The original Bell Telephone Company, formed in 1877, begot in 1885 the American Telephone and Telegraph Co. (AT&T). Since that time, the communications industry has engaged in a cycle of mergers and judicially enforced divestments. leaving us today with four remaining regional monopoly Bell telephone companies: SBC, Verizon, BellSouth, and Qwest, currently offering most of our nation's local phone service.
Making use of evolving communications technologies, in 1969 MCI first challenged AT&T's monopoly for long distance service. As more long distance competitors entered the market, prices for long distance calls fell. However, the market was far from competitive. AT&T enjoyed a market share of more than 90% well into 1984.
The growing desire for marketplace competition and concerns about AT&T's continuing monopoly led the federal government to file an antitrust suit against the Bell System in 1974. This suit was settled in 1982 with an agreement to break the Bell System into two parts: a set of local operating companies controlling local exchange facilities (at that time still viewed as likely "natural monopolies") and essentially all the rest of AT&T, including Long Lines, Western Electric (equipment manufacturing) and Bell Labs (research). State laws typically protected the right of the divested Bell companies to provide local service on a monopoly basis; at the same time, the terms of the divestiture decree kept those companies out of the long distance and equipment manufacturing markets.
Both sectors were, to some extent, dissatisfied with this arrangement. AT&T, MCI and other long distance companies wanted more competitive alternatives to reach their customers - particularly their large business customers. The divested Bell companies wanted to be able to provide long distance and other forbidden services.
In passing the Telecommunications Act of 1996 ("1996 Act"), Congress was attempting to encourage additional competition in telecommunications services, including local phone service, thereby improving services and lowering prices. The 1996 Act introduced the concept of an "Incumbent Local Exchange Carrier," or ILEC, which was defined, essentially, as any existing monopoly telephone company as of the date of passage of the 1996 Act. Although not a defined term in the Act, over time, the many competitors who were positioned to provide local phone services were deemed Competitive Local Exchange Carriers (CLECs). The CLECs were mainly rival telephone companies affiliated with long distance carriers or pre-existing competitive providers of interstate access services, but also included cable TV providers, utility companies and municipalities.
Under the 1996 Act, ILECs are required to enter into "interconnection agreements" with CLECs, embodying the Act's requirements. One of those requirements is that local exchange carriers who send traffic to each other pay each other for completing the calls. As a result, the competing telephone service providers (including both ILECs and CLECs) developed contracts to financially account to each other for calls beginning and ending on their various networks. These payments are referred to in the act as "reciprocal compensation." Section 251(b)(5) identifies "the duty to establish reciprocal compensation arrangements for the transport and termination of telecommunications." With regard to those arrangements, Section 252(d)(2)(A) then states that,
...for the purposes of compliance by an incumbent local exchange carrier with section 251(b)(5), a State commission shall not consider the terms and conditions for reciprocal compensation to be just and reasonable unless-- (i) such terms and conditions provide for the mutual and reciprocal recovery by each carrier of costs associated with the transport and termination on each carrier's network facilities of calls that originate on the network facilities of the other carrier; and (ii) such terms and conditions determine such costs on the basis of a reasonable approximation of the additional costs of terminating such calls.
In determining the rules of engagement, many CLECs sought a "bill and keep" system in which traffic would be exchanged between carriers for free. The ILECs opposed this on statutory and policy grounds, arguing that when one carrier terminates traffic from another, the terminating carrier should be compensated for its efforts.
When the FCC issued rules in August 1996 to implement the 1996 Act, it determined that section 251(b)(5) should apply to "traffic that originates and terminates within a local area," and "is intended for a situation in which two carriers collaborate to complete a local call."
Originally believing the incoming calls would terminate in their favor, ILECs argued for and often received a terminating-cost rate favorable to themselves, i.e., a high rate relative to their costs. They didn't anticipate the number of ILEC-originated calls that would be terminating at CLECs, whose customers were ISPs. As the bills started adding up, however, the debate began.
The disputes typically arose in the context of fights over whether a particular ILEC-CLEC interconnection agreement required payment of compensation as stated in contracts with the originating carrier for ISP-bound calls. CLECs argued to the relevant state commissions that they should receive compensation for calls originating with ILECs and terminating at the modems of the ISPs whom the CLECs served. In contrast the ILECs argued that the ISPs are merely a pass-through point for communications bound not for the ISP but for distant points on the Internet, rendering calls to ISPs interstate (non-local) and therefore not compensable under Section 251(b)(5). However, "more than two dozen state commissions concluded that the interconnection agreements that incumbent LECs had entered into with CLECs required the payment of reciprocal compensation for ISP-bound traffic."
The Bells learned a quick lesson: be careful what they ask for. "Thirty-four out of 39 States have found that CLECs deserve to receive reciprocal compensation for Internet traffic, and 12 courts out of 12 have upheld those decisions. The rates for reciprocal compensation were set by the Regional Bell Operating Companies (RBOCs) themselvesÉ."
Many incumbent local exchange carriers insisted on reciprocal compensation rates as high as $.01 per minute in agreements they entered into with competitive entrants in 1996, based on the apparent expectation that they would be the net beneficiaries of these payments. These agreements are expiring, however, and some of these same carriers are now negotiating dramatically lower reciprocal compensation rates for all traffic, including ISP-bound traffic -- as low as $.00175 per minute. Consumers will be better off and local competition will be fostered as parties continue to negotiate rates that more accurately reflect the actual costs of transport and termination.
Answering industry calls to clarify whether ISP-bound calls were local and therefore subject to reciprocal compensation under Section 251(b)(5) and the FCC's implementing regulations, the FCC in February 1999 issued a decision: they are not. However, the FCC made clear that this generic interpretation of its rules did not resolve the payment problem. Instead, the FCC concluded (a) that there was no specific federal rule applicable to this traffic, and (more troublesome for the ILECs) (b) that even though existing rules did not require payment, ILECs may have agreed to make such payments in contracts with CLECs referring generally to compensation for "local" traffic without identifying ISP-bound traffic as a separate category.
To address the first issue, the FCC initiated a proposed rulemaking. To address the second, it confirmed "parties were bound by their interconnection agreements as interpreted and enforced by state commissions."
While the rulemaking was in progress, the D.C. Circuit Court of Appeals vacated and remanded the FCC's ruling. Although Section 251(b)(5) requires reciprocal compensation for all "telecommunications," the FCC initially construed reciprocal compensation as being limited to "local" traffic, leaving intercarrier compensation for long-distance calls to be treated as it was before the 1996 Act. In Bell Atlantic Telephone Companies v FCC, 206 F.3d 1 (C.A.D.C., 2000), the court found the FCC's treatment of calls to Internet Service Providers (ISPs) was inconsistent with the statute, stating "The issue at the heart of this case is whether a call to an ISP is local or long-distance. Neither category fits clearly." The court also found that the FCC's decision did not constitute "reasoned decisionmaking" on several critical points, including the FCC's notion that calls CLECs deliver to ISPs are "not properly seen as "terminat[ing] ... local telecommunications traffic," and the agency's failure to address whether such traffic falls into the statutory categories of "exchange access" or "telephone exchange service"." The case was vacated and remanded for clarification of the definitions and their applications.
On remand in 2001, the FCC took to heart the court's focus on "local" versus "long distance" calls and concluded that its initial limitation of the reciprocal compensation obligation to "local" traffic - a term not used in the statute - had created ambiguities and had therefore been a mistake. It concluded, however, that calls to ISPs were still excluded from reciprocal compensation because they were a form of "information access." >This and other types of traffic specifically mentioned in another section of the Act, Section 251(g), were deemed excluded from reciprocal compensation.
This decision, too, was appealed, and, while the FCC's rules were allowed to stand, the court rejected the agency's reasoning. In WorldCom, Inc. v FCC, 288 F.3d 429 (C.A.D.C.,2002), the court stated,
"In the order before us the Federal Communications Commission held that under § 251(g) of the Act it was authorized to "carve out" from § 251(b)(5) calls made to internet service providers ("ISPs") located within the caller's local calling area. It relied entirely on § 251(g). Because that section is worded simply as a transitional device, preserving various LEC duties that antedated the 1996 Act until such time as the Commission should adopt new rules pursuant to the Act, we find the Commission's reliance on § 251(g) precluded. Thus we remand the case. "
More recently, in Verizon Md. Inc. v. RCN Telecom Servs., 248 F.Supp.2d 468 (D.Md., 2003), a case that started in 1996 and found its way to the Supreme Court and back, the 4th District Court held that Verizon owes MFS (now a part of MCI) for the termination of local calls dating back to April 1997. These interconnection contracts, even if entered into by the ILECs under statutory compulsion and subject to specific regulatory review and oversight, were again confirmed as binding on the parties.
But, back to 1999. Responding to the timing and uncertainty of the growing compensation imbalance, the ILECs' Congressional champions stepped in to introduce legislation to protect the ILECs' interests.