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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 ) AAD 96-169 Petition for Waivers Filed by ) ) Columbine Telephone Company, Inc., ) Silver Star Telephone Company, Inc., and ) U S WEST Communications, Inc. ) ) Concerning Section 61.41(c)(2) and 69.3(e)(11) ) and the Definition of "Study Area" ) Contained in the Part 36 Appendix-Glossary ) of the Commission's Rules ) MEMORANDUM OPINION AND ORDER Adopted: March 12, 1997 Released: March 12, 1997 By the Chief, Accounting and Audits Division Common Carrier Bureau: I. INTRODUCTION 1. On October 11, 1996, Columbine Telephone Company, Inc. ("Columbine"), Silver Star Telephone Company, Inc. ("Silver Star"), and U S WEST Communications, Inc. ("U S WEST") filed a joint petition for waiver of various Commission rules. The petitioners seek waivers of the definition of "Study Area" contained in the Part 36 Appendix-Glossary of the Commission's rules. The requested waivers would allow U S WEST to alter the boundaries of its existing Idaho study area and allow Columbine, an affiliate of Silver Star, to create a new study area to reflect the sale of three exchanges from U S WEST to Columbine. Columbine also seeks a waiver of the price cap rule contained in Section 61.41(c)(2) of the Commission's rules. This rule requires non-price cap companies, and the telephone companies with which they are affiliated, to become subject to price cap regulation after acquiring a price cap company or any part thereof. The requested waiver would permit Columbine to remain under rate-of-return regulation after acquiring the exchanges that currently are under price cap regulation. Finally, Columbine seeks a waiver of Section 69.3(e)(11) of the Commission's rules, if necessary, so that it may be an issuing carrier in the National Exchange Carrier Association ("NECA") common line tariffs. 2. On November 6, 1996, the Common Carrier Bureau ("Bureau") released a public notice soliciting comments on the joint petition. The petitioners also provided additional information concerning the joint petition. In this Order, we find that the public interest would be served by allowing U S WEST to alter its study area boundaries and by permitting Columbine to continue operating under rate-of-return regulation after acquiring the exchanges. We also find that the public interest would not be served by allowing Columbine to establish a new study area; instead, Columbine should combine its purchased exchanges with the Silver Star study area. We therefore grant the joint petition, in part, as explained below. II. STUDY AREA WAIVERS A. Background 3. A study area is a geographic segment of an incumbent local exchange carrier's ("ILEC") telephone operations. Generally, a study area corresponds to an ILEC's entire service territory within a state. Thus, ILECs operating in more than one state typically have one study area for each state, and ILECs operating in a single state typically have a single study area. Study area boundaries are important primarily because ILECs perform jurisdictional separations at the study area level. For jurisdictional separations purposes, the Commission froze all study area boundaries effective November 15, 1984. The Commission took that action primarily to ensure that ILECs do not set up high-cost exchanges within their existing service territories as separate study areas to maximize interstate cost allocations. An ILEC must apply to the Commission for a waiver of the frozen study area rule if it wishes to sell or purchase an exchange. 4. Waiver of Commission rules is appropriate only if special circumstances warrant deviation from the general rule and such a deviation will serve the public interest. In evaluating petitions seeking a waiver of the rule freezing study area boundaries, the Commission employs a three-prong standard: first, the change in study area boundaries does not adversely affect the universal service fund ("USF") support program; second, the state commission(s) having regulatory authority over the exchange(s) to be transferred does not object to the change; and third, the public interest supports the change. 5. The Commission's concern about adverse USF impacts was mitigated, in the short term at least, by its adoption of the Joint Board's recommendation for an indexed cap on the USF. The Commission nonetheless recognized that, even in the short term, the granting of a study area waiver may adversely affect the fund's distribution, if not its size. Under the indexed USF cap rules, any study area reconfiguration that increases the USF draw of one USF recipient often reduces that of other USF recipients. Consequently, in evaluating whether a study area change would have an adverse impact on the distribution or level of the USF, the Commission applies a "one-percent" guideline to study area waiver requests filed after January 5, 1995. Under this guideline, no study area waiver is granted if it would result in an annual aggregate shift in USF assistance in an amount equal to or greater than one percent of the total USF, unless the parties can demonstrate extraordinary public interest benefit. To prevent ILECs from evading this limitation by disaggregating a single large sale of exchanges into a series of smaller transactions that in the aggregate have the same effect on the USF, the Commission further requires that the guideline be applied to all study area waivers granted to either ILEC, as a purchaser or seller, pending completion of the current review of the universal service program. B. Pleadings 6. U S WEST serves approximately 393,000 access lines in Idaho. U S WEST plans to sell three Idaho exchanges, serving 3,126 access lines, to Columbine, which currently operates only in Colorado. Silver Star, an affiliate of Columbine, serves approximately 500 access lines in Idaho. U S WEST seeks waiver of the rule freezing study area boundaries to enable it to remove the three exchanges from its Idaho study area. Columbine also seeks waiver of that rule to create a new study area separate from its affiliate, Silver Star. 7. Petitioners state that, according to the Idaho Public Utilities Commission findings, the proposed changes would serve the public interest because service will improve with a small, local telephone provider. The petitioners state that Columbine plans an extensive upgrade of telephone facilities. The petitioners also state that Columbine has an obligation to replace the switches to provide CLASS features and access to the Internet. Specifically, the petitioners state that Columbine plans to replace all switches with digital technology operating in a host-remote configuration. In addition, the petitioners state that Columbine plans to modernize outside plant by installing digital loop carrier and new cable. Further, the petitioners state that Columbine plans to replace and upgrade existing air core cable and aerial wire facilities and modernize the transmission facilities. Finally, the petitioners state that Columbine plans to purchase new telephone facilities in order to meet the projected growth of the exchanges being purchased. 8. Columbine states that it proposes to acquire the U S WEST assets as part of a tax free exchange of assets, pursuant to Section 1031 of the Internal Revenue Service ("IRS") Code. Columbine states that because the IRS imposes a number of restrictions on Section 1031 transactions, the most important of which, is that the purchasing company must maintain its independent identity without commingling acquired assets and ongoing operations with affiliated corporations, it should be allowed to establish a separate study area. 9. The petitioners state that, if Columbine were to establish a new study area for its purchased exchanges, its annual USF support would be $1,300,285. Silver Star states that it currently receives $137,821 in annual USF support. The petitioners also state that, if Columbine's purchased exchanges were to be combined with Silver Star's study area, the combined study area would receive $1,338,773 in USF support. The petitioners state that the exchange transfer would have no effect on U S WEST's USF assistance because U S WEST does not and will not qualify for USF assistance before or after the sale. C. Discussion 10. Request for waivers. We have reviewed the data the petitioners filed with NECA and the estimates filed in this proceeding and have determined that the net increase in USF draws will not have a substantial adverse impact on the USF total or on individual ILEC draws. In addition, the Idaho Public Utilities Commission does not object to these requested waivers. The upgrades planned by Columbine should improve customer service in the three exchanges. We believe the petitioners have demonstrated that their customers will likely be well served by Columbine, and therefore, the requested study area waivers are likely to serve the public interest. As a result, we find that the three-prong standard for granting a study area waiver has been met and that the waiver requests should be granted. 11. Request for separate study area. In order to comply with Commission policy, Columbine's and Silver Star's data must be combined as one study area. This does not mean that Columbine and Silver Star cannot be operated as two separate companies. Rather, it merely requires that their cost data must be combined in determining costs for interstate ratemaking purposes. 12. As explained above, the primary intent of the study area freeze rule is to prohibit ILECs from setting up exchanges within their service territories as separate study areas to maximize USF support. ILECs would have no incentive to do this if USF assistance were distributed on an exchange basis. Yet, because it is distributed on a study area basis, an ILEC's USF payment is often greater if it can isolate exchanges in one or more separate study areas. Such action permits the ILEC to report average loop cost in the high-cost study areas further above the USF eligibility threshold than would be possible if the exchanges remained consolidated with lower-cost exchanges. Hence, the creation of a new study area would enable these companies to gain an advantage under the USF support rules or the small carrier assistance rules. In conclusion, we find that in this case, where ILECs will be operating in the same state, the creation of an additional study area is unwarranted. Therefore, the request of Columbine for a new study area is denied. 13. Need for imposed limits on USF draws. Although we find no reason to question Columbine's estimates of the USF impact, we nonetheless are concerned that those estimates may later prove inaccurate when the planned upgrades are completed. We have found that, even in a period of a few years, the USF payments for some ILECs have risen by unexpected amounts. These ILECs generally had undertaken substantial upgrades or expansions of the local network in difficult-to-serve, sparsely populated exchanges that are similar to the exchanges being acquired by Columbine. 14. We therefore find that the waivers should be subject to the condition that, absent explicit approval from the Bureau, the annual USF support provided to Columbine's and Silver Star's combined study area shall not exceed $1,338,773. We note that the Telecommunications Act of 1996, which became effective on February 8, 1996, requires the reform by May 8, 1997, of many mechanisms the Commission uses to support its universal service goals, including the USF. It is likely that any new universal service rules will alter the method used to determine the distribution of USF support to high-cost areas, thereby changing the projected level of support to the petitioner's study area. This, in turn, may require us to revisit this issue, and the related waiver condition that we have established herein. III. PRICE CAPS WAIVER A. Background 15. Section 61.41 of the Commission's rules provides that, when a cost company acquires a price cap company, the acquiring company, and any ILEC with which it is affiliated, shall become subject to price cap regulation within a year of the transaction. The Commission stated that this "all-or-nothing" rule applies not only to the acquisition of an entire ILEC but also to the acquisition of part of a study area. U S WEST is a price cap company and Columbine is a cost company. Hence, Columbine's acquisition of a U S WEST exchange would obligate it to become subject to price cap regulation. 16. The Commission explained that the all-or-nothing rule is intended to address two concerns it has regarding mergers and acquisitions involving price cap companies. The first concern is that, in the absence of the rule, an ILEC might attempt to shift costs from its price cap affiliate to its non-price cap affiliate, allowing the non-price cap affiliate to earn more, due to its increased revenue requirement, without affecting the earnings of the price cap affiliate, i.e., without triggering the sharing mechanism. The second concern is that, absent the rule, an ILEC may attempt to "game the system" by switching back and forth between rate-of-return regulation and price cap regulation. The Commission noted, as an example, the incentive a price cap company may have to increase earnings by opting out of price cap regulation, building up a large rate base under rate-of-return regulation so as to raise rates and, then, after returning to price cap, cutting costs back to an efficient level. It would disserve the public interest, the Commission stated, to allow an ILEC to alternately "fatten up" under rate-of-return regulation and "slim down" under price cap regulation, because rates would not fall in the manner intended under price cap regulation. 17. The Commission nonetheless recognized that a narrow waiver of the all-or-nothing rule might be justified if efficiencies created by the purchase and sale of a few exchanges were to outweigh the threat that the system may be subject to gaming. Such a waiver would not be granted unconditionally, however. Rather, waivers of the all-or-nothing rule would be granted subject to the condition that the selling price cap company shall make a downward adjustment to its price cap indices to reflect the change in its study area. That adjustment is needed to remove the effects of the transferred exchanges from rates that have been based, in whole or in part, upon the inclusion of those exchanges in the study areas subject to price cap regulation. B. Pleadings 18. Petition. Columbine seeks waiver of Section 61.41(c)(2) so it may operate as a rate-of- return ILEC, rather than a price cap ILEC, after acquiring the exchanges which currently are under price cap regulation. The petitioners argue that Columbine is the type of small rural ILEC which the Commission has found to be an inappropriate candidate for price cap regulation. In addition, the petitioners state that in balancing the benefits to be gained under price cap regulation against the costs which would be incurred by Columbine, the public interest is better served by a grant of the requested waiver. The petitioners further argue that the Commission's two concerns, the threat of cost shifting between affiliates and gaming of the system, are not at issue in this case. C. Discussion 19. We agree with the petitioners that the Commission's first concern underlying the all-or- nothing rule is not applicable in this case. Columbine cannot shift costs between price cap and cost affiliates, because it is not seeking to maintain separate affiliates under different systems of regulation. As to the Commission's second concern, we find it implausible that the petitioners could game the system by moving the exchanges back and forth between price cap and other forms of regulation, because the petitioners would require a second study area waiver. Moreover, U S WEST cannot transfer the exchanges without removing the rate-increasing effects of the exchanges from the price-capped rates that have been based, in part, upon the inclusion of these exchanges in its Idaho study area. 20. We therefore find there is good cause to grant Columbine waiver of the all-or-nothing rule to permit it to remain under rate-of-return regulation after acquiring the exchanges which currently are under price cap regulation. As noted above, this waiver is subject to the condition that U S WEST shall make a downward adjustment to its price cap indices to reflect the removal of the three exchanges from its Idaho study area. For the present, we will continue to regulate Columbine as a rate-of-return ILEC. Because we are waiving Section 61.41(c)(2), it need not withdraw from the NECA pools. We note that, as with any other rate-of-return ILEC, Columbine may elect price cap regulation in the future if it decides to withdraw from the NECA pools. IV. OTHER ISSUES 21. To the extent necessary, Columbine seeks a waiver of Section 69.3(e)(11) of the Commission's rules. That rule requires that any changes in NECA carrier common line tariff participation and long term support resulting from a merger or acquisition of telephone properties are to be made effective on the next annual access tariff filing effective date following the merger or acquisition. Columbine is concerned that under a strict interpretation of this rule it, rather than NECA, would be required to file a tariff on the next annual access tariff filing date. Assuming its acquisition occurs this year, Columbine represents that it plans to utilize NECA as its interstate tariff administrator; consequently, Columbine's carrier common line costs will be included in NECA's 1997 filing. We conclude that Columbine is not required to make a separate annual access filing for its carrier common line costs, and therefore, a waiver of Section 69.3(e)(11) is not required. V. ORDERING CLAUSES 22. Accordingly, IT IS ORDERED, pursuant to Sections 1, 4(i), 5(c), 201 and 202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201 and 202, and Sections 0.91, 0.291, and 1.3 of the Commission's rules, 47 C.F.R.  0.91, 0.291, and 1.3, that the Joint Petition of Columbine Telephone Company, Inc., Silver Star Telephone Company, Inc., and U S WEST Communications, Inc. for waiver of Part 36, Appendix-Glossary, of the Commission's rules, 47 C.F.R. Part 36 Appendix-Glossary IS GRANTED subject to the condition stated in paragraph 14 of this Order. 23. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201 and 202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201 and 202, and Sections 0.91, 0.291, and 1.3 of the Commission's rules, 47 C.F.R.  0.91, 0.291, and 1.3, that the Joint Petition of Columbine Telephone Company, Inc. for waiver of Part 36, Appendix-Glossary, of the Commission's rules, 47 C.F.R. Part 36 Appendix-Glossary IS DENIED as to the establishment of a new study area containing the acquired exchanges. 24. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201 and 202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201 and 202, and Sections 0.91, 0.291, and 1.3 of the Commission's rules, 47 C.F.R.  0.91, 0.291, and 1.3, that the Joint Petition of Columbine Telephone Company, Inc. for waiver of Section 61.41(c)(2) of the Commission's rules, 47 C.F.R.  61.41(c)(2), IS GRANTED. 22. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201 and 202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201 and 202, and Sections 0.91, 0.291, 1.3, and 61.43 of the Commission's rules, 47 C.F.R.  0.91, 0.291, 1.3, and 61.43, that U S WEST Communications, Inc. SHALL adjust its price cap indices as discussed in paragraph 20 above, to reflect, in its 1997 annual price cap filing, cost changes resulting from this and other transactions involving the sale of exchanges. 23. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201 and 202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201 and 202, and Sections 0.91, 0.291, and of the Commission's rules, 47 C.F.R.  0.91, 0.291, and 1.3, that the National Exchange Carrier Association shall not distribute USF assistance exceeding the limit imposed in paragraph 14 of this Order. 24. IT IS FURTHER ORDERED, pursuant to Sections 1, 4(i), 5(c), 201 and 202 of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 155(c), 201 and 202, and Sections 0.91 and 0.291 of the Commission's rules, 47.C.F.R.  0.91, 0.291, that this Order IS EFFECTIVE IMMEDIATELY UPON RELEASE. FEDERAL COMMUNICATIONS COMMISSION Kenneth P. Moran Chief, Accounting and Audits Division Common Carrier Bureau