## 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, 20005

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”) 1 promulgated to s at isfy the twin Congressional mandates articulated in the Telecommunications Act of 1996 (the “Act”) 2 of provid i ng universal telecommunications service in the United States and injecting competition into the market for local telephone

s ervice. Petitioners 

### S

S local telephone service providers w h o serve predominantly small

towns and rural areas 

### SS

challenge the orders as inconsistent with the statutory requirements of

the Act; arbitrary and capricious in violation of

the Administrative Procedure Act, 5 U.S.C. § 706(2)(A); violative of the Takings Clause,

U.S. C ONST

. amend. V; and in noncompliance

with the R e gulatory Flexibilit y 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. T HE S TATUTORY M ANDATES

. U niversal service has been a fundament a l 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

p eo ple of the United States . . . a rapid, efficient, Nat io n-wide, and world-wide wire

and communication servi ce with adequate facilities at reasonable charges.” 47 U.S.C. §

151 (as amended). S ee also Texas Office of

Pub. Util. Counsel v. FCC

, 1 83 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 b e “explicit and sufficient,”

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

gu iding principles to govern universal

service 

### SS including, 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 universal service,” and that universal service

support be “specifi c” and “predictable,” i d. § 254(b)(2)-(5); Order ¶ 21. While the FCC is required to obey statutory commands, the guiding principles reflect congressional intent

to delegate diff

icult policy choices to the

Comm ission’s discretion. S ee 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 C C Docket

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

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

, 13 FCC

Rc d. 5318 (1997); E rrata

, 13 FCC Rcd. 2372 (1998) (“Fourth Reconsideration Order”).

2 Telecommunications Ac t of 1996, Pub. L.

No. 104-104, 110 Stat. 56 (to be codi f ied 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). C f. 47 U.S.C. § 254(b)(2) (providing that universal service programs be guided by principle of providing access to

(continued...)6

(...continued)

advanced telecommunications and information services in all regions). Petitioners argue that the orders violate § 157(a).

Unlike the express statutory requirement of sufficient support of universal service supp ort imposed by 47 U.S.C. § 254(e), § 157(a) is merely a broad s tatement 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 un iversal service program that satisfies the specific statutory r equirements of § 254(e) necessarily satisfies the broad policy statement of § 157(a).7

Alongside the universal service mandate is

the directive t hat local telephone markets be opened to competition. S ee 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

servi ce program to ensure that it survives in

the new wo rld of competition. 4 Because

Con gress has conferred broad discretion on

the agency to negotiate these dual m andates,

courts ought not light ly interfere with its

reasoned attempt to ac hieve both objectives.

See Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-44 (1984); 5 U.S.C. § 706(2)(A).

II. T HE U NIVERSAL S ERVICE O RDERS

. The orders under review make various changes to universal service deemed necessary achieve universal service within a competitive

environment. We describe the general prin ci pl es guiding the Commission’s judgment,

then detail the provisions specifically at issue in petitioners’ various challenges.

A. C OMMISSION P RINCIPLES

. T o analyze the purpose and effect of the

FCC’s numerous regulatory changes to its universal service program, we find i t useful first

to articulate three princi

ples the Commission has followed in making the transition from monopolistic to competitive universal service.

First , rates must be based not on h istorica l

, booked costs

, but rather on f orw ard-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 ma r kets

and price produc t s. The business

manager makes a decision to enter a

new market by com

paring anticipated

a d ditional revenues (at a particular price) with anticipated additional costs.

If the exp ect ed revenues cover all the

costs caused by the new product, then a rational business manager has so u nd

business reasons to enter the new

market. The historical costs associated

wit h the plant already in place are essentially ir relevant to this decision

since those costs are ‘sunk’ and

unavoidable and are unaffected by the

new producti on decis io n. This factor

may be particularly signifi cant in indus t ries 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]

t hat this system is sustainable in a compe titive marketplace, thus ensuring that universal service 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 relevan t costs of a carrier

(continued...)8

(...continued)

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

agency would base its calcula tion 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

subsidies 

### SS

that is, “the mani

pulation of rates

for some customers to subsidize more aff ordable rates for others” 

### S S must be phased

out and replaced with explicit universal service

subsidies 

### SS

government grants that c ause no distortion to market prices 

### SS becau s e a competitive market can bear only the latter.

TOPUC , 183 F.3d at 406.

For obvious reasons, this system of implicit subsidies can work well only under regulated co nditions. In a competitive

environm ent, a carrier that tries to

subsidize below-cost rates to rural

customers with above-cost rates to

u rban customers is vulnerable to a competitor that offers at-cost rat e s to
urban customers. Because opening local telephone markets to c o mpetition is a principal objective of the Act, Congress recognized that the universal service system of implicit subsidies would have

to be re-examined.

Id. I ndeed, the Act requires that all universal

service support be e xplicit. S ee 47 U.S.C. § 254(e).

Finally

, the program must treat all market participants equally 

### SS

for e x ample, subsidies

must be portable 

### SS

so that the market, and not
l o cal or federal government regulators, determines who shall compete for and deliver

services to customers. Again, this principle is

made necessary not only by the econ o mic realities of competitive markets but also by statute. S ee 47 U.S.C. § 214(e)(1) (requiring that all “eligible telecommunications carrier[s] . . .

shall be eligible to receive u n iversal service support”). The FCC additionally defends the orders as reasonable interim regulations. The shift from monopoly t o competition is indeed dramatic. Congress thus expressly contemplated that the

Co mmis sio n would adopt an incremental approach to reto o ling 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 ma rket to competition

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

contrast, the Commission ne e d 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 statutor y deadline,

Co n gress assumed the implementation process would o ccur over a transition period after the fifteen-month deadline.”)

.

7 See TOPUC

, 183 F.3d at 437 (“Where the

statutory language does not explicitly c o mmand otherwise, we defer to the agency’s reasonable judgment about what will constitute ‘suffi c ient’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 t he transition period”); M CI Telecomm. Corp. v. FCC

, 750 F.2d 135, 140 (D.C. Cir. 1984) (noting that “substantial deference by cour ts is

accorded to an agency when the issue c oncerns interim relief”).10 B. P ROVISIONS

. 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
with in 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 establis hed 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 competi tion 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. S econ d , 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. H IGH

- COST L OOPS

. 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 charac teristics, for
climate and certain types of
terrain make service calls and repairs more cost ly. 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

expenses SS its “loop costs” SS are fifteen percent or more above

t he 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”).

1 0 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

c omply with FCC, state, an d

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. F irst

, 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

wo rking loops. S ee Order

¶ 302. Second , they object to

a new cap on the amount of
corporate operations expenses that can be included in the

loo p 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. S ee Order ¶ 311.

Fourth

, beginning January 1, 2000, the Order imposes an annual inflation in dex on the loop cost eligibility

benchmark SS the minimum amount a loop must cost to be awarded a subsidy SS replacing the former approach of recalculating a fresh benchmark periodically,

based on upda ted estimates of industry av erages. S ee Order

¶¶ 300-301; 47 C.F.R. § 36.622(d) (1997). F inally

, 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. S WITCHING C OSTS

. 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 operatin g 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 calls SS a process known as “switching” SS are based

on “dial equipment minutes of

use” (“DEM’s”). Under the rules, an LEC divides its total

D EM’s between those used t o 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
maint ain 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 carriers SS such as equal access, intra-LATA toll dialing parity, toll screening,

toll blocking, Signaling System

7 (SS7), expanded carrier
identification codes, and 800 number portability SS require
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,

T he Mountain States Telephone and Telegra ph Company, Northwestern Bell Telephone Company, Pacific Nor thwest Bell

Tel e phone Company (US West), which

o riginally supported the use of weighted

(continued...)13

continues today, n ot out of

adherence to principles of cost causation SS

which provide that costs be charged to the source

of the cost SS

but 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). S ee Order ¶¶ 303-304. Petitioners object for three reasons. First

, they claimthe Order arbitrarily and capriciously
abandons cost-causation principles. S econd, because it

would be financed by all
telecommunications carriers, including sm all LEC’s such aspetitioners, 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

o bject on the ground tha t 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. C OMMUNICATIONS A CT AND

A DMINISTRATIVE P ROCEDURE A CT

C HALLENGES

. 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. S TANDARD OF R EVIEW

. 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 i t believes the ongoing

process of replacing olde

r 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 carr iers continue to replace

older technology equipment w i th digital

switches.

In the Ma tter 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). S ee also In the Matter of MTS and WATS

Market Structure, Am endments of Part 67 (New

Part 36) of the Commission's Rules and

Establishment of a Federal-State Joint Board,

Re port and Order in CC Docket Nos. 78-72,
80-286, 86-297 , 2 FCC Rcd. 2639, ¶ 5 (1987).

1 2 See TOPUC

, 183 F.3d at 425 (noting “the

sorts of implicit subsidies currently use d by the FCC in its [DEM] weighting program”).14

inquiry. S ee 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

d oes not conform to th e

statute’s plain meaning. I d.

at 842-43. Under step two,
which addresses situations in
which the statute is either
silent or ambiguous, “the question for the c ourt is whether the agency’s answer is

based on a permissible construction of the statute.” I d.

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
i nterpretation “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 ac tion that is arbitrary and capricious. See

5 U.S.C. § 706(2)(A); Harris v.

Un ited States , 19 F.3d 1090
(5th Cir. 1994). C hevron 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. S ee TOPUC

, 183

F.3d at 410. Like C hevron 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.” H arris

, 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. A NALYSIS

. Petitioners assert two general the mes. F irst

, the challenges go directly to the

heart of FCC expertise SS whether

the Commission has sufficiently

and explicitly supported
univer sal service in an open, competitive market SS and 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 serv ice 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.

Ra ther, 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 Chevronstep-two, to adopt a methodology that serves its

other goal of encouraging local competition.

T OPUC

, 183 F.3d at 41 2

. 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 n ot
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 una ble 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 providers SS and thus indirectly by the customers SS exc ess subsidization in some cases may detract from universal service by causing rates unnecessarily

to rise, there by pricing some

consumers out of the market.

1. H IGH

- COST L OOPS

. 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. F irst, they object to the agency’s continuation of a

cap on growth in the fund, adjusted only for changes in

the total nu mber 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 amou nt 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. S ee Order ¶¶ 283-285, 307.

Petitioners claim that
corporate operations expenses

are al ready capped and that

there is no need for a second

cap. 14 It is true that, even

before the Order, the amount of reportable co rporate 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 re asonable
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 bu rdensome, driving
interstate rates of retur n 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

exp erience of only a single provider SS the Bay Springs Telephone Company SS and not a statistically valid sample.

Pe titioners’ 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. S ee 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 f ace of a given problem may be highly capricious if that problem does not exist.”). 1 5 See 47 C.F.R. § 1.3; Fourth Reconsideration Order ¶¶ 93, 102, 108.17

rather than st ay 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 thatpredictability is only a principle, not a statutory command.

To satisfy a countervailing

statutory p rinciple, therefore,

the FCC may exercise reasoned discretion to ignore predictability. S ee 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

ca n be achieved regardless of
which carrier ultimately
receives the subsidy. 17 The methodology governing subsidy

d isbursements is plainly stated and made

available to LE C’s. What petitioners seek is

not merely predictable fun ding mechanisms,

but pr edictable market outcomes. Indeed,

what they wish is protecti on from competition, the very antithesis of the Act.

To the ex tent peti ti oners argue that Congress recognized t he precarious competit ive positions of rural LEC’s, their

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

which empowers state commissi ons to regulate

entr y into rural markets. 1 8 Furthermore, portability is not only con s istent with predictability, but also is dictated by principles

of competitive neu t rality and the statutory
command that universal service supp ort b e spent “ o nly for the provision, maintenance,

an d upgrading of facilities and services for

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

Fourth, rather than continue to determine

the eligibilit

y threshold for high-cost loop support by recalculating the national average loop cost, the FCC now simply will adjust the previous l y-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 app ro ach, petitioners nevertheless fail

t o show how this interim approa ch is

unreasonable. Given the eventual transition 1 6 See, e.g., 47 U.S.C. § 254(b)(3) (stating that

“Consumers in all regions of the Nation” shall receive comparable telephone service).

1 7 Petitioners estimate that the intr oduction of

com petition 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. 1 8 Se e 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

sh a ll find that the designation is in the public interest.”).18

from historic cost to forward-looking cost, as required by compet it io n, the FCC reasonably

concluded that the effort of collecting historic cost data no longer was justified.

Finally , petitioners claim that sales and

transfers o f exchanges by rural providers are

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

additional universal service support in cases in

which a rura l 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 universal service

support, without regar d to the rural or nonrural status of the LEC. In t he interim, however, the rules continue to treat rural and

other LEC’s differently, in recog nit ion of the

continued greater need of rural LEC’s. The

opportu nit y 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 tre a tment to an exchange’s original ownership status, without regard to any subsequent transfer in ownership.

The Commission argues that, as a last resort, the availabilit

y of waivers cures its orders

of any deficiency with respec t to sufficiency

and predictability. 19 Even if the waiver provisions w ere 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 amendments relating to the highcost loop fund without addressing the wisdom of allowing waivers.

2. S WITCHING C OSTS

. Petitioners also fail to show that the FCC’s various changes to the treatment of switching equipment costs unreasonably fail to provide

sufficient and explicit funding for universal service or otherwise constitute an arbitrary and capricious e x ercise of agency powers under

the Act

. First , petitioners claim that the

ch anges arbitrarily and capriciously abandon

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

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

pay higher access charges, becaus e they are responsible for a greater proport ion of switching costs.

As we have said, however, the Commission

has long abandoned this assumption. Instead, special weighting has been allowed to continue solely to provide an additional subsidy 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

new fund shall provide support “correspon ding

in amount to that generated formerly by DEM weighting.” Order ¶ 303. Moreover, by mandating that all universal service support be “explicit ,” 47 U.S.C. § 254(e) requires that this special weighting be eliminated. 1 9 See 47 C.F.R. § 1.3 (general waiver provision

for all FCC regulations); Fourth Re consideration

Order ¶ 38 (providing for waiver of indexed cap on growth in high cost loo p fund); I d. at ¶¶ 93, 102,

108 (providing for waiv er of cap on corporate operations expenses).19

Petitioners’ second objection simpl y misconstrues the requirement of “explicit” funding. They argue that, because the new fund would be financed by all

tel ecommunications carriers, including small

LEC’s such as petitioners, the new fund

constitutes an unlawful subsidy i n favor for

IXC’s.

Again, petitioners rest their argument on the same assumption

deemed obsolete by the

FCC 

### SS that long-distance s witching is more costly than local switching. E ven so, we made

clear in TOPUC that the implicit /e x plicit distinction turns on the difference between direct

subsidies from

support funds and recovery

t hrough access charges and rate structures.
“The statute provides little guidance on whether ‘exp l icit’ means ‘explicit to the consumer’

. . . or ‘explicit to the carrier’

. . . [but it] does

state, however, that all universal service

suppor t 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’s such as GTE.” 183 F.3d at

425.

Petitioners thus misconstrue the meaning of

the explicit funding requirement. The fact that

the fund is subsidized by contributions from all

t elecommunications providers, including

L EC’s, does not make it an implicit subsi d y under § 25 4(e), even if it effectively

redistributes reso urces among telecommunications providers.

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

make an equitable and nondiscriminatory contribution to the preservation and advancement

of uni v ersal service.” 47 U.S.C. § 254(b)(4) (emphasis added); see also 47 U.S.C. § 254- (d). The Commission reasonably applied the princ i ple of equitable and nondiscriminatory contribution by requiring contributions from all telecommunications providers.

Finally

, petitioners object on the ground

that portability violates the pr i nciple of predi ct ability and the statutory command of

sufficient funding. Specifically, they claim

t hat , 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 i nterstate

access service will, in many cases, fall to minus

10.53%.20

A s we have said, the Co mmis sion

reas onably construed the predi ctabi l ity principle to require only predictable rules that

govern distribution of the subsidies, and not to require predictable funding amounts

. Indeed,

to construe the predictability principl e 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’ approach to the predicta b ilit y principle would prohibit also the

current subsidy eff

e ct of weighting switching

costs. Under the current plan, LEC’s receive

the subsidy imp licitly through access charges 

### SS

costs that are realized only when

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

than is the explicit subsidies contemplated by

the new fund, for an LEC cannot assess access charge s 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. T AKINGS C HALLENGE

. Notwithstanding the above analysis, petitioners request us to read the Act to avoid

a violation of the Takings Clause. S ee 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 tha t are “so unj ust as to be confiscatory.” D uquesne Lig ht Co. v. Barasch

, 488 U.S. 299, 307 (1989). Peti ti oners therefore must show t hat a regulation will “jeopardize the financial integrity o f the companies, either by leaving t hem insufficient operating capital or by impeding their abilit y to
raise future capital,” or they must demonstrate

that the reduced subsidies “are inadequate to
compensate current equity holders for the risk

associated with their investments under a modified prudent investment scheme.” D uquesne , 488 U.S. at 312.

It is not enough that a par t y merely speculates that a government action will cause it harm. Rather, a taking must “‘necessarily’

result from the regulatory actions.” TOPUC

, 183 F.3d at 437 ( citing Uni ted States v.

Riverside Bayview Homes

, 474 U.S. 121, 128 n.5 (1985)). Such a showing cannot be made

here “until the administrative agenc y has

arrived at a final, definit ive position regarding

how it will apply the regulations at issue to the particul ar [property right] in question.” Williamson County Regional Planning

Comm’n v. Hamilton Bank

, 473 U.S. 172, 191 (1985).

At the very leas t , therefore, petitioners must wait to experience the actual21

consequences of the Order before a court may

even begin to consider whether the FCC has

effected a constitutional tak ing. Until it is

known what level of universal service funding

each petitioner will receive under the Order,

and under what circumstances the Commission

w ill grant a waiver, we cannot seriously entertain a Takings Clause challenge.

Furtherm o re, petitioners do not present
credible evidence t hat the Order ever will

cause the drastic consequences for rural LEC’s

articulated in Duquesne

. The mere fact that, “[f]or many rural c arriers, universal service support provides a large share of the carriers’ revenues,” O rder ¶ 294, i s not enough to

establish that the orders c o nstitute a taking.

The Fifth Amendment protects a g ainst takings;

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

Clause thus erects no b a rrier to our Chevron and APA analysis.

V. R EGULATORY F LEXIBILITY A CT

C HALLENGE

. Under the Regulatory Flexibilit y Act (“RFA”), final agency rules must contai n a “final regulatory flexibilit

y analy sis” (“FRFA”), 5 U.S.C. § 604(a), which must include

a description of the steps the agency has

taken to minimize the signif icant

economic impact on sm all entities

consistent wit h the stated objectives of applicable statutes, incl

udi ng a statement
of the factual, policy, a nd legal reasons

for selecting the alternative adopted in

th e final rule and why each one of the

other significant alternatives to the rule

considered by the agency which affect

the imp act on small entities was rejected. 5 U.S.C. § 604(a)(5). In 1996, Congress provided for judicial review o f agency compliance with the RFA. S ee 5 U. S.C. § 611(a)(1). We review only to determine

whether an agency has ma de a “reasonable, good-faith effort” to carry out the mandate of

the RFA. A ssociated Fisheries, Inc. v. Daley

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

Petition ers’ RFA argument amounts to little

more t han a redressing of its earlier C hevron

and A PA claims. The RFA is a procedural

rather than substantive agency mandate, to be

sure, 20 but petitioners fail to articulate specific procedural flaws in the FCC’s promulgation of

the orders. In fact, both orders are accompanied by substantial discussi on and

deliberation , including consideration and

reasoned rej ection of significant alternatives which, in the Commission’s judgment, would

not have ac hieved with equivalent success its

twi n st atutory mandates of universal service

and local competition. The RFA requires no

more. 21

Petitioners come closest to stating a meritorious procedural objec t ion 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 req uire economic analysis, but mandates on l y 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 co nsideration to less onerous options”).

2 1 See Associated Fisheries

, 127 F.3d at 115 (noting that “section 6 04 does not require that an

FR FA address every alternative, but only that it address significant ones.”).22

minimize the significant economic impact on small ent it ies 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 select ing the alternative adopted in the final

rule.” I d. Nowhere does it require, however,

cost-benefit analysis or economic modeling.

Indee d

, the RFA expressly states that, “[i]n complying with [section 604], an agency may provide either a quan t ifiable or numerical description of the effects of a prop o sed rule or alt ernatives to the proposed rule, or more general descriptive statements if 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.

C ONCLUSION

. Petitioners’ various challenges fail because they fundamentally misundersta n d a primary

purpose of the Communications Act 

### SS to herald and realize a new era of competition in the

market for local tele pho ne service while continuing to pursue the goal of universal

service. They therefore confuse the requirement of sufficient support for universal

service within a market in which telephone

service providers compete for custom e rs, which federal law mandates, with a guarantee
of economic success for all provid ers, a guarantee that conflicts with competition.

The FCC interim orders are reasonably tailored to achieving universal s ervice and competition in lo c al markets. They do not

e f fect a cognizable, unconstitutional taking.

And they were promulg at ed in reasonable compliance with the requirements of the RFA. We therefore DENY the petitions for review.

Judge WIENER concurs in the judgment only.

2 2 Se e 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.”).