Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-97-01497/USCOURTS-caDC-97-01497-0/pdf.json

Parties Involved:
Federal Communications Commission
Respondent
MCI Telecommunications Corporation
Petitioner
United States of America
Respondent

Document Text:

<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued January 20, 1999 Decided May 21, 1999

No. 97-1469

United States Telephone Association, et al.,

Petitioners

v.

Federal Communications Commission and

United States of America,

Respondents

AT&T Corporation, et al.,

Intervenors

Consolidated with

Nos. 97-1471, 97-1475, 97-1479, 97-1494, 97-1495,

97-1496, 97-1497, 97-1498, 97-1500, 97-1501, 97-1645

On Petitions for Review of an Order of the

Federal Communications Commission

Michael K. Kellogg argued the cause for Local Exchange

Carrier petitioners. With him on the briefs were Mark L.

Evans, William P. Barr, M. Edward Whelan, R. Michael

Senkowski, Robert J. Butler, Daniel E. Troy, James R.

Young, Michael E. Glover, Edward Shakin, James D. Ellis,

Robert M. Lynch, Liam S. Coonan, Durward D. Dupre,

Michael J. Zpevak, Thomas A. Pajda, Charles R. Morgan,

William B. Barfield, M. Robert Sutherland, Robert B.

McKenna, William T. Lake, John H. Harwood, II, Lawrence

Sarjeant and Linda Kent. Henk J. Brands, Betsy L.

Anderson and David W. Ogburn, Jr., entered appearances.

Carl S. Nadler argued the cause for petitioners MCI

Telecommunications Corporation and Ad Hoc Telecommunications Users Committee. With him on the briefs were

Donald B. Verrilli, Jr., Anthony C. Epstein, Maria L. WoodUSCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 1 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

bridge, James S. Blaszak and Kevin S. DiLallo.

Laurence N. Bourne, Counsel, Federal Communications

Commission, argued the cause for respondents. On the brief

were Joel I. Klein, Assistant Attorney General, U.S. Department of Justice, Catherine G. O'Sullivan and Robert J.

Wiggers, Attorneys, Christopher J. Wright, General Counsel,

Federal Communications Commission, John E. Ingle, Deputy

Associate General Counsel, and Brian M. Hoffstadt, Special

Counsel. Robert B. Nicholson, Attorney, U.S. Department of

Justice, entered an appearance.

Michael K. Kellogg argued the cause for Local Exchange

Carrier intervenors. With him on the brief were Mark L.

Evans, Michael S. Pabian, Donald M. Falk, James R.

Young, Michael E. Glover, Edward Shakin, Charles R. Morgan, William B. Barfield, M. Robert Sutherland, James D.

Ellis, Robert M. Lynch, Liam S. Coonan, Durward D.

Dupre, Michael J. Zpevak, Thomas J. Pajda, Robert B.

McKenna, William T. Lake and John H. Harwood, II. Henk

J. Brands, Betsy L. Anderson and David W. Ogburn, Jr.,

entered appearances.

Gene C. Schaerr argued the cause for intervenor AT&T

Corporation. With him on the brief were Jules M. Perlberg,

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 2 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

Mark C. Rosenblum, and Peter H. Jacoby. Richard P. Bress

entered an appearance.

Douglas E. Hart was on the briefs for intervenor Independent Telephone and Telecommunications Alliance on Behalf of

Small and Mid-Size Carriers.

Before: Edwards, Chief Judge, Williams and Randolph,

Circuit Judges.

Opinion for the Court filed by Circuit Judge Williams.

Williams, Circuit Judge: Long-distance telephone traffic is

ordinarily transmitted by a local exchange carrier ("LEC")

from its origin to a long-distance carrier (or interexchange

carrier or "IXC"). The IXC carries the traffic to its region of

destination and hands it off to the LEC there. The IXC

charges the customer for the call and pays "access charges"

to the LECs at either end. In a 1997 rulemaking the Federal

Communications Commission amended its methodology for

limiting these charges, as applied to the largest IXCs. The

rule is challenged on one side by a group of LECs, and on the

other by one IXC, namely MCI, and an Ad Hoc Telecommunications Users Committee (collectively referred to here as

MCI).

In regulating access charges the FCC currently uses a

"price cap" method--mandatory for the largest LECs (the

regional Bell operating companies and GTE) and optional for

others. Under traditional rate-of-return regulation an agency

sets rates calculated to allow the utility to recover its costs,

including a reasonable rate of return on investment, with

adjustment as needed to reflect cost changes; here, however,

it sets rate ceilings and, with some qualifications, allows the

utilities to keep whatever profits they can make while charging rates at or under the cap. (A LEC may also file rates

above the caps, but for these the review process is cumbersome and the substantive standards stringent.) The price

cap system is intended (among other things) to improve the

utility's incentives to cut costs and refrain from overinvestment, incentives that are more blunted under the traditional

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 3 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

method. See generally National Rural Telecom Ass'n v.

FCC, 988 F.2d 174, 177-79 (D.C. Cir. 1993).

The price caps were initially set at the levels of each

carrier's rates on July 1, 1990. From the outset they have

been subject to various annual adjustments, including reduction by a "productivity offset," or "X-Factor." See 47 CFR

s 61.45. In the order under review, the agency revised the

method for determining the X-Factor, eliminated a "sharing"

mechanism that forced LECs to return some or all of the

profits above specified levels to ratepayers, and required

"reinitialization," i.e., a reduction in the price caps applicable

after July 1, 1997 so that they would be calculated as if the

new X-Factor had been in effect for the LECs' 1996 tariff

filings. In the Matter of Price Cap Performance Review for

Local Exchange Carriers, Fourth Report & Order, 12 FCC

Rcd 16,642 (1997) ("1997 Order"). Because the access

charges are in the aggregate so enormous, even small

changes in the X-Factor have a large monetary value; the

LECs claim (without dispute) that each 0.1% change in the

factor represents a $23 million change in the industry-wide

access charge.

I. The historic productivity component of the X-Factor

The X-Factor is aimed at capturing a portion of expected

increases in carrier productivity, so that these improvements,

as under competition, will result in lower prices for consumers. In the Matter of Policy and Rules Concerning Rates for

Dominant Carriers, 3 FCC Rcd 3195, 3394 (1988). Apart

from a "consumer productivity dividend" ("CPD") described

below, it is based on an assumption that historic productivity

increases will be matched in the future. The agency resolved

in the 1997 Order that the X-Factor (apart from the CPD)

should be calculated as the sum of the difference in productivity growth and the difference in input price growth between

the LECs and the economy as a whole. See 12 FCC Rcd at

16,680, p 95. It can thus be expressed as follows: X = ( %

LEC TFP - % TFP) + ( % U.S. input prices - % LEC

input prices), where TFP = total factor productivity. See 12

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 4 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

FCC Rcd at 16,785.1 The formula may be more readily

conceptualized as X = ( % LEC TFP - LEC input prices) -

( % U.S. TFP - % U.S. input prices).

Several parties submitted estimates of historical X-Factors. In a determination unchallenged here, the FCC accorded the greatest weight to its own estimates, although it also

gave "some weight" to AT&T's estimates (we discuss this

decision below). See 1997 Order, 12 FCC Rcd at 16,695, p 37.

The estimates the FCC considered, and the averages of those

estimates over specified periods, are the following:

Table 1

Year FCC AT&T

1986 -0.5% 0.2%

1987 5.0 4.1

1988 5.0 6.4

1989 7.9 8.8

1990 8.8 11.0

1991 5.8 6.0

__________

1 This equation is apparently derived as follows from the FCC's

general rule that the X-Factor is to "provide a reliable measure of

the extent to which changes in the LECs' unit costs have been less

than the change in level of inflation," see 1997 Order, 12 FCC Rcd

at 16,647, p 5: The general rule yields X = U - L, where U is the

"change in level of inflation," and L is the change in the LECs' unit

costs. The FCC then observes that "changes in a firm's unit costs

come from two sources: (1) changes in productivity, and (2) changes

in input prices," id. at n.16. Thus, L = % LEC input price - %

LEC productivity. Reading "change in level of inflation" as

"change in unit costs in the economy as a whole," we get the similar

expression: U = % U.S. input price - % U.S. productivity.

Substituting these values into the equation X = U - L, using

"TFP" for productivity, and performing a little algebraic manipulation yields the equation in the text.

As the Commission also increases the cap by general price

inflation, see 12 FCC Rcd at 16,646, p 3, the net effect of these

adjustments is (roughly, subject to effects of the use of different

indices) to increase the cap by the LECs' estimated change in unit

costs. It is somewhat as if the overall adjustment ("A") were (using

the terms of the prior paragraph) A = U - X = U - (U - L) = L.

1992 3.4 4.1

1993 4.7 6.0

1994 5.4 5.9

1995 6.8 9.4

Specified periods (averaged)

1986-95 5.2 6.2

1987-95 5.9 6.9

1988-95 6.0 7.2

1989-95 6.1 7.3

1990-95 5.8 7.1

1991-95 5.2 6.3

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 5 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

Range of Averages: 5.2-6.1 6.2-7.3

1997 Order, 12 FCC Rcd at 16,696, p 137.

The FCC consulted the moving averages to establish a

range of reasonableness from 5.2% to 6.3% and then selected

6.0% as the historical (i.e., non-CPD) component of the XFactor. See id. at 16,697, p 141. The LECs argue that the

FCC did not give a rational explanation of that choice, and we

agree. None of the reasons given for choosing 6.0% holds

water.

A.Devaluation of 1986-95 and 1991-95 averages

First, in choosing a point within the range of reasonableness, the FCC determined that it was "reasonable to place

less weight" on two lowest averages, the ones for 1986-95 and

1991-95. It said that the first, 1986-95, "is heavily influenced

by the improbably low 1986 estimate of-0.5 percent." Id. at

16,697, p 139. But the Commission gave no reason for condemning the 1986 estimate as "improbable," and mere divergence from the other numbers does not justify such a conclusion. See Thomas H. Wonnacott & Ronald J. Wonnacott,

Introductory Statistics for Business and Economics 497 (2d

ed. 1977). The FCC invokes our cases upholding the elimination of outlying data points, but in them the agency explained

why the outliers were unreliable or their use inappropriate.

See Bell Atlantic Tel. Cos. v. FCC, 79 F.3d 1195, 1202 (D.C.

Cir. 1996) (study indicated outlier erroneous); Association of

Oil Pipe Lines v. FERC, 83 F.3d 1424, 1434 (D.C. Cir. 1996)

(skewed data distribution required outlier elimination to avoid

windfall profits to many oil pipelines).

As to the 1991-95 average, the Commission said it was the

one "most affected by the low 1992 estimate," which it in turn

diagnosed as "an artifact of a one-year jump in the measured

productivity of the national economy as economic activity

increased, rather than a change in the growth rate of LEC

productivity or input prices." 1997 Order, 12 FCC Rcd at

16,697, p 139. This is mystifying. If the productivity component of the X-Factor is to reflect the difference between LEC

and overall productivity growth, a proposition that is built

into the Commission's formula, see 1997 Order, 12 FCC Rcd

at 16,785, there seems no reason to slight a datum because its

anomalous character stems from the unusual magnitude of

the second term rather than of the first.

B.Alleged upward trend

In justification of its choice of 6.0% the FCC also cites an

upward trend in the X-Factor during the last years it surveyed. See 1997 Order, 12 FCC Rcd at 16,697, p 139

("[F]rom 1993 onward there has been an upward trend in the

X-Factor"); id. at p 141 ("[T]here appears to be a strong

upward trend in productivity growth from 1992 to 1995").2

The FCC's reliance on the upward trend necessarily reflects

the (unexplained) assumption that the trend will continue, at

least in the immediate future. Explanation might be reasonably omitted if there were no obvious reason to doubt continUSCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 6 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

uation of an observed trend. But two such reasons exist.

First, the trend appears to be part of a cyclical pattern.

Although the X-Factor did increase steadily in the 1992-95

period, it also decreased from 1990 to 1992, after rising from

1986 to 1990. See Table 1, supra. Perhaps there was reason

__________

2 The parties dispute whether the trend in question covers

1992-95 or 1993-95, with the FCC calling the reference to 1992-95

at p 141 a "typographical error," FCC Br. at 34, and the LECs

arguing that any typographical error should have been corrected in

FCC's errata, LEC Reply Br. at 10. The answer makes no

difference to our analysis.

to believe that there would be no cyclical downturn during the

expected life of this X-Factor determination, which was to be

reviewed about two years after being made. See 1997 Order,

12 FCC Rcd at 16,707, p 166. But the FCC offered no such

reason.

Second, the X-Factor is calculated as the sum of two

components, neither of which followed a trend during the

period in question. In fact, their year-to-year fluctuations

swamped the trend increments:

Table 2

Year Difference between Difference between

LEC & US changes in LEC and US changes

total factor in input prices

productivity

1992 0.21 3.21

1993 1.44 3.26

1994 3.69 1.71

1995 1.78 5.04

1997 Order, 12 FCC Rcd at 16,785. Where's the trend? As

the underlying variables appear to be thrashing about wildly,

the FCC's conclusion that the trend in the difference between

the two had some predictive value requires explanation.

C.Partial reliance on AT&T estimates

Finally, the LECs argue that in its treatment of AT&T's

X-Factor estimates the FCC "implicitly endorsed methodologies that it had earlier discredited." LEC Br. at 27. The

FCC incorporated the aspects of AT&T's method that it

deemed reasonable into its own method, see 1997 Order, 12

FCC Rcd at 16,658, p 33, and then gave independent weight

to AT&T's X-Factor estimates in deciding to extend the

range of reasonableness upward, see 1997 Order, 12 FCC Rcd

at 16,697, p 140, and to select a value near the top of the

range. Id. at p 141. We agree that both these uses of

AT&T's estimates appear irrational; any differences between

the FCC's and AT&T's estimates presumably resulted from

elements of AT&T's analysis that the FCC specifically rejected. The FCC's argument that AT&T's estimates were "helpUSCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 7 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 8 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

ful" because AT&T's methodology was "similar," FCC Br. at

37, fails to overcome that logic. If there is an explanation--

for example, conceivably the Commission gave some weight to

AT&T's conclusions out of concern for the risk that it had

erred in rejecting specific elements of AT&T's analysis--the

FCC has failed to mention it.

The Commission having failed to state a coherent theory

supporting its choice of 6.0%, we remand for further explanation.

II. Consumer productivity dividend

The second component of the X-Factor is a "consumer

productivity dividend" ("CPD") of 0.5%. At the time of the

1990 order instituting price-cap regulation, the FCC "expected ... that incentive regulation would result in greater

productivity gains than rate of return regulation," Bell Atlantic, 79 F.3d at 1198, and instituted the CPD, as it said, to

"assure that the first benefits of price caps flow to customers

in the form of reduced rates," In the Matter of Policy and

Rules Concerning Rates for Dominant Carriers, 5 FCC Rcd

6786, 6799, p 100 (1990) ("Price Cap Order"). It retained the

0.5% CPD without specific explanation in a 1995 interim rule,

Bell Atlantic, 79 F.3d at 1204, and retained it again in the

current rule. See 1997 Order, 12 FCC Rcd at 16,690, p 123.

The LECs challenge the 0.5% CPD as based on an "obsolete" justification. The Commission's earlier data on historic

productivity improvement derived from the rate-of-return

era, so an adjustment to reflect the expected incentive effects

of price caps was in order; but the post-1990 data presumably reflect those effects.

FCC counsel responds that the agency believes that an

innovation in the current rule--the Commission's elimination

of the "sharing" of profits exceeding certain benchmarks--

will give the LECs still further productivity incentives, and

that the FCC relied on that in retaining the CPD. Even if

the agency relied on this justification (which the LECs dispute), it never explained retention of the old percentage, a

retention that required some comparison of the current

change with the initial one in terms of their likely impacts on

productivity. Thus we must remand for an explanation of the

Commission's choice of the amount--0.5%.

The LECs claim that the FCC did not rely on the expected

effects of sharing elimination and that it gave no other reason

justifying the retention of any CPD. We do not reach these

arguments because the FCC will be able to give a clearer

statement of its reasons in the remand on the amount and

since the LECs do not dispute the argument FCC's counsel is

presently making--that it is defensible to include a CPD

corresponding to whatever productivity increase may be expected from the elimination of sharing.

III. Elimination of sharing

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 9 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

Before the rule at issue in this case, the FCC's price cap

regime included a "sharing" mechanism, which mandated

LEC rate reductions sufficient to return profits above specified levels to their customers, the IXCs. The most recent

sharing regime, enacted in the 1995 interim order, made the

sharing obligation dependent on the X-Factor, imposing no

obligation of firms choosing a 5.3% X-Factor, and the following on ones choosing 4.7% and 4.0%:

Table 3

Chosen X- 50% Give-back 100% Give-back

Factor required for required for

rate-of-return rate-of-return

over over

4.7% 13.25% 17.25%

4.0% 12.25% 16.25%

In the Matter of Price Cap Performance Review for Local

Exchange Carriers, 10 FCC Rcd 8961, 9058, p 222 ("Performance Review Order") (1995). Attacking the Commission's

elimination of the "sharing" mechanism, MCI first claims that

the statutory mandate of "just and reasonable" rates, 47

U.S.C. s 201(b), requires the FCC to impose a mechanism to

prevent "unreasonable" returns. In the absence of any indication that Congress directly addressed the issue, we defer to

the FCC's interpretation of the Communications Act unless it

is unreasonable. See Chevron U.S.A. Inc. v. NRDC, 467 U.S.

837 (1984). MCI cites no authority rejecting an FCC interpretation of the statute contrary to the one MCI advances,

and in Time Warner Entertainment Co. v. FCC, 56 F.3d 151

(D.C. Cir. 1995), we endorsed a pure price cap regime with no

sharing provision in the face of a statutory mandate to ensure

"reasonable" basic cable rates. See id. at 162, 164-74.

Next, MCI argues that elimination of sharing was arbitrary

and capricious. But the agency advanced two sound rationales for its decision. First, it found that "sharing severely

blunts the efficiency incentives of price cap regulation by

reducing the rewards of LEC efforts and decisions." 1997

Order, 12 FCC Rcd at 16,700, p 148. When all profits are

taken away, a firm has no incentive to make them; when

some proportion is taken away, firms will avoid at least some

otherwise desirable choices with a prospect of enhancing

profit but a risk of loss. Second, the FCC found that

eliminating sharing would remove the incentive to shift costs

to services that are subject to sharing and away from services

that are not, thus cross-subsidizing the latter. 1997 Order, 12

FCC Rcd at 16,700, p 148; id. at 16,701, p 151. MCI does not

contest these effects, nor does it question the Commission's

argument that monitoring to catch them would be administratively burdensome and would increase its reliance on obsolete

embedded accounting costs. Id. at 16,701-02, pp 151-52.

Finally, MCI contends that it was arbitrary and capricious

for the FCC to scuttle sharing but at the same time retain its

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 10 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

"low-end adjustment," which gives the LECs some pricing

leeway to prevent their returns from falling below a given

level. There is clearly a literal asymmetry in protecting

LECs in lean conditions while not constraining them in

unexpectedly fat ones. But the FCC gave a good reason for

creating this asymmetry--the Constitution's takings clause,

which forbids the imposition of confiscatory rates without just

compensation. See 1997 Order, 12 FCC Rcd at 16,704, p 157;

Duquesne Light Co. v. Barasch, 488 U.S. 299, 307-08 (1989).

The Commission thus avoided raising a non-trivial constitutional question, one that has no analogy at the upper end of

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 11 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

the range of allowable rates. See Time Warner, 56 F.3d at

170.

IV. Interstate v. total-company productivity

MCI argues that in calculating the X-Factor the FCC

arbitrarily used the LECs' productivity in all their telecommunications business rather than productivity only in their

interstate operations. Again, we disagree. The FCC reasonably concluded that "the record before us does not allow us to

quantify the extent, if any, to which interstate productivity

growth may differ significantly from total company productivity growth," 1997 Order, 12 FCC Rcd at 16,686, p 110, and

this determination was enough to justify using the total

company data.

In the first place, it is not clear that "interstate productivity," as opposed to total company productivity, is measurable,

or even economically well-defined. This is so because direct

productivity measurement requires measurement of inputs,

and there is no obviously meaningful way to segregate LEC

interstate and intrastate inputs because, as is undisputed,

"interstate and intrastate services are usually provided over

common facilities." 1997 Order, 12 FCC Rcd at 16,685, p 107.

The Commission had previously recognized this analytical

difficulty, questioning "whether it would be possible to develop separate production functions for interstate and intrastate

services," id., and it never unambiguously declared the issue

resolved.

The Commission nonetheless declared itself ready to consider some adjustment if it were shown that inclusion of

intrastate data systematically biased the X-Factor estimate

downward. 1997 Order, 12 FCC Rcd at 16,686, p 109. AT&T

offered claims of faster interstate productivity growth. It

based these on an assumption of equal growth rates for

interstate and intrastate inputs, but it offered no explanation

why that assumption was economically justified, much less

one so compelling that it would be error for the FCC to reject

it. See AT&T Comments, CC Docket No. 94-1, App. A at

23-30, 72-78; 1997 Order, 12 FCC Rcd at 16,686-87, p 110.

MCI argues that in the original 1990 LEC price cap order

the Commission inferred faster productivity growth in interstate services from the undisputed fact of faster output

increase in that sector. See Price Cap Order, 5 FCC Rcd at

6798, p 92 ("[T]he more rapid growth in interstate usage

results in higher apparent interstate productivity growth.").

This assumption should have continued, it says. But the 1990

method of measuring productivity had not depended on the

measurement of inputs at all; the Commission had simply

inferred productivity growth from prior trends in rate reductions. 1997 Order, 12 FCC Rcd at 16,648, p 8. Given the

shift to direct focus on input changes (a move that no one

questions) and the uncertainty over interstate input trends,

we do not see why the agency should have been bound to

retain the assumption of faster interstate productivity growth.

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 12 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

On this record, therefore, we do not find it unreasonable for

the agency to have relied on total company productivity

despite its theoretical shortcomings.

V. Reinitialization

"Reinitialization" is the name for the Commission's setting

a current price cap at what it would have been if past XFactors had been different. For instance, if the price cap

starts at 100 and the X-Factor is 1% for the first three years,

the cap would stand at approximately 97 at the end of those

years. 100 - (3 x 1) = 97. (The figure is only approximate

because of compounding.) If the regulator then changes the

X-Factor to 2% and imposes full reinitialization, it would

revise the cap to about 94 for the year immediately following.

100 - (3 x 2) = 94. In the 1997 Order, the FCC ordered

reinitialization for one year, 1996. See 12 FCC Rcd at 16,714,

p 179. Under our simple example, then, the cap would fall to

approximately 96. 100 - (2 x 1) [two years' reduction of

1%] - (1 x 2) [one year's reduction of 2%] = 96.

Both the LECs and MCI challenge this decision, seeking to

have it modified to favor their respective interests.

A.Reinitialization based on CPD

The LECs challenge the FCC's requirement that they

include the CPD in the X-Factor used for reinitialization. In

Part II, we explained the need to remand the case for further

explanation of size of the CPD. We agree with the LECs

that if the FCC retains the CPD because of the productivity

benefits expected from the elimination of sharing, no element

of reinitialization based on the CPD will be appropriate in the

absence of evidence linking productivity gains to the anticipation of sharing's elimination; the companies could not have

responded to that incentive before its creation.

B.Disparate impact of uniform reinitialization

The LECs argue that reinitialization fell more harshly on

carriers that chose low X-Factors with high sharing obligations for 1996 than on ones that chose high X-Factors. As

a result of reinitialization, the low X-Factor carriers lost

some of the future benefits of that choice, but were not in a

position to recover any of sharing costs that they may have

borne because of it. Reinitialization imposed no such asymmetry on companies that had elected a high X-Factor. The

LECs' specific complaint is that this was "an important

aspect of the problem" before the Commission, which it was

obliged to discuss. See Motor Vehicle Mfrs. Ass'n v. State

Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).

The Commission argues that it failed to discuss the disparity because the LECs never brought the subject up. It cites

s 405 of the Communications Act, 47 U.S.C. s 405, which

bars review of an issue on "which the Commission ... has

been afforded no opportunity to pass," see also United States

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 13 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

v. FCC, 707 F.2d 610, 619 (D.C. Cir. 1983), unless the

petitioners sought rehearing before the Commission--which

the LECs did not. The LECs in turn say they couldn't have

afforded the Commission a chance to pass on it; the Commission had never given notice of any intent to order reinitialization.

Section 405's "no opportunity to pass" clause does not in

terms exclude instances where the lack of opportunity is due

to some fault of the Commission--such as its springing a

novelty at the last minute. But we need not sort that out

here, because we find no fault in the Commission's procedure.

Reinitialization may not have been a subject on which the

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 14 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

Commission explicitly elicited comment in its notices for this

rulemaking, but the prospect surely brooded over the proceeding. In its 1995 mid-course correction of the price caps it

had ordered reinitialization--in a form, in fact, that fell only

on those LECs that had chosen a low X-Factor in exchange

for greater risk of sharing, and not at all on those that had

chosen a high one. Performance Review Order, 10 FCC Rcd

at 9069-73, pp 245-54. If the perceived asymmetry was as

serious as the LECs now make out, we should have expected

them to alert the Commission in this proceeding in advance:

"If you do a reinitialization, at least avoid the dreadful

asymmetry of the 1995 order." No such alert was sounded.

C.Reinitialization for only one year

MCI claims that the FCC should have reinitialized the XFactor all the way back to 1991 (the first year of the price-cap

regime). It says the agency has a policy of correcting errors

in X-Factor determinations and that it decided in the current

rule that prior determinations were in error. In the alternative, MCI argues that the FCC should reinitialize back to

1995, the year in which the previous X-Factor was adopted.

In the 1995 interim price cap review, the FCC determined

that a single year's productivity estimate generated by its

former method was understated, based in large part on the

estimate's discrepancy with the results of a TFP study. See

Performance Review Order, 10 FCC Rcd at 9053, p 208. It

then calculated a new X-Factor designed to eliminate the

effects of the understatement and required LECs to set their

price caps as though the new X-Factor had been in effect

since the advent of price cap regulation. See id. at 9069,

p 245. In 1997 the Commission determined that its former

method had systematically understated productivity relative

to the TFP method, but required reinitialization for one year

only. See 1997 Order, 12 FCC Rcd at 16,713-14, pp 178-79.

The situations are somewhat similar, but the FCC adequately distinguished them. It rested its 1997 decision to

limit reinitialization on the need to "limit harm to LEC

productivity incentives that could result from the perception

that our regulatory policies unnecessarily lack constancy."

1997 Order, 12 FCC Rcd at 16,714, p 179. It seems clear that

a second extensive reinitialization would considerably aggravate such a perception. Universal, complete reinitialization

would impair the supposed incentive advantages of price

caps--which derive from firms' supposing that their efficiencies will not come back to haunt them.

VI. The rule's effects on small and mid-size LECs

The Independent Telephone and Telecommunications Alliance, an intervenor, argues that the FCC acted arbitrarily

and capriciously in establishing a uniform X-Factor for all

LECs, regardless of size and economic characteristics, and in

failing to consider the disparate impact of its reinitialization

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 15 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

requirement on small and mid-size LECs. Because the petitioners here have not raised these issues, ITTA is procedurally barred from arguing them. See Illinois Bell Tel. Co. v.

FCC, 911 F.2d 776, 785-86 (D.C. Cir. 1990).

It is true, as ITTA points out, that this court in Synovus

Fin. Corp. v. Board of Governors, 952 F.2d 426, 434 (D.C. Cir.

1991), characterized the rule against consideration of issues

raised by intervenors and not by petitioners as "a prudential

restraint rather than a jurisdictional bar." But in deciding to

consider the intervenor's issue there, the court relied on the

fact that the relevant issue was "an essential predicate" to an

issue raised by a petitioner. Id. That circumstance is certainly not present here. The Synovus court offered a second

reason to hear the claim--that the intervenor was not "the

losing party in the administrative proceeding," and thus did

not have "every incentive to petition for review." Id. Here,

ITTA itself claims that it "through its members, participated

fully in the proceedings below," ITTA Reply Br. at 3, and that

its "members raised the issue of the necessity of multiple XFactors," the very issue it seeks to raise in this court.

Thus, neither of the special circumstances cited in Synovus

is present. Furthermore, ITTA presents no reason why it

could not have petitioned in its own right. We decline to

consider its arguments.

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 16 of 17
<<The pagination in this PDF may not match the actual pagination in the printed slip opinion>>

Conclusion

The FCC's decisions to select 6.0% as the first component

of the X-Factor and to retain the 0.5% CPD are reversed and

remanded to the agency for further explanation; the FCC

may of course request a stay of this order pending its

reconsideration. The petitions for review are otherwise denied.

So ordered.

USCA Case #97-1497 Document #437388 Filed: 05/21/1999 Page 17 of 17