Traditional Regulatory Models and a VOIP World

1. Traditional Regulatory Models and a VOIP World Presented to NARUC Staff Subcommittee on Accounting and Finance October 14, 2008 Peter Bluhm Director, Telecommunications Research and Policy National Regulatory Research Institute pbluhm@nrri.org see also www.nrri.org NRRI

2. In some ways VoIP is like switched • It still has two end points. • Possible, in theory, to use “end-to-end” analysis to determine which calls are interstate. • Some VoIP systems are facilities based – cable VoiP • Possible to locate calls using E-911 technology NRRI

3. But VoIP is fundamentally different. • Customer may not use facilities owned by the service provider • “Nomadic” VoIP designed to be used on any Internet port. • With nomadic VoIP, customer location could be anywhere. • Service providers do less • Some nomadic VoIP services end when the voice call starts, and the Internet takes it from there. • VoIP is perceived differently by courts and legislators • It’s seen as a creature of the Internet, not of the telephone world. • The service provider may not be located in the state, or even in the USA. • Wiretapping and other public safety functions need to be redesigned. NRRI

4. The Vonage Decisions – high water mark • Vonage offers nomadic VoIP. FCC (2004) preempted the Minnesota commission from: • Requiring that Vonage obtain a state certificate to operate. • Applying other regulations applicable to “telephone companies,” including a requirement that Vonage provide and fund the state’s 911 services. • Dual rationale: 1. Inseverability - Vonage’s VoIP product is a jurisdictionally mixed service, containing both intrastate and interstate components, and it is impossible or impractical for VoIP providers to separate the two components. 2. Frustration of federal purpose. If interconnected VoIP service is: • A telecommunications service, then the state’s certification and tariffing requirements would frustrate the FCC’s policy of removing entry barriers and tariffing requirements in competitive telecommunications markets. • An information-service, state regulation would frustrate the FCC’s policy of minimizing regulation of information services. NRRI

5. Eighth Circuit upheld FCC (2006). • “It was proper for the FCC to consider the economic burden of identifying the geographic endpoints of VoIP communications in determining whether it was impractical or impossible to separate the service into its interstate and intrastate components.” • “Service providers are not required to develop a mechanism for distinguishing between interstate and intrastate communications merely to provide state commissions with an intrastate communication they can then regulate.” • 483 F.3d 570 NRRI

6. 2005-08 – Ebb Tide • After 2004 FCC imposed a number of traditional telephone company duties on “interconnected VoIP” providers that offer their customers at least some interaction with the PSTN. Interconnected VoIP providers must: • Offer E-911. • Contribute to federal universal service programs. • Protect customer proprietary network information. • Comply with common carrier disability access requirements. • Contribute to “TRS” programs for the hearing impaired • Make telephone numbers portable when customers change providers. • Nebraska litigation • Nebraska required interconnected VoIP providers to contribute to state USF. Carrier appealed to court. • FCC brief (2008) said Nebraska’s policy “does not frustrate any federal rule or policy. Rather, the NPSC USF Order is fully consistent with the FCC’s conclusion . . . that requiring interconnected VoIP providers to contribute to the federal universal-service fund would serve the public interest.” NRRI

7. Other challenges • Merging of platforms • TV and cable • Mobile and wireline • Breakdown of traditional intercarrier comp • Even supporters of the status quo think it’s too complex. • Separate rates for intrastate and interstate makes the problem much harder. • Increased competition from zero marginal cost services • Traditional sources of ILEC revenue eroding, but they still prefer status quo to almost any likely change. NRRI

8. Our legal structure - Rooted in the past • Dual jurisdiction • Intrastate v. interstate • Supreme Court’s 1930 decision in Smith v. Illinois Bell suggesetd this was legally fundemantal. 1934 Act carried it forward. • But, was the public ever interested? • End point analysis • Requires knowledge of originating and terminating locations. • “End-to-end” test. • Toll v. local • Reciprocal comp v. access NRRI

9. End-to-end analysis assumes switched technology • Switched technology. • Calls are set up and taken down, and they start and stop at defined times. • There is a calling party and a called party. • Party locations can be estimated by area codes and NXX’s. • Even the switched network requires some muddling through. One cannot always tell where a switched call originates or terminates. • Call forwarding • FX • Leaky PBX • FCC has repeatedly interpreted the end-to-end theory (usually by increasing its own jurisdiction). • Special access (1989) • Voice mail (1998) • DSL (1998) • Calls to ISPs (1989) • Congress, too, has made approximations • Wireless calls use billing address v. tower v. customer’s actual location NRRI

10. What keeps dual jurisdiction alive? 1. Political clout of states NRRI

11. What keeps dual jurisdiction alive? 2. Consumer protection • States are first line of consumer defense, and consumers know it. • But there are large exceptions now. • Wireless NRRI

12. What keeps dual jurisdiction alive? 3. Implicit subsidies keep local rates low, and the FCC cannot, politically or economically, replace these flows with USF. Support flows are: • High toll rates; • High business rates; • High rates for vertical and discretionary services; • High urban rates. NRRI

13. The big one - urban-to-rural support flows • What if the FCC’s interstate ratemaking principles applied to the entire cost or running an ILEC? • If FCC had 100% of loop cost, instead of 25%, SLC might be $26. (=$6.50/25%). • Or maybe $34? (=$8.50/25%). • The scale at which costs are measured determines the amount of USF needed for rural areas. • Large scale – low USF demand but high implicit support flows. • Small scale – high USF demand but low implicit support flows. • Estimating the size of the effect: Nonrural carriers only • Statewide cost averaging - $0.3 B • Costs broken out by exchange - $10 B • Costs broken out within exchanges between “donuts” and “holes” - $20 B (?) • Politically and economically, FCC cannot raise enough USF to fully preempt state jurisdiction, eliminate implicit subsides and keep rates reasonably comparable. NRRI

14. Strategies for the future • Do nothing • Will the FCC simply preempt its way around dual jurisdiction? • Rely on technology and markets • Wi-Max or similar networks could be the answer. • Rely on new legislation • Can Congress pass a bill? A good bill? NRRI

15. Two approaches to jurisdiction • Categorical - regulation flows from the essential “nature” of the service. • Interpretations of section 254(d) • Placed intrastate service revenues beyond the reach of the federal USF fund. Confused regulatory jurisdiction with taxing jurisdiction. • End of toll-local? • End of intrastate-interstate? • Pragmatic – regulation flows from the public’s needs and who can best meet them. • E.g. FCC’s decision to apply 911 duties to VoIP carriers NRRI

16. Plus and minus on categorical analysis • Agencies need to construe statutes and remain within their legal authority. • 1934 Act contains many distinctions encouraging essentialism. • Toll v. local • Interstate v. intrastate • Telecommunications services v. information services • It can be hard to identify what is essential and what is incidental.a) E.g. shelving books raises this problem. Books are classified as fiction or nonfiction What about Capote’s In Cold Blood, a nonfiction novel? NRRI

17. A pragmatic analysis Typical Questions1. What is the service?2. What is the problem with the service?3. What do customers expect of this service?4. Are customer expectations reasonable?5. What is the intervention?6. What is the best scale for intervention?7. Is a solution possible?8. What kind of program would work?9. What will be the side effects? NRRI

18. How will life at state commissions change? • Less retail rate setting • Separations unlikely to be revived, at least in anything like Part 36 rules. • Most states either have deregulated, or nearly so, in last 5 years. NRRI

19. New work – interconnectivity • More work on ensuring interconnectivity • Intercarrier disputes, at least for a while, over prices and terms • Conversion to IP networks will generate issues. • Equipment limitations on some networks will be challenged. • Some standards will need to be written down for the first time. • Many PSTN duties are legacy, duties deriving from the old Bell system or old FCC decisions. New providers are not complying with all these duties. NRRI

20. New work – overseeing markets • More mergers and acquisitions to review • More active roles in promoting private and public investment • Private investors like a clear picture of future regulatory obligations. NRRI

21. New work - managing public investment • Joint board recommended state-administered grants for broadband and wireless. • Not clear always that state commissions are equipped for non-judicial functions like broadband grants envisioned in Joint Board’s November report. • Would public ownership of facilities be useful, if it could be offered neutrally? • In some European cities government owns dark fiber but does not offer retail service. Instead, private companies compete to deliver the best service at the lowest cost. • In essence the governments there own the information highways, just like government here owns the real highways. Service is reportedly very good. NRRI

22. New work - consumer protection • Some (not necessarily more) consumer protection work. • Slamming • Early termination fees • Find ways to preserve or extend public benefits • e.g. Telecom Relay Services assuming new forms • New constraints on regulation • Some carriers will be beyond legal reach - Out of U.S. or state • Some major roles will be preempted. NRRI

23. New information needs • Less about investment, depreciation • More on market competitiveness • ARMIS will no longer be a reliable guide to national trends. • Some relevant information is being generated by expensive private sources, such as stock rating services. • States will need more localized, geographically detailed, information • Location of cell towers or broadband interconnection points • Market shares NRRI

24. New staff skills • New kinds of economic analysis needed, including antitrust • Where are markets not working? • Increased reliance on negotiations (rather than orders and rules) • Is it enough to act like a court and await filings? NRRI

25. New methods of regulation • Reduced reliance on Certificates of Convenience and Necessity. • End of “all-in” regulation • Participating in development of national or international standards • States acting together, not necessarily through US Government • Attorneys Generals’ settlement with wireless industry • E.g. wireless resolution mechanism NRRI

26. A wider range of regulatory methods • Industry self-regulation. • OFCOM says this method works where the industry has an incentive to succeed. • Incentives can emerge as a result of market needs and lack of legal rules to address a new set of circumstances. • In most cases it is in response to a perceived threat of state intervention. • A market environment with an active industry participation and/or cohesiveness is most likely to administer effective self-regulation. • But, self-regulation is less effective where there is a broad spread of smaller businesses that do not communicate with each other and have little resources to commit. • US examples of self-regulation: • Wireless industry code • National Motor Freight Classification NRRI

27. Co-regulation • OFCOM defines as an extension of self-regulation that involves both industry and the government (or regulator) administering and enforcing a solution in a variety of combinations. • Aim is to derive the benefits of self-regulation in cases where some governmental oversight is still required. • Examples in the US are: • National Electrical Code, Life-Safety building codes • In the UK, co-regulation is applied to maintain standards in advertising, particularly with regard to misleading or unsubstantiated claims and offensive material. NRRI