.  Only after a
BOC consummates a transaction with a manufacturing affiliate would the reporting
requirements of section 272(b)(5) trigger.  Transactions between BOCs and third parties are
not subject to the reporting requirements of section 272(b)(5).  Section 272(b)(5)'s requirement
that BOCs reduce their transactions with manufacturing affiliates to writing and make them
available for public inspection permits the Commission and competitors to ensure that the
BOCs are complying with the nondiscrimination and accounting safeguards of the Act.

      124.We decline to adopt our tentative conclusion that a "request" by an affiliate to
its BOC for telephone exchange service or exchange access constitutes a "transaction" within
the meaning of section 272(b)(5) which must be "reduced to writing and available for public
inspection."  We note, however, that once the BOC and its affiliate have agreed upon the
terms and conditions for telephone exchange and exchange access such agreement would
constitute a "transaction."  For clarification, we also find that agreements between a BOC
and its affiliate for the provision of unbundled elements and facilities pursuant to explicit terms
and conditions also constitutes a "transaction."

     i.  Prevailing Company Prices

      125.In the NPRM, we asked whether affiliate transactions conducted "on an arm's
length basis" would necessarily entail the same marketing efforts and transactional costs as
transactions with non-affiliates.  We also solicited comment on the impact that any
differences in marketing efforts and transactional costs might have in accurately valuing
affiliate transactions and how such differences should affect our use of the prevailing price
method to record affiliate transactions between the BOCs and their affiliates engaged in
activities described in section 272(a)(2).

      126.We also sought comment on whether we should eliminate the use of the
prevailing price method as a valuation method for recording affiliate transactions between the
BOCs and their affiliates engaged in activities described in section 272(a)(2).  The prevailing
price describes the price at which a company offers an asset or service to the general public. 
A carrier subject to our current affiliate transactions rules records non-tariffed assets or
services at their prevailing prices if such prices exist.  Prevailing price currently represents one
component in the hierarchy of methods for valuing transactions between a carrier and its
affiliate.  A carrier subject to our current affiliate transactions rules uses one of the following
methods to value asset transfers for regulated accounts:  (1) tariffed rates, (2) prevailing
company prices, (3) net book cost, or (4) estimated fair market value.  These valuation
methods apply when the carrier is either the purchaser or seller of the asset according to the
following set of rules.  First, carriers must record each asset transferred to an affiliate pursuant
to tariff at the tariffed rate.  Second, if no tariff exists and an affiliate that transfers or sells an
asset to its regulated carrier also sells the same kind of asset to third parties at a generally
available price, then the carrier must record the asset sale or transfer at that prevailing
company price.  Non-tariffed assets that are sold or transferred by the carrier to its affiliates
and are sold to third parties at a generally available price, must also be recorded by the carrier
at that price.  Third, all other asset transfers must be recorded at the higher of net book cost
and estimated fair market value when the carrier is the seller, and at the lower of net book cost
and estimated fair market value when the carrier is the buyer (i.e., from the affiliate).  The
United States Court of Appeals for the District of Columbia Circuit affirmed the valuation
methods for asset transfers, finding them "reasonably designed to prevent systematic abuse of
ratepayers."

      127.In comparison to our method for valuing asset transfers, carriers must record
transactions involving services in their Part 32 accounts according to one of three valuation
methods:  (1) tariffed rates,  (2) prevailing company prices, or (3) fully distributed cost. 
These valuation methods are applied when the carrier is either the purchaser or seller of the
service according to the following set of rules.  First, carriers must record services provided to
an affiliate pursuant to tariff at the tariffed rate.  Second, if no tariff exists and a carrier
transfers or sells a service to its regulated affiliate that it also provides to third parties, the
carrier must record the transaction at the prevailing company price.  Non-tariffed services that
are sold or transferred by an affiliate to its regulated carrier and are also sold to third parties at
a generally available price, must also be recorded by the carrier at that price.  Third, all other
services provided to affiliates must be recorded at the service provider's fully distributed
costs.

Comments:

     128.  TRA argues that a company transacting business with its affiliate will benefit
from lower or non-existent marketing costs because the company is already known to the
affiliate, thereby minimizing transactional costs during affiliate transactions.  Therefore,
according to TRA, if a BOC is permitted to use prevailing price to value a transaction with its
affiliate, both parties will be able to transfer all avoided marketing and transactional costs to
their advantage.  Several other parties, including PacTel and Sprint, contend that the idea
that an entity operating in a highly competitive market does not need to devote the same
amount of effort and resources to win business from its affiliates as it does from non-affiliates
is incorrect.  In particular, Sprint maintains that "in a competitive market with a variety of
suppliers offering a plethora of price and service options, an entity has to work just as hard to
sell to its affiliates as it does to non-affiliates.  Otherwise, its affiliates will look to other
suppliers."  

      129.Several parties support the Commission's proposal to eliminate the use of the
prevailing price method to record affiliate transactions between the BOCs and their affiliates
engaged in the activities described in section 272(a)(2).  These parties contend that the
Commission's present prevailing price method is difficult to apply and affords carriers too
much discretion.  A number of other parties, including the BOCs, AT&T and Sprint, argue
against the Commission's proposal to eliminate the prevailing price method.  Puerto Rico
Telephone, in particular, maintains that the importance of using prevailing prices will increase
in the future as interconnection agreements are established and tariffs are eliminated.  APCC
argues that the prevailing price method is more objective than fair market value or fully
distributed costs.  SBC and US West argue that if we eliminated the prevailing price method,
BOCs would be required to conduct fully distributed costs studies of their affiliate transactions
even if all of the products and services involved in the transaction are available to third parties
at a prevailing price.  BellSouth contends that the elimination of the prevailing price
valuation method would impose significant administrative costs and burdens on the BOCs with
virtually no additional protection for customers.

      130.AT&T recognizes the difficulties in determining prevailing price; AT&T,
however, maintains that rather than eliminating prevailing price, the Commission should
modify its rules so that prevailing price is only available if the affiliate sells a substantial
percentage by quantity of that product line to nonaffiliated customers.  TIA contends that the
Commission should adopt a rule that allows a carrier to value affiliate transactions at prevailing
price only when the affiliate can demonstrate that it has made substantial sales of the same
product to third parties.  Sprint argues that sales to third parties cannot reliably be used to
establish prevailing price when an affiliate operates in a non-competitive market or a market
where there are few third-party transactions.  In addition, TRA argues that if the percentage
of third-party business is small, there will be little assurance that an affiliate transaction would
truly be conducted at arm's length.

      131.NYNEX contends that the adoption of a clear definition of what constitutes
prevailing price would clarify our rules and establish consistency.  In particular, NYNEX
argues that if the Commission should determine that some baseline percentage of third-party
sales is necessary to establish prevailing price, then the Commission should adopt a baseline
percentage much less than the 75 percent figure proposed in the Commission's Affiliate
Transactions Notice.  MCI maintains that the prevailing price method is particularly difficult
to apply because of the difficulties in determining whether a substantial portion of an affiliate's
production is being provided to third parties.  MCI argues that in order to correct such
difficulties, the Commission would need to apply any baseline percentage necessary to
establish prevailing price on a product-by-product basis.

Discussion:

      132.We find unpersuasive TRA's argument that a company transacting business with
its affiliate will significantly benefit from lower or non-existent marketing costs because the
company is already known to the affiliate.  In competitive markets, companies devote
significant resources to attracting and retaining customers through sales presentations,
advertising campaigns, volume purchase discounts, or long-term commitments.  In addition,
any potential benefits to a carrier in transacting business with its affiliate are diminished to
some extent by the system and transaction costs incurred in complying with our affiliate
transactions rules.  Accordingly, we conclude that any differences in marketing efforts and
transactional costs that might exist are not significant and should not affect our use of the
prevailing price method to record affiliate transactions.

      133.We decline to adopt our proposal to eliminate prevailing price as a valuation
method under our affiliate transactions rules.  Initially, we selected prevailing price as a
valuation method because we believed that those prices would provide a reliable measure of
fair market value.  Our experience in auditing carriers' application of the prevailing price
method to determine how inter-affiliate transfers of services should be recorded has revealed
difficulties in determining what is necessary to establish a prevailing price.  Rather than
rejecting prevailing price valuation, however, we conclude that these difficulties are best
addressed by modification and clarification of the prevailing price valuation method.

      134.One of the difficulties we have identified with respect to prevailing price
valuation has been determining when carriers should apply the prevailing price method to
transfers of particular assets or services.  The mere offering of an asset or service to
unaffiliated entities is not sufficient to establish a prevailing price.  A substantial quantity of
business must be conducted with unaffiliated third parties in order to establish a true prevailing
price.  Specifically, if the percentage of third-party business is small, there can be no
assurance that the price agreed upon by the carrier and its affiliate represents the true market
price, thus raising legitimate questions as to whether the parties actually negotiated "on an
arm's length basis."  In such situations, the use of prevailing prices to value transactions
could permit an affiliate to charge inflated prices to its affiliated regulated carrier, possibly
leading to higher prices for customers purchasing the regulated services.

      135.Our previous rules did not clarify the meaning of a "substantial" amount of
third-party business for the purpose of establishing a true prevailing price.  We agree with
MCI that without clarification of the meaning of "substantial" in this context, the retention of
the prevailing price method places a difficult burden on the Commission in verifying
compliance with the affiliate transactions rules.  Accordingly, we find that a clear definition
of what constitutes prevailing price is necessary to clarify our affiliate transactions rules and
establish consistency.  We conclude that annual sales, as measured by quantity, of greater
than 50 percent of a particular product or service to third parties must occur to satisfy the
requirement that there be a "substantial" amount of outside business in order to produce a true
prevailing price for that particular product or service.  We find that third-party sales of 50
percent or less are evidence of the fact that a party's primary function is to provide products or
services to affiliates, rather than to outside market participants, and, consequently, those sales
to unaffiliated entities are not sufficient to establish a true prevailing price.  We note that our
modifications here to clarify the prevailing price method apply to all assets and services
transactions governed by our affiliate transactions rules.

      136.We conclude that the 50 percent threshold established in this Order must be
applied on a product-by-product and service-by-service basis, rather than on a product-line or
service-line basis.  Application of the 50 percent threshold on a product-line or service-line
basis would give carriers the incentive to define product lines and service lines as broadly as
possible in order to be able to value as many transactions as possible at prevailing price. 
Additionally, if the 50 percent threshold were applied to a product line or service line, then
products or services that are sold to third parties in quantities of 50 percent or less could be
grouped in the same line with different products or services that are sold primarily to third
parties, qualifying the entire line of products for prevailing price valuation.  Such grouping
would allow products or services for which no true prevailing price exists to be valued by a
carrier at a fabricated prevailing price to the harm of ratepayers if the cost or market value of
such products or services is actually different from this fabricated prevailing price.  Moreover,
verifying that product lines and service lines have been properly defined would place a
significant burden on the Commission.

      137.We do allow one exception to our rule that only a product or service for which
annual sales to third parties, measured by quantity sold, exceed 50 percent of total sales of that
product or service may be recorded by carriers at prevailing price.  Section 272 requires BOCs
to charge their section 272 affiliates the same rates as unaffiliated third parties for facilities,
services, and information.  Because the rates for services subject to section 272 must be
made generally available to both affiliates and third parties, we adopt a rebuttable presumption
that these rates represent prevailing company prices.  Accordingly, products and services
subject to section 272 need not meet the 50 percent threshold in order for a BOC to record the
transaction involving such products and services at prevailing price.

     ii.  Valuation Methods for Assets and Services.
     
      138.In the Joint Cost Order, we did not prescribe uniform valuation methods for all
affiliate transactions.  The Part 64 cost allocation rules direct subject carriers to use different
methods to value transfers of assets and transfers of services.  In the NPRM, we proposed to
direct carriers to apply the valuation method currently prescribed for asset transfers to service
transfers.  The NPRM did propose, however, to continue to define the cost of asset transfers
in terms of net book cost and the cost of service transfers in terms of fully distributed costs. 
We sought comment on whether these proposed modifications to the affiliate transactions rules
would meet the objectives of section 272 better than the existing rules.  We asked commenters
to discuss whether, and under what circumstances, we should allow carriers and their affiliates
to use any alternative valuation methods.  We also sought comment on how the elimination of a
sharing obligation from our price cap rules would affect the validity of our tentative conclusion
in the Affiliate Transactions NPRM that our treatment of the provision of services that are
neither tariffed nor subject to prevailing company prices may reward a carrier's imprudent acts
of buying services from affiliates for more than, and selling services to affiliates for less than,
fair market value.

      139.Section 272(e)(3) requires that "[a] Bell operating company and an affiliate that
is subject to the requirements of section 251(c) . . . shall charge the affiliate described in
subsection (a) or impute to itself (if using the access for its provision of its own services), an
amount for access that is no less than the amount charged to any unaffiliated interexchange
carriers for such service."  Section 272(e)(4) states that "[a] Bell operating company and an
affiliate that is subject to the requirements of section 251(c) . . . may provide any interLATA
or intraLATA facilities or services to its interLATA affiliate if such services or facilities are
made available to all carriers at the same rates and on the same terms and conditions, and so
long as the costs are appropriately allocated."  We also sought comment on how these
requirements should affect our rules for implementing the "arm's length" requirement of
section 272(b)(5).  In addition, we invited comment on whether we should adopt specific
accounting procedures to address the difference, if any, between the rates charged by BOCs
when they provide interLATA or intraLATA facilities or services on a separated basis and "the
costs [that would be] appropriately allocated" for the underlying facilities or services.

Comments:

      140.Many commenters, including AT&T, Wisconsin PSC and GSA, support the
Commission's proposal to conform the valuation methods under the affiliate transactions rules
governing service transfers and asset transfers.  Several of these commenters argue that the
current valuation method for services does not adequately ensure compliance with section
272(b)(5)'s "arm's length" requirement because it rewards a carrier for buying services from
affiliates at more than, and selling them to affiliates for less than, fair market value.  AT&T
further contends that our current valuation rules, by allowing a carrier to sell services for less
than fair market value, would allow carriers to violate section 254(k)'s prohibition against
cross-subsidizing competitive operations. 

      141.The BOCs and Sprint oppose the Commission's proposed change to the affiliate
transactions rules.  They argue that any attempt to establish fair market value for services
would prove inherently subjective.  USTA and several BOCs note that in our reconsideration
of the Joint Cost Order, we rejected a similar proposal to utilize estimates of fair market value
for the transfer of services, stating that "such a valuation standard is fraught with potential for
abuse, and would be difficult to monitor."  PacTel argues that section 272(e)(2)'s
nondiscrimination requirement has eliminated any potential for harm.  PacTel further
contends that the Commission should not require fair market valuation for governance
functions provided to carriers by their regional holding companies.  BellSouth contends that
application of the "asset transfer rules" to transactions involving services will require the BOCs
and their affiliates to incur hundreds of millions of dollars in increased annual administrative
cost.

     142. APCC argues that the Commission should adopt a rule that requires carriers to
value services at the lower of fully distributed costs and estimated fair market value when it is
the purchaser with a price ceiling set at prevailing price.  APCC contends that prevailing
price serves as a check to ensure that the carrier has not overstated the price determined using
the lower of fully distributed costs and estimated fair market value, preventing an affiliate from
charging its affiliated carrier more than a competitor.  APCC similarly argues that the
Commission should set a price floor at prevailing price when the carrier is the seller.

      143.AT&T argues that with regard to the requirements of section 272(e)(3), the
BOC must charge its affiliate, at a minimum, the tariffed rate for access services.  AT&T
maintains that the Commission should require a BOC's interLATA affiliate to reflect these
access charges in end-user rates, at least as long as the BOC retains dominance in the provision
of exchange access services.  AT&T asserts that the Commission should impose price floors
for interLATA services at a level equal to a BOC's access charges plus the incremental cost of
the non-access portions of the service to ensure an affiliate's imputation of access charges.

Discussion:

      144.In the Joint Cost Proceeding, we considered identical valuation methods for
assets and services.  These methods would have required carriers to record all affiliate
transactions that are neither tariffed nor subject to prevailing company prices at the higher of
cost and estimated fair market value when it is the seller, and at the lower of cost and estimated
fair market value when the carrier is the purchaser.  As USTA and several BOCs point out,
however, the Joint Cost Order ultimately did not prescribe uniform valuation methods for all
affiliate transactions.  In the case of services, the Joint Cost Order requires carriers to record
all non-tariffed services other than those having prevailing company prices at the providers'
fully distributed costs while all nontariffed assets other than those having prevailing company
prices must be recorded at the higher of cost and estimated fair market value when it is the
seller, and at the lower of cost and estimated fair market value when the carrier is the
purchaser.

      145.The Commission based its decision not to apply the asset transfer rules to
services on commenters' suggestions that those rules would reduce or eliminate "the incentive
for certain service activities to be provided in a more efficient manner than that which the
regulated entity would alone achieve."  Since the adoption of the affiliate transactions rules,
we have adopted price cap regulation that gives the largest incumbent local exchange carriers
efficiency incentives far stronger than those the valuation methods for affiliate services sought
to preserve.  These changes in regulation have caused us to re-evaluate the effect of our
valuation methods for affiliate services on carrier incentives.  That re-evaluation makes clear
that our current treatment of services that are neither tariffed nor subject to prevailing company
prices made generally available may in fact reward a carrier that acts imprudently when
buying services from affiliates for more than, and selling services to affiliates for less than, fair
market value.  Our current valuation rules require a carrier to record services sold to
nonregulated affiliates at the carrier's fully distributed cost.  These rules apply even when the
carrier's fully distributed cost for the service is less than the fair market value of that service. 
Under these circumstances, our current valuation rules result in a smaller profit for the carrier
in a service transaction with its nonregulated affiliate than would a similar transaction with a
third party for the same service.  Our current valuation rules also require a carrier to record
services purchased from a nonregulated affiliate at the affiliate's fully distributed cost.  These
rules apply even when the affiliate's fully distributed cost for the service is greater than the fair
market value of that service.  Accordingly, our current valuation rules may entice a carrier to
pay its nonregulated affiliate more for a service than the carrier would pay a third party for the
same service.  In either set of circumstances, ratepayers may be harmed if the carrier's
smaller profits or increased costs as a result of our services valuation rules are reflected in
rates for regulated telecommunications services.  Ratepayers and service providers not
affiliated with carriers may also be harmed if the valuation methods for affiliate transactions
induce carriers and their affiliates to "use services that are not competitive to subsidize services
that are subject to competition," thereby putting service providers not affiliated with the
carrier at a competitive disadvantage.
     
      146.We believe that requiring carriers to use the same valuation methods for both
services and asset transfers would also reduce the incentive to record an affiliate transaction as
a service transfer, rather than an asset transfer, especially in the context of procurement
activities.  Under our current rules for recording transfers of services, carriers may record
services sold to their affiliates at cost even if the fair market value of such services is actually
much higher, allowing the carrier's affiliates to take advantage of services at below market
costs to the detriment of the carrier's ratepayers.  With respect to the sale of assets, however,
carriers must record the sale at the higher of cost or fair market value.  Our current rules also
allow carriers to record services purchased from their affiliated carriers at cost even if the fair
market value of such services is actually much lower, allowing the carrier's affiliates to receive
the benefit of higher than market value sales to the detriment of the carrier's ratepayers.  In the
case of the purchase of an asset, however, carriers must record the purchase at the lower of
cost or fair market value.  Requiring a carrier to value transfers of services using the same
valuation methods currently used for asset transfers would reduce the carrier's ability to value
a transfer so that a carrier can pass on to their affiliates any financial advantages flowing from
how they choose to characterize the transaction.   
     
      147.Because of the concerns identified in the preceding paragraph, we believe that
the current rules regarding the valuation of affiliate services may not be consistent with the
requirement of section 272(b)(5) that transactions be conducted "on an arm's length basis." 
The rule we adopt above--requiring carriers to record all affiliate transactions that are neither
tariffed nor subject to prevailing company prices at the higher of cost and estimated fair market
value when the carrier is the seller or transferor, and at the lower of cost and estimated fair
market value when the carrier is the buyer or transferee--appears more likely to ensure that the
transactions between carriers and their nonregulated affiliates take place on an "arm's length"
basis, guarding against cross-subsidization of competitive services by subscribers to regulated
telecommunication services.  This rule will conform the valuation methods under the affiliate
transactions rules for the provision of services to those methods we currently use to value asset
transfers.  We continue, however, to define the cost of asset transfers in terms of net book cost
and the cost of service transfers in terms of fully distributed costs because the net book cost of
an asset is comparable to the fully distributed cost of a service.

      148.We do allow one exception to our rule conforming the valuation methods under
the affiliate transactions rules for the provision of services to those methods we currently use to
value asset transfers.  Under the rule adopted in this Order, when a carrier purchases from its
affiliate services that are neither tariffed nor subject to prevailing company prices and such
affiliate exists solely to provide services to members of the carrier's corporate family, the
carrier would be required to value the transaction at the lower of fair market value and fully
distributed cost.  Under our existing valuation rules, however, such service transactions would
simply be valued at fully distributed cost because insufficient third-party sales exist to
substantiate a prevailing price for these services that are often tailored to the corporate family's
unique needs.  We conclude that these transactions where a carrier purchases from its affiliate
services that are neither tariffed nor subject to prevailing company prices and such affiliate
exists solely to provide services to members of the carrier's corporate family should continue
to be valued at fully distributed cost.  We find that when an affiliate is established to provide
services solely to the carrier's corporate family in an effort to take advantage of economies of
scale and scope, the benefits of such economies of scale and scope are reflected in such
affiliate's costs and are ultimately transferred to ratepayers through transactions with the
carrier for such services valued at fully distributed costs.  Requiring carriers to perform fair
market valuations for such transactions would increase the cost to ratepayers while providing
limited benefit.
 
     iii.  Fair Market Value 

      149.In the NPRM, we proposed to require carriers to make good faith determinations
of fair market value, rather than specifying methodologies that carriers must follow to estimate
fair market value, where such a valuation is required under the affiliate transactions rules. 
We invited comment on this proposal.  We sought comment on whether we should set criteria
for determining what constitutes a good faith estimate of market value.  We also asked
whether we should require carriers to support their valuations by reasonable and appropriate
methods in situations involving transactions that are not easily valued.

Comments:

      150.Several State PUCs and TIA favor the adoption of the proposed good faith
requirement on estimates of fair market value.  Most interexchange carriers, however,
oppose its adoption.  MCI argues that adoption of the proposed good faith requirement
would make it easier for the BOCs to shift costs.  Worldcom contends that the Commission
should establish a uniform set of requirements for fair market value to apply to all the BOCs. 
AT&T argues that, at a minimum, the Commission should apply the criteria discussed in the
NPRM.  AT&T further asserts that the Commission should require a carrier that applies fair
market valuation to a transaction to retain records documenting the methodology used in a
form that would enable third parties to reproduce the analysis in the context of an audit or
investigation.  TRA maintains that because transactions between a carrier and its affiliate do
not involve a "willing" buyer and seller, the Commission should establish specific criteria to
determine fair market value.  TRA asserts that the Commission should not allow carriers to
use alternative valuation methods without obtaining a waiver from the Commission based on a
clear demonstration of the alternative method's accuracy.  
      151.GTE contends that purchases by unaffiliated companies provide an excellent
benchmark because unaffiliated purchasers have no reason to pay unreasonably high prices. 
In particular, GTE argues that if sales to unaffiliated companies of a product at a particular
price generate large revenues then this is "strong evidence" that the price is "a valid price in
market terms."   

      152.While most of their objections appear to relate to the use of fair market value if
the use of prevailing price is eliminated, USTA and several BOCs argue against a good faith
requirement because of the difficulties in determining fair market value.  US West contends
that there is no need to impose a good faith requirement on carriers.

Discussion:

      153.We find that the procedures carriers use in estimating fair market value should
vary with the circumstances of each transaction.  We consequently conclude that we should not
specify the methodologies that carriers must follow to estimate fair market value where such a
valuation method is required under the affiliate transactions rules.  While many commenters
attack the use of fair market value generally in the affiliate transactions rules, we find that no
commenters have provided a sufficient reason why, having determined that fair market value
should be used, we should not impose a good faith requirement.  We believe that allowing
carriers to make good faith determinations of fair market value, rather than prescribing specific
methodologies, will provide them with the flexibility to use a methodology appropriate for the
circumstances of the transaction.  We find that the good faith requirement will help ensure that
transactions involving a BOC and its section 272 affiliate satisfy the "arm's length"
requirement of section 272.  We therefore adopt our proposal to require carriers to make
good faith determinations of fair market value for purposes of our affiliate transactions rules. 
We further conclude that we should impose a good faith requirement on all affiliate
transactions between an incumbent local exchange carrier currently subject to our affiliate
transactions rules and any of its affiliates, not just to affiliate transactions involving the
activities described in section 272(a).

      154.While we decline to specify the methodologies that carriers must follow to
estimate fair market value, we do set the baseline for a good faith determination of fair market
value by requiring carriers to use methods that are routinely used by the general business
community.  For example, when carriers can estimate the market value of transactions using
independent valuation methods, carriers should apply such methods to ascertain fair market
value.  Depending on the type of transaction, examples of methods for determining fair market
values for both assets and services include appraisals, catalogs listing similar items,
competitive bids, replacement cost of an asset, and net realizable value of an asset.  We agree
with GTE that sales to third parties can provide a benchmark and we conclude that if sales to
third parties of a product at a particular price generate large revenues then the sale price is
strong evidence of a good faith estimate of fair market value.  When situations arise involving
transactions that are not easily valued by independent means, we require carriers to maintain
records sufficient to support their value determination.  Specifically, the valuation method
chosen by the carrier must succeed in capturing the available supporting information regarding
the transaction and must utilize generally accepted techniques and principles regarding the
particular type of transaction at issue.  We note that nothing discussed here exempts carriers
from their statutory obligation under section 220(c) to justify their accounting entries.

     iv.  Tariffed-based Valuation

      155.Under section 252, incumbent local exchange carriers may submit agreements
adopted by negotiations or arbitration to State commissions for approval or rejection without
filing a tariff.  Alternatively, they may file statements of generally available terms pursuant
to section 252(f) that state terms on which these incumbent local exchange carriers would
provide services to all customers who desire them.  In the NPRM, we sought comment on
whether, and to what extent, our affiliate transactions rules should be amended to substitute
rates appearing in such publicly filed agreements and statements for tariffed rates.  We also
sought comment on whether such amendments would be consistent with, or required by,
sections 272(e)(3) and 272(e)(4).

Comments:

      156.Most BOCs argue that the Commission should amend its affiliate transactions
rules to allow them to use rates appearing in publicly filed agreements submitted to a State
commission pursuant to section 252(e) or statements of generally available terms pursuant to
section 252(f) in the place of tariffed rates.  NYNEX contends that such rates reflect "arm's
length" transactions.  PacTel argues that because such rates will be subject to review by
State regulators similar to tariff review, such rates provide the same protection against cross-
subsidization.  Ameritech and USTA, however, argue that the Commission need not amend
the affiliate transactions rules in this instance because under the current rules, BOCs must
value transactions at either the prevailing price or cost, which would include rates filed in
interconnection and collocation agreements.  SBC and TRA maintain that the Commission
should allow BOCs to use terms contained in negotiated or arbitrated interconnection
agreements or statements of generally available terms and conditions only to the extent a tariff
is not available.

      157.Worldcom argues that amending the affiliate transactions rules to substitute rates
appearing in such publicly filed agreements and statements for tariffed rates would be
premature because the Commission has not yet proposed to eliminate the tariff requirements
for BOCs' local exchange and exchange access services.  AT&T contends that such an
amendment to the Commission's rules is unnecessary.  AT&T argues that section 272(b)(1)'s
requirement that an affiliate operate independently from the BOC of which it is an affiliate
prohibits any integration of exchange and interexchange facilities, including the purchase of
interconnection and collocation services and network elements.  AT&T maintains that the
Commission should prohibit BOC affiliates from offering any exchange service, except
through total service resale at tariffed rates, and should require them to obtain all transmission
capacity from the BOC pursuant to tariff as was the case under Computer II.

Discussion:

      158.We concur with the majority of BOCs that we should amend our affiliate
transactions rules to allow incumbent local exchange carriers to use charges appearing in
publicly-filed agreements submitted to a State commission pursuant to section 252(e) or
statements of generally available terms pursuant to section 252(f) in the place of tariffed rates
when tariffed rates are not available.  Because charges appearing in such publicly-filed
agreements and statements are subject to State review, we find it unlikely that allowing
incumbent local exchange carriers and their affiliates to record non-tariffed transactions using
such rates when available would lead to the subsidization of competitive services by
subscribers to regulated telecommunications services.  Because carriers must comply with the
cross-subsidization prohibitions of the Act regardless of what accounting rules we or the States
adopt, neither a carrier nor its affiliate may use a charge appearing in publicly-filed agreements
or statements of generally available terms if the use of such charge would violate the Act.  We
do not believe that the fact we have not yet eliminated the tariff requirements for a BOC's local
exchange and exchange access services forecloses us from establishing accounting safeguards
now in anticipation of changes in the telecommunications market permitted by Section 252.

      159. We do not read section 272(b)(1)'s requirement that a BOC affiliate "operate
independently" from the BOC so broadly, as AT&T suggests, that it prohibits all integration of
exchange and interexchange facilities, including the purchase of interconnection and
collocation services and network elements by such an affiliate.  We conclude that section
272(b)(1) does not prohibit BOC affiliates from receiving the same rates that any unrelated
party could receive through publicly-filed agreements submitted to a State commission pursuant
to section 252(e) or statements of generally available terms pursuant to section 252(f) instead
of a tariffed rate. 

     v.  Return Component for Allowable Costs

      160.In the Joint Cost Proceeding, the Commission determined that fully distributed
costs should include a return on investment, but no "profit" in excess of the return then
prescribed for the carrier's interstate regulated activities.  Consequently, carriers that utilize
fully distributed cost to value affiliate transactions include in their cost computations a
component for rate of return.  In the NPRM, we proposed that all carriers providing services
subject to section 272 should use a uniform rate of return to determine the fully distributed
costs associated with affiliate transactions.  The Commission has prescribed a unitary,
overall rate of return for those incumbent local exchange carriers still subject to rate-of-return
regulation to use in computing interstate revenue requirements, unless a carrier can show that
such use would be confiscatory.  The current prescribed rate of return on interstate services
is 11.25 percent.  We sought comment on our proposal.

Comments:

      161.Most commenters that address this issue argue that the Commission should
require the BOCs to use the prescribed interstate rate of return for valuing transactions with
their affiliates engaged in activities permitted under section 272.  PacTel and SBC contend
that the prescribed interstate rate of return is consistent with the return on investment that a
BOC could anticipate if it were to use its investment to provide services to third parties. 
TRA argues that allowing carriers to select their own rate of return, instead of using the
prescribed interstate rate of return, would run counter to the Commission's efforts to promote
arm's length transactions and would unduly burden the Commission with numerous rate-of-
return prescription proceedings.

      162.US West, however, disagrees.  US West argues that the Commission should
permit any BOC to determine the return component included in its cost computations for
valuing affiliate transactions using a composite of the prescribed interstate rate of return and
the intrastate rates of return prescribed or authorized for that carrier.  US West contends that
this approach would recognize that transactions between a BOC and its affiliate benefit both the
interstate and intrastate services that a BOC provides to third parties.  USTA argues that the
current rules are adequate because they permit a BOC to utilize a rate of return that is
"appropriate for affiliate transactions" and require the carrier to reference that rate of return, if
different from the prescribed interstate rate of return, in its cost allocation manual.

      163.MCI argues that the Commission should set the uniform rate of return for
determining the fully distributed costs associated with affiliate transactions involving the
services permitted by section 272 at 10.25 percent, the lowest point of the range that the
Commission allows under its price cap plan.  MCI maintains that an affiliate relationship
reduces a supplier's business risks and therefore lowers the necessary return.  NYNEX
argues that the Commission should reject MCI's suggestion.  NYNEX contends that the fact
that a price cap carrier subject to sharing/low-end adjustments can seek a low-end adjustment if
its interstate earnings fall below 10.25 percent does not provide a basis to establish 10.25
percent as a reasonable return component.  NYNEX notes that many carriers are not subject
to sharing/low-end adjustments.  Finally, NYNEX argues that determination of business
risk, cost of capital and rate of return for particular nonregulated affiliates would be extremely
complicated.

Discussion:

      164.When an incumbent local exchange carrier provides services or assets to an
affiliate, or an affiliate provides services or assets to an incumbent local exchange carrier,
where the transferred goods or services are not provided pursuant to tariff or eligible for
prevailing price valuation (i.e. substantial amount of the transferred goods or services are not
provided to unaffiliated third parties), the transactions typically do not involve the risk inherent
in providing services or assets in a competitive market.  This is because any investment
required to provide the service or asset will not be subject to competitive pressure from
alternative suppliers.  The cost of capital to be imputed in such transactions should meet two
criterion: one, it should impute a reasonable rate of return, and two, it should be uniform for
all carriers and transactions.  The latter criteria, uniformity, avoids the unduly burdensome
calculation of a rate of return and time-consuming carrier-specific rate of return prescription. 

      165.We conclude that a reasonable rate of return to be used by all incumbent local
exchange carriers in determining the fully distributed costs associated with affiliate transactions
is the rate of return on interstate services, as amended periodically by the Commission.  In
establishing the prescribed interstate rate of return, the Commission considered the cost of
capital to provide interstate access services and prescribed a rate of return of 11.25% for the
local exchange carriers.  The Commission concluded that this rate of return for the regulated
activities of local exchange carriers would maintain the carriers' financial integrity and enable
them to attract new capital necessary to serve the public.  The Commission followed the
Supreme Court's holding in FPC v. Hope Natural Gas Co. that the rate prescribed should be
"commensurate with returns on investments in other enterprises having corresponding risks." 
In concluding that the prescribed interstate rate of return is a reasonable rate of return to be
used in affiliate transactions, we agree with PacTel and SBC that the prescribed interstate rate
of return is consistent with the return on investment that an incumbent local exchange carrier
could anticipate if it were to use its investment to provide services to third parties.  We also
disagree with the approach of US West to use a blended rate of return for interstate and
intrastate services because there are states that no longer prescribe a rate of return for intrastate
services.  The approach of US West and that of USTA also would not allow the application of
 a uniform or easily determinable rate of return.

      166.In the Interconnection Order, we concluded that "the currently authorized rate
of return at the federal or state level is a reasonable starting point . . . and incumbent [local
exchange carriers] bear the burden of demonstrating with specificity that the business risks that
they face in providing unbundled network elements and interconnection services would justify
a different risk-adjusted cost of capital."  We similarly conclude that for all affiliate
transactions, incumbent local exchange carriers bear the burden of demonstrating with
specificity that the business risks that they face in providing services to their affiliates would
justify a risk-based adjustment to the cost of capital that would result in a rate of return
different than 11.25%.  We note, however, that we apply the prescribed rate of return on
interstate services to affiliate transactions solely to determine the fully distributed costs
associated with such transactions for accounting purposes and not to determine the prices
charged for these services.

     c.  Accounting Requirements of Sections 272(b)(2) and (c)(2)

      167.Section 272(b)(2) requires the separate affiliates prescribed under section
272(a)(2) to "maintain books, records, and accounts in the manner prescribed by the
Commission which shall be separate from the books, records, and accounts maintained by the
[BOC] of which it is an affiliate."  In the NPRM, we asked what steps the Commission
should take in order to implement this requirement and, in particular, whether we should
mandate that separate affiliates required under section 272(a)(2) maintain their books, records,
and accounts in accordance with generally accepted accounting principles ("GAAP") or
whether it is necessary for the Commission to adopt any additional accounting, bookkeeping or
record-keeping requirements for affiliates prescribed under 272(a)(2).

Comments:

      168.Most parties, including several BOCs, argue that at most we should require
separate affiliates under section 272(a)(2) to maintain their books, records, and accounts in
accordance with GAAP.  TRA contends that GAAP will ensure that costs are based upon
reliable data and will create a more uniform audit trail with minimal cost and without a drastic
restructuring of carriers' accounting systems.  US West maintains that GAAP is a reasonable
requirement because it is widely employed and commonly understood.

      169.AT&T and MCI argue that all BOC affiliates except non-carrier affiliates should
maintain their books pursuant to the Commission's Uniform System of Accounts.  In
particular, MCI contends that standardization of Part 32 accounting between a BOC and its in-
region interLATA affiliate will enable the Commission to make earnings comparisons and
comparisons of investment and expenses that are critical to the Commission's ability to identify
instances where a BOC is possibly subsidizing an interLATA affiliate.    Worldcom
maintains that we should require all BOC affiliates to maintain books in conformance with Part
32's Uniform System of Accounts to facilitate auditing.

Discussion:

      170.We conclude that the separate affiliates prescribed under section 272(a)(2) must
maintain their books, records, and accounts in accordance with GAAP.  We concur with TRA
that a requirement that these affiliates maintain their books, records, and accounts in
accordance with GAAP will result in a uniform audit trail at minimal cost.  Moreover, a
requirement of GAAP for separate affiliates required under section 272(a)(2) imposes some
degree of uniformity upon these affiliates.  We are not persuaded by parties' comments,
however, that we should impose Part 32 accounting systems on BOC affiliates in order to
facilitate auditing.  We currently do not impose Part 32 accounting on the interexchange
telecommunications affiliates of non-BOC incumbent local exchange carriers.  Moreover,
BOCs are currently required to clearly and completely document the manner in which
affiliates' accounting systems flow into the BOCs' Part 32 accounts.  Accordingly, we find no
reason to impose the additional burden of requiring separate affiliates required under Section
272(a)(2) to maintain their books, records, and accounts in accordance with the Part 32
Uniform System of Accounts.
     
     d.  Application to InterLATA Telecommunications Affiliates

      171.Our existing affiliate transactions rules are designed solely for transactions
between regulated carriers and their nonregulated affiliates.  InterLATA telecommunications
services, however, are subject to Title II of the Act, and, absent a Commission determination
to the contrary, the affiliates that offer those services would classify interLATA
telecommunications services as "regulated" for Title II accounting purposes.  In the NPRM, we
tentatively concluded that we should apply our affiliate transactions rules to transactions
between each BOC and any regulated interLATA telecommunications affiliate it establishes
under section 272(a).  We invited comment on this tentative conclusion and asked how we
would need to modify our affiliate transactions rules if applied to such transactions.

      172.Section 272 does not prohibit a BOC from providing more than one
nonregulated service (e.g., manufacturing and an interLATA information service) through the
same affiliate.  It also does not prohibit an affiliate that provides regulated services such as
interLATA telecommunications services, from engaging in other activities not regulated under
Title II.  In the NPRM, we sought comment on whether, in this context, we should apply our
cost allocation rules to prevent subsidization of nonregulated activities by subscribers to
interLATA telecommunications services, and whether section 254(k) authorizes such an
application of our cost allocation rules.

Comments:

      173.Most commenters addressing this issue argue that the Commission should treat
interLATA telecommunications services, such as in-region interLATA services, like a
nonregulated activity for accounting purposes.  As a result, these commenters maintain that
the existing affiliate transactions rules will prevent subsidization between local exchange and
exchange access services and these interLATA telecommunications services.

      174.BellSouth, however, opposes application of the affiliate transactions rules to
transactions between a BOC and its affiliate established under section 272(a).  BellSouth
contends that there is no need to apply these rules because both the BOC and the new
interLATA telecommunications affiliate are subject to Title II of the Act and, therefore, must
establish just, reasonable and nondiscriminatory rates.  In addition, BellSouth argues that,
because the separate affiliate requirement of section 272 sunsets after three years, the costs
incurred to create internal accounting and tracking systems to comply with the affiliate
transactions rules would increase administrative costs with no corresponding benefit.

      175.Worldcom and MCI argue that the Commission should apply its cost allocation
rules to prevent subsidization of nonregulated activities by interLATA services.  USTA and
all of the BOCs that address this issue, however, oppose the application of cost allocation rules
to prevent subsidization of nonregulated activities by subscribers to interLATA
telecommunications services.  They contend that BOC affiliates have no incentive to
subsidize nonregulated activities by subscribers to interLATA telecommunications services
because both services are competitive.  Bell Atlantic further argues that the Commission has
no authority to regulate transactions within or among affiliates.

Discussion:

      176.Section 272(b)(5) requires BOC affiliates established under section 272(a), such
as an affiliate providing in-region services, to "conduct all transactions with the Bell operating
company of which it is an affiliate on an arm's length basis."  Our existing affiliate
transactions rules are designed solely for transactions between regulated carriers and their
nonregulated affiliates.  These rules therefore do not currently protect against a flow of
subsidies from a BOC's exchange services and exchange access to its affiliate providing
regulated interLATA telecommunications services, such as in-region services.  We conclude
that under the current affiliate transactions rules, we can satisfy section 272(b)(5)'s "arm's
length" requirement by treating interLATA telecommunications services like a nonregulated
activity strictly for accounting purposes.  We therefore adopt our tentative conclusion that we
should apply our affiliate transactions rules to transactions between each BOC and any
interLATA telecommunications affiliate it establishes under section 272(a), such as an affiliate
providing in-region services, and order that the BOCs treat such services like nonregulated
activities for accounting purposes.  

      177.We find unpersuasive BellSouth's assertion that there is no need to apply our
affiliate transactions rules to transactions between each BOC and any interLATA
telecommunications affiliate it establishes under section 272(a), such as an affiliate providing
in-region services.  Despite BellSouth's assertion that interLATA telecommunications affiliates
established under section 272 are subject to Title II of the Act and, therefore, must establish
just, reasonable and nondiscriminatory rates, we believe we should apply our affiliate
transactions rules, as modified in this Order, to satisfy our obligation to ensure that all
transactions between BOCs and their section 272 affiliates are conducted at "arm's length." 
Moreover, we disagree with BellSouth's contention that the administrative costs of imposing
our affiliate transactions rules outweigh the corresponding benefit.  To the greatest extent
possible, we have relied upon our existing affiliate transactions rules to minimize the
administrative burden associated with the implementation of a new system of accounting
safeguards.    
     
      178.When a BOC affiliate provides both regulated Title II services permitted under
sections 271 and 272, such as interLATA telecommunications services, and nonregulated
activities, such as interLATA information services, we conclude that we need not apply our
cost allocation rules to prevent subsidization of nonregulated activities by subscribers to these
interLATA telecommunications services.  We agree with those commenters that argue that
market forces leave BOC affiliates with little ability to subsidize nonregulated activities by
interLATA telecommunications services.

     e.  Application to Sharing of Services

      179.In the NPRM, we tentatively concluded that if our companion Non-Accounting
Safeguards Order were to conclude that an affiliate may share marketing personnel with a BOC
then we should apply our cost allocation and affiliate transactions rules, as we proposed to
modify them in our NPRM, to the BOC's Part 32 accounts to govern any joint marketing of
interLATA and local exchange services.  We invited comment on whether any additional
accounting safeguards may be necessary.

Comments:

      180.MCI, NYNEX, Worldcom and TRA argue that if the BOC In-Region Order
concludes that an affiliate may share marketing personnel with a BOC, the Commission's cost
allocation and affiliate transactions rules must apply to the joint marketing of interLATA and
local exchange services.  MCI contends that the BOCs' cost allocation manuals must specify
how they plan to estimate the fair market value of the marketing services they provide to their
interLATA affiliates. 

      181.Washington maintains that the Commission should require that the affiliate
employ and pay for the shared marketing personnel with the costs allocated to the BOC based
on time reporting and other auditable documentation.  USTA and several BOCs argue that
the Commission need not impose any additional safeguards when a separate affiliate subject to
the requirements of section 272(b)(3) shares in-house or outside services with a BOC. 
USTA contends that although section 272 prohibits the BOCs and their affiliates from sharing
employees, nothing in the language of that section prohibits a BOC and its affiliate from
entering into "arm's length" transactions that allow the affiliate to purchase administrative
functions from the BOC.

Discussion:

      182.Our Non-Accounting Safeguards Order concludes that BOCs are permitted to
share in-house services other than operating, installation, and maintenance services with their
section 272 affiliates if the agreement to share in-house services complies with the
requirements of section 272, including section 272(b)(1)'s "operate independently"
requirement, section 272(b)(3)'s "separate officers, directors, and employees" requirement,
section 272(b)(5)'s "arm's length" requirement, and section 272(c)(1)'s nondiscrimination
requirements.  Earlier in this Order, we determined that our affiliate transactions rules
should apply to transactions between BOCs and their section 272 affiliates in order to satisfy
section 272(b)(5)'s "arm's length" requirement.  We conclude, therefore, that our affiliate
transactions rules apply to transactions between BOCs and their section 272 affiliates for the
sharing of in-house services, including joint marketing services.  Moreover, the sharing of in-
house services by a BOC and its section 272 affiliate constitutes a "transaction" within the
meaning of section 272(b)(5) that must be "reduced to writing and available for public
inspection."   

      183. Our Non-Accounting Safeguards Order further concludes that section 272(b)(3)
does not preclude an affiliate of the BOC, such as a services affiliate, or the parent company of
both the BOC and its section 272 affiliate from performing functions for both the BOC and its
section 272 affiliate.  Our affiliate transactions rules apply to transactions between the BOC
and a nonregulated affiliate of the BOC, such as a services affiliate, and to transactions
between the BOC and its parent company.  Under the principle of "chain transactions," our
affiliate transactions rules also apply to any transactions between the section 272 affiliate and a
nonregulated affiliate of the BOC, such as a services affiliate, that ultimately result in an asset
or service being provided to the BOC. 

     f.  Audit Requirements

      184.Section 272(d) requires that a company required to operate a separate subsidiary
under section 272 "shall obtain and pay for a joint federal/State audit every two years
conducted by an independent auditor to determine whether such company has complied with
this section and the regulations promulgated under this section, and particularly whether such
company has complied with the separate accounting requirements under [section 272(b)]."   

      185.In the NPRM, we tentatively concluded that the independent auditor's report
required under section 272(d) should be filed with the Commission and each relevant State
commission and should include a discussion of:  (1) the scope of the work conducted, including
a description of how the affiliate's or joint venture's books were examined and the extent of the
examination;  (2) the auditor's conclusion on whether the examination of the books has
revealed compliance or non-compliance with the affiliate transactions rules and any non-
discrimination requirements in the Commission rules;  (3) any limitations imposed on the
auditor in the course of its review by the affiliate or joint venture or other circumstances that
might affect the auditor's opinion; and (4) a statement by the auditor that the carrier's cost
allocation methodologies conform to the Act and the Commission's rules and that the carrier
has accurately applied the methodologies described in those rules.  We invited comment on
this tentative conclusion.  We also asked whether the independent auditor's report should
address the carrier's compliance with sections 272(e)(3) and 272(e)(4). 

Comments:

      186.With respect to the form and content of the audit report, TRA and TIA support
the Commission's conclusion regarding the information that should be provided in the
independent auditor's report required by section 272(d).  In contrast, Ameritech, Kiesling,
US West, and USTA contend that the independent auditor, in conformance with professional
standards, should determine the content and report format.  BellSouth and PacTel state that
the Commission should not adopt its proposal to require a statement by the auditor that the
carrier's cost allocation methodologies conform to the Act.  BellSouth contends that this
requirement is redundant in light of the Commission's proposal that the auditor include a
conclusion as to whether examination of the books has revealed compliance with the affiliate
transactions rules and any nondiscrimination requirements.  PacTel argues that this
requirement exceeds what Congress intended, compelling a broader and more costly audit than
required by the plain language of section 272(d).

      187.Worldcom, Missouri PSC and CTA state that the audit report should address
whether the carrier has complied with sections 272(e)(3) and 272(e)(4).  Worldcom further
argues that the independent audit required by section 272(d) should include a detailed
examination of the BOCs' methods of access imputation.  TRA recommends that the
Commission require the audit to include a "positive opinion" concerning the carrier's
obligation to charge its affiliate or impute to itself an amount for access no less than that
charged to an unaffiliated carrier, the carrier's obligation to provide facilities and services to
affiliates at the same rates and on the same terms as all other carriers, and the carrier's
obligation to allocate all costs in accordance with Commission rules.

      188.The commenters also addressed other aspects of the joint federal/State audit
required under section 272(d).  Regarding the timing of the audit, MCI, AT&T and NARUC
maintain that the Commission should not wait two years to initiate the first audit of BOC
compliance with section 272.  NARUC states that an audit should be performed and
submitted for the first full year of operations after the new subsidiary begins to provide
services.  AT&T and CTA contend that the Commission should time the first audit so that
one additional audit can be performed before section 272's provisions sunset under section
272(g).  AT&T and MCI further argue that the Commission should require an annual
audit.  They maintain that while section 272(d) requires an audit every two years, nothing
precludes the Commission from exercising its general authority with regard to accounting
matters to require annual audits.  Several BOCs argue that the most logical reading of
section 272 is that the first audit should not occur until two years after a BOC's section 272
affiliate commences operation.  They contend that a Commission requirement of an annual
audit would directly conflict with the congressional mandate in section 272.
 
      189.With respect to coverage of the audit, MCI and NARUC maintain that audits
should be required of all affiliates whose activities involve or whose revenues are derived from
the services specified in section 272, including resale.  MCI and NARUC recommend that
one audit be submitted for each of the three services required by section 272 and that each
audit cover the last two years of operations.  

      190.Regarding access to audit workpapers, PacTel and US West urge the
Commission to state that workpapers, including material obtained from the examined entities,
will receive confidential treatment consistent with section 220(f) and the Commission's policy
for Part 64 audits.   Ameritech and USTA, however, contend that section 272(d)'s
requirements on access to documents, as well as scope and distribution, are clearly articulated
and require no further specification by the Commission.  MCI and NARUC maintain that
access should be given to all working papers with no restriction or time limit placed upon
access to data from prior years. NARUC indicates that any State commission having access
to the audit workpapers should have provisions in place to ensure the protection of proprietary
information as required by section 272(d)(3)(C).   NYDPS contends that federal and State
regulators should have access to the auditor's workplan and correspondence with the BOC and
should be able to attend meetings between the auditor and the BOC where audit procedures and
findings are discussed.  APCC disagrees that access to auditors' workpapers should be
limited only to State utility commissions, the Commission, and any joint audit team formed. 
APCC argues that access should be provided to any interested party so that such parties can
challenge the audit results.  

      191.To facilitate the biennial audit, AT&T states that the Commission should require
all BOC affiliates to make available to the public on a quarterly basis financial reports, an
income statement, a balance sheet, and a statement of cash flows.

      192.Regarding the relation of the biennial audit to the cost allocation manual audit
under Part 64, MCI, NYNEX and TIA state that the Commission should clarify that the audit
specified in section 272(d) supplements the annual audit required by section 64.904 of the
Commission's rules.  To the extent that these audits overlap, PacTel contends that the
Commission should permit the audit required by section 272(d) to meet the requirement of the
section 64.904 annual audit.  Ameritech, BellSouth and US West argue that the Commission
should conduct the section 64.904 audit in alternate years from the audit required by section
272(d).  Ameritech further maintains that each audit should cover only the most recent fiscal
period.

      193.A number of parties offered recommendations in their comments, replies, and ex
parte presentations regarding the audit process and the manner in which the Commission,
States and the particular BOC should participate in the audit process.  NYDPS recommends
that the BOC, the Commission and the State affected by the audit should jointly select the
auditor. NYNEX states that each carrier subject to a section 272 audit should have the
opportunity to participate in the formulation of the audit to ensure its fairness.  

      194.In its comments, NARUC proposed that the Commission adopt specific audit
guidelines for the federal/State joint participation in the audit process.  These guidelines
would require that a separate federal/State joint audit team be established to oversee the audit
process as it relates to compliance with section 272.  The NARUC guidelines would establish
procedures for selecting the independent auditor through a competitive bidding process using
Requests for Proposals ("RFP").  The RFP would address audit purpose and scope, auditor
selection criteria, project controls, audit report content, and protection of proprietary data. 
The federal/State joint audit team would develop a set of standards or objectives that every
audit must meet.  These standards or objectives also would be incorporated into the RFP.  

      195.The NARUC guidelines would require that a staff member of the federal/State
joint audit team follow the progress of the audit and determine whether deadlines and
objectives are being met.  Upon completion of the audit, the NARUC guidelines would require
that the federal/State joint audit team verify that the audit program objectives have been met
and determine whether it is necessary for the independent auditor to perform additional audit
work.

      196.Several State public service commissions recommended that the Commission
adopt the proposals advanced by NARUC.  USTA and several BOCs, however, argue that
the NARUC proposals far exceed the statutory requirements of the Act, and that the
Commission should therefore reject them.  US West specifically objects to NARUC's
proposal to require incumbent local exchange carriers to use an RFP process to select an
independent auditor.  US West claims that the premise behind NARUC's RFP proposal is
apparently that an independent auditor can only be "independent" if selected through a
competitive bidding process.  US West disagrees, stating that independence is one of the
central tenets of the public accounting profession.  US West also opposes NARUC's
proposal to permit the federal/State audit team to participate in developing the audit program
and in determining the scope of the audit.  US West argues that this proposal could
unnecessarily interfere with the independent auditor's professional responsibility under General
Accepted Auditing Standards.

Discussion:

      197.We conclude that some of the recommendations in the NARUC comments
should be adopted.  The purpose of the required audits is to determine whether the BOCs and
their separate subsidiaries are complying with the accounting and structural safeguards
required by section 272 and to report the audit results to the Commission and the state
regulatory agencies.  To obtain a fair assessment of BOC compliance, we must ensure adequate
oversight.  From our experience with the cost allocation manual audits under Part 64, we have
learned that Commission guidance of the audit process is crucial to assuring that the accounting
and structural safeguards are in place and functioning properly.  Because of the critical nature
of accounting safeguards in promoting competition in the telecommunication marketplace and
the critical role the biennial audit will play in ensuring that the safeguards are working, it is
essential that we establish effective biennial audit rules at the outset.  We conclude that the
Commission and the States need to oversee the scope, terms and conditions of the biennial
audit.  Without such oversight, it would be uncertain whether the audits will achieve their
primary objective of ensuring that the carriers have, in fact, complied with section 272 of the
Act and our rules.  

      198.We therefore adopt the NARUC recommendations with certain modifications. 
Under the rules we now adopt, we delegate authority to the Chief, Common Carrier Bureau to
form a federal/State joint audit team with the States having jurisdiction over a BOC's local
exchange service.  This joint audit team will review the conduct of the audit and direct the
independent auditor to take such action as the team finds necessary to ensure compliance with
the audit requirements.  The new rules require that the structural and transactional
requirements and the nondiscrimination safeguards set forth in sections 272(b) 272(c) and
272(e) be subject to audits.  The rules, however, do not require the BOCs to choose the
independent auditor through a competitive bidding process using a request for proposals as
NARUC recommends.  The rules preclude the BOCs from hiring independent auditors who
have participated during the two years preceding the biennial audit in designing any of the
systems under review in the audit.  As with the cost allocation manual audits, we conclude that
the independent auditor who designs a system should not be the one to certify that it is
operating properly.

      199.The rules set an orderly schedule for conducting the audit and for submitting the
audit report to the Commission and the States as well as to interested parties for comment. 
The rules call for participation and agreement by the BOC and by the federal/State joint audit
team in defining the scope and purpose of the audit prior to its commencement.  The rules
also allow the federal/State joint audit team to review and, if necessary, direct modifications to
the design of the independent auditor's audit program.  Allowing the federal/State joint audit
team to participate in this manner at the beginning of the audit is consistent with section 272,
because the audit is being conducted to satisfy the Commission and the State public service
commissions that the prescribed nonstructural and accounting safeguards have been
implemented and are working.  Early input from federal/State joint audit team will ensure that
the needs of the Commission and the States will be met.   

      200.The rules prescribe a number of deadlines that parties must meet to avoid
prolonged delays in the audit's completion.  The final audit report must include:  (1) the
findings and conclusions of the independent auditor; (2) exceptions of the federal/State joint
audit team to the auditor's findings and conclusions; (3) response of the BOC to the auditor's
findings and conclusions, and (4) reply of the independent auditor to both the exceptions of the
federal/State joint audit team and the response of the BOC.  Because the final audit report will
become a single source for the audit findings and any exceptions or comments regarding them,
interested parties wishing to comment on a particular audit could obtain this information
without difficulty.      

      201.With one exception, discussed below, we have decided to adopt our tentative
conclusion regarding the form and content of the auditor's section of the report.  We disagree
with the parties that contend that we should permit independent auditors to select the content
and format of the audit reports.  By prescribing a specific report format, we will ensure the
consistency and adequacy of all such audit reports.  Therefore, in our rules governing the
biennial audits required by section 272(d), we will require that the independent auditor's
section of the audit report include a discussion of:  (1) the scope of the work conducted, with a
description of how the affiliate's or joint venture's books were examined and the extent of the
examination;  (2) the auditor's findings and conclusions on whether examination of the books,
records and operations has revealed compliance or non-compliance with section 272 and with
the affiliate transactions rules and any applicable nondiscrimination requirements; and (3) a
description of any limitations imposed on the auditor in the course of its review by the affiliate
or joint venture or other circumstances that might affect the auditor's opinion. 

      202. We do not require a statement by the auditor that the carrier's cost allocation
methodologies conform to the Act.  The carrier's conformance is already reviewed in our cost
allocation manual audits under Part 64.  Biennial audits review subsidiaries' transactions with
the BOCs to which our affiliate transactions rules apply.  Based on the reasoning presented in
comments filed by CTA, Missouri PSC and Worldcom, we will require that the auditor's
section of the report address whether the carrier has complied with sections 272(e)(3) and
272(e)(4).  These sections contain provisions that are intended to deter cross-subsidization by
the BOCs and, thus, we must know whether the BOCs are complying with them.  It is not
necessary, however, to adopt TRA's recommendation and require a separate "positive opinion"
concerning carrier compliance with sections 272(e)(3) and 272(e)(4) because we are including
these requirements as part of the biennial audit.

      203. We agree with MCI, AT&T and NARUC that we should not wait two years to
require the first audit of BOC compliance with section 272 and we adopt NARUC's suggestion
to require the audit to begin at the close of the first full year of operations.  We agree with
these commenters that nothing in the Act compels us to wait two years after the subsidiary is
formed and offering service to begin the audit.  The next audit will begin two years later and
will cover the operations of the previous two years.  This schedule should assure an
operational period with adequate information and data to audit.  Moreover, such a schedule
will allow at least one, and possibly two, audits before the sunset provision of section 272(f) is
considered.  We will also require that each BOC obtain one audit that covers all affiliates
engaged in services specified in section 272(a)(2), including resale, rather than requiring
individual audits for each of these services.  We believe that one audit of such affiliates should
provide the same degree of assurance as could be derived from audits of individual services
and has the advantage of providing a comprehensive overview.  We do not order an annual
audit under our general accounting powers as suggested by AT&T and CTA, because there is
no indication that the two-year requirement in the Act will not be sufficient. 

      204.Workpapers related to the biennial audits, including material obtained from the
examined entities, will receive confidential treatment consistent with section 220(f) and the
Commission's policy for Part 64 audits.  We believe that the requirements in section
272(d)(3) regarding access by the Commission and State commissions to audit workpapers and
documents, are clearly articulated and require no further specification by the Commission at
this time.  As suggested by MCI and NARUC, we interpret these provisions to require access
by the Commission and States to all working papers with no restriction or time limit placed
upon access to prior years' papers.  Any State commission having access to the audit
workpapers should have provisions in place to ensure the protection of proprietary information
as required by section 272(d)(3)(C).  Without such provisions in place, a State commission
could neither be represented on the federal/State joint audit team nor participate in the biennial
audit.  Section 272(d)(3) limits access to audit workpapers and documents under section to
representatives of the Commission and of the State public utility commissions.  We will not
extend this access to other parties as suggested by APCC.  This is clearly beyond the scope
of section 272(d).  We have already addressed NYDPS's contention that federal and State
regulators should have access to the auditor's workplan and correspondence with the BOC and
should be able to attend meetings between the auditor and the BOC where audit procedures and
findings are discussed.
 
      205.We agree with the commenters that suggest that, to the extent the biennial audit
and the cost allocation manual audit under Part 64 overlap, we should permit the biennial audit
to meet the requirement of the section 64.904 annual audit.  This requirement will meet our
needs and reduce audit costs for the companies.  For a biennial audit to satisfy any part of a
cost allocation manual audit, we will require a statement by the auditor that the carrier's cost
allocation methodologies conform to the Act.  We also note that, unlike the biennial audits, the
cost allocation manual audits under Part 64 do not involve State participation.  Thus, by
relying on the biennial audit, we will allow State participation in the overlapping areas of the
audits.  In their cost allocation manual audit workpapers, the independent auditors should
include copies of the audit work performed under the biennial audit.
  
      2.  Section 273 - Manufacturing by Certifying Entities

     a.  Statutory Language

      206.Section 273(d) requires entities that certify telecommunications or customer
premises equipment to maintain separate affiliates in order to engage in certain types of
manufacturing activities.  Under section 273(d)(3), when such an entity certifies
telecommunications equipment or customer premises equipment manufactured by an
unaffiliated entity, the certifying entity "shall only manufacture a particular class of
telecommunications equipment or customer premises equipment for which it is undertaking or
has undertaken, during the previous eighteen months, certification activity . . . through a
separate affiliate."  "[N]otwithstanding [section 273(d)(3)]," section 273(d)(1)(B) prohibits
"Bell Communications Research, Inc., or any successor entity or affiliate" from "engag[ing] in
manufacturing telecommunications equipment or customer premises equipment as long as it is
an affiliate of more than 1 otherwise unaffiliated [BOC] or successor or assign of any such
company."

      207.Section 273(d)(3)(B) requires the separate affiliate to "maintain books, records,
and accounts separate from those of the entity that certifies such equipment, consistent with
generally acceptable accounting principles[,]" and to "have segregated facilities and separate
employees" from the certifying entity.  Section 273(g) permits "[t]he Commission [to]
prescribe such additional rules and regulations as the Commission determines necessary to
carry out the provisions of this section, and otherwise to prevent discrimination and cross-
subsidization in a [BOC's] dealings with its affiliates and with third parties."

     b.  Comparison of Sections 273 and 272

      208.Both sections 272 and 273 require the use of a separate affiliate to engage in
different specified activities.  In the NPRM, we asked whether section 273's different statutory
language requires or permits different accounting treatment for standard-setting organizations
and their manufacturing affiliates from that required or permitted for BOCs under section
272.  We also asked whether we should apply our affiliate transactions rules, as we proposed
to modify them, to transactions between all certifying entities, whether regulated carriers or
not, and the affiliates they must maintain under section 273(d).

      209.In the NPRM, we tentatively concluded that application of our affiliate
transactions rules, as we proposed to modify them, would be sufficient to satisfy section
273(g)'s requirement that the Commission "prescribe such additional rules and regulations as
the Commission determines necessary . . . to prevent subsidization in a [BOC's] dealings with
its affiliates and with third parties."  We invited comment on this tentative conclusion.

Comments:

      210.Several local exchange carriers argue that the affiliate transactions rules should
not be modified to govern transactions between a certifying entity and its affiliate if that
certifying entity is not also a regulated carrier.  In particular, these local exchange carriers
argue that it is not within the Commission's authority under the Act to impose regulations on
nonregulated affiliates. Ameritech contends that the provisions of section 273(d)(3)(B) that
require compliance with GAAP are sufficient and affiliate transactions rules need not be
applied to certifying entities and their manufacturing affiliates.  Ameritech and USTA
contend that to the extent our affiliate transactions rules are considered necessary, these rules
satisfy the requirements of section 273(g).

      211.TIA argues that the Commission's affiliate transactions rules must be applied, in
particular, to transactions between Bellcore and any manufacturing affiliate that it may create
in order to prevent cross-subsidization because Bellcore is currently owned by the seven
regional BOCs and may remain affiliated with regulated carriers even after it is permitted to
manufacture pursuant to section 273.  On the other hand, Bellcore argues that its accounting
system already provides the protection required by section 273.

Discussion:

      212.We conclude that our affiliate transactions rules, as modified here, satisfy
section 273(g)'s requirement that we "prescribe such additional rules and regulations as [we]
determine are necessary to . . . prevent . . . cross-subsidization in a [BOC's] dealings with its
affiliate."  Elsewhere in this Order, we concluded that BOCs are subject to the modified
affiliate transactions rules in their dealings with their affiliates engaged in activities permitted
under section 272(a), including manufacturing affiliates, in order to assure compliance with the
"arm's length" requirement of section 272(b)(5).  Accordingly, BOCs that perform
certification activities are already subject to the affiliate transactions rules in dealings with their
manufacturing affiliates under section 272(b)(5) and current conditions do not warrant
additional rules to satisfy section 273(g).  In addition, under the principle of "chaining," as
long as a certifying entity, such as Bellcore, remains affiliated with a regulated BOC, our
affiliate transactions rules apply to any transactions between that certifying entity and its
section 273 separated, nonregulated manufacturing affiliate that ultimately result in an asset or
service being provided to the BOC.   

     3.  Section 274 - Electronic Publishing

     a.  Statutory Language

      213.Section 274 prescribes the terms under which a BOC may offer electronic
publishing.  In the NPRM, we noted that section 274(a) permits a BOC or its affiliate to
provide electronic publishing over its own or its affiliate's basic telephone service only through
a "separated affiliate" or an "electronic publishing joint venture."  Section 274(i)(9) defines
"separated affiliate" as "a corporation under common ownership or control with a Bell
operating company that does not own or control a Bell operating company and is not owned or
controlled by a Bell operating company and that engages in the provision of electronic
publishing which is disseminated by means of such Bell operating company's or any of its
affiliate's basic telephone service."  Section 274(i)(8), in turn defines "own" as having "a
direct or indirect equity interest (or the equivalent thereof) of more than 10 percent of an
entity, or the right to more than 10 percent of the gross revenues of an entity under a revenue
sharing or royalty agreement."  Section 274(i)(4) states that "'control' has the meaning that it
has in 17 C.F.R. 240.12b-2, the regulations promulgated by the Securities and Exchange
Commission pursuant to the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) or any
successor provision to such section."  Section 274(i)(5) defines an "electronic publishing
joint venture" as "a joint venture owned by a Bell operating company or affiliate that engages
in the provision of electronic publishing which is disseminated by means of such Bell operating
company's or any of its affiliates' basic telephone service."

     b.  Comparison of Sections 274 and 272

      214.In the NPRM, we noted that the language of section 274's structural and
transactional requirements differs from that of the structural and transactional requirements of
section 272.  We invited comment on whether the distinction between a "separated" affiliate
under section 274 and a "separate" affiliate under section 272 requires or permits different
accounting treatment for affiliate transactions.  Specifically, we sought comment on whether
we should apply our affiliate transactions rules, as we proposed to modify them, to transactions
between a BOC and its "separated" electronic publishing affiliate or joint venture.  We sought
comment on whether application of these rules would provide adequate accounting safeguards
for the joint activities permitted under section 274(c)(2).  We also invited comment on
whether, because section 274 allows a BOC to provide electronic publishing through either a
"separated" affiliate or a joint venture, we should distinguish for Title II accounting purposes
between transactions involving a BOC and its "separated" affiliate and those involving a BOC
and its electronic publishing joint venture.

Comments:

      215.NAA and several BOCs contend that the differences in language between
sections 274 and 272 do not require the Commission to impose different accounting treatments
for those affiliate transactions governed by section 274 and those governed by section 272. 
They also argue that the Commission's affiliate transactions rules provide adequate accounting
safeguards for the joint activities permitted under section 274(c)(2).  In contrast, YPPA
argues that, by placing electronic publishing in a separate section of the Act, Congress
intended the Commission to implement different accounting requirements for sections 272 and
274.  YPPA does not, however, suggest how the requirements should differ.  In addition,
USTA and several BOCs argue that the Commission need not distinguish for Title II
accounting purposes between transactions involving a BOC and its "separated" affiliate and
those involving a BOC and its electronic publishing joint venture. 

      216.SBC notes that the Commission's existing affiliate transactions rules would not
apply to transactions between a BOC and certain "separated" affiliates and joint ventures when
the BOC has insufficient ownership interest in the "separated" affiliate or joint venture for
those entities to qualify as BOC affiliates under section 32.9000 of the Commission's rules. 

      217.BellSouth maintains that section 274's requirement of a "separated" affiliate for
the provision of interLATA information services facially violates BOCs' First Amendment
right of freedom of speech and constitutes an unconstitutional Bill of Attainder. 

Discussion:

      218.We conclude above that our affiliate transactions rules must be applied to
transactions between BOCs and their section 272 affiliates in order to satisfy section
272(b)(5)'s "arm's length" requirement.  The language of section 274's structural and
transactional requirements differs from that of the structural and transactional requirements of
section 272.  Section 274 does not specifically use the phrase "arm's length" to describe the
required nature of transactions between BOCs and their section 274 "separated" electronic
publishing affiliates or joint ventures.  Section 274(b), however, requires that "separated"
electronic publishing affiliates or joint ventures "be operated independently from the
[BOC]," and section 274(b)(3)(A) requires that transactions between a "separated" electronic
publishing affiliate or joint venture and its affiliated BOC be carried out "in a manner
consistent with such independence."   Moreover, section 254(k) prohibits incumbent local
exchange carriers, including the BOCs, from using non-competitive exchange service and
exchange access to subsidize competitive services, such as electronic publishing.  We
conclude that in order to satisfy sections 274(b) and 254(k), we must apply our affiliate
transactions rules, as modified in this Order, to transactions between BOCs and their
"separated" electronic publishing affiliates or joint ventures.  Applying our affiliate
transactions rules to transactions between BOCs and their "separated" electronic publishing
affiliates or joint ventures will serve as a safeguard against the misallocation of costs from a
BOC's nonregulated services, such as electronic publishing services, to regulated
telecommunication services.  Our affiliate transactions rules, as modified in this Order, prevent
the BOCs' ratepayers from bearing the costs of competitive services provided by BOC
affiliates and are, therefore, sufficient to implement section 254(k)'s requirement that carriers
not "use services that are not competitive to subsidize services that are subject to
competition." 

      219.BellSouth has argued that requiring BOCs to provide electronic publishing
services through a "separated" affiliate or joint venture violates the First Amendment.  As
noted above, we find that this result is required by the Act.  Although the courts have ultimate
authority to determine the constitutionality of this and other statutes, we find it appropriate to
state that we find BellSouth's argument to be without merit.  To the extent that BOC
provision of electronic publishing services constitutes commercial speech for First Amendment
purposes, the section 274 "separated" affiliate or joint venture requirement neither prohibits
the BOCs from providing such services, nor places any restrictions on the content of the
information the BOCs may provide.  Instead, the section 274 "separated" affiliate or joint
venture requirement is a content-neutral restriction on the manner in which BOCs may provide
electronic publishing services, intended by Congress to protect against improper cost allocation
and discrimination concerns.  Thus, we conclude that the "separated" affiliate or joint venture
requirement imposed by section 274 on BOC provision of electronic publishing services does
not violate the First Amendment.  BellSouth has also argued that requiring BOCs to provide
electronic publishing services through a "separated" affiliate or joint venture constitutes an
unconstitutional Bill of Attainder.  Although the courts have ultimate authority to determine the
constitutionality of this and other statutes, we find it appropriate to state that we find
BellSouth's argument to be without merit.  We agree with NAA that section 274 does not
single out the BOCs for punishment, but merely imposes temporary, narrowly-focused,
economic regulations.

     c.  Compliance Review

      220.Section 274(b)(8) requires that a BOC and its electronic publishing "separated"
affiliate or joint venture each perform an annual compliance review conducted by "an
independent entity" to determine compliance with section 274.  In the NPRM, we sought
comment on how such compliance reviews should be conducted and specifically what matters
the reviews should encompass.  We proposed to require the independent entity to prepare
and file with the Commission reports describing:  1) the scope of its compliance review,
including a description of how the affiliate's or joint venture's books were examined and the
extent of the examination; (2) the independent entity's conclusion on whether examination of
the books has revealed compliance or non-compliance with the affiliate transactions rules and
any other non-discrimination requirements imposed by Commission rules; (3) a description of
any limitations imposed on the independent entity in the course of its review by the affiliate or
joint venture or other circumstances that might affect the entity's opinion; and (4) statements
by the independent entity as to whether the carrier's accounting and affiliate transactions
methodologies conform to the Act and the Commission's rules and whether the carrier has
accurately applied the methodologies.  We sought comment on the necessity or desirability of
this approach.  We also sought comment on what safeguards we may need to adopt to protect
proprietary information contained in the compliance review report "from being used for
purposes other than to enforce or pursue remedies under [section 274]."

Comments:

      221.NAA is the only commenter to support the Commission's proposal related to the
method for conducting, and the scope of, annual compliance reviews.  Ameritech and PacTel
contend that section 274(b)(8) clearly establishes the requirements of the annual compliance
review and therefore argue that the Commission should not specify any procedures for
conducting the annual compliance reviews.  USTA proposes that the annual compliance
reviews be conducted in accordance with standards set forth by the American Institute of
Certified Public Accountants.  YPPA argues that the independent compliance review
required by section 274(b)(8) should consist only of an examination of the written records of
transactions between a BOC and its electronic publishing "separated" affiliate or joint venture
and should include a report detailing the scope and conclusion of the examination and any
limitations placed on the examiner.  Wisconsin PSC recommends the use of NARUC's
resolution discussed in section IV.B.1.f. above as a "starting point for discussions between the
states and the FCC concerning [compliance reviews under section 274]."

      222.PacTel recommends that to the extent overlap exists, the Commission should
allow the annual compliance review under section 274 to satisfy the requirement of an annual
cost allocation manual audit.  US West recommends that the Commission require the annual
cost allocation manual audit to be conducted biennially to streamline current regulations and
reduce redundancy.  

      223.YPPA notes that the timing of the annual compliance review may vary,
depending on whether the affiliate provided electronic publishing services at the time of the
enactment of the 1996 Act.  YPPA argues that the first audit for grandfathered services should
be conducted by February 8, 1998 because affiliates need not comply with the requirements of
section 274 until February 8, 1997.  For non-grandfathered services, YPPA contends that the
first audit should be conducted one year after the affiliate starts to engage in electronic
publishing activities. 

      224.Most commenters that address the matter argue that the Commission's policies
regarding protection of proprietary information would adequately protect proprietary
information contained in the compliance review report.  PacTel does contend, however, that
the BOCs should be allowed to exclude any competitively-sensitive information from the
compliance review report because of the competitive nature of the electronic publishing
business.  BellSouth recommends the Commission allow the BOCs and their electronic
publishing "separated" affiliates or joint ventures to file two versions of the compliance review
report--a public version with proprietary information omitted and a confidential version. 
BellSouth argues that the Commission should release the confidential version under a
protective order only after a persuasive showing that access is necessary to enforce or pursue
remedies under section 274.

Discussion:

      225.We decline to adopt the proposal presented in the NPRM related to the method
for conducting, and the scope of, annual compliance reviews.  We note that the language of
section 274(b)(8) provides less stringent requirements than section 272(d)'s audit
requirement.  For example, section 274(b)(8) only requires a compliance review performed
by an independent entity, rather than a federal/State joint audit conducted by a trained
independent auditor.  Under section 274(b)(8), the party obtaining the compliance review
need only file a report of exceptions and corrective action to the Commission for public
inspection, making the compliance review itself available only to "lawful authorities."  In
contrast, section 272(d) requires the BOC to file the final audit report required under that
section with the Commission and with the State commission of each state in which the BOC
provides service, which will make such report available for public inspection and comment. 
Moreover, section 274(e) provides a right of action to any person claiming that an act or
practice of the BOC, affiliate, or "separated" affiliate has violated the requirements of section
274.   In view of this, we find that an oversight mechanism similar to the one we adopt in
this Order for section 272(d) is not necessary to implement the provisions of section 274(b)(8)
and we conclude that we need not adopt any rules regarding the compliance review beyond the
plain language of section 274(b)(8)(A).  Because of the differences between a compliance
review under section 274 and an audit, we further conclude that a carrier may not use the
electronic publishing compliance review to satisfy any portion of the annual cost allocation
manual audit required by section 64.904 of the Commission's rules. 

      226.Section 274(b)(9) requires the BOC and its electronic publishing "separated"
affiliate or joint venture to file a report with the Commission of any exceptions and corrective
action resulting from the compliance review.  Section 274(b)(9) further requires the
Commission to "allow any person to inspect and copy such report subject to reasonable
safeguards to protect any proprietary information contained in such report from being used for
purposes other than to enforce or pursue remedies under [section 274]."  We find that these
requirements of section 274(b)(9) are self-effectuating and, therefore, we need not adopt any
rules regarding this requirement beyond the plain language of section 274(b)(9).  We will
apply the same treatment to confidential information in such reports as we apply to confidential
information contained in other Commission filings.

     d.  Section 274(f)'s Reporting Requirement

      227.Section 274(f) requires any "separated" affiliate under section 274 to file annual
reports with the Commission "in a form substantially equivalent to the Form 10-K required by
regulations of the Securities and Exchange Commission."  In the NPRM, we tentatively
concluded that to minimize burdens on the filing companies, we should require the "separated"
affiliate to file the Form 10-K with us as well as the SEC.  We recognized, however, that not
all "separated" affiliates providing electronic publishing services would be subject to the SEC's
10-K requirement and sought comment on what "substantially equivalent to the Form 10-K"
means with regard to these "separated" affiliates.

Comments:

      228.BellSouth agrees that the filing requirements we proposed in the NPRM will
satisfy section 274(f).  For those electronic publishing "separated" affiliates not subject to
the SEC's Form 10-K requirement, BellSouth recommends that the Commission adopt a
standard report that solicits information relevant to the concerns outlined in section 274 and not
require the Form 10-K itself.  BellSouth argues that this report should contain a description
of the entity filing the report, summary financial statements with representations of
management, a list of the officers and directors of the entity, a description of any financing
activity the entity undertakes, and specific transactional compliance results obtained from the
annual compliance review required by section 274(b)(8).

      229.YPPA and NAA argue that the Commission should accept the electronic
publishing "separated" affiliate or joint venture's Form 10-K if its stock is publicly traded. 
YPPA contends that if the "separated" affiliate's stock is not publicly traded, the Commission
should accept the Form 10-K of the "separated" affiliate's holding company.  NAA
disagrees.  NAA maintains that the language of the Act clearly requires "[a]ny separated
affiliate," not the holding company, to file the annual report.  NAA argues that the Form 10-
K of a holding company would fail to provide the Commission and third parties with essential
financial and other information about the "separated" affiliate's operations.  Instead, NAA
proposes that the "separated" affiliate should file a report containing the same information as in
a Form 10-K, except for such information that would only be relevant to a publicly-traded
corporation.  YPPA argues that, if neither the "separated" affiliate nor the holding company
are required to file a Form 10-K with the SEC, then the Commission should require the
"separated" affiliate to complete and file a Form 10-K with the Commission.

Discussion:

      230.To minimize burdens on the filing companies, we adopt our tentative conclusion
that when an electronic publishing "separated" affiliate already files a Form 10-K with the
SEC, the "separated" affiliate may file the same Form 10-K with the Common Carrier Bureau
within 90 days after the end of the "separated" affiliate's fiscal year in satisfaction of section
274(f)'s requirements.  We disagree with BellSouth that, for electronic publishing "separated"
affiliates not subject to the SEC's Form 10-K filing requirement, we should adopt a standard
report that solicits only "that information that is relevant to the concerns outlined in section
274."  Such a requirement would not satisfy the explicit language of section 274, that
requires that "separated" affiliates "file with the Commission annual reports in a form
substantially equivalent to the form 10K required by [the SEC]."  Moreover, we believe that
by requiring all electronic publishing "separated" affiliates to file annual reports containing the
same information in the same format, we will improve our ability to ensure compliance with
the provisions of section 274.  We agree with NAA that the Form 10-K of a "separated"
affiliate's holding company would fail to provide the Commission and third parties with
adequate information about the "separated" affiliate's operations to ensure compliance with
section 274.  Because the Form 10-K of the holding company would present only
consolidated information, the Commission and third parties could not identify from that form
the account balances related to the activities of the electronic publishing "separated" affiliate. 
For each "separated" affiliate not subject to the SEC's Form 10-K requirement, however, we
conclude that the "separated" affiliate need not file an actual SEC Form 10-K with the
Commission.  Instead, such affiliates must file with the Commission a report containing the
same information as is required in the SEC's Form 10-K.  In accordance with section 274(f),
the report must be organized "in a form substantially equivalent to the Form 10-K required by
regulations of the [SEC]."  

     e.  Section 274 Transactional Requirements

      231.Section 274(b)(1) requires the "separated" affiliate or joint venture and the BOC
with which it is affiliated to "maintain separate books, records, and accounts and prepare
separate financial statements."  In the NPRM, we invited comment on the steps we should
take to implement this provision.  We also asked commenters to address whether it is
necessary for the Commission to adopt any additional accounting, bookkeeping,or record-
keeping requirements for these affiliates and joint ventures and, if so, what those additional
requirements should be.

      232.Section 274(b) requires the "separated" affiliate or joint venture to "be operated
independently from the [BOC]."  Pursuant to section 274(b)(3), the "separated" affiliate or
joint venture and the BOC with which it is affiliated must "carry out transactions (A) in a
manner consistent with such independence, (B) pursuant to written contracts or tariffs that are
filed with the Commission and made publicly available, and (C) in a manner that is auditable in
accordance with generally accepted auditing standards."  We also sought comment on the
meaning of "in a manner consistent with such independence."  In addition, we sought comment
on whether any regulations are necessary to implement the provisions of section 274(b)(3)(A)
and (B).

      233.In the NPRM, we further sought comment on whether, and if so, how we should
amend our rules to implement the requirement under section 274(b)(3)(C) that transactions be
"auditable in accordance with generally accepted auditing standards."  We noted that
generally accepted auditing standards refer to standards and guidelines promulgated by the
American Institute of Certified Public Accountants that an independent auditor must follow
when preparing for and conducting an audit of a company's financial statements.  These
standards require, inter alia, that the auditor review a company's internal controls and
determine whether adequate documentation exists to verify that the company has recorded
transactions on its books in a manner consistent with generally accepted accounting
principles. 

      234.Section 274(b)(4) requires the "separated" affiliate or joint venture to "value any
assets that are transferred directly or indirectly from the [BOC] to a separated affiliate or joint
venture, and record any transactions by which such assets are transferred, in accordance with
such regulations as may be prescribed by the Commission or a State commission to prevent
improper cross subsidies."  We proposed elsewhere in the NPRM to conform our valuation
methods under the affiliate transactions rules governing provision of services to those
governing asset transfers.  Regardless of the resolution of that issue in this proceeding, because
section 274 specifically addresses asset transfers between a BOC and its "separated" affiliate or
joint venture, we sought comment in the NPRM on whether we should distinguish between
asset transfers and the provision of services in the context of electronic publishing affiliate
transactions.

Comments:

      235.NAA and PacTel argue that section 274(b)(1)'s requirement of separate books,
records, accounts, and financial statements is self-effectuating and, therefore, the Commission
need not establish any additional regulations.  BellSouth and NYNEX contend that the
Commission should direct the "separated" affiliate or joint venture to keep their books,
records, and accounts in accordance with GAAP in order to satisfy section 274(b)(1). 
Ameritech argues that application of the SEC's Form 10-K reporting regulations, discussed in
section IV.B.3.d. above, would ensure that a "separated" affiliate maintains its books, records,
and accounts in accordance with GAAP and would therefore obviate the need for any
additional rules to implement section 274(b)(1).  

      236.NAA argues that section 274(b)(3)(A)'s requirement that transactions be carried
out "in a manner consistent with such independence" requires transactions to occur as they
would between unrelated parties (i.e., on an "arm's length basis").  PacTel and US West
contend that the requirements of section 274(b)(3)(A) are self-effectuating and, therefore, the
Commission need not establish any additional regulations.

      237.NAA contends that section 274(b)(3)(B)'s requirement that transactions be
carried out "pursuant to written contracts or tariffs that are filed with the Commission and
made publicly available" is self-effectuating and, therefore, the Commission need not establish
any additional regulations.  

      238.BellSouth maintains that section 274(b)(3)(C)'s requirement that transactions be
carried out "in a manner that is auditable in accordance with generally accepted auditing
standards" requires that the section 274 "separated" electronic publishing affiliate or joint
venture maintain its books in accordance with GAAP.  PacTel and US West contend that the
requirements of section 274(b)(3)(C) are self-effectuating and, therefore, the Commission need
not establish any additional regulations.  

      239.Ameritech contends that to the extent the affiliate transactions rules apply, the
Commission need not distinguish between asset transfers and services in the case of electronic
publishing.

Discussion:

      240.We agree with NAA and PacTel that section 274(b)(1)'s requirement of separate
books, records, accounts, and financial statements is self-effectuating and, therefore, we need
not adopt any rules regarding this requirement beyond the plain language of section 274(b)(1).

     241. We agree with NAA that section 274(b)(3)(A)'s requirement that transactions be
carried out "in a manner consistent with such independence" requires that transactions
between a "separated" electronic publishing affiliate or joint venture and its affiliated BOC
occur on an arm's length basis, as the transaction would occur between unrelated parties. 
The phrase "such independence" in section 274(b)(3)(A) refers to section 274(b)'s requirement
that a "separated" electronic publishing affiliate or joint venture "be operated independently
from the [BOC]."  Consistent with this conclusion, we determined in section IV.B.3.b.
above that we should apply our affiliate transactions rules, as modified in this order, to
transactions between BOCs and their "separated" electronic publishing affiliates or joint
ventures. 

      242.We are unpersuaded by NAA's argument that the language of section
274(b)(3)(B) is self-effectuating.  We find the language of section 274(b)(3)(B) to be
ambiguous.  Pursuant to this section, a BOC and its separated affiliate shall carry out
transactions "pursuant to written contracts or tariffs that are filed with the Commission and
made publicly available."  From this language it is unclear whether written contracts must be
filed with the Commission or whether only tariffs are required to be filed with the
Commission.  It is also unclear whether written contracts must be made publicly available or
whether only tariffs are required to be made publicly available.  We therefore intend to seek
further comment on the meaning of section 274(b)(3)(B) in CC Docket No. 96-152.

      243.We agree with BellSouth that the section 274 "separated" electronic publishing
affiliate or joint venture must maintain its books, records, and accounts in accordance with
GAAP in order to satisfy section 274(b)(3)(C)'s requirement that transactions be "auditable in
accordance with generally accepted auditing standards."   A requirement of GAAP imposes a
set of uniform accounting principles.  Such uniformity will assist the Commission in ensuring
that transactions between "separated" affiliates or joint ventures required under section 274 and
their affiliated BOCs are conducted "in a manner consistent with such independence" in
accordance with section 274(b)(3)(A).

      244.For the same reasons discussed in section IV.B.1.b. above with regard to
section 272, we conclude that we should conform our valuation methods governing the
provision of services between an electronic publishing "separated" affiliate or joint venture and
the BOC with which it is affiliated to those governing asset transfers.  We therefore will
require all non-tariffed affiliate transactions to be recorded at prevailing price if such price
exists, and otherwise at the higher of cost and estimated fair market value when the carrier is
the seller or transferor, and at the lower of cost and estimated fair market value when the
carrier is the buyer or transferee.  We will continue to define the applicable cost benchmarks
as net book cost for asset transfers and fully distributed costs for service transfers.  Although
section 274(b)(4) only refers to asset transfers, we read section 274's requirement that the
"separated" affiliate or joint venture and the BOC with which it is affiliated "carry out
transactions . . . in a manner consistent with such independence" to prohibit the "separated"
affiliate or joint venture and the BOC with which it is affiliated from subsidizing electronic
publishing services from regulated telecommunications services.  We designed our affiliate
transactions rules to prevent such cross-subsidization.  We therefore conclude that the affiliate
transactions rules, as we modify them in this Order, should apply to all transactions--both asset
transfers and the provision of services--between a BOC and its "separated" affiliate or joint
venture engaged in electronic publishing activities permitted under section 274.

     f.  Miscellaneous

      245.Section 274(d) requires a BOC under common ownership or control with a
electronic publishing "separated" affiliate or joint venture to "provide network access and
interconnections for basic telephone service to electronic publishers at just and reasonable rates
that are tariffed (so long as rates for such services are subject to regulation) and that are not
higher on a per-unit basis than those charges for such services to any other electronic publisher
or any separated affiliate engaged in electronic publishing."  In the NPRM, we tentatively
concluded that we should apply our modified affiliate transactions rules to the provision of
"network access and interconnections for basic telephone service" by a BOC under common
ownership or control with an electronic publishing "separated" affiliate or joint venture to such
a "separated" affiliate or joint venture to ensure compliance with the requirements of section
274(d).  We sought comment on this tentative conclusion.

Comments:

      246.BellSouth and NAA support the Commission's tentative conclusion that our
affiliate transactions rules should be applied to the provision of "network access and
interconnections for basic telephone service" by a BOC under common ownership or control
with an electronic publishing "separated" affiliate or joint venture to such a "separated"
affiliate or joint venture to ensure compliance with the requirements of section 274(d). 
YPPA disagrees.  YPPA maintains that the Act requires that network access and
interconnection be just, reasonable, and according to a filed tariff (so long as rates for such
services are subject to regulation).  Therefore, YPPA asserts that section 274(d) requires that
the rates charged to affiliated and unaffiliated electronic publishers must be the same.

Discussion:

      247.We adopt our tentative conclusion that our modified affiliate transactions rules
apply whenever a BOC under common ownership or control with an electronic publishing
"separated" affiliate or joint venture provides network access and interconnections for basic
telephone service to such "separated" affiliates or joint venture.  YPPA's argument that section
274(d) requires that the rates charged to affiliated and unaffiliated electronic publishers must be
the same was raised, and will be addressed, in a separate proceeding.

     4.  Separated Operations under Sections 260 and 271 through 276

      248.Even when sections 260 and 271 through 276 do not require BOCs or other
incumbent local exchange carriers to offer services through a separate affiliate, an incumbent
LEC might choose to perform these activities through an affiliate.  At paragraph 118 of the
NPRM, we tentatively concluded that application of our affiliate transactions rules, as we
proposed to modify them, to transactions between an incumbent local exchange carrier and any
of its affiliates engaged in activities that sections 260, 275, and 276 might permit or require the
carrier to offer through a separate affiliate would safeguard against the subsidies prohibited by
sections 260, 275, and 276.  We invited comment on this tentative conclusion.

      249.In the NPRM, we also asked commenters to identify any interLATA
telecommunications services, besides the interLATA telecommunications services that section
272 requires BOCs to provide through a separate affiliate, that the BOCs might choose to
provide through a separate affiliate and for which we should develop appropriate affiliate
transactions rules.  We tentatively concluded that we should apply our affiliate transactions
rules to transactions between each BOC and any interLATA telecommunications services
affiliate it establishes.  We invited comment on this tentative conclusion.  We also asked
whether and how we should adapt our affiliate transactions rules for such transactions and
whether we should adopt special valuation methodologies for these transactions that would
recognize the regulated status of the affiliates on both sides of the transactions.

Comments:

      250.Most parties, including interexchange carriers, BOCs, and trade associations
agree with the Commission's proposal to apply affiliate transactions rules to transactions
between a BOC and its separate affiliates, even if the Act does not require the activities at issue
in the transactions to be conducted through a separate affiliate.  In particular, AT&T
contends that any contrary rule would allow a BOC to transfer operations that it could offer on
an integrated basis to an affiliate in order to circumvent affiliate transactions rules and engage
in cross-subsidization.  APCC argues that the "available for public inspection" requirement
of section 272(b)(5) should cover all transactions between BOCs or other incumbent local
exchange carriers and these "voluntary" affiliates.

Discussion:

      251.We agree with the commenters that assert that our affiliate transactions rules
should apply to transactions between an incumbent local exchange carrier and any of its
affiliates engaged in activities of the types permitted by sections 260 and 271 through 276,
regardless of whether the Act requires those activities to be conducted through a separate
affiliate.  As discussed in detail below, various provisions of the Act prohibit cross-
subsidization through transactions between incumbent local exchange carriers and any affiliates
that these incumbent local exchange carriers choose to establish in order to provide the
competitive activities permitted under sections 260 and 271 through 276.

      252.Earlier we concluded that telemessaging is an information service and that BOC
provision of telemessaging on an interLATA basis is subject to the separate affiliate
requirements of section 272.  Non-BOC incumbent local exchange carriers, however, are not
required to offer telemessaging services through a separate affiliate, but rather may choose to
do so subject to section 260's requirement that "[a]ny local exchange carrier subject to the
requirements of section 251(c) . . . shall not subsidize its telemessaging service directly or
indirectly from its telephone exchange service or its exchange access."  In order to protect
against the subsidies prohibited by section 260, we conclude that we must apply our affiliate
transactions rules to all transactions between non-BOC incumbent local exchange carriers and
their affiliates engaged in telemessaging activities.

      253.Although section 272(a)(2)(B) does not require BOCs to provide certain types of
incidental interLATA services, defined in section 271(g), through an affiliate, a BOC could
still choose to provide these services through an affiliate subject to section 271(h)'s
requirement that provision of these services by a BOC "will not adversely affect telephone
exchange service ratepayers or competition in any telecommunications market."  In order to
protect against the subsidies prohibited by section 271(h), we conclude that we must also apply
our affiliate transactions rules to all transactions between BOCs and their affiliates providing
incidental interLATA services.

      254.Non-BOC incumbent local exchange carriers, although not required to do so,
may choose to offer alarm monitoring services through a separate affiliate subject to section
275's requirement that an incumbent local exchange carrier "not subsidize its alarm monitoring
services either directly or indirectly from telephone exchange service operations."  In order
to protect against the cross-subsidies prohibited by section 275, we conclude that we must
apply our affiliate transactions rules to all transactions between non-BOC incumbent local
exchange carriers and their affiliates engaged in alarm monitoring activities. 

      255.Incumbent local exchange carriers, including BOCs, although not required to do
so, may choose to offer payphone service through a separate affiliate.  Our Pay Telephone
Reclassification Order reclassified payphone service as a nonregulated activity and required
that the nonstructural safeguards described in our Computer III Orders, which include our
affiliate transactions rules, be applied to the provision of payphone services by local exchange
carriers.  As a result, our existing affiliate transactions rules apply to transactions between
incumbent local exchange carriers and their affiliates engaged in payphone service. 

      256.Although section 272(a)(2)(B) does not require BOCs to provide out-of-region
interLATA telecommunications services through an affiliate, a BOC could still choose to do
so.  Moreover, non-BOC incumbent local exchange carriers, although not required to do so,
may choose to provide interLATA telecommunications services of the types described in
section 271 through an affiliate.  Sections 271 and 272, however, contain no language
prohibiting cross-subsidization in the case of activities voluntarily provided through affiliates. 
Although sections 271 and 272 contain no language prohibiting cross-subsidization, Section
254(k) mandates that "[a] telecommunications carrier may not use services that are not
competitive to subsidize services that are subject to competition."  The language of section
254(k) is broad in scope, prohibiting cross-subsidization in all transactions between an
incumbent local exchange carrier and any affiliate that provides any of the competitive services
permitted under sections 260 and 271 through 276.  Accordingly, in order to protect against
the subsidies prohibited by section 254(k), we conclude we must apply our affiliate transactions
rules to all transactions between incumbent local exchange carriers and their affiliates
providing any of the competitive services of the types permitted under sections 260 and 271
through 276.

      257.Our existing affiliate transactions rules do not protect against subsidies from an
incumbent local exchange carrier's exchange services and exchange access flowing to its
affiliate providing regulated telecommunications services, such as in-region services, out-of-
region services, or certain types of incidental services.  Our affiliate transactions rules,
however, are necessary to ensure that cross-subsidization of these services is prevented as
required by sections 271(h) and 254(k).  Earlier we concluded that interLATA
telecommunications services, including in-region services, out-of-region services and certain
types of incidental services, should be treated by the BOCs like nonregulated activities for
federal accounting purposes.  This treatment will prevent cross-subsidization by triggering
the application of our affiliate transactions rules.  Accordingly we conclude that interLATA
telecommunications services should be treated like nonregulated activities for federal
accounting purposes whenever these services are provided by any incumbent local exchange
carrier through an affiliate.

      258.We find unpersuasive APCC's assertion that the requirement in section
272(b)(5) that transactions be "available for public inspection" should apply to all transactions
between incumbent local exchange carriers and their affiliates.  The language of section
272(b)(5) clearly imposes the "available for public inspection" requirement only upon
transactions between BOCs and their affiliates that are specifically required under section 272,
and not to transactions involving activities that a BOC merely chooses to provide through an
affiliate.  Moreover, the "available for public inspection" requirement of section 272(b)(5)
does not apply to transactions involving non-BOC incumbent local exchange carriers and their
affiliates.

                       V.  OTHER MATTERS
                                
A.  Price Caps

     1.  General

      259.Our existing Part 64 cost allocation rules were developed when all local
exchange carriers were still subject to cost-based, rate-of-return regulation.  Today, we rely
upon price cap, rather than rate-of-return regulation to ensure that rates for the interstate
services of the largest incumbent local exchange carriers, including the BOCs, are reasonable. 
In adopting the federal price cap plan, we were influenced by some State plans that moved
away from the traditional rate-of-return regulation.  Under the Commission's plan, price cap
indices limit the prices that incumbent local exchange carriers may charge for their regulated
interstate services.  The indices are adjusted each year in accordance with a formula that
accounts for changes in inflation and industry-wide changes in productivity. 

     2.  Exogenous Costs and Part 64

      260.Under our price cap rules for incumbent local exchange carriers, most changes
in a carrier's costs of providing regulated services are treated as "endogenous," which means
they do not result in adjustments to the carrier's price cap indices.  Certain cost changes,
however, triggered by administrative, legislative, or judicial action that are beyond the control
of the carriers may result in adjustments to those indices.  The Commission concluded that
failing to recognize these cost changes by adjusting price cap indices would either unjustly
punish or reward the carrier.  Price cap carriers may claim adjustments to their indices based
on costs that are beyond their control if those costs are not otherwise accounted for in the price
cap formula.  Such costs are defined as "exogenous."  The Commission has found that those
types of cost changes should be treated "exogenously" to ensure that price cap regulation does
not lead to unreasonably high or unreasonably low rates.

      261.Our price cap rules for incumbent local exchange carriers specify that "[s]ubject
to further order of the Commission, those exogenous cost changes shall include cost changes
caused by . . . [t]he reallocation of investment from regulated to nonregulated activities
pursuant to [section 64.901 of the Commission's rules]."  In the NPRM, we tentatively
concluded that a strict reading of our price cap rules requires exogenous adjustments to price
cap indices only to the extent amounts are reallocated "from regulated to nonregulated
activities."  We invited comment on this tentative conclusion and asked whether all such
reallocation to nonregulated activities that may result from the provision of telemessaging
service should trigger an adjustment to lower price cap indices. We also sought comment on
the potential exogenous treatment of new investment in network plant to be used for
telemessaging service.

Comments:

      262.The BOCs argue, without exception, that section 61.45(d)(1)(v) does not require
a price cap adjustment for reallocation of network investment from regulated to nonregulated
activities.  Several of the local exchange carriers argue that the exogenous cost rule in
section 61.45(d)(1)(v) was only intended to deter under-forecasting of nonregulated usage
pursuant to section 64.901(b)(4).  USTA, US West and Bell Atlantic assert that exogenous
treatment would act as a disincentive for future investment in telecommunications
capabilities.  NYNEX, Bell Atlantic, USTA, Ameritech and US West all assert that
exogenous treatment would result in a double counting of the cost of network investment. 
NYNEX further argues that a reallocation of costs from regulated to nonregulated activities
would only result in a change in how costs are recorded and not a change in economic cash
flow which would require exogenous treatment. 

      263.Parties other than local exchange carriers generally contend that exogenous
adjustments to price cap indices are required when costs are reallocated from regulated to
nonregulated activities.  In particular, Sprint maintains that the current price cap indices do
not reflect the reallocated costs and therefore would not amount to a double counting of
network investment.  Furthermore, because exogenous treatment does not apply to new
investment, Sprint argues that no disincentive is created.

      264.Sprint and GSA contend that new investment associated with nonregulated
services should initially be associated to a nonregulated activity.

Discussion:

      265.Under the current regulatory scheme, only exogenous treatment can ensure that
the benefits of competition are in fact shared with regulated ratepayers.  When the Commission
adopted its cost allocation requirements, it specifically found that "the reallocation rules are
essential to the integrity of a cost allocation system . . . which seeks to prevent regulated
activities from absorbing nonregulated costs, either at the start of a forecast period or
subsequently."  We find unpersuasive the argument that exogenous treatment of reallocated
costs would in some way discourage local exchange companies from investing in
telecommunications capabilities.  We agree with Sprint that exogenous treatment of reallocated
costs will not result in double counting of network investment because those costs are not
reflected in the current price cap indices.  Moreover, while it is true that exogenous treatment
of reallocated costs will reduce the rate base for non-competitive services, such as exchange
service and exchange access, the 1996 Act allows local exchange companies to take advantage
of new competitive markets with new resulting revenue streams virtually unfettered by
regulation.    Thus, we conclude that when costs are reallocated from regulated to nonregulated
activities, exogenous adjustments must be made to price cap indices in accordance with section
61.45(d)(1)(v).  Exogenous adjustments to the price cap indices will only be eliminated when
competition in the local service market eliminates the need for cost allocation rules altogether. 

      266.We agree with Sprint and GSA that any portion of new investment associated
with nonregulated services should be booked initially to a nonregulated activity and, therefore,
will not receive exogenous treatment.

     3.  Part 64 and Sharing

     267. Under our price cap rules, incumbent local exchange carriers can select the
productivity factor they will use to determine annual adjustments to their price cap indices. 
If they choose not to select the highest productivity factor permitted under our rules, they are
required to "share."  Under sharing, incumbent local exchange carriers earning in excess of
prescribed earnings levels must refund a portion of the excess earnings in subsequent rate
periods by reducing their price cap indices.  Those earnings are equal to the incumbent local
exchange carrier's interstate revenues less the regulated interstate costs.  Improper cost
allocation can increase the incumbent local exchange carrier's regulated interstate costs and
therefore can reduce the carrier's sharing obligations.  We note, however, that in their most
recent annual tariff filings all but four price cap local exchange carriers elected the highest
interim productivity factor we had prescribed, which exempts them from sharing obligations
for the 1995-96 access year.

      268.In the NPRM, we asked commenters to address whether our elimination of
sharing obligations permanently for price cap carriers would eliminate the need for Part 64 cost
allocation processes in our regulation of these companies.  We also sought comment on how
the relationship of our cost allocation rules to price cap local exchange carriers should
influence the outcome of this proceeding.

Comments:

      269.The BOCs generally argue that we should eliminate our accounting safeguards
or forebear from enforcing them under section 10 of the Act on the ground that our current
price cap plan removes any incentive or ability for local exchange carriers to cross-subsidize
competitive services.  The BOCs generally emphasize that no-sharing price cap carriers
cannot cross-subsidize because no link between costs and rates exists in the absence of a
sharing requirement. Ameritech argues that even if it were possible to misallocate costs, it
would be practically insignificant because local exchange carriers would have to incorporate
the increased costs into higher rates while competing with other providers to retain
customers.  USTA argues that any attempt to misallocate costs from nonregulated to
regulated activities would serve no purpose because economies of scope are realized through
the productivity offset.

      270.Parties other than local exchange carriers generally maintain that there is a
linkage between costs and rates under price caps that justifies the continued application of our
accounting safeguards.  These parties generally argue that under our current price cap plan,
local exchange carriers retain the annual option of selecting a productivity factor subject to
sharing requirements that are dependent on rate of return, thereby preserving the incentive to
shift costs.  These parties also generally contend that our accounting safeguards are
necessary to monitor the BOCs' rates of return for regulated services in order to evaluate
whether the price cap system is in the public interest, and determine whether adjustments to the
productivity factor must be made.  Sprint and APCC argue that even in the absence of a
sharing requirement, carriers are able to request adjustments to their price cap indices for
exogenous cost changes, which requires the Commission to review costs.

Discussion:

      271.The fact that an incumbent local exchange carrier subject to the Commission's
price cap regulation does not currently have a potential sharing obligation does not obviate the
need for rules governing their allocations of costs between regulated and nonregulated
activities.  As described above, our interim price cap rules permit incumbent local exchange
carriers to select the productivity factor they will use to determine annual adjustments to their
price cap indices.  Incumbent local exchange carriers may select among three productivity
factor choices, two of which impose sharing obligations if the local exchange carrier's
interstate earnings exceed specified benchmarks and permit low-end adjustments if interstate
earnings fall below specified benchmarks.  In addition, our price cap rules permit incumbent
local exchange carriers to file rate increases that exceed their applicable price cap indices,
provided they can satisfy a stringent cost showing.  Consequently, our current system of
interstate price cap regulation does not eliminate the need for cost allocation rules.  Moreover,
because these incumbent local exchange carriers' intrastate services may be subject to cost-of-
service regulation or to a form of price cap regulation that involves potential sharing
obligations or periodic earnings reviews, the incumbent local exchange carriers may still have
an incentive to assign a disproportionate share of costs to regulated accounts.  We recognize
that changes in the competitive conditions of local telecommunications markets in the future
may cause us to re-examine the continued need for our Part 64 cost allocation rules; but, based
on the record in this proceeding, those rules remain important to our efforts to ensure that the
rates for regulated services are just, reasonable, and non-discriminatory.  

B.  Section 254(k)

      272.In the NPRM, we sought comment on whether our proposals related to sections
260 and 271 through 276 are sufficient to implement section 254(k)'s requirement that carriers
not "use services that are not competitive to subsidize services that are subject to
competition."

Comments:

      273.NYNEX and BellSouth contend that the Commission's accounting safeguards
are sufficient to satisfy the requirements of section 254(k).

      274.Several commenters addressed the portion of section 254(k) that requires "[t]he
Commission, with respect to interstate services . . . [to] establish any necessary cost allocation
rules, accounting safeguards, and guidelines to ensure that services included in the definition of
universal service bear no more than a reasonable share of the joint and common costs of
facilities used to provide those services."

Discussion:

      275.We conclude that the accounting safeguards that we adopt in this Order with
respect to sections 260 and 271 through 276 are sufficient to implement section 254(k)'s
requirement that carriers not "use services that are not competitive to subsidize services that
are subject to competition."  Our existing accounting safeguards, with the modifications that
we adopt in this Order, prevent subsidization of competitive nonregulated services, such as
those addressed in Sections 260 and 271 through 276 by subscribers to an incumbent local
exchange carrier's regulated telecommunications services.  We find that the Act does not
require additional safeguards for these particular statutory services.

      276.We note that the portion of section 254(k) that requires "[t]he Commission, with
respect to interstate services . . . [to] establish any necessary cost allocation rules, accounting
safeguards, and guidelines to ensure that services included in the definition of universal service
bear no more than a reasonable share of the joint and common costs of facilities used to
provide those services" will not be addressed in this Order but will be the subject of a separate
rulemaking proceeding.  

         VI.  FINAL REGULATORY FLEXIBILITY ACT ANALYSIS

      277.As required by section 603 of the Regulatory Flexibility Act ("RFA"), as
amended, an Initial Regulatory Flexibility Analysis ("IRFA") was incorporated in the
NPRM.  In the NPRM, the Commission certified that the rules it proposed to adopt in this
proceeding would not have a significant economic impact on a substantial number of small
entities because the proposed rules did not pertain to small entities.  No comments were
received concerning the proposed certification.  For the reasons stated below, we certify that
the rules adopted herein will not have a significant economic impact on a substantial number of
small entities.  This certification conforms to the RFA, as amended by the Small Business
Regulatory Enforcement Fairness Act of 1996 ("SBREFA"). 

      278.The RFA defines a "small business" to be the same as a "small business
concern" under the Small Business Act.  Under the Small Business Act, a "small business
concern" is one that:  (1) is independently owned and operated; (2) is not dominant in its field
of operation; and (3) meets any additional criteria established by the Small Business
Administration.  Section 121.201 of the Small Business Administration regulations defines a
small telecommunications entity in SIC code 4813 (Telephone Companies Except Radio
Telephone) as any entity with 1,500 or fewer employees at the holding company level. 
Entities directly subject to these rule changes are engaged in the provision of local exchange
and exchange access telecommunications services.  These entities are generally large
corporations that are dominant in their fields of operations and thus, are not "small entities" as
defined by the Act.  While these companies may have fewer than 1,500 employees and thus
fall within the SBA's definition of small telecommunications entity, we do not believe that such
entities should be considered small entities within the meaning of the RFA.  Because the small
incumbent LECs subject to these rules are either dominant in their field of operations or are
not independently owned and operated, consistent with our prior practice, they are excluded
from the definition of "small entity" and "small business concerns."  Accordingly, our use of
the terms "small entities" and "small businesses" does not encompass small incumbent LECs. 
Out of an abundance of caution, however, for regulatory flexibility analysis purposes, we will
consider small incumbent LECs within this analysis and use the term "small incumbent LECs"
to refer to any incumbent LECs that arguably might be defined by SBA as "small business
concerns."

      279.The rules adopted in this Order are threefold.  First, the rules adjust the
methodologies by which a carrier must account for transactions or sales of assets and services
with its affiliates ("accounting modifications").  Second, the rules require that BOCs
operating separate affiliates under section 272 of the 1996 Act obtain and pay for a
Federal/State joint audit every two years by an independent auditor.  Finally, BOC electronic
publishing "separated" affiliates must file either a Securities and Exchange Commission
("SEC") Form 10-K or a report "substantially equivalent" to an SEC Form 10-K with the
Commission.  We consider these in turn.

      280.Accounting Modifications.  We certify that although there are a substantial
number of small entities affected by the accounting modifications adopted herein, the
accounting modification rules we adopt in this Order will not have a substantial economic
impact on those affected small entities.  Entities directly subject to the rules adopted herein 
either provide local exchange and exchange access telecommunications services or are owned
by or affiliated with entities that provide such services, and, in the case of smaller incumbent
local exchange carriers, settle their NECA cost pool on an actual cost basis.  We note that
prior to the adoption of this Order, these small entities could already provide nonregulated
services and were already subject to our affiliate transactions rules.  Neither of the two changes
to these rules will have a substantial economic impact on small entities.  We note that the
accounting modifications adopted here are simply accounting changes with no substantial long-
term economic impact.  Moreover, we do not believe that the smaller entities that are affected
by these rules operate with as many affiliates as do larger entities, and thus the changes will
not have a substantial economic impact on small entities.  Under the rules modified here, the
prevailing price methodology will be retained in a modified form.  Previously, a carrier
could use the prevailing price method only when a substantial amount of business was
conducted with third parties.  Our previous rules, however, did not clarify the meaning of a
"substantial" amount of third-party business for the purpose of determining whether the carrier
could set a prevailing price.  Under the rules modified here, if an entity's annual sales, as
measured by quantity, to unaffiliated third parties exceed 50 percent of total annual sales of a
particular product or service then the "substantial" amount of third-party business requirement
has been satisfied and a prevailing price has been established for that particular product or
service.  Also, these entities will have to value assets in a similar manner as they value
services.  As the companies already are familiar with this method of valuation, there will not
be a substantial economic impact from the transition to the new methodology.  We therefore
certify that the accounting modifications adopted in this Order will not have a significant
economic impact on a substantial number of small entities.

      281.Periodic Audit.  Under the rules adopted herein, a BOC operating a separate
subsidiary under section 272 is required to obtain and pay for a biennial Federal/State joint
audit conducted by an independent auditor to determine whether the BOC has complied with
the rules promulgated under section 272.  None of the BOCs is a small entity, since each BOC
is an affiliate of a Regional Holding Company ("RHC"), and all of the BOCs or their RHCs
have more than 1,500 employees.  We therefore certify that the periodic audit requirements
adopted in this Order will not have a significant economic impact on a substantial number of
small entities. 

      282.Filing Form 10-K with the Commission.  Finally, our rules will require that
BOC affiliate entities engaged in electronic publishing file a report "substantially equivalent" to
an SEC Form 10-K with the Commission.  BOC affiliates that already file a Form 10-K with
the SEC may satisfy this requirement by simply filing a copy of that Form 10-K with the
Commission.  BOC affiliates that are not subject to the SEC's 10-K filing requirement,
however, must file with the Commission a report containing the same information in the same
format as the SEC's Form 10-K.  These rules do not apply to small entities because the entities
subject to this rule are BOCs or entities associated or affiliated with the BOCs.  None of the
BOCs is a small entity, since each BOC is an affiliate of a Regional Holding Company
("RHC"), and all of the BOCs or their RHCs have more than 1,500 employees.  Moreover, the
entities affected by this rule that are affiliated or associated with the BOCs are not
independently owned and operated, and therefore do not meet the definition of small entities. 
We therefore certify that the SEC Form 10-K filing requirement adopted in this Order will not
have a significant economic impact on a substantial number of small entities.      283.The Commission shall provide a copy of this certification to the Chief Counsel
for Advocacy of the SBA, and include it in the report to Congress pursuant to the SBREFA. 
The certification will also be published in the Federal Register.

          VII.  FINAL PAPERWORK REDUCTION ACT ANALYSIS

      284.The decision herein has been analyzed with respect to the Paperwork Reduction
Act of 1995, Pub. L. 104-13, and has been approved in accordance with the provisions of that
Act.  The Office of Management and Budget ("OMB") encouraged the Commission, to the
greatest extent possible, to use its existing cost allocation and affiliate transactions rules to
address the requirements established in sections 260 and 271 through 276 of the 1996 Act. 
Furthermore, OMB recommended that the FCC should, where possible, establish industry and
market conditions that, once met, would allow certain provisions of this collection to be
eliminated or mitigated.  First, we believe we have complied with OMB's request to use the
existing cost allocation and affiliate transactions rules wherever possible.  We have amended
the existing rules only where we are certain that the existing rules will not fulfill the overall
goals of the Communications Act of 1934, as amended by the 1996 Act.  Second, in
accordance with the overall policy underlying the 1996 Act, we will revisit these issues in the
future to determine if our regulations are still necessary once competition increases.                    VIII.  ORDERING CLAUSES

      285.Accordingly, IT IS ORDERED that, pursuant to sections 4(i), 4(j), 201-205,
218, 220, 260, 271-76, 303(r), 403 of the Communications Act of 1934, as amended by the
1996 Act, 47 U.S.C.  154(i), 154(j), 201-205, 218, 220, 260, 271-176, 303(r), 403, the
rules, requirements and policies discussed in this Order ARE ADOPTED and sections 32.27,
53.209, 53.211, and 53.213 of the Commission's rules, 47 C.F.R.  32.27, 53.209, 53.211,
and 53.213 ARE AMENDED as set forth in Appendix B.

     286.  IT IS FURTHER ORDERED that the requirements and regulations established in
this decision shall become effective upon approval by OMB of the new information collection
requirements adopted herein, but no sooner than thirty days after publication in the Federal
Register.


     FEDERAL COMMUNICATIONS COMMISSION




     William F. Caton
     Acting Secretary



                                                     Appendix A
                                                               
           List of Commenters in CC Docket No. 96-150

AT&T Corp. ("AT&T")
Alarm Industry Communications Committee ("AICC")
American Public Communications Council ("APCC")
Ameritech Operating Companies ("Ameritech")
Association of Telemessaging Services International ("ASTI")
Bell Communications Research, Inc. ("Bellcore")
Bell Atlantic Telephone Companies ("Bell Atlantic")
BellSouth Corporation and BellSouth Telecommunications, Inc. ("BellSouth")
Cincinnati Bell Telephone Company ("Cincinnati Bell")
Competitive Telecommunications Association ("CTA")
Florida Public Service Commission ("Florida PSC")
GTE Service Corporation and its affiliated domestic telephone operating, long distance and 
     wireless companies ("GTE")
General Services Administration ("GSA")
Kiesling Associates LLP ("Kiesling")
LDDS Worldcom ("Worldcom")
MCI Telecommunications Corporation ("MCI")
Missouri Public Service Commission ("Missouri PSC")
NYNEX Telephone Companies ("NYNEX")
National Association of Regulatory Utility Commissioners ("NARUC")
National Newspaper Association ("NNA")
New York State Department of Public Service ("NYDPS")
Newspaper Association of America ("NAA")
Pacific Telesis Group ("PacTel")
 People of State of California & Public Utilities Commission of the State of California 
("California")
Public Service Commission of Wisconsin ("Wisconsin PSC")
Puerto Rico Telephone Company ("Puerto Rico Telephone")
SBC Communications Inc. ("SBC")
Sprint Corporation ("Sprint")
Telecommunications Resellers Association ("TRA")
U S West, Inc. ("US West")
United State Telephone Association ("USTA")
Voice Tel ("Voice-Tel")
Yellow Pages Publishers Association ("YPPA")        List of Reply Commenters in CC Docket No. 96-150

AT&T Corp. ("AT&T")
American Public Communications Council ("APCC")
Ameritech Operating Companies ("Ameritech")
Bell Atlantic Telephone Companies ("Bell Atlantic")
BellSouth Corporation and BellSouth telecommunications, Inc. ("BellSouth")
Economic Strategy Institute ("ESI")
Florida Public Service Commission ("Florida PSC")
GTE Service Corporation and its affiliated domestic telephone operating, long distance and 
     wireless companies ("GTE")
General Services Administration ("GSA")
LDDS Worldcom ("Worldcom")
MCI Telecommunications Corporation ("MCI")
Missouri Public Service Commission ("Missouri PSC")
Newspaper Association of America ("NAA")
NYNEX Telephone Companies ("NYNEX")
Pacific Telesis Group ("PacTel")
Public Utilities Commission of Ohio ("Ohio")
RBOC Payphone Coalition ("Coalition")
SBC Communications Inc. ("SBC")
Sprint Corporation ("Sprint")
Telecommunications Industry Association ("TIA")
US West, Inc. ("US West")
United States Telephone Association ("USTA")
Washington Utilities and Transportation Commission ("Washington")




                                                    Appendix B 
                                                               
                          Final Rules
                                
         AMENDMENTS TO THE CODE OF FEDERAL REGULATIONS

1. Part 32 of Title 47 of the Code of Federal Regulations (C.F.R.) is amended to read as
follows:

             PART 32 -- UNIFORM SYSTEM OF ACCOUNTS
                FOR TELECOMMUNICATIONS COMPANIES
                                
Subpart B - General Instructions

  32.27Transactions with affiliates.

         ** ***

     (b)  Assets sold or transferred between a carrier and its affiliate pursuant to a tariff,
including a tariff filed with a state commission, shall be recorded in the appropriate revenue
accounts at the tariffed rate.  Non-tariffed assets sold or transferred between a carrier and its
affiliate that qualify for prevailing price valuation, as defined in part (d) below, shall be
recorded at the prevailing price.  For all other assets sold by or transferred from a carrier to its
affiliate, the assets shall be recorded at the higher of fair market value and net book cost.  For
all other assets purchased by or transferred to a carrier from its affiliate, the assets shall be
recorded at the lower of fair market value and net book cost.  For purposes of this section
carriers are required to make a good faith determination of fair market value. 

     (c)  Services provided between a carrier and its affiliate pursuant to a tariff, including a
tariff filed with a state commission, shall be recorded in the appropriate revenue accounts at
the tariffed rate.  Non-tariffed services provided between a carrier and its affiliate pursuant to
publicly-filed agreements submitted to a state commission pursuant to section 252(e) of the
Communications Act of 1934 or statements of generally available terms pursuant to section
252(f) shall be recorded using the charges appearing in such publicly-filed agreements or
statements.  Non-tariffed services provided between a carrier and its affiliate that qualify for
prevailing price valuation, as defined in part (d) below, shall be recorded at the prevailing
price.  For all other services provided by a carrier to its affiliate, the services shall be recorded
at the higher of fair market value and fully distributed cost.  For all other services received by
a carrier from its affiliate, the service shall be recorded at the lower of fair market value and
fully distributed cost, except that services received by a carrier from its affiliate that exists
solely to provide services to members of the carrier's corporate family shall be recorded at
fully distributed cost.  For purposes of this section carriers are required to make a good faith
determination of fair market value.

     (d)  In order to qualify for prevailing price valuation in sections (b) and (c) of this rule,
sales of a particular asset or service to third parties must encompass greater than 50 percent of
the total quantity of such product or service sold by an entity.  Carriers shall apply this 50
percent threshold on a asset-by-asset and service-by-service basis, rather than on a product line
or service line basis.  In the case of transactions for assets and services subject to section 272,
a BOC may record such transactions at prevailing price regardless of whether the 50 percent
threshold has been satisfied.  

         *****
   2.Part 53 of Title 47 of the C.F.R. is added to read as follows:


            PART 53 -- SPECIAL PROVISIONS CONCERNING
                    BELL OPERATING COMPANIES

Subpart C - Separate Affiliate; Safeguards.

  53.209Biennial audit 

     (a)  A Bell operating company required to operate a separate affiliate under section 272
of the Act shall obtain and pay for a Federal/State joint audit every two years conducted by an
independent auditor to determine whether the Bell operating company has complied with the
rules promulgated under section 272 and particularly the audit requirements listed in paragraph
(b) of this section.

     (b)  The independent audit shall determine: 

     (1)  Whether the separate affiliate required under section 272 of the Act has:

     (i)  Operated independently of the Bell operating company;

     (ii)  Maintained books, records, and accounts in the manner prescribed
by the Commission that are separate from the books, records and accounts maintained by the
Bell operating company; 

     (iii)  Officers, directors and employees that are separate from those of
the Bell operating company;

     (iv)  Not obtained credit under any arrangement that would permit a
creditor, upon default, to have recourse to the assets of the Bell operating company; and

     (v)  Conducted all transactions with the Bell operating company on an
arm's length basis with the transactions reduced to writing and available for public inspection,

     (2)  Whether or not the Bell operating company has:

     (i)  Discriminated between the separate affiliate and any other entity in
the provision or procurement of goods, services, facilities, and information, or the
establishment of standards;

     (ii)  Accounted for all transactions with the separate affiliate in
accordance with the accounting principles and rules approved by the Commission.  

     (3)  Whether or not the Bell operating company and an affiliate subject to
section 251(c) of the Act:

     (i)  Have fulfilled requests from unaffiliated entities for telephone
exchange service and exchange access within a period no longer than the period in which it
provides such telephone exchange service and exchange access to itself or its affiliates;

     (ii)  Have made available facilities, services, or information concerning
its provision of exchange access to other providers of interLATA services on the same terms
and conditions as it has to its affiliate required under section 272 that operates in the same
market;

     (iii)  Have charged its separate affiliate under section 272, or imputed to
itself (if using the access for its provision of its own services), an amount for access to its
telephone exchange service and exchange access that is no less than the amount charged to any
unaffiliated interexchange carriers for such service; and

     (iv)  Have provided any interLATA or intraLATA facilities or services
to its interLATA affiliate and made available such services or facilities to all carriers at the
same rates and on the same terms and conditions, and allocated the associated costs
appropriately.

     (c)  An independent audit shall be performed on the first full year of operations of the
separate affiliate required under section 272 of the Act, and biennially thereafter.   

     (d)  The Chief, Common Carrier Bureau, shall work with the regulatory agencies in the
states having jurisdiction over the Bell operating company's local telephone services, to
attempt to form a Federal/State joint audit team with the responsibility for overseeing the
planning of the audit as specified in section 53.211 and the analysis and evaluation of the audit
as specified in section 53.213.  The Federal/State joint audit team may direct the independent
auditor to take any actions necessary to ensure compliance with the audit requirements listed in
paragraph (b) of this section.  If the state regulatory agencies having jurisdiction choose not to
participate in the Federal/State joint audit team, the Chief, Common Carrier Bureau, shall
establish an FCC audit team to oversee and direct the independent auditor to take any actions
necessary to ensure compliance with the audit requirements in paragraph (b) of this section.
 
  53.211Audit planning.

     (a)  Before selecting a independent auditor, the Bell operating company shall submit
preliminary audit requirements, including the proposed scope of the audit and the extent of
compliance and substantive testing, to the Federal/State joint audit team organized pursuant to
section 53.209(d);

     (b)  The Federal/State joint audit team shall review the preliminary audit requirements
to determine whether it is adequate to meet the audit requirements in paragraph (b) of section
53.209.  The Federal/State joint audit shall have 30 days to review the audit requirements and
determine any modifications that shall be incorporated into the final audit requirements.

     (c)  After the audit requirements has been approved by the Federal/State joint audit
team, the Bell operating company shall engage within 30 days an independent auditor to
conduct the biennial audit.  In making its selection, the Bell operating company shall not
engage any independent auditor who has been instrumental during the past two years in
designing any of the accounting or reporting systems under review in the biennial audit.   

     (d)  The independent auditor selected by the Bell operating company to conduct the
audit shall develop a detailed audit program based on the final audit requirements and submit it
to the Federal/State joint audit team.  The Federal/State joint audit team shall have 30 days to
review the audit program and determine any modifications that shall be incorporated into the
final audit program.  

     (e)  During the course of the biennial audit, the independent auditor, among other
things, shall: 

     (1)  Inform the Federal/State joint audit team of any revisions to the final audit
program or to the scope of the audit.

     (2)  Notify the Federal/State joint audit team of any meetings with the Bell
operating company or its separate affiliate in which audit findings are discussed.

     (3)  Submit to the Chief, Common Carrier Bureau, any accounting or rule
interpretations necessary to complete the audit.

  53.213Audit analysis and evaluation.

     (a)  Within 60 dates after the end of the audit period, but prior to discussing the audit
findings with the Bell operating company or the separate affiliate, the independent auditor shall
submit a draft of the audit report to the Federal/State joint audit team.

     (1)  The Federal/State joint audit team shall have 45 days to review the audit
findings and audit workpapers, and offer its recommendations concerning the conduct of the
audit or the audit findings to the independent auditor.  Exceptions of the Federal/State joint
audit team to the finding and conclusions of the independent auditor that remain unresolved
shall be included in the final audit report.

     (2)  Within 15 days after receiving the Federal/State joint audit team's
recommendations and making appropriate revisions to the audit report, the independent auditor
shall submit the audit report to the Bell operating company for its response to the audit findings
and send a copy to the Federal/State joint audit team.  The independent auditor may request
additional time to perform additional audit work as recommended by the Federal/State joint
audit team. 
 
     (b)  Within 30 days after receiving the audit report, the Bell operating company will
respond to the audit findings and send a copy of its response to the Federal/State joint audit
team. The Bell operating company's response shall be included as part of the final audit report
along with any reply that the independent auditor wishes to make to the response.

     (c)  Within 10 days after receiving the response of the Bell operating company, the
independent auditor shall make available for public inspection the final audit report by filing it
with the Commission and the state regulatory agencies participating on the joint audit team.

     (d)  Interested parties may file comments with the Commission within 60 days after the
audit report is made available for public inspection.