```

[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]

 
  EXEMPT FROM RECIPROCAL COMPENSATION REQUIREMENTS TELECOMMUNICATIONS 
                        TRAFFIC TO THE INTERNET

=======================================================================

                                HEARING

                               before the

                  SUBCOMMITTEE ON TELECOMMUNICATIONS,
                     TRADE, AND CONSUMER PROTECTION

                                 of the

                         COMMITTEE ON COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                                   on

                               H.R. 4445

                               __________

                             JUNE 22, 2000

                               __________

                           Serial No. 106-134

                               __________

            Printed for the use of the Committee on Commerce

                    ------------------------------  

                    U.S. GOVERNMENT PRINTING OFFICE
65-903CC                    WASHINGTON : 2000

                         COMMITTEE ON COMMERCE

                     TOM BLILEY, Virginia, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio               HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                    RALPH M. HALL, Texas
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
  Vice Chairman                      SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania     BART GORDON, Tennessee
CHRISTOPHER COX, California          PETER DEUTSCH, Florida
NATHAN DEAL, Georgia                 BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma              ANNA G. ESHOO, California
RICHARD BURR, North Carolina         RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California         BART STUPAK, Michigan
ED WHITFIELD, Kentucky               ELIOT L. ENGEL, New York
GREG GANSKE, Iowa                    TOM SAWYER, Ohio
CHARLIE NORWOOD, Georgia             ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma              GENE GREEN, Texas
RICK LAZIO, New York                 KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming               TED STRICKLAND, Ohio
JAMES E. ROGAN, California           DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois               THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico           BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona             LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING, 
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland

                   James E. Derderian, Chief of Staff

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

   Subcommittee on Telecommunications, Trade, and Consumer Protection

               W.J. ``BILLY'' TAUZIN, Louisiana, Chairman

MICHAEL G. OXLEY, Ohio,              EDWARD J. MARKEY, Massachusetts
  Vice Chairman                      RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               BART GORDON, Tennessee
PAUL E. GILLMOR, Ohio                BOBBY L. RUSH, Illinois
CHRISTOPHER COX, California          ANNA G. ESHOO, California
NATHAN DEAL, Georgia                 ELIOT L. ENGEL, New York
STEVE LARGENT, Oklahoma              ALBERT R. WYNN, Maryland
BARBARA CUBIN, Wyoming               BILL LUTHER, Minnesota
JAMES E. ROGAN, California           RON KLINK, Pennsylvania
JOHN SHIMKUS, Illinois               TOM SAWYER, Ohio
HEATHER WILSON, New Mexico           GENE GREEN, Texas
CHARLES W. ``CHIP'' PICKERING,       KAREN McCARTHY, Missouri
Mississippi                          JOHN D. DINGELL, Michigan,
VITO FOSSELLA, New York                (Ex Officio)
ROY BLUNT, Missouri
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
  (Ex Officio)

                                  (ii)

                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Blossman, Hon. Jay A., Jr., Commissioner, Louisiana Public 
      Service Commission.........................................    28
    Kissinger, Chad, President, On Ramp Access Inc...............    34
    Smith, Hon. Joan, Commissioner, Oregon Public Utility 
      Commission, and Chair, NARUC Telecommunications Committee..    25
    Strickling, Lawrence E., Chief, Common Carrier Bureau, 
      Federal Communicatiions Commission.........................    16
    Strumingher, Eric, Managing Director, Research, Paine Webber.    31
    Tauke, Thomas J., Executive Vice President, External Affairs 
      and Corporation Communications, Bell Atlantic..............    21
    Taylor, Robert, President and CEO, Focal Communications......    36
Material submitted for the record by:
    Selwyn, Lee E., President, Economics and Technology, Inc., 
      prepared statement of......................................    69

                                 (iii)

  

  EXEMPT FROM RECIPROCAL COMPENSATION REQUIREMENTS TELECOMMUNICATIONS 
                        TRAFFIC TO THE INTERNET

                              ----------                              

                        ThURSDAY, JUNE 22, 2000

              House of Representatives,    
                         Committee on Commerce,    
                    Subcommittee on Telecommunications,    
                            Trade, and Consumer Protection,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 11 a.m., in 
room 2123, Rayburn House Office Building, Hon. W.J. ``Billy'' 
Tauzin (chairman) presiding.
    Members present: Representatives Tauzin, Oxley, Stearns, 
Gillmor, Deal, Largent, Shimkus, Pickering, Fossella, Ehrlich, 
Bliley, ex officio, Markey, Boucher, Rush, Luther, Sawyer, 
Green, McCarthy, and Dingell, ex officio.
    Staff present: Justin Lilley, majority counsel; Cliff 
Riccio, legislative analyst; and Andy Levin, minority counsel.
    Mr. Tauzin. The subcommittee will please come to order. 
Good morning. I will ask our guests to take seats and to get 
comfortable. We have a good schedule today and we are going to 
have some interesting testimony.
    We meet today to discuss an issue that, at first glance, 
seems as complex and as arcane as any telecommunications we 
have ever discussed here. But upon further review, the 
reciprocal compensation framework of section 251 of the Telecom 
Act of 1996 is really quite simple. The reciprocal compensation 
requirement simply mandates the telecommunications carriers 
compensate each other for the cost of handling and terminating 
local phone calls.
    Ted, if you will put up the first billboard, here's how it 
works, or how it was intended to work.
    It was intended to be reciprocal. It was intended such that 
when a CLEC customer calls a Bell customer, the CLEC company 
would then compensate the Bell company terminating the call on 
its network, basically delivering the call to the Bell 
company's end customer. Likewise, when the Bell company is 
similarly situated, the company would pay the CLEC with where 
the Bell company customers placed a call to a CLEC customer, 
who then terminates the call on the CLEC network. That all 
sounds simple enough.
    Reciprocal compensation was designed in a situation where 
each is supposed to have a bunch of customers for whom the 
other company terminates the calls, completes the calls. It was 
a good idea, designed to work well.
    But it worked well in a telephone world; when the Internet 
comes along, it complicates the picture in a way I think the 
Congress never foresaw back in 1996.
    Ted, if you put up the second billboard.
    With Internet traffic almost doubling every 100 days, many 
CLECs are terminating high volumes of calls which are bound for 
the Internet under the act; that is portrayed on this second 
billboard. In this situation, the caller's Internet service 
provider, the ISP, serves as a CLEC customer--and this is an 
important point--which does not return any of phone calls that 
it receives. So in the Internet world, when the ISP is a 
customer, there is no reciprocal call back. There is no world 
where customers are equally calling each other and companies 
are equally terminating or completing calls. All of the traffic 
goes one way.
    In this situation, the caller's Internet service provider 
serves as the CLEC customer, and obviously doesn't call back. 
To the contrary, the ISP directs all the calls to the sites on 
the World Wide Web. As a result, reciprocal compensation is no 
longer there and compensation flows only one way, from the Bell 
company to the CLEC to the ISP. And, in fact, ISPs get part of 
the deal and have even referred to it in public statements as 
``kickbacks.'' The money is then used, by the ISPs own words, 
``above and beyond'' the flat rate that the ISP bills to its 
customers. So the ISP is getting a nice little kickback on the 
deal. The CLEC is getting the benefit of one-way compensation.
    Now, when you consider that reciprocal compensation charges 
are permitted charges on top of the fact that the average 
Internet session lasts 32 minutes in duration, you can see how 
the one-way flow of money adds up quickly. The average phone 
call lasts 4 or 5 minutes at most. A CLEC to any ISP will last 
on average 32 minutes, and customers are doubling every 100 
days.
    Just how much are Bell companies paying in reciprocal 
compensation? Well, I am told, in some cases it is more than 
they collect this revenue from their customers for the services 
they provide. In such a situation, then, they are left with no 
choice but to increase basic phone service, the phone service 
rates they must charge their customers, the consumers of 
America.
    I want you to think about it. If a company pays out more 
than it takes in, it has to increase the amount it takes in 
from its own customers to survive. So it is paying out more 
money than it takes in, to the CLECs and ISPs, and has to 
collect more from its basic customers, those who support the 
basic telephone network.
    Let me tell you how the situation can and is getting worse. 
Ted, if you put up the third chart. I am told that there are 
some CLECs out here who have recognized the tremendous cash-
flow that reciprocal compensation can be as it pertains to the 
Internet-bound traffic. As a result, these CLECs have allegedly 
built businesses around collecting reciprocal compensation for 
Internet bound traffic with no intention of providing 
competitive local phone service to the customers as the 1996 
act contemplates.
    Let me say it again. In 1996, we contemplated CLECs coming 
into business to compete with local phone companies, to provide 
service to phone customers and to have active local 
competition. But now, because of reciprocal compensation, some 
CLECs have figured out that all they need do is become a 
``switch,'' if you will, for traffic to the World Wide Web, and 
they can make money without ever becoming a local competitor to 
a local phone company.
    These CLECs, I am told, are nothing more than shells with 
no residential customers to speak of, and they serve as alter 
egos of the ISPs. In fact, ISPs are meeting in seminars across 
America to learn how to become CLECs so they can take advantage 
of this situation.
    I am waiting for the first one to call itself 
Bonnie&Clyde.com, because what we are talking about is the 
Information Highway robbery of the century. And if these CLECs 
are allowed to continue to do this, obviously the drain on the 
capital and the assets of our basic telephone networks is going 
to accelerate and consumers of America are going to take it 
very seriously.
    Now, I understand there are witnesses here today who will 
take issue with the scenario I just described. Frankly, I am 
glad you came. If the information that has been reported to us 
is wrong, we would love a detailed account of how and why, 
particularly when we read stories about shell game CLECs 
setting up 93 phones in a horse barn and turning it on for 23 
hours and 59 seconds each day in order to take advantage of 
reciprocal compensation, as though horses were going to somehow 
be an important player in the Internet world.
    Furthermore, I want the CLECs and ISP witnesses here to 
explain why collecting reciprocal compensation for Internet-
bound traffic does not provide their companies with an economic 
windfall far exceeding the amounts that are necessary for the 
recovery of their business costs.
    As a Member of Congress, I appreciate the fact that all 
businesses need to recover the costs; recovery of costs is the 
very notion that inspired section 251(b)(5) of the 1996 act in 
the first place. But we are concerned that the dollar amounts 
passing from the incumbent local exchange carriers to the CLECs 
under the present reciprocal arrangements do not result in the 
over-recovery of costs, leading to unfair subsidization of one 
competitor by another. I am sure that we can all agree the act 
was never intended to have that result.
    So I welcome our CLEC--our ISP witnesses to help us clear 
the air and set the record straight as they claim they are 
anxious to do.
    In addition to discussing the nexus between reciprocal 
compensation requirements and certain business practices, we 
are also going to spend some time today discussing certain 
regulatory issues that surround the reciprocal compensation 
debate. As a matter of law, reciprocal compensation only 
applies to local calls, not to long distance calls and not to 
telecommunications traffic that is interstate in nature. CLECs 
contend that when an interstate user places a call to an ISP 
that isn't a CLEC customer, that user is connecting to the ISP 
locally based server. As a result, the call is being terminated 
on the CLEC network, and as a result, the call is entirely a 
local call subject to the reciprocal compensation.
    On the other hand, the incumbent carriers contend that 
because many Web sites are located across the country, the data 
passing to these sites, regardless of CLEC distribution 
functions, are clearly interstate, long distance in nature, and 
therefore, not subject to reciprocal compensation. The FCC, it 
appears, was once well on its way to agreeing with the 
incumbent carriers, but on February 26, 1999, the Commission 
released a reciprocal compensation declaratory ruling that the 
NPRM, which established that Internet-bound calls, are not 
local at all and therefore not subject to reciprocal 
compensation.
    The FCC based its decision on so-called ``end-to-end 
analysis'' of Internet-bound calls. This analysis brought the 
FCC to the conclusion that because Internet-bound calls do not 
terminate at the ISP local server, but instead continue to one 
or more Internet Web sites located other States, such calls 
were long distance calls not subject to reciprocal 
compensation.
    In a letter sent to me by Chairman Kennard, dated June 7, 
he states, ``We found that ISP-bound calls are jurisdictionally 
mixed, largely interstate, not subject to section 251(b)(5) 
reciprocal compensation which applies to local traffic.''
    While as intriguing as that may be, I am inclined to agree 
with Chairman Kennard's statement; I think he is probably right 
in his observation. However, in the same declaratory ruling 
that the FCC characterized Internet-bound calls as interstate 
in nature, it did something quite peculiar, something we never 
thought in our wildest dreams that FCC would do, something that 
really makes its characterization of ISP-bound calls hollow and 
meaningless.
    The FCC, out of bewilderment, ruled that State PUCs could 
require reciprocal compensation to be paid by the incumbent 
carriers for Internet-bound calls, despite its ruling that 
reciprocal compensation doesn't apply to these calls in the 
first place. That, of course, leaves us rather dumbfounded.
    What is it all about? To me, this sounds like the 
Commission is saying, no, emphatically, but then turning around 
and saying what it really meant was yes. States go right ahead 
and impose reciprocal compensation, despite the fact that doing 
so allows to you regulate interstate commerce as if each of you 
was the FCC reincarnated. In the textbook example of how a 
hard-and-fast rule can be so readily negated or swallowed by an 
exception, based upon our experience, I know the FCC fights 
vigorously for its preemptive jurisdiction in this type of 
situation.
    If any of you disagree, look at the battle we had in the 
local rate-setting in the utility boards case. I have never 
seen a case where federalism was more at issue.
    So I am very anxious to hear today from Mr. Strickling of 
the FCC Common Carrier Bureau about the FCC's rationale here. 
Frankly, the letter I received from the chairman only raises 
additional questions concerning why the court of appeals 
remanded the FCC's order when it was challenged by Bell 
Atlantic back in March.
    Mr. Strickling, I want to thank you in advance for joining 
us today, and ask you that you please help me understand why 
the FCC can say that while traffic is interstate that it can be 
wholly regulated by the States that assert the right to do so. 
I am interested in learning more about the Commission's thought 
process on this one.
    With that having been said, I am looking forward to today's 
hearing. I think we are in for an interesting debate about an 
issue that is crucial to the future of phone service and of 
Internet service, and of the prices that are charged to 
consumers for both services.
    We have assembled, I think, a very balanced panel. We want 
a complete record on it. We want to give the CLECs, the ISPs, a 
chance to answer these persons.
    I thank you for coming, and I am sure that before we are 
through, we can somehow unravel this intricate web and figure 
out what is fair to consumers on both the Internet world and 
the telephone world.
    The Chair will now yield to my friend from Massachusetts, 
the ranking minority member, Mr. Markey, for a statement.
    Mr. Markey. Thank you, Mr. Chairman, very much; and I thank 
you very much for holding this hearing.
    The issue that the subcommittee will receive testimony on 
today stems from the Telecommunications Act of 1996, and its 
success in creating competition in the local telecommunications 
marketplace. The act required telecommunications carriers to 
compensate each other for the cost of terminating traffic on 
each other's networks.
    This was not a new concept. After the breakup of AT&T, we 
had to institute an access charge regime to deal equitably with 
the new relationships between AT&T and the Baby Bells, as well 
as with the emerging long distance competition. We also had 
intercarrier payments for wireless calls when wireless service 
developed.
    In developing our policy for so-called ``local loop'' 
competition in the early 1990's, I was an advocate for an 
arrangement known as ``bill and keep'' as the best and most 
straightforward way of dealing with intercarrier compensation 
and local markets. Under ``bill and keep,'' what we were 
essentially saying to telecommunications carriers is that 
everything will sort of come out in the wash as traffic flows 
between networks with identical payments or no payments, 
characterizing the compensation method. In crafting the 1994 
Markey-Fields legislation, however, we settled upon a standard 
for compensation that was not explicitly ``bill and keep,'' but 
rather a provision that called for just and reasonable 
compensation. Although the Markey-Fields bill and the companion 
Dingell-Brooks bill passed the House, the Senate failed to act, 
and the next Congress the relevant provision became known as 
reciprocal compensation and was enacted into law as part of the 
Telecom Act of 1996.
    Since local telecommunications carriers have local networks 
that carry voice data and other telecommunications services, 
and the Telecom Act of 1996 obviously encompassed promoting 
competition for all of these services, reciprocal compensation 
agreements developed among carriers in the aftermath of the 
act, which are affected by the rapid emergence of the Internet.
    Telephone traffic involving Internet service providers is 
largely characterized by the fact that the flow of traffic is 
overwhelmingly in one direction. The telecommunications carrier 
who obtained an ISP as a customer, therefore, could count on 
network traffic flowing onto its network and directed to the 
ISP. This flow of traffic to the ISP in the local market 
obviously affects the compensation to the carrier serving that 
ISP.
    How much money? The fact that we are having a hearing on 
this marketplace phenomenon reflects the fact that there is a 
significant amount of money involved.
    There is no question that innovation challenges 
telecommunications marketplace participants. But it also 
presents difficult policy questions for lawmakers and 
regulators.
    Issues revolving around local telecommunications 
competition, such as reciprocal compensation or enhanced 
service provider access charges, Internet telephony or even 
plain access charges are all difficult issues and will be with 
us for some time. For example, we have had access charges in 
place for years, and policymakers must routinely revisit the 
issue and investigate whether charges are appropriate, whether 
they should apply to ISPs, ascertain if such charges are in 
fact coming down or if access charge reductions are being 
flowed through to end-users in the form of rate reductions.
    In delving into these telecommunications issues, we must be 
mindful to ascertain whether the remedies to any current 
imbalances exist in the current marketplace with State 
regulators, or with the FCC; or finally, if Congress needs to 
intervene.
    I believe it is important to address these issues in a 
consistent way carefully balancing the interrelated policy 
implications and ending uncertainty for marketplace 
participants. I look forward to today's excellent panel that 
you have assembled, Mr. Chairman.
    I yield back the balance of my time.
    Mr. Tauzin. Thank you very much.
    The Chair is now pleased to recognize the chairman of the 
full committee, the gentleman from Richmond, Virginia, the 
cosponsor of H.R. 4445, along with Mr. Dingell and Mr. Boucher 
and I. Anytime Mr. Bliley gets together on a bill on 
telephones, you have got to figure there is a real problem out 
there.
    I want to welcome my friend.
    Chairman Bliley. Thank you, Mr. Chairman, for holding this 
hearing on the Reciprocal Compensation Adjustment Act of 2000.
    The cornerstone of the 1996 act was bringing competition to 
local telephone markets. This committee carefully crafted those 
provisions to ensure that consumers would have the same choice 
and innovation in local services that they now have in all 
other telecommunications markets. As a component of bringing 
competition to the local loop, we provided a mechanism for 
carriers to compensate each other for the exchange of local 
traffic.
    Congress and the FCC have been enabling intercarrier 
competition since 1984 in the market for interstate access. 
Long distance carriers they may access charge--pay access 
charges to local phone companies when they exchange 
traffic.Congress also ensured that wire line carriers are 
compensated for terminating calls that originate on wireless 
networks.
    My colleagues will recall that we considered the idea of 
``bill and keep,'' a concept which would essentially have 
barred compensation for the exchange of local traffic. But in 
the end, we opted for requiring reciprocal compensation, in 
part because the local phone companies argued that ``bill and 
keep'' would be unfair. But here we are, 4 years later, and the 
local phone companies now think some forms of intercarrier 
compensation may not be such a good idea after all.
    But what is even more ironic is that I find myself in 
general agreement with them.
    As my colleagues know, I have fought long and hard for the 
laws of reducing access charges, which is just another form of 
intercarrier compensation. While the recent calls proposal 
helps matters, access charges will remain too high in my view, 
and I therefore look forward to further reductions. But in the 
meantime, access charges will continue to tax consumers and 
distort competition.
    I raise the issue of inflated access charges because this 
committee must be vigilant that the same pricing distortions do 
not grab hold of the local market, which is struggling enough 
as it is to become competitive.
    This legislation is a good starting point for this 
committee to debate this important issue. It is equally 
important that the FCC insert itself in this debate as well. I 
note that the court of appeals remanded their most recent 
ruling on this issue last February. Yet the FCC has yet to take 
a single step toward resolving the matter. The committee should 
get answers this morning from the FCC witness as to why this is 
the case. We should also make sure that the FCC will meet our 
September 30 deadline for completing this matter.
    Mr. Chairman, I look forward to the testimony of all the 
witnesses this morning. And I look forward to working with you 
on this issue as we move forward.
    Thank you, Mr. Chairman, and I yield back the balance of my 
time.
    Mr. Tauzin. Thank you, Mr. Chairman.
    The Chair is now please to welcome and recognize the other 
cosponsor of H.R. 4445, my friend the ranking minority member 
of the full committee, Mr. Dingell.
    Mr. Dingell.
    Mr. Dingell. Mr. Chairman, I thank you.
    I, first, commend you for holding this hearing today on 
H.R. 4445, a bipartisan bill which is introduced along with 
Chairman Bliley, Congressman Boucher, and myself. And I am 
pleased that you have taken this leadership, both as a sponsor 
and in convening this hearing. If anyone ever needs to find an 
example of the law of unintended consequences at work, he or 
she needs to look no further than the reciprocal compensation 
provision of the Telecom Act of 1996.
    Your comments with regard to the horse barn are a matter of 
real concern. The best that it could be described as is a scam. 
The events that have been associated with this have brought to 
my mind and attention other things which can also be called 
scams, which are about to occur.
    On its face, the reciprocal compensation provision seems 
innocuous enough. In fact, it appears to make perfectly good 
sense. If two local telephone companies compete in a market 
then each must compensate the other when sending calls to the 
other's customers on the other's network. It is a perfectly 
legitimate cost settlement basis that has been used 
historically in many different business contexts.
    In an unregulated market, when businesses agree to settle 
costs this way, any unforeseen consequences may be remedied 
rather easily through private contracting. And if one party to 
the contract is engaged in an abusive practice to gain an 
unfair advantage, the other may have a legal claim that can be 
pursued in court to obtain appropriate redress.
    But in a regulated market, particularly when one exists in 
which the Congress has explicitly legislated a duty upon a 
party, the remedies for unforeseen consequences are quite 
different and, regrettably, more difficult and time-consuming 
to accomplish.
    It is not simply a matter of renegotiating a contract or 
taking the offending party to court. The law has to be changed 
to correct the inequity. And it may only be done prospectively, 
as opposed to retrospectively, to correct the wrong about which 
a complaint is very valid indeed. The longer it takes to 
accomplish the fix, the more economic harm accrues to the 
parties. And there is no redress available for past losses. 
That is why the situation before us must be remedied, and the 
sooner the better.
    Reciprocal compensation was intended to be just that, 
reciprocal. Traffic that is carried exclusively in one 
direction, as is the case for dial-up Internet connections, 
should not be subject to the same inter-carrier compensation 
scheme as calls that flow in both directions between two 
networks. This is only common sense. To do otherwise leads to 
inefficient, uneconomic behavior, where the costs are borne by 
the parties who receive no benefit. And worse, it attracts, as 
this situation before us, a host of scams where swindlers can 
profit from innocent parties with complete impunity.
    The time for action, then, is now. Internet traffic is 
increasing at an extraordinary pace. Not surprising, too, is 
the number of competitive LECs that primarily serve ISPs. 
Taking advantage of this one-way reciprocal compensation 
loophole is indeed a lucrative business. Nearly $2 billion will 
flow this year from traditional telephone companies to those 
companies serving mainly ISPs. Scott Cleland, a leading 
telecommunications analyst with Legg Mason, described this 
windfall in the following way, and I now quote:
    ``No other place in the telecom sector can companies reap a 
4,000 percent arbitrage for minimal, value-added service.'' But 
Mr. Cleland warned investors in the same article that that 
loophole was, a ``gravy train running out of track.'' The 
warning came nearly 2 years ago. Unfortunately, the remaining 
track was longer than thought by Mr. Cleland. But I hope and I 
believe the end is in sight; it certainly should be.
    Mr. Chairman, I thank you for your leadership on this 
matter. I thank my colleagues for joining me in cosponsoring 
this matter. I urge our colleagues to listen to the testimony 
closely and then examine their conscience as to the justice and 
justification for the practices that we will hear described 
today.
    I thank you, Mr. Chairman.
    Mr. Tauzin. I thank the gentleman.
    The Chair now recognizes the vice chairman of the 
subcommittee, the gentleman from Ohio, Mr. Oxley.
    Mr. Oxley. Thank you, Mr. Chairman. While the issue may be 
new, it somehow has a familiar ring to it. The battle lines 
certainly seem to be forming along well-established boundaries.
    I think it is safe to say that the issue before us is an 
example of an unintended consequence of the 1996 act. It shows 
the unpredictable nature of technology and the market. As 
rapidly as things are evolving, the wonder is there aren't a 
lot more such circumstances around.
    The question before us is whether the problem, such as it 
is, requires a legislative solution. There certainly is an 
imbalance, but is it one that the industry and the market won't 
work out over time? That is really the question.
    Amending the act is not something that should be undertaken 
lightly. If there is a true marketplace distortion resulting 
from our work, especially if it is a large discriminatory 
distortion, certainly we should fix it; but there is a 
cautionary tale here. If we could not accurately predict what 
the 2000 market would look like when we put the finishing 
touches on the act in 1996, what are the chances that we will 
accurately predict the 2004 marketplace today? This committee 
is pretty good, but not that good.
    I want to commend our former colleague and friend, Tom 
Tauke, and one of the architects of the 1996 act, for being 
with us.
    And with that, I yield back.
    Mr. Tauzin. The Chair thanks the gentleman. The Chair 
recognizes the gentleman from Virginia another cosponsor of the 
legislation and an active participant in telephone and telecom 
reform, Mr. Boucher.
    Mr. Boucher. Thank you, Mr. Chairman. I want to commend you 
for introducing H.R. 4445 and for conducting the hearing today 
which focuses on a practice that is contrary to the public 
interest and which calls for the remedy that your legislation 
provides.
    During this subcommittee's hearing on May 3, when we were 
addressing the extension of the Internet tax moratorium, I 
urged that the subject of reciprocal compensation and the abuse 
that it entails when traffic that is destined for the Internet 
is delivered by one local exchange carrier to a second local 
exchange carrier in the community has as its customer an 
Internet access provider be placed on this committee's agenda. 
H.R. 4445 is a complete response to this need and to that 
request; and I am pleased to be one of the cosponsors of the 
measure.
    The abuses to which the bill responds are real. While the 
reciprocal compensation arrangement, as the chairman indicated, 
works well with regard to traditional telephone traffic, it 
operates in a manner that is both illogical and inequitable 
when applied to traffic that is data based and is destined for 
the Internet. In this context, it has become a one-way 
arrangement with essentially no reciprocal nature.
    In many instances, CLECs have gone into the business just 
for the purpose of receiving Internet access providers so that 
they can receive reciprocal compensation payments. Since no 
calls ever originate on their networks, they make no payments 
in return.
    In other instances, the primary customers of the CLEC are 
Internet providers with the result that while some calls do, in 
fact, originate on the CLEC networks, the balance of reciprocal 
compensation payments greatly favors the CLEC. The prevalence 
of these arrangements is well illustrated by the experience of 
one large incumbent local exchange carrier which reports that, 
system-wide, it makes $20 in payments to the CLEC within its 
system as compared to every $1 in payment that the CLEC made to 
the incumbent local exchange carrier. If traditional telephone 
traffic were involved, you would expect the payments to be 
roughly equal in nature. These are largely CLECs that are 
serving ISPs and receiving a huge amount of reciprocal 
compensation flowing essentially one way only.
    I should mention that in the most egregious cases the ISPs 
themselves have qualified as CLECs of which they are the only 
customer, and they receive payment from the ILEC when their own 
customers' Internet traffic is brought to their facilities. 
They are being paid for the privilege of receiving their own 
customers' traffic. It is kind of hard to imagine a scam that 
is much greater than that.
    This distorted application of reciprocal compensation 
causes demonstrable public harm. Users of traditional telephone 
services are today subsidizing the users of enhanced services. 
This arrangement is contrary to our long-standing tradition in 
this Nation of having a set of public policies designed to keep 
basic local telephone service affordable; and in the past, if 
we have had any subsidy, it has flown from the users of 
advanced services to the users of basic telephone service. This 
use of reciprocal compensation reverses that long tradition.
    Second, the arrangement thwarts one of the primary purposes 
of the 1996 Telecommunications Act because it discourages CLECs 
from making facilities-based investments and extending their 
services to residential customers with their local exchange 
service. They actually receive more revenue from the reciprocal 
compensation payment than they would receive if they had that 
particular customer as a local telephone customer. So the last 
thing they want is to extend local telephone service on a 
competitive basis to the people with respect to whom they are 
getting reciprocal compensation payments today.
    As Internet usage grows and today's $2 billion problem 
becomes, next year, a $4 billion problem and as Internet growth 
pushes that total of disingenuous reciprocal compensation 
payments even higher, the local telephone companies are going 
to have to recover the cost of these payments through higher 
telephone bills, through reduced services or by some other 
means. The passage of the bill that we have before us would 
prevent that result. It would successfully address the other 
concerns that I have raised this morning; and Mr. Chairman, I 
very much hope that this subcommittee can report the measure at 
its earliest opportunity.
    I want to commend you for introducing the bill. I want to 
commend the other cosponsors and, along with you, I look 
forward to today's testimony.
    Mr. Tauzin. I thank my friend and I thank him for his 
extraordinarily long held interest in this reform.
    And the Chair now yields to the gentleman from Illinois, 
Mr. Shimkus, for an opening statement.
    Mr. Shimkus. Thank you, Mr. Chairman. I will be brief as I 
think most of my colleagues already have fully explained a lot 
of the concerns.
    I am one to look at it from two points of view. And I will 
be observing the question and answers. What is this going to do 
to the consumer and the price both currently and if this law is 
enacted? Because of the issue of, although current reports say 
that if the digital divide is decreasing, everybody's got 
computers, we want to make sure that it is not only that the 
hardware and the software is accessible to those, but also the 
ability to interconnect--so cost.
    And the other issue will be the smallest of the small 
companies of which I have a couple in my district. Because 
there are some real costs there, and there is some real 
switching, real lines, and some real charges that have to be 
paid for use of services, I understand that there may be 
problems out there. I am not a cosponsor yet, but I look 
forward to working with the chairman and committee members to 
address these issues and hopefully find a way to protect 
consumers.
    With that, I yield back my time.
    Mr. Tauzin. The Chair yields to the gentleman from Texas, 
Mr. Green, for an opening statement.
    Mr. Green. Thank you, Mr. Chairman, for holding this 
important hearing.
    The issue of reciprocal compensation is very complex and it 
affects every consumer. Reciprocal compensation is originally 
designed to offset the costs of terminating phone calls between 
different carriers. I am not going to bore the subcommittee, 
describing the technical workings of the billing process; what 
I do stress is, reciprocal compensation in its present form is 
not working. However, I am not completely convinced that H.R. 
4445 is the answer.
    Do I support ISPs pretending to be to be CLECs just to 
collect reciprocal compensation? Obviously not. But does there 
need to be some minimal level of compensation for those that 
terminate Internet traffic? I am not sure. We spend a 
significant amount of time trying to enhance the availability 
of Internet to our constituents, and there is a significant 
amount of debate whether reciprocal compensation is helping or 
hurting the digital divide.
    Mr. Chairman, I need to be convinced that there is a better 
solution than maybe what is before the committee today, and I 
look forward to the testimony and I hope both the benefits and 
drawbacks of the reciprocal compensation has on Internet 
accessibility to be thoroughly discussed.
    Thank you, Mr. Chairman.
    Mr. Tauzin. The Chair recognizes the gentleman from 
Mississippi, Mr. Pickering.
    Mr. Pickering. Thank you, Mr. Chairman. I thank you for 
holding this hearing today.
    As my friend from Illinois said, we do need to look first 
at, how does this affect the consumers? Second, how does this 
affect competition? Are there legitimate issues of arbitrage 
that we can effectively and narrowly address? And the last 
question is, what is the best way to resolve these? Can we 
maintain the contractual arrangements and methods with State 
help and oversight? Is that the right jurisdiction or do we 
need a Federal fix through legislation for this issue?
    I look forward to the panel's testimony. And again we do 
need to look at the market, as competition is emerging, to do 
nothing that would impede or serve as a hindrance to the 
developments of the markets evolving. If there are legitimate 
issues, we need to address them, but do it as narrowly as 
possible.
    I look forward to the rest of the hearing and, again, thank 
you for your leadership on this issue.
    Mr. Tauzin. The Chair now recognizes the gentleman from 
Oklahoma, Mr. Largent, for an opening statement.
    Mr. Largent. Thank you, Mr. Chairman. I want to thank you 
for holding this hearing on H.R. 4445, which would exempt 
reciprocal compensation requirements for the telecommunications 
traffic to the Internet.
    In 1996, when the act was first being implemented, Bell 
Atlantic submitted comments to the FCC, ``The most blatant 
example of a plea for a government handout comes from those 
parties who urge the Commission to adopt a reciprocal 
compensation price of zero. A regulatory mandated price of zero 
by any name would violate the 1996 act, the Constitution, and 
sound economic principles.''
    That was submitted to the FCC by Bell Atlantic; 4 years 
later the Bell companies have found that reciprocal 
compensation as it applies to Internet traffic is not such a 
great deal for them, and that it should be viewed as an 
unintended consequence and therefore be corrected by the 
legislation before us today.
    Mr. Chairman, if CLECs are being created that are 
essentially ISPs and their only purpose for being is to collect 
reciprocal compensation to gain the system, created by section 
251, then we need to address that problem in a selectively 
targeted manner. However, H.R. 4445 goes well beyond that 
rifle-shot approach by eliminating reciprocal compensation for 
all Internet traffic to all CLECs.
    My concern is that if ISPs are no longer eligible for 
reciprocal compensation, or calls to ISPs are no longer 
eligible for reciprocal compensation, CLECs will have two 
choices, neither of which is positive. CLECs may have to raise 
the rates they charge to ISPs, which in turn will be passed 
along to our constituents and the customer. The other option is 
that CLECs may have to go out of business. It is important to 
note that many of these reciprocal compensation contracts are 
beginning to expire. Most were made for 3-year terms and are 
coming to an end.
    The incumbent local exchange carriers are not going to make 
the same mistake twice. In all likelihood, the new negotiated 
or arbitrated reciprocal compensation rates for Internet 
traffic will be substantially less than they are today.
    Last month, I joined with you, Mr. Chairman, and several 
members of this subcommittee and sent a letter to Chairman 
Kennard requesting that the Commission complete its action on 
this issue in a fair and economically efficient manner by 
September 30 of this year. I would hope that the FCC will abide 
by that request.
    Mr. Chairman, thank you for holding this important hearing. 
I look forward to hearing from all of our witnesses, and I 
yield back.
    Mr. Tauzin. I thank my friend.
    I might add that I think 50 members of this committee all 
but two members, Democrats and Republicans, cosigned that 
letter to the FCC. I thank the gentleman.
    The Chair recognizes the gentleman from Ohio, Mr. Sawyer, 
for an opening statement.
    Mr. Sawyer. Thank you, Mr. Chairman. It is good to see our 
old colleague, Tom Tauke, here. It has been some time, and I am 
glad to know he is still in there and kicking.
    By way of summary, it seems to me we are dealing with 
several dimensions here and that the actual costs that are 
incurred are not clear to me. I don't understand what is 
driving the costs at their core, which it seems to me is very 
important to understand if we are to come to a conclusion about 
the questions that are at stake in this hearing today.
    With that, I probably revealed more about my ignorance than 
I cared to, so with that, I will stop talking and start 
listening.
    Mr. Tauzin. Mr. Stearns is recognized.
    Mr. Stearns. Thank you, Mr. Chairman.
    I, like Mr. Sawyer, am a little bit nonplussed by some of 
the issues here. I don't believe the issue is clear-cut, and I 
believe that both sides of the industry have legitimate 
concerns. CLECs argue that reciprocal compensation serves as a 
cost-based payment allowing them to recover costs for 
terminating incumbent calls.
    Additionally, they argue that CLECs have been successful in 
gaining ISP business due to superior services. Furthermore, the 
CLECs are quick to point out that elimination of reciprocal 
compensation will mean they will have to raise their rates for 
users; and I think that is something, Mr. Chairman, we have to 
put in perspective.
    The incumbent phone companies, on the other hand, argue 
that since the transmission originated by a user ultimately 
terminates at the source on the Internet, the use is excessive, 
accessing communications between an end user and an ISP, and is 
interstate and thus not subject to reciprocal compensation 
payments.
    Additionally, the incumbents argue that ISP-bound traffic 
is basically all one way; reciprocal compensation is anything 
but reciprocal and is outside the scope of the intent of the 
Telecommunications Act. So, I mean, you have, Mr. Chairman, 
both sides of the argument that are presented.
    So I look forward to this debate and compliment you on this 
hearing and ask that my entire statement be made part of the 
record.
    Mr. Tauzin. The gentleman asks unanimous consent that his 
entire statement be made part of the record. Without objection, 
it is ordered.
    [The prepared statement of Hon. Cliff Stearns follows:]
Prepared Statement of Hon. Cliff Stearns, a Representative in Congress 
                       from the State of Florida
    Mr. Chairman, thank you for holding this important hearing on H.R. 
4445, the Reciprocal Compensation Adjustment Act of 2000. I would also 
like to thank the witnesses here this morning. The purpose of this 
hearing is to examine the issue of ISP-bound traffic and whether 
federal legislation is needed to address billing and accounting of such 
traffic. Like many issues before this committee, this is a matter in 
which our witnesses all have valid points and concerns.
    The goal of the 1996 Telecommunications Act was to introduce 
competition in the local telephone market. In order to do so, one of 
the many issues that was addressed was reciprocal compensation, the 
settlement mechanism for when one local network hands traffic on to 
another. Under provisions of section 251(b)(5) of the Act, local 
exchange carriers are required to estimate reciprocal compensation for 
the transportation and termination of telecommunications. Under this 
billing and accounting mechanism, the network that originates a local 
call pays a fee to the network that terminates the local call and 
payments flow in the direction of network traffic.
    While the Federal Communications Communication, in its Reciprocal 
Compensation Order, ruled that telecommunications between the user and 
the ISP is interstate and not subject to reciprocal compensation, it 
left state PUC rulings requiring reciprocal compensation intact. 
Earlier this year, a U.S. District Court vacated the FCC's rules on 
reciprocal compensation, ruling the FCC had not adequately explained 
why calls to ISPs were interstate, rather than intrastate, in nature.
    While the FCC reevaluates the dynamics of reciprocal compensation. 
Competitive Local Exchange Companies (CLECs) are aggressively signing 
up ISPs as customers. Since an ISP's telephone network doesn't 
typically make any outbound telephone calls, there is no compensation 
that flows to the incumbent carrier for origination and termination of 
traffic by the ISP's carrier, the CLEC.
    As I stated earlier, I believe this is an issue which is far from 
clear cut and believe both sides of the industry have legitimate 
concerns. CLECs argue that reciprocal compensation serves as a cost-
based payment, allowing them to recover costs for terminating 
incumbents' calls. Additionally, they argue that CLECs have been 
successful in gaining ISP business due to superior service. 
Furthermore, the CLECs are quick to point out that elimination of 
reciprocal compensation will mean they will have to raise rates for 
users.
    The incumbent phone companies, on the other hand, argue since the 
transmission originated by a user ultimately terminates at the source 
on the Internet the user is accessing, communication between an end 
user and an ISP is interstate, and thus, not subject to reciprocal 
compensation payments. Additionally, the incumbents argue that since 
ISP-bound traffic is practically all one way, reciprocal compensation 
is anything but reciprocal, and is outside the scope of the intentions 
of the Telecommunications Act.
    On top of it, incumbents cite instances of CLECs now ``gaming'' 
reciprocal compensation in such a way as to aggressively sign-up 
customers that only terminate traffic, there by allowing them to 
collect millions of dollars from the incumbents. Furthermore, in some 
instances, reciprocal compensation has opened the door for fraud and 
abuse. Earlier this year, the North Carolina Utilities Commission ruled 
that BellSouth would not have to pay reciprocal compensation to US LEC 
of North Carolina, because the CLEC had deliberately manipulated the 
routing of calls ``for the purpose of generating reciprocal 
compensation.'' One of the commissioners, in fact, described the 
actions of US LEC as ``fraudulent, unfair and deceptive and perhaps 
even criminal.''
    As Congress and the FCC examine reciprocal compensation, it is 
imperative to be mindful of the original intent of this billing and 
accounting mechanism, to reimburse competitors for the costs of 
terminating traffic. While there certainly are legitimate business 
models centered around one way-traffic schemes, effective 
telecommunications policy needs to recognize and distinguish, these 
legitimate systems from ones created merely to manipulate the system. 
At the end of the day, as in any accounting model, if there is no off-
setting model, then it is not reciprocal.
    I look forward to a lively debate and listening to both sides of 
the industry on this important matter. Once again, thank you for 
holding this hearing Mr. Chairman.

    Mr. Tauzin. The Chair will ask general, unanimous consent 
that all members' written statements and all witnesses' written 
statements be made part of the records. Without objection, so 
ordered.
    [Additional statement submitted for the record follows:]
Prepared Statement of Hon. Barbara Cubin, a Representative in Congress 
                       from the State of Wyoming
    Thank you, Mr. Chairman, for holding this important legislative 
hearing on your bill to establish a separate reciprocal compensation 
rule regarding ISP-bound traffic.
    I want to begin by saying I think the authors of the 1996 
Telecommunications Act had it right when they allowed local and long 
distance telephone companies to compensate each other for carrying the 
others' telephone traffic.
    These types of charges were implicitly negotiated between--and 
obviously accepted by--the incumbent and competitive local exchange 
carriers and subsequently put forth in the '96 Act.
    I do, however, have a problem with Internet Service Providers 
(ISPs) posing as Competitive Local Exchange Carriers (CLECs) to receive 
a slice of the reciprocal compensation pie even though they are not 
providing--and have no intention of providing--competition to the 
incumbent local telephone company.
    These bogus CLECs should not be allowed to operate for the sole 
purpose of milking the customers of incumbent telephone companies--and 
that's exactly what ends up happening. The incumbent local exchange 
carriers (ILECs) are having to charge more from their customers to 
cover these costs.
    That type of activity, however, can be easily avoided since these 
are negotiated agreements with the ILECs. In addition, if CLECs are not 
providing adequate services, they cannot become certified by the 
state's Public Utility Commission.
    We passed--and I enthusiastically supported--the Telecommunications 
Act of 1996 to bring more competition into all areas of the United 
States, provide telephone customers with lower costs, and bring more 
advanced services to all Americans.
    Mr. Chairman, I'm proud of the work we've done to ensure that 
competition reaches all comers of this country.
    To my knowledge there are about 27 CLECs operating in Wyoming. 
That's a significant number of Wyoming telephone customers being served 
by companies that probably weren't around before 1996.
    I'm worried, however, about the thought of pulling the reciprocal 
compensation rug out from under the competitive telephone industry and 
how that could adversely affect the rollout of both telephone and 
advanced services, especially in rural areas.
    These types of Congressional actions--like the one we're 
participating in today--put investors on Wall Street on alert and 
fosters uncertainty.
    That spells disaster for those start up companies out there that 
are thinking of bringing telecommunication services to Wyoming.
    During this hearing I want to hear from all the witnesses on how 
these reciprocal compensation charges either hinder or help spur 
competition.
    It is my position that if it hurts competition in any way or will 
end up costing Internet users more, I will have a hard time supporting 
the legislation before us today.
    Again, Mr. Chairman, thank you for holding this hearing today. I 
look forward to hearing from the witnesses.

    Mr. Tauzin. Now that sets us up for our first panel, and it 
also is cause for me to remind you that your written statements 
are part of our record. So we would ask you in the 5 minutes 
allotted to each one of our witnesses to use the time to 
summarize the high points of your testimony for the committee.
    Let me also define the schedule for the members and the 
witnesses. Ms. Smith has a 12:30 requirement, I think a 
presentation elsewhere in the Capitol. We are going to make 
time for you to leave and make that commitment, Joan. What we 
will do is, we will go through our panel and we will dismiss 
Ms. Smith so she can make her commitment; and ask you to 
return, if you can, after that commitment. We will continue our 
panel and our discussion, our dialog, with the panel.
    We are told that there are votes scheduled about 1. So we 
will try to go until then and when we break for the votes, we 
will take an hour break to give everyone a chance to go to 
lunch and take care of business.
    So we will proceed by first welcoming all the panel. I 
particularly want to welcome my friend from Louisiana, Jay 
Blossman, a member of our Public Service Commission and, I 
think, a rising star in Louisiana political history.
    And welcome. We appreciate that you are here.
    And also--my colleagues have also noted our friend, Mr. 
Tauke, who served this committee for many years and was an ally 
of mine in many deregulatory efforts.
    Tom, welcome back.
    We will start with our star witness from the FCC, Mr. 
Strickling, the Chief of the Common Carrier Bureau of the FCC; 
and I again remind you that we have a timer. We will set the 
timer and ask you to summarize within 5 minutes. Welcome, Mr. 
Strickling.

  STATEMENTS OF LAWRENCE E. STRICKLING, CHIEF, COMMON CARRIER 
 BUREAU, FEDERAL COMMUNICATIIONS COMMISSION; THOMAS J. TAUKE, 
  EXECUTIVE VICE PRESIDENT, EXTERNAL AFFAIRS AND CORPORATION 
 COMMUNICATIONS, BELL ATLANTIC; HON. JOAN SMITH, COMMISSIONER, 
      OREGON PUBLIC UTILITY COMMISSION, AND CHAIR, NARUC 
   TELECOMMUNICATIONS COMMITTEE; HON. JAY A. BLOSSMAN, JR., 
    COMMISSIONER, LOUISIANA PUBLIC SERVICE COMMISSION; ERIC 
  STRUMINGHER, MANAGING DIRECTOR, RESEARCH, PAINE WEBBER; AND 
         CHAD KISSINGER, PRESIDENT, ON RAMP ACCESS INC.

    Mr. Strickling. Good morning, Mr. Chairman, and members of 
the subcommittee. I want to thank you for the opportunity to 
testify here this morning on this issue of the regulatory 
treatment of dial-up telephone calls to the Internet.
    My written statement provides a summary of the history of 
this issue in the enactment of the Telecommunications Act, so I 
won't repeat that discussion here except to respond to the 
questions you put to me in your opening statement.
    You asked how, if the FCC could conclude that this traffic 
was interstate, we could then turn it over to the States to 
actually determine what compensation scheme should apply to it. 
And the answer is quite simple: At the same time that we made 
the declaration that the traffic was interstate, we needed then 
to undertake an additional rulemaking to set the Federal 
compensation scheme.
    The Administrative Procedures Act requires that and we 
proceeded with that rulemaking at the time. But we were faced 
with the quite practical difficulty that this traffic existed 
today and there were contracts under which this traffic was 
being exchanged today, so what would the regime be for this 
interim period while the Commission could collect comments and 
determine what the Federal rule should be. It was in that 
context that the Commission said, well, let's preserve the 
status quo, let's allow these contracts and the State 
commissions, that had already been very actively engaged in 
this process, to continue to evaluate how to deal with this 
traffic until we could complete our rulemaking.
    As you correctly observed, before we could conclude that 
rulemaking, the court of appeals intervened and said, well, 
wait a second, Commission, we want you to go back and take a 
second look at your jurisdictional determination.
    That is back before us; it is an open proceeding. The 
Commission will be releasing a public notice in the next few 
days to seek additional comment and information from all the 
interested parties to that. And I do hope and expect that the 
Bureau will complete its work on this matter in time to meet 
the September 30 deadline that you and many other members of 
the committee have requested we do.
    But it is important to understand that this Commission has 
never yet spoken to the question of what should be the 
compensation scheme, if any, that applies to this traffic, 
assuming it is interstate. Obviously, I am somewhat constrained 
in what I can say today, because this matter is in an open 
proceeding. But I do think it is certainly appropriate for the 
subcommittee to educate itself about the controversy today and 
evaluate whether legislation would be warranted. And in that 
spirit, while we again obviously can't provide a Commission 
recommendation on H.R. 4445 and whether it should be passed in 
its present form, I would like to offer some factual 
observations about the debate to assist members of the 
subcommittee as it evaluates the various positions of the 
stakeholders in this debate.
    I'd like to offer five points for your consideration.
    First, this issue of intercarrier compensation is much 
bigger than just the controversy over dial-up traffic to the 
Internet, and I would urge the subcommittee to take a look at 
all the various schemes that exist today for inter-carrier 
compensation before it decides to legislate on just this one 
piece of a much larger puzzle. We have separate compensation 
arrangements for pay phone providers, paging companies, long 
distance companies, competitive local exchange carriers. 
Depending on what label we apply to a transaction in one case, 
a carrier may receive compensation for delivering traffic to a 
second carrier, and in another, the same carrier performing the 
same function may be required to pay compensation to the 
carrier to which it delivers traffic. And this issue of the one 
way nature of Internet traffic again is not unique just to the 
Internet. There are other examples of particular services that 
are dealt with in various schemes, where again the traffic is 
one way. Chat lines would be an example. Indeed, cellular calls 
when they began, much of the traffic was almost all one-way, 
going there the wire line network--I am sorry--going from the 
wireless network to the wire line network. That has evolved 
over time.
    But then last year we were in a situation where wire line 
companies received four times as many calls from cellular 
networks as traveled from the wire line network to the cellular 
network. Again, Mr. Tauke's companies and other local exchange 
carriers receive reciprocal compensation for that traffic even 
though it is weighted 4 to 1 in favor of the incumbent. Of 
course, it was in that context that the comments about the 
incumbents insisting on a constitutional right to compensation 
were made. Because at that time they saw that this traffic was 
going to be coming to them, and they wanted to make sure that 
they would be compensated for it.
    In any event, given the different schemes that exist today, 
I would urge you to consider whether it makes sense to select 
just Internet traffic for legislative action.
    Second, if there is to be compensation, we absolutely 
believe it should be cost based. One of the members referred to 
an economic windfall that may exist today for certain 
competitive carriers. But as Mr. Taylor of Focal observes in 
his written testimony, one of the reasons this compensation 
appears to be a problem is because at the time these agreements 
were negotiated 3 or 4 years ago, the incumbent carriers 
insisted on rates that were clearly well above cost. Rates in 
the range of a penny a minute, which were not unusual in these 
early agreements, are far higher than the actual cost of 
providing service.
    We are very encouraged by the fact that as these contracts 
are expiring, the companies are negotiating between themselves 
far, far lower rates that are much closer to actual cost. We 
are now seeing rates negotiated as low as one- or two-tenths of 
a cent per minute. We also expect that further negotiations and 
arbitrations will lead to novel rate structures such as 
capacity charges, not based on per minute use or cap charges. 
We certainly encourage experimentation in that regard.
    Third, any action that Congress takes should have as its 
goal to foster the continued development of local competition. 
Here I would observe that Mr. Tauke's argument that requiring 
the incumbents to pay competitive carriers that focus only on 
serving Internet service providers reduces their incentive to 
service other customers does make some sense as a theoretical 
matter, but we don't see that strategy being pursued in the 
marketplace by any significant number of competing carriers. On 
the contrary, companies such as Focal, headed by Mr. Taylor who 
will be testifying soon, seek to serve a wide range of 
customers in addition to the Internet service providers; and we 
have observed that, over time, the share of total revenue that 
companies such a Focal receive that are triggered to reciprocal 
compensation has dropped dramatically. I think last year, in 
the case of Focal, they have gone from 73 percent of their 
revenues being attributed to reciprocal compensation down to 35 
percent in the past year. So we are seeing them expand just 
beyond serving Internet service providers to serving a much 
wider range of customers.
    There are certainly examples, such as the North Carolina 
example that you mentioned, where a company was just 
terminating calls into a barn, of people who are out there, 
just scam artists. But we are finding that the State 
commissions, who we will hear from later, as well as State 
courts are well equipped to deal with these cases of fraud.
    Commissions are refusing to certify competitors who seek 
only to serve one customer, you know, they are affiliated with 
Internet service providers. So we think that problem is being 
dealt with in the States.
    Fourth, if Congress decides to legislate in this area, it 
should ensure that its action does not discourage the 
deployment of broadband advanced services. There is some 
suggestion in the written testimony that continuing the 
existing arrangements discourage investment in broadband 
technologies. I understand those arguments, but I think the 
subcommittee also needs to consider that the current scheme may 
also increase the incentives of the incumbent to invest in 
broadband technologies, because when they deploy the ADSL at 
that time, they are bringing back the Internet service provider 
to them as their customer, and as a result, their obligation to 
pay reciprocal compensation will be reduced.
    Fifth and finally, I urge the subcommittee to take no 
action which might lead to the possibility that per minute 
charges to use the Internet might be imposed on consumers. In 
his prepared testimony, Mr. Tauke suggests that if H.R. 4445 is 
not passed, there will be a greater threat that end user 
charges will be imposed.
    On the other hand, Mr. Taylor argues that passing H.R. 4445 
will lead to significant increases in the prices consumers pay 
to access the Internet.
    I cannot tell you today who is right in this and who is 
wrong. This is a factual issue we are pursuing in our 
proceeding. But I can say that Congress has made it very clear 
in other contexts that it does not want regulators imposing 
access charges on Internet service providers or otherwise 
taking action that might lead to consumers paying more to use 
the Internet.
    That is very good advice. Chairman Kennard reminds us of 
this constantly, and I would urge the subcommittee to ensure 
that this goal is met in any legislation it pursues.
    Those are my observations. I thank you for the opportunity 
to appear and I look forward to your questions.
    [The prepared statement of Lawrence E. Strickling follows:]
  Prepared Statement of Lawrence E. Strickling, Chief, Common Carrier 
               Bureau, Federal Communications Commission
    Good morning, Chairman Tauzin, and members of the Subcommittee, and 
thank you for the opportunity to appear before you today to testify 
regarding H.R. 4445, the ``Reciprocal Compensation Adjustment Act of 
2000.'' This legislation addresses the applicability of the reciprocal 
compensation provisions of the Telecommunications Act of 1996 (1996 
Act) to dial-up Internet traffic, an issue that has occupied the 
attention of the state regulatory commissions and numerous courts as 
well as the Federal Communications Commission. The question of whether 
to require compensation for delivery of dial-up traffic to the Internet 
is a difficult and complex issue that admits of no easy solution from 
either a legal or policy perspective.
    In order to put the current controversy in context, I first would 
like to trace the background of reciprocal compensation in the 1996 Act 
and how the statute and our rules implementing the law have been 
applied by state commissions and the courts. As part of the 1996 Act, 
Congress passed section 251(b)(5), which requires all local exchange 
carriers (LECs) ``to establish reciprocal compensation arrangements for 
the transport and termination of telecommunications.'' Congress 
recognized that a carrier incurs costs when it delivers to one of its 
customers a local call that originates on the network of another 
carrier. Thus, the statute provides in section 252(d) that the 
reciprocal compensation arrangements must compensate carriers for the 
``additional costs of terminating such calls.''
    In August 1996, the FCC issued rules implementing section 
251(b)(5). The FCC concluded that section 251(b)(5) applies only to 
``local'' telecommunications traffic--traffic that originates and 
terminates within the same local calling area--and not to interstate 
traffic. We reasoned that Congress intended reciprocal compensation to 
address the situation in which two carriers collaborate to complete a 
local call, a scenario that would occur with increasing frequency as 
competition developed in the local exchange market as a result of the 
1996 Act. Access charges, not reciprocal compensation, would continue 
to apply when three carriers--typically the originating LEC, a long 
distance carrier, and a terminating LEC--collaborated to complete a 
long distance call. In the access charge regime, the caller pays the 
long distance carrier, which in turn must pay both LECs for originating 
and terminating access service. Neither our reciprocal compensation 
rules nor our access charge rules directly addressed the situation 
where two local carriers collaborate to deliver dial-up traffic to the 
Internet.
    In the course of arbitrating and interpreting local interconnection 
agreements under sections 251 and 252, state commissions were presented 
with claims from competitive local carriers (CLECs) that they should 
receive reciprocal compensation, as defined in section 251(b)(5), for 
dial-up Internet traffic that they transported from incumbent carriers 
to Internet service providers (ISPs) served by the competitive 
carriers. ISPs provide their customers the ability to access the 
Internet. An ISP subscriber typically will dial a seven-digit number to 
reach an ISP server in the same local calling area, and the ISP then 
provides routing and transmission services to enable its subscribers to 
access Internet content and services throughout the United States and 
the world.
    The competitive carriers have generally contended that traffic 
bound for ISPs is local telecommunications traffic that terminates at 
the local ISP server and is thus subject to reciprocal compensation 
under section 251. Incumbent LECs have asserted that this traffic is 
interstate traffic and, therefore, beyond the scope of section 
251(b)(5). The incumbent carriers have pointed out that the FCC has 
characterized enhanced service providers (ESPs), a category that 
includes ISPs, as users of interstate access services and that the FCC 
explicitly exempts ESPs from the payment of certain interstate access 
charges. They have argued that our adoption of this ``ESP exemption'' 
reflects our understanding that ESPs use interstate access services; 
otherwise, no exemption from access charges would be necessary.
    More than two dozen state commissions concluded that the 
interconnection agreements that incumbent LECs had entered into with 
CLECs required the payment of reciprocal compensation for ISP-bound 
traffic. Many of these states accepted the ``two call'' argument 
advanced by the CLECs and concluded that the ``telecommunications'' in 
question terminated at the ISP's local server. This ``local'' call, for 
which reciprocal compensation was due, was then followed by a second 
``call'' initiated by the ISP server to access the Internet.
    In February 1999, in response to requests from both incumbent and 
competitive LECs, the FCC issued a decision clarifying that ISP-bound 
calls are not local calls and therefore are not subject to reciprocal 
compensation under our rules implementing section 251(b)(5). In that 
decision, we noted that the FCC traditionally has determined the 
jurisdictional nature of communications by the end points of the 
communication--where a call starts and where it ends--and has rejected 
attempts to divide communications at intermediate points of switching 
or exchanges between carriers. Using this ``end-to-end'' analysis, we 
concluded that ISP-bound telecommunications traffic does not terminate 
at the ISP's local server but continues to its ultimate destination, an 
Internet website that is often located in another state or even in 
another country. We found, therefore, that ISP-traffic is 
jurisdictionally mixed, largely interstate, and thus, not subject to 
our rules on reciprocal compensation for local traffic. We explained 
that this result is consistent with the statutory definition of 
``information service,'' which makes clear that these services, 
including Internet access services, are provided ``via 
telecommunications,'' thus rebutting the argument that the 
telecommunications traffic terminates at the ISP server. It also 
accords with the ESP exemption and the FCC's historic characterization 
of ISPs as users of interstate access services. We stressed that the 
decision in no way altered the ESP exemption. To the contrary, the FCC 
acted in this instance for the purpose of ensuring that the Internet 
continues to flourish under our ``hands off'' regulatory approach.
    However, having determined that dial-up Internet traffic was 
interstate in nature, the FCC emphasized that the jurisdictional 
finding did not answer the question whether compensation should be 
paid. The FCC acknowledged that there was no federal rule of 
compensation and no federal mechanism by which carriers should 
compensate one another for delivering this traffic. In the absence of a 
federal rule, we initiated a rulemaking to determine whether to 
establish a federal intercarrier compensation mechanism for ISP-bound 
traffic.
    In the interim, we stated that parties were bound by their 
interconnection agreements as interpreted and enforced by state 
commissions. Accordingly, state commissions have continued to address 
this issue. Many states have required local exchange carriers to pay 
reciprocal compensation for these calls, and none of these decisions 
has been overturned in court. A few commissions have concluded, 
however, that no compensation is required. Other states have developed 
innovative compensation schemes that take into account the extent of 
traffic imbalance. The Massachusetts Department of Telecommunications 
and Energy, for example, adopted on an interim basis a proposal by the 
incumbent carrier, Bell Atlantic, that it would not pay reciprocal 
compensation for traffic that exceeds a 2:1 ratio in favor of the CLEC, 
unless the CLEC demonstrates that the imbalance is not associated with 
ISP-bound traffic. The New York Public Service Commission took a 
similar approach, holding that Bell Atlantic could pay a lower rate to 
a CLEC for all terminating traffic that exceeds originating traffic by 
a 3:1 ratio, unless the CLEC could rebut the presumption that the 
traffic imbalance results in lower costs. Other commissions have 
imposed a ``bill and keep'' regime for ISP-bound traffic, which 
requires each carrier to recover the costs of carrying that traffic 
from its own end users.
    Most significant, perhaps, are the agreements that parties have 
reached through private negotiation. Many incumbent local exchange 
carriers insisted on reciprocal compensation rates as high as $.01 per 
minute in agreements they entered into with competitive entrants in 
1996, based on the apparent expectation that they would be the net 
beneficiaries of these payments. These agreements are expiring, 
however, and some of these same carriers are now negotiating 
dramatically lower reciprocal compensation rates for all traffic, 
including ISP-bound traffic--as low as $.00175 per minute. Consumers 
will be better off and local competition will be fostered as parties 
continue to negotiate rates that more accurately reflect the actual 
costs of transport and termination.
    Before we could complete the rulemaking, on March 24, the Court of 
Appeals for the D.C. Circuit vacated our decision on the regulatory 
treatment of dial-up Internet traffic and remanded the matter to the 
FCC. The Court agreed that the FCC may examine the end points of a 
call--whether it originates in one state and terminates in another--in 
order to determine the jurisdictional nature of the communication. The 
Court felt, however, that we had not adequately explained how that 
jurisdictional analysis is relevant to determining whether ISP-bound 
traffic is subject to the reciprocal compensation obligations of 
section 251(b)(5). The Court also struggled to understand whether our 
conclusion that ISPs use interstate ``access service,'' which is not 
defined in the Act, is consistent with the statutory definitions of 
``telephone exchange service'' and ``exchange access service,'' neither 
of which explicitly encompasses Internet access service.
    In response to the Court's remand, the Common Carrier Bureau has 
recommended to the Commission that it issue a notice inviting parties 
to comment on the court's decision. The notice will also request 
parties to provide information about any new intercarrier compensation 
arrangements that they may have entered into, either as a result of 
private negotiation or at the direction of a state commission. Once 
these comments are received, we will reexamine our conclusions 
regarding the jurisdictional nature of ISP-bound traffic and the scope 
of the reciprocal compensation provisions of section 251(b)(5). While 
it would be premature now to suggest how the Commission might rule on 
this matter, we previously have identified broad policy principles to 
guide our analysis. The mandate of the 1996 Act that we ``preserve the 
vibrant and competitive free market that presently exists for the 
Internet and other interactive computer services' underscores the 
strong federal interest in ensuring that regulation does nothing to 
impede the growth of the Internet. It is also incumbent upon us to 
realize Congress' goal of promoting competitive entry into markets for 
all telecommunications services, including local telephone and Internet 
access services, in a manner that yields tangible benefits to consumers 
of those services.
    Thank you again for the opportunity to testify. I look forward to 
working with the Subcommittee as it addresses this important issue.

    Mr. Tauzin. Thank you very much Mr. Strickling.
    And now we welcome again our former colleague, the 
Honorable Tom Tauke, Executive Vice President, External Affairs 
and Corporate Communications of Bell Atlantic.
    Mr. Tauke.

                  STATEMENT OF THOMAS J. TAUKE

    Mr. Tauke. Thank you, Mr. Chairman and distinguished 
members. It is good to be here. I had a nice statement about 
explaining the issue, but all of you have done that so well 
that I will take a little different tack and focus on the 
question that Congressman Shimkus asked, what does this mean 
for consumers?
    I think that for consumers it is essentially--there are 
essentially two questions: How can you best prevent the charges 
for Internet usage, the permanent charges for Internet use; and 
how can you get real competition for residential consumers in 
the local exchange marketplace? I brought a couple of charts 
with me that focus on these two issues.
    First, this committee has had a lot of interest in trying 
to prevent Internet--permitted Internet charges. And the first 
chart, at the top, deals with the old problem that we have been 
resolving for years. And that is the prevention of the 
application of traditional access charges, long distance access 
charges to Internet traffic.
    If we had permitted access charges to apply to Internet 
traffic, and assuming that you had a penny a minute for 
Internet access charges and assuming that a typical Internet 
customer is online 2 hours a day, then you would have a 
situation where you would have $36 flowing from a CLEC, or 
company B in this case, to an incumbent company like Bell 
Atlantic, $36 a month that would be the result of the payment 
of interstate access charges for that Internet traffic to the 
incumbent local exchange carrier.
    Now the bottom line is that the FCC long ago recognized 
that was a problem, said, no, even though these are interstate 
calls, we don't want to have interstate access charges. So they 
said, no access charges. This became known as the ESP 
exemption. This committee and the House of Representatives 
several weeks ago passed the Upton bill which confirmed in 
statute, or is attempting to confirm in statute, that indeed 
there will be no application of interstate access charges to 
this Internet traffic which has been declared interstate. So 
that is the old problem.
    Now, there is the current problem which is the reciprocal 
compensation problem. That problem has a different application 
in this case of reciprocal compensation for local traffic 
trying to apply that scheme to Internet traffic.
    Now, just understand reciprocal compensation was applied to 
local voice traffic. That is what it was structured to do. This 
traffic has been declared interstate by the FCC. But as the FCC 
representative, Mr. Strickling, has indicated, they haven't set 
a compensation scheme yet. So while we are waiting around for 
this--and the wait has been a long time--the reciprocal 
compensation scheme is being applied, even though it was never 
intended for this kind of traffic.
    If somebody is online 2 hours a day, and if the CLEC gets 
in front of the ISP and says this is incoming traffic, what 
happens is you have $18 a month flowing from Bell Atlantic to a 
CLEC. Now, I think it is fair to say that this is a lot of 
money when you are collecting $15 per customer on average for 
the second line. You collect $15, you pay out $18. For Bell 
Atlantic, this has amounted to, the first 3 months of this 
year, over $60 million a month. It is doubling every year.
    We can hide this in the wash for awhile, and the local 
exchange companies across the country have been doing that for 
the last couple of years; but it is getting to the point that 
it is too big to hide any longer and something has to give.
    So what gives? Well, I think we are seeing that with 
Roseville telephone in California. One of the small telephone 
companies in California, Roseville just filed with the 
California commission and said, the way this is going, we have 
to implement a charge on Internet usage by our telephone 
customers because we can't keep shelling out this money with 
nothing coming in; something has to give. We are proposing a 
permanent Internet usage charge.
    For all of the companies who are on the paying end, they 
have got to recover it someplace; it is a real cost for the 
companies that are paying. And one alternative is to have an 
Internet charge; another alternative is to dump it on other 
customers, which doesn't seem fair.
    I think it is important to note that there is a big 
question about what the real costs are for company B that is 
receiving the $18. And if I read my testimony and the testimony 
from the gentleman from Focal, you get different answers, but 
the bottom line is, we can have discussion of this.
    There is no evidence that the cost is anything related to 
the $18 a month. H.R. 4445 tries to say, no payment either way 
under either of these schemes. But it does not--and I emphasize 
this--it does not prevent the FCC from establishing a different 
kind of compensation system for Internet-bound traffic.
    The incumbent local exchange industry has been over and 
over again saying, let people recover their costs by some 
mechanism; and we continue to adhere to that view. But 
reciprocal compensation doesn't permit that.
    And the second thing that I was going to talk about, but I 
know I have run out of time, is why this hinders local 
competition. The bottom line is, if you look at that other 
chart, if a CLEC today is serving an ISP, they have the ability 
while serving that ISP to be able to make about--I can't see 
the number there, but I think it is about $18 a month in 
reciprocal compensation with essentially no cost.
    If they go off and serve, however, the residential customer 
and take that line, let's say from a Bell Atlantic, and serve 
that customer themselves, they lose $16 a month. It is not hard 
for them to figure out what business plan they ought to pursue.
    And so, yes, Mr. Strickling says Focal is serving other 
customers, but look at their annual report. They aren't 
interested in serving residential customers and they aren't 
going to be interested in getting that second line from this 
residential customer because it is a loser for them under the 
current compensation scheme.
    Mr. Chairman, thank you very much.
    [The prepared statement of Thomas J. Tauke follows:]
   Prepared Statement of Thomas J. Tauke, Executive Vice President, 
       External Affairs & Corporate Communications, Bell Atlantic
    Mr. Chairman, thank you for this opportunity to testify before the 
Committee. I am Tom Tauke, Executive Vice President of External Affairs 
& Corporate Communications for Bell Atlantic. I am also Chairman of the 
United States Telecom Association, and I appear on behalf of that 
Association. I am before you today to urge you to correct an unintended 
consequence of the Telecommunications Act of 1996, an unintended 
consequence that actually reduces companies' incentives to compete in 
the local exchange business. If not corrected, this unintended 
consequence also could result in per minute charges being imposed on 
Internet use, a result that, I know, no Member of this Committee 
desires.
    The problem that H.R. 4445 seeks to fix is a problem with the way 
the Telecommunications Act has been warped to undermine the purposes of 
that Act. As the Massachusetts commission wrote:
          ``The unqualified payment of reciprocal compensation for ISP-
        bound traffic . . . does not promote real competition in 
        telecommunications. Rather, it enriches competitive local 
        exchange carriers, Internet service providers, and Internet 
        users at the expense of telephone customers or shareholders. 
        This is done under the guise of what purports to be 
        competition, but is really just an unintended arbitrage 
        opportunity derived from regulations that were designed to 
        promote real competition.'' 1
---------------------------------------------------------------------------
    \1\ Complaint of MCI WorldCom, Inc. against New England Telephone 
and Telegraph Company d/b/a Bell Atlantic-Massachusetts for breach of 
interconnection terms entered into under Sections 251 and 252 of the 
Telecommunications Act of 1996, D.T.E. 97-116-C at 25-26.
---------------------------------------------------------------------------
    And the Colorado commission agreed:
          ``[W]e find that reciprocal compensation would introduce a 
        series of unwanted distortions into the market. These include: 
        (1) cross-subsidization of CLECs, ISPs, and Internet users by 
        the ILEC's customers who do not use the Internet; (2) excessive 
        use of the Internet; (3) excessive entry into the market by 
        CLECs specializing in ISP traffic mainly for the purpose of 
        receiving compensation from the ILECs; and (4) disincentives 
        for CLECs to offer either residential service or advanced 
        services themselves.'' 2
---------------------------------------------------------------------------
    \2\ Petition of Sprint Communications Company, L.P. for Arbitration 
Pursuant to U.S. Code Sec. 252(b) of the Telecommunications Act of 1996 
To Establish an Interconnection Agreement with U S West Communications, 
Inc., DOCKET NO. 00B-011T, Initial Commission Decision at 22 (May 3, 
2000).
---------------------------------------------------------------------------
    Congress needs to act to prevent this situation from continuing.
                      ``reciprocal compensation''
    The subject of this hearing, and of H.R. 4445, is one provision of 
that Act that has not worked out exactly as Congress intended and, in 
fact, has had a perverse effect on competitive incentives--an effect 
that none of us could have foreseen in 1994 and 1995 during the debates 
that led to the passage of the Act.
    Section 251(b)(5) establishes a mechanism for local telephone 
companies to compensate each other for handling local calls, a system 
referred to as ``reciprocal compensation.'' Under this system, one 
telephone company pays another telephone company for each local call 
the second company completes to one of its customers. For example, if 
Company A is your local telephone company and you make a local call to 
a friend who uses Company B, another telephone company, Company A pays 
Company B for completing your call. When your friend calls you, Company 
B pays Company A for completing the call. This compensation system is 
truly ``reciprocal,'' and the payments flow in both directions. This 
system makes sense and has worked well for local calling.
                        . . . enter the internet
    But calls to the Internet are anything but ``local.'' Your call to 
the Internet does not stay in your local area, but goes across the 
country or around the world. The FCC has recognized this fact and has 
declared calls to the Internet to be interstate and interexchange, but 
not local.
    However, some companies have figured out ways to make money--in 
some instances quite a lot of money--by applying the Act's system for 
compensating carriers for handling local calls to calls to the 
Internet. And with the explosive growth of calls to the Internet, in 
short time since the '96 Act was passed, this has resulted in payments 
of billions of dollars for calls that were never intended to be part of 
this compensation system.
    This is how it works: Consumers get access to the Internet through 
Internet Service Providers (ISPs). If your local telephone company--
Company A--connects directly to your ISP, there is no compensation 
payment. However, if Company B signs up your ISP, then Company B can 
demand that Company A pay local service compensation for Internet-bound 
calls. Of course, the Internet is not going to call you back, and there 
is no reciprocity in calls, and no balance in payments.
    In fact, the application of reciprocal compensation to Internet-
bound traffic has spawned a generation of ``telephone companies'' that 
have few or no facilities at all. Many times Company B is just a shell 
that provides little or no service. Thus, Company B can set up its 
arrangements so that it has no facilities of its own and simply gets 
Company A to deliver the calls directly to the ISP. Company A still has 
to pay Company B, even though Company A provides the entire service and 
Company B does nothing at all--other than cash the compensation checks.
    This has been a major problem for local telephone companies. The 
latest estimates are that compensation payments for Internet-bound 
calls will exceed two billion dollars this year. And if history is any 
guide, they will double next year. Some state commissions have taken 
steps to stop these abuses. However, this is a federal issue, under 
federal law, and should be dealt with on a consistent national basis on 
the federal level.
                      the unintended consequences
    H.R. 4445 will confirm that calls to the Internet are interstate, 
not local, and therefore, that the compensation system for local calls 
does not apply to them. If Congress does not make this simple 
clarification it will allow the existing skewed, uneconomic system to 
continue. It will also unjustly reward carriers that are essentially 
doing nothing to enhance the competitive marketplace.
    More important, it's bad for competition, the very competition that 
Congress enacted the '96 Act to encourage. It's hard work going out 
into the marketplace to compete for the business of hundreds or 
thousands of individual telephone customers. It's relatively easy to 
try to sell to one or two ISPs--especially when you can offer them 
exceptionally low priced service based on the compensation payments you 
will receive. As a result, many competing telephone companies have 
decided it is better to serve a few ISPs and reap these windfall 
profits than to invest and to compete to serve consumers.
    And that's not the worst part--actually serving residential 
customers would reduce their revenues. Because it is available only 
when a customer's line is served by another carrier, Internet 
reciprocal compensation actually pays carriers not to invest in their 
own competing facilities and not to provide their own competing service 
to residence or small business customers. As a Wall Street analyst 
observed, ``it turns customers from an asset to a liability.'' As both 
the Massachusetts and Colorado public utility commissions found, the 
economics of applying reciprocal compensation to Internet-bound calls 
are simply too attractive to make entering the competitive fray worth 
the candle.
    Let me give an example. Assume Company A has a residential customer 
that uses her second line for two hours each day to reach her ISP, 
which uses Company B. Reciprocal compensation rates range up to 1.2 
cents per minute. So at a moderate rate of \1/2\ cent per minute, 
Company A pays Company B $18 per month for this customer's Internet 
use.
    Two-hours-per-day is just moderate Internet use--many consumers 
routinely spend more time on line, doing e-mail, surfing the Web and 
``chatting'' with friends. And compensation on Internet-bound calls 
gives carriers an incentive to artificially increase this amount. In 
fact, at least one provider has indicated that its customers may be 
logged on full time. At \1/2\ cent per minute, Company A's liability 
would be $216 per month.
    Whether the compensation is $18, $216 or somewhere in between, it 
is more than the $15 basic typical monthly charge for this line (a rate 
that does not cover the real costs of providing the service). And 
because this is a second line, the customer will not be using it to 
make long distance calls and will not be buying value-added features 
for it. Providing this service is clearly a losing proposition for 
Company A.
    But these numbers also show why Company B will never try to sign up 
this residential customer. If the customer moves to Company B, Company 
B will gain the $15 monthly service fee from the customer, but it will 
lose the $18 it gets in compensation and will incur at least $13 in 
real costs to serve the customer--an overall loss of $16. To make 
matters worse for Company B, if the customer then changes ISPs (or the 
ISP switches to Company C), Company B actually has to pay out $18 in 
compensation to Company C, making Company B $34 per month worse off for 
signing up the residential customer.
    This situation also has unhealthy consequences for the deployment 
of advanced services. It drains millions and millions of dollars from 
the local telephone industry that would otherwise be invested in local 
networks to provide new and better services. In addition, Internet-
bound calls could be handled more efficiently by moving them off the 
circuit-switched network, and onto more efficient packet-switched 
technologies. However, there is no incentive to deploy these 
technologies if they won't be used. But as long as ISPs (or their 
carrier affiliates) can get paid reciprocal compensation if they stay 
on the circuit-switched network, they have little incentive to move to 
new packet-switched technologies, no matter how reasonably priced. And 
as long as no one is willing to use these new technologies, there is 
little incentive for originating carriers to deploy them in the first 
place.
    What will happen if Congress doesn't fix this problem? Local 
telephone companies are faced with multi-billion dollar annual outflows 
of cash. They have two ways to respond. The most logical is to pass on 
their compensation costs to the customers that cause them--those who 
use the Internet. If Company A pays \1/2\ cent per minute because a 
consumer calls the Internet, then Company A would bill that \1/2\-cent-
per-minute to the consumer. The other alternative would be for Company 
A to recover these costs from all its local customers, which would 
result in consumers who do not use the Internet subsidizing those who 
do.
    The reciprocal compensation provisions of the '96 Act do not apply 
to calls to the Internet, and Congress should put any arguments to the 
contrary permanently to rest by passing H.R. 4445.

    Mr. Tauzin. Thank you very much, Mr. Tauke.
    I now will welcome the Honorable Joan Smith, Commissioner 
the Oregon Public Utility Commission, who chairs the NARUC 
Telecommunications Committee in Salem, Oregon.
    Joan Smith.

                  STATEMENT OF HON. JOAN SMITH

    Ms. Smith. Thank you, Mr. Chairman. For the record, my name 
is Joan Smith from Oregon. I would like to thank you and the 
members of the subcommittee for offering me this opportunity to 
discuss the State's views of H.R. 4445, the Reciprocal 
Compensation Act of 2000.
    As Chairman of the National Association of Regulatory 
Utility Committees on Telecommunications and a member of the 
Oregon Commission, I am deeply concerned about the negative 
impacts that H.R. 4445 could have on consumers, the competitive 
marketplace and on the carefully crafted structure of the 1996 
act. And I too had some and--there they are, posters which are 
not quite as elegant as some of the rest of the posters have 
been, but just to dwell on them for a moment--and I must say to 
you, in this day and age, regulators, I am afraid, are 
considered agents of the devil--but I want you to know that my 
duties are purely ceremonial.
    When we started in to look at reciprocal compensation, who 
would have expected, as many of you pointed out, that the 
traffic would be anything but balanced? And those little cars 
and trucks just show that that is what we thought would happen. 
And bill and keep was certainly a choice. But if we go to the 
next poster, lo and behold, traffic to the Internet, as many of 
you have pointed out, had longer holding times and, therefore, 
under the old scheme, more minutes and, therefore, more money. 
And that is the dilemma that we face today through this bill.
    I would just like to remind you that in the act of 1996 
there is no preset regime for how reciprocal compensation 
works. There is no instruction, you will do this and you will 
do that. It has basically been worked out over time. So when we 
use reciprocal compensation, unfortunately the semantics are 
such that it is bad. It is unfair.
    But, again, I would like to remind the committee that it is 
a two-party arrangement, by and large, and that it can be 
worked out, that it is renegotiable and that this is a 
contract. And most of the States do not dictate what kind of 
scheme there should be. We leave it to the two business 
entities to figure out what is best for them. But as you have 
pointed out, of course, there is this imbalance and an 
imbalance of payments.
    So what is the key issue for the States? We worry that H.R. 
4445 singles out a certain type of traffic, that it is 
technology specific. What happens when the next imbalance 
occurs? Will there be another bill? We strive to make sure that 
our regulations are technology-neutral. The key here, of 
course, as all of you have noted, is that there is no payment 
in the bill for this service; and no payment, it seems to us, 
may not be fair and even invite litigation.
    Where do those costs go? Even though we partially 
deregulate the environment, it is still a zero sum game. Some 
think that the cost will go to Internet users, as Mr. Tauke 
pointed out. Some think that it will fall back on all the 
customers to support advance services. We really can't know at 
this point, but both dangers exist.
    The reciprocal compensation issue, in our minds, is best 
addressed through the existing statutory regulatory framework 
of the act. Under this act, as I pointed out, the incumbent and 
competitive carriers are required to negotiate and the States 
are required to arbitrate disagreements. And we think we have 
done a pretty good job, by and large; 38 States have ruled on 
the issue--33, that dialing is a local issue and intrastate 
issue, and the fifth, seventh and ninth circuits have agreed.
    We, of course, are waiting on the FCC as well. And 
obviously that is ultimately a public policy call, your call, 
on whose jurisdiction is which.
    So, summing up, I would like to say that basically we are 
worried whenever a service is provided by one carrier to 
another carrier. There is no compensation. What happens? And I 
have a few solutions.
    One, as other people have noted, when there is arbitrage 
going on, why not make that illegal? It is not too hard to seek 
that out and figure it out. Why not use solutions like the New 
York Public Service Commission's solution and reciprocal 
compensation that checks out whether carriers are truly 
carriers and carry lots of kinds of traffic, not just Internet, 
and put aside money for infrastructure improvement and 
investment. Why not consider the fact that paying for minutes 
per use is really pretty old fashioned? I think we need to look 
at other ways to pay for traffic, for example, a flat rate.
    And third, I would suggest that Congress look at the States 
as near the traffic, near the customers, near the parties and 
ask us to continue, as the act suggests, sorting out the issues 
around compensation and so much that is a part of the act.
    If Congress and if the FCC declare that this is an 
interstate transaction, then we would insist, ask, beg, plead, 
kneel----
    Mr. Tauzin. Never.
    Ms. Smith. [continuing] that the costs associated with that 
decision go with the jurisdiction. And we are talking billions 
here.
    And I thank you again, Mr. Chairman.
    [The prepared statement of Hon. Joan Smith follows:]
Prepared Statement of Joan Smith, Commissioner, oregon Public Utilities 
                               Commission
    Thank you, Mr. Chairman and Members of the Subcommittee, for 
offering me this opportunity to discuss the states' view of H.R. 4445, 
The Reciprocal Compensation Act of 2000. As Chairman of the National 
Association of Regulatory Utility Commissioners (NARUC) Committee on 
Telecommunications, I am deeply concerned about the negative impacts 
that H.R. 4445 could have on consumers and the competitive marketplace.
    The 1996 Telecommunications Act was about encouraging the 
development of a competitive marketplace for local telephone services. 
The Act was also about encouraging the deployment of advanced 
telecommunications services, which are often called broadband services. 
Our hope was that consumers would benefit from lower prices and have a 
broader array of telecommunications services and technologies to choose 
from.
    So far, Congress has wisely held itself back from tinkering with 
the carefully crafted system it created in the Act. If H.R. 4445 
becomes law, the balance of that system will be upset and the progress 
that is being made will be seriously undermined. This bill will also 
invite costly and unnecessary litigation both on the state and federal 
level.
    Before there was competition in the local exchange market, a single 
provider served all telephone customers. That sole provider both 
originated and terminated telephone calls on behalf of its customers 
whenever those customers made a local call. The revenues collected from 
customers by that single company covered both the origination and 
termination costs of its customers' local calls. I fear that there is a 
lot of misinformation and confusion about this matter and I would be 
happy to explain this issue to any of you in more detail if necessary.
    Now, the customers at the two ends of a local telephone call might 
be served by two different telecommunications carriers. One originates 
the call, and one terminates the call. Both carriers take part in 
carrying this ``traffic''. Both carriers should be paid for the 
services they provide to customers. The Act's reciprocal compensation 
provisions were designed to ensure that, when more than one company 
handles a local telephone call, both of those companies will be paid 
for their services.
    In many cases, a local exchange carrier can assume that their 
customers will call the customers of another local exchange carrier 
serving the same local area about the same number of times that the 
customers of the other carrier will call their own customers. Traffic 
is balanced, and a ``bill and keep'' method of payment can be employed, 
or a reciprocal compensation agreement may be reached.
    In the case where a local exchange customer is an Internet Service 
Provider (ISP), local calls will be made to the ISP, but the ISP will 
not be making local calls from its dial-up numbers. H.R. 4445 would 
eliminate the requirement that the ISP's local exchange carrier be paid 
for transporting and terminating calls to its customer ISP, but it does 
not eliminate the requirement that the ISP's local exchange carrier 
must provide that service. In other words, it changes the Act so that a 
business is required to provide a service for free to its competitors.
    Without revenues to offset the costs of providing 
telecommunications service, a company terminating calls (often a 
competitive local exchange carrier rather than an incumbent Bell 
company) would have to increase prices to offset the loss in reciprocal 
compensation revenues. This may choke the flow of investment in 
broadband services and new technologies. The increase in rates would 
make the company less competitive, and it would, in turn, raise the 
ISP's costs, which, in turn, would raise the cost to consumers who 
access the Internet. Congress should not create a special exemption for 
the Bell companies who are seeking a legislative fix to system they 
fought hard to have in 1996.
    The reciprocal compensation issue is best addressed through the 
existing statutory and regulatory framework in the Act. Under the Act, 
incumbent and competitive carriers are required to negotiate reciprocal 
compensation payments. If these negotiations break down, state 
commissions are given the responsibility to arbitrate any disputes. 
Thirty-eight state commissions have ruled on the issue, 33 of which 
have found that dialing a local number to reach an ISP should be 
treated like any other local call to a business customer.
    We must not forget that just after the Act passed, Bell companies 
successfully argued before state commissions that reciprocal 
compensation was the payment of choice. H.R. 4445 alters the payment 
process to significantly favor the Bell companies at the expense of new 
entrants. H.R. 4445 also assumes that the decisions made by state 
commissions are irrelevant and that the federal government knows best.
    If Congress continues to adhere to the goals of the 1996 Act, 
consumers will continue to see lower prices and more choice in 
services. H.R. 4445 runs directly counter to these goals. I urge you to 
reaffirm your support for the 1996 Act which your state colleagues have 
worked so hard to implement and not move forward with H.R. 4445.

    Mr. Tauzin. Thank you, Ms. Smith.
    And now we are pleased to welcome a fellow Louisianan, Jay 
Blossman, Jr., one of our Louisiana Public Service 
Commissioners from Mandeville, Louisiana.
    Mr. Blossman.

             STATEMENT OF HON. JAY A. BLOSSMAN, JR.

    Mr. Blossman. Thank you, Mr. Chairman.
    Good afternoon, and as the chairman said, I have been asked 
to give a State public service commissioner's perspective on 
the issue of payment of recall compensation for transport and 
delivery of Internet traffic to Internet service providers.
    The Louisiana Public Service Commission examined this issue 
in depth in a case brought before it in early 1999, in which a 
CLEC has sought payment of reciprocal compensation for local 
traffic in its interconnection agreement. A majority of the 
Commission concluded in that case that reciprocal compensation 
was not owed for this traffic for basically three reasons:
    First, the FCC has made it clear that reciprocal 
compensation under the Telecom Act of 1996 is owed for local 
traffic only. The FCC has traditionally classified Internet 
traffic as, jurisdictionally, interstate switched access 
traffic. The FCC has traditionally regulated this Internet 
traffic. We State commissions certainly have not.
    The FCC is the agency that created the exemption for policy 
reasons that ISPs historically have enjoyed from the 
requirement that switched access charges be paid on switched 
access traffic. Obviously, there would have been no need to 
create this exemption in the first place if this traffic were 
in fact local traffic.
    Second, the evidence of the actual intent in the record and 
the language of the contract itself supported the conclusion 
that the parties did not intend to pay reciprocal compensation 
for this traffic.
    Third, the evidence in the records showed that an award of 
reciprocal compensation in this case would have resulted in an 
unwarranted and irrational windfall to the plaintiff. In my 
view, awarding this kind of free money to competitors is not 
what the 1996 act contemplated. If reciprocal compensation is 
paid for Internet-bound traffic, I would have to provide a 
mechanism for the incumbent LECs, who are originating most of 
this traffic, to recover that cost. When that happens, I may be 
forced to consider higher rates for consumers, and this is 
something I don't want to see.
    In its own pending rulemaking proceeding on this issue the 
FCC has said that in the interim, and until it issues a binding 
ruling, the State commissions are free to adopt or not to 
adopts a compensation scheme for this traffic.
    The Louisiana Public Service Commission has opened a 
generic docket to consider what compensation mechamisms other 
than reciprocal compensation may be appropriate, pending the 
FCC's ruling. I am open to a fair cost recovery scheme for all 
concerned.
    In summary, I want to close by stating that I am anxious 
for the FCC to expeditiously resolve its pending rulemaking on 
this issue, and it is my belief that many State commissioners 
are also waiting for the FCC to act. Rather than give this 
issue renewed attention, it is my personal opinion that the 
industry and State commissioners alike would like--would all be 
best served by the FCC's rapid resolution of its rulemaking 
proceeding. The litigation spawned by this one issue has gone 
on long enough and has taxed the resources of everyone 
concerned.
    Again, I want to thank you for being here today, and I will 
answer any questions you have, Mr. Chairman.
    [The prepared statement of Jay A. Blossman, Jr. follows:]
  Prepared Statement of Jay Blossman, Commissioner, Louisiana Public 
                           Service Commission
    Good morning/afternoon. I have been asked to give a state public 
service commissioner's perspective on the issue of payment of 
reciprocal compensation for transport and delivery of internet traffic 
to Internet Service Providers.
    The Louisiana Public Service Commission examined this issue in 
depth in a complaint case brought before it in early 1999 in which a 
competitive local exchange carrier sought payment of the reciprocal 
compensation rate for local traffic in its interconnection agreement--
$.09 per minute--for the transport and delivery of internet traffic to 
its ISP customers. A majority of the commission concluded in that case 
that reciprocal compensation was not owed for this traffic for 
basically three reasons:
    First, and as a matter of law, the FCC has made it clear that 
reciprocal compensation under the Telecommunications Act of 1996 is 
owed for local traffic only. It is not owed for the transport and 
termination of interstate traffic. I am convinced as a matter of law 
that internet traffic is not local traffic. The FCC has traditionally 
classified internet traffic as jurisdictionally interstate switched 
access traffic. The FCC has traditionally regulated this internet 
traffic (we state commissions certainly have not). The FCC is the 
agency that created the exemption, for policy reasons, that ISPs 
historically have enjoyed from the requirement that switched access 
charges be paid on switched access traffic. Obviously, there would have 
been no need to create this exemption in the first place if this 
traffic were in fact local traffic.
    Second, in my view, the evidence of actual intent in the record and 
the language of the contract itself supported the conclusion that the 
parties did not intend to pay reciprocal compensation for this traffic. 
For example, the contract clearly limited the parties' obligation to 
pay reciprocal compensation to what was required by law, nothing more 
and nothing less. That certainly made sense to me. And as I've already 
stated, the law is clear that reciprocal compensation is owed for local 
traffic only, not interstate traffic. Moreover, the contract contained 
an express exemption for payment of reciprocal compensation on switched 
access traffic.
    Third, the evidence in the record showed that an award of 
reciprocal compensation in this case would have resulted in an 
unwarranted and irrational windfall to the plaintiff. Indeed, the 
evidence showed that the reciprocal compensation sought by the 
plaintiff exceeded by over 300% the total revenues received by the 
plaintiff for providing local service to its 10 ISP customers. In my 
view, awarding this kind of ``free money'' to competitors is not what 
the 1996 Act contemplated. It would create perverse economic incentives 
that would seriously inhibit the rapid development of competition in 
the residential marketplace. In addition, from my perspective as a 
state public service commissioner, if reciprocal compensation is paid 
on internet bound traffic, I would have to provide a mechanism for the 
incumbent LECs who are originating most of this traffic to recover that 
cost. When that happens, I may be forced to consider higher rates for 
my constituents, the ratepayers of Louisiana, and that is something I 
don't want to see.
    I am aware that some carries have argued strenuously that they are 
entitled to recoup their costs of transporting and terminating this 
traffic. (I note for this record that the plaintiff in the case before 
the LPSC chose not to offer any evidence of any actual costs incurred). 
Nothing the LPSC has done to date has foreclosed that possibility. Nor 
is it my understanding that HR 4445 is intended to foreclose this 
possibility; rather it provides only that reciprocal compensation under 
the 1996 shall not be paid for this traffic. I agree for the reasons I 
have stated that reciprocal compensation under the 1996 Act is not 
appropriate because this traffic is not local.
    In its own pending rulemaking proceeding on this issue, the FCC 
itself has commented that efficient rates for inter-carrier 
compensation for ISP-bound traffic are not likely to be based entirely 
on minute-of-use pricing structures; and that, in particular, pure 
minute-of-use pricing structures are not likely to reflect accurately 
how costs are incurred for delivering ISP-bound traffic. Further, the 
FCC has said that, in the interim, and until it issues a binding 
ruling, the state commissions are free ``to adopt (or not adopt) a 
compensation scheme for this traffic.''
    In fact, the LPSC has opened a generic docket to consider what 
compensation mechanism other than reciprocal compensation may be 
appropriate pending the FCC's ruling. I note that I have heard 
arguments, not only that CLECs are not recovering adequate compensation 
for delivering this traffic to their ISP customers, but also from ILECs 
that they are not adequately compensated for originating this traffic 
from their local exchange customers. I would look forward to seeing in 
our generic docket evidence of the actual costs incurred in originating 
and sending this traffic to ISP customers, and whether or not those 
costs are being covered today, for example, whether ILECs are 
compensated for originating this traffic through the basic local 
exchange rates paid by their customers, and whether CLECs are 
compensated for delivering this traffic by the ISDN or other line rates 
paid by their ISP customers. If costs are not being recovered, I am 
open to a fair cost recovery scheme for all concerned. I fully support 
the fair recovery of actually incurred costs. What I cannot support is 
a system that will result in over-recovery of costs and the 
subsidization of one competitor by another or one competitor by another 
competitor's end user customers. And that is what I believe will happen 
if reciprocal compensation for ISP bound traffic is required.
    In summary, I want to close by stating that I am anxious for the 
FCC to expeditiously resolve its pending rulemaking on this issue, and 
it is my belief that many state commissions are also waiting for the 
FCC to act, rather than give this issue renewed attention. It is my 
personal opinion that the industry and state commissions alike would 
all be best served by the FCC's rapid resolution of its rule-making 
proceeding. The litigation spawned by this one issue has gone on long 
enough and has taxed the resources of everyone concerned.
    Thanks for the opportunity to be here today.

    Mr. Tauzin. Thank you, Mr. Blossman.
    Ms. Smith, if at any time you need to move over to your 
other function, you are more than welcome to do that. As we 
invited the Commission and the ILECs and CLECs and since we 
also asked for some advice from those who determine, in effect, 
how these markets work and how these companies are valued; and 
so we brought someone from PaineWebber, Mr. Eric Strumingher, 
Managing Director, Research, from PaineWebber in New York.
    We welcome you Mr. Strumingher.

                  STATEMENT OF ERIC STRUMINGHER

    Mr. Strumingher. Thanks for having me Mr. Chairman, members 
of the committee. I am a security analyst, as the chairman 
said. I hope that I can give you a view about how the issues 
that you are examining today are going to affect the financial 
markets.
    I am not here representing any particular group, and I hope 
that I don't harbor any strong biases one way or another. As 
evidence of that, I have buy recommendations to my investment 
clients for companies that benefit from the current scheme of 
reciprocal compensation and also those who are taking a hit. So 
I really hope that that can substantiate my claim that I am not 
biased and just giving you an objective view here.
    Now, while I am not, you know, an expert in public policy 
or in law-making, I can tell you how this issue that you are 
examining is affecting investment in an industry that is one of 
the true pillars of the new economy, telecommunications. 
Uncertainty is clearly the enemy of investment, and uncertainty 
about this issue, about paying reciprocal compensation for 
Internet-based services, is in my opinion raising the cost of 
capital, hindering investment decisions and thus slowing the 
growth of this industry.
    Mr. Tauke mentioned something that was interesting, the 
expenses of Bell Atlantic occurring based on reciprocal 
compensation. Now, as a securities analyst, I don't really know 
whether these expenses are going to go up, if they are going to 
go down; and that means that my view of the predictability of 
Bell Atlantic's investment plan, if it wants to go out and, 
let's say, accelerate investment in building broadband networks 
to people, is challenged. I have a very difficult time.
    Uncertainty equals higher cost of capital. That is what you 
should really focus on when you are taking a look at this 
issue.
    Now, I do believe that we need clear and enforceable rules 
governing the payment for the Internet; the Internet didn't 
come for free, and those rules simply do not exist today.
    Now, I was also planning, like some of the others, to talk 
a little bit about the issue itself. I think it has been pretty 
fully vetted here. I did want to return to something that Mr. 
Strickling mentioned, and that is that the rates today for the 
payment of reciprocal compensation for the Internet are higher 
than cost.
    Well, if we know that they are higher than cost, I think 
that we should set some rules. And maybe there are some 
procedural or administrative issues that are at place here, and 
if that is so, government should empower the FCC to make some 
decisions, in my opinion. That would help visibility in the 
financial markets and, therefore, lower the cost of capital.
    Now, in the complex language of securities analysis, this 
situation is a mess, and it really does need some clearing up; 
and I would encourage you to do that.
    I wanted to also make two other brief observations based on 
some things that I have heard surrounding this issue. There 
seems to be a concern that ending the current system of payment 
of reciprocal compensation for Internet service would thwart 
investment in the industry--some have even said, maybe stifle 
investment in the industry. I would disagree with these claims. 
I think that the opportunities for investing in this sector are 
as good and probably better than they have ever been in the 
history of the industry.
    There are tremendously good changes in technology 
regulation that are encouraging investment today, and 
particularly in the segment of the market that has historically 
been called the ``local exchange,'' you know, although it is 
not really clear to me why we should still be using this 
regulatory designation of ``local,'' which is unique in the 
United States, while we have a deregulated market.
    But nonetheless, local has been a monopoly up until the 
Telecom Act. It has tremendous opportunities, given the fact 
that the industry is growing so rapidly, and still the 
incumbent carriers control a lot of it. So if I had a lot of 
money and if I knew something about running a telephone 
business, I would certainly be interested in entering that 
market.
    No. 2, things--in terms of additional issues or concerns, I 
have heard that you will have conditions that go bankrupt if we 
end the current system of payment for reciprocal compensation 
for Internet. Now, this well may contribute in a small 
percentage of the cases to some bankruptcies--and I say 
``contribute''; it won't necessarily cause in total, but 
contribute. But it is hard for me to sit here and really 
justify how taxpayers should foot the bill for high-risk 
ventures that go under.
    Knowledgeable investors are well aware of the risks 
associated with this current system of payment for reciprocal 
compensation for the Internet, and I think value securities 
accordingly. So while the riskiness of these revenue streams 
may not be known by informed speculators, it is well understood 
by knowledgeable investors, and the current stock prices I 
believe do reflect this.
    So just in closing and to reemphasize this point, if you 
know it is a decision of the U.S. Government to start to bail 
out high-risk investors and speculators, let me know right now. 
I will go out and I will go buy options on some new issue 
Internet stocks and let other people bear the risks. But I do 
feel, in all seriousness, that is not a good idea; and I don't 
think that this notion that a lot of companies will go bankrupt 
is a fair characterization of the current environment.
    Thank you very much.
    [The prepared statement of Eric Strumingher follows:]
 Prepared Statement of Eric Strumingher, Managing Director, Research, 
                        PaineWebber Incorporated
    Thank you, Mr. Chairman and Members of the Subcommittee, for 
inviting me to offer some observations on H.R. 4445. I am a securities 
analyst specializing in the telecommunications industry, not an expert 
on the law or public policy, and I am not here to recommend to you a 
specific course of action to remedy the industry issues that you seek 
to address in H.R. 4445. However, I am an experienced securities 
analyst in the telecommunications industry, and I can tell you with 
conviction that uncertainty is the enemy of investment. In my opinion, 
the uncertainty regarding the payment of reciprocal compensation for 
Internet service is raising the cost of capital for industry 
participants and thus retarding the growth of an industry that is one 
of the pillars of the new economy. The Internet does not come for free, 
and this industry is in need of specific, enforceable rules that will 
establish who will pay for it so that low cost capital can be made 
available to fuel its growth.
    Reciprocal compensation is a framework for inter-carrier 
compensation governing the termination of local traffic that is 
mandated by the Telecommunications Act of 1996. Until 1999, there was a 
big controversy over the classification of dial-up Internet traffic: is 
it ``local'' traffic, and thus subject to payment of reciprocal 
compensation, or is it ``long distance'' traffic, and thus not subject 
to payment of reciprocal compensation? In 1999, the FCC issued an order 
asserting that dial-up Internet traffic uses telecommunications 
services that are interstate. Traffic can not be both interstate and 
intrastate: these are mutually exclusive jurisdictional designations. 
Therefore, if it's interstate, it's not local. This cleared up the 
ambiguity . . . or so we thought. In the same order, the FCC also gave 
state commissions great latitude to compel carriers to continue paying 
reciprocal compensation for dial-up Internet traffic. This is a logical 
inconsistency that I do not comprehend. Furthermore, more than half of 
the states have determined through regulatory proceedings that the FCC 
erred in its assertion that dial-up Internet traffic uses interstate, 
as opposed to local, telecommunications service. These events have 
introduced uncertainty that has increased the cost of capital in this 
industry. In the technical language of the financial markets, this 
situation is a mess.
    I'd like to also address some concerns that have been raised about 
the impact that ending the payment of reciprocal compensation for 
Internet traffic would have on the industry. Some are concerned that 
ending the payment of reciprocal compensation for Internet traffic will 
thwart investment in telecommunications. In my opinion, this is the 
wrong conclusion. The investment opportunities in the industry brought 
on by the significant changes in regulation and technology are huge, 
with or without reciprocal compensation for Internet traffic. The 
opportunity to invest in facilities that connect directly to customers, 
a segment of the market that was historically a government granted 
monopoly, may be the best opportunity of all for carriers that have the 
industry knowledge and the management skills to seize them. Large 
companies such as AT&T and WorldCom and smaller companies like 
Allegiance Telecom and Nextlink Communications are examples of 
competitors that have successfully invested in this area and that are 
continuing to invest here. Competition in this ``local exchange'' 
segment of the industry and investment in productivity enhancing assets 
will not stop as a result of ending the current system of reciprocal 
compensation for Internet service.
    There is also concern that companies will go bankrupt as a result 
of a change in the current system of paying reciprocal compensation for 
Internet service. Business plans that are based solely or in great part 
on receiving reciprocal compensation for Internet service are very 
high-risk business plans. While some businesses could have a hard time 
if the system of paying reciprocal compensation for Internet service 
was ended, I don't think that it's the government's job to bail out 
entrepreneurs from bad investment decisions. Informed investors realize 
that the sustainability of revenues generated from this source is 
subject to great uncertainty given the ambiguity/inconsistency of the 
current regulations. It has been clear for years to knowledgeable 
entrepreneurs and investors that reciprocal compensation for Internet 
service is a source of revenue that could very well go away. 
PaineWebber financial advisors and professional investors managing 
large sums of money have been made well aware of these issues, and I 
can tell you that companies relying heavily on revenue from reciprocal 
compensation for Internet service are having a much harder time raising 
money today than they were several years ago. Private and publicly 
traded competitive local exchange carriers (CLECs) command lower 
valuations than their peers to the extent that they have a higher 
percentage of total revenue and profit represented by reciprocal 
compensation for Internet service.

    Mr. Tauzin. Thank you very much.
    Indeed, we also requested someone to represent the ISP 
community, and recommended to us was Mr. Chad Kissinger, 
President of On Ramp Access Inc., of Austin, Texas.
    Welcome Mr. Kissinger.
    I will point out to my friend, Mr. Markey, I don't think 
there is any relationship to the other famous Kissinger.

                   STATEMENT OF CHAD KISSINGER

    Mr. Kissinger. Unfortunately not. Thank you, Mr. Chairman 
and members. Again, my name is Chad Kissinger. I am the 
President of On Ramp Access, Inc., the local Internet service 
provider in Austin Texas. We provide service in all the big 
cities in Texas. I also the immediate past president of the 
Texas Internet Providers Association, which is the largest and 
most active ISP association in the United States.
    I would like to tell you a few things before I get into my 
four points. I know on a first-name basis well over 100 ISPs, 
and I have never, ever heard of an ISP getting a kickback from 
a CLEC for reciprocal compensation. I have certainly never 
received a kickback for a reciprocal compensation; it has never 
been offered. I have asked for it, because it sounds like a 
good idea, but I have never been offered it.
    I also am not against a CLEC. Out of those 100-plus people 
that I know that are ISPs, I know of one that has become a 
CLEC. He became a CLEC because a CLEC bought him. So the idea 
that we are all becoming CLECs to garner reciprocal 
compensation, I don't think is quite accurate.
    First of all, my testimony today will cover a few points. 
The first point is that it seems to me that the ILECs are 
protesting a little bit too much about the expense of the 
Internet and the expense that the reciprocal compensation is 
costing. The ILECs have benefited greatly from the 
proliferation of the Internet. They are signing up more and 
more telephone lines in businesses and in homes. Homes are 
adding second telephone lines in their homes so that they can 
connect to the Internet and still receive calls from their 
neighbors. In fact, Mr. Tauke mentioned annual reports; in 
SBC's 1999 annual report, on page 8, they talk about how they--
39 percent of their increased demand in 1999 was for access 
lines, was due to second and third telephone lines put in the 
houses that already have telephone lines. That 39 percent 
increased demand in 1999 resulted in, according to my 
calculations of the numbers on that page, in $480 million of 
new revenues. That is on top of the revenues that they had got 
even from new lines installed in 1998 because of the Internet 
in 1999, 1998, 1997, 1996, 1995, 1994, and that is only the 
residential customers. That doesn't count the businesses that 
are adding telephone lines.
    Much further back in the annual report--I am sorry I don't 
have the page reference with me--you will find that they say 
that Internet calls are costing them $288 million in reciprocal 
compensation. So in 1999 they have received billions and 
billions of dollars of new revenues generated specifically to 
serve Internet calls, and they have only paid out a few hundred 
million dollars in reciprocal compensation. I think they 
protest a little bit too much.
    If you understand the economics of how this network works--
and I will be glad to expand upon that a little bit later if 
you would like--if you understand how the economics of this 
work, the CLECs are the people that are building the Internet 
and incurring the cost. The CLECs are the people that are 
trying to offer services, that are digging holes in the streets 
and puting out fiberoptics to ISPs like myself.
    Which brings me to my second point. I know right now I pay 
3 percent less for my telephone lines than I pay--because I buy 
them from a CLEC, than I would pay if I bought them from 
Southwestern Bell, pay 3 percent. That is not a hard sell if 
Southwestern Bell really, truly wanted my business. If they 
wanted my business and were to come out and offer me quality 
service, they would have it. I have no preference to buy 
service from Time Warner or ICG, other than--rather than 
Southwestern Bell.
    But Southwestern Bell is obstructionist. They are one of my 
competitors; they are competing with me in the marketplace, and 
they would like to monopolize the marketplace for Internet 
traffic. They do not participate in the market for Internet 
service providers' business. We are here; come get us. That is 
a good way to eliminate reciprocal compensation, have the ILECs 
come get our business; no payments will occur.
    The third point that I would like to bring up is kind of 
talk about that monopoly station, the fact that I think will 
occur if we eliminate reciprocal compensation. You would think 
that these ILECs would want to deregulate the cost, the floor 
costs, of their services so that they could go out and compete 
better against the CLECs and get some of our business back and 
eliminate all of this reciprocal compensation. In fact, in 
1995, Southwestern Bell came into our legislature in Texas and 
help pass a bill called Senate Bill 560, which helped alter the 
prices of telephone lines offered to Internet service 
providers.
    But you would think they would try to alter the floor; they 
didn't. They eliminated the ceiling. Right now, in Texas, 
Southwestern Bell--it is legal for them with 24 hours' notice 
to the Public Utility Commission to change the prices for a 
telephone line to an Internet service provider to any price 
they want. They can charge a billion dollars per telephone line 
to us if they want.
    So if we eliminate reciprocal compensation and Time Warner 
and ICG stop drilling trenches out to my building and stop 
hauling fiber up into my suites and stop trying to get my 
business, I have no hope that Southwestern Bell is going to all 
of a sudden show up and change heart and try to get my service.
    The last point I would like to bring up is that it seems 
kind of strange that the ILECs are making the argument that 
Internet traffic is not local, that it is long distance in 
nature. Well, if it is long distance in nature, how are they 
running Internet service providers? How are they competing with 
me? It is against the law for them, except in New York in Bell 
Atlantic's case, to offer long distance service.
    Repeatedly, when we hear them testify on access charges, 
they argue that a call is a call. And a call terminated across 
a telephone line for long distance service is the equivalent of 
a call terminated across the Internet for long distance 
service. If that is the case, why are they in the business? Why 
are we allowing them to be in the business?
    I am all for you ruling that it is a long distance call, 
and that will get them out of the Internet business and let us 
compete for that business.
    That is the conclusion of my remarks.
    Mr. Tauzin. Thank you.
    Finally, we welcome Mr. Bob Taylor, the Chairman of the 
Association for Local Communications, a CLEC, facilities-
based--and the Association is primarily and completely, I 
think, a facility-based CLEC; is that right--Mr. Taylor, for 
your testimony here, sir.

                   STATEMENT OF ROBERT TAYLOR

    Mr. Taylor. Thank you, Mr. Chairman and members of the 
committee. My name is Bob Taylor; I am President and CEO of 
Focal Communications. I also appear as the Chairman of ALTS, 
the Association for Local Telecommunications Services. I 
welcome the opportunity to explain why I think H.R. 4445 is 
unnecessary and also anticompetitive.
    The act in 1996 was a tremendously important piece of 
legislation and this committee really led the forefront into 
making it happen. As a direct result of that, CLECs have 
invested and built over $30 billion of new assets. Our revenues 
have exploded, going from less than a billion dollars before 
the act to about $6.3 billion in revenues last year. Real 
competition is happening, and the act jump-started that.
    But H.R. 4445 really would reverse the aspects of local 
competition. And let me give you sort of my five points as to 
why I think that.
    First, there is a cost to building this business. The $30 
billion is an investment that has been raised on Wall Street, 
raised through private investors; there needs to be a just 
return for them. When we provide service, whether it is to an 
ISP, to a residential customer--of which Focal will have 
hundreds of thousands of residential customers up and running 
across the country in the next 12 months; we have tens of 
thousands today, as well as all three branches of the Federal 
Government buy service from us--there is simply a cost to 
providing that service.
    Just as the Bell companies deserve compensation for one-way 
traffic from wireless providers, CLECs deserve compensation for 
the traffic that they terminate. Eliminating reciprocal 
compensation is really an unjust taking of property.
    Second, it will cause great harm to the Internet. As Mr. 
Kissinger pointed out, CLECs are putting in the fiber, putting 
in the infrastructure that is used by most of the ISPs today. 
It is simply the point that we provide good service. There is 
no cost advantage, no price difference, between our service and 
the Bells. In fact, many of the Bell companies buy Internet 
access from CLECs in their out-of-territory markets because it 
is better.
    We have built a better network with better technology, and 
we provide a better service; and if we eliminate reciprocal 
compensation, the cost of that service will go up. In my 
written testimony Peter Engdahl indicated that his customers 
would have to pay more than $6 a month for their Internet 
service bills. So there is a cost and it will be borne by the 
ISP user, the AOL user, if reciprocal compensation goes away.
    Third, the Bell companies came up with this idea. I mean, 
you know--we, as the CLECs, you know, don't want high rates. In 
fact, we have been working to drive these rates lower. It is 
something that when we started out in this industry, as many of 
you pointed out, bill and keep was the direction that the CLECs 
wanted and that many, including Bell Atlantic, fought hard for 
reciprocal compensation.
    Well, being business people, we couldn't fight the process 
forever; we had to take the rules that were given to us, and we 
think we have made a good business decision. Most State 
regulators agree, as it has been pointed out--15 States have 
pointed out that since this issue has been addressed in 
arbitration cases, that reciprocal compensation should be paid 
for Internet traffic. In fact, as Mr. Dingell pointed out of 
the relatively astute horses in North Carolina that have been 
using the Internet for some time, the North Carolina PUC was 
very astute in making sure that that type of sham Internet 
service provider, sham organization, didn't get compensated.
    By all means, Mr. Chairman, we are against the sham ISP. We 
share your concern and we would love to work with you and your 
staff to make sure that doesn't happen. But by and large, that 
is far and few between, and we think that is the exception not 
the rule.
    Finally, on the fourth point, reciprocal compensation rates 
are going down. As Mr. Tauke pointed out on his charts of $18 a 
month, we see reciprocal compensation rates today that are 10 
percent of what they were when we started out. When we built 
Focal in 1996, we were seeing reciprocal compensation rates in 
excess of a penny a minute. Again, we didn't set those rates, 
the Bell companies told us, here are the rates.
    Today, we are seeing reciprocal compensation rates of a 
tenth of a cent a minute. That is where it should be going.
    I think everybody has agreed that there is a cost. We think 
that this should get to the cost, and the Bell companies are 
the ones that set the rate, not us. They could have set this at 
a tenth of a cent a minute 4 years ago; they chose and, in 
fact, in New York, over a penny a minute because they were not 
recipients and they were playing the same game with the 
wireless service providers.
    And finally the FCC and the States are really the proper 
bodies to resolve any issues regarding this. As it was pointed 
out, 33 States have ruled that CLECs should receive reciprocal 
compensation payments and five States have ruled otherwise. 
Whether or not you would agree with these results, it is clear 
that the States have the ability, the knowledge; and the Bell 
companies have made very well and very poignant argument that 
they should not have the obligation to pay it, yet 33 States 
have said they should.
    So, really, it is the FCC that is all about--is considering 
its decision on reciprocal compensation; and virtually all of 
the members of this committee have asked them to do that.
    We support the chairman and the committee members in having 
the FCC relook at this, and focusing it back where it belongs, 
in the hands of the regulators who have the ability to make the 
right decision.
    Thank you very much.
    [The prepared statement of Robert Taylor follows:]
 Prepared Statement of Robert Taylor, Chairman of the Association for 
    Local Telecommunications Services, and CEO, Focal Communications
    Thank you Mr. Chairman and members of the Committee. I welcome the 
opportunity to appear here today on behalf of the facilities-based 
local telephone competitors to explain why H.R. 4445 is unnecessary and 
anti-competitive, and to show why the '96 Act will continue fostering 
local telephone competition and consumer welfare without any 
amendments.
    The '96 Act was the most important piece of telecommunications 
legislation passed by Congress in sixty-two years, and this Committee 
led the way. Thanks to the '96 Act, the competitive local telecom 
industry has raised the capital to build over thirty billion dollars of 
local infrastructure, the competitive ``bricks and mortar'' that mean 
lower prices and new choices for local telephone consumers.1 
Local revenues for competitive local exchange providers (``CLECs''), 
have exploded from less than one billion dollars in 1996 to more than 
6.3 billion dollars in 1999, access lines have climbed from 
approximately one million in 1996 to over 10 million in 1999, 
2 and CLEC employees now exceed 70,000.3 Of 
course, the competitive industry would prefer to move even faster, but 
it is manifest that the '96 Act has jump-started competition in local 
telecom markets.
---------------------------------------------------------------------------
    \1\ The State of Competition in the U.S. Local Telecommunications 
Marketplace, ALTS Annual Report, February 2000, Graphic F.
    \2\ Id. at Graphics I and J.
    \3\ Id. at Graphic F.
---------------------------------------------------------------------------
    With that background, let me turn to the subject of today's 
hearing--reciprocal compensation. Inter-carrier compensation is 
necessary in competitive local markets because the carrier serving an 
end user making a local call may be different from the carrier serving 
the called party. Since terminating carriers receive no additional 
revenue from end users for completing local calls, the '96 Act requires 
originating carriers to compensate terminating carriers for their 
variable costs. This inter-carrier payment is called ``reciprocal 
compensation.''
    Reciprocal compensation applies anytime one carrier originates a 
call and another carrier terminates a call. So, reciprocal compensation 
applies to cellular calls that originate on a cellular carrier's 
network and terminate on a landline network. In this case, the cellular 
company compensates the ILEC for its costs of terminating the call. The 
same is true for local voice phone calls. If a call originates on an 
ILEC network and terminates on a CLEC customer, the ILEC compensates 
the CLEC. And vice versa if the call originates on the CLEC network and 
terminates on the ILEC network. Finally, the same regime applies to 
calls to the internet. If the call is originated by an ILEC customer 
and terminates on a CLEC network to an Internet service provider (ISP), 
the ILEC compensates the CLEC.
    Incumbent local telephone companies complain these rates were set 
too high in the first round of contracts that were concluded between 
the RBOCs and new entrants in '96 and '97 following passage of the Act. 
These contracts usually last for three years. According to the RBOCs, 
the '96 Act cannot be trusted to reduce these rates to the actual costs 
of terminating local traffic in the next round of contracts, so they 
propose to totally eliminate these charges in subsequent contracts for 
one category of traffic--calls to Internet service providers 
(``ISPs'').
          summary of alts' and focal's opposition to h.r. 4445
    H.R. 4445 would prohibit all reciprocal compensation payments for 
carriers that terminate calls to the internet. ALTS and Focal 
Communications strongly oppose this legislation for the following 
reasons:
    First, prohibiting competitive telecom providers from receiving 
payment for terminating calls to the internet is anti-competitive and 
possibly unconstitutional. Competitors incur costs of carrying these 
calls, and we deserve to be compensated for these costs. Second, if 
competitors are not allowed to receive compensation from the 
originating carrier, we may have to attempt to recover these costs from 
the Internet provider. The internet provider may then be forced to flow 
those rate increases through to its customers. Thus, eliminating 
reciprocal compensation could cause rate increases for thousands of 
internet consumers. Third, it was the RBOCs, not the CLECs, who 
supported high reciprocal compensation rates three years ago. Fourth, 
the negotiation and arbitration of successor ILEC/CLEC contracts 
pursuant to the '96 Act is already moving reciprocal compensation rates 
down. Some recent contracts have reduced reciprocal compensation rates 
by over half. Thus, there is no need to amend the '96 Act to make sure 
this will happen. Fifth, if any fine-tuning of reciprocal compensation 
rules for ISP-bound traffic were needed, it would be far better 
accomplished by the FCC and the states than through legislation.
1. CLECs incur costs for carrying internet calls, and thus deserve to 
        be compensated for providing this service to Internet Service 
        Providers.
    Inter-carrier compensation among telephone companies wasn't needed 
when American telecommunications was still a monopoly in the early 
``80s. All toll and most local calls were completed by a single 
carrier, the Bell System, which owned the long distance operations of 
AT&T, as well as the Bell operating companies.4
---------------------------------------------------------------------------
    \4\ Some local calls were exchanged between the Bell companies and 
independent local telephone companies, but there wasn't any need for 
inter-carrier compensation since the costs of these calls were 
automatically included within and recovered by the basic rates of the 
local phone monopolies.
---------------------------------------------------------------------------
    This changed radically with the emergence of long distance 
competition. Not only did the local Bells lack common ownership with 
new long distance competitors like MCI and Sprint, they also lost their 
common ownership with AT&T when the Bell System was split up on January 
1, 1984. The advent of unaffiliated long distance carriers forced the 
FCC to create an inter-carrier compensation mechanism because the long 
distance carriers collected all toll revenues even though the 
originating and terminating local companies (usually two separate 
carriers) also incurred costs when they carried toll traffic between 
end user locations and the interchange carriers' facilities. At the 
request of the local Bell operating companies, the FCC created the 
``access charge'' system to ensure originating and terminating local 
carriers were fully compensated by long distance carriers.
    The emergence of wireless communications in the '80's, and the 
increasing exchange of calls between wireless carriers and the RBOCs, 
required the creation of a second Federal inter-carrier compensation 
mechanism. Traffic tended to flow from wireless carriers to the 
wireline companies, so some wireless companies argued that the inter-
carrier compensation rate should be zero (a zero rate means the 
originating carrier does not share any of its billed end user revenue 
with the terminating carrier, and is often referred to as ``bill and 
keep''). But the RBOCs insisted they had to be compensated for 
transporting and terminating this traffic, and argued vehemently that 
``bill and keep'' would violate the Fifth Amendment's prohibition 
against the ``taking'' of private property.5 The FCC agreed 
with the RBOCs, and ordered reasonable compensation for the transport 
and termination of wireless-wireline calls.6 Today this 
traffic still flows in the direction of the wireline carriers, and the 
RBOCs continue to collect substantial amounts for transporting and 
terminating wireless calls.
---------------------------------------------------------------------------
    \5\ See the May 16, 1996, letter of Prof. Richard Epstein in FCC 
Docket No. 95-185, on behalf of USTA.
    \6\ Implementation of Sections 3(n) and 332 of the Communications 
Act, Regulatory Treatment of Mobile Services, Second Report and Order, 
9 F.C.C. Rec. 1411, 1497-98 (1994).
---------------------------------------------------------------------------
    The need for a third Federal inter-carrier compensation system 
emerged when Congress opened America's local markets to competition in 
the 1996 Telecom Act. Both the Senate and House bills that became the 
'96 Act contained provisions requiring inter-carrier compensation for 
local traffic. This Committee described the requirement that eventually 
became Section 251(b)(5) of Title 47 as ``integral to a competing 
provider seeking to offer local telephone services over its own 
facilities'' (H.R. 104-204, pp. 72-73).
    The FCC agreed with the RBOCs, and required the establishment of 
cost-based reciprocal compensation rates: ``. . . we find that carriers 
incur costs in terminating traffic that are not de minimis, and 
consequently bill-and-keep arrangements that lack any provisions for 
compensation do not provide for recovery of costs'' (Local Competition 
Order, CC Docket No. 96-98, August 8, 1996, at para. 1112). The FCC 
concluded these rates should include ``the economic cost of end-office 
switching that is recovered on a usage-sensitive basis'' (id. at 1057), 
and that such costs ranged from ``$0.002/MOU to $0.004/MOU'' (id. at 
1060).
    I note there is at least one point of agreement between the RBOCs 
and myself: It is plainly unconstitutional to impose bill and keep 
instead of reciprocal compensation, for the reasons USTA explained to 
the FCC back in '96:
          ``Finally, mandatory bill-and-keep arrangements would run 
        afoul of the Takings Clause to the extent they require a LEC to 
        incur the costs of transporting and terminating another 
        carrier's traffic without `just compensation'.''*
        * See generally, Ex Parte Letter of Richard Epstein to William 
        Kennard, CC Dkt. No. 95-185 (May 15, 1996).''
    This same argument was also made by Bell Atlantic, GTE, and 
numerous other incumbents. If bill and keep is unconstitutional in 
regards to the RBOCs, which enjoy many other regulated sources of 
revenue, it applies with even greater force for CLECs, which have no 
embedded monopoly markets or other revenue streams to fall back upon.
2. Eliminating Reciprocal Compensation could harm Internet consumers.
    If reciprocal compensation were prohibited for Internet traffic, it 
will have significant and harmful effects on the internet marketplace.

a. As stated above, CLECs incur costs of carrying calls to ISPs. If 
        CLECs cannot receive payment for carrying these calls from the 
        ILEC, the CLEC will have to seek payment from someone else, 
        most likely the ISP itself. The ISPs may have to flow through 
        this cost increase to their consumers. Cost-based reciprocal 
        compensation ranges around $3-$6 a month for a average 
        household using the Internet, who pay an average of about $17 a 
        month. Flowing those costs through to end users would thus mean 
        an 18%-35% increase in the monthly cost of access to the 
        Internet via CLECs.
b. Another alternative is that, if CLECs cannot be paid for providing 
        this service to ISPs, CLECs may simply exit the market 
        altogether. ISPs would be forced to return to receiving service 
        from the incumbent telephone company, effectively 
        remonopolizing the local market.
c. Finally, eliminating reciprocal compensation could force consumers 
        to have to make long distance telephone calls to obtain access 
        to their internet provider. One of the substantial benefits 
        that CLECs provide to ISPs is that CLECs allow the ISP to use a 
        local phone number. If the CLECs exit the market, ISPs may not 
        be able to receive local telephone numbers from the incumbent. 
        Forcing consumers to pay long distance charges on top of their 
        higher internet charges could make internet access unaffordable 
        for many consumers.
    As this Committee is well aware, the Internet has become a huge 
engine of economic growth in America. Passage of legislation that 
either forces ISPs back to the monopoly providers, or else increases 
the cost of Internet access for millions of Americans by 18% to 35% is 
terrible public policy, pure and simple.
3. It was the RBOCs, not the CLECs, who supported high reciprocal 
        compensation rates three years ago.
    When the FCC requested comments on how it should implement Section 
252(b)(5) of the Communications Act, the RBOCs supported reciprocal 
compensation and opposed ``bill and keep.'' According to Bell Atlantic:
          The most blatant example of a plea for a government handout 
        comes from those parties who urge the Commission to adopt a 
        reciprocal compensation price of zero, which they 
        euphemistically refer to as `bill and keep.' A more appropriate 
        name, however, would be `bilk and keep,' since it will bilk the 
        LECs' customer out of their money in order to subsidize entry 
        by the likes of AT&T, MCI, and TCG . . . [A] regulatorily 
        mandated price of zero--by any name--would violate the Act, the 
        Constitution, and sound economic principles'' (emphasis in 
        original; BA Reply Comments in 96-98 at 20).
    Bell Atlantic also pointed out that reciprocal compensation would 
apply to ISP-bound traffic (id. at p. 21).7
---------------------------------------------------------------------------
    \7\ See Appenidix B. Bell Atlantic subsequently claimed its 1996 
statement was not an admission that calls to ISPs were local calls. 
According to Bell Atlantic, the statement assumed that calls to ISP 
were long distance calls, and that the access charge regime for long 
distance calls would be replaced by reciprocal compensation instead. 
But Bell Atlantic opposed replacement of access charges by reciprocal 
compensation elsewhere in the same document (at pp. 4-6), and contended 
the long distance companies' arguments were only ``lip service'' 
because the proposal was already dead (id. at p. 40). Accordingly, it 
is not credible that Bell Atlantic would silently assume the adoption 
of a proposal it had opposed so strongly and treated as so unlikely 
just 16 pages earlier in the same document.
---------------------------------------------------------------------------
    As noted earlier, the FCC initially proposed that the rates for 
reciprocal compensation should fall in the range of $0.002 to $0.004 
per minute of usage. However, the RBOCs succeeded in obtaining a stay 
of the FCC's Local Competition Order in the Fall of 1996. This enabled 
the RBOCs to demand much higher reciprocal compensation rates--around 
$0.008/MOU to .0009/MOU--believing they would terminate more traffic 
than they would send to the CLECs. The CLECs had to obtain signed 
agreements from the RBOCs quickly in order to start requesting 
unbundled elements, interconnection, and the other facilities that they 
needed from the RBOCs to begin their businesses. Consequently CLECs had 
no choice except to accept the high rates demanded by the RBOCs rather 
than risk delay by litigating the issue.
4. The CLECs have out-competed the RBOCs in the marketplace. Congress 
        should not consider legislation that would overturn this free 
        market result.
    As stated earlier, Bell Atlantic had predicted to the FCC in May of 
1996 that the CLECs would start pursuing in-bound traffic if reciprocal 
compensation rates were set too high--a prediction that proved far more 
prescient that Bell Atlantic could have anticipated.8 As the 
CLECs began to offer service three years ago, the Internet providers 
were among the first customers to recognize the benefits of the CLECs' 
new technologies. The ISPs realized that the CLECs provide better 
overall value--the combination of price and service.
---------------------------------------------------------------------------
    \8\ Appendix B.
---------------------------------------------------------------------------
    The important service factors for ISPs are: installation intervals 
and order accuracy, repair response time and effectiveness, cost-
effective colocation, and minimal call blocking. The ISP industry 
consistently ranks the CLECs ahead of the RBOCs on each of these 
service parameters, and continues to award CLECs with most of the 
growth in ISP lines even though the ILECs now charges basically the 
same price. Indeed, a CLEC like Focal has been so successful at meeting 
these needs in comparison to Ameritech that about one-third of the 
dial-up traffic to ISPs in Chicago is carried by Focal.
    Of course, the key point here is not to praise the job being done 
by CLECs, but rather to point out that the RBOCs obviously have the 
financial and technical resources to provide the same services to ISPs 
that CLECs provide--but have chosen not to do so. Nothing stops 
Ameritech from meeting or beating Focal's ISP services, and ending the 
traffic imbalance. Taking just the example of call blocking, Focal has 
made a major investment in interconnection with numerous Ameritech end 
offices to ensure calls don't get blocked if an individual office 
unexpectedly reaches its capacity, and starts blocking calls. Ameritech 
has provided phone service in Chicago for over a hundred years, and 
could easily provide the same guarantee against call blocking. But it 
does not. I don't question that Ameritech has the right to make that 
business decision, but I do think it clearly demonstrates the current 
traffic imbalance between ILECs and CLECs is not the result of a policy 
problem, but rather the result of the RBOCs own preference to forego 
competing for ISP traffic.
    In short, the CLECs out-competed the RBOCs the in the marketplace 
by providing better service to the ISPs. Having lost in the 
marketplace, the RBOCs should not be permitted to undermine this 
marketplace result through legislation.
5. Reciprocal compensation rates are rapidly declining.
    Although the 8th Circuit's stay of the FCC's rules prevented 
implementation of cost-based reciprocal compensation in the initial 
interconnection contracts, the Supreme Court's reversal of the 8th 
Circuit has reinstated those rules in time to control the negotiation 
and arbitration of subsequent interconnection contracts (the initial 
contracts usually lasted about three years).
    The application of the FCC's rules by the states is clearly moving 
rates down toward cost. For example, the New York Public Service 
Commission determined last August that the proper rate for terminating 
ISP-bound traffic should be one-third of a cent per minute, a reduction 
of more than sixty percent from the nine-tenths of a cent ($0.009/MOU) 
rate that had applied. Bell Atlantic did not appeal that order. And 
earlier this year the Illinois Commerce Commission cut reciprocal 
compensation rates by almost one-half. Needless to say, the RBOCs 
submitted extensive witnesses and evidence in each of these proceedings 
in support of a reduced rate.
    Negotiated settlements reveal the same trend. While the rates 
contained in settlements are obviously driven by the needs of the 
particular carriers involved and do not necessarily reflect economic 
cost, several CLECs have recently announced settlement agreements with 
Bell Companies that reduce their reciprocal compensation rates 
substantially, sometimes to 10% of the former rate level.
6. The Federal Communications Commission and state regulatory 
        commissions should continue to address reciprocal compensation 
        issue.
    The FCC is currently examining the issue of reciprocal compensation 
for ISP-bound traffic. Upon requests from several parties, the FCC 
addressed the issue of reciprocal compensation for ISP-bound traffic in 
a February 26, 1999, Order. First, it concluded that calls to ISPs are 
interstate as a jurisdictional matter. Second, it investigated the 
particular interstate service involved (are interstate calls to ISPs 
local, or are they interstate access; i.e., the access portion of 
interstate long distance calls?). While the RBOCs had tried to confuse 
the issue of jurisdiction with the issue of service category, 
9 the fact that a call is interstate jurisdictionally does 
not automatically make it a long distance call. The FCC needed to 
resolve this service category issue because long distance calls are not 
covered by the reciprocal compensation rules for local traffic inasmuch 
as long distance calls are already covered by the access charge inter-
carrier compensation mechanism.10
---------------------------------------------------------------------------
    \9\ The RBOCs still attempt this confusion; see USTA's May 3, 2000, 
letter in FCC CC Docket No. 96-98.
    \10\ Local Competition Order at para. 1034: ``. . . in the access 
charge regime, the long distance carrier pays long-distance charges to 
the IXC, and the IXC must pay both LECs for originating and terminating 
access service. By contrast, reciprocal compensation for transport and 
termination of calls is intended for a situation in which two carriers 
collaborate to complete a local call.''
---------------------------------------------------------------------------
    The FCC concluded that ISP-bound calls constitute the access 
portion of long distance calls, and thus were not subject to the 
reciprocal compensation rules for local traffic. The FCC went on to 
propose creating Federal inter-carrier compensation rules for ISP-bound 
traffic, noting there are costs for transporting and terminating this 
traffic, and held that until these Federal rules became effective, 
states could supervise all aspects of inter-carrier compensation for 
ISP-bound traffic, including enforcement of existing contracts.
    CLECs appealed the FCC's determination that ISP-bound traffic was 
not local, but the FCC's jurisdictional finding was not challenged. The 
D.C. Circuit agreed with the CLECs, and vacated this determination. 
According to the Court, the FCC had failed to explain why 
jurisdictional precedent had any application to the service category 
issue, where the correct question is: ``. . . discerning whether a call 
to an ISP should fit within the local call model of two collaborating 
LECs or the long-distance model of a long-distance carrier 
collaborating with two LECs''.11
---------------------------------------------------------------------------
    \11\ Slip opinion at p. 11
---------------------------------------------------------------------------
    The FCC has not yet requested public comment concerning the 
vacation and remand of its finding that ISP-bound traffic is access 
traffic. CLECs believe the FCC will have to conclude in its remand that 
ISP-bound traffic is clearly local, given the Court's articulation of 
the service category test.
    If the FCC concludes this traffic is local, then its reciprocal 
compensation rules automatically apply. However, if the FCC concludes 
this traffic is actually exchange access, then it will not be covered 
by the reciprocal compensation rules, nor will it be included within 
the access charge regime because the FCC's policy that such calls not 
pay access charges.12 I expect the FCC to formulate inter-
carrier compensation rules for this traffic segment, since the 
Commission clearly believes there are terminating costs involved. I 
have no reason to believe that the FCC's ultimate inter-carrier 
compensation rules for ISP-bound traffic would differ from the cost-
based rules that already apply to all other local calls. However, the 
delay and contingencies associated inherent in constructing a new 
inter-carrier compensation might raise questions in the mind of the 
investment community about the ability of CLECs to recovery their 
terminating costs. Thus, there is also a serious policy problem in 
treating ISP-bound calls as access, in addition to the underlying legal 
issue.
---------------------------------------------------------------------------
    \12\ This Committee and the full House last month adopted ,The 
Internet Access Charge Prohibition Act of 1999, which codifies the 
FCC's policy.
---------------------------------------------------------------------------
    Furthermore, the state regulatory commissions have taken the bull 
by the horns and are actively ruling on reciprocal compensation 
agreements. As of today, thirty-eight states and twelve federal courts 
have heard the arguments on both sides, and none has been persuaded 
that they actually intended to exclude internet traffic from the 
initial interconnection agreements.13 The record clearly 
demonstrates that reciprocal compensation rates are already coming down 
through the states' application of the FCC's existing rules for cost-
based reciprocal compensation rates.
---------------------------------------------------------------------------
    \13\ See Appendix A to this testimony. The conclusion of the Ohio 
Public Utilities Commission is typical: conclusion as the Ohio PUC: ``. 
. . a review of the interconnection agreement reflects that the parties 
were very specific in identifying services that were not subject to 
reciprocal compensation. Had Ameritech truly believed that ISP traffic 
was exchange access traffic [i.e., not local traffic] at the time the 
interconnection agreement was negotiated, Ameritech should have 
identified it as such'' (Case No. 97-1557-TP-CSS, August 27, 1998, at 
9).
---------------------------------------------------------------------------
7. Conclusion
    In conclusion, it is clear that reciprocal compensation rates are 
declining through private negotiations among the carriers. Eliminating 
reciprocal compensation altogether, as proposed by H.R. 4445 would be 
unconstitutional, would deny CLECs the ability to recover their costs 
of providing service to internet providers, and could cause substantial 
harm to internet consumers. There is simply no need for Congress to 
interrupt these trends through legislation such as H.R. 4445, or by 
creating yet another inter-carrier compensation mechanism.
    Once again I want to thank the Committee for its leadership in 
introducing competition into local telecommunications markets. The '96 
Act is working to foster fair, cost-based competition, and it should be 
allowed to continue working.

                                  APPENDIX A: State and Court Orders Upholding
                        Reciprocal Compensation for ISP-Bound Traffic as of June 14, 2000
----------------------------------------------------------------------------------------------------------------
                                        Initial ILEC-CLEC Contracts
                                 ----------------------------------------     Subsequent         Court appeals
                                    Pre-FCC ruling      Post-FCC ruling      Arbitrations
----------------------------------------------------------------------------------------------------------------
Alabama.........................                      Yes...............  Yes...............  Yes
Arizona.........................  Yes...............                      No................
Arkansas........................  Yes
California......................  Yes...............  Yes...............  Yes...............
Colorado........................  Yes...............                      No................
Connecticut.....................  Yes...............
Delaware........................                      Yes...............
Florida.........................  Yes...............  Yes...............  Yes...............
Georgia.........................  Yes...............  Yes...............  Yes...............  Yes
Hawaii..........................  Yes...............  Yes...............
Illinois........................  Yes...............                      Yes...............  Yes + Yes*
Indiana.........................  Yes...............  Yes...............
Kentucky........................                      Yes...............  Yes...............
Louisiana.......................                      No................  No................
Maryland........................  Yes...............                                          Yes
Massachusetts...................  Yes...............  No................
Michigan........................  Yes...............                                          Yes
Minnesota.......................  Yes...............  Yes...............
Missouri........................  Yes...............  ?**...............  ?.................
Nebraska........................  Yes...............  Yes...............
Nevada..........................                                          Yes...............
New Jersey......................                      No................
New Mexico......................                                          Yes...............
New York........................  Yes...............  Yes...............  Yes...............
North Carolina..................  Yes...............  Yes...............  Yes...............
Ohio............................  Yes...............  Yes...............
Oklahoma........................  Yes...............                                          Yes
Oregon..........................  Yes...............   Yes..............   Yes..............   Yes
Pennsylvania....................  Yes...............  Yes...............  Yes...............
Rhode Island....................                      Yes...............
South Carolina..................                                          No................
Tennessee.......................  Yes...............  Yes...............  Yes...............  Yes
Texas...........................  Yes...............                      Yes...............  Yes + Yes
Utah............................  Yes...............
Virginia........................  Yes...............  ?.................  ?.................
Washington......................  Yes...............  Yes...............                      Yes + Yes
West Virginia...................  Yes...............  Yes...............  Yes...............
Wisconsin.......................  Yes...............
Totals..........................  29-0..............  20-3..............  15-4..............  12-0
----------------------------------------------------------------------------------------------------------------
* ``Yes + Yes'' indicates both the district court and the court of appeals affirmed that reciprocal compensation
  applies to ISP-bound traffic.
** ``?'' indicates an unclear ruling.

                APPENDIX B: ILEC Comments in FCC Docket
              No. 96-98 Concerning Reciprocal Compensation
    Ameritech Reply Comments filed May 30, 1996:
          ``These parties misapprehend that the period during which new 
        carriers first enter the local market will be the time when the 
        traffic is most unbalanced between these new entrants and the 
        incumbent LECs. Presumably, the traffic will become more 
        balanced as new entrants become established in the local 
        marketplace. A reciprocal compensation mechanism will then 
        naturally evolve into a system where payments on one side 
        cancel out the other. But the possibility that competition may 
        someday reach the equivalent of bill-and-keep is no reason to 
        ignore the traffic imbalance that will likely occur at 
        startup.''
          ``Given the fundamental axiom that prices must reflect actual 
        costs for economic efficiency to be achieved, mandatory bill-
        and-keep would be economically inefficient. Bill-and-keep 
        arrangements may lead to overconsumption and underinvestment 
        even in situations when traffic is balanced.''
    Bell Atlantic Reply Comments filed May 30, 1996:
          ``The most blatant example of a plea for a government handout 
        comes from those parties who urge the Commission to adopt a 
        reciprocal compensation price of zero, which they 
        euphemistically refer to as ``bill and keep.'' A more 
        appropriate name, however, would be ``bilk and keep,'' since it 
        will bilk the LECs' customers out of their money in order to 
        subsidize entry by the likes of AT&T, MCI, and TCG. As we 
        demonstrated in our opening comments, a regulatorily mandated 
        price of zero--by any name--would violate the Act, the 
        Constitution, and sound economic principles. See Bell Atlantic 
        Br. at 40-42.''
          ``Indeed, the proponents of bill and keep appear to recognize 
        the flaws in their proposal, and shift their focus here to 
        arguing that the FCC should mandate bill and keep as an 
        ``interim'' pricing mechanism, and as a default price when 
        parties do not agree to a different rate. AT&T Br. at 69; MCI 
        Br. at 52-53; TCG Br. at 83-84.*

          * Some parties also have suggested that the cost to terminate 
        calls during off-peak periods is very low, and that setting 
        prices at zero during those periods is close enough. In 
        reality, while setting different peak and off-peak prices may 
        make sense in some contexts, here it would merely encourage 
        providers to find ways to modify their traffic flows--and 
        thereby effectively change the peak--in order to take advantage 
        of the zero rates while forcing LECs to incur peak load costs. 
        Under these circumstances, peak and off-peak users must share 
        the costs of capacity, and it would be irrational to set a 
        price of zero during any period. See Kahn, The Economics of 
        Regulation, Vol. 1 at 91-93.''
          ``This will create a ``threat point,'' so the argument goes, 
        that will encourage LECs to negotiate reasonable rates for 
        reciprocal compensation. But whether they are termed interim or 
        permanent, mandatory bill and keep arrangements suffer from the 
        same flaws, and simply cannot be squared with the Act's mandate 
        that LECs be permitted to recover their costs absent a 
        voluntary waiver of that right. Bell Atlantic Br. at 42. Nor 
        will adopting bill and keep as a mandatory solution encourage 
        parties to negotiate a reasonable price. It will do the 
        opposite. So long as competitors know that they can get a zero 
        rate if they do not agree to something else, the result will be 
        bill and keep in every case.''
          ``Moreover, the notion that bill and keep is necessary to 
        prevent LECs from demanding too high a rate reflects a 
        fundamental misunderstanding of the market. If these rates are 
        set too high, the result will be that new entrants, who are in 
        a much better position to selectively market their services, 
        will sign up customers whose calls are predominantly inbound, 
        such as credit card authorization centers and internet access 
        providers. The LEC would find itself writing large monthly 
        checks to the new entrant. By the same token, setting rates too 
        low will merely encourage new entrants to sign up customers 
        whose calls are predominantly outbound, such as telephone 
        solicitors. Ironically, under these circumstances, the LECs' 
        current customers not only would subsidize entry by 
        competitors, but would subsidize low rates for businesses they 
        may well not want to hear from.''
    GTE Comments filed May 16, 1996:
          ``FCC adoption of a Bill and Keep mandate would also violate 
        the Fifth Amendment by requiring interconnection--physical 
        occupation and use--of the LEC's network without just 
        compensation. There can be no doubt that mandated 
        interconnection is physical occupation of the ILEC's network. 
        Mandatory interconnection involves not only interconnection 
        with, but carriage upon, the existing ILEC network. Thus, there 
        is the physical taking of an ILEC's property by other local 
        service providers being granted mandatory access to, and 
        carriage over, (limited capacity) closed transmission paths. By 
        governmental fiat, the ILEC has no alternative but to open its 
        network to use by another carrier. The other carrier's signals 
        are transmitted on the ILEC's network. These signals physically 
        occupy the ILEC's network in the same manner that a property 
        owner having an easement for ingress and egress may physically 
        occupy the drivepath of an adjacent property owner in order to 
        traverse the space from his home to a public roadway. In each 
        instance, the servient tenement--be it adjacent property owner 
        or ILEC--must be compensated.'' [Emphasis in the original]
    USTA Comments filed May 16, 1996:
          ``Finally, mandatory bill-and-keep arrangements would run 
        afoul of the Takings Clause to the extent they require a LEC to 
        incur the costs of transporting and terminating another 
        carrier's traffic without `just compensation.'*

          * See generally, Ex Parte Letter of Richard Epstein to 
        William Kennard, CC Dkt. No. 95-185 (May 15, 1996).''
          ``The Commission must have a ``clear warrant'' to adopt an 
        interpretation of a statute that effectuates a taking.** As 
        stated above, the Commission not only lacks a clear warrant to 
        mandate bill and keep under the Act, but lacks any authority to 
        do so.

          ** See Bell Atlantic Tel. Cos. v. FCC, 24 F.3d at 1445; see 
        also Rust v. Sullivan, 500 U.S. at 190-91.''
           APPENDIX C: Remarks of Peter Engdahl of SnowCrest
I. Introduction
    A. Name: Peter Engdahl
    B. President of SnowCrest, Inc. an Internet Provider, family 
founded and run.
    C. SnowCrest, Inc. was started in late 1994 in rural Northern CA 
and was the first company to offer Internet service to towns like Mt. 
Shasta, Weed, Happy Camp, Weaverville, and many others. In many of 
these areas we remained the only Internet provider for two years. The 
areas we serve range from around 100 people to at most 10,000 with the 
only large area being Redding with 60-70k people.
II. Changing from an ILEC to a CLEC
    A. SnowCrest, Inc. began business with the local ILEC(Pac Bell) and 
continued with them for approx. two years. After the 1996 
telecommunications Act allowed for competition we began looking at the 
possibility of moving much of our infrastructure over to a 
CLEC.(specifically Pac West). We decided to switch and have been with 
Pac West since 96/97.
    B. We chose a CLEC due to several reasons:
    1. There were more innovative services offered by the CLEC. (Ie. 
Co-location of equipment inside of the switchroom, purchase of outside 
local POPs from a central location). Co-location of equipment offered 
us the ability to lower costs by reducing the distance the necessary 
phone lines had to travel between the phone company and our equipment 
and offered easy access for repair and maintenance. The CLEC, by 
allowing ISP's to purchase local access numbers from other towns while 
still having our equipment in a single location, allowed us to 
significantly lower our costs and provide the same new technologies and 
speeds to rural areas as well as urban. Note: The Incumbent could offer 
these services and compete with the CLEC instead of seeking federal 
policy changes, but they have choosen not to.
    2. The ILEC is incapable(or unwilling) to fulfill orders by due 
date or correctly fulfill orders. The CLEC almost always fulfills order 
correctly by the due date. Comparison: we have found that ordering a 
line that takes the ILEC 30 days to complete and will require another 
1-3 weeks to repair from improper installation/programming will take 
the CLEC 7-10 days to install and if installed incorrectly 1 day to 
repair.
    3. We were told by the ILEC they were unwilling to add more 
services in cities that we needed to expand in unless SnowCrest, Inc. 
payed the ILEC for the installation of their infrastructure to service 
those areas. Currently the ILEC's are complaining that the CLEC's have 
focused upon ISP's as their customers. However, many ISP's such as 
ourselves were more than willing to leave the ILEC's who did not want 
us or even bother to offer us competitive services.
II. Reciprocal Compensation
    A. The reason for Reciprocal Compensation
    1. Although Reciprocal Compensation is explained in greater detail 
by the CLECs I will voice my observation that if traffic from an ILEC 
is passed to a CLEC no matter what kind of traffic it is, it is the 
right of the CLEC to expect and be guaranteed payment for that service 
from the ILEC.
    B. If Reciprocal Compensation Were Eliminated
    1. Those ISP's receiving service through CLEC's would be billed for 
the CLEC's cost of terminating the call. The reason the ISP's would be 
billed is because there is currently no other structure for the CLEC's 
to collect compensation from the ILECs for the cost they are incurring 
on the CLEC's equipment. This would force ISP's to either raise their 
rates accordingly or move from the CLEC.
    2. If SnowCrest, Inc. were to stay with the CLEC our rate increase 
would be about $6 per user which would take us from $15 per month to 
$21 per month(this is based on an average user load of 53 hours per 
month and multiplying by 2/10 of a cent). The cost for terminating a 
call has been estimated at 2/10 of a cent per minute. As we are mostly 
a rural provider a great number of our users are fixed income or low 
income and would not be able to make this jump. Thererfore SnowCrest, 
Inc. would be forced to drop the CLEC and either move back to the 
ILEC(which the lack of services they offer would at this point make 
that move impossible) or have to ``piggy-back'' our service onto a 
larger Internet wholesaler. ``Piggy-backing'' on an Internet Wholesaler 
would not offer the same coverage of local access numbers in rural 
areas and so would leave some areas completely without local access to 
the Internet.
    3. There would be a distinct reduction in choice of ISP's if 
reciprocal compensation were eliminated. IE. In my home town of Mt. 
Shasta(about 8000 population) SnowCrest, Inc. was the only Internet 
service available until a CLEC(Pac West) opened up the opportunity for 
other ISP's to enter the market, currently there are easily 10-20 
different ISP's to choose from. Currently there are NO other ISP's 
physically based out of Mt. Shasta, therefore if Pac West were to fold 
due to the loss of reciprocal compensation and the subsequent 
abandonment of ISP's Mt. Shasta would again return to only one Internet 
Provider besides the ILEC.
IV. Conclusion
    A. Reciprocal Compensation is not a handout but rather payment for 
the service and cost of terminating a call.
    B. The presence of CLEC's has brought about large increase in 
competition in California which gives consumers greater choice, lower 
prices, and faster access to new technologies.
    C. Congress should not eliminate or change reciprocal compensation 
in its present form unless they wish to risk severe change to the 
manner in which consumers access the Internet.

    Mr. Tauzin. Thank you very much.
    The Chair recognizes himself for 5 minutes, and we will 
thereafter take that hour break as we go to vote. We will come 
back, and Mr. Markey will be first up.
    Mr. Strickling, first of all, you issued--the FCC issued 
the order, declaring it interstate traffic. In February 1999 
you said we had to have some regime in place while we were 
deciding what to do about it. It wasn't until February 2000 
that the court finally ruled.
    Why didn't you use the year between February 1999 and 2000 
to settle this, if this is truly an interstate issue?
    Mr. Strickling. Yes, sir. That is a good question.
    Mr. Tauzin. Let me preface it even better for you. We have 
seen you move fast when you want to move fast. Low-power 
television, e-rates all kinds of quick movement. When you want 
to do something, you can go there. You obviously didn't want to 
do there for a year. Why not?
    Mr. Strickling. Well, Mr. Chairman, I don't think it was a 
question of not wanting to do it, but I think as this 
demonstrates today----
    Mr. Tauzin. Did you notice any notice inquiries during that 
year?
    Mr. Strickling. Yes, sir, we did. At the time of our 
ruling, we issued a notice of proposed rulemaking. Parties 
filed a ream of comments in response to that. Extensions were 
granted to parties to file additional comments. Parties came in 
and peppered us with ex parte meetings all throughout the 
summer and fall; and then we organized to get going on that, 
and were working on it. We were nearly through with our work 
before the court of appeals then intervened with its decision 
earlier this year.
    Mr. Tauzin. What have you done since the court of appeals 
rule?
    Mr. Strickling. As I indicated, the Commission is issuing a 
further notice in this matter in the next few days.
    Mr. Tauzin. So what happened in the 4 months?
    Mr. Strickling. Well, sir, I would suggest to you the New 
York 271 happened, the Texas 271 has been before us.
    Mr. Tauzin. So you have been busy.
    Let me just tell you again, when you want to move on things 
with all these other things, you move pretty fast. I appreciate 
your commitment to get it done by September. Let me just thank 
you for that; and I hope that you move as expeditiously on it 
as you move on other issues when you really want to do 
something.
    I want to get quickly into the issues while I have time.
    First of all, Mr. Kissinger and Mr. Taylor, are you aware 
of the meeting that occurred in Orlando, reported by 
Communications Daily on Thursday, May 25, called ``ISP/CLEC 
Expo Conference''?
    Mr. Taylor. Yes, I am.
    Mr. Tauzin. Are you aware of the report that came out of 
that meeting? I will read it to you.
    One ISP leader complained that CLECs never shared much 
reciprocal compensation money, barely even offering her company 
the discounted phone rates when they clearly profited from 
every call. Another unapologetically talked of her annual 
battle to get her kickback if she became a CLEC herself. The 
conference session showed ISPs how to make the transition to 
CLEC status to ensure they reap the benefits.
    You tell me you don't know of it going on. Here's a 
conference where people are being taught how do it. What is the 
truth here?
    Mr. Taylor. Certainly there was a panel on ISPs becoming 
CLECs, and there are a lot of people selling sham business 
ideas.
    Mr. Tauzin. And there are kickbacks obviously.
    Mr. Taylor. I am unaware of any kickback.
    Mr. Tauzin. I am making you aware of it. Communications 
Daily on the conference, here's a gal that says she had an 
annual battle to get her kickback. Apparently she has to fight 
every year to get it, but she gets it. She finally figured out 
she didn't have to fight for it if she became a CLEC. So it 
goes on.
    Mr. Taylor. I think we had the example of the horses making 
calls into the Internet. There is always going to be a bad 
apple.
    Mr. Tauzin. Horses making calls kind of makes an example, 
makes the case for us to act.
    Aside from the case of the shams and the conferences 
teaching people how to sham this system and how to get 
kickbacks, let's talk about the numbers, Mr. Kissinger. You and 
Mr. Tauke have a very different set of numbers. Mr. Tauke told 
us it is costing his company $60 million a month, doubling 
every 100 days. I will multiply that by 12; that is $720 
million a year just to one company, just to one of the Bells--
$720 million a year, not the $200 million.
    Mr. Kissinger. The numbers I quoted from were SBC's annual 
report. That is their numbers.
    Mr. Tauzin. That is for one company last year.
    Mr. Tauke, your numbers are a current $60 million a month 
right now?
    Mr. Tauke. Yes. I am going to the first quarter of this 
year. I don't remember precisely what our numbers were last 
year, but our numbers last year were much less.
    Mr. Tauzin. This thing is accelerating into a problem, I 
think.
    So the numbers you have, if they are dated, might not 
reflect how big they are today; is that fair?
    Mr. Kissinger. The current annual report that is 
available----
    Mr. Tauzin. I understand. But I am hearing testimony, and I 
have heard from other from ILECs the same kind of testimony, 
that the numbers are accelerating pretty rapidly right now.
    Mr. Kissinger. My point was, as those numbers are going up, 
there is a much larger explosion.
    Mr. Tauzin. Let's ask about that. Mr. Tauke pointed out in 
his charts, he collects certainly $15, a flat rate for a second 
line. But he may be paying out $18 or much more to the CLEC 
under this compensation arrangement. So then, while collecting 
for that second line, they are being charged a lot more; is 
that correct?
    Mr. Kissinger. I would say that is a contrived situation. 
What we need to do is look at the bottom line.
    If you do, on their annual report, they will show they are 
generating billions of dollars in new revenues and they have--
--
    Mr. Tauzin. Mr. Tauke, respond quick.
    Mr. Tauke. The bottom line is that if they have $400-and-
some million dollars in revenues, as he said, for second lines, 
and they are paying out $288 million in recip comp, they also 
have a lot of other costs associated with those second lines.
    Mr. Kissinger. That is not right.
    Mr. Tauke. But I don't know precisely what is in the SBC 
annual report. What I do know is, if you are on the Internet 2 
hours a day, if the recip comp cost is greater than the cost 
for the second line--let me point out, too, if you look at the 
Web site, the Texas ISP Association puts up, they say many 
CLECs build business plans around being the low-cost providers 
of local exchange services to Internet service providers. And 
the cash-flow currently is from SWBT, that is, SBC, to the 
CLECs, millions of dollars each month, because a dial-up or SDN 
connection to the Internet is currently handled as a local 
exchange call terminating at the ISP.
    So maybe there is no direct kickback, but they certainly 
point out that the way they are financing these lower costs 
is----
    Mr. Tauzin. Is through the payments.
    You make in your testimony--I want to give you a chance to 
comment. We will have to go vote. You make in your testimony, 
Mr. Tauke, the argument that, look, we agreed in advance there 
wouldn't be access charges coming our way in this one-way 
traffic.
    Mr. Tauke. Correct.
    Mr. Tauzin. But now we are being charged the other way. 
What you are telling us, in effect, is, if you are going to 
continue to be charged in this direction, you either have to 
collect it from your customers--as Mr. Blossman pointed out, 
from your consumers, or you are going to be up here asking for 
some kind of access charge to balance the scale. Either way, 
somebody is going to get hit.
    Mr. Tauke. Somebody has got to pay when there isn't much 
money flowing. The money doesn't relate in any way to the 
costs.
    Mr. Tauzin. Mr. Blossman, you are an elected public 
commissioner. You have to answer to consumers on election day.
    Mr. Blossman. Yes, sir.
    Mr. Tauzin. I take it your testimony is, you are deeply 
concerned that you are going to be asked, as in the case Mr. 
Tauke pointed out, for rate increases to cover this?
    Mr. Blossman. If they are allowed to pay reciprocal 
compensation for this, the Bell companies are going to come to 
us and ask for us to raise their rates to help pay for it. And 
some consumers who will pay that aren't hooked onto Internet, 
and that is something I am trying to avoid.
    Mr. Tauzin. See, I like the--I think Ms. Smith kind of 
points us in the right direction. Here the consumer is being 
charged a flat rate by the local telephone company for access 
to the Internet, and we in Congress have very much--strongly 
opposed the charges.
    But the ILEC is being charged per minute for, indeed, these 
same services. So they are being charged per minute, but then 
only charged a flat rate. There is something wrong with that 
system. I don't know what the total answer is yet, but we have 
got to correct it.
    Mr. Taylor, Mr. Kissinger, I want to give you a last 
statement.
    Mr. Kissinger. Again, Bell Atlantic is distorting the 
issue. Southwestern Bell generated 488 additional revenues just 
from lines installed in homes--second telephone lines in.
    Mr. Tauzin. Let me ask you to do this. We will gather the 
latest and best information. Substantiate your numbers. 
Substantiate the best you can. We want to see them both.
    The Chair will declare a recess for 1 hour. We will come 
back at 1:45. The committee stands in recess.
    [Whereupon, at 12:45 p.m., the subcommittee recessed, to 
reconvene at 1:45 p.m. The same day.]
    Mr. Tauzin. The subcommittee will please come back to 
order.
    The Chair is pleased to welcome and recognize my friend 
from Massachusetts, Mr. Markey, for a round of questions.
    Mr. Markey. Thank you, Mr. Chairman, very much.
    Mr. Tauke, let me clarify here, because I think we just 
have to understand, to be honest with you, the nature of this 
debate. Because if I could summarize what the Bell companies 
seem to be suggesting is that telecommunications carriers 
should operate under a regime of reciprocal compensation except 
that ISP-bound calls should be dealt with under bill and keep. 
Earlier, your chart suggested that zero compensation would 
exchange hands between carriers in the case of an ISP-bound 
call. Do you believe that the carriers who have ISPs as 
customers incur no costs for terminating traffic?
    Mr. Tauke. First, let me start this way. I want to clarify 
that this legislation and the position--that we are saying is 
not necessarily that there should be no compensation paid by a 
local exchange carrier to an another company if an Internet 
call goes to that company and is then sent to an ISP. We are 
saying that the reciprocal compensation scheme that was 
established for local voice traffic should not be the 
compensation mechanism.
    Mr. Markey. Should?
    Mr. Tauke. Should not be the compensation mechanism. Or to 
put it another way, do not look at the cost of--for delivery of 
a voice call and apply that to the Internet traffic.
    Now, in terms of costs, this is a real challenging issue. 
What is the cost? Because there are a lot of different 
circumstances. We cannot demonstrate but we believe that today 
over half of the ISPs in our district who are in our region who 
are served by competitive local carriers are co-located with 
the competitive local carrier. The competitive local carrier 
can require Bell Atlantic to deliver the traffic to them. If 
they are co-located then with that ISP, they have virtually no 
cost in transferring the traffic to the ISP.
    Mr. Markey. Now just stop right there. Let me go over to 
Mr. Kissinger and Mr. Taylor. Virtually no cost. Can you 
comment on that?
    Mr. Taylor. Yes. In the New York metropolitan area we 
connect with fiber, our switches, to over 300 Bell Atlantic end 
offices. There is a tremendous cost. And we pay Bell Atlantic a 
lot of money for that connectivity. We need to connect to all 
of those end offices because we need to improve our network to 
offer a better quality of service than the Bell Atlantic 
network. So we have cost in taking fiber to the 300 central 
offices that Bell Atlantic operates in the New York City-New 
Jersey metro area. Then there is the cost of the rent and the 
cost of the switching and the fiber in the ground and then, 
finally, the cost of electricity to run it. And half of our ISP 
customers are not co-located with it.
    Mr. Markey. But, Mr. Tauke, you believe the ISP call 
composition should be cost-based, is that correct?
    Mr. Tauke. Yes. But let me point out that the compensation 
should be cost-based, taking into account two things. One is 
that you have to question whether or not the network that he is 
talking about is not a network that should--where the cost 
should be covered by the ISP. If we serve the ISP, we are 
paying for that network based on the recovery we get from the 
ISP.
    The second observation I would make is that he acknowledged 
in their case half of their ISPs are co-located with them, 
which was the same figure that I gave you. But where there 
isn't that network cost----
    Mr. Markey. I think this is a very interesting discussion, 
because it kind of gets us to this now kind of 25-year-old 
discussion of cost-based, you know, access. And it raises 
necessarily, you know, the issue of all local traffic in terms 
of whether or not access that is cost-based on the wireless 
traffic and all access charges whether or not they should be 
cost-based. Because I think that is a good discussion, 
actually, for the committee, I mean, philosophically, one way 
or the other, where should we be?
    Because then we don't kind of tease out one part of it, but 
we look at it in this larger kind of long-term 
telecommunications philosophical perspective. And I think that 
is the question that we have. Should we look at the Tauzin bill 
and just add cost base for ISP traffic or should we broaden 
that out and add cost base for everything? And then we have 
kind of need a larger policy discussion that gets kind of at 
the core of the dispute that exists on both sides regardless of 
what is going to be done because they are going to be doing 
more and more as will our other competitors and will constantly 
see these disputes.
    I guess the question I have is, should we have one set of 
rules and then we don't have to revisit them or should we have 
an ongoing revisitation of separate rulemaking, separate rules 
for each individual sector which causes us, you know, to be 
basely serving as a national PUC up here?
    Mr. Strickling, then Mr. Tauke.
    Mr. Strickling. I think you are raising an excellent point, 
but I would also urge you to go perhaps even the next step and 
consider whether, since one of the goals of the act is the 
eventual deregulation of this business, whether the end game 
regime we should be looking at is one in which there is no 
longer any requirement of compensation between carriers for any 
purpose. In other words, if you want to get into this business, 
you get into this business knowing that you must recover the 
costs of being in business from your customers.
    This is an issue that would take years to implement on a 
regulatory--as a regulatory matter, but it is, I think, part of 
the debate that we ought to be moving to at this point. Now 
that we have completed a fairly comprehensive and massive 
access charge reform program, we have got some years here to 
take a look at what the end game really ought to be. I think we 
ought to be looking at that as an option.
    Mr. Tauzin. Without objection, the gentleman is yielded an 
additional 2 minutes.
    Mr. Markey. I thank you.
    Let me go to Mr. Tauke, then Mr. Taylor.
    Mr. Tauke. First, I think that what Mr. Strickling 
suggested is not a bad idea for the long term. But we do have 
to understand there are a lot of questions. For example, are we 
willing to bite the bullet on local service costs if we say 
that there are no intercarrier compensation charges? And this 
is just a tough issue. I think there are a lot of economic and 
market reasons why you might want to do that, but I also can 
acknowledge from your perspective that that is a tough one in 
terms of this particular issue of whether you wait until you 
see the whole picture of intercarrier.
    Mr. Markey. In other words, should we go to bill and keep 
for everything and just jump-start this whole deregulation 
process? Should we just go for it and whatever happens, 
happens? You know, rather than trying to be seers, we just 
accept the marketplace. Then picking winners and losers based 
upon who is doing the better job?
    Mr. Tauke. I happened yesterday to be in Coeur d'Alene, 
Idaho. If you say to Coeur d'Alene, Idaho, listen, there is no 
intercarrier compensation, the end user pays the bill for the 
cost of that service, it is going to be kind of problematic for 
places in Idaho or Montana or Iowa--or even Massachusetts. So 
that is just the political issue.
    But on this other question about do we wait until we see 
the whole picture, traditionally, that is not what we have 
done. When there was a problem about access charges being paid 
by Internet conditions to local exchange carriers, we acted to 
address Congress, the FCC acted to address that problem. Pay 
phone compensation, which Mr. Strickling alluded to earlier, 
there was an action to address that problem. This is a problem 
where I think there is a sense of urgency because of the 
amounts of money that are flowing and the distortions that are 
occurring.
    Mr. Markey. I appreciate that. But there is huge amounts of 
money in these other areas as well, just vast amounts of money 
that are almost impossible to accurately determine access 
charges.
    Mr. Taylor.
    Mr. Taylor. I think when you look at it from a cost-base 
standard--and certainly the act that you all created that had 
that as the mandate and really asked the States and the FCC to 
enforce cost base, doesn't matter then what the dollar amount 
being paid by Bell Atlantic to CLECs is because that is also 
the cost they are avoiding. So at the end of the day, if we get 
to a rate that is cost based, everybody will be indifferent. 
There is no game left in the system. There is no ability for 
somebody to take advantage of the direction of traffic, and we 
have achieved the optimal point in the business game.
    And the costs getting to those cost rates in the last 12 
months--our rate with Bell Atlantic dropped 90 percent. I don't 
believe that Bell Atlantic has changed their business that 
remarkably in the last 12 months, that they have driven that 
much cost out of their business, but they simply said the rate 
will go down by 90 percent.
    Mr. Markey. Mrs. Smith, I am glad that you were able to 
come back. The States are acting on this issue. They are making 
decisions. Some of the decisions are not to act, but they are 
making decisions.
    How would you answer the charge that the PUCs are not 
responding to a very real marketplace anomaly, something that 
is out of whack with the real intent of the law, and that the 
Congress has to intervene in order to supercede the 
decisionmaking process which has been going on at the PUC 
level? How would you answer that in terms of what the PUCs have 
been doing?
    Ms. Smith. I would respond with utter surprise since this 
is an issue we really dealt with since the early 90's, ever 
since any other carrier entered the marketplace and we had to 
figure out how the relationship would go. And, of course, 
compensation is the No. 1 issue.
    In Oregon, in the early 90's, we spent 2 years on this 
stuff. As Commissioner Blossman said, they have an open docket 
now. I think the States are basically dealing very creatively 
with it.
    And if you look at Mr. Tauke's testimony, you will see 
references to Colorado, for example, and what they came up 
with. As things change, as technology changes, I see the States 
changing, but I still want to emphasize that, essentially, this 
is a contract between two business entities. And we really need 
to pay a vital role--play a vital role only when the two 
entities can't agree. But I would say across the board--and I 
would love to provide you with the information--that it is 
being handled.
    Mr. Markey. Thank you, Mr. Chairman.
    Mr. Tauzin. The gentleman's time has expired.
    The Chair recognizes the gentleman from Illinois, Mr. 
Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. Perfect timing, 
because I--Mr. Largent, in his opening statement, talked about 
the contracts coming up for renewal, which means negotiating 
between two parties. Why won't--I think if that is coming 
about, how would the proposal--let me say it another way. I 
think we ought to--will the ability of the two parties to 
renegotiate these contracts change this entire debate? And will 
the market forces cause there to be the change that some are 
proposing legislatively?
    And I will just--let's go to, with all due respect, to Mr. 
Tauke. Then I will go to you Mr. Taylor.
    Mr. Tauke. This is at the heart of the problem, the way the 
negotiation process works.
    An example is with our friends at Focal. We work for the 
Delaware Commission. We were unable to reach a negotiated 
agreement, a rate. So the Delaware--we went to fact finding. 
The Delaware Commission asked Focal as a company to produce 
information about costs. At that point, Focal said, no, we are 
withdrawing; and then they MFN'd another contract.
    Our problem is that we can't as a--we do not have any 
leverage to be able to force the issue. Which is why this 
legislation puts--in a sense draws a line at the end of the 
current contracts to force a new negotiation. Because today 
somebody can take another agreement that is already in place, 
and as long as you have another agreement in place with the 
reciprocal compensation rate of three-tenths of a cent or four-
tenths of a cent or six-tenths of a cent, a minimum, that 
becomes almost a floor in these negotiations. You don't have to 
have a negotiation. You can just take another agreement that is 
on the record in that State.
    So these things just keep rolling, and that is the problem 
with the negotiating process. And, in essence, what this 
legislation does is stop the MFNing so you can give a 
negotiation on this issue.
    Mr. Shimkus. What is MFNing? Can you----
    Mr. Tauke. I am sorry. It is like Most Favored Nation 
status. If we have an agreement----
    Mr. Shimkus. We call it normal trade relations these days. 
I know you have been gone for awhile.
    Mr. Tauke. Sorry about that.
    Mr. Shimkus. Mr. Taylor.
    Mr. Taylor. Certainly in the specifics of Delaware we chose 
to opt into an agreement versus go through the cost of a cost 
study. But by no means did we get any length of increased term. 
We simply got the same term that the other agreement had.
    So we as a company and as an organization are not in favor 
of sort of the perpetual daisy chaining of agreements. This was 
simply we opted into an agreement that had a shorter duration 
actually than if we had gone by ourselves and negotiated a new 
one.
    But I think your question and the key point is, in every 
State we have negotiated an interconnection agreement, from our 
inception to today, the rates have gone done. And that is 
important because we as a business, we as a CLECs and the CLECs 
community need those rates to go down.
    None of us wanted high rates as to begin with. As a number 
of members, including Mr. Largent, pointed out, we had all 
asked for bill and keep at the inception of competition. So we 
as an industry have been driving to cost-based rates since it 
was determined that the rates couldn't be zero a la bill and 
keep. And we think once we get to cost base--and we have seen 
it. There are certain Bell operating companies that aren't 
there yet, but hopefully, as Mr. Strickling pointed out, the 
incentives should be there for them to get to cost base 
quickly. Once they are there, the costs that they incur are the 
costs that they avoid, and they should be indifferent to the 
issue.
    But I think in Illinois and California and Texas and New 
York, we have all seen rates drop dramatically, some 90 
percent, these rates have gone down in a 12-month period, which 
means somewhere costs evaporated.
    Mr. Shimkus. Let me follow up. The legislation proposed--
obviously, would you take the opposite tack and say it would be 
detrimental to the reduction in the cost-base negotiation that 
you are saying is currently going on, is that correct?
    Mr. Taylor. Our point is that the current contractual 
process between two business parties works. And if that doesn't 
work, the current arbitration process with the States and the 
various parties presenting information in front of a hearing 
and arbiter does work. And we have seen through both the 
contractual process and the State arbitration process the rates 
coming down and people agreeing to do this.
    Mr. Shimkus. Thank you.
    And now, if I could, I want to go to Ms. Smith. I know you 
are not from Delaware, but based upon the two comments from 
Bell Atlantic and an ISP provider, what works for you, the 
Public Utility Commission?
    Ms. Smith. I hope it is all right to answer in Oregon terms 
rather than Delaware terms.
    Mr. Shimkus. I think the folks from Delaware would probably 
appreciate that.
    Ms. Smith. Since I don't know their background.
    Mr. Shimkus. But you are part of the association. You 
probably know more about this negotiation and case than we 
would.
    Mr. Smith. It varies from State to State, the extent to 
which the commissions butt in. I use that term advisedly 
because in our State we are looking for as open a market as 
possible.
    So in our arbitrations, for example, there are only two 
parties, the two negotiating parties. No other parties are 
allowed. So we don't get a whole bunch of folks in there 
stirring the batter, if you will.
    The parties could choose their arbitrator. They could 
choose one of our administrative law judges or anybody else 
they want.
    What we try to do is encourage those two parties to make 
the best deal they can with each other. And sometimes for 
transactional cost for one side or the other, both sides do it, 
will choose a piece of another contract for reasons such as Mr. 
Taylor described. But, by and large, again, I am having 
trouble, except for this one anomaly, understanding what the 
major problem is if the two parties are negotiating in good 
faith.
    Mr. Shimkus. And, Mr. Chairman, if I could just follow up 
to Ms. Smith, will H.R. 4445 open the system, as is your desire 
in the State of Oregon as the Public Utility Commissioner, or 
it will hinder the opening of the system?
    Ms. Smith. Well, as I said in any testimony, there are two 
major concerns that we have. First of all, that the bill says 
specifically no compensation. That is not right. That will 
hinder competition, because it shifts the costs all around. And 
the second is it picks out one kind of service and regulates 
that service outside of the State regulation. And we think that 
the marketplace is more a whole than just carving out one 
piece, especially the Internet piece.
    Mr. Shimkus. Thank you.
    Mr. Chairman, I will yield back my time.
    Mr. Tauzin. The Chair now recognizes the gentleman from 
Michigan for a round of questions.
    Mr. Dingell. Thank you, Mr. Chairman. I appreciate your 
courtesy.
    This question to Mr. Kissinger. Mr. Kissinger, I understand 
you say that the Bell companies are profiting greatly from the 
explosion of the Internet through second lines. However, I 
would like to raise a couple points. If I subscribe to Bell 
Atlantic and lease a second line for $20 per month and I use 
that line, as do many people, to dial up to my ISP for 24 hours 
a day, 7 days a week, then Bell Atlantic must pay the CLEC 
serving my ISP over $200 a month in reciprocal compensation, 
isn't that correct?
    Mr. Kissinger. I don't know what the rates are, sir, so I 
couldn't comment on whether that is.
    Mr. Dingell. That is about the average amount.
    Mr. Kissinger. Okay.
    Mr. Dingell. But you wouldn't deny that.
    Mr. Kissinger. I don't have any basis to deny.
    Mr. Dingell. That works out to a net loss for Bell Atlantic 
of about $180 a month--every month. Now, how is this money to 
be made up? Bell Atlantic has lost $180 a month. How do they 
get it back?
    Mr. Kissinger. If I may, I think that that example is 
somewhat contrived. And if I could----
    Mr. Dingell. Let's hear from Mr. Tauke. Mr. Tauke, is that 
contrived?
    Mr. Tauke. Well, right now, the average is about half a 
cent a minute. If you are on 24 hours a day, I think that is 
what it amounts to. So there are people who do this.
    Mr. Dingell. Do you disagree, Mr. Strickling?
    Mr. Strickling. No, sir.
    Mr. Dingell. How about you, Ms. Smith? Do you disagree?
    Ms. Smith. I am sorry, sir. I was distracted because of 
further appointments.
    Mr. Dingell. I would hate to bother you while you are 
distracted. I guess we will have to go on with another 
question.
    Now, you are testifying, Mr. Kissinger, in support of this 
practice, is that right?
    Mr. Kissinger. In support of which practice?
    Mr. Dingell. The one described by Mr. Strickling and Mr. 
Tauke.
    Mr. Kissinger. I am saying that practice doesn't exist in 
the marketplace.
    Mr. Dingell. Why do you say that?
    Mr. Kissinger. What I am saying is that my experience has 
shown that 30 to 40 percent of my users that sign up never 
called in a month. They sign up for Internet service, and they 
buy a telephone line, and they are excited about the Internet--
--
    Mr. Dingell. Would you deny that what I have said is 
factual?
    Mr. Kissinger. I am not saying it is not--that that 
situation would actually happen.
    Mr. Dingell. So you agree that it is factual.
    Let's go then to the next question. Mr. Kissinger, do you 
receive heavily discounted service?
    Mr. Kissinger. No, sir.
    Mr. Dingell. Do you receive other special payments or 
benefits from the CLEC to which your ISP subscribes?
    Mr. Kissinger. Absolutely not. My telephone service is 3 
percent lower than that, that I get under tariffed basis, than 
Southwestern Bell. I receive no other compensation.
    Mr. Dingell. No other compensation whatsoever.
    Mr. Kissinger. None.
    Mr. Dingell. Does anybody else in the industry receive 
compensation of a special character?
    Mr. Kissinger. Competitors within industries typically 
don't talk about their contracts with partners.
    Mr. Dingell. It strikes me that you should probably 
renegotiate your deal with your CLECs.
    Thank you very much.
    Now, Mr. Strickling, are you aware of a company called 
Navipath?
    Mr. Strickling. I am sorry, what is the name again?
    Mr. Dingell. Are you aware of a company called Navipath?
    Mr. Strickling. No, I am not, sir.
    Mr. Dingell. Are you, Ms. Smith?
    Let's just talk about this then. It has been widely 
reported that there has been a terrific new technology that 
they provide the CLECs. The technology permits Internet-bound 
calls to bypass the CLEC switch entirely. Are you either you or 
Ms. Smith aware of this?
    Mr. Strickling. Yes, I am.
    Mr. Dingell. You are.
    Ms. Smith. No.
    Mr. Dingell. Is this possible?
    Mr. Strickling. I think technically it is.
    Mr. Dingell. Is it going on?
    Mr. Strickling. I don't know.
    Mr. Dingell. You would anticipate if it is possible it 
probably would start if there is an economic advantage, would 
you not?
    Mr. Strickling. Absolutely, sir.
    Mr. Dingell. I would note that Navipath requires the CLECs 
to share the reciprocal compensation windfalls siphoned from 
the Bell companies in exchange for using this technology. Would 
that surprise you?
    Mr. Strickling. No, sir.
    Mr. Dingell. Now, in your view, is this legal or proper? 
Oh, I would note that it results in zero cost to the CLEC for 
terminating that traffic.
    Mr. Tauzin. Mr. Dingell, would you yield for a second? I 
think we have got a poster that demonstrates exactly that 
situation.
    Mr. Dingell. I am not familiar with it, so I would be happy 
to continue yielding to you, Mr. Chairman, for purposes of 
enlightening us all.
    Mr. Tauzin. I ask the witnesses who are answering Mr. 
Dingell's question to examine the poster here which illustrates 
exactly that situation, where the traffic goes directly to the 
ISP under this technology, and there is no--it simply bypasses 
the CLECs completely, as you can see in the demonstration here. 
Is this, Mr. Strickling, what Mr. Dingell is referring to, this 
sort of situation?
    Mr. Strickling. I really can't see the chart to tell--but I 
think we can go along and let's assume it is.
    Mr. Dingell. Let's now get to the point here. If this is 
going to result in no cost to the CLECs, why should the CLEC be 
in there to get paid by any of the providers?
    Mr. Strickling. Again, our Commission hasn't spoken to this 
topic yet, but let me give you my own personal view.
    Mr. Dingell. You are a very intelligent fellow. You are 
here as an expert to guide the committee. And I want to you 
know I am impressed with your qualifications. And this 
impression that I have of talents and ability down there 
compels me to ask this question.
    Mr. Strickling. Fine. I will try to answer to the best of 
my personal ability.
    First off, the act is based on the notion that parties are 
going to negotiate contracts with each other.
    Mr. Dingell. But is it negotiated--is it passed on the 
thesis that they are going to be getting something for doing 
nothing?
    Mr. Strickling. You would expect and hope that that would 
be a matter handled in negotiations. My personal view is if a 
regulator intervened in that situation you would not allow 
compensation on----
    Mr. Tauzin. Would the gentleman yield for a second?
    Mr. Dingell. I am happy to yield, because I am struggling 
with this.
    Mr. Tauzin. Mr. Tauke indicated to us I think--what is the 
correct phrase in this enterprise--the notion of the Most 
Favored Nation contract. If this fake CLEC comes along and has 
this technology to bypass a CLECs so the compensation flows 
directly to the ISP that has shell-gamed the situation, if it 
applies for a contract reciprocal compensation with Bell 
Atlantic and they can't come to a negotiated term, it is 
entitled to the best Most Favored Nation's contract, right?
    Mr. Strickling. That is the way the law was written.
    Mr. Tauzin. So it gets paid for doing nothing, doesn't it?
    Mr. Dingell. Is that law or is that FCC ruling?
    Mr. Strickling. No, sir, that is in the law.
    Mr. Dingell. So you are forcing me to believe that to 
change this unfortunate situation that Congress has to pass a 
law, am I right?
    Mr. Strickling. I don't think so, sir. I think that you are 
seeing that the market is changing to adapt to this today.
    Mr. Dingell. It hasn't shown me any signs of change today.
    Mr. Strickling. I think Mr. Taylor mentioned--and we can 
give you other examples. Bell Atlantic has negotiated with 
Level 3 rates only 10 percent of what they were charging.
    Mr. Dingell. I would hate to wake up the FCC to have them 
look at a problem of this kind, because they have been resting 
so comfortably beside it for so long that I am not sure that 
they wouldn't wake up in a bad state of mind and that might be 
a shock to their systems. So I am not really anxious to do 
that.
    Let me ask Ms. Smith. Ms. Smith, these arrangements under 
current practice are arbitrated by the States, are they not?
    Ms. Smith. I think so.
    Mr. Dingell. If there is no agreement, the State arbitrates 
them. And the State says now to poor Mr. Tauke, who is sitting 
there between you looking very sad, you say, Mr. Tauke, you 
have got to pay Navipath or somebody else, perhaps one of the 
other panel members, so much money a month. And now this new 
technology comes along, and they don't have to do anything, and 
they still get paid. I am curious, do the States endorse this 
and does the FCC endorse this practice?
    Ms. Smith. First of all----
    Mr. Dingell. It is a very simple question. You have 
arbitrated this thing. They have to pay. There is zero cost to 
the CLECs for terminating the traffic, and they still get paid.
    Ms. Smith. We wouldn't arbitrate it because they wouldn't 
be certified as a competitive local exchange carrier, and they 
couldn't get certified as a competitive local exchange carrier 
unless----
    Mr. Dingell. With all respect, Ms. Smith, this is a 
wonderful answer. I do want to hear it in good time. But the 
question was, really, do you endorse this practice?
    Ms. Smith. No.
    Mr. Dingell. Do you think this is fair and good in the 
overall public interest?
    Ms. Smith. As I said in my testimony, I do not.
    Mr. Dingell. You do not.
    How about you, Mr. Strickling? Do you endorse this practice 
and think this is good and sound?
    Mr. Strickling. If you are referring to opting into 
agreements, it is in the law.
    Mr. Dingell. I am asking whether getting paid for doing 
something is something that the Federal and State law enforcers 
should insist upon, because that is the current system it 
seems.
    Mr. Strickling. Sir, it is the law today. I don't think I 
could change it if I wanted to.
    Mr. Dingell. But you told me that this would all work out 
in testimony just a little bit back now. My heart suddenly 
leaped with hope.
    Mr. Strickling. It is working out because contracts are 3-
year terms, generally. They can't be extended beyond the term 
they were originally negotiated for. So the threat that Mr. 
Tauke is worried about is a very limited, short duration.
    Mr. Dingell. Let's talk about poor Mr. Levin, who is 
standing here next to me. He is a great believer in the 
Internet, and he subscribes. He is paying all this money into 
Bell Atlantic, and Bell Atlantic is getting screwed by having 
to pay money to somebody who is doing nothing, and it actually 
is resulting in a situation where they are functioning at a 
loss. And now poor Mr. Levin is now going to have to pony up in 
his monthly telephone bills because neither you nor Ms. Smith 
is doing anything to see to it that somebody doesn't get paid 
for doing nothing.
    Mr. Tauzin.  Give that man a raise, Mr. Dingell.
    Mr. Dingell. I want you and Mrs. Smith to tell me how fair 
this is or, in the alternative, tell me you think this is 
profoundly unfair. Which view do you have?
    Ms. Smith. I think it is profoundly unfair.
    Mr. Dingell. How about you, Mr. Strickling? We have here 
some expert advice. I am waiting to hear what you have to say.
    Mr. Strickling. I don't know that it is profoundly unfair 
or not. The question that is being begged here is, why does Mr. 
Levin get to stay on the Internet 24 hours a day, 7 days a 
week, and pay $15 a month for phone service?
    Mr. Dingell. Because he has a contractual arrangement with 
Mr. Tauke. Are you telling me that Mr. Levin ought not to be 
able to negotiate a contractual relationship with Mr. Tauke 
whereunder he could use the Internet for 24 hours a day? 
Certainly the FCC has not become so totally authoritarian as 
to----
    Mr. Strickling. Certainly he should be able to negotiate.
    Mr. Dingell. Now come back and tell me again. Do you think 
this is fair or unfair?
    Mr. Strickling. I think it is an isolated example from 
which one could not draw a general conclusion.
    Mr. Dingell. Am I interpreting that as meaning that you and 
the FCC don't care a lick about this matter?
    Mr. Strickling. Not at all, sir.
    Mr. Dingell. But your diligence in addressing this matter 
seems to be rather small.
    Now, Ms. Smith, we have a few good questions for you. The 
State commissions are responsible for certifying companies as 
CLECs, are they not?
    Ms. Smith. Yes.
    Mr. Dingell. Let me read to you and the rest of the panel--
I think you will all enjoy this--a press report from 
Communications Daily on May 25, and I am now quoting: At a 
joint ISP-CLEC expo in Orlando last month, one ISP leader 
complained that the CLECs never shared much reciprocal 
compensation money, barely even offering her company discounted 
phone rates when they clearly profited from every call. Another 
unapologetically talked of her annual battle to get her--and I 
quote, ``kickback,'' until she came a CLEC herself.
    The article continues to say, the conference held seminars 
to show ISPs how to obtain CLEC status themselves to ensure 
that they could reap the reciprocal compensation benefits.
    Now what are the States doing to combat this scheme where 
ISPs become CLECs solely for the purpose of compensation 
windfall and who has no intention of actually competing in the 
local telephone market? Here you got an entity which is being 
set up for the sole purpose, according to one of the insiders, 
of collecting money from poor Mr. Tauke who is sitting there 
and still looking sad.
    Ms. Smith. As I said in my testimony, let me give you the 
example of New York----
    Mr. Dingell. Pardon?
    Ms. Smith. Let me give you the example of the New York 
Public Service Commission which, when it discovered this issue, 
this anomaly, as it developed, sorted out the kinds of entities 
that you are concerned about, said, look, you don't get 
anything. You have to be somebody who is going to be facilities 
based.
    Mr. Dingell. I am hearing in your remark the kind of sense 
of outrage that I would expect from somebody from Oregon. I 
gather that you find this a displeasing situation, is that 
right?
    Ms. Smith. Absolutely.
    Mr. Dingell. Good. Pray continue.
    Ms. Smith. Any way they work out a scheme by which they 
take the reciprocal compensation and assure that the CLECs--if 
I have got this wrong, let me know, because I have just learned 
it last night--and assure that that money is put into 
infrastructure. If a company is doing as you described or as 
that poster describes, they don't get any.
    Mr. Dingell. Am I hearing you telling me that you don't 
like them stealing, but you don't mind them stealing if they 
put it in infrastructure?
    Ms. Smith. I am just, sir, telling you what New York 
decided to do. As I said in my testimony, I think----
    Mr. Dingell. Is my interpretation correct? I am just a poor 
Polish lawyer from Detroit, and I sometimes have a hard time 
dealing with these difficult technical questions.
    Ms. Smith. No, sir, your interpretation is not correct.
    Mr. Dingell. You object to them being paid for nothing, but 
you don't object to them being paid for doing nothing if they 
put the ill-gotten gains into infrastructure construction.
    Ms. Smith. Sir I am just saying what New York's solution 
was.
    Mr. Tauzin. The Chair would suggest to the gentleman--I am 
going to have to ask Mr. Shimkus to take the Chair, if he can 
do that, and I will be happy to make time available.
    Mr. Dingell. I will be happy to yield to the gentleman 
again. Because your questions are so much better than mine.
    Mr. Tauzin. Let me suggest that I am going to put Mr. 
Shimkus in the Chair, and he will make a time available to the 
gentleman from Michigan again. I want to make sure that the 
gentleman from Oklahoma has a chance.
    I wanted to make one statement before I had to leave. The 
speaker is calling me to his office.
    Mr. Dingell. You have been so gracious that I will limit 
myself to one more question, if you would permit to ask that.
    Mr. Tauzin. Proceed.
    Mr. Dingell. Ms. Smith, would you tell us what is NARUC 
doing to eliminate this scam on the rest of the States and what 
is the FCC doing, other than sitting comfortably beside it?
    Ms. Smith. NARUC is educating its members on the issues, 
surveying which States actually have these problems, because I 
can't identify it for Oregon, and looking at solutions so that 
we can speak out authoritatively before Congress on what we 
believe the issues to be. But we can also solve them at our 
State level, if it takes State legislation to make sure if the 
act intended that facilities-based carriers that are getting 
the compensation that is what we are doing.
    Mr. Dingell. I gather you are telling me that you consider 
this strange new breed of combined ISP CLECs to not be true 
competitors in the local telephone market and in grave need of 
some additional attention, am I correct?
    Ms. Smith. Yes.
    Mr. Dingell. I hope that the FCC was listening with all 
proper diligence to that and that my colleagues on the 
committee were doing the same thing.
    Mr. Chairman, I thank you.
    Mr. Tauzin. Thank you, Mr. Dingell.
    I am going to put Mr. Shimkus in the Chair. Then he can 
round out the hearing. But ordinarily I like to make a few 
comments at the end. I won't have the chance since the Speaker 
has asked me to join him in his office right now. Let me, 
however, take a moment, with the consent of my friend from 
Oklahoma, to make a couple of comments. Then we will recognize 
him.
    The first is that it seems to me one of the big problems we 
have in this whole equation of determining how to resolve these 
issues is that, on the one hand, coverage; and the FCC has set 
a policy in place that says we don't want people who use the 
Internet for data services to pay on a permit basis--or even 
passing a bill to codify that rule. At the same time, the phone 
companies whose lines are used to connect to the ISPs are being 
charged on a per minimum basis under this system. So that they 
are charging a flat rate to their customers and yet being 
charged on a permanent basis to support connecting up to an 
ISP.
    And by the way, Mr. Kissinger, one of the CEOs of one of 
the large Bell companies last year told me about his own 
daughter, having to sell her a second line for which he is 
collecting $20 and it is costing him $200 a month. So it is not 
an unreal situation. Apparently, it occurs.
    The bottom line is that we have a situation where, because 
Congress wants to keep data Internet service as cheap as 
possible, be available to people as this new economy develops, 
we are dead set against charging customers on a per minute 
basis, but the companies are charging each other on a per 
minute basis here. So it rattles. It somehow perhaps creates 
some of these anomalies we are talking about.
    The second thing that I wanted to make a mention of and ask 
you all to think about is that, as we move from regular dial-up 
voice communications in America to IP telephony, there is going 
to be more and more discussion about should there be access 
charges, the charges that the telephone companies do not 
collect for data services. Should there be access charges in 
order to continue support for universal service? And we will be 
debating that at some point. Are there going to be permanent 
charges to use the Internet to make telephone calls?
    And that whole issue of access charges and regulations on 
prices and terms and conditions is invading the whole Internet 
economy, will be before this Congress again, something this 
member, as chairman of the committee, is desperately opposed 
to.
    And it concerns me that the longer we debate, all of you, 
the CLECs, the Internet providers and the companies that are 
providing the conduits, the longer we debate and continue this 
whole process of regulating who pays whom for what in a 
government forum, be it a public utility forum or FCC or 
Congress, the longer that pertains, the more likely it is that 
at some point all these regulations and subsidies are going to 
invade the new economy marketplace on the Internet, and that 
concerns me deeply.
    So as a last comment I would ask you all to give some real 
serious thought to what we have learned today. I would 
certainly urge the Commission to have that sense of outrage Mr. 
Dingell was asking you to have about these abuses but also to 
speed up your consideration of how we might provide a better 
system for the time being until we have a fully competitive 
marketplaces where customers ought to make those decision 
before it is too late, before we see this marketplace move so 
rapidly into IP telephony where voice is almost given away in a 
package of services and all of a sudden we have demand for 
access fees and regulations to support universal service to 
close the digital divide. Who knows what else? I hope you are 
all thinking about that.
    Help us, I am asking you. I am on my knees asking you to 
give us your best thoughts on how to resolve this as quickly as 
possible--hopefully without the need for us to pass bills in 
the area.
    The Chair will pass Mr. Shimkus in the Chair and will yield 
to Mr. Largent for questions.
    Mr. Largent. I want to get some perspective on this issue 
that I am supposed to be outraged about. When we talk about the 
local loop, what percent of the local loop is controlled by 
CLECs?
    Mr. Strickling. In terms of how much local loop do they own 
themselves?
    Mr. Largent. That is correct.
    Mr. Strickling. We don't have perfect numbers on that, but 
it is certainly under 10 percent and probably under 5 percent.
    Mr. Largent. The number I have is 4 percent. So the outrage 
that we are talking about here is why 4 percent of the people 
that control the local loop are being portrayed as monsters and 
abusing the people who control 96 percent of the local, am I 
understanding this correctly?
    Mr. Strickling. That is certainly one way to look at it.
    Mr. Largent. That really is outrageous, isn't it? How did 
you come up with--what I am trying to understand here--and I 
think it was Mr. Kissinger, maybe Mr. Taylor, who asked the 
question--the FCC made a determination that these sorts of 
phone calls were interstate. How did that come about?
    Mr. Strickling. It was pursuant to a question that we make 
a declaratory ruling on this. And we took a look at the traffic 
and evaluated the fact that, even if it originates in one 
jurisdiction and then by going onto the Internet could travel 
to another State, could travel to another country--and indeed 
it seemed that the dominant nature of the traffic was it did 
cross State boundaries. And then looking at the analysis of 
where the call began and where that customer was and who he was 
communicating with, we concluded it was an interstate call. But 
that doesn't answer the compensation question.
    Mr. Largent. This to me is a real fundamental issue that we 
need talk about in this hearing for this reason. It is my 
understanding--and I know I have this correct--that Bell 
companies cannot engage in long distance phone calls which are 
interstate. How can they engage in these phone calls that the 
FCC has determined are interstate?
    Mr. Strickling. They are not allowed to transport traffic 
across the LATA boundaries, the inter exchange boundaries. It 
is probably better put to Mr. Tauke, but my understanding is 
the Bell companies, even with their Internet service provider, 
do not engage in the transport of that traffic themselves 
across LATA boundaries. They engage companies called global 
service providers to actually carry the traffic across the 
inter LATA boundaries.
    Mr. Largent. Is it interstate or intrastate? You can't have 
it both ways. You can't say, on one hand, it is not really 
going across the LATA boundaries and so it is not really a long 
distance call but it is interstate transmission.
    Mr. Strickling. I think the confusion there is that you 
have multiple companies involved in that transmission of one 
end user. And that the portion of the call handled by the Bell 
company is not itself crossing LATA boundaries, but then when 
you look for the transmission from end to end, from--in the 
example we are now talking about may involve a minimum of three 
providers even before you get to the Internet backbone provider 
who can be a fourth and presumably fifth, sixth and seventh 
provider, depending on where the call actually went. If you 
look at it end to end, those seven different providers all 
combine to offer an interstate transmission.
    Mr. Largent. But what I am saying, because of the confusion 
and the ambiguity on this particular issue, it really allows a 
Bell company to come and sit at this table and argue any 
variety of issues on either side, whichever one benefits them. 
You understand what I am saying?
    Mr. Strickling. Um-hmm.
    Mr. Largent. And that makes it more confusing for members 
who are sitting on this side of the desk as a result of that.
    Mr. Strickling. If I could just speak to that. A perfect 
example of that was raised by the chairman's last comment about 
how what we are dealing with is a combination of end user rates 
and per minute rates for this reciprocal compensation. That 
wasn't dictated by a regulatory scheme as much as it was by the 
negotiations of the parties back in 1996. At that time, the 
Bell companies wanted high per minute compensation rates. That 
is what we are living with now. And as we end this round of new 
negotiations we are seeing different structures result because 
the incentives have now changed. There is no longer a desire on 
the part of the Bell companies to have high permanent rates for 
this as compensation, and we are now seeing much lower rates 
and different kinds of rates as a result. I think that is good.
    Mr. Largent. Mr. Tauke, is there a cost associated with 
terminating a call? I mean, beyond this new system that 
apparently came up. I am talking about the traditional sense. 
Is there a cost associated with terminating a call that is 
going to an ISP?
    Mr. Tauke. Yes. The problem that we have is that there is 
no mechanism that is being used to assess what that cost is. 
And, instead, the cost of terminating a voice call is used as a 
proxy for the termination of an ISP call, and the costs that 
are looked at are the costs of a Bell company, in this case, in 
terminating a voice call which includes loops to Aunt Tillie's 
house, if you will, at no the cost for an ISP. And if we have 
half of the ISPs, for example, where they don't have switching, 
they are collocated with the CLECs, the cost is very minimal.
    Mr. Largent. But my question specifically is, is there a 
cost associated with terminating a call to an ISP? Yes or no.
    Mr. Tauke. Yes, there undoubtedly is some cost.
    Mr. Largent. Then my next question is, H.R. 4445 says that 
it will be zero compensation, right? Is that fair?
    Mr. Tauke. I don't think that is what H.R. 45445 says. H.R. 
4445 says there won't be reciprocal compensation.
    Mr. Largent. That is what I am saying. There won't be 
reciprocal compensation.
    Mr. Tauke. But reciprocal compensation is the compensation 
rate determined for local traffic. It doesn't say there can't 
be some other form of compensation.
    Mr. Largent. Let's talk about this issue. What I am asking 
you is, you have said that there is some cost, and I think we 
would all agree across this whole deal that it is probably not 
a cent a minute, it is something less than that. That is what 
the negotiations and the contracts that have been signed 
recently reflect. There is a cost associated with that. And yet 
we are eliminating reciprocal compensation on these types of 
calls. We are eliminating that. It is zero. My question to you 
is, is that fair?
    Mr. Tauke. Yes.
    Mr. Largent. That is fair?
    Mr. Tauke. I will tell you why it is fair. Because, first 
of all, if you have a cost it doesn't necessarily have to be 
paid by the carrier who is sending the call. The people who are 
receiving the call are charging their end user, the ISP, for 
some service; and part of that service is for receiving the 
call. So they are covering their costs from their customer, not 
from the carrier who is receiving the call.
    So then have you to determine whether that cost for 
terminating the call is so great that you should also receive 
some subsidy from the carrier sending the call. It is as we 
have talked about today. There a variety of mechanisms for 
compensating for costs. In some cases, it comes from another 
carrier. In some cases, it comes from end user. And the 
question is, what is the rate methodology for reimbursing the 
cost? And our contention is that the reciprocal compensation 
methodology, which was established for local traffic, not 
interstate, which was established for voice, not Internet 
traffic, is the wrong model for this determination of costs.
    Mr. Largent. But it seems to me--I mean, I bet if we had 
another panel and we were talking about access charges for long 
distance, that we might hear you argue the other side of this 
debate. I mean, you might be on the other side of the fence 
when we start talking about access charges on long distance 
service.
    Mr. Tauke. It could be. It would depend on where the cost 
is.
    But let me just say, as I said to Congressman Strickling--
some days I think he is a Senator. As Mr. Strickling alluded to 
earlier, the fact is that you can make a strong argument there 
should be no intercarrier compensation. But then, when you go 
back to Oklahoma, you will have to say to your end users that 
they are going to pick up the total cost for the telephone 
service that they have.
    That has never been a politically viable solution, and that 
is why we have various forms of intercarrier compensation. 
Because many end users, particularly residential end users, we 
assume, should not pick up the total cost of the services 
provided to them.
    Mr. Largent. And that is exactly--brings us right back full 
circle to reciprocal compensation, which is essentially an 
intercarrier way of compensation. Just as you mentioned, we 
have that. And so what you are saying is, when it doesn't 
benefit you, we shouldn't have it. But when it benefits you, we 
should have it. Essentially, that is what you are saying. I 
mean, not even essentially, that is what you are saying.
    Mr. Tauke. I might be saying that, but I think----
    Mr. Largent. That is what you get paid to say. You are 
supposed to say.
    Mr. Tauke. I do believe that you would recognize that that 
is an unfair characterization. What we are talking about is, 
does the method of compensation, A, make any economic sense; 
and, B, does the method of compensation result in bad--have bad 
results? And the bad results are that you are providing a lot 
of money that may be totally unrelated to the cost; B, that 
this could result in unintended consequences such as Internet 
usage charges; and, C, that you are making it very unattractive 
for competitors to go after the residential customer who is 
using the line for Internet access.
    Mr. Largent. Let me just argue those points with you, but--
not argue, but say, No. 1, I agree with you on A. Because I 
think everybody--as I said, that this should be a cost-based 
determining factor. I mean, the cost base should be what 
determines. And I think the negotiations that are occurring 
between the two parties that Ms. Smith talked about, those are 
happening.
    Second of all, Congress has acted on the access charge and 
the per minute charge on the Internet. We said we are not going 
to do that. We are not going to go there. So we have addressed 
that legislatively.
    And your third--what was your third point?
    Mr. Tauke. With all due respect, you haven't addressed the 
second issue. You said there will be no access charges, but you 
are doing nothing to prevent Roseville telephone, as I alluded 
to earlier, in California, from saying to the California 
Commission, we have got all these costs. Now we have got to 
recover them. We are recommending that you allow us to have a 
permanent charge for second lines so that I can recover that 
way.
    And the California Commission can tell Roseville, yeah, we 
will allow to you have a permanent charge on second lines, 
which then means you have--that customer is paying an access 
charge to the Internet. Or they can say to Roseville, we won't 
let you do that, but we will allow you to raise your basic line 
costs a certain percent so that Aunt Tillie, who never goes on 
the Internet, gets to help pay for it.
    There are a variety of ways that they could decide it, but 
the costs are very real for Roseville telephone; and somewhere 
along the line those costs are going to be recovered from an 
end user.
    Mr. Largent. Has Bell Atlantic renegotiated any reciprocal 
compensation?
    Mr. Tauke. We are renegotiating all the time.
    Mr. Largent. What has happened with the rates with 
negotiations with the CLECs?
    Mr. Tauke. They are essentially going down.
    Mr. Largent. Substantially?
    Mr. Tauke. A number of them have gone done substantially. 
Some of them have not.
    Mr. Largent. Have you been involved in renegotiating 
contracts with cell phone providers on reciprocal compensation?
    Mr. Tauke. Yes.
    Mr. Largent. What happens to those rates?
    Mr. Tauke. Some of those rates are coming down as well.
    Mr. Largent. As substantially as the ones related to the 
ISPs?
    Mr. Tauke. I don't think that the--I don't know that I can 
tell you what the rates are between--the difference in the 
rates between the wireless and the wire line, because they are 
treated differently in different negotiations. And the costs 
are totally different between wireless and wire line--comparing 
apples and oranges.
    Mr. Largent. When you negotiate with a wireless provider 
you look at the cost as well.
    Mr. Tauke. Yes.
    Mr. Largent. It is cost-based negotiations, right? Why 
shouldn't these be cost based? Why shouldn't we have cost-based 
rates when have you a reciprocal compensation agreement with an 
ISP?
    Mr. Tauke. They should be. But there are two factors--one 
is the MFN issue, which we talked about. The other factor is 
the determination of cost is made under the rules in this way 
in most States. They look at, first, the RBOC cost, not the 
CLECs costs; and they look at voice calls, not the cost of 
delivering traffic to an ISP.
    Mr. Largent. Isn't that that a matter that the FCC could 
address?
    Mr. Tauke. The FCC could do a lot of things, but they 
haven't done it.
    Mr. Strickling. What Mr. Tauke says is correct, but those 
relate to contracts negotiated in 1996. But no one had focused 
on these differences between handling traffic destined for 
Internet service providers as compared to voice traffic.
    The States are very competent in this regard. When these 
issues come back before them in arbitrations, they know the 
field has shifted. They know that they will perhaps need to 
look at costs on this different bases and focus on the costs 
unique to Internet service providers. So I think it is way 
premature to be suggesting that whatever, however it was done 3 
years ago we are going to repeat that in the States as these 
contracts come back through for arbitration this year and next.
    Mr. Largent. I thank the chairman for giving me a little 
more time. I see it is not a very busy panel. But I just want 
to ask if Mr. Taylor and Mr. Kissinger had any comments, 
because I know you didn't get a chance to participate in the 
questions with Mr. Dingell.
    Mr. Taylor. And I am deeply disappointed that I didn't have 
that opportunity.
    I think when you look at the types of phone traffic as you 
were describing the way Bell Atlantic provides Internet access, 
we do the same thing that a Bell company does. We provide 
switching, we provide line, we provide phone numbers.
    The thing, though, that is important to understand is, 
while the characteristics of usage of the Internet might be 
different than a voice phone call, from a telephone company 
perspective we don't see anything that is different. It looks 
and operates and smells exactly like a voice phone call or a 
fax phone call or, quite frankly, a cellular phone call.
    We have many Bell operating companies that buy phone lines 
from us for their cellular units because we are a better 
provider of lines than the other competitive Bell company. We 
have big, large, soon-to-be Bell operating companies after 
their mergers that their Internet units buy phone lines from us 
because they are better.
    And I think the key point is we do have a cost. You know, 
there has been $30 billion of costs that have been put in the 
ground by CLECs building for broad band infrastructure, 
bringing phone lines to homes and residential customers as well 
as big businesses in the Federal Government; and that $30 
billion needs to be recovered through some mechanism.
    And whether it is as Mr. Tauke describes some small phone 
company that is the exception in California having to raise its 
rates for--maybe they have never raised their rates in the last 
50 years. I mean, it is difficult to say why they are raising 
their rates. Or the other extreme is to tell everybody that 
their AOL bill is going from $20 a month to $27 a month.
    I think the key point is there is a cost. We as Focal and 
as a CLECs organization always believe that we should really 
focus on finding what that cost is. Because when it is a true 
cost it is simply--and every Bell company will be indifferent 
to paying that cost because it is a cost that they will be 
avoiding in the process. So I think you have, you know, really 
uncovered this issue very well and have gotten to the heart of 
this. Let's get to the cost.
    Mr. Largent. Mr. Kissinger.
    Mr. Kissinger. Real quickly, about the free bypass on the 
switch, that is not a new technology. I bought that 3 years ago 
from Southwestern Bell. It was Internet throughway. It was a 
tariff service. When they had that tariff, they had to prove up 
their costs to get that tariff. It wasn't free. And I don't 
have access to those costs, but somebody does. And you might 
want to find out what they said it cost to provide that bypass 
of the switch for an Internet service.
    Mr. Taylor. If I could, add Bell Atlantic does the same 
thing in New York.
    Mr. Kissinger. It is not new. It is available to them.
    I think the fundamental thing--the two things that I think 
are real telling, is, No. 1, and I brought in the substantial 
issue, my claim that they are making so much money from 
Southwestern Bell's annual report and they are making a ton of 
money on this and they are not investing any of that money to 
service Internet service providers. They aren't showing up at 
our door to try to provide us service. When we call them, they 
put up all sorts of obstructions for us to buy service from 
them.
    Thank you for the 1996 Telecom Act. It is working. We exist 
and the Internet today exists in the manner and the fashion 
that we see it specifically because we have competitive 
telephone service and because ISPs can buy competitive 
telephone service. If you remove the incentive for these people 
to do business with us, we are going to be left to the wolves, 
the ILECs who are our competitors. I would encourage you to be 
careful about doing that. This is going to have a dramatic 
effect on us.
    Mr. Largent. Thank you, Mr. Chairman. I yield back.
    Mr. Shimkus [presiding]. The gentleman yields back his 
time. And we are going to close, although I was informed by the 
minority staff, Mr. Taylor, that the ranking member did have 
questions for you; and you are probably the first one that 
would have liked to engage Chairman Dingell again. They did 
notify me that we could get him down here if you would like.
    Mr. Taylor. Oh, that is okay.
    Mr. Shimkus. Smart man. Quick learner.
    This has been a great--obviously, a great hearing and one 
of the reasons why many of many of us love this committee, 
because we have to wrestle with this issue. There are a lot of 
issues.
    My last shot across the bow is, I didn't ask questions--I 
am not going to--just for some of us in rural America have 
small telephone companies. I think of Grafton Telephone, which 
probably has about 350 households; Home Telephone Company in 
St. Jacob, Illinois, which probably has about 650; how will 
they be helped or hurt through this process. There are some 
costs.
    But I think the point is being made the structure today may 
not work, but we do know there are some costs and how do we get 
to an amicable compensation and not just compensation for the 
cost but compensation for the investment and the return on the 
investment. And most of us understand that that has to be there 
for the country to grow and the services to be provided, but we 
want to make sure, just as universal service charges on our 
telephone bills, that all America has access to not only 
telephony but also data services through the Internet.
    With that, I will adjourn the meeting. Thank you for 
attending.
    [Whereupon, at 3:05 p.m., the subcommittee was adjourned, 
subject to the call of the Chair.]
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