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If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of) ) Implementation of the ) Telecommunications Act of 1996:)CC Docket No. 96-150 ) Accounting Safeguards Under the) Telecommunications Act of 1996 ) REPORT AND ORDER Adopted: December 23, 1996 Released: December 24, 1996 By the Commission: TABLE OF CONTENTS I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . 1 II. BACKGROUND AND OVERALL GOALS. . . . . . . . . . . . . . . 3 A. Summary of the Relevant Statutory Provisions. . . . . 3 B. Goals of the Proceeding . . . . . . . . . . . . . . 13 C. Scope of Commission's Authority . . . . . . . . . . . 29 D. Structure of this Order . . . . . . . . . . . . . . . 47 III. SAFEGUARDS FOR INTEGRATED OPERATIONS . . . . . . . . . . 48 A. General . . . . . . . . . . . . . . . . . . . . . . . 48 B. Specific Services . . . . . . . . . . . . . . . . . . 51 1. Section 260 - Telemessaging Service. . . . . . . 51 2. Section 271 - InterLATA Telecommunications Services 61 a. Incidental InterLATA Services . . . . . . . 62 b. Integrated Provision of InterLATA Services. 66 c. Other Matters . . . . . . . . . . . . . . . 77 3. Section 275 - Alarm Monitoring Services. . . . . 88 4. Section 276 - Payphone Services. . . . . . . . . 93 IV. SAFEGUARDS FOR SEPARATED OPERATIONS . . . . . . . . . . 101 A. General. . . . . . . . . . . . . . . . . . . . . . . 101 B. Specific Services . . . . . . . . . . . . . . . . . 110 1. Section 272 - Manufacturing and InterLATA Services 110 a. Statutory Language. . . . . . . . . . . . 110 b. "Arm's Length" Requirement of Section 272(b)(5) 111 i. Prevailing Company Prices. . . . . . 125 ii. Valuation Methods for Assets and Services. 138 iii. Fair Market Value. . . . . . . . . 149 iv. Tariffed-based Valuation. . . . . . 155 v. Return Component for Allowable Costs 160 c. Accounting Requirements of Sections 272(b)(2) and (c)(2) 167 d. Application to InterLATA Telecommunications Affiliates 171 e. Application to Sharing of Services. . . . 179 f. Audit Requirements. . . . . . . . . . . . 184 2. Section 273 - Manufacturing by Certifying Entities 206 a. Statutory Language. . . . . . . . . . . . 206 b. Comparison of Sections 273 and 272. . . . 208 3. Section 274 - Electronic Publishing. . . . . . 213 a. Statutory Language. . . . . . . . . . . . 213 b. Comparison of Sections 274 and 272. . . . 214 c. Compliance Review . . . . . . . . . . . . 220 d. Section 274(f)'s Reporting Requirement. . 227 e. Section 274 Transactional Requirements. . 231 f. Miscellaneous . . . . . . . . . . . . . . .245 4. Separated Operations under Sections 260 and 271 through 276248 V. OTHER MATTERS. . . . . . . . . . . . . . . . . . . . . . .259 A. Price Caps. . . . . . . . . . . . . . . . . . . . . .259 1. General. . . . . . . . . . . . . . . . . . . . .259 2. Exogenous Costs and Part 64. . . . . . . . . . .260 3. Part 64 and Sharing. . . . . . . . . . . . . . .267 B. Section 254(k). . . . . . . . . . . . . . . . . . . .272 VI. FINAL REGULATORY FLEXIBILITY ACT ANALYSIS . . . . . . . .277 VII. FINAL PAPERWORK REDUCTION ACT ANALYSIS . . . . . . . . .284 VIII. ORDERING CLAUSES. . . . . . . . . . . . . . . . . . . .285 I. INTRODUCTION 1.In this Report and Order ("Order") we address the accounting safeguards necessary to satisfy the requirements of sections 260 and 271 through 276 of the Communications Act of 1934, as amended by the Telecommunications Act of 1996. This Order prescribes the way incumbent local exchange carriers, including the Bell Operating Companies ("BOCs"), must account for transactions with affiliates involving, and allocate costs incurred in the provision of, both regulated telecommunications services and nonregulated services, including telemessaging, interLATA telecommunications, information, manufacturing, electronic publishing, alarm monitoring and payphone services, to ensure compliance with the Act. In particular, the Order adopts the tentative conclusion in the Notice of Proposed Rulemaking ("NPRM") in this proceeding that our current cost allocation rules generally satisfy the Act's accounting safeguards requirements when incumbent local exchange carriers, including the BOCs, provide services permitted under sections 260 and 271 through 276 on an integrated basis (i.e., within the telephone operating companies). The Order also adopts the tentative conclusion in the NPRM that our current affiliate transactions rules generally satisfy the Act's accounting safeguards requirements when incumbent local exchange carriers, including the BOCs, are required to, or choose to, use an affiliate to provide services permitted under sections 260 and 271 through 276. The Order adopts most of the NPRM's proposed modifications to the affiliate transactions rules to provide greater protection against subsidization of competitive activities by subscribers to regulated telecommunications services. 2.By applying our current cost allocation rules and modified affiliate transactions rules to incumbent local exchange carriers, including the BOCs, that provide services permitted under sections 260 and 271 through 276, we seek to protect regulated service ratepayers from bearing the risks and costs of carriers' nonregulated ventures. We also seek to promote competition by preventing carriers from using their market power in local exchange services to obtain an anti-competitive advantage in the markets that they seek to enter. We will monitor the development of competition to determine whether further changes to these accounting safeguards are needed to achieve the objectives of the Act. II. BACKGROUND AND OVERALL GOALS A. Summary of the Relevant Statutory Provisions 3.The Act permits the BOCs to engage in previously proscribed activities if the BOCs satisfy certain conditions that are intended to prevent them from recovering costs of their new ventures from subscribers to local exchange and exchange access services and from discriminating against their competitors in these new markets. The Act places similar conditions on other incumbent local exchange carriers electing to enter or continue to participate in certain markets. 4.The Act prescribes structural and nonstructural safeguards that are intended to protect ratepayers, consumers, and competitors against the effects of potential improper cost allocation and discrimination. These structural and nonstructural safeguards apply to activities such as payphone services that BOCs are currently permitted to provide and to activities such as alarm monitoring services that BOCs are currently permitted to provide in certain markets. In addition, these safeguards apply to other activities that incumbent local exchange carriers may now provide as a result of the Act. 5.Sections 260 and 271 through 276 outline the conditions under which incumbent local exchange carriers may offer telemessaging and alarm monitoring services and under which the BOCs may manufacture and provide telecommunications equipment, may manufacture customer premises equipment ("CPE"), and may offer interLATA telecommunications, information, electronic publishing and payphone services. While the Act requires that many of these services must be provided through separate affiliates, it also permits some to be offered on an integrated basis. 6.Sections 260 and 275 generally prohibit an incumbent local exchange carrier, including the BOCs, from subsidizing its telemessaging and alarm monitoring services with revenues from regulated telecommunications services. Section 260 provides that an incumbent local exchange carrier, including a BOC, that provides telemessaging service "shall not subsidize its telemessaging service directly or indirectly from its telephone exchange service or its exchange access," but does not require a separate affiliate. Section 275(b)(2) bars an incumbent local exchange carrier, including a BOC, that provides alarm monitoring services from "subsidiz[ing] its alarm monitoring services either directly or indirectly from telephone exchange service operations," but does not require a separate affiliate. 7.Section 271(b) authorizes the BOCs to immediately provide "out-of-region" interLATA services but requires the BOCs to obtain Commission approval before providing "in-region" interLATA services. Section 271(g) lists specific "incidental interLATA services" that BOCs and their affiliates may provide after February 8, 1996. Section 271(h) states that "[t]he Commission shall ensure that the provision of services authorized under [section 271(g)] by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." 8.Section 272 permits a BOC (including any affiliate) that is subject to section 251(c) to manufacture equipment (as defined in the AT&T consent decree), originate in- region interLATA telecommunications services, other than incidental and previously authorized interLATA services, and provide certain interLATA information services only if it does so through one or more separate affiliates. Each of the separate affiliates must "maintain [separate] books, records, and accounts in the manner prescribed by the Commission" and "shall conduct all transactions with the Bell operating company of which it is an affiliate on an arm's length basis." In its dealings with the separate affiliate, each BOC must "account for all transactions . . . in accordance with accounting principles designated or approved by the Commission." 9.Section 273(d)(3) imposes separate affiliate requirements for the manufacture of telecommunications equipment and customer premises equipment upon entities that certify the same class of telecommunication equipment and customer premises equipment produced by unaffiliated entities. 10.Section 274(a) prohibits any "Bell operating company or any affiliate [from] engag[ing] in the provision of electronic publishing that is disseminated by means of such Bell operating company's or any of its affiliates' basic telephone service," other than through "a separated affiliate or electronic publishing joint venture." This separated affiliate or electronic publishing joint venture must, among other requirements, "maintain separate books, records, and accounts and prepare separate financial statements." 11.Section 276(b)(1)(C) directs the Commission to prescribe rules for BOC provision of payphone service that, "at a minimum, include the nonstructural safeguards equal to those adopted in the Computer Inquiry-III (CC Docket No. 90-623) proceeding." Section 276(a)(1) states that any BOC that provides payphone service after the effective date of those rules "shall not subsidize its payphone service directly or indirectly from its telephone exchange service operations or its exchange access operations." 12.Finally, section 254(k) imposes a more general prohibition against cross- subsidization by barring telecommunications carriers from "us[ing] services that are not competitive to subsidize services that are subject to competition." B. Goals of the Proceeding 13.In our NPRM, we set forth two goals for this proceeding: (1) preserving for the benefit of interstate telephone ratepayers legitimate economies of scope that could be realized by BOCs and other incumbent local exchange carriers when entering markets from which they were previously barred or in which they continue to participate; and (2) discouraging, and facilitating detection of, improper cost allocations in order to prevent incumbent local exchange carriers from imposing the costs of their competitive ventures on interstate telephone ratepayers. In the NPRM, we asked the threshold question: to what, if any, extent should we rely on our existing accounting safeguards in Parts 32 and 64 of our rules to achieve these two goals. We tentatively concluded that our existing accounting safeguards, with the modifications described in the NPRM, would best meet the requirements and underlying goals of sections 260 and 271 through 276. We invited comment on this tentative conclusion. We also sought comment on whether less detailed accounting safeguards would suffice to achieve the objectives of the Act. 14. To the extent that BOCs or other incumbent local exchange carriers maintain control over the bottleneck facility, these BOCs or other incumbent local exchange carriers could potentially engage in predatory behavior. In the NPRM, we also sought comment on how the extent to which a BOC or other incumbent local exchange carrier has the opportunities to engage in predatory behavior should affect our decisions in this proceeding. Comments: 15.Worldcom contends that the Act does not support the Commission's statement in the NPRM concerning the need to preserve "economies of scope" for the BOCs. SBC, however, maintains that, except to the extent Congress imposed temporary separation requirements as well as other restrictions such as the nondiscrimination provisions on incumbent local exchange carriers, Congress did not deny incumbent local exchange carriers the benefits of their own efficiencies. 16.Several parties, including NYNEX, contend that existing accounting safeguards are more than adequate to meet the requirements of sections 260 and 271 through 276 and no additional safeguards are required. In particular, Cincinnati Bell argues that incumbent local exchange carriers will not be able to raise prices based upon improperly allocated costs given the choices that will be available to customers in a competitive market. Many parties, including States, interexchange carriers, and trade associations, generally support our proposal to use current Part 32 and Part 64 accounting rules, with some modifications. USTA and SBC argue that given the pro-competitive, deregulatory goals of the Act and the increase in competition since the adoption of the accounting safeguards in the Joint Cost and Computer III Proceedings, we should not impose more stringent rules. Ameritech contends that we should adopt less detailed accounting rules consistent with the Act's mandate to foster a national deregulatory policy framework. 17.Sprint, GSA, Puerto Rico Telephone and several BOCs argue that a new system of accounting safeguards would require the BOCs to develop new systems and retrain employees, requiring substantial investments of time and resources without any assurance that a new system will be more effective. Ameritech adds that the substantial costs associated with the adoption of a different accounting safeguards approach would not be justified by the benefit. 18.USTA maintains that where we determine that current accounting safeguards will continue to apply to incumbent local exchange carriers, we should streamline those safeguards to the extent possible to ensure fair competition and to make the rules clear and predictable. USTA recommends streamlining our current rules as follows: (1) modify the shared forecast investment rules; (2) modify the affiliate transactions valuation standards; (3) simplify the Part 64 administrative process; and, (4) modify the frequency of the independent audit. Ameritech and SBC recommend adoption of USTA's streamlining proposals to implement provisions under the Act related to both separated and integrated operations. Several parties, including USTA, allege that competition and a number of existing safeguards, most notably price cap regulation, provide the most effective constraints on the ability of incumbent local exchange carriers to cross-subsidize. 19.In contrast, APCC argues that existing safeguards have not adequately prevented cross-subsidization. In particular, APCC suggests that we should make extensive changes to the cost allocation manuals, impose additional requirements to annual attestation audits, and reconsider the allocation methodology presently employed by incumbent local exchange carriers. ESI recommends that we adopt rules that ensure that vertically integrated telecommunications carriers with proven market power be more strictly regulated than carriers without the potential to price squeeze. 20.MCI maintains that the Act clearly recognizes the incentives for incumbent local exchange carriers to shift costs between their new competitive activities and their monopoly local exchange and exchange access operations. Accordingly, MCI asserts that we must adopt safeguards stricter than our existing accounting safeguards to account for the increased opportunities for BOCs to enter new lines of nonregulated businesses and for the increased incentives and opportunities for incumbent local exchange carriers to shift costs following passage of the 1996 Act. In particular, MCI suggests that we adopt a rule requiring carriers to maintain a complete audit trail of all cost allocations and affiliate transactions. 21.GTE agrees with our contention that any commenter urging us to adopt more detailed accounting safeguards than those in our current rules or those specifically mandated by the Act bears a heavy burden of persuading us to adopt such safeguards. Ameritech alleges, however, that we have not satisfied this heavy burden of persuasion test with regard to the more detailed accounting safeguards proposed in the NPRM. 22.With respect to our concerns regarding opportunities for incumbent local exchange carriers to engage in predatory behavior, Worldcom argues that "the very act of competing head-on with the BOCs creates a heightened degree of reliance on the BOCs' bottleneck facilities that did not exist before." AT&T alleges that the BOCs still control bottleneck facilities and that as long as their control continues, the BOCs will be able to engage in predatory behavior, forcing non-affiliated interexchange carriers to absorb high access charges as a real cost and allowing the BOCs and their interexchange affiliates to underprice these non-affiliated carriers. 23.Ameritech and USTA, however, contend that predatory behavior is not likely to occur. In particular, USTA argues that given the difference in resources between incumbent local exchange carriers and competitors, such as AT&T and MCI in the interexchange market, it is more likely that incumbent local exchange carriers will be the victims of predatory behavior, not the perpetrators of it. SBC maintains that predatory behavior concerns prices in competitive markets and has no place in an accounting safeguards proceeding. Discussion: 24.In addressing the issues in this proceeding, we adopt and follow the two fundamental goals for this proceeding articulated in the NPRM and discussed above. We are committed to facilitating the development of competitive telecommunications service offerings and, in particular, to giving effect to the provisions relating to incumbent local exchange carrier entry into, or expansion within, the markets covered by sections 260 and 271 through 276. We affirm that protecting ratepayers from cross-subsidizing competitive ventures is a primary goal behind all our cost allocation and affiliate transactions rules. The 1996 Act clarifies the meaning of what constitutes just and reasonable rates by adding to the Communications Act of 1934 section 254(k), which provides that incumbent local exchange carriers may "not use services that are not competitive to subsidize services that are subject to competition." 25.Many commenters endorse adoption of the goals we set forth in the NPRM. The primary objective of this proceeding is to examine whether our existing accounting safeguards adequately respond to new competitive opportunities created by the 1996 Act. These accounting safeguards consist of cost allocation and affiliate transactions rules that were designed to keep incumbent local exchange carriers from imposing the costs and risks of their competitive ventures on interstate telephone ratepayers, and to ensure that interstate ratepayers share in the economies of scope realized by incumbent local exchange carriers when they expand into additional enterprises. Our cost allocation and affiliate transactions rules, in combination with audits, tariff review, and the complaint process, have proven successful at protecting regulated ratepayers from bearing the risks and costs of incumbent local exchange carriers' competitive ventures. 26. With respect to affiliate transactions, we note that the Act requires BOCs to create a separate affiliate for certain services. While the volume of affiliate transactions may increase as the result of this requirement, we do not believe that the nature and type of such transactions will raise any accounting concerns that our current rules do not already address. Similarly, the 1996 Act will also likely increase the scope of nonregulated activities in which BOCs participate because they may now provide, on an integrated basis, services that they were previously prohibited from providing. Since the inception of our Part 64 cost allocation rules, the type and level of nonregulated activities have continued to grow. We designed our cost allocation rules to accommodate the growth of these nonregulated activities and affiliate transactions. We conclude that our existing cost allocation and affiliate transactions rules, as modified herein, are appropriate for any of the new activities described in Sections 260 and 271 through 276. Where we find that our accounting safeguards should be strengthened, we do so in this Order. We therefore find that adoption of the existing cost allocation rules and the affiliate transactions rules, as modified herein, will successfully achieve our goals. 27.We noted in the NPRM that any commenter urging us to adopt more detailed accounting safeguards than those in our current rules or those specifically mandated by the Act bears a heavy burden in demonstrating the necessity to adopt such safeguards. The imposition of this burden is consistent with the requirement of the Administrative Procedure Act that our actions be supported by the language of the Act as well as substantial evidence in the record. 28.Finally, we see no need for additional accounting safeguards designed specifically to prevent predatory behavior by incumbent local exchange carriers. We believe that the accounting rules we adopt here will effectively prevent predatory behavior that might result from cross-subsidization. None of the commenters proposed any additional accounting rules to guard against predatory behavior. C. Scope of Commission's Authority 29. In the NPRM, we asked whether the Act grants the Commission authority to establish accounting safeguards for the intrastate services described in sections 260 and 271 through 276. With respect to interLATA services of the types described in sections 271 and 272, we tentatively concluded, in accordance with the analysis developed and discussed in the BOC In-Region NPRM, that the Commission has authority to set the accounting safeguards for both interstate and intrastate interLATA services and interLATA information services governed by these sections. With respect to payphone service, we tentatively concluded that the language of section 276 specifically grants the Commission jurisdiction to preempt any State regulations that may be inconsistent with the Commission's regulations. With respect to manufacturing by certifying entities, we tentatively concluded that the provisions of section 273 apply to all BOC manufacturing activities, irrespective of any jurisdictional distinctions. 30.We sought comment in the NPRM on the role the states might have in implementing the accounting safeguards provisions of sections 260 and 271 through 276. We also sought comment on whether, if these sections do not specifically grant the Commission jurisdiction over intrastate services, the Commission has the authority to preempt State regulation with respect to accounting matters addressed by these sections pursuant to Louisiana Public Service Commission v. F.C.C. ("Louisiana PSC"). We tentatively concluded that if the Commission has the authority to preempt pursuant to Louisiana PSC, we should refrain from exercising that authority and retain our policy of not preempting States from using their own accounting safeguards for intrastate purposes. Comments: 31.Sprint asserts that the Act grants the Commission jurisdiction over section 260 telemessaging services without regard to either State or LATA boundaries. Voice-Tel maintains that the inherent interstate nature of telemessaging services permits the Commission to preempt States even with respect to an individual local exchange carrier operating in a single state. BellSouth, however, argues that there is no basis for the Commission to preempt State Commission actions that are consistent with section 260 and the Part 64 rules. 32.In general, interexchange carriers contend that sections 271 and 272 grant the Commission authority to regulate all interLATA services including intrastate, interLATA services because sections 271 and 272 expressly address BOC provision of interLATA services, making no distinction between interstate and intrastate aspects of those services. NARUC and the States generally disagree. CTA and Sprint contend that the Commission should preempt the States with regard to intrastate, intraLATA telecommunications services and information services if the lack of sufficient cross-subsidization safeguards by a State will hinder the development of competition and allow the BOCs to abuse their market power in the intraLATA market. California and Wisconsin PSC allege that the Commission has no authority to preempt States from using their own accounting safeguards unless individual State rules compromise the goals and intent of the Act. US West argues that we should consider the necessity of preemption on a case-by-case basis because there is no record to justify a blanket preemption of State accounting safeguards procedures for intrastate purposes. 33.Sprint and AICC argue that the Act grants the Commission jurisdiction over alarm monitoring under section 275 without regard to either State or LATA boundaries. AICC argues that even if section 275 does not, by its terms, grant the Commission jurisdiction over all alarm monitoring services, the Commission has the power to preempt State regulation in order to ensure that alarm monitoring services are not subsidized by exchange and exchange access ratepayers. Florida PSC contends, however, that the Commission has no authority to preempt the States from applying their own cost allocation systems for intrastate alarm monitoring services. 34.BellSouth and NYNEX contend that section 276 contains express language that, with respect to payphone service, specifically grants the Commission authority to preempt any State regulations that may be inconsistent with the Commission's regulations. California and NYDPS contend that the Act does not authorize the Commission to preempt States from imposing accounting safeguards on payphone service. 35.Sprint and TIA maintain that the Commission has jurisdiction over all manufacturing activities under section 273 because manufacturing cannot be segregated into interstate and intrastate portions. NYDPS, however, argues that the Act does not limit States from exercising jurisdiction over manufacturing. 36.All commenters that addressed the Commission's scope of authority over electronic publishing services agree that section 274 covers both interLATA and intraLATA electronic publishing. YPPA contends that if Congress had intended to distinguish between interLATA and intraLATA electronic publishing, it would have done so, as it did in section 272. NYDPS argues that the Act does not preclude States from exercising jurisdiction over electronic publishing. NAA maintains that the requirements of section 274 apply when the electronic publishing is disseminated by means of a BOC's "basic telephone service." Thus, NAA argues that the Commission's authority with respect to complaints and cease and desist orders applies to interstate and intrastate electronic publishing. NAA contends, however, that Congress has manifested no intent to preclude the States from also enforcing section 274. 37.AT&T contends that the role of the States in implementing the Act's various prohibitions against cross-subsidization arises in the auditing process. According to AT&T, States will also continue to have authority to use their own accounting methods for intrastate services that have not been preemptively deregulated by the Commission or for which jurisdiction has not been expressly vested in the Commission under the Act. 38.With respect to the Commission's authority to preempt State accounting regulations pursuant to Louisiana PSC, NYDPS contends that because two sets of accounting regulations can co-exist and have co-existed in the past, the Commission's tentative conclusion to refrain from preempting States under Louisiana PSC is correct as a matter of law. TIA contends that any State regulation with respect to BOC manufacturing that is inconsistent with the requirements of section 272 or 273 would necessarily "thwart or impede" federal policies and should therefore be preempted. Discussion: 39. Sections 260, 271, 274, 275 and 276 of the Communications Act of 1934 all expressly prohibit BOCs and, in some cases, other incumbent local exchange carriers from subsidizing services permitted under those sections from their "telephone exchange service" or their "basic telephone service." The term "telephone exchange service" as defined under section 3(47) of the Act is a primarily intrastate service. Moreover, the term "basic telephone service" as defined under section 274(i)(2) is a primarily intrastate service. Therefore, by barring BOCs and, in some cases, other incumbent local exchange carriers from subsidizing activities permitted pursuant to sections 260, 271, 274, 275 and 276 from their "telephone exchange service" or their "basic telephone service," these sections of the Act expressly reach intrastate services. In addition, section 273(g) states that the Commission may prescribe such additional rules and regulations as may be necessary to prevent cross- subsidization. 40. The relevant statutory references to intrastate services are extensive. Section 260(a)(1) provides that "[a]ny local exchange carrier subject to the requirements of section 251(c) that provides telemessaging service . . . (1) shall not subsidize its telemessaging service directly or indirectly from its telephone exchange service or its exchange access." Section 274(a) provides that "[n]o Bell operating company or any affiliate may engage in the provision of electronic publishing that is disseminated by means of such Bell operating company's or any of its affiliates' basic telephone service." Similarly, section 275(b)(2) provides that an incumbent local exchange carrier shall "not subsidize its alarm monitoring services either directly or indirectly from telephone exchange service operations," while section 276(a)(1) prohibits any BOC that provides payphone service from subsidizing its payphone service "directly or indirectly from its telephone exchange service operations or its exchange access operations." Further, section 271(h), pertaining to BOC entry into interLATA services, states that the "Commission shall ensure that the provision of services authorized under subsection (g) by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." 41. In addition, we note that in the companion Non-Accounting Safeguards Order, we conclude that sections 271 and 272 give us jurisdiction over all interLATA services covered by those sections, including intrastate, interLATA services. The Act defines "interLATA services" as "telecommunications between a point located in a [LATA] and a point located outside such area." The definition does not distinguish between domestic and international interLATA services. Further, international telecommunications services, which originate in a LATA and terminate in a country other than the United States, or vice versa, fit within the statutory definition of interLATA services. Thus, we conclude, as we do in the Non-Accounting Safeguards Order that Congress intended the section 272 safeguards to apply to all domestic and international interLATA services. Because the scope of sections 271 and 272 extends to both interstate and intrastate services, carriers must comply with the requirements of those sections for both interstate and intrastate services. We emphasize, however, that the scope of the Commission's authority under sections 271 and 272 extends only to matters covered by those sections. Those sections do not alter the jurisdictional division of authority with respect to matters falling outside their scope. For example, rates charged to end users for intrastate interLATA service have traditionally been subject to state authority, and will continue to be. 42. Based on the express statutory language prohibiting cross-subsidization, as well as our interpretation of the term "interLATA," as discussed in the Non-Accounting Safeguards Order, and our interpretation of the terms "telephone exchange service" and "basic telephone service," as discussed above, we conclude that the reach of sections 260, 271, 272 and 274 through 276 extends to intrastate services, and that the Commission has jurisdiction, under the cross-subsidization prohibitions contained in these sections, to adopt regulations governing intrastate services. Again, we emphasize that the scope of the Commission's authority under sections 260, 271, 272, and 274 through 276 extends only to matters covered by those sections. Those sections do not alter the jurisdictional division of authority with respect to matters falling outside their scope, including rates charged to end users for intrastate interLATA service. 43.We also find, as discussed in the Non-Accounting Safeguards Order, that section 2(b) of the Communications Act of 1934 does not limit the Commission's authority to establish regulations governing intrastate matters under these sections. For the reasons explained below, however, we decline to impose any additional accounting rules on carriers' intrastate services. We note that the language of sections 260, 271, 272 and 274 through 276 that extends our jurisdiction to include certain intrastate activities is both more recent and more specific than section 2(b). As a result, the language of these more recent provisions is controlling. 44. As we discuss in section II.B. above, we already have an accounting safeguards system in place that prevents incumbent local exchange carriers from imposing the costs and risks of their competitive ventures on interstate telephone ratepayers and ensures that interstate ratepayers share in the economies of scope that incumbent local exchange carriers may realize upon expansion into additional enterprises. In this Order, we apply our existing accounting safeguards system, consisting of our cost allocation and modified affiliate transactions rules in Parts 32 and 64 of our rules, to the services permitted by sections 260, 271, 272 and 274 through 276. Our experience with these safeguards has demonstrated their ability to protect interstate ratepayers from improper cross-subsidization. The cross-subsidization prohibitions of sections 260, 271, 272 and 274 through 276, however, cover certain intrastate services, as noted in the previous paragraph. Neither the information contained in the record nor our experience provides us with any basis to conclude that existing state accounting systems that differ from our federal system will result in the type of subsidization of competitive activities prohibited by sections 260, 271, 272 and 274 through 276. Therefore, we decline to impose any additional accounting rules on intrastate services. 45. Regardless of whether we or the States adopt accounting rules to prevent subsidies flowing from regulated services within our respective jurisdictions to the services permitted under sections 260, 271, 272 and 274 through 276, carriers must comply with the cross-subsidization prohibitions in those sections of the Act. Any ratepayer or other person alleging a violation of these provisions by a carrier may file a complaint with the Commission pursuant to section 208 of the Communications Act. In the event that a carrier or customer believes that any State has imposed accounting rules that may force a carrier to violate the cross-subsidization prohibitions of sections 260, 271, 272 and 274 through 276, then the carrier or customer may seek declaratory relief from the Commission pursuant to section 1.2 of the Commission rules on a case-by-base basis. 46. With regard to the manufacturing activities covered by section 273, we conclude that States are preempted from implementing any part of that section, including its accounting safeguards provisions. We base this conclusion on the fact that such manufacturing activities cannot be separated between the interstate and intrastate jurisdictions, rendering any separation between interstate and intrastate jurisdictions infeasible. As a result, we must preempt States from implementing accounting safeguards related to manufacturing activities. Moreover, while section 2(b) of the Communications Act of 1934 limits the Commission's authority over "charges, classifications, practices, services, facilities, or regulation for or in connection with intrastate communications service," we find that the manufacturing activities addressed by section 273 do not fit within any of these categories and therefore are not within the scope of section 2(b). We therefore conclude that section 2(b) does not preclude our assertion of jurisdiction over manufacturing activities, as required by section 273. D. Structure of this Order 47.Section III of this Order addresses accounting safeguards that apply when an incumbent local exchange carrier, including a BOC, provides on an integrated basis a service within the ambit of sections 260 and 271 through 276. Section IV discusses the accounting safeguards that apply when an incumbent local exchange carrier, including a BOC, uses an affiliate to provide a service within the ambit of sections 260 and 271 through 276. Within sections III and IV, we address the application of accounting safeguards to meet the individual requirements of each statutory section addressed in this Order. Section V of this Order presents our analysis as to why price cap regulation does not obviate the need for accounting safeguards to ensure against the subsidization of services permitted under sections 260 and 271 through 276 with revenues from regulated telecommunications services. III. SAFEGUARDS FOR INTEGRATED OPERATIONS A. General 48.In this section of the Order, we discuss the provisions in sections 260, 271, 275, and 276 relating to accounting safeguards for telemessaging, certain interLATA telecommunications and information, alarm monitoring, and payphone services that the BOCs and other incumbent local exchange carriers may provide on an integrated basis. In the NPRM, we tentatively concluded that our existing Part 64 cost allocation rules, developed in our Joint Cost and Computer III proceedings, satisfy the requirements of these sections of the Act that certain competitive telecommunications and information services not be subsidized by subscribers to regulated telecommunications services. We invited comment on this tentative conclusion. In the NPRM, we asked whether the benefits of a fundamentally different approach to cost allocation would be outweighed by the costs that implementation of such a change would impose. Alternatively, we asked commenters to discuss how, if necessary, we might adapt the existing cost allocation system to accommodate the services discussed in section III of the NPRM. Comments: 49.Most parties, including several BOCs, support the Commission's tentative conclusion that our existing Part 64 cost allocation rules generally satisfy the requirements of the Act that certain competitive and information services not be subsidized by subscribers to regulated telecommunications services. In particular, Puerto Rico Telephone contends that we need not modify our cost allocation rules because competition in the local exchange and exchange access markets will ensure that local exchange carriers do not shift costs of nonregulated services to regulated ratepayers. In contrast, MCI maintains that additional safeguards for integrated operations are necessary to protect the public interest. Ameritech argues that our current cost allocation rules exceed the statutory requirements of the Act. Discussion: 50.We developed our cost allocation rules in the Joint Cost and Computer III Proceedings to help ensure that interstate ratepayers do not bear the costs and risks of the telephone companies' nonregulated activities. These rules prescribe how subject carriers must separate the costs of activities regulated under Title II from the costs of nonregulated activities when the nonregulated activities are performed directly by the carrier rather than through an affiliate. Under these rules, incumbent local exchange carriers may not apportion the costs of nonregulated activities to regulated products and services. We adopt our tentative conclusion that our existing Part 64 cost allocation rules satisfy the requirements of sections 260, 271, 275, and 276 that certain competitive telecommunications and information services not be subsidized by subscribers to regulated telecommunications services. Incumbent local exchange carriers have implemented internal cost allocation systems to help ensure their compliance with these rules. No commenter has presented a plan for redesigning these internal systems to accommodate a fundamentally different cost allocation approach. We discuss below the application of our cost allocation rules to services permitted under sections 260, 271, 275, and 276. B. Specific Services 1. Section 260 - Telemessaging Service 51.Section 260(a)(1) provides that each "local exchange carrier subject to the requirements of section 251(c) that provides telemessaging service . . . shall not subsidize its telemessaging service directly or indirectly from its telephone exchange service or its exchange access." Section 251(c), in turn, applies to every "incumbent local exchange carrier." Section 260(c) defines "telemessaging service" as "voice mail and voice storage and retrieval services, any live operator services used to record, transcribe, or relay messages (other than telecommunications relay services), and any ancillary services offered in combination with these services." 52.In the NPRM, we tentatively concluded that applying our Part 64 rules to telemessaging will safeguard against the cross-subsidies prohibited by section 260(a)(1). We also tentatively concluded, as we did in a companion NPRM, the BOC In-Region NPRM, that telemessaging is an information service and that our authority under sections 271 and 272 over interLATA information services extends to intrastate, interLATA information services provided by BOCs or their affiliates. Therefore, BOC provision of telemessaging service on an interLATA basis would be subject to the separate affiliate requirements of section 272. We invited comment on these tentative conclusions. Comments: 53.In general, incumbent local exchange carriers assert that the existing Part 64 rules will effectively prevent cross-subsidization of telemessaging services. ATSI contends that existing rules applicable to telemessaging are not sufficient to safeguard against the subsidies prohibited by section 260 because they fall short of equalizing cost attributions. 54.Voice-Tel maintains that existing accounting safeguards in Parts 32 and 64 cannot ensure that telemessaging services that are marketed and provided by incumbent local exchange carriers on an in-house basis will not be subsidized by ratepayers. Voice-Tel argues that because telemessaging is part of basic service offered by a local exchange carrier and is marketed by customer service representatives at the same time that other basic service options are presented, there are no easily identifiable separate marketing activities that can be isolated and separately costed. Telemessaging often uses the same facilities that are used for other basic and optional services provided by the local exchange carrier, and the switch is not necessarily partitioned in a manner that permits direct allocation. Voice-Tel contends that even if the switch can be partitioned, it is questionable whether the use of lines and trunks can be properly allocated because most telemessaging services permit access to a mailbox by dialing either a special number or by dialing one's own number. In both cases, there is no separate trunk or line cost to allocate. Accordingly, Voice-Tel's advocates that we should require all incumbent local exchange carriers that wish to offer telemessaging services to do so through a separate affiliate in order to meet the goals of section 260. 55.MCI and Voice-Tel contend that telemessaging is an information service, and that when a BOC provides telemessaging on an interLATA basis, it must do so in accordance with the section 272 separate affiliate requirements. Certain local exchange carriers argue that section 272 only requires that interLATA information services, not intraLATA information services such as many existing telemessaging services, be offered through a separate affiliate. BellSouth asserts that the requirement of a separate subsidiary for the provision of interLATA information services facially violates incumbent local exchange carriers' First Amendment right to freedom of speech. Discussion: 56.We concur with the incumbent local exchange carriers that assert that our existing accounting safeguards will effectively prevent cross-subsidization of telemessaging services in accordance with section 260(a)(1). We presently classify telemessaging service as a nonregulated activity for Title II accounting purposes. Consequently, costs associated with the provision of telemessaging services are already addressed by our Part 64 cost allocation rules and, to the extent telemessaging is provided through affiliates, our affiliate transactions rules also apply. Our Part 64 rules require carriers to allocate a portion of their network investment plant used to provide telemessaging services to nonregulated accounts. 57.We find unpersuasive Voice-Tel's assertion that existing accounting safeguards in Parts 32 and 64 cannot ensure that telemessaging services that are marketed and provided by incumbent local exchange carriers on an in-house basis will not be subsidized by ratepayers. Our Part 64 cost allocation rules require local exchange carriers providing services in addition to local exchange service to use a cost allocation methodology based on fully distributed costs ("FDC"). This methodology establishes a hierarchy of cost apportionment rules designed to prevent cross-subsidies. These rules are applied to costs recorded in the accounts specified in the Uniform System of Accounts ("USOA") set out in Part 32 of our rules. The methodology requires carriers to assign costs directly, wherever possible, to regulated or nonregulated activities. If costs cannot be directly assigned, they are considered "common costs" and must be placed in homogenous cost pools. The carrier must then divide the costs in each pool between regulated and nonregulated activities using formulas or factors known as "allocators." Depending upon the information available, carriers must apply these allocators in the following order. Whenever possible, common costs must be directly attributed based upon a direct analysis of the origins of those costs. Common costs that cannot be directly attributed must be indirectly attributed based on an indirect, but cost-causative, linkage to another cost pool or pools for which a direct assignment or attribution is possible. Only if direct or indirect attribution factors are not available may the carrier allocate a pool of common costs using what is known as a "general allocator." Our Part 64 cost allocation rules are designed to prevent cross-subsidization of nonregulated activities such as telemarketing by establishing a methodology for allocating joint and common costs such as those described by Voice-Tel between regulated and nonregulated activities. 58. Our cost allocation and affiliate transactions rules have been in place for approximately ten years. As already observed, these rules and procedures, in combination with audits, tariff review, and the complaint process, have proven successful at protecting regulated ratepayers from bearing the risks and costs of incumbent local exchange carriers' competitive ventures. Since the inception of our Part 64 cost allocation rules, the types of nonregulated activities have continued to grow. The Commission designed the cost allocation system in such a way that it can accommodate the evolving nature of nonregulated activities, such as telemessaging services. Thus, we conclude that our current rules protect local exchange service subscribers from subsidizing telemessaging services that are marketed and provided by incumbent local exchange carriers on an integrated basis. 59.Based upon the analysis set forth in our companion item, the Non-Accounting Safeguards Order, we adopt our tentative conclusion that telemessaging is an information service. We also adopt, as we do in our companion item, our tentative conclusion that BOCs providing telemessaging services that meet the definition of interLATA information services must comply with the section 272 separate affiliate requirements, in addition to the section 260 requirements. 60.BellSouth has argued that requiring BOCs to provide out-of-region interLATA information services through a section 272 separate affiliate violates the First Amendment. As noted above, we find that this result is required by the Act. Although the courts have ultimate authority to determine the constitutionality of this and other statutes, we find it appropriate to state that we find BellSouth's argument to be without merit. BellSouth bases its argument on an assertion that information services are commercial speech entitled to First Amendment protections. We conclude, first, that with respect to certain information services, a BOC neither provides, nor exercises editorial discretion over, the content of the information associated with those particular services, and therefore provision of those information services does not constitute speech subject to First Amendment protections. Second, to the extent that BOC provision of other interLATA information services constitutes speech for First Amendment purposes, the section 272 separate affiliate requirement neither prohibits the BOCs from providing such services, nor places any restrictions on the content of the information the BOCs may provide. Instead, the section 272 separate affiliate requirement is a content-neutral restriction on the manner in which BOCs may provide interLATA information services, intended by Congress to protect against improper cost allocation and discrimination concerns. Thus, we conclude that the separate affiliate requirement imposed by section 272 of the Communications Act on BOC provision of interLATA information services does not violate the First Amendment. 2. Section 271 - InterLATA Telecommunications Services 61.The NPRM noted that section 272(a)(2)(B) permits BOCs to provide on an integrated basis certain regulated, interLATA telecommunications services, including out-of- region services and certain types of incidental services. In our Interim BOC Out-of-Region Order, we determined that the BOCs must provide out-of-region interstate, interexchange services (including interLATA and intraLATA services) through separate affiliates, at least on an interim basis, in order to qualify for non-dominant regulatory treatment in the provision of those services. Under the Interim BOC Out-of-Region Order, however, a BOC could still choose to provide these services on an integrated basis, subject to dominant carrier regulation. Accordingly, this Order addresses the cost allocation rules that should be applied to BOCs that choose to provide certain regulated, interLATA telecommunications services, including out-of-region services and certain types of incidental services, on an integrated basis. a. Incidental InterLATA Services 62.Section 271(h) states that "[t]he Commission shall ensure that the provision of services authorized under [section 271(g)] by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." In the NPRM, we sought comment on whether our present Part 64 cost allocation rules are adequate to prevent the adverse effects proscribed by section 271(h) with respect to incidental interLATA services. We asked commenters to describe in detail the modifications or additions to Part 64 they believe necessary, to explain how these modifications or additions would better enable the Commission to fulfill its obligations under section 271(h), and to identify the category of ratepayers or markets the proposed modifications or additions would protect. Comments: 63.Incumbent local exchange carriers generally assert that our current cost allocation rules are adequate to "ensure that the provision of services authorized under [section 271(g)] by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market" in accordance with section 271(h). 64.Worldcom contends that the language of section 271(h) strongly implies that the Commission's current cost allocation rules are not adequate to ensure that the BOC's provision of incidental interLATA services would not adversely affect ratepayers and competitors. Worldcom asserts that at a minimum we should apply the same cost allocation requirements to incidental interLATA services as are applied to other interLATA services provided by the BOCs on an integrated basis. Discussion: 65.We incorporate our conclusions regarding the accounting safeguards necessary to prevent the adverse effects proscribed by section 271(h) with respect to the integrated provision of incidental interLATA services by the BOCs in our discussion of accounting safeguards to be applied to BOC provision of interLATA services. That discussion appears in Section III.B.2.b. below. b. Integrated Provision of InterLATA Services 66.The NPRM tentatively concluded that we should apply our Part 64 cost allocation rules to regulated services other than local exchange and exchange access services, including out-of-region services and certain types of incidental services, provided by BOCs on an integrated basis in accordance with section 272(a)(2)(B). We invited comment on this tentative conclusion. We also asked whether we needed to develop different cost allocation rules for these regulated services other than local exchange and exchange access to prevent allocation of the costs of such regulated services to local exchange and exchange access customers. We suggested two possible solutions: (1) the creation of a separate category for Title II accounting purposes to include regulated services other than local exchange and exchange access services, or (2) the classification of any regulated services other than local exchange and exchange access services that are provided on an integrated basis as nonregulated activities for Title II accounting purposes. We invited comment on these solutions. 67.In the NPRM, we asked whether, if incumbent local exchange carriers provide out-of-region interstate interexchange services on an integrated basis, our accounting rules for such incumbent local exchange carriers should be similar to those we adopt for the BOCs. Comments: 68.Many parties support our proposal to apply our Part 64 cost allocation rules to regulated interLATA telecommunications services, including out-of-region services and certain types of incidental services, that may be provided by BOCs on an integrated basis and contend that such services should be treated like nonregulated activities for federal accounting purposes. In particular, TRA maintains that treating such services like nonregulated activities for federal accounting purposes will lessen the chance that costs associated with such services are inadvertently assigned to a local exchange or exchange access category. Worldcom asserts that the potential for improper cost allocation is greater between two regulated categories than between regulated and nonregulated activities. 69.SBC argues that it would be improper to treat all incidental interLATA services like nonregulated activities for federal accounting purposes because a number of the activities that these incidental interLATA services support would be regulated Title II activities. SBC contends that the costs of such incidental services are supposed to flow through the Part 36 process to separate integrated plant serving state and interstate jurisdictions. 70.MCI proposes that, as in the Video Dialtone Proceeding, we should create a separate category for Title II accounting purposes to include regulated services other than local exchange and exchange access services in order to clearly identify the allocation of costs between a BOC's local and interLATA operations. In contrast, the BOCs generally argue that no separate regulated category is needed for interLATA telecommunications services provided on an integrated basis, such as out-of-region services and certain types of incidental services, because our current accounting safeguards rules ensure that ratepayers do not subsidize interexchange operations. In particular, several of the BOCs assert that Part 36 will separate the costs of these services into state and interstate portions, and Part 69 will allocate the costs of all regulated, interLATA telecommunications services to the interexchange basket separate from local exchange and exchange access costs. BellSouth and PacTel argue that there is also no need to treat these services like nonregulated activities for federal accounting purposes because the Commission can review the costs of providing such services, including the allocation of overhead, during the tariff review process. 71.Several parties contend that we should require all incumbent local exchange carriers, including non-BOCs, to treat any regulated services other than local exchange and exchange access like nonregulated services for Title II accounting purposes to ensure the prevention of subsidies flowing from the latter services to the former. 72.Cincinnati Bell and USTA argue that sections 271 through 276 apply solely to BOCs and the Commission has no authority to apply additional accounting safeguards to non- BOC incumbent local exchange carriers. Discussion: 73.Section 254(k) prohibits a "telecommunications carrier" from using "services that are not competitive to subsidize services that are subject to competition." We conclude that section 254(k) bars all incumbent local exchange carriers, including BOCs, from subsidizing competitive interLATA telecommunications services, such as out-of-region services and certain types of incidental interLATA services, with revenues from exchange services and exchange access that are not subject to competition. Section 271(h) specifically requires the Commission to ensure that the provision of incidental interLATA telecommunications services by a BOC or its affiliate "will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." Accordingly, we concur with the parties that assert that our Part 64 cost allocation rules should apply to interLATA telecommunications services, including out-of-region services and certain types of incidental services, that may be provided by incumbent local exchange carriers on an integrated basis. 74.Our Part 64 cost allocation rules require a carrier to assign costs directly, wherever possible, to regulated or nonregulated activities. These rules protect subscribers to interstate exchange and exchange access services from bearing the costs and risks of the carrier's nonregulated activities provided on an integrated basis. These rules do not, however, protect against improper cost allocations from one regulated activity to another regulated activity. Therefore, if interLATA telecommunications services, including out-of-region services and certain types of incidental services, that may be provided by incumbent local exchange carriers on an integrated basis, were treated as regulated for accounting purposes, our Part 64 rules would not prevent any improper cost allocations that may occur between local exchange and exchange access services and these interLATA telecommunication services. 75.For these reasons, we agree with TRA, GSA and AT&T that under our current cost allocation rules we can most efficiently and comprehensively satisfy sections 254(k) and 271(h) if, solely for federal accounting purposes, we treat like nonregulated activities both out- of-region and certain types of incidental interLATA services that may be provided by incumbent local exchange carriers on an integrated basis. We believe that this should sufficiently safeguard against cross-subsidization without imposing additional accounting requirements on carriers. This would parallel the approach taken in the Interim BOC Out-of- Region Order that classified out-of-region interstate, interexchange services provided by BOC affiliates as nonregulated activity for accounting purposes. Because incumbent local exchange carriers currently have internal accounting systems in place to allocate costs fairly between nonregulated activities and regulated services provided on an integrated basis, such a requirement will not impose extensive expense upon incumbent local exchange carriers. 76.We agree with several of the BOCs that assert that Part 36 will jurisdictionally separate the costs of regulated, interLATA telecommunications services into state and interstate portions, and Part 69 will allocate the costs of all regulated interstate, interLATA telecommunications services to the interexchange basket separate from local exchange and exchange access costs. We conclude, however, that the Part 36 jurisdictional separations process and the Part 69 access charge process were not designed to prevent subsidization of competitive telecommunications services by subscribers to exchange and exchange access services. Although the Part 36 and Part 69 processes produce the secondary effect of assigning the costs of regulated interstate, interLATA telecommunications services to the interexchange basket, classifying both out-of-region and certain types of incidental interLATA services as nonregulated activities for federal accounting purposes will achieve greater accuracy in safeguarding against cross-subsidization. Classifying such services as nonregulated activities allows the allocation of costs for these activities to occur immediately after such costs are assigned to Part 32 accounts. Such treatment avoids the necessary imprecisions inherent in the Part 36 jurisdictional separations process, the Part 69 access charge process, and our Part 61 price cap rules. Moreover, we concur with TRA that treating such services like nonregulated activities for federal accounting purposes will lessen the chance that costs associated with such services are inadvertently assigned to a local exchange or exchange access category. c. Other Matters 77.Section 272(e)(3) requires that "[a] Bell operating company . . . impute to itself (if using [exchange] access for its provision of its own services), an amount for access that is no less than the amount charged to any unaffiliated interexchange carriers for such service." In the NPRM, we invited comment on how BOCs should account for these access charges. The NPRM suggested that one possible approach would be for BOCs to record these imputed exchange access charges as an expense that would be directly assigned to nonregulated activities with a credit to the regulated access revenue account. We invited comment on this approach as well as alternative approaches. 78.Section 272(e)(4) states that "[a] Bell operating company and an affiliate that is subject to the requirements of section 251(c) . . . may provide any interLATA or intraLATA facilities or services to its interLATA affiliate if such services or facilities are made available to all carriers at the same rates and on the same terms and conditions, and so long as the costs are appropriately allocated." In the NPRM, we invited comment on whether and, if so, how the requirements of sections 272(e)(3) and (4) should affect our rules for allocating costs between activities regulated under Title II and nonregulated activities for those BOCs that provide interLATA services on an integrated basis. We also requested comment on whether, in light of section 272(e)(4), we may require BOCs that provide interLATA or intraLATA facilities or services on an integrated basis to provide these facilities or services to their own internal operation only at the same rates as those facilities or services are made available to all carriers. When those rates differ for different carriers, we sought comment on which rate should be applicable to BOC affiliate transactions. We also invited comment on whether we should adopt specific accounting procedures to address the difference, if any, between those rates and the costs that would be appropriately allocated for the underlying facilities or services. Comments: 79.AT&T and Worldcom agree with the tentative conclusion in the NPRM that BOCs should record imputed exchange access charges as an expense that would be directly assigned to nonregulated activities with a credit to the regulated access revenue account. In general, incumbent local exchange carriers disagree with the tentative conclusion stated in the NPRM. In particular, PacTel contends that the approach suggested in the NPRM is only workable for structurally separate affiliates where revenues and expenses of the BOC and its affiliate are each stated correctly for regulated reporting purposes (each entity separately reports the results of its own operations). US West and GSA argue that recording imputed access charges as a nonregulated expense might result in a doubling of overhead costs allocated to the nonregulated activity because the imputed charge would already contain an element of overhead. 80.Several incumbent local exchange carriers argue that we should require imputed access charges to be recorded as debits to nonregulated revenues and credits to regulated access charge revenues. In general, incumbent local exchange carriers maintain that section 32.5280 of our rules defines the accounting treatment for regulated services provided on an integrated basis: "[the nonregulated operating revenue] account shall be debited, and regulated revenue accounts credited at tariffed rates when tariffed services are provided to nonregulated activities." 81.NYNEX contends that imputing exchange access charges is not necessary because treating interexchange service as nonregulated would trigger the application of the Part 64 requirement that nonregulated services record the use of the underlying tariffed services at tariff rates, satisfying section 272(e)(3)'s requirements and ensuring against cross- subsidization. 82.AT&T and Worldcom assert that we must ensure that the full access charge is reflected in a BOC's end-user rates, and is not merely a book entry in the case of a BOC that uses exchange access for the provision of its own services. AT&T argues that in order to ensure that the full access charge is reflected in a BOC's end-user rates, we should establish price floors at a level equal to the amount of the access charge plus the incremental cost of the non-access portions of the service. Wisconsin PSC states that it presently makes use of price floors such that when a carrier subject to Wisconsin PSC's regulations uses a noncompetitive service in the provision of its own competitive service, the competitive service must be priced to exceed total service long-run incremental cost ("TSLRIC"). Accordingly, like AT&T, Wisconsin PSC argues that we should adopt a price floor to prevent cross-subsidization. 83.With respect to whether the requirements in sections 272(e)(3) and (e)(4) should affect our rules for allocating costs between activities regulated under Title II and nonregulated activities for those BOCs that provide interLATA services on an integrated basis, SBC argues that sections 272(e)(3) and (e)(4) relate solely to in-region interLATA services that BOCs are required to provide through an affiliate and are not relevant to the interLATA services that the BOCs are permitted to provide on an integrated basis. 84.TRA and Worldcom argue that when a BOC charges different rates to different unaffiliated carriers for facilities or services, the BOC must impute the highest rate paid for the same facilities or services to the BOC's integrated operations. USTA, however, alleges that an approach requiring the BOC's integrated operations to pay the highest rate paid for the same facilities or services by unaffiliated carriers would unnecessarily constrain a BOC from volume discount purchases. 85.Bell Atlantic and US West assert that what local exchange carriers charge for interLATA services is not an accounting issue, but rather a pricing issue and has no place in this proceeding. Discussion: 86.We conclude that we should not require BOCs to record imputed exchange access charges required under section 272(e)(3) as an expense that would be directly assigned to nonregulated activities with a credit to the regulated access revenue account. We conclude that the approach suggested in the NPRM would result in an overstatement of operating revenues. Instead, we concur with the BOCs that the logic of section 32.5280 of our rules provides the proper framework for recording imputed exchange access charges. Accordingly, to record imputed exchange access charges required under section 272(e)(3), BOCs should debit the nonregulated operating revenue account by the amount of the imputed exchange access charges and credit the regulated revenue account by the amount of the imputed exchange access charges. By requiring BOCs to account for imputed exchange access charges in this manner, the accounting for this imputed revenue will be consistent with our current accounting rules adopted in the Joint Cost Proceeding for imputing revenues derived from services provided to nonregulated affiliates. 87.Section 272(e)(3) requires a BOC to impute to itself an amount for access it provides to its telephone exchange service "that is no less than the amount charged to any unaffiliated interexchange carriers for such service." Accordingly, where a BOC charges different rates to different unaffiliated carriers for access to its telephone exchange service, the BOC must impute to its integrated operations the highest rate paid for such access by unaffiliated carriers. In determining the highest rate paid by unaffiliated carriers, the BOC may consider the comparability of the service provided. If, for example, rates charged unaffiliated carriers vary based on the volume purchased, the BOC may consider comparable volume in determining the highest rate to impute to its integrated operations. Accordingly, a BOC's integrated operations may take advantage of the same volume discount purchases offered to its interLATA affiliate and other unaffiliated carriers. As for AT&T's and Worldcom's concerns regarding the reflection of the full access charge in a BOC's end-user rates, we agree with Bell Atlantic and US West that those concerns involve pricing issues, rather than accounting issues, and therefore lie beyond the scope of this proceeding. 3. Section 275 - Alarm Monitoring Services 88.Section 275(e) defines "alarm monitoring service" as "a service that uses a device located at a residence, place of business, or other fixed premises (1) to receive signals from other devices located at or about such premises regarding a possible threat at such premises to life, safety, or property, from burglary, fire, vandalism, bodily injury, or other emergency, and (2) to transmit a signal regarding such threat by means of transmission facilities of a local exchange carrier or one of its affiliates to a remote monitoring center to alert a person" about the emergency. Section 275(a)(1) delays entry by the BOCs not already providing alarm monitoring services until five years from the date of enactment of the 1996 Act. If a BOC or BOC affiliate provided alarm monitoring services as of November 30, 1995, it may continue to do so, but cannot expand its alarm monitoring business by acquiring "any equity interest in, or obtain financial control of, any unaffiliated alarm monitoring service entity" during the five-year period after the date of enactment of the 1996 Act. 89.Section 275(b)(2) specifies that an incumbent local exchange carrier engaged in the provision of alarm monitoring services "not subsidize its alarm monitoring services either directly or indirectly from telephone exchange service operations." As with the prohibition against subsidizing telemessaging services, this prohibition against subsidizing alarm monitoring services specifically applies to incumbent local exchange carriers. 90.In the NPRM, we asked whether our present Part 64 cost allocation rules are necessary or sufficient to prevent subsidization of alarm monitoring services either directly or indirectly from telephone exchange service operations in accordance with section 275(b)(2). Comments: 91.Commenters generally agree that the Commission's present Part 64 cost allocation rules are sufficient to prevent subsidization of alarm monitoring services from telephone exchange service operations because alarm monitoring services are presently treated as nonregulated activities for Title II accounting purposes and the Commission's Part 64 cost allocation rules require carriers to allocate the costs of alarm monitoring services to nonregulated activities. SBC believes that the language of section 275 does not require the imposition of any accounting safeguards with respect to alarm monitoring services. Discussion: 92.We concur with the numerous commenters that assert that application of our present Part 64 cost allocation rules to alarm monitoring services will adequately safeguard against the subsidies prohibited by section 275(b)(2) because our rules require that the fully distributed cost of providing alarm monitoring service be removed from the carrier's regulated activities. We presently classify alarm monitoring services as nonregulated activities for Title II accounting purposes. Consequently, our cost allocation rules and affiliate transaction rules apply to alarm monitoring services. Carriers are required to allocate a portion of their network investment plant used to provide alarm monitoring services to these nonregulated activities. We already have experience with the application of our existing rules to alarm monitoring services because some companies already provide alarm monitoring services on a nonregulated basis. 4. Section 276 - Payphone Services 93.Section 276(a)(1) states that "any Bell operating company that provides payphone service shall not subsidize its payphone service directly or indirectly from its telephone exchange service operations or its exchange access operations." This prohibition against cross-subsidization is an integral part of the statutory plan "to promote competition among payphone providers and promote the widespread deployment of payphone services to the benefit of the general public." To implement the prohibition, section 276(b)(1)(C) directs the Commission to prescribe nonstructural safeguards for BOC payphone service that, "at a minimum, include the nonstructural safeguards equal to those adopted in the Computer Inquiry-III (CC Docket No. 90-623) proceeding." In Computer III, we examined our regulatory regime for the provision of enhanced services and replaced the Computer II requirements with a series of nonstructural safeguards. These safeguards included the Part 64 cost allocation rules and the affiliate transactions rules that we developed in the Joint Cost Order. 94.In the NPRM, we tentatively concluded that we should apply accounting safeguards identical to those adopted in the Computer III proceedings to prevent the cross- subsidization of payphone services by BOC telephone exchange service or exchange access operations in accordance with sections 276(a)(1) and (b)(1)(C). We invited comment on this tentative conclusion. 95.The provision of payphone service by local exchange carriers has traditionally been treated as a regulated activity for Title II accounting purposes. In the NPRM, we tentatively concluded that we should reclassify payphone service as a nonregulated activity for accounting purposes so that its costs will be separated from telephone exchange service and exchange access operations. Under this proposal, BOCs would classify their payphone investment, expenses and revenues as nonregulated for Title II accounting purposes while continuing to use the Commission's Part 32 accounts to record their payphone service activities. We invited comment on this tentative conclusion and asked whether this proposal would provide nonstructural accounting safeguards equivalent to those adopted in the Computer III proceeding and whether such changes would prevent subsidization of payphone services by BOC telephone exchange service or exchange access operations. 96.Section 276 does not prescribe accounting safeguards to govern the provision of payphone service by incumbent local exchange carriers other than the BOCs. We also asked in NPRM whether we should require non-BOC incumbent local exchange carriers to reclassify their payphone service operations as a nonregulated activity for Title II accounting purposes. Comments: 97.In general, BOCs and interexchange carriers contend that payphone service should be treated like a nonregulated activity for federal accounting purposes. Several BOCs assert that adoption of the Computer III safeguards is sufficient to prevent cross-subsidization of payphone services. Coalition argues that section 276(b) specifically identifies the nonstructural safeguards in Computer III as an appropriate standard. MCI maintains that any new safeguards or revisions adopted pursuant to our reconsideration of Computer III on remand should also apply to the provision of payphone service. 98.Worldcom, CTA and APCC argue that Computer III safeguards are insufficient to satisfy section 276. APCC asserts that our Computer III safeguards were devised to incorporate concerns regarding efficiency that are outside the realm of section 276. APCC also contends that incumbent local exchange carriers have dominated the payphone industry for some time and their payphone operations have traditionally benefitted from cross- subsidization. Accordingly, APCC concludes that stronger safeguards are needed in the payphone context. 99.Several parties maintain that the Computer III safeguards should be applied to all incumbent local exchange carriers providing payphone service. APCC contends that any proposed accounting safeguard should apply, at a minimum, to all incumbent local exchange carriers with greater than $100 million in annual revenues, as well as local exchange carriers serving island territories such as Puerto Rico and the Virgin Islands. Discussion: 100.The Commission reclassified pay telephone service as a nonregulated service in the Pay Telephone Reclassification Order. As a result, carriers must apportion payphone service costs to nonregulated and common cost pools, ensuring that subscribers to interstate exchange services and exchange access do not bear the costs and risks of the carrier's payphone service. Our Pay Telephone Reclassification Order also requires that BOCs and incumbent local exchange carriers providing payphone service on an integrated basis follow the nonstructural safeguards described in Computer III in order to provide sufficient protection against the possibility that payphone service could be subsidized by local exchange service or exchange access operations. The nonstructural safeguards in Computer III include our Part 64 cost allocation rules and our Part 32 affiliate transactions rules adopted in the Joint Cost Order. This requirement satisfies both the prohibition against cross-subsidization in section 276(a)(1) and the requirement in section 276(b)(1)(C) that we adopt a set of nonstructural safeguards at least equal to those adopted in Computer III. Although Worldcom, CTA and APCC argue that Computer III safeguards are insufficient to satisfy section 276, these parties offer no substitute safeguards to implement the requirements of section 276. Our experience with accounting safeguards in Computer III has demonstrated that these safeguards can effectively guard against the subsidization of competitive activities by regulated ratepayers, which section 276 prohibits. In fact, section 276(b) specifically identifies the Computer III safeguards as the appropriate standard for nonstructural safeguards regarding payphone service. Accordingly, we adopt our tentative conclusion that we should apply accounting safeguards identical to those adopted in Computer III to BOCs and incumbent local exchange carriers providing payphone service on an integrated basis. IV. SAFEGUARDS FOR SEPARATED OPERATIONS A. General 101.Section 272(a)(2) allows BOCs to provide the following services only through a separate subsidiary: the sale of telecommunications equipment and manufacturing of telecommunications equipment and customer premises equipment; origination of interLATA telecommunications services, other than incidental, out-of-region, and previously authorized services; and interLATA information services other than electronic publishing and alarm monitoring services. Section 273(d)(3) requires "any entity which certifies telecommunications equipment or customer premises equipment manufactured by an unaffiliated entity . . . only [to] manufacture a particular class of telecommunications equipment or customer premises equipment for which it is undertaking or has undertaken, during the previous eighteen months, certification activity for such class of equipment through a separate affiliate." Section 274(a) requires that BOCs providing electronic publishing must do so only through a "separated affiliate" or electronic publishing joint venture. These requirements for "separate" or "separated" affiliates or joint ventures implicitly assume that structural safeguards limit the carrier's ability to engage in cross-subsidization and discrimination, and enhance the ability of the Commission or a State to detect cross- subsidization and discrimination. 102.In the NPRM, we tentatively concluded that, except where the Act imposes specific additional requirements, our current affiliate transactions rules generally satisfy the Act's requirements on safeguards to ensure that the services that section 272, 273 and 274 require BOCs to provide through a separate or "separated" affiliate are not subsidized by subscribers to regulated telecommunications services. We invited comment on this tentative conclusion as well as whether the benefits of any fundamentally different approach to affiliate transactions would be outweighed by the costs that implementation of such a system would entail. 103.We also sought comment in the NPRM on whether we should modify our affiliate transactions rules in certain respects. In 1993, we released an Affiliate Transactions Notice proposing certain rule changes, including changes in how subject carriers would value for Title II accounting purposes services they provide, or receive from, nonregulated affiliates in order to provide more complete protection against cross-subsidization. In the NPRM, we invited comment on whether, in implementing the Act's provisions regarding cross- subsidization, we should amend the current affiliate transactions rules to incorporate certain of the modifications proposed in the Affiliate Transactions Notice or any other changes. We also sought comment on whether the affiliate transactions rules we adopt in this proceeding should apply to all transactions between incumbent local exchange carriers and their affiliates, or simply to entities that engage in activities for which the Act requires the use of a separate or separated subsidiary. Comments: 104.Most parties support our tentative conclusions that our current affiliate transactions rules generally satisfy the Act's requirements except where amendments made by the 1996 Act impose specific additional requirements. In particular, AT&T contends that existing accounting rules could be extended to new separated operations with a minimum of disruption because incumbent local exchange carriers have already implemented internal accounting systems designed to ensure compliance with the Commission's existing accounting rules. MCI, however, maintains that we must adopt more stringent affiliate transactions rules to account for the increased opportunities for BOCs to enter new lines of nonregulated businesses and for the increased incentives and opportunities for incumbent local exchange carriers to shift costs. Specifically, MCI argues that we should adopt a rule requiring carriers to maintain a complete audit trail for all cost allocations and affiliate transactions. 105.TIA sets forth three justifications for strengthening the affiliate transactions rules in the manner described in the NPRM. First, TIA contends that the Commission has had almost a decade of experience with the existing affiliate transactions rules and that the Commission found the current rules to be inadequate as far back as 1993 in its Affiliate Transactions NPRM. Second, TIA alleges that a number of recent State and federal audits have indicated improper allocations of costs by the BOCs under the current rules. Finally, TIA contends that the removal of the MFJ's restrictions on BOC entry into competitive markets has increased the risk of cross-subsidization. 106.The BOCs generally oppose the modifications to the affiliate transactions rules that we proposed in the NPRM. They assert that any benefits of new or modified affiliate transactions rules would be outweighed by the costs of implementing these new or modified rules. In particular, SBC maintains that parties advocating additional and more detailed affiliate transactions rules have not provided sufficient justification to outweigh the increased burden that would result. SBC and US West contend that, if we decide to modify our affiliate transactions rules, we should apply those modifications only to transactions involving BOCs and their section 272 separate affiliates. Discussion: 107.In the Joint Cost Order, we adopted rules to govern how costs are recorded, for Title II accounting purposes, when a regulated carrier does business with nonregulated affiliates. These affiliate transactions rules were designed to protect ratepayers from subsidizing the competitive ventures of incumbent local exchange carriers' affiliates. The affiliate transactions rules do not require carriers or their affiliates to charge any particular price for assets transferred or services provided; rather, the rules require carriers to use certain specified valuation methods in determining the amounts to record in their Part 32 accounts, regardless of the prices charged. 108.In agreement with most commenters, we adopt our tentative conclusion that, except where the 1996 Act imposes specific additional requirements, our current affiliate transactions rules generally satisfy the statute's requirement of safeguards to ensure that these services are not subsidized by subscribers to regulated telecommunications services. We have previously concluded that these rules provide effective safeguards against cross- subsidization. Moreover, incumbent local exchange carriers have already implemented internal accounting systems for affiliate transactions to help ensure compliance with these rules. These systems have proven generally effective and we see no reason to require a change to a different system. 109.While we decline to alter our prescribed accounting treatment of affiliate transactions, we do adopt several of the modifications to the affiliate transactions rules initially proposed in the NPRM. We now have had approximately ten years experience with the cost allocation and affiliate transactions regime created by the Joint Cost Order. This experience has convinced us that amending certain aspects of the affiliate transactions rules would provide more complete protection against cross-subsidization. We first presented in the 1993 Affiliate Transaction Notice some of the proposed modifications incorporated in our NPRM. We discuss these modifications and present our rationale for adopting or rejecting them below. We note that modifications that we make to improve the affiliate transactions rules will apply to all transactions between incumbent local exchange carriers currently subject to these rules and their affiliates, not just to transactions between a BOC and an affiliate required under the Act. B. Specific Services 1. Section 272 - Manufacturing and InterLATA Services a. Statutory Language 110.Section 272(a) prohibits a "Bell operating company (including any affiliate) which is a local exchange carrier that is subject to the requirements of section 251(c)" from "provid[ing] any service described in [section 272(a)(2)] unless it provides that service through one or more affiliates that (A) are separate from any operating company entity that is subject to the requirements of section 251(c); and (B) meet the requirements of [section 272(b)]." Section 272(a)(2) states that: [t]he services for which a separate affiliate is required by [section 272(a)(1)] are: (A) [m]anufacturing activities (as defined in section 273(h)); (B) [o]rigination of interLATA telecommunications services, other than (i) incidental interLATA services described in [section 271(g)(1)-(3) and (5)-(6)]; (ii) out-of-region services described in section 271(b)(2); or (iii) previously authorized activities described in section 271(f); [and] (C) [i]nterLATA information services, other than electronic publishing (as defined in section 274(h)) and alarm monitoring services (as defined in section 275(e)). Section 272(b)(2) requires each of these separate affiliates to "maintain books, records, and accounts in the manner prescribed by the Commission which shall be separate from the books, records, and accounts maintained by the [BOC] of which it is an affiliate." Under section 272(b)(5), each of these separate affiliates must "conduct all transactions with the [BOC] of which it is an affiliate on an arm's length basis with any such transactions reduced to writing and available for public inspection." Pursuant to section 272(c)(2), BOCs must account for all transactions with these affiliates "in accordance with accounting principles designated or approved by the Commission." b. "Arm's Length" Requirement of Section 272(b)(5) 111.Section 272(b)(5) requires that transactions between the BOC and its affiliates engaged in the manufacturing activities, origination of interLATA telecommunications services, and offering of interLATA information services described in section 272(a)(2) be conducted on "an arm's length basis." In the Computer II Final Decision, we required AT&T to provide enhanced services and customer premises equipment only through a "separate corporate entity" that would "deal with any affiliated manufacturing entity only on an 'arm's length'" basis. We stated that "the transfer of any products" between this separate corporate entity and "any affiliated equipment manufacturer must be done at a price that is compensatory." In the NPRM, we asked commenters to address whether we should adopt requirements similar to those in the Computer II Final Decision in order to implement section 272(b)(5). We also asked whether a requirement that all transfers of products between the BOC and its affiliates be done at a price that is compensatory would be consistent with the congressional intent behind section 272(b)(5). In Computer III and the Joint Cost Proceeding, we re-examined our regulatory regime for the provision of enhanced services and replaced the Computer II requirements with a series of nonstructural safeguards, including affiliate transactions rules. In the NPRM, we invited comment on whether our affiliate transactions rules, incorporating some of the changes proposed in the Commission's Affiliate Transactions NPRM to provide greater protection against cross-subsidization, would be necessary or sufficient to ensure compliance with the "arm's length" requirement of section 272(b)(5). 112.In the NPRM, we sought comment on whether and, if so, how we should amend our rules to address section 272(b)(5)'s requirement that all transactions be "reduced to writing and available for public inspection." We also asked whether Internet access to information about these transactions would be sufficient to comply with the "public inspection" requirement and whether we need to adopt safeguards to protect any confidential or sensitive information contained in these publicly available documents. 113.In the NPRM, we tentatively concluded that a "request" by an affiliate to its BOC for telephone exchange service or exchange access constitutes a "transaction" within the meaning of section 272(b)(5) which must be "reduced to writing and available for public inspection." We invited comment on this tentative conclusion and asked whether we need to adopt safeguards to protect any confidential or sensitive information related to these types of transactions. Comments: 114.The BOCs generally contend that we need not prescribe any particular accounting methods to ensure that the "arm's length" requirement of section 272(b)(5) is met. In contrast, MCI argues that our existing affiliate transaction rules, without modification, do not satisfy the "arm's length" requirement because the existing rules give the BOCs too much latitude in valuing their affiliate transactions. MCI and AT&T assert that we should adopt the modifications to the existing affiliate transactions rules proposed in the Affiliate Transactions NPRM. TRA maintains that in order to successfully demonstrate satisfaction of the "arm's length" requirement of section 272(b)(5), a BOC must be able to provide evidence that the terms and conditions of its transactions with affiliates are comparable to the terms and conditions that would have been secured from non-affiliates. Accordingly, TRA suggests that we should require each BOC to accumulate and retain information regarding affiliate transactions. 115.TIA contends that section 272(b)(5)'s requirement that affiliate transactions be conducted on an "arm's length basis" requires that all transfers of assets or services between a BOC and its affiliate required under section 272(a) must occur at a price that is "compensatory." TIA and TRA argue that the affiliate transactions rules, with the modifications proposed in the NPRM, would help ensure that BOCs are fully compensated for any goods or services provided to an affiliate and that BOCs pay reasonable prices for any goods or services procured from an affiliate. Several of the BOCs assert that because the Commission, in its Computer III decision, retained the notion of compensatory pricing in Parts 32 and 64, existing affiliate transactions rules already ensure that such transactions are conducted at compensatory prices. 116.MCI argues that section 272(b)(5)'s requirement that transactions be "reduced to writing and available for public inspection" indicates that Congress contemplated vigorous involvement by interested third parties in deterring cross-subsidization and discriminatory activity by BOCs. Accordingly, MCI suggests that BOCs should be required to provide to the Commission and make publicly available a complete list of transaction activities with their interLATA and manufacturing affiliates on a periodic basis, at least quarterly, specifying all contracts, arrangements, and other agreements between the BOC and its affiliates, providing a description of the asset or service transferred, the transfer price, and the method of valuation. 117. The BOCs generally argue that there is no need for the Commission to amend its rules to address section 272(b)(5)'s requirement that transactions be "reduced to writing and available for public inspection" because the Commission's rules already require carriers to disclose certain information regarding affiliate transactions in section V of their cost allocation manuals. MCI, however, asserts that the "reduced to writing and available for public inspection" requirement of section 272(b)(5) cannot be satisfied by the Commission's existing cost allocation manual filing requirements because the information in the BOCs' cost allocation manuals is not sufficiently detailed. 118.MCI and Worldcom contend that Internet access to information about transactions between BOCs and their affiliates required under section 272(a) would be sufficient to comply with section 272(b)(5)'s requirement that transactions be "reduced to writing and available for public inspection." Although US West agrees that Internet access would meet the obligations of section 272(b)(5), US West maintains that we should not require companies to post internal documents on the Internet because the companies could not monitor who was inspecting the documents. In contrast, TRA and APCC argue that, while the Commission should encourage Internet access to information concerning affiliate transactions, Internet access alone does not satisfy section 272(b)(5)'s "available for public inspection" requirement because Internet access is still unavailable to many. USTA asserts that we should simply require that documents related to affiliate transactions be available at a location designated by the carrier. Several parties oppose a rule that would allow BOCs to choose a single location where documents concerning affiliate transactions are available to the public and contend that such a rule would severely limit a third party's ability to gain access to such information. 119.With regard to concerns about the protection of confidential or sensitive information contained in any documents that BOCs make "available for public inspection" in accordance with section 272(b)(5), APCC contends that pricing information based upon tariffed rates, prevailing market prices, or fair market value should not involve proprietary information. According to APCC, only pricing based upon fully distributed costs might be considered proprietary, and, for the sake of ensuring arm's length transactions, the Commission should impose a heavy burden on BOCs and independent local exchange carriers of demonstrating that such information warrants proprietary status. TIA asserts that to the extent that relevant documents contain proprietary information, the Commission should use reasonable non-disclosure agreements to ensure that such information is not misused. The BOCs urge the Commission to adopt and apply the standards for the protection of confidential information are contained in the Comments of the Joint Parties in response to the Commission's Confidential Information Notice. 120.Several interexchange carriers support our tentative conclusion that a request by an affiliate to its BOC for telephone exchange service or exchange access constitutes a "transaction" within the meaning of section 272(b)(5) which must be "reduced to writing and available for public inspection." TRA asserts that only by requiring all requests by affiliates to their BOCs for telephone exchange service or exchange access to be available for public inspection will the public and the Commission be able to evaluate the BOCs' compliance with section 272(e)(1). US West disagrees with our tentative conclusion and contends that only once the BOC and its affiliate have agreed upon the terms and conditions for telephone exchange and exchange access does the agreement constitute a "transaction." Discussion: 121.We decline to adopt Computer II type requirements in order to implement section 272(b)(5). We agree with several of the BOCs that because our Computer III decision retained the concept of compensatory pricing in Parts 32 and 64, our existing affiliate transactions rules already ensure that affiliate transactions are conducted at compensatory prices. We conclude that our affiliate transactions rules, developed in Computer III and the Joint Cost Proceeding, with some of the changes proposed in the Commission's Affiliate Transactions NPRM, will ensure compliance with the "arm's length" requirement of section 272(b)(5). We discuss the requirements of these rules in section IV.B.1.b.ii. below. 122.To satisfy section 272(b)(5)'s requirement that transactions between section 272 affiliates and the BOC of which they are an affiliate be "reduced to writing and available for public inspection," we require the separate affiliate, at a minimum, to provide a detailed written description of the asset or service transferred and the terms and conditions of the transaction on the Internet within 10 days of the transaction through the company's home page. The broad access of the Internet will increase the availability and accessibility of this information to interested parties, while imposing a minimal burden on the BOCs. We require that the description of the asset or service and the terms and conditions of the transaction should be sufficiently detailed to allow us to evaluate compliance with our accounting rules. This information must also be made available for public inspection at the principal place of business of the BOC. The information made available at the principal place of business of the BOC must include a certification statement identical to the certification statement currently required to be included with all Automated Reporting and Management Information System ("ARMIS") reports. Such certification statement declares that an officer of the BOC has examined the submission and that to the best of the officer's knowledge all statements of fact contained in the submission are true and the submission is an accurate statement of the affairs of the BOC for the relevant period. Information contained in a BOC's cost allocation manual is not sufficiently detailed to satisfy section 272(b) because the BOC's cost allocation manual contains only a general description of the asset or service and does not describe all of the terms and conditions of each transaction. While section 272(b)(5) requires BOCs to reduce their transactions to writing and make them "available for public inspection," we will continue to protect the confidential information of BOCs, as well as other incumbent local exchange carriers. 123.We recognize a need to clarify how the requirements of section 273(e)(5) relate to the full scope of a BOC's reporting obligations under section 272(b)(5) of the Act. Section 273(e)(5)'s general mandate that BOCs "shall protect the proprietary information submitted for procurement decisions from release not specifically authorized by the owner of such information" neither curtails nor obviates section 272(b)(5)'s requirement that transactions between BOCs and their manufacturing affiliates be reduced to writing and made available for public inspection. Section 273(e)(5) addresses a BOC's duties solely with regard to submissions for procurement decisions, either by an affiliate or a third party. Only after a BOC consummates a transaction with a manufacturing affiliate would the reporting requirements of section 272(b)(5) trigger. Transactions between BOCs and third parties are not subject to the reporting requirements of section 272(b)(5). Section 272(b)(5)'s requirement that BOCs reduce their transactions with manufacturing affiliates to writing and make them available for public inspection permits the Commission and competitors to ensure that the BOCs are complying with the nondiscrimination and accounting safeguards of the Act. 124.We decline to adopt our tentative conclusion that a "request" by an affiliate to its BOC for telephone exchange service or exchange access constitutes a "transaction" within the meaning of section 272(b)(5) which must be "reduced to writing and available for public inspection." We note, however, that once the BOC and its affiliate have agreed upon the terms and conditions for telephone exchange and exchange access such agreement would constitute a "transaction." For clarification, we also find that agreements between a BOC and its affiliate for the provision of unbundled elements and facilities pursuant to explicit terms and conditions also constitutes a "transaction." i. Prevailing Company Prices 125.In the NPRM, we asked whether affiliate transactions conducted "on an arm's length basis" would necessarily entail the same marketing efforts and transactional costs as transactions with non-affiliates. We also solicited comment on the impact that any differences in marketing efforts and transactional costs might have in accurately valuing affiliate transactions and how such differences should affect our use of the prevailing price method to record affiliate transactions between the BOCs and their affiliates engaged in activities described in section 272(a)(2). 126.We also sought comment on whether we should eliminate the use of the prevailing price method as a valuation method for recording affiliate transactions between the BOCs and their affiliates engaged in activities described in section 272(a)(2). The prevailing price describes the price at which a company offers an asset or service to the general public. A carrier subject to our current affiliate transactions rules records non-tariffed assets or services at their prevailing prices if such prices exist. Prevailing price currently represents one component in the hierarchy of methods for valuing transactions between a carrier and its affiliate. A carrier subject to our current affiliate transactions rules uses one of the following methods to value asset transfers for regulated accounts: (1) tariffed rates, (2) prevailing company prices, (3) net book cost, or (4) estimated fair market value. These valuation methods apply when the carrier is either the purchaser or seller of the asset according to the following set of rules. First, carriers must record each asset transferred to an affiliate pursuant to tariff at the tariffed rate. Second, if no tariff exists and an affiliate that transfers or sells an asset to its regulated carrier also sells the same kind of asset to third parties at a generally available price, then the carrier must record the asset sale or transfer at that prevailing company price. Non-tariffed assets that are sold or transferred by the carrier to its affiliates and are sold to third parties at a generally available price, must also be recorded by the carrier at that price. Third, all other asset transfers must be recorded at the higher of net book cost and estimated fair market value when the carrier is the seller, and at the lower of net book cost and estimated fair market value when the carrier is the buyer (i.e., from the affiliate). The United States Court of Appeals for the District of Columbia Circuit affirmed the valuation methods for asset transfers, finding them "reasonably designed to prevent systematic abuse of ratepayers." 127.In comparison to our method for valuing asset transfers, carriers must record transactions involving services in their Part 32 accounts according to one of three valuation methods: (1) tariffed rates, (2) prevailing company prices, or (3) fully distributed cost. These valuation methods are applied when the carrier is either the purchaser or seller of the service according to the following set of rules. First, carriers must record services provided to an affiliate pursuant to tariff at the tariffed rate. Second, if no tariff exists and a carrier transfers or sells a service to its regulated affiliate that it also provides to third parties, the carrier must record the transaction at the prevailing company price. Non-tariffed services that are sold or transferred by an affiliate to its regulated carrier and are also sold to third parties at a generally available price, must also be recorded by the carrier at that price. Third, all other services provided to affiliates must be recorded at the service provider's fully distributed costs. Comments: 128. TRA argues that a company transacting business with its affiliate will benefit from lower or non-existent marketing costs because the company is already known to the affiliate, thereby minimizing transactional costs during affiliate transactions. Therefore, according to TRA, if a BOC is permitted to use prevailing price to value a transaction with its affiliate, both parties will be able to transfer all avoided marketing and transactional costs to their advantage. Several other parties, including PacTel and Sprint, contend that the idea that an entity operating in a highly competitive market does not need to devote the same amount of effort and resources to win business from its affiliates as it does from non-affiliates is incorrect. In particular, Sprint maintains that "in a competitive market with a variety of suppliers offering a plethora of price and service options, an entity has to work just as hard to sell to its affiliates as it does to non-affiliates. Otherwise, its affiliates will look to other suppliers." 129.Several parties support the Commission's proposal to eliminate the use of the prevailing price method to record affiliate transactions between the BOCs and their affiliates engaged in the activities described in section 272(a)(2). These parties contend that the Commission's present prevailing price method is difficult to apply and affords carriers too much discretion. A number of other parties, including the BOCs, AT&T and Sprint, argue against the Commission's proposal to eliminate the prevailing price method. Puerto Rico Telephone, in particular, maintains that the importance of using prevailing prices will increase in the future as interconnection agreements are established and tariffs are eliminated. APCC argues that the prevailing price method is more objective than fair market value or fully distributed costs. SBC and US West argue that if we eliminated the prevailing price method, BOCs would be required to conduct fully distributed costs studies of their affiliate transactions even if all of the products and services involved in the transaction are available to third parties at a prevailing price. BellSouth contends that the elimination of the prevailing price valuation method would impose significant administrative costs and burdens on the BOCs with virtually no additional protection for customers. 130.AT&T recognizes the difficulties in determining prevailing price; AT&T, however, maintains that rather than eliminating prevailing price, the Commission should modify its rules so that prevailing price is only available if the affiliate sells a substantial percentage by quantity of that product line to nonaffiliated customers. TIA contends that the Commission should adopt a rule that allows a carrier to value affiliate transactions at prevailing price only when the affiliate can demonstrate that it has made substantial sales of the same product to third parties. Sprint argues that sales to third parties cannot reliably be used to establish prevailing price when an affiliate operates in a non-competitive market or a market where there are few third-party transactions. In addition, TRA argues that if the percentage of third-party business is small, there will be little assurance that an affiliate transaction would truly be conducted at arm's length. 131.NYNEX contends that the adoption of a clear definition of what constitutes prevailing price would clarify our rules and establish consistency. In particular, NYNEX argues that if the Commission should determine that some baseline percentage of third-party sales is necessary to establish prevailing price, then the Commission should adopt a baseline percentage much less than the 75 percent figure proposed in the Commission's Affiliate Transactions Notice. MCI maintains that the prevailing price method is particularly difficult to apply because of the difficulties in determining whether a substantial portion of an affiliate's production is being provided to third parties. MCI argues that in order to correct such difficulties, the Commission would need to apply any baseline percentage necessary to establish prevailing price on a product-by-product basis. Discussion: 132.We find unpersuasive TRA's argument that a company transacting business with its affiliate will significantly benefit from lower or non-existent marketing costs because the company is already known to the affiliate. In competitive markets, companies devote significant resources to attracting and retaining customers through sales presentations, advertising campaigns, volume purchase discounts, or long-term commitments. In addition, any potential benefits to a carrier in transacting business with its affiliate are diminished to some extent by the system and transaction costs incurred in complying with our affiliate transactions rules. Accordingly, we conclude that any differences in marketing efforts and transactional costs that might exist are not significant and should not affect our use of the prevailing price method to record affiliate transactions. 133.We decline to adopt our proposal to eliminate prevailing price as a valuation method under our affiliate transactions rules. Initially, we selected prevailing price as a valuation method because we believed that those prices would provide a reliable measure of fair market value. Our experience in auditing carriers' application of the prevailing price method to determine how inter-affiliate transfers of services should be recorded has revealed difficulties in determining what is necessary to establish a prevailing price. Rather than rejecting prevailing price valuation, however, we conclude that these difficulties are best addressed by modification and clarification of the prevailing price valuation method. 134.One of the difficulties we have identified with respect to prevailing price valuation has been determining when carriers should apply the prevailing price method to transfers of particular assets or services. The mere offering of an asset or service to unaffiliated entities is not sufficient to establish a prevailing price. A substantial quantity of business must be conducted with unaffiliated third parties in order to establish a true prevailing price. Specifically, if the percentage of third-party business is small, there can be no assurance that the price agreed upon by the carrier and its affiliate represents the true market price, thus raising legitimate questions as to whether the parties actually negotiated "on an arm's length basis." In such situations, the use of prevailing prices to value transactions could permit an affiliate to charge inflated prices to its affiliated regulated carrier, possibly leading to higher prices for customers purchasing the regulated services. 135.Our previous rules did not clarify the meaning of a "substantial" amount of third-party business for the purpose of establishing a true prevailing price. We agree with MCI that without clarification of the meaning of "substantial" in this context, the retention of the prevailing price method places a difficult burden on the Commission in verifying compliance with the affiliate transactions rules. Accordingly, we find that a clear definition of what constitutes prevailing price is necessary to clarify our affiliate transactions rules and establish consistency. We conclude that annual sales, as measured by quantity, of greater than 50 percent of a particular product or service to third parties must occur to satisfy the requirement that there be a "substantial" amount of outside business in order to produce a true prevailing price for that particular product or service. We find that third-party sales of 50 percent or less are evidence of the fact that a party's primary function is to provide products or services to affiliates, rather than to outside market participants, and, consequently, those sales to unaffiliated entities are not sufficient to establish a true prevailing price. We note that our modifications here to clarify the prevailing price method apply to all assets and services transactions governed by our affiliate transactions rules. 136.We conclude that the 50 percent threshold established in this Order must be applied on a product-by-product and service-by-service basis, rather than on a product-line or service-line basis. Application of the 50 percent threshold on a product-line or service-line basis would give carriers the incentive to define product lines and service lines as broadly as possible in order to be able to value as many transactions as possible at prevailing price. Additionally, if the 50 percent threshold were applied to a product line or service line, then products or services that are sold to third parties in quantities of 50 percent or less could be grouped in the same line with different products or services that are sold primarily to third parties, qualifying the entire line of products for prevailing price valuation. Such grouping would allow products or services for which no true prevailing price exists to be valued by a carrier at a fabricated prevailing price to the harm of ratepayers if the cost or market value of such products or services is actually different from this fabricated prevailing price. Moreover, verifying that product lines and service lines have been properly defined would place a significant burden on the Commission. 137.We do allow one exception to our rule that only a product or service for which annual sales to third parties, measured by quantity sold, exceed 50 percent of total sales of that product or service may be recorded by carriers at prevailing price. Section 272 requires BOCs to charge their section 272 affiliates the same rates as unaffiliated third parties for facilities, services, and information. Because the rates for services subject to section 272 must be made generally available to both affiliates and third parties, we adopt a rebuttable presumption that these rates represent prevailing company prices. Accordingly, products and services subject to section 272 need not meet the 50 percent threshold in order for a BOC to record the transaction involving such products and services at prevailing price. ii. Valuation Methods for Assets and Services. 138.In the Joint Cost Order, we did not prescribe uniform valuation methods for all affiliate transactions. The Part 64 cost allocation rules direct subject carriers to use different methods to value transfers of assets and transfers of services. In the NPRM, we proposed to direct carriers to apply the valuation method currently prescribed for asset transfers to service transfers. The NPRM did propose, however, to continue to define the cost of asset transfers in terms of net book cost and the cost of service transfers in terms of fully distributed costs. We sought comment on whether these proposed modifications to the affiliate transactions rules would meet the objectives of section 272 better than the existing rules. We asked commenters to discuss whether, and under what circumstances, we should allow carriers and their affiliates to use any alternative valuation methods. We also sought comment on how the elimination of a sharing obligation from our price cap rules would affect the validity of our tentative conclusion in the Affiliate Transactions NPRM that our treatment of the provision of services that are neither tariffed nor subject to prevailing company prices may reward a carrier's imprudent acts of buying services from affiliates for more than, and selling services to affiliates for less than, fair market value. 139.Section 272(e)(3) requires that "[a] Bell operating company and an affiliate that is subject to the requirements of section 251(c) . . . shall charge the affiliate described in subsection (a) or impute to itself (if using the access for its provision of its own services), an amount for access that is no less than the amount charged to any unaffiliated interexchange carriers for such service." Section 272(e)(4) states that "[a] Bell operating company and an affiliate that is subject to the requirements of section 251(c) . . . may provide any interLATA or intraLATA facilities or services to its interLATA affiliate if such services or facilities are made available to all carriers at the same rates and on the same terms and conditions, and so long as the costs are appropriately allocated." We also sought comment on how these requirements should affect our rules for implementing the "arm's length" requirement of section 272(b)(5). In addition, we invited comment on whether we should adopt specific accounting procedures to address the difference, if any, between the rates charged by BOCs when they provide interLATA or intraLATA facilities or services on a separated basis and "the costs [that would be] appropriately allocated" for the underlying facilities or services. Comments: 140.Many commenters, including AT&T, Wisconsin PSC and GSA, support the Commission's proposal to conform the valuation methods under the affiliate transactions rules governing service transfers and asset transfers. Several of these commenters argue that the current valuation method for services does not adequately ensure compliance with section 272(b)(5)'s "arm's length" requirement because it rewards a carrier for buying services from affiliates at more than, and selling them to affiliates for less than, fair market value. AT&T further contends that our current valuation rules, by allowing a carrier to sell services for less than fair market value, would allow carriers to violate section 254(k)'s prohibition against cross-subsidizing competitive operations. 141.The BOCs and Sprint oppose the Commission's proposed change to the affiliate transactions rules. They argue that any attempt to establish fair market value for services would prove inherently subjective. USTA and several BOCs note that in our reconsideration of the Joint Cost Order, we rejected a similar proposal to utilize estimates of fair market value for the transfer of services, stating that "such a valuation standard is fraught with potential for abuse, and would be difficult to monitor." PacTel argues that section 272(e)(2)'s nondiscrimination requirement has eliminated any potential for harm. PacTel further contends that the Commission should not require fair market valuation for governance functions provided to carriers by their regional holding companies. BellSouth contends that application of the "asset transfer rules" to transactions involving services will require the BOCs and their affiliates to incur hundreds of millions of dollars in increased annual administrative cost. 142. APCC argues that the Commission should adopt a rule that requires carriers to value services at the lower of fully distributed costs and estimated fair market value when it is the purchaser with a price ceiling set at prevailing price. APCC contends that prevailing price serves as a check to ensure that the carrier has not overstated the price determined using the lower of fully distributed costs and estimated fair market value, preventing an affiliate from charging its affiliated carrier more than a competitor. APCC similarly argues that the Commission should set a price floor at prevailing price when the carrier is the seller. 143.AT&T argues that with regard to the requirements of section 272(e)(3), the BOC must charge its affiliate, at a minimum, the tariffed rate for access services. AT&T maintains that the Commission should require a BOC's interLATA affiliate to reflect these access charges in end-user rates, at least as long as the BOC retains dominance in the provision of exchange access services. AT&T asserts that the Commission should impose price floors for interLATA services at a level equal to a BOC's access charges plus the incremental cost of the non-access portions of the service to ensure an affiliate's imputation of access charges. Discussion: 144.In the Joint Cost Proceeding, we considered identical valuation methods for assets and services. These methods would have required carriers to record all affil