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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 97-73 Petition for Waivers Filed by ) ) Rural Telephone Service Company, Inc. and ) United Telephone Company of Kansas ) ) Concerning Sections 61.41(c)(2) and the ) Definition of "Study Area" Contained in the ) Part 36 Appendix-Glossary ) of the Commission's Rules ) MEMORANDUM OPINION AND ORDER Adopted: October 9, 1997 Released: October 9, 1997 By the Chief, Accounting and Audits Division Common Carrier Bureau: I. INTRODUCTION 1. On May 29, 1997, Rural Telephone Service Company, Inc. ("Rural") and United Telephone Company of Kansas ("United") filed a petition for waiver of the definition of "Study Area" contained in the Part 36 Appendix-Glossary of the Commission's rules. The requested waivers would allow Rural and United to alter the boundaries of their existing Kansas study areas to reflect the sale of two rural telephone exchanges from United to Rural. Rural also seeks a waiver of 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 Rural to be regulated under rate-of-return regulation after acquiring the exchanges that are currently under price cap regulation. 2. On June 13, 1997, the Common Carrier Bureau ("Bureau") released a public notice soliciting comments on the petition. In this Order, we find that the public interest would be served by allowing Rural and United to alter their study area boundaries and by allowing Rural to be regulated under rate-of-return regulation after acquiring the exchanges from United. We therefore grant the petition as explained more fully 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. In recent years the Commission has taken a number of steps to mitigate potential adverse effects on the USF. Beginning in 1993 it adopted a series of orders that established indexed caps on the growth of the total USF. In addition, earlier this year the Commission adopted an Order implementing the universal service provisions of the Telecommunications Act of 1996. In that Order, the Commission decided that, eventually, all high cost area support would be provided based upon a forward-looking economic cost methodology. The Commission also determined that an indexed cap on universal service support will remain in effect until all carriers, rural and non-rural, receive support for high cost areas based upon forward-looking economic cost mechanisms. The Commission also adopted a "one-percent guideline" under which no study area waiver would be granted if it would result in an annual shift in USF assistance in an amount equal to or greater than one percent of the total USF, unless the parties demonstrate an extraordinary public interest benefit. B. Pleadings 6. United, a price cap company, currently serves approximately 75,000 access lines in Kansas. Rural, a cost company, currently serves approximately 8,739 access lines also in Kansas. United proposes to sell the Quinter and Wakeeney exchanges, serving approximately 2,761 access lines, to Rural. United seeks waiver of the rule freezing study area boundaries to allow it to remove these exchanges from its study area. Rural seeks waiver of this rule to allow it to add the purchased exchanges to its existing study area. 7. Petitioners state that the proposed expansion of Rural's study area will produce significant public interest benefits for the Quinter and Wakeeney residents and businesses. The petitioners state that Rural plans to install and maintain new Northern Telecom digital remote switches at Quinter and Wakeeney. The petitioners also state that these new remote switches will be linked with Rural's digital host switch which will permit the provision of state-of-the-art services including CLASS features. Finally, the petitioners state that the upgrades will allow Rural to honor the Modernization plan agreement between United and the Kansas Corporation Commission ("KCC"), which inter alia, calls for the provision of one-party service to all customers in the Quinter and Wakeeney exchanges. 8. The petitioners state that the transfer of the exchanges will not have an undue adverse effect on the USF. The petitioners estimate that the transfer of the two exchanges, and the planned upgrades, would result in an annual USF increase of $637,573 as shown below. ANNUAL USF DRAWS Company Before Purchase After Purchase Including Upgrades Difference Rural $3,329,269 $4,204,696 $875,427 United $7,083,401 $6,845,547 ($237,854) TOTALS $10,412,670 $11,050,243 $637,573 In addition, the petitioners state that the increased USF cost recovery will be used for the very purpose for which the USF was established: "to promote or preserve universal service by supporting improved and affordable modern telecommunications service in high cost rural areas." C. Discussion 9. Request for waivers. We have reviewed the data the petitioners filed with the National Exchange Carrier Association ("NECA") and the estimates filed in this proceeding and have determined that grant of the requested waivers would not have a substantial adverse impact on the USF total or on individual ILEC draws. In addition, the KCC states that it does not object to these requested waivers. Furthermore, Rural's planned upgrades would enable it to improve customer service in the acquired exchanges. Thus, the petitioners have demonstrated that their customers will likely be well served by Rural, and that 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 in this instance and that the waiver requests should be granted. III. PRICE CAPS WAIVER A. Background 10. 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. United is a price cap company; hence, absent a waiver, Rural's acquisition of United exchanges would obligate it to become subject to price cap regulation. 11. The Commission explained that the rules under Section 61.41(c)(2) are intended to address a concern regarding mergers and acquisitions involving price cap companies. Absent these rules, an ILEC may attempt to "game the system" by switching back and forth between rate-of-return regulation and price cap regulation. The Commission cited, 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 caps, cutting costs back to an efficient level. It would not serve the public interest, the Commission stated, to allow a carrier 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. 12. The Commission nonetheless recognized that a narrow waiver of Section 61.41(c)(2) 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 13. Petition. Rural 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 exchanges which currently are subject to price cap regulation. The petitioners argue that the Commission's concern of gaming of the system is not at issue in this case. C. Discussion 14. We find it very unlikely 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, United 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 Kansas study area. 15. We therefore find there is good cause to grant Rural 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 United shall make a downward adjustment to its price cap indices to reflect the removal of the two exchanges from its Kansas study area. IV. ORDERING CLAUSES 16. 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 petition of Rural Telephone Service Company, Inc. and United Telephone Company of Kansas for waiver of Part 36, Appendix-Glossary, of the Commission's rules, 47 C.F.R. Part 36 Appendix-Glossary IS GRANTED. 17. 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 petition of Rural Telephone Service 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. 18. 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, 61.43 and 61.45 of the Commission's rules, 47 C.F.R.  0.91, 0.291, 1.3, 61.43, and 61.45, that United Telephone Company of Kansas SHALL ADJUST its price cap indices, as discussed in paragraph 15 above, to reflect, in its annual price cap filing, cost changes resulting from this transaction. 19. 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 this Order IS EFFECTIVE IMMEDIATELY UPON RELEASE. FEDERAL COMMUNICATIONS COMMISSION Kenneth P. Moran Chief, Accounting and Audits Division Common Carrier Bureau