Today the Federal Communications Commission adopted an order and further notice of proposed rulemaking on reform of the high cost universal service program and intercarrier compensation. As expected, the order will create two new universal service funds – a Connect America Fund for landline broadband and a Mobility Fund for wireless broadband – and phase out the current high cost fund that supports voice service. The order also will replace the current intercarrier compensation regime for both long distance local calls, eliminating access charges and reciprocal compensation payments over a transition period and implementing a “bill and keep” regime for all traffic exchanged by carriers. Further, the FCC will require all carriers to negotiate in good faith for “IP to IP” interconnection. The press release is available at http://transition.fcc.gov/Daily_Releases/Daily_Business/2011/db1027/DOC‐310695A1.pdf, the executive summary of today’s decision is available at http://www.fcc.gov/document/connectamerica‐ fund‐commission‐meeting‐item‐executive‐summary and the statements by the commissioners are available at http://transition.fcc.gov/Daily_Releases/Daily_Business/2011/db1027/DOC‐310695A2.pdf (Genachowski), http://transition.fcc.gov/Daily_Releases/Daily_Business/2011/db1027/DOC‐310695A3.pdf (Copps), http://transition.fcc.gov/Daily_Releases/Daily_Business/2011/db1027/DOC‐310695A4.pdf (McDowell) and http://transition.fcc.gov/Daily_Releases/Daily_Business/2011/db1027/DOC‐310695A5.pdf (Clyburn). The order itself has not yet been released.

OVERVIEW

The FCC has been struggling with universal service and intercarrier compensation issues for decades, as Chairman Genachowski acknowledged when discussing his personal experience on these issues. While this order generally is not surprising, and it largely follows the outline the FCC proposed in February, it is a significant achievement, if for no other reason than that the FCC had failed to act so many times in the past.  

The key elements of the new regime are as follows:

  • The FCC created a new Connect America Fund to support landline broadband deployment in unserved high cost areas.
  • Incumbent carriers operating under price caps will be given a right of first refusal for broadband support for at least the first five years of the Connect America Fund, and incumbent carriers operating under rate of return rules may not be subject to any competition for these funds.
  • The FCC created a new Mobility Fund to support wireless broadband deployment in unserved areas.
  • The order adopts an annual cap of $4.5 billion on the total amount devoted to high cost universal service support.
  • The decision phases out existing high cost support mechanisms over time, including support for competitive carriers and wireless providers.
  • The FCC approved a multi‐year transition from the current intercarrier compensation regime to one in which there are no intercarrier compensation charges. The transition will be longer for carriers that set their rates using rate of return methodologies than for other carriers.
  • Carriers will be permitted to recover some of their lost intercarrier compensation revenues through an Access Recovery Charge.
  • Calls that originate or terminate via voice over IP will be subject to intercarrier compensation on a goingforward basis, starting at the current interstate access rate for toll calls and the current reciprocal compensation rate for local calls.
  • The FCC adopted new rules intended to limit access stimulation (also known as traffic pumping) and phantom traffic.
  • While it put off more detailed decisions on Internet Protocol‐based interconnection to a later order, the FCC announced that carriers will be required to negotiate requests for IP‐to‐ IP interconnection in good faith, signaling that the FCC believes that it is covered by the requirements of the Communications Act.

KEY IMPLICATIONS

This is the most significant telecommunications decision adopted under Chairman Genachowski. It effectively wipes out two sets of rules that have been central to telecommunications regulation since the AT&T divestiture in the early 1980s. In doing so, it also could have an enormous effect on the balance of power within the industry and on how carriers approach their businesses going forward. At the same time, it also reinforces some old approaches, particularly in the delivery of universal service support.

Most significantly, this order reflects a shift from supporting voice service to supporting broadband service, and a shift away from indirect subsidies provided via intercarrier compensation and towards direct support. These two changes are related in several ways. For instance, access charges are specifically connected to voice service and to supporting the costs of the voice network. The shift to direct subsidies has been a longstanding goal of the FCC, and the shift to support for broadband is a key element of Chairman Genachowski’s agenda.

The shift is particularly clear for wireless providers, which will lose access to support for voice services, but will gain new, specific support for broadband service in unserved areas. One interesting innovation in the decision is a focus on highways and roads, which the FCC suggests is result of considering the significance of mobility, rather than just of broadband coverage.

Eliminating access charges will force local carriers to recover a much higher proportion of their costs from their local customers, principally through increases in local service charges. While the order places limits on these increases, the net effect will be to place more pressure on local service.

At the same time, eliminating access charges will make long distance service more attractive because it will lower the cost of providing that service. It is unclear how much this will help long distance carriers, as their business has been shrinking over time, but it will at least allow them to price their services based on their own network costs. In fact, the FCC has estimated that consumers will save $2 billion annually under the new rules, and all of those savings are likely to come from reduced access charges.

The most obvious concession to the old ways comes from the Connect America Fund. The new fund mostly will support the same carriers who receive high cost support today; indeed, the right of first refusal for price cap carriers and the explicit structure of the fund for rate of return carriers ensures that this will be the case for at least the next five years. However, carriers that accept this support will have new obligations to provide broadband service and to serve community anchor institutions. The FCC expects that this will shift investment into broadband facilities, and it likely is correct. In practice, though, this may merely reinforce an existing trend.

The order also provides key support for voice over IP providers, both through the explicit determination that voice over IP traffic is subject to intercarrier compensation and through the decision to require good‐faith negotiation for IP‐to‐IP interconnection. The intercarrier compensation decision is intended to end the series of disputes about whether voice over IP providers can collect anything for providing access services, and may make it much more difficult for long distance carriers to dispute these charges going forward. In the long run, the IP interconnection requirements likely will prove to be more important, although there are difficult steps remaining before IP interconnection becomes the norm.

The clearest losers in today’s decision are state regulators. It appears that this order will relegate states to enforcing the FCC’s intercarrier compensation rules, rather than making their own decisions about intrastate services. However, they still will retain their role as the gatekeepers for access to universal service support through their ability to designate eligible telecommunications carriers.

At the same time, the order also suggests that the power of rural carriers is waning. The long‐run result of today’s decision, if it goes into full effect, will be significant reductions in the revenues that rural carriers receive from both access charges and the universal service fund. Some of today’s statements suggest that the FCC almost is concerned that carriers have been abusing the access regime and the universal service fund, for instance by using that money to charge unreasonably low local service rates. Even the discussions of the ability to seek waivers of the new rules suggests that the FCC is not likely to be sympathetic to complaints from rural carriers.

THE CONNECT AMERICA FUND

The Connect America Fund is the central element of the order. The new fund will refocus the FCC’s support for universal service in high cost areas from traditional voice services to broadband. By the time that existing support mechanisms end, the Connect America fund will provide $4 billion a year in support for deployment and operation of broadband in high cost areas across the country. According to the FCC staff presentation at the meeting, this will include approximately $2 billion to support service in areas served by small, rural carriers that operate under the rate of return rules, $1.8 billion to support service in most of the rest of the country and $100 million for a new fund for service to extremely remote areas.

What Will Be Supported

The Connect America Fund will support the deployment and operation of broadband services in high cost areas. The support will be available only to companies that agree to provide service that meets the FCC requirements for broadband speeds, which initially will be set at 4 Mbps downstream and 1 Mbps upstream, although the FCC has an expectation that much of the supported service will be provided at speeds of 6 Mbps downstream and 1.5 Mbps upstream or greater and that these speeds will increase over time. Service also will be required to be offered at affordable prices, although the FCC’s public statements have not provided any specific information on how to determine whether a service is affordable.

One of the new requirements for receiving support is providing service to “community anchor institutions,” such as schools, libraries and colleges and universities. According to Commissioner Clyburn, anchor institutions will be “provided an opportunity to confer” with support recipients during the network planning process and support recipients will be required to provide information on community institutions that receive broadband service through supported facilities.

Eligibility for Support

To receive funding the Connect America Fund, a carrier must qualify as an eligible telecommunications carrier under the Communications Act. In general, states are empowered to decide whether to grant this status to carriers, and the FCC indicated today that states will continue to have this role. While many commenters in this proceeding urged the FCC to adopt rules placing some limits on state discretion to designate eligible telecommunications carriers, it is not apparent whether the FCC took such steps.

Determining What Providers Receive Support

Initially, eligibility for support from the Connect America Fund will be limited to incumbent local exchange carriers. Eligibility will be expanded later in the process. Funding will be available only in areas that are not served by an unsubsidized competitor.

In the first phase of support, $300 million in additional funding will be made available to price cap carriers. Their existing support will be subject to obligations to build and operate broadband services in areas not served by an unsubsidized competitor. Carriers that receive the additional support will agree to offer broadband at an incremental cost of $775 per unserved location.

In the second phase of support in price cap areas, support will be based on a cost model that will be developed by the FCC. Incumbent carriers will have a right to choose whether to accept that support for the entire high cost portion of each state they serve (except for areas that have exceptionally high costs and areas that are served by an unsubsidized competitor). If a carrier accepts the funding, it will have exclusive rights to support for five years. Carriers that accept support will have specific build‐out obligations and will be subject to financial penalties if they do not meet those obligations.

If an incumbent carrier does not exercise its right of first refusal and, in any event, after the five‐year first refusal period has ended, the FCC will use a competitive bidding mechanism to distribute support in the area. The details of the bidding process have not been determined and are subject to further comment.

It does not appear that rate of return carriers will be subject to any bidding requirements. According the executive summary, they will, however, be required to provide broadband service to their customers “upon reasonable request.”

The Remote Areas Fund

The FCC indicated that it will allocate “at least $100 million per year” to a fund focused on providing broadband service to “Americans living in the most remote areas in the nation, where the cost of deploying traditional terrestrial broadband networks is extremely high.” This fund likely will support service provided via satellite and unlicensed wireless services, and providers probably will not be required to offer service that is as robust as will be required under the main Connect America Fund.

The specific structure of the Remote Areas Fund will be one of the subjects of the further notice of proposed rulemaking to be issued along with the order adopted today. The FCC expects to adopt rules in late 2012 and begin implementation of this fund in 2013.

Sources of Funding

The money for the Connect America Fund will come from several sources. First, existing support for voice services provided by incumbent carriers will be reduced over time. Second, the FCC will phase out the “identical support rule,” which allows competitive carriers to receive the same support on a per‐line basis that incumbent carriers receive today. This phase‐out likely will provide the principal source of the new funding for broadband, as competitive carriers currently receive $1.36 billion annually in support. Third, the FCC has adopted a series of changes to the high cost support rules that will reduce the amount of support going to incumbent carriers. These changes include a phased‐in $250 per line cap on high cost support and reducing support for carriers “that maintain artificially low end‐user voice rates.”

THE MOBILITY FUND

The Mobility Fund is intended to support broadband wireless service in areas that currently do not have such service. Like the Connect America Fund, it will be set up in two phases. The order also creates a parallel Tribal Mobility Fund, with separate funding.

Phase One

Phase one will offer up to $300 million in what the FCC describes as “one‐time support.” These funds will be made available through a national reverse auction, which currently is scheduled to take place in the third quarter of 2012. The auction will focus on maximizing “coverage of unserved road miles within the budget,” and so presumably will rank all bidders based on the number of road miles served per dollar of support. Winners will be required to deploy either 4G service within three years or 3G service within two years.

Phase Two

In the second phase, the Mobility Fund will be set at $500 million per year. This funding will cover both deployment and operations. Carriers that receive support in the first phase will be eligible for phase two funding, but may not use phase two funding to support the service covered by their phase one funding.

The FCC has not decided on the specific structure and operational format for the fund, but will seek comments in the further notice of proposed rulemaking.  

The Tribal Mobility Fund

Initially, the Tribal Mobility Fund will consist of $50 million in addition to the first phase of the Mobility Fund. This funding will be awarded using many of the same principles as the initial Mobility Fund support, but carriers will be required to focus their coverage on tribal areas. Once phase two of the Mobility Fund is implemented, up to $100 million will be made available annually for tribal areas. While this funding is not guaranteed, it is likely that substantial amounts of support will be provided each year for support in tribal areas.

Identical Support Phase‐Out

As noted above, the FCC will be phasing out the identical support rule as part of its plan to pay for the Connect America Fund and the Mobility Fund. Today, the vast majority of competitive carrier high cost support goes to wireless carriers.

Recognizing that the phase‐out of competitive carrier support will have a substantial effect on wireless providers, the FCC decided to adopt a backstop mechanism. Under this mechanism, the phase‐out for wireless providers will proceed until June 30, 2014, but will stop if phase two of the Mobility Fund is not operational by that time. This will ensure that wireless providers have access to $600 million in annual universal service support until the Mobility Fund is fully operational.

UNIVERSAL SERVICE WAIVERS

To eliminate the potential for consumer harm from changes in the universal service rules, the FCC has adopted a mechanism to permit carriers to “seek relief from some or all of our reforms if the carrier can demonstrate that the reduction in existing high‐cost support would put consumers at risk of losing voice service, with no alternative terrestrial providers available to provide voice telephony.”

The FCC has not provided specifics on the waiver process, but it was described by Commissioner McDowell as “frugallyminded but reasonable” and by Commissioner Clyburn as “firm, predictable, yet fair.” During the postmeeting press conference, the FCC staff indicated that the order would include specific “factors that [carriers] would have to provide” to obtain a waiver. It appears from the comments of the commissioners that the intent is for the FCC to grant very few waivers under any circumstances.

INTERCARRIER COMPENSATION

While the headlines likely will be focused on the universal service fund, the new structure for intercarrier compensation is an equally fundamental change. Under the order, the current system under which carriers pay each other to terminate traffic and under which toll calls are subjected to charges that far exceed actual costs will be replaced with a system in which almost no money will be exchanged between carriers that exchange traffic. At the end of the transition, in fact, carriers will be obligated to exchange traffic on a “bill and keep” basis, meaning that they will be required to recover all of their costs from their own customers and that they will not be permitted to impose charges on originating carriers.

Structure of the Transition

The order adopts a structure that first will bring intrastate access rates down to interstate levels and then steps down all intercarrier compensation rates to zero. The intrastate rate transition will take place in two annual steps, starting on July 1, 2012. From there, price cap carriers will be required to reduce their rates to zero over the following four years, and rate of return carriers will be required to reduce their rates to zero over the following seven years. This means that the transition will take a total of six years in price cap areas and a total of nine years in rate of return areas.

This transition covers all termination rates, including rates for termination of local traffic now subject to reciprocal compensation. The FCC is seeking comments on how to address rates for other services, including originating access. Carriers also are free to negotiate alternatives to this rate transition, although it is unlikely that many long distance carriers will be willing to negotiate higher rates for terminating access.

Compensation for Lost Revenues

To compensate carriers for revenues lost during the transition, the FCC has created a new monthly charge, called the Access Recovery Charge. Incumbent telephone companies can impose this charge, with certain limits, in amounts up to the amounts they lose from reductions in the access charges they receive. The FCC has estimated that the average Access Recovery Charge will be in the range of 10 to 15 cents per month in the first year, with similar increases in later years.

The limitations on the charge are important. First, in addition to not being able to recover revenue than they lose, carriers may not increase the monthly Access Recovery Charge by more than 50 cents a year for consumers and small businesses or by more than $1 a year for multi‐line businesses. Second, the combination of the current charges and the Access Recovery Charge cannot be more than $30 for residential and small business customers; for multi‐line customers, the combination of the Access Recovery Charge and the subscriber line charge cannot be more than $12.20. The charge also may not be collected from Lifeline customers.

In addition, the amount recovered from the charge will phase down over time as what the FCC describes as “eligible revenue” declines. The rules essentially will reduce the eligible revenues by 10 percent a year for the price cap carriers that serve most customers. Rate of return carriers will have their eligible revenues reduced by five percent per year.

The FCC also will devote some Connect America Fund support to offsetting revenues lost as a result of intercarrier compensation reform. Carriers that receive this funding will be required to use it to support both voice and broadband service. This support will phase out starting in the sixth year of the transition.

Voice over IP Traffic

The order will, for the first time, explicitly apply intercarrier compensation rules to voice over IP traffic. Under the rules, the default charge for toll traffic exchanged between a voice over IP provider and a public switched telephone network provider will be the interstate access rate.

The default charge for local traffic exchanged with a voice over IP provider will be the reciprocal compensation rate. The executive summary emphasized that these rules cover “prospective payment obligations” and that the intent of the rules was to place voice over IP providers “on equal footing in their ability to obtain compensation for this traffic.” In response to a question at the post‐meeting press conference, the staff indicated that the intent of the rule is to be “technologically neutral” and to ensure payment to voice over IP providers because “they are providing the services” used by long distance carriers. Chairman Genachowski said “that as long as there is intercarrier compensation” the FCC wanted to “clear[] up some of the confusion about whether VoIP calls should get compensated.”

Competitive Carriers

With the exception of voice over IP providers, there was little discussion today of how the new intercarrier compensation rules will apply to competitive carriers. All of the explanations of the transition framework and the Access Recovery Charge, for instance, refer only to incumbent local carriers.

It is likely, however, that this omission means that competitive carriers will be subject to the same transition rules as incumbent carriers, and that they also will be able to impose an Access Recovery Charge or some equivalent charge. Under current rules, competitive carrier interstate access rates are capped at the levels charged by the local incumbent carrier, and there was no indication that this would change. Similarly, competitive carriers are permitted to impose a subscriber line charge or its equivalent today, and the same logic could be applied to the Access Recovery Charge.

Wireless Compensation

The order takes steps to clarify how the intercarrier compensation rules apply to wireless traffic. The new rules will address compensation for local traffic, compensation for other traffic and when a call is treated as coming from a wireless provider.

First, the rules adopt a default bill and keep rate for all local calls exchanged with wireless providers. There will be a special transition period for rate of return carriers to permit them to adapt to this change. The FCC noted that any call to or from a wireless customer that originates and terminates in the same Major Trading Area is treated as local under its rules.

Second, the order will clarify the relationship between the intercarrier compensation rules and the FCC’s existing wireless compensation rules, which essentially require negotiation of rates. The FCC’s intent is to allow carriers to avoid disputes.

Finally, the order clarifies that a call will be treated as originating from a wireless provider only if the person making the call is using a wireless device. Calls that originate on landline phones and are routed through wireless carriers are to be treated as landline calls.

Abuse

The order also addresses two specific abuses of the intercarrier compensation system: access stimulation, or traffic pumping, and phantom traffic.

The FCC’s approach to traffic pumping is to create special, lower access rates for carriers engaged in that practice. Carriers will be required to file tariffs at the lower rates if they enter into any agreement to share access revenues with a customer; if they have a 3:1 or higher ratio of incoming to outgoing access traffic in any month; or if they have more than 100 percent growth in access traffic in a month, as compared to the same month in the previous year. The FCC has not indicated what the lower rate will be, but it likely will be low enough to make traffic pumping unattractive at the interstate level.

The rules addressing phantom traffic are less likely to be effective. Phantom traffic has been described as traffic that is made to appear as if it comes from a different location than where it actually originates as a way to avoid paying access charges. The new rules will require all carriers to include accurate information on the originating telephone number in all call signaling and to pass that information along with the call.

In effect, the new phantom traffic rule codifies the industry standard for passing along call information. It is unclear how effectively the FCC can enforce that requirement, particularly for traffic that is passed from carrier to carrier as it travels from its originating point to its terminating point.

IP‐TO‐IP INTERCONNECTION

Another element of the further notice of proposed rulemaking will be creation of what the FCC describes as “a policy framework for IP‐to‐IP interconnection.” In the interim, though the FCC says that “we expect all carriers to negotiate in good faith in response to requests for IP‐to‐IP interconnection for the exchange of voice traffic.”

This statement is significant because it marks the first time the FCC has imposed any obligations on IP‐based interconnection. It suggests that the FCC has concluded that it has jurisdiction over such interconnection for voice traffic (if not necessarily for data or Internet traffic). The “good faith” language, in particular, may indicate that the FCC intends to include IP interconnection under the umbrella of the competitive interconnection provisions of the Communications Act, which could include a right to arbitration to obtain an interconnection agreement. This would be a significant victory for providers of competitive services.

STATE ROLE

The ongoing state role in high cost universal service and intercarrier compensation was mentioned by nearly every FCC official who spoke today. These statements were largely symbolic, as much of what was done today was intended to reduce state authority.

Probably the most significant concessions to the states related to their ability to name eligible telecommunications carriers and to impose carrier of last resort obligations on individual carriers. Under the new rules, states will continue to name eligible telecommunications carriers, and therefore to decide what carriers can receive universal service funds. This is no surprise, however, because the Communications Act explicitly gives this role to the states and the courts have ruled that the FCC has little power to constrain state decisions.

The FCC also declined to preempt state carrier of last resort requirements, despite requests from many commenters that it do so. The FCC’s reason for not removing these requirements is not clear, but it may not have been convinced that these requirements are that onerous.

At the same time, the FCC essentially is eliminating the state role in intercarrier compensation, and even is placing constraints on the states’ rate‐setting powers for local telephone service. While there was discussion of a state role in intercarrier compensation reform, it largely will be limited to enforcing the FCC’s new rules, which is far different from what the states do today.

Given the FCC’s actions, and previouslyexpressed state opposition to preemption, it is likely that the states will seek to challenge the FCC’s authority through an appeal. States view regulation of intrastate access charges as a core element of their regulatory authority, and will not be likely to give up that authority without a fight.

A central issue in any appeal will be the reach of statutory provisions adopted in 1996 that gave the FCC the power to adopt rules governing interconnection and compensation for exchanging local traffic. In response to a similar claim that the FCC’s rules overstepped the boundary between its authority and state power, the Supreme Court ruled that the 1996 changes increased the scope of the FCC’s power. As the FCC’s general counsel indicated in today’s press conference, the FCC’s theory is that those same provisions give it the right to adopt rules governing intrastate access charges as well.

NEXT STEPS

Most of the implementation of today’s decision will not start until mid‐2012 or later, and it is evident that much of framework for implementing the Connect America Fund and the Mobility Fund has yet to be settled. As a result, the next steps for the FCC will involve seeking comment on those issues, as well as on the cost model that will be used to set the amounts of support in price cap carriers’ markets and the rules for IP‐to‐IP interconnection. Some of these issues need to be settled before the FCC can fully implement the new universal service regime; others, like IP‐to‐IP interconnection, need not be addressed on a specific timetable.

Once the order is issued, it almost certainly will be the subject of appeals. In addition to state regulators, it is likely that rural carriers and their trade associations will attempt to overturn the portions of the order that reduce long‐term universal service support and the access charges they can impose. Those challenges likely will be made more difficult by the availability of a waiver mechanism, particularly because the FCC has indicated that nearly all of the new rules could be waived in appropriate circumstances.

It does not appear likely that this order will result in any Congressional action. In recent weeks, many members of Congress who have been interested in universal service and intercarrier compensation issues either have expressed their support for the FCC’s reforms or made it clear that they did not see a role for Congress on these issues. This is not so much a reflection of a lack of interest as an indication that these Members believe the FCC generally was on the right path and that legislation was highly unlikely.