Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-97-01048/USCOURTS-caDC-97-01048-0/pdf.json

Parties Involved:
Federal Communications Commission
Respondent
Paging Network, Inc.
Petitioner
United States of America
Respondent

Document Text:

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued May 13, 1997 Decided July 1, 1997 

No. 96-1394

ILLINOIS PUBLIC TELECOMMUNICATIONS ASSOCIATION,

PETITIONER

v.

FEDERAL COMMUNICATIONS COMMISSION AND 

UNITED STATES OF AMERICA,

RESPONDENTS

COMPETITIVE TELECOMMUNICATIONS ASSOCIATION, ET AL.,

INTERVENORS

Consolidated with

Nos. 96-1395, 96-1407, 96-1428, 96-1429, 96-1466,

96-1476, 96-1478, 96-1479, 96-1482, 96-1484,

96-1485, 96-1486, 97-1016, 97-1021, 97-1022,

97-1039, 97-1048, 97-1069, 97-1070, 97-1080

On Petitions for Review of Orders of the 

Federal Communications Commission

-

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Michael K. Kellogg argued the cause and filed briefs for 

petitioners Bell Atlantic Corporation, BellSouth Corporation, 

NYNEX Corporation, Pacific Telesis Group, Southwestern 

Bell Telephone Company and U.S. West, Inc.

Robert F. Aldrich argued the cause for petitioners American Public Communications Council, Georgia Public Communications Association and Illinois Public Telecommunications 

Association, with whom Albert H. Kramer was on the briefs.

Robert M. Gillespie, Associate General Counsel, Virginia 

State Corporation Commission, argued the cause for petitioners Utility Regulatory Commissions of the Various States. 

With him on the briefs were Lawrence G. Malone, Solicitor, 

Public Service Commission of New York, Jonathan D. Feinberg, Assistant Counsel, Penny Baker, Patrick S. Berdge, 

Peter G. Ballou, Sheldon M. Katz, Ann E. Henkener, George 

M. Fleming, and Terrence J. Buda.

Theodore B. Olson argued the cause for petitioners Personal Communications Industry Association, Paging Network, 

Inc., and Pagemart II, Inc., with whom Scott Blake Harris

and Robert L. Hoggarth were on the briefs.

David W. Carpenter argued the cause for petitioners Interexchange Carriers, with whom Mark C. Rosenblum, Peter H. 

Jacoby, Genevieve Morelli, Danny E. Adams, Steven A. 

Augustino, Michael J. Shortley, III, Dana Frix, C. Joel Van 

Over, Frank W. Krogh, Richard S. Whitt, Douglas F. Brent, 

Leon M. Kestenbaum, Jay C. Keithley and Harold R. Juhnke

were on the briefs.

John E. Ingle, Deputy Associate General Counsel, Federal 

Communications Commission, argued the cause for respondent, with whom William E. Kennard, General Counsel, 

Christopher J. Wright, Deputy General Counsel, Laurence N. 

Bourne, Joel Marcus, Counsels, Joel I. Klein, Acting Assistant Attorney General, U.S. Department of Justice, Robert B. 

Nicholson and Robert J. Wiggers, Attorneys, were on the 

brief.

Michael K. Kellogg argued the cause for intervenors, the 

Regional Bell Operating Companies and National Telephone 

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Cooperative Association, with whom L. Marie Guillory and 

David Cosson were on the brief.

Richard P. Bress argued the cause for intervenor Peoples 

Telephone Company. Maureen E. Mahoney was on the 

brief.

Robert F. Aldrich argued the cause for intervenor American Public Communications Council, with whom Albert H. 

Kramer was on the brief.

S. Walter Washington, Eva King Andries, and Elizabeth A. 

Noel, filed the joint brief for intervenors National Association 

of State Utility Consumer Advocates, et al.

Charles C. Hunter and Catherine M. Hannan filed the 

brief for intervenor Telecommunications Resellers Association.

Before: EDWARDS, Chief Judge, GINSBURG and SENTELLE, 

Circuit Judges.

Opinion for the Court filed PER CURIAM.

PER CURIAM: Before us are 20 consolidated petitions seeking review of an order of the Federal Communications Commission revamping the regulatory regime for the payphone 

industry pursuant to the Telecommunications Act of 1996. 

The petitions challenge the Commission's decisions to (1) 

assume authority over the rates for intrastate local coin calls; 

(2) set the interim rate of compensation to payphone service 

providers (PSPs) for access code calls and subscriber 800 calls 

at the market rate prevailing in the majority of states that 

have deregulated local coin calls; (3) tie the permanent rate 

of compensation for such calls to the market rate for local 

coin calls; (4) require only large interexchange carriers 

(IXCs) to pay PSPs for these calls during the first year; (5) 

require all IXCs both to track compensable coin calls and to 

compensate PSPs after the first year; (6) reclassify payphone 

assets transferred from the regulated to the deregulated 

operations of a Bell Operating Company (BOC) at net book 

value and those transferred from a BOC to a separate 

affiliate at fair market value; and (7) forbid the BOCs from 

discriminating between their own and their competitors' PSPs 

in the provision of tariffed services.

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We conclude that the Commission acted arbitrarily and 

capriciously in selecting the interim and permanent rates of 

compensation for access code and subscriber 800 calls; in 

requiring only large IXCs to pay PSPs for these calls during 

the first year; in failing to provide any interim compensation 

to PSPs for so-called "0+" calls and calls from inmate 

payphones; and in prescribing fair market value for payphone assets transferred from a BOC to a separate affiliate. 

Therefore, we grant in part and deny in part the petitions for 

review.

I. BACKGROUND

Historically only local exchange carriers (LECs) provided 

payphone service because its provision could not be accomplished independently from an LEC's network. In the mid1980s the development of "smart" payphones enabled independent PSPs to begin competing against the payphone operations of the LECs. See Implementation of the Pay Telephone Reclassfication and Compensation Provisions of the 

Telecommunications Act of 1996, Notice of Proposed Rulemaking (NPRM), 11 F.C.C.R. 6716 WW 4-6.

Generally speaking PSPs do not own the premises on which 

their payphones are located; instead, a PSP must contract 

with the owner of the premises, also known as the "location 

provider." See NPRM ¶ 6. PSPs are compensated for calls 

made from their phones in two ways. First, they collect coins 

directly deposited into the payphones. This is the usual 

method of compensation for local calls. In the states (all but 

five) that regulate the rates for local coin calls a call costs 

from $0.10 to $0.35. Id. ¶ 19 & n.59. In the states that have 

deregulated local coin rates, the market rate for a coin call is 

$0.35 per call in four and $0.25 per call in one. Id. Second, 

each PSPexcept those affiliated with a BOCis compensated through a contract with an IXC (also known as an operator 

services provider or OSP) for the provision of operator services for collect calls and for calls billed to a calling card or to 

a third party. Pursuant to these contracts, the PSP agrees to 

"presubscribe" its payphones to the OSP for these types of 

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calls; in other words, the OSP is the default IXC for any call 

made from the PSP's payphones. In exchange, the IXC 

agrees to pay the PSP a percentage of the revenues it earns 

from calls made from that PSP's payphones. Id. WW 7, 8. 

Calls made using the services of the presubscribed OSP are 

called "0+" calls because the caller simply dials "0" plus the 

number he is trying to reach. In addition to the above two 

methods of receiving compensation for calls made from payphones, the payphone operations of LECs also receive a 

subsidy from the carrier common line charges that the LECs 

assess the IXCs for originating and terminating long-distance 

calls. These subsidies place independent PSPs at a significant competitive disadvantage vis-a-vis the LECs' payphone 

operations. Id. ¶ 8.

PSPs receive no compensation for access code calls and 

subscriber 800 calls. Access code calls are the calls to 800 

numbers or 10XXX numbers that the caller uses to reach the 

long-distance carrier of his choice; all other 800 calls are 

known as subscriber 800 calls. PSPs used to block callers' 

attempts to "dial-around" the presubscribed OSP by means of 

an access code. With the passage of the Telephone Consumer Services Improvement Act (TOSCIA), Pub. L. No. 

101-435, 104 Stat. 986 (1990) (codified at 47 U.S.C. § 226), 

PSPs were no longer permitted to block such calls. See 47 

U.S.C. § 226(c)(1)(B). Because access codes are often 800 

numbers, TOSCIA effectively prevented the PSPs from 

blocking subscriber 800 calls as well. At the same time the 

Congress authorized the Commission to prescribe the compensation to be paid by the OSPs to the PSPs "for calls 

routed to providers of operator services" other than the 

presubscribed OSP. Id. § 226(e)(2). Pursuant to this provision the Commission ordered the OSPs to compensate the 

PSPs for access code calls but declined to prescribe compensation for subscriber 800 calls. See Policies and Rules 

Concerning Operator Services Access and Pay Telephone 

Compensation, 6 F.C.C.R. 4736 WW 34, 36 (1991), recon., 7 

F.C.C.R. 4355 ¶ 50 (1992).

It was against this background that the Congress enacted 

§ 276 of the Telecommunications Act of 1996 "to promote 

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competition among payphone service providers," 47 U.S.C. 

§ 276(b)(1), by having the Commission "establish a per call 

compensation plan to ensure that all payphone service providers are fairly compensated for each and every completed 

intrastate and interstate call using their payphone." Id.

§ 276(b)(1)(A). In addition, the Act forbids a BOC from 

"subsidiz[ing] its payphone service directly or indirectly from 

its telephone exchange service operations or its exchange 

access operations" or from "prefer[ing] or discriminat[ing] in 

favor of its payphone service." Id. § 276(a). The Act also 

provides that the Commission must

(B) discontinue the intrastate and interstate carrier access charge payphone service elements and payments 

... and all intrastate and interstate payphone subsidies 

from basic exchange and exchange access revenues ...; 

[and]

(C) prescribe a set of nonstructural safeguards for Bell 

operating company payphone service ... which safeguards shall, at a minimum, include the nonstructural 

safeguards equal to those adopted in the Computer InquiryIII (CC Docket No. 90-623) proceeding.

Id. § 276(b)(1).

The Commission's first task was to determine the scope of 

its new mandate. The Commission decided that the Act's 

broad directive to promulgate regulations that would ensure 

that PSPs are "fairly compensated for each and every intrastate and interstate call" required the Commission to act only 

with respect to those types of calls for which a PSP does not 

already receive fair compensation. Implementation of the 

Pay Telephone Reclassification and Compensation Provisions of the Telecommunications Act of 1996 (CC Docket No. 

96-128), FCC 96-388 WW 48-49 (rel. Sept. 20, 1996) (Order), 

recon., FCC 96-439 ¶ 4 (rel. Nov. 8, 1996) (Reconsideration). 

The Commission found that such calls included local coin 

calls, access code calls, subscriber 800 and other toll-free 

calls, and 0+ calls provided by PSPs affiliated with a BOC. 

Order WW 52-58.

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The Commission then decided that the best way of ensuring that PSPs are "fairly compensated" is to let the competitive market set the price for each call. Order ¶ 49. Accordingly, the Commission declared that the local market for coin 

calls would be deregulated except where a particular State 

could demonstrate that competition would not constrain 

prices, because, for example, payphones at certain locations 

could be priced at monopoly rates. Id. ¶ 51. In determining 

the rate at which PSPs should be compensated for access 

code calls, subscriber 800 calls, and other toll-free calls, the 

Commission rejected the cost-based approach, which attempts 

to approximate a PSP's actual cost for each type of call. The 

Commission instead adopted a "market-based" surrogate for 

the pricing of such callsnamely, the price for a local coin 

call at a particular payphone once the rates for such calls are 

deregulatedstating that the "cost[s] of originating the various types of payphone calls are similar." Id. ¶ 70. The 

Commission emphasized, however, that the local coin rate 

would be only the default rate, from which the PSPs and 

IXCs could negotiate a departure; and the Commission expected the IXCs would have "substantial leverage" to negotiate due to their ability to block subscriber 800 calls from any 

particular PSP's payphones. Id. WW 70-71; Reconsideration

¶ 71.

The Commission then had to decide who would pay the new 

charges for access code calls and subscriber 800 calls. The 

Commission concluded that rather than have the caller deposit money directly into the payphone for such calls, the IXC 

should be required to pay these charges, for which it could 

later bill the caller or the 800 subscriber, respectively. Order

WW 17, 83-85. An IXC that did not want to incur charges 

from payphones charging excessive rates could block such 

calls from those phones. Id. ¶ 17. The Commission also 

decided to hold the IXC responsible for tracking the number 

of access code calls and subscriber 800 calls it carries from 

each payphone in order to determine the amount of compensation it owes each PSP; the Commission found that it is 

technically feasible for the IXCs to track compensable calls. 

Id. ¶ 96.

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The Commission established a two-year interim compensation scheme whereby PSPs not affiliated with an LEC would 

receive compensation for access code calls and subscriber 800 

calls (but not for inmate and other 0+ calls). The interim 

compensation scheme relies upon the modal rate ($0.35) for a 

local coin call in the five states that have deregulated the rate 

for such calls. For the first year after the effective date of 

the new rules, IXCs with annual toll revenues in excess of 

$100 million must contribute monthly to a fund to be paid out 

pro rata to PSPs; the amount each IXC must contribute is 

based upon its share of total long distance toll revenues. The 

total amount to be paid into the fund is determined by 

multiplying the average number of compensable calls made 

from payphones each month by $0.35, the price of a local call 

in the majority of deregulated states. For the second year of 

the interim period, all IXCs must pay the PSPs either a 

negotiated rate or the default per-call rate of $0.35 for each 

compensable call. Order WW 50-51, 72, 117-26.

In order to ensure that LECs would be unable to subsidize 

their payphone operations with revenues from other telephone services, the Commission decided to treat all LEC 

payphones as unregulated, untariffed customer premises 

equipment; accordingly, the LECs must transfer their payphone assets from their regulated accounts to their unregulated accounts. Order WW 142-43. As a consequence the 

LECs have to "reduce their interstate CCL charges by an 

amount equal to the interstate allocation of payphone costs 

currently recovered through those charges." Order ¶ 181; 

Reconsideration ¶ 170. The Commission did not, however, 

require the LECs to provide payphone service through structurally separate affiliates; an LEC may instead maintain its 

payphone assets on its own books provided that it treats 

those assets as unregulated. Order ¶ 157. As explained 

below, the method for the valuation of the LEC's payphone 

assets depends upon whether the LEC transfers them to a 

separate corporate entity or merely segregates them for the 

purpose of regulatory accounting. Id. ¶ 162.

Finally, the Commission required the BOCs to make available to all PSPs without discrimination any basic services it 

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provides to its own payphone affiliate or division. The Commission did not prohibit the BOCs from discriminating 

against PSPs in the provision of untariffed services, such as 

the installation and maintenance of equipment, billing and 

collection for payphone services, and the provision of operator 

services. Order ¶ 149; Reconsideration ¶ 166.

II. ANALYSIS

The various petitions for review now before the court 

challenge different aspects of the Commission's new payphone regulations. The State regulatory commissions and 

the National Association of the State Utility Consumer Advocates et al. (NASUCA) contend that the Commission lacks 

authority to regulate, or in this instance to deregulate and 

prevent the States from regulating, rates for local coin calls. 

The IXCs argue that the Commission acted arbitrarily and 

capriciously insofar as it (1) used the rate for local coin calls 

in the majority of States that have deregulated their local 

coin call rates as the basis for determining the interim 

compensation for access code and subscriber 800 calls; (2) 

excused IXCs with toll revenues of less than $100 million 

from compensating PSPs for such calls during the first year 

of the interim compensation period; and (3) adopted the local 

coin call rate that a PSP sets at each payphone as the default 

rate of permanent compensation for access code and subscriber 800 calls made from that phone. Members of the paging 

industry, Personal Communications Industry Association et 

al. (PCIA), contend that the Commission arbitrarily and 

capriciously required carriers, rather than callers, to pay 

PSPs for access code and subscriber 800 calls; a group of 

IXCs (led by Cable & Wireless, Inc.) join PCIA's challenge to 

the Commission's decision to require the carriers to track 

such calls as well. Two IXCs (Telco Communications Group, 

Inc. and Excel Telecommunications, Inc.) argue that the 

Commission did not give the parties adequate notice that it 

was planning to adopt a market-based interim compensation 

scheme. The American Public Communications Council et al.

(APCC) and the Regional Bell Operating Companies 

(RBOCs), which are the seven holding companies that own 

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the BOCs, challenge the Commission's choice of methodologies for valuing payphone assets transferred from regulated 

to unregulated status; the RBOCs also contend that the 

Commission arbitrarily and capriciously excluded inmate and 

other 0+ calls from the interim compensation plan.

A. Jurisdiction over Intrastate Rates

The utility regulatory commissions of nine states, as petitioners, and the NASUCA, as an intervenor, argue that the 

Act does not give the Commission the authority to preempt 

the States' power to regulate local coin rates. The Supreme 

Court has held that "[t]he crucial question in any preemption 

analysis is always whether Congress intended that federal 

regulation supersede state law." Louisiana Public Serv. 

Comm'n v. FCC, 476 U.S. 355, 369 (1986). In the quoted case 

the Court explained that in the Communications Act of 1934 

the Congress set up a dual system of state and federal 

regulation of telephone service: under § 151 the FCC has the 

power to regulate "interstate and foreign commerce in wire 

and radio communication," but under § 152(b) we are advised 

that "nothing in [the Act] shall be construed to apply or give 

the Commission jurisdiction with respect to (1) charges, classifications, practices, services, facilities, or regulations for or 

in connection with intrastate communication service by wire 

or radio of any carrier." 47 U.S.C. §§ 151, 152(b). The 

Court read § 152(b) as "not only a substantive jurisdictional 

limitation on the FCC's power, but also a rule of statutory 

construction." 476 U.S. at 373. Because § 276 of the Telecommunications Act of 1996 is an amendment to the 1934 Act, 

it too is subject to the substantive and interpretative limitations of § 152(b). Therefore, § 276 should not be read to 

confer upon the FCC jurisdiction over local coin rates unless 

§ 276 is "so unambiguous or straightforward so as to override 

the command of § 152(b)." Id. at 377.

As we have seen, the Congress in § 276 directed the 

Commission to establish regulations to "ensure that all payphone service providers are fairly compensated for each and 

every completed intrastate and interstate call." The indicated petitioners and intervenors contend that § 276(b) does not 

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manifest the clear congressional intent necessary to preempt 

the States' power over local coin rates. They claim that the 

term "compensation" is not used interchangeably in the Act 

with the phrase "rates and charges," which appears in 

§ 226(b)(1)(c) (providing that OSPs are required to disclose to 

their customers "a quote of its rates or charges for a call"), or 

with the phrase "local coin rate," a term of art with which the 

Congress is familiar. Their point is that if the Congress had 

intended to give the Commission jurisdiction over local coin 

rates, instead of requiring only generally that PSPs be "fairly 

compensated," then it would have stated specifically that it 

was giving the Commission the authority to set the rates for 

such calls.

It is undisputed that local coin calls are among the intrastate calls for which payphone operators must be "fairly 

compensated"; the only question is whether in § 276 the 

Congress gave the Commission the authority to set local coin 

call rates in order to achieve that goal. We conclude that it 

did. The States' and the NASUCA's argument to the contrary notwithstanding, the Congress has in fact used the term 

"compensation" elsewhere in the Act in such a way so as to 

encompass rates paid by callers. For example, § 226 provides that "[t]he Commission shall consider the need to 

prescribe compensation (other than advance payment by consumers) for owners of competitive payphones"; if the petitioners were correct, then the parenthetical exception would 

be mere surplusage. The Congress also has used the term 

"compensation" in other parts of the Act in such a way as to 

include payments made by customers. See 47 U.S.C. 

§ 203(c)(1) (providing that a common carrier may not 

"charge, demand, collect, or receive a greater or less or 

different compensation"i.e., from customersthan that set 

forth in its tariffs); 47 U.S.C. § 309(j)(2)(A) (providing that 

competitive bidding may be used to grant licenses to use the 

electromagnetic spectrum if the "principal use of such spectrum will involve, or is reasonably likely to involve, the 

licensee receiving compensation from subscribers."). Because 

the only compensation that a PSP receives for a local call 

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phone providers enjoy) is in the form of coins deposited into 

the phone by the caller, and there is no indication that the 

Congress intended to exclude local coin rates from the term 

"compensation" in § 276, we hold that the statute unambiguously grants the Commission authority to regulate the rates 

for local coin calls.

The States and the NASUCA next argue that even if the 

Commission has jurisdiction over local coin rates, its decision 

to deregulate those rates was arbitrary and capricious because the Commission did not adequately take into account 

the possibility of "locational monopolies" with substantial 

market power. Here the States and the NASUCA have in 

mind situations in which a PSP obtains an exclusive contract 

for the provision of all payphones at an isolated location, such 

as an airport, stadium, or mall, and is thereby able to charge 

an inflated rate for local calls made from that location. See 

Order ¶ 59.

The Commission did not ignore the possibility of problematic locational monopolies, however; rather it concluded 

that it would deal with them if and when specific PSPs are 

shown to have substantial market power. Order ¶ 61; Reconsideration ¶ 62. The petitioners and intervenors failed to 

present any evidence that there are significant locational 

monopolies in the states that have already deregulated their 

local coin rates; accordingly, it was not unreasonable for the 

Commission to conclude that market forces generally will 

keep prices at a reasonable level, thereby making locational 

monopolies the exception rather than the rule. If locational 

monopolies turn out to be a problem, however, the Commission suggested some ways in which it might deal with them: a 

State might be permitted to require competitive bidding for 

locational contracts, or to mandate that additional PSPs be 

allowed to provide payphones at the location; and if these 

remedies fail, the Commission may consider the matter further. Order ¶ 61. Indeed, the Commission specifically reserved the right to modify its deregulation scheme, for example, by limiting the number of compensable calls from each 

payphone. Id.

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The NASUCA argues that the Commission's authority to 

act under § 276 must be narrowly tailored in order to avoid 

unnecessarily preempting the States' power to act. In this 

vein it contends that the Commission did not have to preempt 

the States' authority to regulate local coin rates in order to 

promote the widespread deployment of payphone services. 

The FCC points out that its regulation of intrastate matters 

must be as narrow as possible only when the preemption 

arises by implicationfor example, where it is impossible to 

regulate interstate matters without regulating intrastate matters. See Public Serv. Comm'n of Maryland v. FCC, 909 

F.2d 1510, 1514-15 (D.C. Cir. 1990); Public Utility Comm'n 

of Texas v. FCC, 886 F.2d 1325, 1331-32 (D.C. Cir. 1989). In 

this case the Commission has never argued that it has 

jurisdiction over local coin call rates merely by implication. 

Rather, as we have seen, the Commission has been given an 

express mandate to preempt State regulation of local coin 

calls. Accordingly, the requirement that the FCC's regulation be narrowly tailored simply does not come into play.

Finally, the petitioners argue that if the Commission has 

the authority to regulate the rates for local coin calls, then it 

may not forebear from regulating themthat is, by relying 

upon market forces to determine pricesunless it makes the 

three findings required by 47 U.S.C. § 160. These are that 

enforcement of the Act or regulation is not necessary (1) to 

ensure "just and reasonable" nondiscriminatory charges, or 

(2) "for the protection of consumers," and that (3) forbearance 

is "consistent with the public interest." The Commission 

responds that it did not forbear from applying any regulation 

or any provision of the Act, as contemplated by § 160, 

because it did establish a compensation plan in accordance 

with the directive of the statute. We agree. A market-based 

approach is as much a compensation scheme as a rate-setting 

approach; hence § 160 is simply not relevant to the regulations presently under review.

B. Setting Compensation for 800 and Access Code Calls 

Equal to the Deregulated Local Coin Rate

The FCC decided that the compensation rate for 800 and 

access code calls should be equal to the deregulated local coin 

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rate. The FCC rested this conclusion on one groundthat 

the costs of coin calls, 800 calls, and access code calls all are 

similar:

If a rate is compensatory for local coin calls, then it is an 

appropriate compensation amount for other calls as well, 

because the cost[s] of originating the various types of 

payphone calls are similar.

Order ¶ 70 (emphasis added); see also id. ("[W]e conclude 

that deregulated local coin rates are the best available surrogates for payphone costs . ..." (emphasis added)); Reconsideration ¶ 71 ("[T]he costs of originating the various types of 

payphone calls are similar."). No other justification was 

offered by the FCC for its conclusion.

The problem with the FCC's decision is that the record in 

this case is replete with evidence that the costs of local coin 

calls versus 800 and access code calls are not similar. Numerous IXCs pointed out that the costs of coin calls are 

higher than those for coinless calls because of the costs 

typically associated with use of coin equipment (e.g., the costs 

of purchasing the equipment and coin collection). See, e.g.,

AT&T Reply 6 (July 15, 1996); Cable & Wireless, Inc., 

Petition for Reconsideration 5-6 (Oct. 21, 1996); Comments 

of Sprint Corporation 9 (July 1, 1996); WorldCom, Inc., 

Petition for Reconsideration 8-9 (Oct. 21, 1996). In addition, 

IXCs showed that costs of local coin calls are higher because 

the PSP bears the costs of originating and completing local 

calls (i.e., the "end-to-end" costs); by contrast, for coinless 

calls, the PSP only bears the costs of originating the calls. 

See, e.g., AT&T Reply 12-13; Comments of Sprint Corporation 9. Even the APCC, a trade group for independent PSPs, 

acknowledged that the costs of coin calls are higher than 

those of coinless calls. See Comments of the American Public 

Communications Council 16 n.15 (July 1, 1996) ("Arguably the 

local coin rate should be higher than the rate for a [coinless] 

call because of the usage and coin collection costs typically 

associated with local coin calling."). AT&T estimated that the 

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costs of local coin calls are three times higher than those of 

coinless calls. See AT&T Reply 8-9.

The FCC failed to respond to any of the data showing that 

the costs of different types of payphone calls are not similar. 

Rather, the FCC's Order cavalierly proclaims that the costs 

of local coin calls versus 800 and access code calls are 

"similar," without even acknowledging any of the contrary 

data. See Order ¶ 70. The agency's order on Reconsideration at least recognizes that some parties had argued that the 

costs of coin calls are not "similar" to those of 800 and access 

code calls; but the FCC then dismissed the argument with 

two words"We disagree"and never provided any reasons 

for its "disagreement." See Reconsideration ¶ 71. The 

FCC's ipse dixit conclusion, coupled with its failure to respond to contrary arguments resting on solid data, epitomizes 

arbitrary and capricious decisionmaking. See Motor Vehicle 

Mfrs. Ass'n v. State Farm Mut. Automobile Ins. Co., 463 U.S. 

29, 46-57 (1983).

The FCC contends that even if the compensation rate is 

unsupported, it should be upheld because it is only a "default" 

rate. In other words, the FCC claims that IXCs will be able 

to "block" calls from overpriced payphones and, therefore, 

will be able to negotiate lower rates if the local coin rates are 

too high. See Reconsideration ¶ 71. This possibility, however, does not save a default rate that is inexplicably tied to a 

local coin rate.

We have no good reason to doubt the FCC's conclusion that 

the IXCs' potential to block calls gives them some leverage to 

negotiate. Although the IXCs protest that they cannot currently recognize overpriced payphones in "real time," see

AT&T Reply 4 n.8, they do not argue that they lack the 

technology to do so. In fact, at oral argument, counsel for 

the IXCs all but conceded that the relevant technology is 

currently available. See Tr. of Oral Argument at 15-19. We 

therefore conclude that the FCC's assumption that IXCs have 

the capacity to "block" calls is reasonable. See Telocator 

Network of Am. v. FCC, 691 F.2d 525, 539-42 (D.C. Cir. 

1982). However, this conclusion does not save the default 

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compensation rate for 800 and access code calls. The critical 

point here is that the FCC has failed to justify tying the 

default rate to local coin rates; and the mere possibility that 

the default rate might be adjusted by negotiation does not 

negate the fact that it is arbitrary. Indeed, blocking is hardly 

an ideal option for the IXCs, for it is not only expensive to 

implement, see, e.g., Petition of Sprint for Reconsideration 10 

n.8 (Oct. 21, 1996); Tr. of Oral Argument at 19 (counsel for 

the IXCs, without contradiction, stated that blocking is "immensely more expensive" then tracking), but its use invariably will result in a mutual loss of business for both the PSPs 

and the IXCs. Thus, at a minimum, the IXCs are entitled to 

a default rate that is reasonably justified, so they are not 

forced to resort to blocking only because the default rate has 

been set at an unreasonable level.

In short, the FCC's conclusion that compensation for 800 

and access code calls should be set at the deregulated local 

coin rate is unjustified. Accordingly, we remand this issue to 

the agency for further consideration.

C. Interim Plan

1. Compensation for 800 and Access Code Calls During 

the Interim Period

The IXCs also challenge the FCC's interim plan for compensation for 800 and access code calls based on a rate of $.35 

per call. Under the first phase of the interim plan, large 

IXCs (with toll revenues over $100 million) are required to 

pay a flat-rate compensation of $45.85 per payphone per 

month ($.35 per call multiplied by 131, the average number of 

800 and access code calls per payphone per month); the large 

IXCs must pay the flat-rate compensation in proportion to 

their total long distance revenues. During the second phase, 

all IXCs are required to pay $.35 per 800 or access code call. 

We find that the interim plan is arbitrary and capricious for 

two reasons.

First, the FCC cites no reasonable justification for an 

interim rate based on $.35 per call. The FCC picked the $.35 

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tion of a deregulated coin rate, as it is "the rate in the 

majority of states that have allowed the market to determine 

the appropriate local coin rate," Order ¶ 72. However, as we 

have already found, the FCC's decision to set compensation 

for 800 and access code calls at the deregulated local coin rate 

was arbitrary and capricious. Thus, the $.35 rate, which is an 

attempt to approximate the deregulated coin rate, cannot 

stand. The FCC must now set a new interim rate and decide 

what is to happen once the interim period is over. The 

agency may of course elect to use the new interim rate as a 

"default rate" at the conclusion of the interim period. If this 

were done, the PSPs and IXCs still could be left free to 

depart from the default rate through negotiations (with IXCs 

having to resort to blocking to gain leverage in any such 

negotiations).

Second, we also find that the FCC acted arbitrarily and 

capriciously in requiring payments only from large IXCs

those with over $100 million in toll revenuesfor the first 

phase of the interim plan. The FCC based this decision on 

concerns of administrative convenience. See Reconsideration

¶ 126. It is far from clear that the administrative burdens 

are as heavy as the FCC seems to believe them to be, as each 

carrier would merely be required to write a check based on 

its percentage of annual toll revenues. Yet, even assuming, 

arguendo, that the FCC's limitation marginally increases 

administrative convenience, this limitation comes at a huge 

cost. For example, if small IXCs were included, they could 

be required to pay as much as $4 million per month. As the 

small IXCs concede, this amount is "far from de minimis." 

Final Brief of Intervenor Telecommunications Resellers Association at 9. Administrative convenience cannot possibly 

justify an interim plan that exempts all but large IXCs from 

paying for the costs of services received. Perhaps more 

fundamentally, the FCC did not adequately justify why it 

based its interim plan on total toll revenues, as it did not 

establish a nexus between total toll revenues and the number 

of payphone-originated calls. Accordingly, we grant the petition for review on these points, and remand the matter to the 

FCC for further consideration.

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2. Compensation for 0+ Calls During the Interim Period

Section 276 requires the Commission to "prescribe regulations that establish a per call compensation plan to ensure 

that all payphone service providers are fairly compensated for 

each and every completed intrastate and interstate call using 

their payphone." 47 U.S.C. § 276(b)(1)(A). The Commission's Order, however, limits compensation during the first 

interim year to access code and 800-calls. Order ¶ 124-25. 

PSPs will therefore receive no interim compensation for socalled "0+" calls. Nowhere does the Commission explain 

why this is so.

The RBOCs complain that the Commission's failure to 

provide compensation for 0+ calls is both unreasoned and 

contrary to the plain language of § 276. The Commission 

does not dispute this claim on the merits. It argues rather 

that we should not consider the RBOCs' claim because they 

failed to raise it before the Commission. 47 U.S.C. § 405. 

We disagree.

The RBOCs mentioned the argument in their petition for 

clarification, but stated that they did not "anticipate any 

challenge to the Commission's failure to include, in its interim 

compensation levels, an estimate of the 0+ calls carried by 

RBOC payphones." RBOC Petition for Clarification at 5 n.1. 

The Commission uses this language to argue that the RBOCs 

affirmatively abandoned this claim in their proceedings before 

the Commission and cannot therefore raise it in this court. 

The Commission, however, focuses only on a single sentence. 

The next sentence reads, "[s]o long as the interim compensation mechanism provides some level of recompense ... on 0+ 

calls where RBOCs are not otherwise compensated, the 

RBOCs see no reason to upset the Commission's balance of 

competing concerns." Id. (emphasis in original). The 

RBOCs' promise to refrain from challenging this portion of 

the regulations was conditioned on the Commission's provision of "some level of recompense" for 0+ calls during the 

first interim year. The Commission's final interim plan included no such "level of recompense." The RBOCs did not, 

therefore, abandon this claim. Their petition for clarification 

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gave the Commission an "opportunity to pass" upon this 

question. That is all that § 405 requires. We therefore 

reject the Commission's waiver argument. On the merits, it 

is clear that the RBOCs are correct. The Commission's 

failure to provide interim compensation for 0+ calls is patently inconsistent with § 276's command that fair compensation 

be provided for "each and every completed ... call." The 

Commission's failure to provide an explanation for this seemingly illogical decision is arbitrary and capricious. On remand, the Commission must correct this flaw in the interim 

compensation scheme.

3. Compensation for Inmate Calls During the Interim 

Period

The RBOCs raise a different but related issue regarding 

compensation during the interim period for calls made from 

inmate payphones. The Commission decided that inmate 

payphones would not be eligible for any interim flat-rate 

compensation for coinless calls. The Commission said this 

decision was justified "because such payphones are not capable of originating either access code or subscriber 800 calls, 

and the interim compensation is provided only for those two 

types of calls." Reconsideration ¶ 52. The RBOCs claim 

that the Commission never adequately reconciled this determination with the "each and every completed call" language 

of § 276.

The Commission does not respond to this claim on the 

merits. It requests instead that we delay deciding this issue 

until we consider a different petition for review that also 

raises issues related to inmate payphones. We deny the 

Commission's request. There is no reason why we should 

defer judgment. The Commission has pointed to no way in 

which this issue is inextricably intertwined with the issues 

that we will decide in the subsequent inmate payphone case. 

It is entirely appropriate for us to decide this question at this 

time.

Doing so, we hold that the issue must be remanded to the 

Commission. Section 276 requires the Commission to promulgate regulations that will ensure that PSPs receive fair 

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compensation "for each and every completed intrastate and 

interstate call using their payphone." 47 U.S.C. 

§ 276(b)(1)(A). Under the regulations the Commission has 

promulgated, PSPs will receive no compensation for coinless 

calls made from inmate phones during the first interim year. 

This appears to be blatantly inconsistent with the language of 

the statute. The Commission has not explained why it is not. 

The Commission's interim compensation plan must therefore 

be remanded.

D. Carrier Pays

The PCIA petitioners challenge as arbitrary and capricious 

the Commission's decision to adopt a "carrier pays" compensation system for 800 calls. In developing a payphone compensation system, the Commission's expressed desire was to 

create "a competitive payphone industry," Order ¶ 8, that 

would be both "cost effective" and "place[ ] the payment 

obligation on the primary economic beneficiary," id. ¶ 83. 

The Commission concluded that "carrier pays" compensation 

furthers each of these goals. Petitioners disagree.

Petitioners first argue that a "carrier pays" system does 

notindeed, cannotpromote competition. This is so, petitioners explain, because the party causing the cost (the caller) 

does not have to pay it, and the party incurring the cost (the 

carrier, or, if the cost is passed on, the 800 service subscriber) has no way to decline it. The Commission, however, 

concluded that the party incurring the cost could avoid it. As 

the Commission explained, carriers have some leverage "to 

negotiate for lower per-call compensation amounts" in that 

they can block calls from particular payphones charging 

excessive rates. Reconsideration ¶ 66, ¶ 71. Subscribers to 

an 800 service can utilize a carrier's call-blocking capability 

by negotiating with the carrier to block calls from payphones 

with excessive per-call compensation charges. Order ¶ 17. 

Further, as discussed above, we have determined that the 

Commission reasonably concluded that carriers can and will 

develop blocking technology. Thus, a "buyer" (the carrier or 

the 800 service subscriber) will have the option of rejecting a 

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"seller's" (the PSP) excessively priced service. Given this 

explanation, the Commission's conclusion that a "carrier 

pays" compensation system will result in competitive market 

pricing of 800 service payphone per-call compensation 

charges was not arbitrary or capricious.

Petitioners also argue that the substantial burdens of the 

"caller pays" system outweigh the minor inconvenience to 

callers of requiring coin deposits. The Commission did not 

disagree that the burden of requiring coin deposits was slight. 

See Order ¶ 85. Nevertheless, the Commission elected to 

adopt a "carrier pays" system in order to maintain the 

convenience of coinless calling upon which the public has 

come to rely. Id. The Commission's balancing of the competing concerns of administrative efficiency and consumer 

convenience was not arbitrary.

Finally, petitioners contend that the Commission's "primary economic beneficiary" analysis is flawed. The Commission concluded that the carrier is the "primary economic 

beneficiary" of an 800 call because the call utilizes a particular carrier regardless of where the call is originated. Reconsideration ¶ 88. In addition, the Commission concluded that 

the called party received "greater economic benefit" from an 

800 service call than the calling party as evidenced by the 

fact that the called party is willing to pay for the call. See id.

As a result, the Commission concluded that it was appropriate 

for carriers to bear the per-call compensation charges for the 

calls, and that "the IXC can best pass on ... any charges for 

compensable calls" to the 800 service subscribers. Id. Petitioners argue that this analysis is arbitrary in that a carrier 

benefits from an 800 service call regardless of whether that 

call is made from a payphone or a home phone. It is the 

caller that primarily benefits from the use of the payphone. 

We fail to understand petitioners' point. The Commission did 

not disagree with petitioners that carriers (and subscribers) 

benefit from 800 service calls regardless of the source of the 

call. See id. What the Commission concluded was that as 

the "primary economic beneficiaries" of 800 service calls, 

carriers should incur the costs of the calls which, in the case 

of payphone calls, now include per-call compensation charges. 

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The Commission's judgment on this matter was neither arbitrary nor capricious. We therefore reject petitioners' challenge to the "carrier pays" compensation scheme.

E. Tracking

We can quickly dispose of the argument, made by a subset 

of IXCs, that the FCC acted arbitrarily and capriciously in 

requiring that IXCs "track" payphone calls. In its Order, the 

FCC concluded that "the requisite technology exists for IXCs 

to track calls from payphones." Order ¶ 96. None of the 

commenters disputed this claim. Instead, the complaining 

IXCs merely argue that the call tracking responsibility should 

be placed on another party. The FCC, however, acted well 

within the bounds of reasonableness in assigning this responsibility to the IXCs. As a result, we deny the petition for 

review on this claim.

F. Non-discrimination

The APCC petitioners challenge the Commission's decision 

to prohibit discrimination by BOCs only in the provision of 

basic services. According to petitioners, the nondiscrimination mandate of § 276(a)(2) of the Communications 

Act requires that the Commission adopt regulations prohibiting all discrimination by BOCs, including discrimination in the 

provision of basic services. We, of course, review an agency's 

construction of a statute which it administers under the twostep test developed by the Supreme Court in Chevron U.S.A. 

Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 

(1984). Under the first step of the Chevron test, we ask 

"whether Congress has directly spoken to the precise question at issue." Id. at 842. If so, "that is the end of the 

matter." Id. However, if Congress has not spoken directly 

to the question at issue, we then ask "whether the agency's 

answer is based on a permissible construction of the statute." 

Id. at 843. We apply this test to the FCC's construction of 

§ 276.

Section 276(a)(2) of the Communications Act provides that 

"any Bell operating company that provides payphone service 

... shall not prefer or discriminate in favor of its payphone 

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service." 47 U.S.C. § 276(a)(2). This command, taken alone, 

appears to express an unambiguous congressional intent to 

eliminate all discrimination by BOCs in favor of their payphone services. However, under step one of Chevron, we 

consider not only the language of the particular statutory 

provision under scrutiny, but also the structure and context of 

the statutory scheme of which it is a part. Amalgamated 

Transit Union v. Skinner, 894 F.2d 1362, 1368 (D.C. Cir. 

1990). Considering these other indicators of congressional 

intent, the command of § 276(a) is far from clear.

Subsection (b) of § 276 requires the Commission to adopt 

"regulations that ... prescribe a set of nonstructural safeguards ... to implement the provisions of ... subsection (a), 

which safeguards shall, at a minimum, include the nonstructural safeguards equal to those adopted in the Computer 

Inquiry-III ... proceeding." Id. § 276(b)(1)(C). The safeguards adopted in the Computer Inquiry-III proceeding do 

not prohibit all discrimination in the provision of nontariffed 

services to independent PSPs. See In the Matter of Computer III Remand Proceedings: Bell Operating Company Safeguards and Tier 1 Local Exchange Company Safeguards, 6 

F.C.C.R. 7571, 7575-76 (1991). Section 276(b)(1) thus implies 

that Congress did not view the elimination of discrimination 

in the provision of nontariffed services as necessary to comply 

with the command of § 276(a). Although petitioners point us 

to a House Report concerning § 276 which expresses an 

intent to " 'eliminate all discrimination between BOC and 

independent payphones,' " H.R. REP. NO. 104-204(I), at 88 

(1995) (emphasis added), the language and structure of the 

statute enacted do not establish an unambiguous congressional intent to eliminate all discrimination in the provision of 

nontariffed services.

We therefore proceed to step two of the Chevron test and 

ask whether the Commission's resolution of the ambiguity in 

§ 276 was "permissible." The Commission concluded that it 

was unnecessary to prohibit BOC discrimination in the provision of nontariffed services as those services "are available on 

a competitive basis and do not have to be provided by [BOCs] 

as the only source of services." Reconsideration ¶ 166. This 

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policy judgment is both reasonable and consistent with the 

Act's purposes of "promot[ing] competition and reduc[ing] 

regulation." Pub. L. No. 104-104. We therefore hold that 

the Commission's interpretation of § 276 as only requiring 

regulations eliminating discrimination in the provision of basic 

services was permissible.

G. Payphone Asset Valuation

Finally, both the BOC and APCC petitioners challenge as 

arbitrary the Commission's method of valuing payphone assets. Section 276(a)(1) provides 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." 47 U.S.C. § 276(a)(1). Subsection (b) of § 276 requires the Commission to issue "regulations that ... discontinue ... all intrastate and interstate payphone subsidies

from basic exchange and exchange access revenues." Id.

U.S.C. § 276(b)(1)(B). The Commission's rules governing the 

accounting valuation of assets transferred between affiliates 

("affiliate transaction rules") provide that:

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 

paragraph (d) of this section, 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.

47 C.F.R. § 32.27(b).

Interpreting these provisions, the Commission concluded 

that an LEC providing payphone service may, but need not 

transfer its payphone operations to a "structurally separate 

affiliate[ ]." See Order ¶ 157. Those LECs that elect not to 

transfer their payphone assets to a separate affiliate may 

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maintain the assets on the books at net book value. Id. ¶ 163. 

If, on the other hand, an LEC transfers its "payphone assets 

to either a separate affiliate or an operating division that has 

no joint and common use of assets or resources with the LEC 

and maintains a separate set of books," the LEC must record 

the transfer of assets at the higher of fair market value or net 

book value. Id. ¶ 164. Fair market value includes the value 

of "intangible assets such as location contracts." Id. According to the Commission, fair market valuation will "effectively 

capture[ ] on the carrier's books any appreciation in value of 

those assets, thus ensuring that any eventual gains would 

accrue to the benefit of the ratepayers and shareholders." 

Id. ¶ 166. The BOC petitioners contend that the Commission 

acted arbitrarily in requiring fair market valuation of those 

payphone assets transferred to a separate affiliate or operating division. Conversely, the APCC petitioners argue that 

the Commission acted arbitrarily in requiring the use of net 

book value for payphone assets not transferred.

As a general rule, utility service ratepayers "pay for service" and thus "do not acquire any interest, legal or equitable, 

in the property ... of the company. Property paid for out of 

moneys received for service belongs to the company." Board 

of Pub. Util. Comm'rs v. New York Tel. Co., 271 U.S. 23, 32 

(1926). However, we have held that neither ratepayers nor 

the company (and thus its shareholders) are necessarily entitled to increases in the value of assets employed in the 

utility's operations. See Democratic Cent. Comm. of the Dist. 

of Columbia v. Washington Metro. Area Transit Comm'n,

485 F.2d 786, 805 (D.C. Cir. 1973), cert. denied, 415 U.S. 935 

(1974). Rather, such increases are to be allocated under a 

two-step test in which the court first asks which party "bears 

the risk of loss" on the assets. AT&T Info. Sys., Inc. v. FCC,

854 F.2d 1442, 1444 (D.C. Cir. 1988). The party that bore the 

risk of loss is the party entitled to the capital gains on the 

assets. See id. Only if it is difficult to determine who bore 

the risk of loss will "the second principle come[ ] into play, 

namely, 'that those who bear the financial burden of particular utility activity should also reap the benefits resulting 

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therefrom.' " Id. (quoting Democratic Cent., 485 F.2d at 

808).

In developing its valuation methodology, the Commission 

declined to apply the two-step test we developed in Democratic Central. According to the Commission, that test is not 

"directly applicable either to the situation where a carrier 

retains the payphone assets on its books or transfers the 

payphone assets to a separate affiliate." Order ¶ 168. Instead, the Commission concluded that its affiliate transaction 

rules adequately protected the interests of ratepayers. Id.

Taken alone, this conclusion may be correct. But the Commission fails to recognize that our test in Democratic Central

was designed to protect not only the interests of ratepayers, 

but also the competing interests of shareholders. See 485 

F.2d at 806. By adopting a going concern valuation methodology, the Commission was attempting to transfer the increase in the value of the payphone operations from the 

LECs (and their shareholders) to ratepayers. This was 

plainly inappropriate under Democratic Central.

As explained above, in allocating increases in asset value 

under Democratic Central, we first ask which 

party bore the risk of loss on the assets. The answer to that 

question may change over time depending on the regulatory 

scheme in place. Prior to October 1990, the FCC regulated 

the rates of local telephone exchange companies under a rateof-return regulatory system. See Policy and Rules Concerning Rates for Proposed Dominant Carriers, Further Notice 

of Proposed Rulemaking, 3 F.C.C.R. 3195 (1988). Under a 

rate-of-return system, a company "can charge rates no higher 

than necessary to obtain sufficient revenue to cover" the costs 

of regulated activities and "achieve a fair return on equity." 

See National Rural Telecom Ass'n v. FCC, 988 F.2d 174, 177-

78 (D.C. Cir. 1993) (internal quotations and citations omitted). The 

provision of payphone service traditionally has been treated 

as a regulated activity. See 47 C.F.R. §§ 32.2351, 32.6351, 

32.5010. Thus, LEC shareholders were protected against 

losses from depreciation expenses on the assets of regulated 

activities; it was ratepayers who bore the risk of loss on such 

assets. See AT&T Info. Sys., 854 F.2d at 1444.

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However, in October 1990, the Commission switched to a 

"price cap" system of regulating the larger LECs (i.e., the 

BOCs and GTE companies). Policy and Rules Concerning 

Rates for Dominant Carriers: Second Report and Order, 5 

F.C.C.R. 6786 (1990). Under a price cap system, "the regulator sets a maximum price, and the firm selects rates at or 

below the cap." National Rural Telecom, 988 F.2d at 178. 

Cost reductions under the price cap scheme "do not trigger 

reductions in the cap," but rather increase the company's 

profits. See id. Thus, after 1990, the ratepayers no longer 

bore the risk of losses from payphone operation assets. To 

the extent a BOC incurred expenses in connection with 

payphone operations, company and shareholder profits declined. As a result, at least since 1990, investors rather than 

ratepayers have borne the risk of loss on payphone assets 

(tangible and intangible), and thus, under Democratic Central, investors should reap the benefit of increases in the 

value of such assets.

The Commission argues that our decision in Southwestern 

Bell Corp. v. FCC, 896 F.2d 1378 (D.C. Cir. 1990), forecloses 

the BOCs' challenge to the Commission's interpretation and 

application of the affiliate transaction rules to this case. We 

disagree. In Southwestern Bell, we upheld the Commission's 

affiliate transaction rules against a challenge by 

the GTE companies. In so doing, we specifically rejected the 

argument that the Commission's affiliate transaction rules 

violated Democratic Central. Id. at 1381. We concluded 

that a deviation from the rule of Democratic Central was 

appropriate in the case of "complex, ongoing affiliate transactions" so that the Commission could guard against systematic 

cost misallocation by the local exchange companies. Id. at 

1381-82. However, we specifically noted Democratic Central 's continued applicability to "one-time" transfers mandated by industry reform. Id. at 1382. In this case, the 

Commission's affiliate transaction rules as applied 

to the transfer of payphone assets pursuant to § 276's command to discontinue payphone subsidies clearly falls within 

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lenge to the Commission's application of its rules was not 

foreclosed by Southwestern Bell.

The APCC petitioners argue that the Commission erred in 

allowing payphone assets to be placed in regulated accounts 

at net book value rather than fair market value. We reject 

the APCC petitioners' challenge to the net book valuation 

method for the same reasons we accept the BOCs' challenge to the Commission's fair market method. The risk of 

loss on payphone assets was borne by shareholders. Thus, 

any increases in the value of the payphone operations belongs 

to the shareholders, not the ratepayers. Democratic Central,

485 F.2d at 806.

We also reject the APCC petitioners' argument that § 276 

requires that a BOCs payphone assets be transferred to its 

unregulated books. Section 276 simply requires that payphone subsidies be discontinued. 47 U.S.C. § 276(b)(1)(B). 

The Commission interpreted this provision as requiring only 

that payphone assets not transferred to a separate affiliate be 

accounted for under the Computer Inquiry-III nonstructural 

safeguards. Order ¶ 157. These safeguards were designed 

to "effectively protect against cross-subsidization." 6 

F.C.C.R. at 7575. We fail to see how the application of these 

safeguards to payphone service operations violates § 276's 

command to discontinue payphone subsidies.

In sum, we agree with the BOC petitioners that the Commission's fair market valuation methodology is arbitrary and 

capricious and contrary to our precedent. Therefore, we will 

vacate and remand that portion of the Commission's order for 

further proceedings. However, we reject the APCC petitioners' argument that the Commission's net book valuation 

method is arbitrary or contrary to the command of § 276. 

III. CONCLUSION

For the foregoing reasons, we grant in part and deny in 

part the petitions for review.

So ordered.

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