2005 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

7-14-2005

SBC Comm Inc v. FCC

Precedential or Non-Precedential: Precedential

Docket No. 03-4311

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Judge Chertoff heard oral argument in this case but *

resigned before the opinion was filed. The opinion is filed by a

quorum of the panel. 28 U.S.C. §§ 46(d). 

The Hon. Ronald L. Buckwalter, Senior District Judge **

of the United States District Court for the Eastern District of

1

PRECEDENTIAL

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No: 03-4311

SBC INC.,

 Petitioner

 v.

FEDERAL COMMUNICATIONS COMMISSION;

UNITED STATES OF AMERICA,

 Respondents

Petition for Review of an Order of the 

Federal Communications Commission

Argued: November 16, 2004

Before: McKEE and CHERTOFF, Circuit Judges,

*

and BUCKWALTER, Senior District Judge**
Pennsylvania, sitting by designation.

2

(Opinion filed: July 14, 2005)

JAMES D. ELLIS, ESQ.

PAUL K. MANCINI, ESQ.

SBC Communications, Inc.

175 East Houston Street

San Antonio, Texas 78205

GARY L. PHILLIPS, ESQ.

JAMES P. LAMOUREUX, ESQ.

SBC Communications, Inc.

1401 I Street, N.W., 4th Floor

Washington, D.C. 20005

MICHAEL K. KELLOGG, ESQ.

COLIN S. STRETCH, ESQ. (Argued)

Kellogg, Huber, Hansen, Todd & Evans, P.L.L.C.

1615 M Street, N.W. Suite 400

Washington, D.C. 20036

Attorneys for Petitioner

R. HEWITT PATE, ESQ.

Assistant Attorney General

MAKAM DELRAHIM, ESQ.

Deputy Assistant Attorney General

ROBERT B. NICHOLSON, ESQ.

ROBERT B. WIGGERS, ESQ.

Attorneys
3

United States Department of Justice

Washington, D.C. 20530

JOHN A. ROGOVIN, ESQ.

General Counsel

RICHARD K. WELCH, ESQ.

DANIEL M. ARMSTRONG, ESQ. (Argued) 

Associate General Counsel

JOHN E. INGLE, ESQ.

Deputy Associate General Counsel

RODGER D. CITRON, ESQ.

Counsel

Federal Communications Commission

Washington, D.C. 20554

Attorneys for Respondent

OPINION

McKEE, Circuit Judge.

SBC Communications, Inc., petitions for review of an

order of the Federal Communications Commission captioned,

“Cost-Based Terminating Compensation for CMRS Providers,

18 FCC Rcd 18441, released on September 3, 2003 (the “Order

Under Review”). SBC contends that the Order Under Review

violated the Administrative Procedure Act by improperly

revising an FCC rule without first affording notice and an

opportunity for comment as required by the APA. SBC also

argues that the Order Under Review cannot be upheld because

it is arbitrary and capricious. For the reasons explained below,
 The jargon used in the telecommunications industry can 1

be confusing because everyday words are used in a highly

technical manner. For example, although the instant dispute

involves the “switches” used in telecommunications, those

switches bear no resemblance to the single pole, single throw,

toggle switch that most of us use to turn lights on and off in our

homes. Rather, these “switches” are computers that direct the

flow of telephone traffic by controlling the electric circuits that

conduct the electro magnetic energy that telephone calls consist

of. See Indiana Bell v. McCarty, 362 F.3d 378 (7th Cir. 2004).

4

we will deny the petition for review. 

I. GENERAL BACKGROUND

The technological sea change that has occurred in the

telecommunications industry has revolutionized the manner in

which local telephone service is provided. It has also resulted

in dramatic changes in federal and state regulations of the

industry. Prior to the passage of the Telecommunications Act

of 1996 (the “1996 Act”), Pub. L. 104-104, 110 Stat. 56,

“[s]tates typically granted an exclusive franchise in each local

service area to a local exchange carrier (“LEC”).” AT&T Corp.

v. Iowa Utilities Board, 525 U.S. 366, 371 (1999). The LEC

typically owned, “among other things, the local loops (wires

connecting telephones to switches), the switches (equipment

directing calls to their destinations), and the transport trunks

(wires carrying calls between switches) that constitute a local

exchange network.” Id. The 1996 Act restructured local

1

telephone markets by preempting state and local franchise
5

arrangements, 47 U.S.C. § 253, and by requiring “incumbent

local exchange carriers (ILECs) to share their networks and

services with competitors seeking entry into the local service

market.” MCI Telecommunication Corp. v. Bell AtlanticPennsylvania, 271 F.3d 491, 498 (3d Cir. 2001). 

Congress recognized that without allowing new

entrants to use the incumbents’ local exchange

networks and other technology and services, the

incumbents would maintain a stranglehold on

local telephone service: no new entrant could

realistically afford to build from the ground up

the massive communications grid the incumbents

had developed through years of monopolistic

advantage.

Indiana Bell v. McCarty, 362 F.3d 378, 382 (7th Cir., 2004)

(footnote omitted). 

Among other things, the 1996 Act required that ILECs

allow competitors to “interconnect” to their networks. See 47

U.S.C. § 251(c)(2). Interconnection is critically important to

a competitive local exchange market. Without it, customers of

one carrier – e.g., the ILEC, that has historically served that area

– would not be able to call customers of another carrier – e.g.,

a competitive LEC (“CLEC”), that hasrecently initiated service

in that same area. 

When local carriers establish interconnection

arrangements, the 1996 Act requires them to include

compensation terms, known as “reciprocal compensation
6

arrangements,” for delivery of the traffic they exchange. 47

U.S.C. § 251(b)(5). When a customer of carrier A makes a

local call to a customer of carrier B, and carrier B uses its

facilities to connect, or “terminate,” that call to its own

customer, the “originating” carrier A is ordinarily required to

compensate the “terminating” carrier B for the use of carrier B’s

facilities. See Global NAPS, Inc. v. FCC, 247 F.3d 252, 254

(D.C. Cir. 2001) (Reciprocal compensation arrangement “means

that when a customer of Carrier X calls a customer of Carrier Y

who is within the same local calling area,Carrier X pays Carrier

Y for completing or ‘terminating’ the call.”). With respect to

the compensation a carrier may recover for the transport and

termination of traffic that originates with another carrier, the

1996 Act requires just and reasonable rates that provide for “the

mutual and reciprocal recovery by each carrier of costs

associated with the transport and termination on each carrier’s

network facilities of callsthat originate on the network facilities

of the other carrier.” 47 U.S.C. § 252(d)(2)(A)(I). The 1996

Act effectively defines a reasonable rate as one that is “a

reasonable approximation of the additional cost of terminating

such calls,” and prohibits any regulatory proceeding to establish

such costs “with particularity.” 47 U.S.C. §§ 252(d)(2)(A)(ii),

252(d)(2)(B)(ii).

The 1996 Act directs competing LECs to address

“reciprocal compensation” terms in the first instance through

voluntary negotiations. See 47 U.S.C. §§ 251(b)(5), 252(a);

MCI Telecommunications, 271 F.3d at 500. When they are

unable to do so, the 1996 Act permits either party to petition the

appropriate state utilities commission to arbitrate the dispute in

accordance with the terms of the 1996 Act and the FCC’s
Many parties petitioned for review of numerous aspects 2

of the Local Competition Order. Those petitions were

consolidated in the Eighth Circuit. The Order’s subsequent

history is as follows: Modified on recon., 11 FCC Rcd 13042

(1996), vacated in part, Iowa Utils. Bd. v. FCC, 120 F.3d 753

(8th Cir. 1997), aff’d in part, rev’d in part, AT&T Corp. v. Iowa

Utils. Bd., 525 U.S. 366 (1999), decision on remand, Iowa Utils.

Bd. v. FCC, 219 F.3d 744 (8th Cir. 2000), aff’d in part, rev’d in

part, Verizon Communications Inc. v. FCC, 535 U.S. 467

(2002). However, no party petitioned for review of the FCC’s

rule for determining the availability of the tandem

interconnection rate for interconnecting carriers. That rule is the

subject of this petition for review, and will be explained in more

detail below.

7

implementing regulations. See 47 U.S.C. § 252(b)(1). The

1996 Act also required the FCC to adopt regulations to

implement the Act, including its reciprocal compensation

provisions. See generally Iowa Utilities Board, 525 U.S. at 377-

78, 384. Within six months of the adoption of the 1996 Act, the

FCC issued a comprehensive rulemaking decision to satisfy that

requirement. See First Report and Order, Implementation of the

Local Competition Provisions in the Telecommunications Act

of 1996, 11 FCC Rcd 15499 (1996) (the “Local Competition

Order”). 

2

In the Local Competition Order, the FCC established a

presumption that the reciprocal compensation rates that two

interconnecting carriers maycharge each other are symmetrical.
 As noted above, a switch is a computer that directs the 3

path of a telephone call by opening and closing the electrical

pathway (or circuit) over which the call travels. Supra at n. 1.

8

Accordingly, the ILECs’ rates generally serve as the proxy for

other telecommunications carriers’ additional costs of transport

and termination. Local Competition Order, 11 FCC Rcd at

16031-44 (¶¶ 1069-1093); see also 47 C.F.R. § 51.71(a)

(symmetrical reciprocal compensation rules). The FCC adopted

symmetric rates because, among other things, they are easy to

administer, can prevent ILECs’ from taking advantage of their

“unequal bargaining position,” and do not discourage carriers’

incentives to reduce costs. 11 FCC rcd at 16040-41 (¶¶ 1086,

1087, 1088); see also Id. at 16040 (¶ 1086). The FCC

explained that it adopted the ILECs’ rates as a proxy for the

rates of other carriers because “[b]oth the incumbent LEC and

the interconnecting carriers will be providing service in the

same geographic area, so the[ir] forward-looking economic

costs should be similar in most areas.” Local Competition

Order, 11 FCC Rcd at 16040 (para. 1085). This ratemaking

scheme thus allows carriers to recover, through reciprocal

compensation, “a reasonable approximation” of their costs. See

47 U.S.C. § 252(d)(2)(A)(ii).

The older, established telephone networks that

traditionally have been built by ILECs utilize a hub-and-spoke

design. The outside of the network – the ends of the spoke –

are switches, known as “end-office” switches, that directly 3

serve customers in a particular local calling area. These endoffice switches may be connected directly, one to another. In
9

addition (or alternatively), the end-office switches are

connected to a “tandem” switch – the hub of the wheel. These

tandem switches do not directly serve customers, but instead

route calls to the appropriate end-office switch (sometimes via

another tandem switch) and, therefore, serve a number of local

calling areas. See MCI Telecommunications, 271 F.3d at 502.

When a call goes through the ILEC’s tandem switch, the ILEC

incurs additional costs because it then has to transport the call

from the tandem switch to the end-office switch. Local

Competition Order, 11 FCC Rcd at 16042 (¶ 1090). See also

Indiana Bell Tel. Co. Inc. v. McCarty, 362 F.3d at 384.

Moreover, interconnecting carriers do not always have identical

networks and therefore must sometimes terminate calls over

different types of facilities. 

The FCC recognized that “[n]ew entrants cannot hope to

replicate the incumbents’ network switch for switch” and would

instead deploy “new technology” to terminate calls on their

network. Local Competition Order, 11 FCC Rcd at 16042 (¶

1090). Nevertheless, the FCC’s Local Competition Order

adopted a general regime of symmetrical reciprocal

compensation rates and directed the states to establish

“presumptive symmetrical rates based on the incumbent LEC’s

costs for transport and termination of traffic. . . .” 11 FCC Rcd

at 16042 (¶ 1089). Given the advantages it perceived from

using symmetrical rates, the FCC found that the ILECs’ costs

“serve as reasonable proxies for other carriers’ costs of

transportation and termination for the purpose of reciprocal

compensation.” Id. at 16041 (¶ 1088).

The FCC separately addressed the special situation that
10

occurs when a competing carrier’s newer technology does not

precisely replicate the traditional “tandem switch” routing

typically employed by the ILEC. The FCC offered the

following explanation of its resolution of that problem: 

We find that the “additional costs” incurred by a

LEC when transporting and terminating a call on

a competing carrier’s network are likely to vary

depending on whether tandem switching is

involved. We, therefore, concluded that states

may establish transport and termination rates in

the arbitration process that vary according to

whether the traffic is routed through a tandem

switch or directly to the end-office switch. In

such event, statesshall also consider whether new

technologies (e.g., fiber ring or wireless

networks) perform functions similar to those

performed by an incumbent LEC’s tandem switch

and thus, whethersome or all callsterminating on

the new entrant’s network should be priced the

same as the sum of transport and termination via

the incumbent LEC’s tandem switch. Where the

interconnecting carrier’s switch serves a

geographic area comparable to that served by the

incumbent LEC’s tandem switch, the appropriate

proxy for the interconnecting carrier’s additional

costs is the LEC tandem interconnection rate.

11 FCC Rcd at 16042 (¶ 1090).

The FCC thus mandated an inquiry into the geographic
11

area served in determining the appropriate compensation rate in

some circumstances that may involve tandem switching even

though the state of the competing carrier’s technology might not

use tandem switching to complete a given call.

The substance of thisrule isset forth in the final sentence

of ¶ 1090 of the Local Competition Order. That text is nearly

identical to the text of Rule 51.711 (a)(3). Pursuant to ¶ 1090

and Rule 51.711(a)(3), a non-ILEC carrier is entitled to recover

the tandem interconnection rate for terminating traffic on its

network upon a showing that its switch serves a geographical

area comparable to that served by the ILEC’s tandem switch.

According to the FCC, there is no need for the non-ILEC to

also show that its switch is “functionally equivalent” to the

ILEC’s tandem switch. 

The FCC claims that the initial reciprocal compensation

rules inadvertently encouraged some competitive carriers to

“game the system” by such practices as soliciting business only

from internet service providers (“ISPs”). See generally

WorldCom, Inc. v. FCC, 288 F.3d 429 (D.C.Cir. 2002), cert.

denied sub nom. Core Communications, Inc v. FCC, 538 U.S.

1012 (2003). An ISP’s dial-up customers call the ISP to

connect to the internet and typically remain on the line for an

extended period of time. When the ISP subscribes to a CLEC

for its local service and the ISP’s dial-up customers are local

telephone customers of an ILEC, the CLEC’s transport and

termination services are used to connect the caller to the

internet. However, the exaggerated duration of the connected

calls meant that the CLEC recorded protracted use for purposes

of reciprocal compensation calculations. As the Court of
12

Appeals for the D.C. Circuit recently found, the FCC’s initial

reciprocal compensation regime was “flaw[ed]” because “ISPs

typically generate large volumes of one-way traffic in their

direction.” WorldCom, Inc. v. FCC, 288 F.3d at 431.

According to the FCC, some competitive carriers were able to

earn substantial parts of their revenues by delivering traffic that

originated on the ILEC network to the ISPs on the competitive

carriers’ own networks. CLECs would therefore receive

compensation for completing lengthy calls made by an ILEC’s

customers yet never have to pay an ILEC for completing traffic

in the other direction. This system attracted some competitive

LECs “that entered the business simply to serve ISPs, making

enough money from reciprocal compensation to pay their ISP

customers for the privilege of completing the calls.” Id.

According to the FCC, this practice by some CLECs

was partly responsible for causing some state utility

commissioners to try to reduce what they perceived as excessive

payments to competitive carriers that were solely in the business

of terminating calls to ISPs. See Intercarrier Compensation

Regime, 16 FCC Rcd at 9649 n.173. In arbitration proceedings

before state utility commissions after the Local Competition

Order became effective, some state commissioners interpreted

¶ 1090 of the Local Competition Order as imposing upon a

non-ILEC carrier two separate conditions precedent to

recovering the tandem interconnection rate. Id. Such a carrier

would have to establish both that its switch served a geographic

area comparable to the ILEC’s, and that its switch functioned

in a manner equivalent to the ILEC’s tandem switch. See, e.g.,

Arbitration Award, Proceeding to Examine Reciprocal

Compensation Pursuant to Section 252 of the Federal
13

Telecommunications Act of 1996, Docket No. 21982, 2000 Tex.

PUC Lexis 95 (Tex. PUC July 13, 2003) at *45-47; see also

Opinion and Order Concerning Reciprocal Compensation,

Proceeding on Motion of the Commissioner to Reexamine

Reciprocal Compensation, N. Y. PUC LEXIS 398 at *96-97

(N.Y. PSC Aug. 26 1999). 

This two prong test resulted in some CLECs receiving

the lower non-tandem rate forreciprocal compensation and thus

receiving smaller amounts of compensation. According to the

FCC, some federal district courts affirmed some of those state

commission decisions. FCC’s Br. at 11 (citing, e.g., U. S. West

Communications, Inc. v. Public Serv. Comm’n, 75 F.Supp.2d

1284, 1289 (D.Utah 1999)).

In addition to these specific rules regarding the tandem

interconnection rate, the FCC also adopted two more general

rules relating to reciprocal compensation rates. First, the FCC

adopted a rule that mirrored the “additional costs” language of

§ 252(d)(2)(A)(ii) requiring that reciprocal compensation rates

be “structured consistently with the manner that carriers incur

th[e] costs” of terminating local calls. 47 C.F.R. § 51.709(a);

see also id. § 51.507(a) (requiring rates to be “structured

consistently within the manner in which the costs of providing

the elements are incurred”). Second, the FCC stressed that

reciprocal compensation rates must be crafted consistently with

“rate structure rules” that require distinct rates for different

functions, including (I) “tandem switching,” (2) “local

switching,” and (iii) the use of “transmission facilities between

tandem switches and end offices.” Id. §§ 51.509, 51.709(a). 
14

II. THE CURRENT DISPUTE.

On February 2, 2000, Sprint PCS wrote a letter to the

chiefs of the FCC’s Common Carrier Bureau (now known as

the “Wireline Competition Bureau”) and Wireless

Telecommunications Bureau seeking guidance on whether a

wireless telephone service provider may “recover in reciprocal

compensation all the additional costs it incurs in terminating

local traffic originated on other networks.” See Letter from

Jonathan M. Chambers, Sprint PCS, January 26, 2000. The

letter was prompted by state commissioner decisions on

reciprocal compensation that Sprint PCS claimed were

inconsistent with the 1996 Act and the Local Competition

Order. Id. at 18, 19-20. 

The FCC issued a public notice requesting comments on

the Sprint letter, and numerous parties responded. Attwood

Letter, 16 FCC Rcd at 9598. Many of the responses also asked

the FCC to clarify the rule governing payment of the tandem

interconnection rate for terminating traffic to commercial

mobile radio service providers (“CMRS” or “wireless” or

“mobile carriers”). See, e.g., Comments of Western Wireless

Corporation, June 1, 2000 (App. 48-49); see also Reply

Comments of US West Communications, Inc., June 13, 2000

(App. 62). 

On April 27, 2001, while Sprint’s letter request was

pending, the FCC released a Notice of Proposed Rulemaking

(“NPRM”), in which it undertook to reexamine the general

subject of intercarrier compensation. See Intercarrier

Compensation NPRM, 16 FCC Rcd 9610. The NPRM
15

addressed many subjects, including the question of when an

interconnecting carrier is entitled to recover the tandem rate for

reciprocal compensation.

The FCC acknowledged that there had been some

disagreement over the availability of the tandem interconnection

rate – specifically, whether a competitive carrier must

demonstrate functional equivalency as a separate requirement

independent of, and in addition to, comparable geographic area

coverage in order to recover the tandem rate. Intercarrier

Compensation NPRM, 16 FCC Rcd at 9647, 9648 (¶¶ 103,

105). The FCC noted that “in dealing with problems presented

by ISP-bound traffic, some states have incorporated a functional

equivalency test into their interpretations of section

51.711(a)(3).” Id. at 9649 n.173. For example, both “the Texas

PUC and the New York PCS concluded that large imbalances

in traffic flows strongly suggest that a carrier is serving a higher

proportion of convergent customers rather than a large

distribution of customers similar to those served by an ILEC

tandem switch.” Id.

The FCC stated that the state commission decisions

imposing a separate functional equivalency requirement in

addition to the geographic area test were “inconsistent with our

rule.” Intercarrier Compensation NPRM, 16 FCC Rcd at 9649

n.173. The Commission pointed out that Rule 51.711(a)(3)

requires only that a carrier demonstrate that its switch serve “a

geographic area comparable to that served by the incumbent

LEC’s tandem switch” in order to receive the tandem rate. Id.

at 9648 (¶ 105). Nevertheless, the FCC acknowledged the

problems addressed in those state decisions and it undertook to
The issues raised in the FCC’s NPRM have not yet 4

been resolved.

 The FCC had confirmed this in the Intercarrier 5

Compensation NPRM.

16

“consider whether to amend the rule to give states greater

flexibility in applying a tandem interconnection rate to networks

using newer, more efficient technologies.” Id. at 9649 n.173.

It also invited comment, including comment on whether it

should amend its rule to include “the ‘functional equivalency’

concept. . . .” Id. at 9649 (¶ 107). 

4

On May 9, 2001, the chiefs of the Common Carrier

Bureau and the Wireless Telecommunications Bureau, acting on

delegated authority, released the Attwood Letter addressing the

issues raised in Sprint’s letter as well as the responsive

comments. 16 FCC Rcd 9597. The Attwood Letter was an

opinion letter of the FCC staff. Although it primarily addressed

Sprint’s inquiry regarding wireless carriers’ incurring

asymmetrical, “additional costs” in terminating telephone

traffic, it also addressed “when a carrier is entitled to the tandem

interconnection rate.” Id. at 9599. The Letter noted that the

FCC had recently confirmed that, “[w]ith respect to when a

carrier is entitled to the tandem interconnection rate, . . . section

51.711(a)(3) requires only a geographic area test.” Id. The 5

opinion Letter concluded: “Therefore, a carrier demonstrating

that its switch serves a ‘geographic area comparable to that

served by the incumbent LEC’standem switch’ is entitled to the

tandem interconnection rate to terminate local
17

telecommunications traffic on its network.” Id.

SBC then sought review of the Attwood Letter by the full

Commission. SBC argued that in eliminating the “functional

equivalence” test, the Attwood Letter allowed a CLEC that

meets the geographic comparability test to charge for both

tandem switching and transmission to the end-office switch,

even if it did not perform those functions. SBC was concerned

that, absent an inquiry into functional equivalence to ensure that

the switching in question was tantamount to tandem switching,

originating carriers may pay the higher tandem switching rate

even though the terminating carrier never had to provide that

service to terminate calls on its network. 

In applying for review of the Attwood Letter, SBC

alleged that the FCC staff had engaged in legislative rulemaking without complying with the procedural notice and

comment requirements of the APA. SBC also argued that the

Attwood Letter was contrary to the language of the 1996 Act

and the Commission’s rules and orders. See Application for

Review of SBC Communications, Inc., June 8, 2001 (App. 65,

74-80). 

The Commission denied both claims in the Order Under

Review. The Order Under Review affirmed the reasoning of the

FCC staff in the Attwood Letter. The full Commission thus

concluded that the clarification of the applicable rule – as

announced in the Intercarrier Compensation NPRM and the

Attwood Letter – was an interpretive ruling not subject to the

notice and comment requirements of the APA. Order Under

Review at ¶¶ 22-25. The FCC also concluded that the plain
 We have jurisdiction pursuant to 28 U.S.C. § 2342(1), 6

which provides”

The court of appeals (other than the

United States Court of Appeals for

the Federal Circuit) has exclusive

jurisdiction to enjoin, set aside,

suspend (in whole or in part), or to

determine the validity of – 

(1) all final orders of the Federal

Communications Commission

made reviewable by section 402(a)

of title 47;

and 47 U.S.C. § 402(a), which provides:

Any proceeding to enjoin, set aside,

annul, or suspend any order of the

Commission under this chapter

(except those appealable under

subsection (b) of this section) shall

be brought as provided by and in

the manner prescribed in chapter

158 of Title 28.

18

language of the relevant statutory provisions governing

reciprocal compensation only required satisfaction of the

geographic area test. Id. at ¶¶ 17-21. Thereafter, SBC filed the

instant petition for review.

6

III. STANDARD OF REVIEW

Here, as before the Commission, SBC argues that the
19

FCC’s elimination of the functional equivalency test in

determining appropriate compensation between carriers violated

the APA because it was tantamount to legislative rule-making

and therefore subject to the APA’s requirement of notice and

comment. If we conclude that the agency acted “without

observance of procedure as required by law,” 5 U.S.C. §

706(2)(D), we must vacate the Order Under Review and remand

the issues raised in the Attwood Letter back to the FCC so that

the agency can comply with the notice and comment

requirements of the APA. See Sprint Corp. v. FCC, 315 F.3d

369, 377 (D.C. Cir. 2003). However, an agency’s

determination that “its order is interpretative,” and therefore not

subject to notice and comment requirements, “in itself is entitled

to a significant degree of deference.” Viacom International Inc.

v. FCC, 672 F.3d 1034, 1042 (2d Cir. 1982) (citation and

internal quotations omitted).

In reviewing the substance of SBC’s claim that the

Attwood Letter is inconsistent with the 1996 Act, we must

uphold the Order Under Review unless it is “arbitrary,

capricious, [an] abuse of discretion, or otherwise not in

accordance with law.” 5 U.S.C. § 706(2)(A). This is a

“deferential standard” that “presume[s] the validity of agency

action.” Southwestern Bell Tel. Co. v. FCC, 168 F.3d 1344,

1352 (D.C.Cir. 1999). The FCC is due substantial deference in

its implementation of the Communications Act, and “even

greater deference” when interpreting its own rules and

regulations.” Capital Network Sys. v. FCC, 28 F.3d 201, 206

(D.C.Cir. 1994). Global NAPs, Inc. v. FCC, 247 F.3d 252, 257-

58 (D.C.Cir. 2001). 
20

IV. DISCUSSION

Given the apparent complexity of the subject matter, and

the resulting potential for confusion, it will be helpful to restate

the substance of SBC’s challenge to the Order Under Review

and place it in context before discussing the merits of the

parties’ positions. 

To reiterate, when a customer of carrier A makes a local

call to a customer of carrier B, carrier B must use its facilities to

connect (or “terminate”) that call to its customer. Under the

Act, carrier A (the “originating” carrier) is required to

compensate carrier B (the “terminating” carrier) for using

carrier B’s facilities to connect the call to carrier B’s customer.

SBC is an ILEC. As we also explained earlier when

discussing the hub-and-spoke design that typifies “traditional”

telephone networks, when a call goes through SBC’s tandem

switch, SBC incurs additional costs because it has to transport

the call from the tandem switch to the end-office switch. More

specifically, SBC must (I) switch the call at the tandem switch,

(ii) transport the call to the end-office switch that serves the

CLEC’s customer, and then (iii) switch the call at the end-office

switch and deliver it to that customer. Under the 1996 Act,

SBC can recover the costs of each of those functions from the

CLEC. The costs are grouped together into a single rate known

as the “tandem interconnection rate,” or “tandem rate,” and that

is the rate that the CLEC must pay SBC for using SBC’s

network to complete calls to the CLEC’s customer.

However, the same is not true when a local customer of
21

SBC calls a CLEC’s customer because the CLEC will

frequently have the advantage of more efficient and

sophisticated technology that was not available when SBC built

its network. Accordingly, the CLEC may not duplicate SBC’s

end-office switch and tandem switch network in terminating

traffic. According to SBC, the CLEC’s new technology will

not involve the three distinct functions to connect an incoming

call. SBC claims that the CLEC’s compensation for completing

the call should therefore reflect the CLEC’s reduced costs.

SBC submits that the functional equivalency test better captures

that actual cost than the geographic area test because the

equivalency inquiry allows the greater efficiency of more

modern technology to be factored into the equation. According

to SBC, the geographic area test ignores any differences

between its network and the CLEC’s network by only focusing

on the area served by competing carriers. As noted above, SBC

makes two arguments to support its position, and we consider

each claim separately.

A. The Order Under Review Violates the Notice and

Comment Requirements of the Administrative Procedure

Act.

In the Attwood Letter, the FCC’s staff stated:

With respect to when a carrier is entitled to the

tandem interconnection rate, the Commission

stated that section 51.711(a)(3) of its rules

requires only that the comparable geographic area

test be met before a carrier is entitled to the

tandem interconnection rate for local call

termination. It noted that although there has been
22

some confusion stemming from additional

language in the text of the Local Competition

Order regarding functional equivalency, section

51.711(a)(3) requires only a geographic area test.

Therefore, a carrier demonstrating that its switch

serves “a geographic area comparable to that

served by the incumbent LEC’s tandem switch”

is entitled to the tandem interconnection rate to

terminate local telecommunications traffic on its

network. The NPRM does seek comment on

whether we should change this rule.

16 FCC Rcd 9597. In affirming that interpretation, the FCC

explained:

We find that the [Attwood Letter’s] interpretation

of our rules is correct. Section 51.711(a)(3) of

our rules governs when the tandem rate is

applicable, and plainly requires only a

comparable geographic area test to be met for a

carrier to receive the tandem interconnection rate:

“Where the switch of a carrier other than an

incumbent LEC serves a geographic area

comparable to the area served by the incumbent

LEC’s tandem switch, the appropriate rate for the

carrier other than an incumbent LEC is the

incumbent LEC’s tandem interconnection rate.”

Order Under Review, at 8 (quoting 47 C.F.R. § 51.711(a)(3))

(emphasis in original). 
23

SBC claims that the FCC announced the functional

equivalency test in its Local Competition Order, and that the

Order Under Review effectuated a substantive change in the law

without adhering to the notice and comment requirements of the

APA. Therefore, SBC contends the Order Under Review is

unlawful and must be vacated.

“It is a maxim of administrative law that: ‘If a second

rule repudiates or is irreconcilable with a prior legislative rule,

the second rule must be an amendment of the first rule; and, of

course, an amendment to a legislative rule must itself be

legislative.’” National Family Planning and Reproductive

Health Ass’n, Inc. v. Sullivan, 979 F.2d 227, 235 (D.C. Cir.

1992) (citation and internal brackets omitted). “‘Legislative’

rules that impose new duties upon the regulated party have the

force and effect of law and must be promulgated in accordance

with the proper procedures under the Administrative Procedure

Act.” Chao v. Rothermel, 327 F.3d 223, 227 (3d Cir. 2003)

(citation omitted). The applicable provision of the APA

provides, in relevant part:

(b) General notice of proposed rule making shall

be published in the Federal Register, unless

persons subject thereto are named and either

personally served or otherwise have actual notice

thereof in accordance with law. . . .

(c) After notice required by this section, the

agency shall give interested persons an

opportunity to participate in the rule making

through submission of written data, views, or
24

arguments with or without opportunity for oral

presentation.

5 U.S.C. § 553(b), (c). 

Legislative rules are subject to the notice and comment

requirements of the APA because they “work substantive

changes in prior regulations,” Sprint Corp., 315 F.3d at 374, or

“create new law, rights, or duties.” Fertilizer Institute v. EPA,

935 F.2d 1303, 1307-08 (D.C. Cir. 1991). “‘Interpretative’

rules, on the other hand, seek only to interpret language already

in properly issued regulations.” Chao, 327 F.3d at 227 (citation

omitted). “If the agency is not adding or amending language to

the regulation, the rules are interpretative.” Id. (citation

omitted). “Interpretative, or ‘procedural,’ rules do not

themselves shift the rights or interests of the parties, although

they may change the way in which the parties present

themselves to the agency.” Id. (citation omitted). “An

interpretative rule simply states what the administrative agency

thinks the statute means, and only reminds affected parties of

existing duties.” Fertilizer Institute, 935 F.2d at 1307 (citation

and internal quotations omitted). “Interpretative or procedural

rules and statements of policy are exempted from the notice and

comment requirement of the APA.” Chao, 327 F.3d at 227

(citing 5 U.S.C. § 553(b)(A)). 

Thus, one of the questions that must be answered in

determining whether an agency rule is legislative or

interpretative is “whether the rule effectively amends a prior

legislative rule.” American Mining Congress v. Mine Safety &

Health Administration, 995 F.2d 1106, 1112 (D.C. Cir. 1993).
25

 Furthermore, if an agency’s present interpretation of a

regulation is a fundamental modification of a previous

interpretation, the modification can only be made in accordance

with the notice and comment requirements of the APA.

Paralyzed Veterans of America v. D.C. Arena, L.P., 117 F.3d

579, 586 (D.C. Cir. 1997).

SBC insists that the Order Under Review eliminated the

functional equivalency test, and that it therefore changed the

FCC’s prior interpretation of a CLEC’s entitlement to the

tandem rate. Accordingly, argues SBC, it was tantamount to a

legislative amendment and subject to the APA’srequirement of

notice and comment. According to SBC, the legislative

amendment results from the focus of the Order Under Review

on the language of Rule 51.711(a)(3). 

As noted, that rule states that a CLEC is entitled to the

tandem rate where the CLEC’s switch “serves a geographic area

comparable to the area served by the incumbent LEC’s tandem

switch.” According to SBC, the Order Under Review therefore

had the effect of completely eliminating the functional

equivalency inquirymandated by the Local Competition Order.

SBC claims that worked a substantive change in the FCC’s

prior pronouncements regarding a CLEC’s entitlement to the

tandem rate without invoking the notice and comment

provisions of the APA. See Paralyzed Veterans of America,

117 F.3d at 586 (“Once an agency gives its regulation an

interpretation, it can only change that interpretation as it would

formally modify the regulation itself: through the process of

notice and comment rulemaking.”). 
26

SBC’s claim is not without some force as there is

language in the Local Competition Order that appears to

support SBC’s claim. The Local Competition Order provides,

in relevant part:

the “additional costs” incurred by a LEC when

transporting and terminating a call on a

competing carrier’s network are likely to vary

depending on whether tandem switching is

involved. We, therefore, concluded that states

may establish transport and termination rates in

the arbitration process that vary according to

whether the traffic is routed through a tandem

switch or directly to the end-office switch. In

such event, states shall also consider whether

new technologies (e.g., fiber ring or wireless

networks) perform functions similar to those

performed by an incumbent LEC’s tandem switch

and thus, whether some or all calls terminating

on the new entrant’s network should be priced

the same asthe sum of transport and termination

via the incumbent LEC’s tandem switch. Where

the interconnecting carrier’s switch serves a

geographic area comparable to that served by the

incumbent LEC’s tandem switch, the appropriate

proxy for the interconnecting carrier’s additional

costs is the LEC tandem interconnection rate.

11 FCC Rcd at 16042 (¶ 1090) (emphasis added). 

Moreover, the FCC concedes that some state
27

commissions have interpreted this portion of the Local

Competition Order as establishing a two-part test for

determining a CLEC’s entitlement to the tandem rate. Those

commissions have concluded that a CLEC seeking the tandem

rate must establish both that its switch served a geographic area

comparable to the ILEC’s tandem switch and that its own

switch performed functions equivalent to the functions

performed by the ILEC’s tandem switch. However, the FCC

notes that the only regulation it actually adopted for purposes

of determining when a CLEC is entitled to the tandem rate

(after discussing the issue in the Local Implementation Order)

was Rule 51.711(a)(3), which provides:

Where the switch of a carrier other than an

incumbent LEC serves a geographic area

comparable to the area served by the incumbent

LEC’s tandem switch, the appropriate rate for the

carrier other than an incumbent LEC is the

incumbent LEC’s tandem interconnection rate.

47 C.F.R. § 51.711(a)(3). The FCC correctly emphasizes that

that regulation says nothing about requiring the “other carrier”

(the CLEC) to also satisfy a functional equivalency test to

qualify for compensation at the LEC’s tandem interconnection

rate.

Nevertheless, SBC insists that the regulation cannot be

read in isolation from the Local Competition Order, and there

is support for that position. In Verizon Communications Inc. v.

FCC, 535 U.S. 467, 537-38 (2002), the Supreme Court upheld

an FCC rule on the basis of a limitation expressed not in the
The Local Competition Order at issue here is the First

7

Report and Order. The FCC has issued subsequent Reports and

Orders also referred to as the Local Competition Order. For

example, the Second Report and Order can be found at 11 FCC

Rcd 19392 (1966) and the Third Report and Order can be found

at 15 FCC Rcd 3696 (1999). Each Report and Order was

mentioned by the Supreme Court in Verizon Communications;

however, the Court’s ruling mentioned in the text of this opinion

was based on the First Report and Order, which is the Local

Competition Order involved here. 

28

rule itself, but rather in the text of the Local Competition

Order. Moreover, SBC contends that the rule’s omission of 7

a functional equivalency requirement does not resolve the

inquiry because the discussion of functional equivalence in the

Local Competition Order can not be ignored. 

As a general proposition, we agree that SBC’s argument

that the regulation must be read in conjunction with the Local

Competition Order has merit. We cannot accept SBC’s position

here, however, without ignoring FCC pronouncements before

it issued the Order Under Review on September 3, 2003. For

example, in the Intercarrier Compensation NPRM, released on

April 27, 2001, the FCC did note that some states had applied

a functional equivalency test to determine the availability of the

tandem rate. Intercarrier Compensation NPRM, 16 FCC Rcd

at 9646-49 (¶¶ 102-107 & n.173). However, the FCC then

clearly stated in the NPRM that such state interpretations were

“inconsistent with our rule.” Id. at n.173. Significantly, the

FCC issued the NPRM partly to “seek comment on whether
29

section 51.711(a)(3) should be amended to include the

‘functional equivalency’ concept discussed in the text of the

Local Competition Order.” Id. at 9649 (¶ 107) (emphasis

added). Obviously, if the FCC believed that § 51.711(a)(3)

contained a functional equivalency requirement when

promulgated, no amendment would have been necessary. 

Moreover, the Order Under Review specifically

addressed SBC’s contention that the regulation must be read in

conjunction with the Local Competition Order. The Order

Under Review reads, in relevant part, as follows:

SBC also argues that section 51.711(a)(3) of our

rules must be interpreted to require both a

functional equivalence test and a comparable

geographic area test based on the discussion in

the Local Competition Order addressing this

issue. As the [Attwood Letter] correctly noted,

however, the Commission has previously

addressed the import of this language in the

[NPRM] and stated that “although there has been

some confusion stemming from additional

language in the text of the [Local Competition

Order] regarding functional equivalency, section

51.711(a)(3) is clear in requiring only a

geographic area test.” We reaffirm this

interpretation.

Order, at 9, ¶ 21 (footnotes omitted). In a footnote to the

second sentence, the FCC further clarified what it was referring

to in the Local Competition Order when it discussed functional

equivalence:
30

In reaffirming the Commission’s interpretation of

the tandem interconnection rate rule, we find no

inconsistency between the discussion in the Local

Competition Order . . . and the language in the

promulgated rule. The Local Competition Order

does refer to a functional analysis that states

should apply, but then imposes a geographic area

test as a sufficient condition for receiving the

tandem rate. The comparable geographic area

test acts as a special case of the functional

analysis, i.e, if the geographic area test is

satisfied, then functional similarity is established

for purposes of determining the appropriate

reciprocal compensation rate. The Commission

thus did not preclude states from finding that new

technologies are functionally similar to tandem

switches even though they do not serve a

geographic area comparable to that served by the

incumbent LEC’s tandem switch. See, e.g.,

Florida PSC Order, 2002 WL 1576912 (“it is

appropriate to consider the functionality of an

CLEC’s network in situations where it does not

serve a geographic area comparable to that served

by an ILEC tandem switch.”). 

Id. at 9 n.63 (emphasis added). 

Accordingly, the Order Under Review clearly explained

that the FCC decided that a CLEC’s newer technology switch

is considered the functional equivalent of an ILEC’s tandem

switch if the geographic area served by the CLEC’s newer
This is not a case like Caruso v. Blockbuster-Sony Music 8

Entertainment Center, 193 F.3d 730 (3d Cir. 1999) where an

agency’s subsequent interpretation of a rule would result in the

adoption of an entirely new regulation without the notice and

comment required by the APA. In Caruso, the agency’s initial

rule, which addressed the placement of wheelchair locations in

facilities like the Blockbuster-Sony Music Center, did not

include a requirement that wheelchair users be able to see over

standing patrons. A subsequent interpretation of that rule that

included such a requirement was relied on by a wheelchair

bound plaintiff alleging a violation of the rule. However, we

found that because the initial rule did not address the issue of

31

switch is comparable to the area served by the ILEC’s tandem

switch. However, a functional equivalency test is still required

when, and only when, the CLEC’s newer technology switch

does not serve a geographic area comparable to that served by

the ILEC’s tandem switch. Therefore, reading the Local

Competition Order in conjunction with the regulation does not

produce the result SBC advocates. 

We conclude that the Order Under Review is thoroughly

consistent with the Local Competiton Order, the regulation, and

the Intercarrier Compensation NPRM. The Order Under

Review did not modify or substantively change the FCC’s prior

interpretation of the regulation or impose new duties upon

regulated parties, and therefore the APA’s notice and comment

requirements do not apply. The Order Under Review is, at

most, interpretative. It simply clarified, and explained, an

existing rule. Sprint Corp., 315 F.3d at 373. 

8
sightlines over standing spectators, the subsequent interpretation

of that rule to include such a requirement was really an adoption

of a new regulation without notice and comment. 

In making this argument, SBC cites National Mining 9

Ass’n v. Department of Labor, 292 F.3d 849 (D.C. Cir. 2002).

SBC contends that National Mining stands for the proposition

that where an agency’s decision sustains one court’s

interpretation of a regulation, but reverses another court’s

interpretation of the same regulation, the agency’s decision is a

new rule that must meet the APA’s notice and comment

requirements. However, National Mining had nothing to do

with the APA’s notice and comment requirements. Instead, it

addressed the question of the retroactivity of a new agency rule

32

SBC also contends that the Order Under Review

repudiated the decision in U.S. West Communications v. MFS

Intelenet, Inc., 193 F.3d 1112 (9th Cir. 1999). There, the court

cited the Local Competition Order at ¶ 1090 in stating that “the

Commission found that MFS’s switch ‘is comparable in

geographic scope’ to U.S. West’standem switch and ‘performs

the function of aggregating the traffic . . ..” 193 F.3d 1112.

SBC relies upon that statement in arguing that the court

interpreted FCC rulings as requiring a functional equivalence

test as well as a geographic area test. SBC then argues that,

since the Order Under Review substantively altered the legal

landscape in the Ninth Circuit, it constituted a new rule and was

therefore subject to the APA’s notice and comment

requirements. 

9
that essentially adopts the position taken on an issue by one

court of appeals, but rejects the position taken by another court

of appeals on the same issue. Nevertheless, we will, for

argument’s sake, accept SBC’s claim that where there has been

a substantive change in the law, the test for retroactivity is the

same as an inquiry into whether notice and comment are

required under the APA. Reply Br. at 12 n.5. 

33

The difficulty with this argument is that the court in MFS

Intelenet did not hold that functional equivalency was a factor

in determining compensation rates. Rather, there, the court was

only considering whether “[t]he Commission’s classification of

MFS’s switch as a tandem switch was . . . arbitrary and

capricious.” 193 F.3d at 1124. In holding that it was not, the

court noted that the Commission “properly considered whether

MFS’s switch performs similar functions and serves a

geographic area comparable to U.S. West’s tandem switch.” Id.,

at 1124 (citing Local Competition Order at ¶ 1090.). However,

the court was not concerned with reciprocal compensation or

calculating the appropriate rate a CLEC can charge for

completing an ILEC’s customer’s calls over the CLEC’s

network. Accordingly, the court’s inquiry into whether MFS’s

network relied upon tandem switches has nothing to do with

whether functional equivalency is an element of the

compensation rate at issue here.

Moreover, in a later case, the Court of Appeals for the

Ninth Circuit clarified this by adopting the same interpretation

of the tandem interconnection rate rule that the FCC approved

in the Order Under Review. In U.S. West Communications, Inc.
34

v. Washington Utilities and Transportation Commission, 255

F.3d 990 (9th Cir. 2001), the issue was whether AT & T

Wireless (the CLEC) was entitled to reciprocal compensation

based on U.S. West’s (the ILEC) end-office rate or tandem rate.

U.S. West argued that AT & T should receive reciprocal

compensation at the less expensive end-office rate rather than

the higher tandem rate because AT&T’s mobile switches “[did]

not provide the ‘same services’” as U.S. West’s tandem switch.

Id. at 996. “AT & T argue[d] that, according to § 51.711(a)(3)

. . . it is entitled to the tandem rate because its [mobile switching

centers] serve a geographic area comparable to the area served

by U.S. West’s tandem switches.” Id. Relying upon the

regulation and the text of the Local Competition Order, the

court concluded that, pursuant to § 51.711(a)(3), AT & T only

needed to establish that it served a comparable geographic area

to be entitled to the higher tandem compensation rate. Id. at

994-98. The court rejected U.S. West’s argument to the

contrary. Id. at 995-96. Accordingly, we can not agree that the

Order Under Review substantively altered the legal landscape in

the Ninth Circuit. 

In its Reply Brief, SBC changes its tactic somewhat.

There, it argues that the Order Under Review was subject to the

notice and comment requirements of the APA because it

removed the prior authority state commissions had been given

to consider functional equivalence in arbitrating compensation

agreements pursuant to the Local Competition Order. See Reply

Br. at 10 to 12. SBC claims that “the FCC has no tenable

response to the undisputed fact that numerous state commissions

and federal courts interpreted the Local Competition Order to

authorize an inquiry into functional equivalence.” Id., at 10. In
As recited in the earlier discussion of the standard of 10

review:

35

its opening brief, the FCC had argued that “to [its] knowledge,

no federal court of appeals has embraced the ILECs’ argument

that paragraph 1090 of the Local Competition Order imposes a

separate functionality requirement in addition to the comparable

geographic area test for a competitive carrier to recover the

tandem interconnection rate.” Appellee’s Br. at 12 n.5. SBC

then relies upon MFS Intelenet to support its attempt to refute

the FCC’s claim. 

However, as we have already explained, the holding in

MFS Intelenet does not support SBC’s position in this dispute.

Moreover, the fact that several state utilities commissions

adopted a functional equivalence test in arbitrating

compensation agreements can not change the text of the

regulation that should have governed those arbitrations. That

regulation only allows an inquiry into the equivalence of the

ILEC’s and CLEC’s networks when the competing carriers do

not serve comparable geographic areas. The fact that state

commissions may have strayed beyond those parameters during

the regulatory process does not mean that the FCC had to follow

the notice and comment requirements of the APA before

clarifying what had already been pronounced in the Local

Competition Order. 

B. The Order Under Review Is Not Arbitrary or Capricious.

10
Under the APA, a reviewing court

must uphold an FCC order unless it

is found to be “arbitrary,

capricious, and abuse of discretion,

or otherwise not in accordance with

law.” 5 U.S.C. § 706(2)(A). This

is a “deferential standard” that

“presume[s] the validity of agency

action.” Southwestern Bell Tel. Co.

v. FCC, 168 F.3d 1344, 1352

(D.C.Cir. 1999). The FCC is due

substantial deference in its

i m p l e m e n t a t i o n o f t h e

Communications Act, and “even

g r eat e r d e f e r ence ” w hen

interpreting its own rules and

regulations.” Capital Network Sys.

v. FCC, 28 F.3d 201, 206 (D.C.Cir.

1994).

Global NAPs, Inc. v. FCC, 247 F.3d 252, 257-58 (D.C.Cir.

2001). 

36

SBC also argues that even if the Order Under Review did

not violate the notice and comment requirements of the APA,

it is arbitrary and capricious because it ensures that a CLEC will

receive the higher tandem interconnection rate for all the local

traffic terminated over its networks, whether or not it has

incurred the costs related to tandem switches. In SBC’s view,
37

that result is contrary to the language of the 1996 Act and the

FCC’s own regulations; it is therefore arbitrary and capricious.

As explained below, we need not reach the merits of that

argument because it is time-barred. However, even if SBC

were not foreclosed from raising that argument, we would find

that it is without merit.

(1). The Time-Bar.

In arguing that the Order Under Review is arbitrary and

capricious in not including functional equivalence in the

compensation equation, the SBC is actually attacking the

reasonableness of Rule 51.711(a)(3) itself. However, 28

U.S.C. § 2344, provides that judicial review of a final order of

the FCC must be filed within 60 days after its entry. Rule

51.711(a)(3) was promulgated and adopted in August 1996.

Rather than seeking judicial review within that 60 day period,

SBC attacked the substance of the Rule in its application for

review of the Attwood Letter in June of 2001. However, the

period within which it could seek the judicial review of Rule

51.711(a)(3) has long since passed and it cannot be challenged

in this petition for review.

Not unexpectedly, SBC contends that its substantive

challenge to the Rule is not foreclosed by 28 U.S.C. § 2344. It

argues that it had no reason to seek review of the Rule in 1996

because the Local Competition Order allowed an inquiry into

the functional equivalency of a CLEC’s switching technology

in determining the compensation rate. SBC contends that it was

only after the Attwood Letter and the Order Under Review

affirming that Letter, that it had reason to know of the demise
38

of the functional equivalency test. SBC believes, therefore, that

it may challenge the substantive validity of the rule in a petition

for review outside of the 60-day filing deadline. 

SBC cites RCA Global Communications, Inc. v. FCC,

758 F.2d 722 (D.C. Cir. 1985) in support of its claim that its

petition for review is timely. There, the court wrote:

Although statutory time limitations on judicial

review of agency actions are jurisdictional, selfevidently the calender does not run until the

agency has decided a question in a manner that

reasonably puts aggrieved parties on notice of the

rule’s content.

Id. at 730. Similarly, in Northwest Tissue Ctr. v. Shalala, 1

F.3d 522, 530 n.8 (7th Cir. 1993), the court explained: 

Before any litigant reasonably can be expected to

present a petition for review of an agency rule, he

first must be put on fair notice that the rule in

question is applicable to him. Otherwise the

agency could promulgate a confusing regulation

and, after expiration of the time for any judicial

contest, clarify it to the surprise and prejudice of

a party whose opportunity for judicial review

meanwhile has been extinguished.

However, we can not accept SBC’s position without

ignoring the fact that the text of Rule 51.711(a)(3) only required

functional equivalency in determining if a CLEC is allowed the
39

tandem rate when the CLEC and ILEC do not serve a

comparable geographic area. Absent that limitation, the rule

simply does not contain an additional requirement of functional

equivalency. Accordingly, SBC was on notice about the proper

application of the rule when it was initially promulgated. Yet,

it sought review long after the 60 day period for doing so had

expired. Therefore, SBC’s belated attempt to now challenge the

reasonableness of the Rule is barred by 28 U.S.C. § 2344.

(2). SBC’s Claim Is Meritless Even If It Is Timely.

We would find SBC’s claim that the Order Under

Review is arbitrary and capricious meritless even if its claim was

not time-barred. SBC maintains that the “tandem

interconnection rate” consists of three discrete rate elements for

each of three distinct functions – tandem switching,

transmission between the tandem switch and the end-office

switch, and end-office switching. SBC cites the Local

Competition Order to support its contention that, under the

1996 Act, a CLEC is only entitled to the tandem rate to the

extent that the CLEC performs the three functions that comprise

that rate. The statute authorizes reciprocal compensation rates

that compensate carriers for the “costs associated with the

transport and termination . . . of calls that originate on the

network facilities of the other carrier.” 47 U.S.C. §

2552(d)(2)(A)(I). It also states that the only compensable costs

are those that a carrier actually incurs in performing such

“transport and termination.” Finally, under the statute,

reciprocal compensation rates are to be set “on the basis of a

reasonable approximation of the additional costs of terminating

such calls.” 47 U.S.C. § 252 (d)(2)(A)(ii). SBC reminds us
40

that the FCC has explained that the statute thus contemplates

that reciprocal compensation rates be cost-based, and that they

“treat transport and termination as separate functions – each

with its own cost.” Local Competition Order, 11 FCC Rcd at

16106 (¶ 1040). 

In SBC’s view, however, the tandem rate rule, as

interpreted in the Order Under Review, is not cost-based.

Rather, that interpretation of the tandem rate rule entitles a

CLEC to receive the entire tandem rate for all traffic delivered

to its switch based only upon a showing that its switch serves a

geographic area comparable to that served by the ILEC’s

switch. In SBC’s view, that approach is over-inclusive for a

number of reasons.

First, SBC claims that the FCC’s staff has held that the

geographic area test refers not to the actual area served by the

CLEC’s switch, but rather to the area that could be served by

thatswitch. SBC’s Br. at 27 & n.7 (citing autorities). In SBC’s

view, that is no test at all because modern switches, i.e.,

switches used by CLECs, are capable of serving wide

geographic areas equivalent to 10 to 15 times the area ILEC

tandem switches can cover. SBC argues that we can not

uphold the Order Under Review because it allows a CLEC to

receive the tandem rate for all the traffic it receives solely

because it could in theory terminate some of that traffic over a

broad area, divorced from any reasonable conception of actual

cost. 

Second, SBC contends that even if the test is confined to

circumstances in which the CLEC actually serves a comparable
See Opinion and Order Concerning Reciprocal 11

Compensation, Proceeding on Motion of the Commmission to

Reexamine Reciprocal Compensation, Case 99-C-0529, N.Y.

PUC LEXIS 398 (N.Y. PSC Aug. 26, 1999). 

41

geographic area, it still remains over-inclusive because it would

nevertheless permit a CLEC to receive the tandem rate on all

the local traffic it receives at its switch, even where the traffic

is switched only once and where the CLEC need not transmit it

to a distant end-office switch. According to SBC, this allows

the CLEC to receive the tandem rate on all the traffic it

receives, even though it never performs two of the three

functions (tandem switching and transmission to the end-office

switch) encompassed by the tandem rate.

Moreover, SBC claims that this is no idle-possibility

because, prior to the FCC’s revision of its rules, several state

commissions had ruled that a CLEC could not, consistent with

the statute, receive the tandem rate on all of the traffic delivered

to its switch when the bulk of that traffic wasswitched once and

delivered to so-called convergent customers – i.e, customers

located right next door to the CLEC’s switch. SBC cites New

York as an example of a state commission realizing that many

new CLECs had targeted specific types of customers primarily

for the purpose of generating large reciprocal compensation

payments from the ILEC and refusing to permit the CLECs to

receive the tandem compensation rate in all circumstances.11

The state commissioner explained that the costs of serving a

small number of large, convergent customers will likely be

lower than the costs of serving a mass market. The
42

commissioner concluded that compensating CLECs that serve

such customers at the tandem rate would overcompensate them

and encourage them to target convergent customers not as a

sustainable business strategy, but rather as a means of drawing

above-cost revenues from ILECs.

SBC contends that the “convergent customer situation”

highlights the anomalies inherent in always compensating a

CLEC as though it is serving a geographically dispersed

customer base through a network architecture similar to the

ILEC’s when it is in fact using a single switch and no

transmission facilities to terminate traffic. However, SBC

claims that the Order Under Review mandates that result.

SBC also claims the result reached in the Order Under

Review is not just contrary to the cost-based approach mandated

by the statute, but contrary to other FCC regulations as well. As

an example, SBC cites to the rule requiring that, “[i]n state

proceedings, a state commissioner shall establish rates for the

transport and termination of telecommunications traffic that are

structured consistently with the manner that carriers incur

those costs.” 47 C.F.R. 51.709(a) (emphasis SBC’s).

According to SBC, where a CLEC uses only a single switch to

terminate traffic to its customers, it does not incur the costs

associated with the two levels of switching, much less the costs

of transmitting the traffic from one switch to another.

Therefore, in SBC’s view, paying rates designed to cover such

costs is simply a windfall to the CLEC that cannot be justified

under the FCC’s “cost-causative” approach to reciprocal

compensation. Local Competition Order, 11 FCC Rcd at 16029

(¶ 1063). We are also told that the windfall violates FCC rules
43

requiring that rates for transport and termination be “structured

. . . consistently with the principles in . . . [section] 51.509.” 47

C.F.R. § 51.109(a). Rule 51.509 established “rate structure

rules” contemplating different and discrete rates for (1) “tandem

switching,” (2) “local switching,” and (3) the use of “shared

transmission facilities between tandem switches and end

offices.” 47 C.F.R. § 51.509. However, according to SBC, the

Order Under Review allows the CLEC to be compensated for

all of these functions in all cases without regard for whether

they were all performed, simply because the CLEC serves a

geographic area comparable to the area served by the ILEC.

Finally, SBC notes that the FCC’s rules generally require

symmetrical reciprocal compensation rates. As we explained

earlier, the “incumbent LEC’s transport and termination prices

[serve] as a presumptive proxy for other . . . carrier’s additional

costs of transport and termination.” Local Competition Order,

11 FCC Rcd at 16040 (¶ 1085); see also 47 C.F.R. § 51.711(a).

 Yet, SBC claims that the Order Under Review is asymmetrical

because it allows an ILEC to recover the tandem rate only when

the CLEC elects to deliver traffic at the ILEC’s tandem switch,

and thus only when the ILEC actually performs each of the

discrete functions (tandem switching, transmission to the endoffice switch, and end-office switching) intended to be

recovered in the tandem rate. Yet, CLECs are entitled to

recover the entire rate, even when they do not perform those

discrete functions. 

For all of these reasons, SBC contends that the Order

Under Review is arbitrary and capricious. We cannot agree. 
44

SBC’s arguments are based upon its interpretation of

“costs” in § 252(d)(2)(A) isolated from the rest of the text. 

Section 252(d)(2)(A), authorizesreciprocal compensation rates

based upon a “reasonable approximation” of costs. 47 U.S.C.

§ 252(d)(2)(A)(ii) (emphasis added). SBC’s reading of the rule

and regulation ignores the a crucial portion of the text. More

importantly, in § 252(d)(2)(B)(ii), Congress specifically

prohibited “any rate regulation proceeding to establish with

particularity additional costs of transporting and terminating

calls.” See 47 U.S.C. § 2552(d)(2)(B)(ii) (emphasis added). It

is therefore clear that Congress did not contemplate, and clearly

did not require, a calculation of the “actual” costs of

transporting and terminating calls. In fact, Congress precluded

taking that approach to compensation between carriers.

The issue is therefore whether the FCC’s rules governing

reciprocal compensation establish rates that recover a

“reasonable approximation” of the CLEC’s costs. It is a basic

principle of statutory construction that “a word is known by the

company it keeps,” and this rule of construction is “wisely

applied where a word is capable of many meanings.” Jarecki v.

G.D. Searle & Co., 367 U.S. 303, 307 (1961); see also Deal v.

United States, 508 U.S. 129, 132 (1993) (“the meaning of a

word cannot be determined in isolation, butmust be drawn from

the context in which it is used”); Sekula v. FDIC, 39 F.3d 448,

454 (3d Cir. 1994) (“[o]ne must look at the entire provision,

rather than seize on one part in isolation”). 

With these canons as our compass, we note that §

252(d)(2)(A) does not define “costs” as “actual costs.” Yet,

SBC’s submission is precisely that. It is arguing that “costs”
45

means “actual costs,” even though proceedings to determine

“actual costs” are prohibited by Congress. Congress’s use of the

term “costs” in the reciprocal compensation context indicates

that it intended to avoid reciprocal compensation rates based on

actual costs and complex cost studies. 47 U.S.C. §

252(d)(2)(B)(ii). Instead, Congress required that the rates for

reciprocal compensation be based upon a “reasonable

approximation of the additional costs of terminating” calls that

originate on another carrier’s network. 47 U.S.C. §

252(d)(2)(A)(I), (ii). 

When all is said and done, SBC’s understandable desire

to see compensation it pays to CLECs be based upon a more

precise calculus than the geographic area test can perhaps best

be answered by a pronouncement the Supreme Court made in

another context in Verizon Communications Inc. v. FCC, 535

U.S. 467, 539 (2002). There, in rejecting a claim that the price

of leasing a competitor’s network must be based on a precise

evaluation of various economic factors and costs, the Court

said:

The 1996 Act sought to bring competition to

local-exchange markets, in part by requiring

incumbent local-exchange carriers to lease

elements of their networks at rates that would

attract new entrants when it would be more

efficient to lease than to build or resell. Whether

the FCC picked the best way to set these rates is

the stuff of debate for economists and regulators

versed in the technology of telecommunications

and microeconomic pricing theory. The job of
As an aside, and without suggesting anything about the 12

merits of SBC’s concerns, we agree with the FCC that SBC

should present the argument it is making in this petition for

review to the FCC in proceedings under the NPRM. There, the

FCC has invited comment on whether to revise § 51.711(a)(3)

to include a functional equivalency test. 

46

judges is to ask whether the Commission made

choices reasonably within the pale of statutory

possibility in deciding what and how items must

be leased and the way to set rates for leasing

them. The FCC's pricing and additional

combination rules survive that scrutiny.

The FCC’s compensation scheme for reciprocal rates

also survives that scrutiny. The Order Under Review is

thoroughly consistent with the Local Competition Order and the

Rule 51.711(a)(3), and we will therefore deny SBC’s petition

for review.12

IV. CONCLUSION

For all of the above reasons, we will deny SBC’s petition

for review of the FCC’s Order Under Review dated September

3, 2003.