New phone and data companies require cheap rates for leased access lines from phone incumbents in order to compete, and how low those rates should be set was the question before the U.S. Supreme Court last Wednesday.
The Telecommunications Act of 1996 set the stage for local phone and data competition after a century of monopoly, handing the Federal Communications Commission the role of establishing the rates that new entrants must pay.
But Verizon Communications Inc. told the high court that the FCC's rate rules had to be set aside because they failed to fairly compensate the company.
Verizon attorney William Barr, a former U.S. Attorney General, said the FCC rates contained a "systemic defect" in that the agency ordained that rates had to be based on the most efficient existing technology — whether or not that technology was actually deployed — and that they had to be shorn of costs previously incurred in building the network.
"We are entitled to the value of what we have to spend," Barr said
U.S. Solicitor General Theodore Olson, defending the FCC's rules, said the agency followed the law by setting rates designed to promote competition, lower prices and deployment of new technology.
"It may not be perfect, but in this rate-setting area, it's the way it should be done," Olson said.
Several justices, including Anthony Kennedy and Antonin Scalia, suggested the FCC's rules were arbitrary because the inevitable result was that new entrants would receive below-cost rates.
"That just has to be," Kennedy said.
Scalia indicated Olson was defending a regulatory "wheel of fortune" that provided no certainty as to whether rates would fairly compensate Verizon and other incumbent phone companies.
Olson replied that Verizon was exaggerating the "draconian impact" of the FCC's rules. He also argued that Congress didn't promise that the phone incumbents would "recover every nickel they invested."
In 1996, the FCC issued its rate rules, but state regulators were required to determine the specifics when called upon to arbitrate pricing disputes between phone incumbents and their new competitors.
During the 90-minute oral argument, several justices pressed Barr on whether state regulators could ensure that phone incumbents were adequately compensated.
Chief Justice William Rehnquist said FCC rules "seem to allow the state commission to do what you want done."
Justice David Souter and Kennedy indicated that it might be premature to toss out the FCC rate rules prior to hearing a case that actually challenged rates established by the states.
"Our cases say we have to wait until we see what the rate is," Kennedy said.
The debate was loaded with the fine points of utility regulation, including depreciation schedules and return rates on invested capital. Barr repeatedly emphasized that the FCC rules took billions of dollars in invested capital and slashed them by 50 percent in calculating network leasing rates.
Eight justices heard the case. Justice Sandra Day O'Connor did not participate, likely because of a financial conflict of interest. A 4-to-4 decision would mean the lower court decision would stand.
In the U.S. Court of Appeals for the 8th Circuit, Verizon won on the issue that rates have to be based on the network actually built, not on the FCC's hypothetical most efficient network. But the 8th Circuit upheld the FCC's decision requiring states to set rates based upon a forward-looking pricing model that excluded historic costs.