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The Federal Communications Commission ("FCC" or "Commission") has initiated a rulemaking proceeding that may substantially affect the profitability of competitive local exchange carriers ("CLECs") and Internet Service Providers ("ISPs"). (1) The rulemaking is intended to resolve some of the issues raised in the Commission's recent Reciprocal Compensation Order, which is more fully described in our memorandum of February 25, 1999. (2) Comments in the proceeding are due April 12, 1999 and reply comments are due April 27, 1999.

The new proceeding concerns the method by which CLECs will be compensated when the customers of incumbent local exchange carriers ("ILECs") place calls to ISPs that obtain their local telephone service from CLECs. CLECs have taken the position that they are entitled to payment for these calls under their interconnection agreements with ILECs, which generally provide that the parties will compensate each other for the costs incurred to transport and terminate all "local" calls.

ILECs became dissatisfied with this interpretation of the interconnection agreements when they discovered that CLECs were acquiring large numbers of ISPs as local exchange service customers. (3) Accordingly, ILECs withheld compensation payments for ISP-bound traffic and argued to the state commissions and the FCC that seven-digit calls placed to ISPs are not local at all, but are links in end-to-end interstate communications that terminate at distant locations on the Internet. According to this argument, ILECs are not required to pay CLECs for terminating ISP-bound calls under interconnection agreements that require reciprocal compensation for local traffic.

The ILECs' arguments were arbitrated before over 20 state commissions, all of which declared that reciprocal compensation must be paid for these calls. However, as described in our memorandum of February 25, 1999, the FCC ruled last month that seven-digit calls placed to ISPs are interstate and therefore subject to the FCC's jurisdiction. Accordingly, to the extent that state commissions have declared ISP-bound traffic to be subject to reciprocal compensation, and have done so on the basis that calls to ISPs are local calls separate from the end users' transmissions to distant Internet sites, those state decisions effectively are overturned by the FCC's recent order.

The immediate effect of the FCC's ruling is to cause considerable confusion. Part of the confusion has to do with the interpretation of existing interconnection agreements that already have been arbitrated before state commissions. The FCC was careful to say that all state commission decisions remain in effect pending further proceedings. However, all of the state decisions are likely to be challenged by the ILECs as inconsistent with FCC's determination that calls to ISPs are interstate rather than local.

A longer-term source of confusion is the absence of guidance as to how CLECs will be compensated in the future for transporting and terminating calls placed to their ISP customers by callers who are ILEC customers. As the Commission acknowledges, CLECs incur costs when they perform these functions for ILECs and should be compensated accordingly. (4) By removing this traffic from the category of communications eligible for reciprocal compensation, however, the Commission leaves a vacuum that must be filled by further ILEC-CLEC negotiations, new regulations or some combination of both approaches.

The FCC has issued an open-ended, somewhat confusing Notice of Proposed Rulemaking ("NPRM") intended to address this long-term question. The NPRM asks for comments on both the procedural and substantive questions posed by the need to compensate carriers for transport and termination of ISP-bound traffic.

Procedurally, the Commission asks for comments on how future reciprocal compensation arrangements should be negotiated, how disputes should be arbitrated and which set of regulators -  state or federal - should supervise the process. The Commission tentatively concludes that inter-carrier compensation for ISP-bound traffic should be worked out as part of the overall interconnection agreement negotiations in which ILECs and CLECs engage under sections 251 and 252 of the 1996 Act. (5) Under this approach, state commissions will arbitrate disputes concerning ISP-bound traffic along with all other questions as to which negotiations have reached an impasse. As an alternative, the Commission asks whether it should establish a separate negotiating track confined to the question of compensation arrangements for ISP-bound traffic, with the FCC acting as arbitrator when negotiations on this issue have reached an impasse. (6) As a variant of this second procedure, the Commission asks for comment on an approach under which parties engage in "a single broad interconnection negotiation" on all issues but must pursue a bifurcated arbitration process in which disputes concerning ISP traffic are resolved by the FCC and disputes on all other issues are addressed by state arbitrators. (7)

On the substantive question of how carriers should be compensated for ISP-bound traffic, the Commission expresses certainty on only one point. The FCC makes it clear that it will not consider, in this rulemaking proceeding, "whether interstate access charges should be imposed on ESPs . . ." (8) Accordingly, the FCC will not at this time declare that ILECs and CLECs may be compensated for termination of ISP traffic by imposing on ISPs the same access charges that ILECs presently impose upon interexchange carriers.

Aside from this single exception, the Commission appears open to any and all suggestions. Although the NPRM does not propose specific rules, the Commission offers the following observations that suggest the wide range of options that it will consider:

The FCC's disposition of the questions raised in the NPRM will have a substantial impact on CLECs and their ISP customers. CLECs and ISPs should determine the type and level of inter-carrier compensation that will permit CLECs to recover the cost of transporting calls placed to ISPs by ILEC customers, and consider filing comments with the Commission that advocate those arrangements. (15) CLECs and ISPs also should urge the Commission to adopt efficient and expeditious procedures under which this issue can be negotiated and arbitrated.

 

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This memorandum was written by Cheryl A. Tritt and Charles H. Kennedy of Morrison & Foerster's Washington, D.C. office. It is intended to provide information on legal developments to clients and friends of Morrison & Foerster LLP, and is not a substitute for legal advice on specific questions. For further information, please contact Cheryl A. Tritt at 202-887-1510, ctritt@mofo.com, or Charles H. Kennedy at 202-887-8794, ckennedy@mofo.com.

 

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Footnotes

1. Inter-Carrier Compensation for ISP-Bound Traffic, CC Docket No. 99-68 (Notice of Proposed Rulemaking 1999) ("NPRM").
2. Memorandum to Client and Friends from Morrison & Foerster LLP (Feb. 25, 1999). We are pleased to provide additional copies of this memorandum upon request.
3. Because end users call their ISPs but their ISPs do not call them, a CLEC with a high proportion of ISP customers will receive more traffic from ILEC customers than it sends to those customers. Accordingly, the CLEC will earn more reciprocal compensation than it pays.
4. NPRM at ¶ 29.
5. Id. at ¶ 30.
6. Id. at ¶ 31.
7. Id.
8. Id. at ¶ 34. The term "ESPs" stands for "enhanced service providers," which are exempt from payment of access charges under a 1983 FCC decision. Internet service providers are classified as ESPs and therefore are not required to pay access charges, but ILECs continue to press for removal of this exemption.
9. Id. at ¶ 29.
10. Id. at ¶ 34.
11. Id. at ¶ 34.
12. Id. at ¶ 31.
13. Id at ¶ 29.
14. Id. at ¶ 35.
15. Because CLECs continue to enroll a disproportionate number of ISP customers, ILECs can be expected to argue for relatively low levels of compensation. CLECs, however, can plausibly argue that compensation for this traffic should be set at least as high as the reciprocal compensation rates established for other calls under current interconnection agreements.