FEDERAL COMMUNICATIONS COMMISSION AND UNITED STATES OF AMERICA, RESPONDENTS BELL ATLANTIC TELEPHONE COMPANIES, ET AL., INTERVENORS

The statute says that the ILECs may charge a ‘‘just and reasonable rate’’ for these unbundled network elements (‘‘UNEs’’).

... and the Commission adopted as its standard ‘‘total element long-run incremental cost,’’ or ‘‘TELRIC.’’ Under this criterion UNE prices are to be ‘‘based on the use of the most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent LEC’s wire centers.’’

In litigation over this pricing rule, which the Supreme Court upheld... it appears to have been common ground that, because of ongoing technological improvement (among other things), prices so determined would fall well below the costs the ILECs had actually historically incurred in constructing the elements.

The FCC acknowledges that § 251(d)(2) instructs ‘‘the Commission’’ to ‘‘determine[ ]’’ which network elements shall be made available to CLECs on an unbundled basis. But it claims that agencies have the presumptive power to subdelegate to state commissions, so long as the statute authorizing agency action refrains from foreclosing such a power.

...

When an agency delegates authority to its subordinate, responsibility--and thus accountability-- clearly remain with the federal agency. But when an agency delegates power to outside parties, lines of accountability may blur, undermining an important democratic check on government decision-making. ... Also, delegation to outside entities increases the risk that these parties will not share the agency’s ‘‘national vision and perspective,’’... and thus may pursue goals inconsistent with those of the agency and the underlying statutory scheme. In short, subdelegation to outside entities aggravates the risk of policy drift inherent in any principal-agent relationship.

The Telecommunications Act of 1996 sought to foster a competitive market in telecommunications. To enable new firms to enter the field despite the advantages of the incumbent local exchange carriers (‘‘ILECs’’), the Act gave the Federal Communications Commission broad powers to require ILECs to make ‘‘network elements’’ available to other telecommunications carriers, most importantly the competitive local exchange carriers (‘‘CLECs’’). The most obvious candidates for such obligatory provision were the copper wire loops historically used to carry telephone service over the ‘‘last mile’’ into users’ homes. But Congress left to the Commission the choice of elements to be ‘‘unbundled,’’ specifying that in doing so it was to consider, at a minimum, whether the failure to provide access to such network elements would impair the ability of the telecommunications carrier seeking access to provide the services that it seeks to offer.

The Act became effective on February 8, 1996, a little more than eight years ago.

Twice since then the courts have faulted the Commission’s efforts to identify the elements to be unbundled.

The Supreme Court invalidated the first effort in AT&T Corp. v. Iowa Utilities Board, 525 U.S. 366 (1999) (‘‘AT&T’’).

We invalidated much of the second effort (including separately adopted ‘‘line-sharing’’ rules) in United States Telecom Association v. FCC, 290 F.3d 415 (D.C. Cir. 2002) (‘‘USTA I’’).

The Commission consolidated our remand in that case with its ‘‘triennial review’’ of the scope of obligatory unbundling and issued the Order on review here.

Again, regrettably, much of the resulting work is unlawful.

I. Legal Background

Section 251(c)(3) of the Act imposes on each ILEC the duty to provide any requesting telecommunications carrier with access to network elements on an unbundled basis at any technically feasible point on rates, terms, and conditions that are just, reasonable, and nondiscriminatory.

The statute says that the ILECs may charge a ‘‘just and reasonable rate’’ for these unbundled network elements (‘‘UNEs’’), see id. § 252(d)(1),

and the Commission adopted as its standard ‘‘total element long-run incremental cost,’’ or ‘‘TELRIC.’’

Under this criterion UNE prices are to be ‘‘based on the use of the most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent LEC’s wire centers.’’

because of ongoing technological improvement (among other things), prices so determined would fall well below the costs the ILECs had actually historically incurred in constructing the elements.

In its first effort to interpret the ‘‘impairment’’ standard of § 251(d)(2), the Commission held that lack of unbundled access to an element would ‘‘impair’’ a CLEC’s ability to provide telecommunications service ‘‘if the quality of the service the entrant can offer, absent access to the requested element, declines and/or the cost of providing the service rises.’’

The Supreme Court found this reading of ‘‘impair’’ unreasonable in two respects.

First, the Commission had irrationally refused to consider whether a CLEC could self- provision or acquire the requested element from a third party. AT&T, 525 U.S. at 389.

Second, the Commission had considered any increase in cost or decrease in quality, no matter how small, sufficient to establish impairment--a result the Court concluded could not be squared with the ‘‘ordinary and fair meaning’’ of the word ‘‘impair.’’

Responding to the AT&T decision, the Commission adopted a new interpretation under which a would-be entrant is ‘‘impaired’’ if, ‘‘taking into consideration the availability of alternative elements outside the incumbent’s network, including self-provisioning by a requesting carrier or acquiring an alternative from a third-party supplier, lack of access to that element materially diminishes a requesting carrier’s ability to provide the services it seeks to offer.’’

But in USTA I we held that this new interpretation of ‘‘impairment,’’ while an improvement, was still unreasonable in light of the Act’s underlying purposes. The fundamental problem, we held, was that the Commission did not differentiate between those cost disparities that a new entrant in any market would be likely to face and those that arise from market characteristics ‘‘linked (in some degree) to natural monopoly that would make genuinely competitive provision of an element’s function wasteful.’’

We also made clear that the Commission’s broad and analytically insubstantial concept of impairment failed to pursue the ‘‘balance’’ between the advantages of unbundling (in terms of fostering competition by different firms, even if they use the very same facilities) and its costs (in terms both of ‘‘spreading the disincentive to invest in innovation and creating complex issues of managing shared facilities,’’ ),

We also objected to the Commission’s decision to issue, with respect to most elements, broad unbundling requirements that would apply ‘‘in every geographic market and customer class, without regard to the state of competitive impairment in any particular market.’’

Thus, the Commission is obligated to establish unbundling criteria that are at least aimed at tracking relevant market characteristics and capturing significant variation.

Finally, we vacated the Commission’s decision to require ILECs to unbundle the high- frequency portion of their copper loops to requesting CLECs--a practice known as ‘‘line sharing’’ and used by CLECs to provide broadband DSL service--because the Commission had failed to consider adequately whether intermodal competition from cable providers tilted the balance against this form of unbundling in the broadband market.

In response to USTA I the Commission again revised its definition of impairment. This time around, the Commission determined that a CLEC would ‘‘be impaired when lack of access to an incumbent LEC network element poses a barrier or barriers to entry, including operational and economic barriers, that are likely to make entry into a market uneconomic.

That is, we ask whether all potential revenues from entering a market exceed the costs of entry, taking into consideration any countervailing advantages that a new entrant may have.’’

The ILECs filed two mandamus petitions with this Court, arguing that the Order violated our decision in USTA I, and in addition filed a petition for review here. Various CLECs, state commissions, and an association of state utility consumer advocates filed petitions for review in several other circuits; these petitions were transferred to the Eighth Circuit under the random lottery procedure established in 28 U.S.C. § 2112(a)(3), and then transferred to this court by the Eighth Circuit under 28 U.S.C. § 2112(a)(5). We consolidated the petitions for review with the mandamus petitions.

A. Unbundling of Mass Market Switches The Commission made a nationwide finding that CLECs are impaired without unbundled access to ILEC switches for the ‘‘mass market,’’ consisting of residential and relatively small business users.

This finding was based primarily on the costs associated with ‘‘hot cuts’’ (discussed below), which must be performed when a CLEC provides its own switch.

But the Commission, apparently concerned that a blanket nationwide impairment determination might be unlawfully overbroad in light of the record evidence of substantial market-by-market variation in hot cut costs, delegated authority to state commissions to make more ‘‘nuanced’’ and ‘‘granular’’ impairment determinations.

First, the Commission directed the state commissions to eliminate unbundling if a market contained at least three competitors in addition to the ILEC, or at least two non-ILEC third parties that offered access to their own switches on a wholesale basis. For purposes of this exercise the Commission gave the states virtually unlimited discretion over the definition of the relevant market.

Second, where these ‘‘competitive triggers’’ are not met, the Commission instructed the states to consider whether, despite the many economic and operational entry barriers deemed relevant by the Commission, competitive supply of mass market switching was nevertheless feasible.

The Commission also instructed the states to explore specific mechanisms to ameliorate or eliminate the costs of the ‘‘hot cut’’ process. The Commission mentioned, for example, the possible use of ‘‘rolling’’ hot cuts, a process in which CLECs could use ILEC switches for some time after a customer selected the CLEC as its provider, and after an accumulation of such customer changes, the ILEC would make all the necessary hot cuts in one fell swoop. If a state failed to perform the requisite analysis within nine months, the Commission would step into the position of the state commission and do the analysis itself.

Finally, the Order provided that a party ‘‘aggrieved’’ by a state commission decision could seek a declaratory ruling from the Commission, though with no assurance when, or even whether, the Commission might respond.

We consider first whether the Commission’s subdelegation of authority to the state commissions is lawful. We conclude that it is not.

We then consider whether the Commission’s nationwide impairment determination can nevertheless survive, even without the safety valve provided by subdelegation to the states. We conclude that it cannot.

We therefore vacate the Commission’s decision to order unbundling of mass market switches.

1. Subdelegation of § 251(d)(2) impairment determinations to state commissions

The Commission’s position is based on a fundamental misreading of the relevant case law. When a statute delegates authority to a federal officer or agency, subdelegation to a subordinate federal officer or agency is presumptively permissible absent affirmative evidence of a contrary congressional intent.

But the cases recognize an important distinction between subdelegation to a subordinate and subdelegation to an outside party.

This distinction is entirely sensible. When an agency delegates authority to its subordinate, responsibility --and thus accountability--clearly remain with the federal agency. But when an agency delegates power to outside parties, lines of accountability may blur, undermining an important democratic check on government decision-making.

Also, delegation to outside entities increases the risk that these parties will not share the agency’s ‘‘national vision and perspective,’’

In short, subdelegation to outside entities aggravates the risk of policy drift inherent in any principal-agent relationship.

The fact that the subdelegation in this case is to state commissions rather than private organizations does not alter the analysis.

2. Impairment in provision of mass market switching

Without the (unlawful) innovation of transforming a national impairment finding into a provisional national impairment finding from which state commissions could deviate if they found no impairment under local market conditions, the FCC’s Order on mass market switches must stand or fall as a nationwide determination that CLECs are impaired in the mass market without unbundled access to ILEC switches.

After reviewing the record, we conclude that we must vacate the (no longer provisional) national impairment finding as inconsistent with our conclusion in USTA I that the Commission may not ‘‘loftily abstract[ ] away from all specific markets,’’ but must instead implement a ‘‘more nuanced concept of impairment,’’

The Commission’s national finding of impairment for mass market switches is based on entry barriers related to the need for ILECs to perform ‘‘hot cuts’’ (manual connections) for CLECs if the latter choose to self-provision mass market switches.

A ‘‘hot cut’’ requires an ILEC technician to physically disconnect a customer loop from the ILEC switch (to which the loop was hard-wired) and re-wire the loop to the CLEC switch, while simultaneously reassigning the customer’s phone number from the ILEC switch to the CLEC switch.

A hot cut must be performed every time a CLEC seeks to connect a new customer. In contrast, ILEC connection of a customer generally only requires a software change .

The Commission explains that, according to evidence in the record, the need to perform hot cuts can delay a CLEC in providing service with its own switch and can cause service disruptions, and that these delays and disruptions, even if minor, can damage customer perceptions of CLEC service and impede the CLECs’ ability to compete.

Though the Commission in its brief alludes to ‘‘other operational and economic factors’’ that might create barriers to competition in mass market switching, FCC Br. at 36, the Order makes clear that the national impairment finding was based solely on hot cuts. Order ¶ ¶ 459 n.1405 & 476. (The other factors were to be considered by state commissions in the exercise of the unlawfully delegated authority.) There appears to be no suggestion that mass market switches exhibit declining average costs in the relevant markets, or even that switches entail large sunk costs. The Commission nonetheless concluded that hot cut costs are not the sort of cost disparity that a new entrant into any market might face, since they arise due to the fact that ‘‘incumbent LECs’ networks were designed for use in a single carrier, noncompetitive environment,’’ which means that CLECs face operational costs that the ILECs do not.

Though certain sections of the Order suggest that impairment due to hot cut costs might be sufficiently widespread to support a general national impairment finding even in the absence of more ‘‘nuanced’’ determinations to be made by the state commissions, the Commission at other points concludes that a national finding, without the possibility of market-specific exceptions authorized by state commissions, would be inconsistent with USTA I. At the very least, these latter passages demonstrate that the Commission’s own conclusions do not clearly support a non-provisional national impairment finding for mass market switches, and thus require us to vacate and remand.

Moreover, we doubt that the record supports a national impairment finding for mass market switches. ...

On the general point about the open-endedness of the Commission’s standard, we observe that the Order’s interpretation of impairment is an improvement over the Commission’s past efforts in that, for the most part, the Commission explicitly and plausibly connects factors to consider in the impairment inquiry to natural monopoly characteristics (declining average costs throughout the range of the relevant market), or at least connects them (in logic that the ILECs do not seem to contest) to other structural impediments to competitive supply. These barriers include sunk costs, ILEC absolute cost advantages , first-mover advantages, and operational barriers to entry within the sole or primary control of the ILEC. In contrast to the First Report and Order and the Third Report and Order, the Commission has clarified that only costs related to structural impediments to competition are relevant to the impairment analysis.

Relation of ‘‘impairment’’ to the ‘‘at a minimum’’ clause.

We note that there are at least two ways in which the Commission could have accommodated our ruling in USTA I that its impairment rule take into account not only the benefits but also the costs of unbundling (such as discouragement of investment in innovation), in order that its standard be ‘‘rationally related to the goals of the Act.’’

One way would be to craft a standard of impairment that built in such a balance, as for example by hewing rather closely to natural monopoly features.

The other is to use a looser concept of impairment, with the costs of unbundling brought into the analysis under § 251(d)(2)’s ‘‘at a minimum’’ language.

The Commission has chosen the latter, and we cannot fault it for doing so. This is especially true as the statutory structure suggests that ‘‘impair’’ must reach a bit beyond natural monopoly. While for ‘‘proprietary’’ network elements the statute mandates a decision whether they are ‘‘necessary,’’ for nonproprietary ones it requires a decision whether their absence would ‘‘impair’’ the requester’s provision of telecommunications service. Thus, in principle, there is no statutory offense in the Commission’s decision to adopt a standard that treats impairment as a continuous rather than as a dichotomous variable, and potentially reaches beyond natural monopoly, but then to examine the full context before ordering unbundling.

That said, we do note that in at least one important respect the Commission’s definition of impairment is vague almost to the point of being empty. The touchstone of the Commission’s impairment analysis is whether the enumerated operational and entry barriers ‘‘make entry into a market uneconomic.’’ Uneconomic by whom? By any CLEC, no matter how inefficient? By an ‘‘average’’ or ‘‘representative’’ CLEC? By the most efficient existing CLEC? By a hypothetical CLEC that used ‘‘the most efficient telecommunications technology currently available,’’ the standard that is built into TELRIC?

We need not resolve the significance of this uncertainty, but we highlight it because we suspect that the issue of whether the standard is too open-ended is likely to arise again. Intermodal alternatives. As for the ILECs’ claim that the Commission’s impairment standard unlawfully excludes consideration of intermodal alternatives, we observe that the Commission expressly stated that such alternatives are to be considered when evaluating impairment. Whether the weight the FCC assigns to this factor is reasonable in a given context is an question that we need not decide, except insofar as we reaffirm USTA I’s holding that the Commission cannot ignore intermodal alternatives.

Impairment in markets where state regulation holds rates below historic costs.

In the name of ‘‘universal service,’’ state regulators have commonly employed cross-subsidies, tilting rate ceilings so that revenues from business and urban customers subsidize residential and rural ones. On remand from our decision in USTA I, the Commission decided to consider regulated below-cost retail rates as a factor that may ‘‘impair’’ CLECs in competing for mass market customers. The ILECs object strenuously, and it appears virtually certain that the issue will recur on remand.

The Commission’s brief treatment of the issue makes no attempt to connect this ‘‘barrier’’ to entry either with structural features that would make competitive supply wasteful or with any other purposes of the Act (other than, implicitly, the purpose of generating ‘‘competition,’’ no matter how synthetic). The Commission rightly says that if prevailing rates are too low to elicit CLEC entry even with the benefit of UNEs, the unbundling mandate will have no consequences. True 26 enough. But it is no defense of a rule to say that it is harmless in those cases where it has no effect at all; that presumably is true even of the most absurd rule.

The interesting case is the one where TELRIC rates are so low that unbundling does elicit CLEC entry, enabling CLECs to cut further into ILEC revenues in areas where the ILECs’ service is mandated by state law--and mandated to be offered at artificially low rates funded by ILECs’ supracompetitive profits in other areas. If the scheme of the Act is successful, of course, the very premise of these below-cost rate ceilings will be undermined, as those supracompetitive profits will be eroded by Act-induced competition. In competitive markets, an ILEC can’t be used as a pinata. The Commission has said nothing to address these obvious implications, or otherwise to locate its treatment of the issue in any purposeful reading of the Act.

We recognize, of course, that the historic accounting costs relied upon by state regulators are, like TELRIC itself, an artificial construct that may not closely track true economic cost. But that is no justification for the Commission’s refusal to evaluate the probable consequences of its approach, and to adopt, in the light of those estimations, a policy that it can reasonably say advances the goals of the Act.

We do not see how the Commission can simply ignore facilities deployment along similar routes when assessing impairment. (p.29)

Suppose points A, B, and C are all in the same geographic market and are similarly situated with regard to the ‘‘barriers to entry’’ that the Commission says are controlling.

Suppose further that multiple competitors supply DS1 transport between points A and B, but only the ILEC and one other CLEC have deployed DS1 transport between A and C. The Commission cannot ignore the A-B facilities deployment when deciding whether CLECs are impaired with respect to A-C deployment without a good reason. The Commission does explain why competition on the A-B route should not be sufficient to establish competition is possible on the A-C route, but this cannot explain the Commission’s implicit decision to treat competition on one route as irrelevant to the existence of impairment on the other.

Nor does the Commission explain whether, and why, the error costs (both false positives and false negatives) associated with a route-by-route market definition are likely to be lower than the error costs associated with alternative market definitions.

While it may be infeasible to define the barriers to entry in a manageable form, i.e., in such a way that they may usefully be applied to MSAs (or other plausible markets) as a whole, the Commission nowhere suggests that it explored such alternatives, much less found them defective.

b. Wireless providers’ access to unbundled dedicated transport (p. 29)

In addition to their general challenge to the FCC’s provisional national finding that competitors are impaired without access to dedicated transport facilities, the ILEC petitioners also attack the Commission’s conclusion that providers of wireless service (also known as commercial mobile radio services, or ‘‘CMRS’’) qualify for unbundled access to these facilities. According to the ILECs, the Commission not only failed to conduct the requisite impairment analysis for wireless providers, but in fact found that wireless growth has been ‘‘remarkable’’: 90% of the U.S. population lives in areas served by at least three wireless providers, 40% of Americans and 61% of American households own a wireless phone, wireless prices have been steadily declining, and 35% of wireless customers use wireless as their only phone, treating it as a full substitute for traditional land line service.

Where competitors have access to necessary inputs at rates that allow competition not only to survive but to flourish, it is hard to see any need for the Commission to impose the costs of mandatory unbundling.

We recognize that, given the ILECs’ incentive to set the tariff price as high as possible and the vagaries of determining when that price gets so high that the ‘‘impairment’’ threshold has been crossed, a rule that allowed ILECs to avoid unbundling requirements simply by offering a function at lower-than-TELRIC rates might raise real administrability issues.

Those complications might in principle support a blanket rule treating the availability of ILEC tariffed service as irrelevant to impairment. But the FCC hasn’t defended its decision in those terms or even tried to explicate these complications. Moreover, where (as here) market evidence already demonstrates that existing rates outside the compulsion of § 251(c)(3) don’t impede competition, and where (as here) there is no claim that ILECs would be able drastically to hike those rates, those possible complications recede even farther in the background.