Court Opinion

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Opinions of the United
2005 Decisions                                                                                                             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Precedential or Non-Precedential: Precedential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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                                             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 **

       *
       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
                (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

Pennsylvania, sitting by designation.

                               2
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,

                               3
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.”1 Id. The 1996 Act restructured local
telephone markets by preempting state and local franchise

       1
        The jargon used in the telecommunications industry can
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
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 Atlantic-
Pennsylvania, 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 has recently 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

                                 5
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 calls that 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

                                 6
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 may charge each other are symmetrical.

       2
        Many parties petitioned for review of numerous aspects
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
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,3 known as “end-office” switches, that directly
serve customers in a particular local calling area. These end-
office switches may be connected directly, one to another. In

       3
        As noted above, a switch is a computer that directs the
path of a telephone call by opening and closing the electrical
pathway (or circuit) over which the call travels. Supra at n. 1.

                               8
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

                               9
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, 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 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

                             10
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 this rule is set 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

                                11
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

                                12
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 for reciprocal 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).

                               13
              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

                             14
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

                                15
“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.5 The
opinion Letter concluded: “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

       4
        The issues raised in the FCC’s NPRM have not yet
been resolved.
       5
           The FCC had confirmed this in the Intercarrier
Compensation NPRM.

                                 16
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 rule-
making 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

                               17
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

       6
        We have jurisdiction pursuant to 28 U.S.C. § 2342(1),
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
             C om m unications C om m ission
             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
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).

                                19
                       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

                                 20
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

                              21
      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).

                              22
      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

                                23
       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).

                               24
  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’s requirement 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 inquiry mandated 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.”).

                               25
       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 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) (emphasis added).

      Moreover, the FCC concedes that some state

                             26
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

                               27
rule itself, but rather in the text of the Local Competition
Order.7 Moreover, SBC contends that the rule’s omission of
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

       7
       The Local Competition Order at issue here is the First
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
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:

                              29
      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

                              30
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.8 Sprint Corp., 315 F.3d at 373.

       8
         This is not a case like Caruso v. Blockbuster-Sony Music
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
        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’s tandem 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

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.

       9
        In making this argument, SBC cites National Mining
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
       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.

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
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

                                 34
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

       10
            As recited in the earlier discussion of the standard of
review:

                                 35
         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,

              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
              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).

                               36
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

                              37
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, self-
       evidently 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

                                38
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

                               39
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
that switch. 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

                              40
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 was switched 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

       11
       See Opinion and Order Concerning Reciprocal
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
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

                               42
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 end-
office 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.

                                 43
        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), authorizes reciprocal 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, but must 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”

                               44
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

                               45
       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.

       12
         As an aside, and without suggesting anything about the
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.

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