IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

_______________

m 98-60213

_______________

ALENCO COMMUNICATIONS, INC.;

AMANA SOCIETY SERVICE COMPANY;

ARROWHEAD COMMUNICATIONS CORPORATION;

AYERSVILLE TELEPHONE COMPANY;

BARAGA TELEPHONE COMPANY;

BARRY COUNTY TELEPHONE COMPANY;

BAY SPRINGS TELEPHONE COMPANY, INC.;

BENTLEYVILLE TELEPHONE COMPANY;

BENTON RIDGE TELEPHONE COMPANY;

BLOOMINGDALE HOME TELEPHONE COMPANY;

BLUE EARTH VALLEY TELEPHONE COMPANY;

BRUCE TELEPHONE COMPANY;

CASEY MUTUAL TELEPHONE COMPANY; CFW COMMUNICATIONS

COMPANY; CITIZENS TELEPHONE COMPANY OF KECKSBURG;

CITIZENS TELEPHONE COMPANY OF HAMMOND;

CITIZENS TELEPHONE CORPORATION;

CLEMENTS TELEPHONE COMPANY; CLIMAX TELEPHONE COMPANY;

COMMUNITY SERVICE TELEPHONE COMPANY;

CRAIGVILLE TELEPHONE COMPANY, INC.;

CROCKETT TELEPHONE COMPANY; DIXVILLE TELEPHONE COMPANY;

DOYLESTOWN TELEPHONE COMPANY;

DUNBARTON TELEPHONE COMPANY, INC.;

DUNKERTON TELEPHONE COOPERATIVE;

EAGLE VALLEY TELEPHONE COMPANY;

EASTON TELEPHONE COMPANY; ECKLES TELEPHONE COMPANY;

ELKHART TELEPHONE COMPANY;

EUSTIS TELEPHONE EXCHANGE;

FARMERS COOP TELEPHONE COMPANY;

FARMERS MUTUAL TELEPHONE COMPANY-OHIO;
2

FARMERS MUTUAL TELEPHONE COMPANY-MINNESOTA;

FLAT ROCK MUTUAL TELEPHONE COMPANY;

FORT JENNINGS TELEPHONE COMPANY;

FRONTIER COMMUNICATIONS OF DEPUE;

GEETINGSVILLE TELEPHONE COMPANY, INC.;

GERVAIS TELEPHONE COMPANY;

GRACEBA TOTAL COMMUNICATIONS, INC.;

GRANADA TELEPHONE COMPANY;

GRANBY TELEPHONE & TELEGRAPH COMPANY-MASSACHUSETTS;

GULF TELEPHONE COMPANY; HARTINGTON TELEPHONE COMPANY;

HICKORY TELEPHONE COMPANY;

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

TELEPHONE COMPANY;

HOME TELEPHONE COMPANY-NEBRASKA;

HOME TELEPHONE COMPANY-MINNESOTA;

HOT SPRINGS TELEPHONE COMPANY;

HUXLEY COOPERATIVE TELEPHONE COMPANY;

INDIANHEAD TELEPHONE COMPANY;

IRONTON TELEPHONE COMPANY;

JEFFERSON TELEPHONE COMPANY, INC.;

KADOKA TELEPHONE COMPANY; KALEVA TELEPHONE COMPANY;

KALIDA TELEPHONE COMPANY, INC.;

LAUREL HIGHLAND TELEPHONE COMPANY;

LIGONIER TELEPHONE COMPANY;

MANKATO CITIZENS TELEPHONE COMPANY;

MANTI TELEPHONE COMPANY;

MARIANNA & SCENERY HILL TELEPHONE COMPANY;

MARSEILLES TELEPHONE COMPANY;

MCCLURE TELEPHONE COMPANY;

MCDONOUGH TELEPHONE COOP, INC.; MEBTEL COMMUNICATIONS;

MERCHANTS & FARMERS TELEPHONE COMPANY;

METAMORA TELEPHONE COMPANY;

MID CENTURY TELEPHONE COOP, INC.;

MID COMMUNICATIONS TELEPHONE COMPANY;

MID-IOWA TELEPHONE COOP ASSOCIATION;

MIDDLE POINT HOME TELEPHONE COMPANY;

MIDSTATE TELEPHONE COMPANY-NORTH DAKOTA;
3

MIDWEST TELEPHONE COMPANY;

MILES COOPERATIVE TELEPHONE ASSOCIATION;

MILLRY TELEPHONE COMPANY, INC.;

MINFORD TELEPHONE COMPANY, INC.;

MINNESOTA LAKE TELEPHONE COMPANY;

MT. ANGEL TELEPHONE COMPANY;

NATIONAL TELEPHONE OF ALABAMA, INC.;

NEW LISBON TELEPHONE COMPANY;

NORTH-EASTERN PENNSYLVANIA TELEPHONE COMPANY;

NORTH ENGLISH COOP TELEPHONE COMPANY;

NORTHWESTERN INDIANA TELEPHONE COMPANY, INC.;

NOVA TELEPHONE COMPANY; ODIN TELEPHONE EXCHANGE, INC.;

ORWELL TELEPHONE COMPANY; OSAKIS TELEPHONE COMPANY;

PALMERTON TELEPHONE COMPANY;

PANHANDLE TELEPHONE COOP, INC.;

PANORA COOPERATIVE TELEPHONE ASSOCIATION;

PATTERSONVILLE TELEPHONE COMPANY;

PENNSYLVANIA TELEPHONE COMPANY;

PEOPLES MUTUAL TELEPHONE COMPANY;

PEOPLES TELEPHONE COMPANY, INC.;

PIERCE TELEPHONE COMPANY, INC.;

PINE ISLAND TELEPHONE COMPANY; PINNACLE COMMUNICATIONS;

PRAIRIE GROVE TELEPHONE COMPANY;

PYMATUNING INDEPENDENT TELEPHONE COMPANY;

REDWOOD COUNTY TELEPHONE COMPANY;

ROANOKE TELEPHONE COMPANY, INC.;

ROBERTS COUNTY TELEPHONE COOP ASSOCIATION;

RONAN TELEPHONE COMPANY; SCHALLER TELEPHONE COMPANY;

SEARSBORO TELEPHONE COMPANY;

SHELL ROCK TELEPHONE COMPANY;

SOUTH CANAAN TELEPHONE COMPANY;

SOUTHERN MONTANA TELEPHONE COMPANY;

STATE LONG DISTANCE TELEPHONE COMPANY;

STATE TELEPHONE COMPANY;

STAYTON COOPERATIVE TELEPHONE COMPANY;

STOCKHOLM-STRANDBURG TELEPHONE COMPANY;

SUMMIT TELEPHONE COMPANY; SWAYZEE TELEPHONE COMPANY;
4

SYCAMORE TELEPHONE COMPANY;

TRI COUNTY TELEPHONE COMPANY, INDIANA;

TRI-COUNTY TELEPHONE MEMBERSHIP CORPORATION;

VALLEY TELEPHONE COOPERATIVE, INC.;

VAN HORNE COOPERATIVE TELEPHONE COMPANY;

VENUS TELEPHONE CORPORATION;

VOLCANO TELEPHONE COMPANY;

WEST IOWA TELEPHONE COMPANY;

WEST LIBERTY TELEPHONE COMPANY;

WEST SIDE TELEPHONE COMPANY;

WEST SIDE TELEPHONE COMPANY-PENNSYLVANIA;

WEST TENNESSEE TELEPHONE COMPANY, INC.;

WESTERN TELEPHONE COMPANY-SOUTH DAKOTA;

WIKSTROM TELEPHONE COMPANY, INC.;

WILTON TELEPHONE COMPANY-NEW HAMPSHIRE;

YADKIN VALLEY TELEPHONE MEMBERSHIP CORPORATION;

YUKON-WALTZ TELEPHONE COMPANY;

and

UNITED STATES TELEPHONE ASSOCIATION,

Petitioners,

VERSUS

FEDERAL COMMUNICATIONS COMMISSION

and

UNITED STATES OF AMERICA,

Respondents.

_________________________

Petitions for Review of Orders

of the Federal Communications Commission

_________________________

January 25, 2000
5

Before SMITH, WIENER, and

EMILIO M. GARZA, Circuit Judges.

JERRY E. SMITH, Circuit Judge:

This is a consolidated challenge to two orders of the Federal Communications Commission (the “FCC,” the “Commission,” or the

“agency”)1promulgated to satisfy the twin

Congressionalmandates articulated inthe Telecommunications Act of 1996 (the “Act”)2

 of

providing universal telecommunications service in the United States and injecting

competitioninto the market forlocaltelephone

service. PetitionersSSlocal telephone service

providers who serve predominantly small

towns and rural areasSSchallenge the orders as

inconsistent with the statutory requirements of

the Act; arbitrary and capriciousin violation of

the Administrative Procedure Act, 5 U.S.C.

§ 706(2)(A); violative of the Takings Clause,

U.S. CONST. amend. V; and in noncompliance

with the Regulatory Flexibility Act, 5 U.S.C.

§ 604. Having jurisdiction to review the orders pursuant to 28 U.S.C. § 2342(1) and

47 U.S.C. § 402(a), we deny the petitions for

review.

I. THE STATUTORY MANDATES.

Universal service has been a fundamental

goal of federal telecommunications regulation

since the passage of the Communications Act

of 1934. Indeed, the FCC’s very purpose is

“to make available,so far as possible, to all the

people of the United States . . . a rapid,

efficient, Nation-wide, and world-wide wire

and communication service with adequate

facilities at reasonable charges.” 47 U.S.C. §

151 (as amended). See also Texas Office of

Pub. Util. Counsel v. FCC, 183 F.3d 393,

405-06 & n.2 (5th Cir. 1999) (“TOPUC”),

petition for cert. filed (Dec. 23, 1999) (No.

99-1072).

Specifically, the Act requires that universal

service support be “explicit and sufficient,”

47 U.S.C. § 254(e), and it articulates several

guiding principles to govern universal

serviceSSincluding, for example, that “access

. . . be provided in all regions of the Nation . .

. including low-income consumers and those in

rural, insular, and high cost areas,” that

services and rates be “reasonably comparable”

to those offered “in urban areas,” that “[a]ll

providers of telecommunications services . . .

make an equitable and nondiscriminatory contribution to the preservation and advancement

of universalservice,” and that universalservice

support be “specific” and “predictable,” id.

§ 254(b)(2)-(5); Order ¶ 21. While the FCC is

required to obey statutory commands, the

guiding principles reflect congressional intent

to delegate difficult policy choices to the

Commission’s discretion. See TOPUC, 183

F.3d at 411-12.3

 

1

In re: Federal-State Joint Board on Universal

Serv.; Report and Order in CC Docket No. 96-45,

12 FCC Rcd. 8776 (1997) (“Order”); Fourth

Order on Reconsideration in CC Docket

No. 96-45; Report and Order in CC Docket

Nos. 96-45, 96-262, 94-1, 91-213, 95-72, 13 FCC

Rcd. 5318 (1997); Errata, 13 FCC Rcd. 2372

(1998) (“Fourth Reconsideration Order”).

 

2 Telecommunications Act of 1996, Pub. L.

No. 104-104, 110 Stat. 56 (to be codified as

amended in scattered sections of title 47, United

States Code).

 

3 The Act additionally states that “[i]t shall be

the policy of the United States to encourage the

provision of new technologies and services to the

public.” 47 U.S.C. § 157(a). Cf. 47 U.S.C.

§ 254(b)(2) (providing that universal service programs be guided by principleof providing accessto

(continued...)
6

(...continued)

advanced telecommunications and information services in all regions). Petitioners argue that the 

orders violate § 157(a).

Unlike the expressstatutory requirement ofsufficient support of universal service support imposed by 47 U.S.C. § 254(e), § 157(a) is merely a

broad statement of policy conferring substantial

discretion on the Commission to determine how

best to provide for new technologies and services.

To our knowledge, § 157(a) has never been used to

invalidate an FCC action. We conclude, therefore,

that a universal service program that satisfies the

specific statutory requirements of § 254(e)

necessarily satisfies the broad policy statement of

§ 157(a).
7

Alongside the universal service mandate is

the directive that local telephone markets be

opened to competition. See 47 U.S.C. §§ 251-

253; AT&T Corp. v. Iowa Utils. Bd., 525 U.S.

366, 371; TOPUC, 183 F.3d at 406, 412. The

FCC must see to it that both universal service

and local competition are realized; one cannot

be sacrificed in favor of the other. The

Commission therefore is responsible for

making the changes necessary to its universal

service program to ensure that it survives in

the new world of competition.4 Because

Congress has conferred broad discretion on

the agency to negotiate these dual mandates,

courts ought not lightly interfere with its

reasoned attempt to achieve both objectives.

SeeChevronU.S.A., Inc. v. NaturalResources

Defense Council, Inc., 467 U.S. 837, 842-44

(1984); 5 U.S.C. § 706(2)(A).

II. THE UNIVERSAL SERVICE ORDERS.

The orders under review make various

changesto universalservice deemed necessary

achieve universal service within a competitive

environment. We describe the general

principles guiding the Commission’s judgment,

then detail the provisions specifically at issue

in petitioners’ various challenges.

A. COMMISSION PRINCIPLES.

To analyze the purpose and effect of the

FCC’s numerousregulatorychangesto its universal service program, we find it useful first

to articulate three principles the Commission

has followed in making the transition from

monopolistic to competitive universalservice.

First, rates must be based not on historical,

booked costs, but rather on forward-looking

costs. After all, market prices respond to current costs; historical investments, by contrast,

are sunk costs and thus ignored. 

[I]t is current and anticipated cost, rather than historical cost[,] that is relevant

to business decisions to enter markets

and price products. The business

manager makes a decision to enter a

new market by comparing anticipated

additional revenues (at a particular

price) with anticipated additional costs.

If the expected revenues cover all the

costs caused by the new product, then a

rational business manager has sound

business reasons to enter the new

market. The historical costs associated

with the plant already in place are

essentially irrelevant to this decision

since those costs are ‘sunk’ and

unavoidable and are unaffected by the

new production decision. This factor

may be particularly significant in industries such as telecommunications

which depend heavily on technological

innovation, and in which a firm’s accounting, or sunk, costs may have little

relation to current pricing decisions.

MCI Communications Corp. v. American Tel.

& Tel. Corp., 708 F.2d 1081, 1116-17 (7th

Cir. 1983).5

 

4

See Order ¶¶ 1-4, 20 (stating that it “ensure[s]

that this system is sustainable in a competitive

marketplace, thus ensuring that universalservice is

available at rates that are ‘just, unreasonable, and

affordable’ for all Americans”).

 

5

See also TOPUC, 183 F.3d at 407 (stating

that “the FCC decided to use the ‘forward-looking’

costs to calculate the relevant costs of a carrier

(continued...)
8

(...continued)

. . . . To encourage carriers to act efficiently, the

agency would base its calculation on the costs an

efficient carrier would incur (rather than the costs

the incumbent carriers historically have incurred)”).
9

Second, the old regime of implicit

subsidiesSSthat is, “the manipulation of rates

for some customers to subsidize more

affordable rates for others”SSmust be phased

out and replaced with explicit universalservice

subsidiesSSgovernment grants that cause no

distortion to market pricesSSbecause a

competitive market can bear only the latter. 

TOPUC, 183 F.3d at 406.

For obvious reasons, this system of implicit subsidies can work wellonly under

regulated conditions. In a competitive

environment, a carrier that tries to

subsidize below-cost rates to rural

customers with above-cost rates to

urban customers is vulnerable to a

competitor that offers at-cost rates to

urbancustomers. Because opening local

telephone markets to competition is a

principal objective of the Act, Congress

recognized that the universal service

system of implicit subsidies would have

to be re-examined.

Id. Indeed, the Act requires that all universal

service support be explicit. See 47 U.S.C.

§ 254(e).

Finally, the program must treat all market

participants equallySSfor example, subsidies

must be portableSSso that the market, and not

local or federal government regulators,

determines who shall compete for and deliver

services to customers. Again, this principle is

made necessary not only by the economic realities of competitive markets but also by statute. See 47 U.S.C. § 214(e)(1) (requiring that

all “eligible telecommunications carrier[s] . . .

shall be eligible to receive universal service

support”).

The FCC additionally defendsthe orders as

reasonable interim regulations. The shift from

monopoly to competition is indeed dramatic.

Congressthus expressly contemplated that the

Commission would adopt an incremental approach to retooling universal service for a

world of competition.6 Because the

provisions under review are

merely transitional, our review

is especially deferential.7

 

6

It requires the Commission to adopt rules

opening the local services market to competition

“within 6 months.” 47 U.S.C. § 251(d)(1). By

contrast, the Commission need only adopt rules

establishing a “specific timetable for

implementation” of universal service, and even

then, it has “15 months” to do so. 47 U.S.C. §

254(a)(2). See also TOPUC, 183 F.3d at 436

(“By instructing the FCC to establish a ‘timetable

for implementation’ by the statutory deadline,

Congress assumed the implementation process

would occur over a transition period after the

fifteen-month deadline.”).

 

7

See TOPUC, 183 F.3d at 437 (“Where the

statutory language does not explicitly command

otherwise, we defer to the agency’s reasonable

judgment about what will constitute ‘sufficient’

support during the transition period from one universal service system to another.”); id. at 440 n.85

(acknowledging that “we extend the FCC greater

discretion in deciding what will be ‘sufficient’

during the transition period”); MCI Telecomm.

Corp. v. FCC, 750 F.2d 135, 140 (D.C. Cir. 1984)

(noting that “substantial deference by courts is

accorded to an agency when the issue concerns

interim relief”).
10

B. PROVISIONS.

Telephone service is jointly

provided by two sets of

carriers. Local exchange

carriers (“LEC’s”) provide

local telephone service in a

given geographical calling area

through monopoly networks, or

“exchanges,” each comprising a

series of “local loops” allowing for interconnection

within the exchange.8 Interexchange carriers (“IXC’s”)

provide long distance service

by connecting callers served by

different LEC’s; such service

is called “exchange access.”9

Petitioners are LEC’s serving

predominantly small towns and

rural areas.10 Intervenor Bell

Atlantic, supporting the FCC

and opposing petitioners, is

also an LEC. Intervenor MCI is

an IXC and also supports the

FCC.

The FCC has established a

number of universal service

programs involving LEC’s and

IXC’s. The Order implements a

myriad of amendments to bring

those programs into compliance

with competition in the LEC

market, but petitioners object

to amendments to two of them. 

First, they oppose various

changes to the universal

service support fund for high

cost loops. Second, before

issuing the Order, the FCC

allowed certain small,

generally rural LEC’s to weight

specially the amount of time

spent by their telephone

switching equipment on

switching long distance calls,

for purposes of calculating the

access charges those LEC’s may

collect from IXC’s. The Order

would eliminate this effective

subsidy and replace it with a

new, explicit support fund.

1. HIGH-COST LOOPS.

Rural LEC’s face special

obstacles. The cost of

providing telephone service

varies with population density,

because dispersed populations

require longer wires and permit

lesser economies in

installation, service, and

maintenance. Also relevant are

geographic characteristics, for

climate and certain types of

terrain make service calls and

repairs more costly. Rural

areas where telephone customers

are dispersed and terrain is

unaccommodating are therefore

the most expensive to serve.

To meet its historic mandate

of universal service, the FCC

has established a universal

service fund to subsidize highcost rural LEC’s to reduce the

rates they must charge their

customers. An LEC is eligible

for a subsidy if its operating

expensesSSits “loop costs”SSare

fifteen percent or more above

the national average. Loop

 

8

See 47 U.S.C. § 153(26) (defining “local exchange carrier”); 47 U.S.C. § 153(47) (defining

“telephone exchange service”).

 

9

See 47 U.S.C. § 153(16) (defining “exchange

access”); 47 U.S.C. § 153(48)(defining “telephone

toll service”).

 

10

See 47 U.S.C. § 153(37) (defining “rural

telephone company”).
11

costs include the costs of the

depreciated cable, wire, and

circuit equipment used to

provide local service, the

depreciation and maintenance

expenses associated with that

local plant, and the corporate

operations expenses related to

the provision of local service.

“Corporate operations expenses” include the costs

incurred in formulating

corporate policy, providing

overall administration and management, and hiring

accountants, consultants, and

lawyers to understand and

comply with FCC, state, and

local regulations. To determine the amount of corporate

operations expense that is

properly chargeable to the provision of local service (and

therefore included in total

loop costs for purposes of

determining eligibility for a

subsidy), an LEC must reduce

its total corporate operations

expenses to correspond to the

proportion of its entire plant

that is local exchange plant.

Petitioners object to a

variety of changes the Order

effects to the administration

of the fund. First, they

oppose the continued imposition

of a cap on growth in fund

expenditures, which cap limits

total available support to the

previous year’s level, adjusted

for growth in the number of

working loops. See Order

¶ 302. Second, they object to

a new cap on the amount of

corporate operations expenses

that can be included in the

loop cost calculation. The

Order allows LEC’s to report

corporate operations expenses

only up to 115% of the industry

average for LEC’s of like size.

See Order ¶¶ 283-285, 307. 

Third, the Order makes the

subsidy portable, following the

customer who switches service

from one LEC to another.

Petitioners claim that

portability violates the

principle of predictable

funding. See Order ¶ 311.

Fourth, beginning January 1,

2000, the Order imposes an

annual inflation index on the

loop cost eligibility

benchmarkSSthe minimum amount a

loop must cost to be awarded a

subsidySSreplacing the former

approach of recalculating a

fresh benchmark periodically,

based on updated estimates of

industry averages. See Order

¶¶ 300-301; 47 C.F.R. §

36.622(d) (1997). Finally, the

Order disallows additional

universal service support when

a rural LEC acquires and

upgrades another exchange, see

Order ¶ 308, despite

petitioners’ claim that such

mergers are efficient and

should be encouraged.
12

The cumulative result of all

these changes, petitioners say,

is that the Commission has rendered LEC’s unable to earn a

fair return and has discouraged

future investment in

telecommunications, and thereby

has acted arbitrarily and

capriciously and has violated

the Act’s sufficient funding

requirement and the Takings

Clause.

2. SWITCHING COSTS.

IXC’s pay “access charges” to

LEC’s for the right to have

access to an LEC’s local

exchange to connect longdistance calls to and from that

exchange. Jurisdiction to

regulate access charges is

shared between federal and

state governments. To

implement rate-of-return regulation, state and federal

regulators must allocate the

costs of operating an LEC

between the delivery of

intrastate, interexchange

telephone service (which is

regulated by state entities)

and the provision of interstate

service (which is subject to

the FCC’s jurisdiction). To

determine how the allocations

are to be made, the agency has

promulgated a number of cost

separation rules.

The separation rules for

costs associated with

connecting callsSSa process

known as “switching”SSare based

on “dial equipment minutes of

use” (“DEM’s”). Under the

rules, an LEC divides its total

DEM’s between those used to

switch interstate calls and

those used to switch intrastate

calls. 

Before the orders under

review, the FCC allowed certain

small, generally rural LEC’s to

weight their DEM totals with a

“toll weighting factor,”

thereby providing LEC’s with a

higher cost basis on which

their federal access charge

would be based. Petitioners

maintain that the practice of

DEM weighting reflects the

higher cost of switching a long

distance or “toll” call than

that of switching a local call,

because certain network

functions required by interexchange carriersSSsuch as

equal access, intra-LATA toll

dialing parity, toll screening,

toll blocking, Signaling System

7 (SS7), expanded carrier

identification codes, and 800

number portabilitySSrequire

additional central processing

hardware and software.

The FCC has long held,

however, that the disparity

between intrastate and

interstate call switching is a

relic of old, electromechanical

technology and that modern

digital switching equipment

largely eliminates the cost

differential.11 Toll-weighting

 

11 As the Commission stated in 1987,

The Mountain States Telephone and

Telegraph Company, Northwestern Bell

TelephoneCompany, PacificNorthwest Bell

Telephone Company (US West), which

originally supported the use of weighted

(continued...)
13

continues today, not out of

adherence to principles of cost

causationSSwhich provide that

costs be charged to the source

of the costSSbut rather to

provide an implicit subsidy for

rural LEC’s.12

The Order replaces tollweighting with a new universal

service fund (separate from the

fund for high-cost loops). See

Order ¶¶ 303-304. Petitioners

object for three reasons. 

First, they claim the Order

arbitrarily and capriciously

abandons cost-causation

principles. Second, because it

would be financed by all

telecommunications carriers,

including small LEC’s such as

petitioners, the new fund constitutes an unlawful subsidy by

small LEC’s in favor of IXC’s

because it effectively saves

IXC’s from having to pay for

the more expensive cost of

switching their long-distance

calls. Finally, just as they

do with respect to the highcost loop fund, petitioners

object on the ground that

portability violates the

principle of predictability and

the statutory command of

sufficient funding.

Specifically, they claim that

if just 25% of the revenue that

the FCC has made portable is

lost by a typical small LEC,

the annual rate of return for

interstate access service will,

in many cases, fall to minus

10.53%.

III. COMMUNICATIONS ACT AND 

ADMINISTRATIVE PROCEDURE ACT

CHALLENGES.

Petitioners’ main challenge

is that the orders are

inconsistent with the statutory

mandates of the Act.

Therefore, they claim, the

orders constitute arbitrary and

capricious regulation.

A. STANDARD OF REVIEW.

Courts review agency conduct

in two ways. First, we review

agency interpretation of their

statutory authority under the

familiar Chevron two-step

(...continued)

DEM in its comments, changed its position

to support measured DEM in reply

comments because it believes the ongoing

process of replacing older technology with

digital switches will eliminate the need for

any toll weighting. We believe that modern

digital switching equipment has greatly reduced, if not eliminated, the additional cost

of toll switching. . . . [W]e believe that the

need for toll weighting will continue to diminish and will eventually be eliminated as

the exchange carriers continue to replace

older technology equipment with digital

switches.

In the Matter of Amendment of Part 67 of the

Commission’s Rules and Establishment of a Joint

Board, Recommended Decision and Order in CC

Docket No. 80-286, 2 FCC Rcd. 2551, ¶ 49

(1987). See also In the Matter of MTS and WATS

Market Structure, Amendments of Part 67 (New

Part 36) of the Commission's Rules and

Establishment of a Federal-State Joint Board,

Report and Order in CC Docket Nos. 78-72,

80-286, 86-297, 2 FCC Rcd. 2639, ¶ 5 (1987).

 

12

See TOPUC, 183 F.3d at 425 (noting “the

sorts of implicit subsidies currently used by the

FCC in its [DEM] weighting program”).
14

inquiry. See Chevron, 467 U.S.

at 842-44.

Under step one, where

“Congress has directly spoken

to the precise question at

issue,” we must “give effect to

the unambiguously expressed

intent of Congress,” reversing

an agency’s interpretation that

does not conform to the

statute’s plain meaning. Id.

at 842-43. Under step two,

which addresses situations in

which the statute is either

silent or ambiguous, “the

question for the court is

whether the agency’s answer is

based on a permissible construction of the statute.” Id.

at 843. We reverse only if the

agency’s construction is “arbitrary, capricious or

manifestly contrary to the

statute.” Id. at 844. If, on

the other hand, the

interpretation “is based on a

permissible construction of the

statute,” we defer to the agency’s construction.

In addition, the

Administrative Procedure Act

(“APA”) empowers courts to

reverse agency action that is

arbitrary and capricious. See

5 U.S.C. § 706(2)(A); Harris v.

United States, 19 F.3d 1090

(5th Cir. 1994). Chevron steptwo focuses on the agency’s

interpretation of its statutory

power, while APA arbitrary-andcapricious review focuses on

the reasonableness of the

agency’s decision-making

process pursuant to that

interpretation. See TOPUC, 183

F.3d at 410. Like Chevron

step-two, APA arbitrary and

capricious review is narrow and

deferential, requiring only

that the agency “articulate[] a

rational relationship between

the facts found and the choice

made.” Harris, 19 F.3d at 1096

(quoting Motor Vehicles Mfrs.

Ass’n of the United States v.

State Farm Mut. Auto. Ins. Co.,

463 U.S. 29, 43 (1983)).

“[T]he agency’s decision need

not be ideal.” Id. Moreover,

our review here is especially

deferential, because the

provisions under review are

merely transitional, as

expressly contemplated by the

Act.13

B. ANALYSIS.

Petitioners assert two

general themes. First, the

challenges go directly to the

heart of FCC expertiseSSwhether

the Commission has sufficiently

and explicitly supported

universal service in an open,

competitive marketSSand thus

must overcome substantial

judicial deference. Examining

the Act through the lens of

Chevron, we note that Congress

obviously intended to rely

primarily on FCC discretion,

and not vigorous judicial

review, to ensure satisfaction

of the Act’s dual mandates. As

we noted in a prior challenge

to an FCC universal service

regulation,

[t]o be sure, the FCC’s

reason for adopting this

methodology is not just to

 

13 See note 7, supra.
15

preserve universal service.

Rather, it is also trying

to encourage local

competition . . . . As

long as it can reasonably

argue that the methodology

will provide sufficient

support for universal

service, however, it is

free, under the deference

we afford it under Chevron

step-two, to adopt a methodology that serves its

other goal of encouraging

local competition.

TOPUC, 183 F.3d at 412.

Petitioners do not satisfy the

high evidentiary standard

necessary to establish that the

Commission acted arbitrarily

and capriciously when it

produced its interim rules.

Second, petitioners’

sufficiency challenge

fundamentally misses the goal

of the Act. The Act does not

guarantee all local telephone

service providers a sufficient

return on investment; quite to

the contrary, it is intended to

introduce competition into the

market. Competition

necessarily brings the risk

that some telephone service

providers will be unable to

compete. The Act only promises

universal service, and that is

a goal that requires sufficient

funding of customers, not

providers. So long as there is

sufficient and competitivelyneutral funding to enable all

customers to receive basic

telecommunications services,

the FCC has satisfied the Act

and is not further required to

ensure sufficient funding of

every local telephone provider

as well.

Moreover, excessive funding

may itself violate the

sufficiency requirements of the

Act. Because universal service

is funded by a general pool

subsidized by all

telecommunications

providersSSand thus indirectly

by the customersSSexcess

subsidization in some cases may

detract from universal service

by causing rates unnecessarily

to rise, thereby pricing some

consumers out of the market.

1. HIGH-COST LOOPS.

Petitioners fail to show that

the FCC’s various changes to

the universal service support

fund for high-cost loops

unreasonably fails to provide

sufficient funding for

universal service or otherwise

constitutes an arbitrary and

capricious regulation under the

Act. First, they object to

the agency’s continuation of a

cap on growth in the fund,

adjusted only for changes in

the total number of working

loops. The cap’s track record,

however, reflects a reasonable

balance between the

Commission’s mandate to ensure

sufficient support for

universal service and the need

to combat wasteful spending.

The agency’s broad discretion

to provide sufficient universal

service funding includes the

decision to impose cost

controls to avoid excessive

expenditures that will detract

from universal service.
16

Petitioners do not show how the

FCC has abused that discretion.

Second, petitioners object to

the introduction of a cap on

the amount of corporate operations expenses that may be

reported to determine

eligibility for high-cost loop

support. The Order limits

LEC’s to 115% of the industry

average for corporate

operations expenses accrued by

carriers of like size. See

Order ¶¶ 283-285, 307.

Petitioners claim that

corporate operations expenses

are already capped and that

there is no need for a second

cap.14 It is true that, even

before the Order, the amount of

reportable corporate operations

expenses was determined by

multiplying an LEC’s total

corporate operations expenses

by the percentage of its total

plant that is local exchange

plant. This is no cap,

however, but rather a

reasonable method of allocating

costs. The proposed 115% rule

is thus a wholly reasonable

exercise of the Commission’s

legitimate power to combat

abusive spending; absent the

proposed rule, the regulations

provide no incentive to keep

costs down. Moreover, given

its legitimate cost concerns,

the agency was well within its

discretion to impose a cap

rather than to undertake the

more costly alternative of

intensive auditing.

Petitioners additionally

claim that the cap on review is

excessively burdensome, driving

interstate rates of return to

2.81% for rural LEC’s. Even

assuming that this statistic

proves that customers have

failed to receive sufficient

universe service support, this

statistic is based on the

experience of only a single

providerSSthe Bay Springs

Telephone CompanySSand not a

statistically valid sample.

Petitioners’ evidence therefore

does not establish that the cap

unreasonably fails to provide

sufficient service; at most it

presents an anomaly that can be

addressed by a request for a

waiver.15

Moreover, the statistic

ignores the Fourth

Reconsideration Order, in which

the FCC responded to

petitioners’ concerns by, inter

alia, establishing a minimum

cap of $300,000. See Fourth

Reconsideration Order ¶¶ 85-

109. Petitioners present no

evidence disputing the sufficiency of the currently

operative cap.

Third, the order provides

that the universal service

subsidy be portable so that it

moves with the customer,

 

14 See Alltel Corp. v. FCC, 838 F.2d 551, 561

(D.C. Cir. 1988) (“A regulation perfectly

reasonable and appropriate in the face of a given

problem may be highly capricious if that problem

does not exist.”).

 

15

See 47 C.F.R. § 1.3; Fourth Reconsideration

Order ¶¶ 93, 102, 108.
17

rather than stay with the

incumbent LEC, whenever a

customer makes the decision to

switch local service providers.

Petitioners claim that

portability violates the

statutory principle of

predictability, see 47 U.S.C. §

254(b)(5), and the statutory

command of sufficient funding.

We reiterate that

predictability is only a principle, not a statutory command.

To satisfy a countervailing

statutory principle, therefore,

the FCC may exercise reasoned

discretion to ignore

predictability. See TOPUC, 183

F.3d at 411-12.

Moreover, petitioners cannot

even show that portability

violates sufficiency or

predictability. The purpose of

universal service is to benefit

the customer, not the

carrier.16 “Sufficient”

funding of the customer’s right

to adequate telephone service

can be achieved regardless of

which carrier ultimately

receives the subsidy.17 

The methodology governing subsidy

disbursements is plainly stated and made

available to LEC’s. What petitioners seek is

not merely predictable funding mechanisms,

but predictable market outcomes. Indeed,

what theywish is protection fromcompetition,

the very antithesis of the Act. 

To the extent petitioners argue that

Congress recognized the precarious

competitive positions of rural LEC’s, their

concerns are addressed by 47 U.S.C. § 214(e),

whichempowersstate commissions to regulate

entry into rural markets.18 Furthermore,

portability is not only consistent with

predictability, but also is dictated by principles

of competitive neutrality and the statutory

command that universal service support be

spent “only for the provision, maintenance,

and upgrading of facilities and services for

which the [universal service] support is intended.” 47 U.S.C. § 254(e).

Fourth, rather than continue to determine

the eligibility threshold for high-cost loop support by recalculating the national average loop

cost, the FCC now simply will adjust the previously-calculated national average by an annual inflation index. Even assuming, as

petitioners contend, that inflation adjustments

to historical averages in fact would render

fewer LEC’s eligible for universal service

subsidies than would be the case under the

former approach, petitioners nevertheless fail

to show how this interim approach is

unreasonable. Given the eventual transition

 

16

See, e.g., 47 U.S.C. § 254(b)(3) (stating that

“Consumers in all regions of the Nation” shall

receive comparable telephone service).

 

17 Petitioners estimate that the introduction of

competition will result in a loss of approximately

25% of the customer base. The FCC counters with

historical trends that would predict market share

losses of only 3%. Because we conclude that the

sufficiency requirement is intended to benefit the

customer, not the provider, we need not resolve this

particular dispute.

 

18

See 47 U.S.C. § 254(e)(2) (“Before

designating an additional eligible

telecommunications carrier for an area served by a

rural telephone company, the State commission

shall find that the designation is in the public

interest.”).
18

from historic cost to forward-looking cost, as

required by competition, the FCC reasonably

concluded that the effort of collecting historic

cost data no longer was justified.

Finally, petitioners claim that sales and

transfers of exchanges by rural providers are

efficient and ought to be encouraged and subsidized. The Order, by contrast, denies

additional universalservice support in casesin

which a rural LEC purchases another

exchange.

When the permanent rules for universal

access within the context of local competition

are in place, all exchanges will be governed by

uniform rules with respect to universalservice

support, without regard to the rural or nonrural status of the LEC. In the interim,

however, the rules continue to treat rural and

other LEC’s differently, in recognition of the

continued greater need of rural LEC’s. The

opportunity thus exists for gaming the

different universal service support regimes by

transferring ownership to a rural LEC. The

FCC acted within its discretion to combat such

gaming by keying regulatory treatment to an

exchange’s original ownership status, without

regard to any subsequent transfer in

ownership.

The Commission argues that, as a last resort, the availability of waivers curesits orders

of any deficiency with respect to sufficiency

and predictability.19 Even if the waiver

provisions were debatable as a policy matter,

they are not an issue for judicial review. For

our purposes, a waiver provision is legitimate

if the underlying rule is rational, see National

Rural Telecomm. Ass’n v. FCC, 988 F.2d 174,

181 (D.C. Cir. 1993), and cannot save a rule

that on its own has no rational basis, see Alltel

Corp, 838 F.2d at 561-62. We therefore can

uphold these amendmentsrelating to the highcost loop fund without addressing the wisdom

of allowing waivers.

2. SWITCHING COSTS.

Petitioners also fail to show that the FCC’s

various changes to the treatment of switching

equipment costs unreasonably fail to provide

sufficient and explicitfunding for universalservice or otherwise constitute an arbitrary and

capricious exercise of agency powers under

the Act. First, petitioners claim that the

changes arbitrarily and capriciously abandon

cost-causation principles. They insist on retaining special weighting on the assumption

that it is in fact more costly to switch longdistance calls than local calls. Therefore, under cost-causative principles, IXC’s should

pay higher access charges, because they are

responsible for a greater proportion of

switching costs.

As we have said, however, the Commission

has long abandoned this assumption. Instead,

specialweighting has been allowed to continue

solely to provide an additionalsubsidy to rural

LEC’s, an interest that would be equally

served by the new universal service support

fund. Indeed, the Order makes plain that the

newfund shallprovide support “corresponding

in amount to that generated formerly by DEM

weighting.” Order ¶ 303. Moreover, by

mandating that all universalservice support be

“explicit,” 47 U.S.C. § 254(e) requires that

this special weighting be eliminated.

 

19

See 47 C.F.R. § 1.3 (general waiver provision

for all FCC regulations); Fourth Reconsideration

Order ¶ 38 (providing for waiver of indexed cap on

growth in high cost loop fund); Id. at ¶¶ 93, 102,

108 (providing for waiver of cap on corporate

operations expenses).
19

Petitioners’ second objection simply

misconstrues the requirement of “explicit”

funding. They argue that, because the new

fund would be financed by all

telecommunications carriers, including small

LEC’s such as petitioners, the new fund

constitutes an unlawful subsidy in favor for

IXC’s.

Again, petitioners rest their argument on

the same assumption deemed obsolete by the

FCCSSthat long-distance switching is more

costly than localswitching. Even so, we made

clear in TOPUC that the implicit/explicit distinction turns on the difference between direct

subsidies from support funds and recovery

through access charges and rate structures.

“The statute provideslittle guidance onwhether ‘explicit’ means ‘explicit to the consumer’

. . . or ‘explicit to the carrier’ . . . [but it] does

state, however, that all universal service

support should be ‘explicit.’ . . . By forcing

GTE to recover its universal service

contributions from its access charges, the

FCC’s interpretation maintains an implicit

subsidy for ILEC’ssuch as GTE.” 183 F.3d at

425. 

Petitionersthusmisconstrue the meaning of

the explicit funding requirement. The fact that

the fund issubsidized by contributionsfromall

telecommunications providers, including

LEC’s, does not make it an implicit subsidy

under § 254(e), even if it effectively

redistributes reso urces among

telecommunications providers.

Moreover, § 254(b)(4) requires “[a]ll providers of telecommunications services [to]

make an equitable and nondiscriminatory contribution to the preservation and advancement

of universal service.” 47 U.S.C. § 254(b)(4)

(emphasis added); see also 47 U.S.C. § 254-

(d). The Commission reasonably applied the

principle of equitable and nondiscriminatory

contribution by requiring contributions from all

telecommunications providers.

Finally, petitioners object on the ground

that portability violates the principle of

predictability and the statutory command of

sufficient funding. Specifically, they claim

that, if just 25% of the revenue that the FCC

has made portable is lost by a typical small

LEC, the annual rate of return for interstate

accessservice will, in many cases, fall to minus

10.53%.
20

As we have said, the Commission

reasonably construed the predi ctability

principle to require only predictable rules that

govern distribution of the subsidies, and not to

require predictable funding amounts. Indeed,

to construe the predictability principle to

require the latter would amount to protection

from competition and thereby would run

contrary to one of the primary purposes of the

Act.

Moreover, petitioners’ approachto the predictability principle would prohibit also the

current subsidy effect of weighting switching

costs. Under the current plan, LEC’s receive

the subsidy implicitly through access

chargesSScosts that are realized only when

customers make telephone calls. The old system of implicit subsidies is no less portable

than is the explicit subsidies contemplated by

the new fund, for an LEC cannot assess access

charges against IXC’s for the costs of a

customer who has left that LEC for another

provider. We therefore uphold the Order over

petitioners’ APA and Chevron challenges.

IV. TAKINGS CHALLENGE.

Notwithstanding the above analysis,

petitioners request us to read the Act to avoid

a violation ofthe Takings Clause. See Edward

J. DeBartolo Corp. v. Florida Gulf Coast

Building & Constr. Trades Council, 485 U.S.

568, 575 (1988). We see no reason to invoke

the canon of avoidance, however, because we

are simply not presented with a constitutional

violation.

The Fifth Amendment protects utilities

from regulations that are “so unjust as to be

confiscatory.” Duquesne Light Co. v. Barasch, 488 U.S. 299, 307 (1989). Petitioners

therefore must show that a regulation will

“jeopardize the financial integrity of the

companies, either by leaving them insufficient

operating capitalor byimpeding their ability to

raise future capital,” or theymust demonstrate

that the reduced subsidies “are inadequate to

compensate current equity holders for the risk

associated withtheirinvestments under a modified prudent investment scheme.” Duquesne,

488 U.S. at 312.

It is not enough that a party merely

speculatesthat a government action will cause

it harm. Rather, a taking must “‘necessarily’

result from the regulatory actions.” TOPUC,

183 F.3d at 437 (citing United States v.

Riverside Bayview Homes, 474 U.S. 121, 128

n.5 (1985)). Such a showing cannot be made

here “until the administrative agency has

arrived at a final, definitive position regarding

how it will apply the regulations at issue to the

particular [property right] in question.”

Williamson County Regional Planning

Comm’n v. Hamilton Bank, 473 U.S. 172, 191

(1985). 

At the very least, therefore, petitioners

must wait to experience the actual
21

consequences of the Order before a court may

even begin to consider whether the FCC has

effected a constitutional taking. Until it is

known what level of universal service funding

each petitioner will receive under the Order,

and under what circumstancestheCommission

will grant a waiver, we cannot seriously

entertain a Takings Clause challenge.

Furthermore, petitioners do not present

credible evidence that the Order ever will

cause the drastic consequencesfor ruralLEC’s

articulated in Duquesne. The mere fact that,

“[f]or many rural carriers, universal service

support provides a large share of the carriers’

revenues,” Order ¶ 294, is not enough to

establish that the orders constitute a taking.

TheFifthAmendment protects against takings;

it does not confer a constitutionalright to government-subsidized profits. The Takings

Clause thus erects no barrier to our Chevron

and APA analysis.

V. REGULATORY FLEXIBILITY ACT

CHALLENGE.

Under the Regulatory Flexibility Act

(“RFA”), final agency rules must contain a

“finalregulatoryflexibilityanalysis” (“FRFA”),

5 U.S.C. § 604(a), which must include

a description of the stepsthe agency has

taken to minimize the significant

economic impact on small entities

consistent with the stated objectives of

applicable statutes, including a statement

of the factual, policy, and legal reasons

for selecting the alternative adopted in

the final rule and why each one of the

other significant alternatives to the rule

considered by the agency which affect

the impact on small entities was rejected.

5 U.S.C. § 604(a)(5). In 1996, Congress

provided for judicial review of agency

compliance with the RFA. See 5 U.S.C. §

611(a)(1). We review only to determine

whether an agency has made a “reasonable,

good-faith effort” to carry out the mandate of

the RFA. Associated Fisheries, Inc. v. Daley,

127 F.3d 104, 114 (1st Cir. 1997).

Petitioners’ RFA argument amounts to little

more than a redressing of its earlier Chevron

and APA claims. The RFA is a procedural

rather than substantive agency mandate, to be

sure,20 but petitioners fail to articulate specific

proceduralflawsin the FCC’s promulgation of

the orders. In fact, both orders are

accompanied by substantial discussion and

deliberation, including consideration and

reasoned rejection of significant alternatives

which, in the Commission’s judgment, would

not have achieved with equivalent success its

twin statutory mandates of universal service

and local competition. The RFA requires no

more.21

Petitioners come closest to stating ameritorious procedural objection when they assert

that the FCC failed either to undertake or to

present economic analysis. Even assuming

that that were so, the RFA plainly does not require economic analysis, but mandates only

that the agency describe the steps it took “to

 

20 See Associated Fisheries, 127 F.3d at 114

(stating that “section 604 does not command an

agency to take specific substantive measures, but,

rather, only to give explicit consideration to less

onerous options”).

 

21

See Associated Fisheries, 127 F.3d at 115

(noting that “section 604 does not require that an

FRFA address every alternative, but only that it

address significant ones.”).
22

minimize the significant economic impact on

small entities consistent with the stated

objectives of applicable statutes.” 5 U.S.C. §

604(a)(5). 

The RFA specifically requires “a statement

of the factual, policy, and legal reasons for selecting the alternative adopted in the final

rule.” Id. Nowhere does it require, however,

cost-benefit analysis or economic modeling.

Indeed, the RFA expressly states that, “[i]n

complying with [section 604], an agency may

provide either a quantifiable or numerical description of the effects of a proposed rule or

alternatives to the proposed rule, or more

generaldescriptive statementsif quantification

is not practicable or reliable.” 5 U.S.C.

§ 607.22 We therefore conclude that the FCC

reasonably complied with the requirements of

the RFA. 

CONCLUSION.

Petitioners’ various challenges fail because

they fundamentally misunderstand a primary

purpose of the Communications ActSSto herald and realize a new era of competition in the

market for local telephone service while

continuing to pursue the goal of universal

service. They therefore confuse the

requirement ofsufficient support for universal

service within a market in which telephone

service providers compete for customers,

which federal law mandates, with a guarantee

of economic success for all providers, a

guarantee that conflicts with competition.

The FCC interim orders are reasonably tailored to achieving universal service and

competition in local markets. They do not

effect a cognizable, unconstitutional taking.

And they were promulgated in reasonable

compliance with the requirements of the RFA.

We therefore DENY the petitions for review.

Judge WIENER concurs in the judgment

only.

 

22

See also Associated Fisheries, 127 F.3d

at 115 (“Section 604 prescribes the content of an

FRFA, but it does not demand a particular mode of

presentation.”).