Regulatory News – BOC Break-Up Campaign Gains Momentum

Posted: 05/2001

BOC Break-Up Campaign Gains Momentum
Competitive Carriers Press State
Regulators to Save Competition by Splitting Bells
By Kim Sunderland

Competitive carriers don’t want to hear any sad songs from the BOCs about
what it means to be forced by state and federal regulators to carve up their
local exchange service operations into separate retail and wholesale affiliates.

They simply want it to happen. Now.

If not, competing carriers say the onslaught of cross-subsidization and
discriminatory access that is slowing them down will only intensify.

The Bells, on the other hand, say the costs associated with such separation
are high, as is the stress level associated with dividing a company’s core
businesses.

State-level actions sought by competitors reflect a growing perception in
their ranks that new regulatory measures are required as a remedy to the
failings of the Telecommunications Act of 1996. Policymakers "must consider
whether the Telecommunications Act’s market-opening provisions and the rules to
implement them are, by themselves, sufficient to open up markets quickly, and
whether they can prevent the stalling that hurts competitors both operationally
and financially," says H. Russell Frisby Jr., president of the Competitive
Telecommunications Association (CompTel, www.comptel.org).

Frisby says that the difficulty with enforcing the market-opening provisions
of the Telecom Act is that it’s virtually impossible to get a monopolist to
relinquish its monopoly. "The alternative is structural separation,"
he says.

Several states, including Maryland, Illinois, Pennsylvania and New Jersey,
already are considering or have asked a BOC to structurally separate in order to
prohibit anti-competitive behavior and encourage greater local competition.

Structural separation isn’t a new concept in the telecommunications industry.
It’s been employed in the long distance, Internet and equipment markets, all of
which are extremely competitive today, according to CompTel.

Frisby says that structural separation also has been shown to work in the
local market, having been instituted successfully more than five years ago in
Rochester, N.Y.

But the BOCs have no plans to go along peacefully with structural separation
and are rallying their troops.

"Policy experts [also] are weighing in on the wacky notion of structural
separation," says Eric Rabe, vice president of media relations for Verizon
Communications Inc. (www.verizon.com)
citing support from various experts at organizations across the country who
"all agree this is one of the worst ideas to come along in years."

Members of the conservative Progress & Freedom Foundation (www.pff.org),
The Cato Institute (www.cato.org), the
Competitive Enterprise Institute (www.cei.org),
The Commonwealth Foundation (www.commonwealthfoundation.org),
Citizens for a Sound Economy (www.cse.org), the
Independent Institute (www.independent.org),
and the Mercatus Center at George Mason University (www.mercatus.org)
recently sent a letter to several congressional leaders slamming structural
separation.

The public policy experts called the break-up proposal–which they contend is
being advanced by AT&T Corp. (www.att.com)–as
a "setback to the clear vision" of the Telecom Act.

"The fact that some firms are performing poorly in the
marketplace–despite numerous regulatory advantages–is hardly cause for
returning to the failed model of regulated monopoly," the policy pundits
noted in their letter.

"As a company, we split lines every day, and we might split hairs about
different provisions in the Telecom Act, but we won’t split up," Rabe says.

In Maryland, Verizon fought proposed legislation (HB 957) that would have
forced the incumbent to separate. The pending bill was dumped from consideration
by a Maryland House of Delegates committee but could return again, sources
speculate.

And in Pennsylvania, Verizon has asked a court to overturn a decision by the
Pennsylvania Public Utility Commission (PUC, http://puc.paonline.com)
that ordered Verizon to separate its wholesale and retail operations.

Calling it "Divorce, Government Style," Rabe says that the alimony
on structurally separating Verizon in Pennsyl-vania could be enormous, totaling
more than $1 billion.

The pain also would be shared by more than 7,600 employees who could lose
their jobs, Pennsylvania customers whose phone bills could increase up to $7 per
month, and see disrupted service, Rabe says.

"Unfortunately, like many marital splits, this one has a third-party
that clearly is fanning the flames," Rabe says. "Trying to resurrect
its dismal performance in the financial market, AT&T has now become the
‘Temptation Island of Telecoms,’ doing everything it can with regulators in
Pennsylvania and elsewhere to cause the breakup of Verizon."

A telecom economist hired by AT&T, in fact, claims that it will cost no
more than $41 million to structurally separate Verizon in Pennsylvania.

Economist Lee Selwyn’s findings were included in a petition AT&T filed
with the PUC when it asked that more hearings be held on the record about this
case. CompTel also has asked Maryland lawmakers to hold more hearings on its
bill proposing to separate Verizon.

"Make no mistake about it–Verizon’s anti-competitive conduct is slowing
the pace of competition in Maryland," says Frisby, a former chairman of the
Maryland Public Service Commission (www.psc.state.md.us/psc).
"As a result, Verizon still controls 97 percent of the residential and
small-business market."

"The same conditions that the Pennsylvania PUC addressed in its order
exist all over the country," Frisby says. "Other states should
consider structural separation as a regulatory approach to speed the
process."

Future Considerations Likely

Competitive carriers, in fact, already are forcing the issue in other states,
which now are becoming increasingly aware of the BOC-separation proposal.

AT&T, for instance, filed a petition in Florida on March 22 seeking
structural separation of BellSouth Telecommunications Inc. (www.bellsouth.com)
into wholesale and retail corporate subsidiaries.

The timing, from a competitor’s point of view, was perfect. The day before
AT&T filed its petition, BellSouth announced that largely positive
third-party testing of its OSS in Georgia had been delivered to state telecom
regulators. BellSouth has said it’s on track to seek approval first to provide
long-distance service in Georgia and then in Florida. Its OSS is the same
throughout its nine-state region. When approved, BellSouth will be competing
with AT&T in the long-distance market throughout the Southeast region.

"AT&T … is simply proposing to further handicap BellSouth as it
attempts to compete against AT&T and other companies in providing broadband
and long-distance services," says Joseph Lacher, BellSouth president in
Florida. "This fear of competition is causing AT&T to use the
regulatory process to delay our entry into their markets."

Lacher says that the company’s current structure isn’t deterring the more
than 160 local exchange competitors in Florida from being successful. He says
that competitors in Florida have claimed roughly 20 percent to more than 30
percent of the business customers.

Competition in the residential market has been slower, Lacher says, because
the rates for local residential service have traditionally been set below cost.

BellSouth also is in the midst of third-party OSS testing in Florida, where
the testing will be completed this summer.

"We expect it to show that the company has opened its markets to
competition [and that] further regulation is unnecessary and wasteful,"
Lacher says. "It is time, if not long past time, for AT&T to stop
complaining and start competing."

On the side of competitors, John D. Windhausen Jr., president of the
Association of Local Telecommunications Services (ALTS, www.alts.org),
says that a separate wholesale unit would treat all customers equally, including
CLECs and Verizon’s retail company.

"The upshot would be an increase in competitive choice and increased
revenue for Verizon from the very competitors that today they’re trying to
thwart–CLECs," Windhausen says.

"Verizon certainly has no business reason to oppose restructuring into
wholesale and retail units, since both would be better off," adds Kim
Kirby, ALTS’ vice president of state affairs. "The problem is an ingrained
monopoly mindset and way of doing business. But once Verizon looks to the future
instead of the past, it will see the benefits of the proposed
restructuring."

Pennsylvania Gets Tough

Moving to break the industry logjam in Pennsylvania’s local market, the PUC
in March adopted a plan for the "functional structural separation" of
Verizon-Pennsylvania into wholesale and retail units.

While this was good news for competitive carriers in Pennsylvania and
elsewhere, the decision fell short of requiring full structural separation,
observers note.

"The Pennsylvania commission decision comes as close as may have been
politically possible to the threshold of implementing full structural separation
of Verizon’s wholesale and retail operations," observes Dena Alo-Colbeck,
director of public policy for Miller Isar Inc. (www.millerisar.com).

And even though state regulators did not implement true structural
separation, for the first time, an incumbent has been required to treat its
wholesale and retail operations at arm’s length, Alo-Colbeck says. But, she
adds, Verizon isn’t giving up without a fight, which could still alter the
outcome. The BOC, along with appealing the order to the state Supreme Court, is
backing newly introduced legislation that would prohibit any form of structural
separation. "We are hopeful, however, that the commission will prevail, and
that its order will create a blueprint for action in other states, and in
Congress," she says.

The PUC’s functional structural separation plan will be accomplished, in
part, by applying a strict code of conduct that would provide for
nondiscriminatory access to the phone system for Verizon’s retail arm and for
Verizon’s competitors, according to the PUC. The plan also contains provisions
to reduce costs for competitors serving rural areas, and to substantially
increase the fines Verizon would have to pay for violating performance
standards, the PUC says.

PUC Chairman John M. Quain says that the plan strikes a workable balance
between Verizon and its competitors.

"A functional structural separation will be seamless for Verizon
customers because they will never actually be moved to a new company,"
Quain says. "At the same time, a strong code of conduct and increased
penalties tied to Verizon’s performance should be enough to convince competitors
that this commission will not tolerate any discriminatory actions by Verizon."

If Verizon doesn’t accept the PUC plan, it will face the possibility of full
structural separation and the breakup of the company in its Section 271
proceeding currently before the commission. The company was reviewing the PUC
order at press time.

The PUC made clear that with a functional structural separation, Verizon
would continue to operate as one company, but with both divisions required to
operate apart pursuant to a code of conduct.

In addition to several conditions and requirements imposed on Verizon, the
PUC’s order also increases the fines Verizon would pay for failing to meet
service standards for fulfilling orders.

The order also contains a provision to make it cheaper for competitors to
serve rural areas, where competition is severely lacking, the PUC says. The cost
to competitors to lease a standard loop will be lowered by 75 cents, or 4.4
percent, in Verizon’s Density Cell 4, which encompasses most rural areas in the
state.

Quain says that a functional structural separation approach should deliver
the benefits of competition to customers sooner than a physical breakup because
a physical breakup would be followed by years of costly lawsuits.

Announcing the decision, Quain said, "After carefully reviewing the
record in this case and examining all of the proposals, we believe this form of
separation will enable us … to open the local telecommunications market to
competition and to create more choices for Pennsylvania consumers."

Immediately following the 5-0 vote, Quain also sharply criticized Verizon for
deliberately obstructing the structural separation proceedings that led to the
PUC’s decision and for trying to alarm the public with a campaign of
misinformation. Pointing to a blitz of advertising over much of March, Quain
said that Verizon "has threatened the citizens and businesses of the
commonwealth with negative consequences and outcomes … far beyond the
foreseeable scope of the proceeding.

"Verizon did this to portray structural separation as leading to lost
jobs and broad-based negative economic impact, while Verizon threatened to
relegate Pennsylvania to virtual ‘backwater’ status in the Information
Age," he added.

Quain has requested that the PUC Law Bureau initiate an order requiring
Verizon to justify why the commission should not fine the company for its
conduct. If Verizon fails to prove its case, Quain says the PUC should order the
company to run an ad campaign to cure the damage it has caused and to contribute
funds to a technology deployment fund. The ad campaign would be equal in dollars
to the one Verizon has been running to stop its separation, according to the PUC.

Quain and Commissioner Nora Mead Brownell, in a joint statement, also
directed an inquiry into the scope of Verizon’s assertions about potential job
losses and the level of infrastructure investment in Pennsylvania.

New Trend Emerges

The proposal of structural separation is gaining ground nationwide.

"This is like any other innovative state regulatory approach to a
problem. Regulatory innovation at the state level, if successful, almost always
results in a trend," says James Bradford Ramsay, general counsel for the
states’ lobbyist, the National Association of Regulatory Utility Commissioners (NARUC,
www.naruc.org).

Price-based regulation is a good example, Ramsay says. It began in one or two
states in late ’80s and early ’90s, and over about a six-year span, it migrated
to the majority of state commissions–at least with respect to their largest
carriers, Ramsay says.

"If the Pennsylvania PUC’s decision is not derailed by state legislative
or, less likely, court action, it will be closely watched by other states during
its implementation phase," Ramsay says, adding that it’s likely to take
about a year to work out the kinks.

NARUC will undoubtedly have regular presentations on this functional
structural separation during its implementation phase, he says.

"CLECs pushing the idea at various commissions will get a boost once it
is apparent that the anticipated benefits are being realized," Ramsay says.
"But the fact that this has gotten out of the Pennsylvania PUC, despite
Verizon’s intense lobbying efforts, has already given AT&T and others …
added impetus."

A dozen or more states have at least informally discussed the idea, Ramsay
says.

The next big question, he adds, is will any court "stay" the PUC’s
action, or will the state legislature step in?

The industry is watching.