FCC Puts Providers “Exploiting Loopholes” Under Fire (Finally)

JSI Capital Advisors continues its detailed analysis of the 759-page USF/ICC Reform Order by looking at the FCC’s new rules for curbing access stimulation and phantom traffic—two forms of access charge arbitrage, which together have likely cost the telecom industry and consumers hundreds of millions of dollars per year. The new rules to reduce arbitrage are not especially drastic, and for the most part reflect the FCC’s initial recommendations in the USF/ICC NPRM. The intention is that these new rules, in conjunction with the overall transition to bill-and-keep, will eventually eliminate access stimulation and phantom traffic…and hopefully not give rise to new forms of arbitrage along the way.

Access Stimulation – A Two-Prong Definition  

Access stimulation is a pervasive problem that “occurs when a LEC with high-switched access rates enters into an agreement of high call volume operations such as chat lines, adult entertainment calls, and ‘free’ conference calls.” The FCC explains, “the arrangement inflates or stimulates the access minutes terminated to the LEC, and the LEC then shares a portion of the increased access revenues resulting from the increased demand with the ‘free’ service provider, or offers some other benefit to the ‘free’ service provider….Meanwhile, the wireless and interexchange carriers (collectively IXCs) paying the increased access charges are forced to recover these costs from all their consumers.” The FCC claims that access stimulation “imposes undue costs on consumers,” has cost IXCs over $2b in the last five years, and harms competition especially in the conference calling market.

A sudden jump in traffic can equal a boon for the LEC because “they are currently not required to reduce their access rates to reflect their increased number of minutes.” Not all situations that result in drastically increased traffic are a result of an access stimulation scheme, and may occur if a new call center or other call-heavy business moves into the area. However, the FCC is hoping that the new rules will weed out the “bad actors” and ensure that access rates are not “unjust and unreasonable under section 201(b) of the Act.”

The FCC adopts a definition of access stimulation that includes two conditions, and “if both conditions are satisfied, the LEC generally must file revised tariffs to account for its increased traffic:”

1. A revenue sharing condition
2. An additional traffic volume condition, achieved by either a 3:1 interstate terminating-to-originating traffic ratio in one month; or a greater than 100% growth in interstate originating and/or terminating traffic compared to the same month in the previous year

To help identify LECs who may be engaging in access stimulation, IXCs can file “complaints based on evidence from their traffic records.” Following a complaint, the LEC has the burden of proof to “establish that it has not met the access stimulation definition and therefore that it is not in violation.” The FCC explains that it adopted the two-prong definition for access stimulation because “the use of a revenue sharing approach alone was criticized by some as being ambiguous, circular, or a poor indicator of access stimulation.” The definition that the FCC adopts for revenue sharing arrangements is contingent on a net payment from the LEC to its revenue sharing-partner. The FCC believes that this definition “best identifies the revenue sharing agreements likely to be associated with access stimulation and thus those cases in which an LEC must re-file its switched access rates.”

The traffic volume condition has two triggers in order to “address the shortcomings of using either component separately.” The FCC intends for the 100% growth trigger to act as backup insurance in case a carrier tries to “game” the 3:1 ratio trigger: “The traffic growth component protects against this possibility because increasing originating access traffic to avoid tripping the 3:1 component would likely mean that total access traffic would increase enough to trip the growth component.”

Once it has been determined that a LEC is engaged in access stimulation, the carrier must file a revised tariff “except under limited circumstances.” RLECs and CLECs cannot file a new tariff again until their revenue sharing agreements are terminated, even if the 3:1 or traffic growth conditions are no longer met. Access stimulating RLECs are also no longer able to base rates on historical costs and demand, and cannot participate in NECA tariffs. Carriers who are currently engaged in access stimulation have a bit of a window to end this behavior before facing the consequences: “If a carrier sharing access revenues terminates its access revenue sharing agreement before the date on which its revised tariff must be filed, it does not have to file a revised tariff,” because “traffic patterns should return to levels that existed prior to the LEC entering into the access revenue sharing agreement.”

One last point worth mentioning about the access stimulation rules is that CLECs engaged in access stimulation have to benchmark their interstate switched access rates to the lowest in the state, and the FCC concludes “the lowest interstate switched access rate of a price cap LEC in the state” is the appropriate benchmark.

Overall, the FCC anticipates that “the approach we adopt will reduce the effects of access stimulation significantly, and the intercarrier compensation reforms we adopt should resolve remaining concerns.”

Phantom Traffic – “Gamesmanship is Rife”

Phantom traffic in the most basic sense, “refers to traffic that terminating networks receive that lacks certain identifying information.” The FCC further explains, “In some cases, service providers in the call path intentionally remove or alter identifying information to avoid paying the terminating rates that would apply if the call were accurately signaled and billed.” The FCC estimates that the problems are “widespread,” and anywhere from 3-20% of all traffic is missing identifying information. This costs carriers and consumers “potentially hundreds of millions of dollars annually.”

The FCC is taking a straightforward approach to reducing phantom traffic—simply requiring that certain identifying information be included in PSTN and VoIP calls. As with access stimulation, the FCC is adopting its recommendations from the NPRM with some minor modifications. The new rule is as follows, which the FCC anticipates “will assist service providers in accurately identifying billing for traffic terminating on their network, and help guard against further arbitrage practices:”

Service providers that originate interstate or intrastate traffic on the PSTN, or that originate inter- or intrastate interconnected VoIP traffic destined for the PSTN, will now be required to transmit the telephone number associated with the calling party to the next provider in the call path. Intermediate providers must pass calling party number (CPN) or charge number (CN) signaling information they receive from other providers unaltered, to subsequent providers in the call path.

The FCC believes that requiring all telecommunications providers (PSTN and interconnected VoIP) to maintain the integrity of the calling party information, and prohibiting the stripping or alternation of such information, is in the public interest. The FCC is not allowing any general exceptions to the phantom traffic rule, for example if a carrier does not have the technical feasibility to comply. However, “parties seeking limited exceptions or relief” can file a waiver.

Simple and straightforward, right? The FCC maintains that the phantom traffic rule “is consistent with our goal of helping to ensure complete and accurate passing of call signaling information, while minimizing disruption to industry practices or existing carrier agreements;” and “should significantly reduce the amount of unbillable traffic that terminating carriers receive.”

Do you think that the FCC’s access stimulation and phantom traffic rules will get to the root of the problems? Will the rules provide necessary relief for the carriers and consumers who are pulled into these costly arbitrage schemes, and prevent future arbitrage schemes from arising? The rules appear to be very uncontroversial, obvious and easy remedies; and it is almost surprising that they have not been adopted sooner.

Coming up next, we will take a look at the new bill-and-keep ICC transformation regime that surely has some RLECs quite concerned.

The full FCC Order is available here, with access stimulation and phantom traffic rules covered on pages 209-240.

FCC Acknowledges Complementary Nature of Fixed and Mobile Broadband

Earlier this week, JSI Capital Advisors gave a first look at the overall Universal Service Fund reforms for price cap and rate-of-return LECs, but now we are switching gears and diving into the newly-established, first-of-its-kind Mobility Fund intended for both rapid and longer-term mobile network deployment and recovery. Overall, the Mobility Fund text contained some surprises, some departures from last year’s Mobility Fund NPRM and some potential opportunities for small wireless carriers.

The first phase of the Mobility Fund, expected to be implemented before the end of 2012, “will provide one-time support through a reverse auction, with a total budget of $300 million, and will provide the Commission with experience in running reverse auctions for universal service support.” Reverse auctions are uncharted waters, and the precise methodology will primarily be determined by the Wireless and Wireline Bureaus in forthcoming proceedings. However, the FCC did lay down some ground rules which are discussed at greater detail below. Perhaps the biggest “win” in the Mobility Fund comes in Phase II, which will distribute up to $500m annually (including $100m specifically for Tribal Lands). The initial Mobility Fund NPRM recommended a one-time investment of $100-300m only, but due to outcries from the wireless industry the FCC decided to implement a dedicated annual mobile broadband fund.

Phase I – A “Jump Start” to Reducing Mobility Gaps

The one point that the FCC emphasizes repeatedly about Phase I is that it is one-time funding intended for one provider per unserved area to rapidly deploy mobile voice and broadband. This does not mean that Phase I funding is specifically intended to go to the highest-cost areas—those problems will be solved with Phase II and the new $100m/year Remote Areas fund. The FCC intends to support only one carrier per unserved area (based on census blocks), because “permitting multiple winners as a routine matter in any geographic area to serve the same pool of customers would drain Mobility Fund resources with limited corresponding benefits to consumers.” However, there may be occasional overlaps in supported service areas so long as the separate carriers are adding to the number of road miles served in an unserved area and not both serving the same customers. The FCC is ardently hoping to avoid a repeat of the current CETC situation, where multiple carriers receive funding without actually improving service in unserved areas. Mobility funding is also not intended for carriers to use to complete existing deployment plans or other regulatory commitments.

The FCC attacks many of the arguments presented in last year’s Mobility Fund NPRM comments, including the argument that Phase I will not provide “sufficient and predictable support.” The FCC contends that “Bidders are presumed to understand that Mobility Phase I will provide one-time support, that bidders will face recurring costs when providing service, and that they must tailor their bid amounts accordingly.” The FCC also defends the reverse auction mechanism: “we believe it is the best available tool” for identifying areas in need of mobile voice and broadband deployment “in a transparent, simple, speedy and effective way.”

Many small wireless carriers showed great concern that the reverse auction process would unfairly favor large companies, with some commenters even requesting that Tier I carriers, like Verizon Wireless, be barred from participating. Unfortunately, the FCC was “unpersuaded” by these arguments and insists that there will be “opportunities for smaller providers to compete effectively at auction.” Furthermore, parties such as the Blooston Rural Carriers argued that reverse auctions would “lead to construction and equipment short-cuts due to cost cutting measures,” but the FCC held that there will be “clear performance standards and effective enforcement of those standards.”

So what are the standards, methodologies and enforcement measures? Much of the auction methodology will be determined via future proceedings, but the FCC set a fairly clear framework. Some of the Mobility Fund Phase I rules and guidelines include:

• Unserved areas will be determined on a census block basis, support can be offered for groups of unserved census blocks (census tracts).
• Road miles are the unit of measurement, not population.
• American Roamer data will be used to determine unserved areas: “American Roamer data is recognized as the industry standard for the presence of service.” Although it is not perfect, the FCC felt that American Roamer data was better than the National Broadband Map, where “inconsistencies with respect to wireless service have been noted.”
• The Bureaus will decide if census blocks can be aggregated, or if there will be a minimum eligible area for bidding.
• There will be no prioritization of unserved areas, and all unserved areas are equally eligible.
• Recipients are required to provide 3G or 4G service. The 3G floor is 200/50 kbps and the 4G floor is 768/200 kbps throughout the entire cell area (edge included). However, speeds will most likely be much higher near the base station to reflect the 4/1 Mbps CAF standard.  
• Recipients will have 2 years to deploy 3G or 3 years to deploy 4G; in either case at least 75% of the road miles must be covered. The percent of support received will also be contingent on the percent of road miles that must be served, as determined by the Bureaus.
• Recipients who build new towers with the funding must allow for collocation, they must also comply with voice and data roaming requirements. Noncompliance could result in sanctions, penalties, and ineligibility for future funding.
• Rates and data capacity must be reasonably comparable to urban areas.
• Eligibility will be based on 3 criteria: ETC designation, access to spectrum for at least five years, and demonstrated financial and technical capability. There will be a short-form and long-form application process akin to spectrum auctions.
• Funding to winners will be distributed in 3 installments: one-third when the long-form application is approved, one-third when 50% of the recipient’s minimum requirement is served, and the final one-third once the project’s requirements are fully met.

One aspect that was particularly positive was that the FCC seemed to acknowledge the complementary nature of fixed and mobile broadband by not excluding census blocks served by fixed services from receiving Phase I support. According to the FCC, “The ability to communicate from any point within a mobile network’s coverage area lets people communicate at times they may need it most, including during emergencies. The fact that fixed communications may be available nearby does not detract from this critical benefit.”

Phase II - Hello $500m Annual Budget, Goodbye Identical Support Rule

Although many of the details of Phase II are yet to be worked out, the FCC explains that Phase II will include “a budget of $500 million to promote mobile broadband…where a private sector business case cannot be met without federal support.” $100m will be dedicated specially to Tribal Lands (which will be discussed in a future article). The FCC believes that this budget is appropriate. Although it is less than CETC Identical Support in recent years, the $500m/year “will be sufficient to sustain and expand the availability of mobile broadband.” Furthermore, “mobile providers may also be eligible for support in CAF 1 areas where price cap carriers opt not to accept the state-level commitment, in addition to Mobility Phase II support.”

The trade-off of course is that the much-maligned Identical Support Rule will be eliminated. The FCC explains that in 2010, “about $611 million went to one of the four national wireless providers,” and $579m went to small and mid-sized wireless carriers (out of $1.2b total). According to the FCC, “identical support does not provide appropriate levels of support for the efficient deployment of mobile services in areas that do not support a private business case for mobile voice and broadband.”

The intention is that the Mobility Fund will revamp support for competitive wireless carriers so that funding reflects the efficient costs of providing service in unserved and underserved areas, not the costs of overbuilding already highly competitive and well-served areas. As we saw in the details about Phase I CAF, the FCC is definitely dedicated to making sure support goes where it is needed most—areas that have little or no fixed or mobile broadband today.

What are your thoughts on the Mobility Fund and the elimination of the Identical Support Rule?

The full USF Reform Order is available here, with pages 108-174 covering the Mobility Fund.

Resolution Stirs up Thoughts on USF-Related Merger Conditions

Are recently-merged Internet service providers meeting their various public interest commitments to deploy broadband and increase adoption? We know that Comcast is certainly working hard, with great fanfare, to offer broadband to low-income households for $10 per month—this was indeed a merger commitment, not a “warm fuzzy” gift to the public. Comcast’s required move into affordable broadband for low-income households has been applauded by FCC Chairman Genachowski, who also recently unveiled the FCC’s low-income broadband initiative Connect to Compete. Now, many other large cable providers are jumping on the $10 per month broadband bandwagon—including companies who are not obliged to do so due to a merger condition.

Comcast’s slightly fulsome, PR-friendly efforts aside; are other recently merged telecom providers (large and small, cable and DSL, wireless and wired) meeting their merger conditions to deploy broadband to rural, low-income and other unserved populations? The National Association of Regulatory Utility Commissioners (NARUC) is concerned that “some commitments to deploy additional broadband infrastructure made to secure merger approvals are not being fully met.”

On November 16, 2011, NARUC approved a resolution to “Request that the [FCC] undertake a public inquiry to assess the extent to which public interest broadband deployment and adoption obligations imposed on previously approved merger applicants are being met.” NARUC’s Resolution on Accountability for FCC Imposed Merger Public Interest Commitments to Deploy Broadband Infrastructure and Adoption Programs recognizes that the FCC can (and often does) impose obligations that merged companies increase broadband adoption and deployment, sometimes with an aggressive deadline. The resolution also recognizes that the FCC can require merged companies to use private capital to meet these obligations, “without reliance on federal Universal Service Fund (USF) financial support.”

This resolution stirs up some interesting, and slightly touchy, ideas about whether the FCC should prevent merged companies from receiving USF post-merger to meet public interest requirements. According to the NARUC resolution, “Some carriers have made voluntary public interest commitments to deploy broadband infrastructure on the basis that USF financial support would enable them to satisfy the FCC approved merger obligation and the FCC has approved those commitments.”

NARUC resolved “That the FCC consider, on a case-by-case basis whether to approve the use of federal financial support from the Connect America Fund or the Mobility Fund for expenses related to supplementing an applicant’s public interest obligations in the FCC order approving such applicant’s merger to deploy broadband infrastructure and/or to implement broadband adoption and usage programs.”

On one hand, two companies’ demonstrated need for USF to deploy broadband in rural areas is not likely to change significantly just by a merger. Their service area’s geography and demographics certainly don’t change due to a merger, and the reasons that small companies decide to merge are diverse and not always just because one company has a stockpile of cash. The addition of a lofty build-out commitment may make the case for needing USF even stronger, especially for capital-strapped rural carriers. On the other hand, one can’t help but think that if companies have enough money to afford a merger, then perhaps they should use that money to pay for broadband deployment. This argument may apply more strongly to large companies, for example AT&T. It would be hard to argue that AT&T should be allowed to receive Mobility Fund support if the T-Mobile merger is approved—which will quite likely include major rural deployment conditions (if it is approved by the FCC, that is—a big if!).

Whether companies should receive CAF or Mobility Fund support to help finance merger commitments is probably best determined on a case-by-case basis, like NARUC recommends. A blanket restriction on support may serve as a significant deterrent for small companies who wish to merge—which might be the exact opposite of what the FCC wants. The FCC has repeatedly dropped hints throughout the USF Reform proceeding that it wishes to encourage RLEC consolidation, so tactically speaking the FCC probably would consider taking a cautious approach to restricting support. Furthermore, the FCC is strongly committed to improving rural and low-income broadband deployment and adoption, so a merger obligation to extend services in low ROI areas without any federal support seems contradictory.

Then there is Connect to Compete, which adds a layer of complexity to the USF-or-no-USF merger condition debate. National Cable and Telecommunications Association (NCTA) members will offer eligible, school-lunch program families two years of cable broadband service for $9.95 per month with no installation, activation or modem rental fees. This program apparently will enable 15-25 million Americans to have high-speed broadband, but keep in mind this is in large cable company territory. Whether Connect to Compete will extend into RLEC territory is unknown at this point, but it is definitely an issue to watch. RLECs competing with Connect to Compete cable participants might encounter some challenges with retaining their low-income consumers.  

Going forward, it will be interesting to see if the FCC takes up the NARUC-approved challenge to conduct on inquiry into how well companies are meeting merger commitments and if they should be using CAF/Mobility Fund support to meet said merger commitments. Are these various market and regulatory forces a deterrent for RLEC mergers? What do you think about merged companies using CAF or Mobility Fund support to help finance broadband deployment and adoption requirements?

The NARUC resolution is available here, on pages 7-8.