New rules favor Bells, threaten ISPs
The Federal Communications Commission is scheduled to vote at its Thursday meeting on a change in the way one phone company pays another for terminating a local call, although a vote could be held behind closed doors before then.
Wherever a local phone call ends, that phone company is paid to handle the call by the phone company where the call originated. Thus, when consumers use their BellSouth phone lines, for example, to dial an Internet service provider, BellSouth pays the phone provider hired by the ISP, which sometimes is the ISP itself. Bells such as Verizon Communications, SBC Communications and Qwest Communications International pay as much as $5 billion a year in such fees, known as reciprocal compensation, and claim it has become a subsidy for competitive local exchange companies, or CLECs. That industry has been reeling in the last year, with precipitous stock drops and bankruptcies.
"Many CLECs are using this regulatory loophole to help them compete," U.S. Telecommunications Association President Gary Lytle said recently.
Precursor Group analyst Scott Cleland went further, calling reciprocal compensation "pure regulatory arbitrage" that he said gives CLECs returns of up to 4,000 percent. "You can't get that kind of return selling drugs," he said.
But to competitors, the Bells' success at moving these new rules forward represents another sign of the Bells' growing market dominance. In a recent speech in which he called for greater enforcement of the 1996 Telecom Act, which outlines the reciprocal compensation formula, CompTel President H. Russell Frisby issued a warning.
"We face the very real possibility that the Bell companies could re-monopolize the industry," he said.
The FCC has been under enormous political pressure to address this issue. The top two members of the House Commerce Committee, Rep. Billy Tauzin, R-La., and Rep. John Dingell, D-Mich., backed legislation last year that would have bypassed the FCC and eliminated reciprocal compensation. The bill died along with many others in the waning days of the Congress.
Even CLECs and ISPs acknowledge that the FCC is going to seriously reduce the payments they receive. Most industry officials and analysts believe the agency will phase out the fees terminating with ISPs to the extent it's possible to isolate that traffic.
Last month CompTel and the Association of Local Telecommunications Services (ALTS) wrote the FCC saying that while they continue to oppose any disruption to reciprocal compensation, if the agency was determined to act, it asked that no new payment structure be imposed without a transition period, perhaps three years.
Meanwhile, ALTS wrote Tauzin and said that without reciprocal compensation revenue, CLECs could raise the fees they charge ISPs, and "this could force ISPs to increase the rates that 31 million consumers pay for Internet access by up to 35 percent."
Not everyone believes that argument. "If ISPs are trying to compete in the marketplace, will it help them to raise their fees?" Cleland asked. He answered his rhetorical question with an emphatic no.
But Dave Baker, Earthlink's vice president for law and public policy, said the FCC's upcoming action at a minimum "doesn't do anything to help affordable access to the Internet."
When the compensation formulas were created in the 1996 Telecom Act, Bell lobbyists played an active role in drafting them. What they did not anticipate was the massive growth of the Internet and of dial-up accounts.
They also didn't anticipate that ISPs would tend to receive a lot of local calls but not place many and that, for the most part, ISPs have signed up for phone service with CLECs.
Under the FCC's new rules, the Bells should save billions of dollars, but it's likely they will be required to invest some or all of that money in building out broadband services. The FCC wouldn't comment on what might be included in the new rules.
The FCC tried to dodge this issue entirely two years ago by ruling that calls terminating with an ISP were actually long-distance calls because the consumer then travels globally on the Internet. Thus, the call was exempt from reciprocal compensation. That angered many states that saw the FCC rescinding their role in regulating local traffic, and concerned some Internet advocates who feared the FCC was extending its phone regulations online.
The U.S. Court of Appeals for the D.C. Circuit last year threw out that rule, suggesting the FCC had demonstrated a "want of reasoned decision-making." The FCC has been working on new rules ever since.
At a House Commerce Committee vote on the reciprocal compensation bill last fall, some members had unkind things to say about CLECs. Dingell, for example, called them "looters" that were living off a "gravy train" and relying on reciprocal compensation to make a profit rather than actually providing consumers with local phone service.ALTS President John Windhausen took issue with that assessment in a letter to committee members, however. He noted the reason CLECs get most of the reciprocal compensation is because they signed contracts with ISPs, not the Bells. "The fact is that the CLECs aggressively competed with the (Bells) to serve ISPs and won that market share fairly. That is not a loophole; it is competition."
However, Cleland said, CLECs won those contracts with ISPs because "they shared the money with them" from reciprocal compensation.
Windhausen admits that reciprocal compensation funds are very important to a number of CLECs, but he said he knows of only one--a CLEC that operated briefly in North Carolina before it shut down after being fined by state regulators--that established itself with the intent of profiting from reciprocal compensation.
Lytle said ALTS and CompTel's real agenda is "protecting companies that are hemorrhaging cash and whose poor business plans were founded on the windfalls of reciprocal compensation."
Cleland said the FCC shouldn't worry about the possibility of this new rule putting CLECs out of business. "If the government is in the business of subsidizing companies by regulatory arbitrage, then it should continue the program."