Alenco Comm, et al v. FCC, et al

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
_______________
m 98-60213
_______________
ALENCO COMMUNICATIONS, INC.;
AMANA SOCIETY SERVICE COMPANY;
ARROWHEAD COMMUNICATIONS CORPORATION;
AYERSVILLE TELEPHONE COMPANY;
BARAGA TELEPHONE COMPANY;
BARRY COUNTY TELEPHONE COMPANY;
BAY SPRINGS TELEPHONE COMPANY, INC.;
BENTLEYVILLE TELEPHONE COMPANY;
BENTON RIDGE TELEPHONE COMPANY;
BLOOMINGDALE HOME TELEPHONE COMPANY;
BLUE EARTH VALLEY TELEPHONE COMPANY;
BRUCE TELEPHONE COMPANY;
CASEY MUTUAL TELEPHONE COMPANY; CFW COMMUNICATIONS
COMPANY; CITIZENS TELEPHONE COMPANY OF KECKSBURG;
CITIZENS TELEPHONE COMPANY OF HAMMOND;
CITIZENS TELEPHONE CORPORATION;
CLEMENTS TELEPHONE COMPANY; CLIMAX TELEPHONE COMPANY;
COMMUNITY SERVICE TELEPHONE COMPANY;
CRAIGVILLE TELEPHONE COMPANY, INC.;
CROCKETT TELEPHONE COMPANY; DIXVILLE TELEPHONE COMPANY;
DOYLESTOWN TELEPHONE COMPANY;
DUNBARTON TELEPHONE COMPANY, INC.;
DUNKERTON TELEPHONE COOPERATIVE;
EAGLE VALLEY TELEPHONE COMPANY;
EASTON TELEPHONE COMPANY; ECKLES TELEPHONE COMPANY;
ELKHART TELEPHONE COMPANY;
EUSTIS TELEPHONE EXCHANGE;
FARMERS COOP TELEPHONE COMPANY;
FARMERS MUTUAL TELEPHONE COMPANY-OHIO;

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2
FARMERS MUTUAL TELEPHONE COMPANY-MINNESOTA;
FLAT ROCK MUTUAL TELEPHONE COMPANY;
FORT JENNINGS TELEPHONE COMPANY;
FRONTIER COMMUNICATIONS OF DEPUE;
GEETINGSVILLE TELEPHONE COMPANY, INC.;
GERVAIS TELEPHONE COMPANY;
GRACEBA TOTAL COMMUNICATIONS, INC.;
GRANADA TELEPHONE COMPANY;
GRANBY TELEPHONE & TELEGRAPH COMPANY-MASSACHUSETTS;
GULF TELEPHONE COMPANY; HARTINGTON TELEPHONE COMPANY;
HICKORY TELEPHONE COMPANY;
HINTON TELEPHONE COMPANY OF HINTON, OKLAHOMA, INC.; HOLLIS
TELEPHONE COMPANY;
HOME TELEPHONE COMPANY-NEBRASKA;
HOME TELEPHONE COMPANY-MINNESOTA;
HOT SPRINGS TELEPHONE COMPANY;
HUXLEY COOPERATIVE TELEPHONE COMPANY;
INDIANHEAD TELEPHONE COMPANY;
IRONTON TELEPHONE COMPANY;
JEFFERSON TELEPHONE COMPANY, INC.;
KADOKA TELEPHONE COMPANY; KALEVA TELEPHONE COMPANY;
KALIDA TELEPHONE COMPANY, INC.;
LAUREL HIGHLAND TELEPHONE COMPANY;
LIGONIER TELEPHONE COMPANY;
MANKATO CITIZENS TELEPHONE COMPANY;
MANTI TELEPHONE COMPANY;
MARIANNA & SCENERY HILL TELEPHONE COMPANY;
MARSEILLES TELEPHONE COMPANY;
MCCLURE TELEPHONE COMPANY;
MCDONOUGH TELEPHONE COOP, INC.; MEBTEL COMMUNICATIONS;
MERCHANTS & FARMERS TELEPHONE COMPANY;
METAMORA TELEPHONE COMPANY;
MID CENTURY TELEPHONE COOP, INC.;
MID COMMUNICATIONS TELEPHONE COMPANY;
MID-IOWA TELEPHONE COOP ASSOCIATION;
MIDDLE POINT HOME TELEPHONE COMPANY;
MIDSTATE TELEPHONE COMPANY-NORTH DAKOTA;

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MIDWEST TELEPHONE COMPANY;
MILES COOPERATIVE TELEPHONE ASSOCIATION;
MILLRY TELEPHONE COMPANY, INC.;
MINFORD TELEPHONE COMPANY, INC.;
MINNESOTA LAKE TELEPHONE COMPANY;
MT. ANGEL TELEPHONE COMPANY;
NATIONAL TELEPHONE OF ALABAMA, INC.;
NEW LISBON TELEPHONE COMPANY;
NORTH-EASTERN PENNSYLVANIA TELEPHONE COMPANY;
NORTH ENGLISH COOP TELEPHONE COMPANY;
NORTHWESTERN INDIANA TELEPHONE COMPANY, INC.;
NOVA TELEPHONE COMPANY; ODIN TELEPHONE EXCHANGE, INC.;
ORWELL TELEPHONE COMPANY; OSAKIS TELEPHONE COMPANY;
PALMERTON TELEPHONE COMPANY;
PANHANDLE TELEPHONE COOP, INC.;
PANORA COOPERATIVE TELEPHONE ASSOCIATION;
PATTERSONVILLE TELEPHONE COMPANY;
PENNSYLVANIA TELEPHONE COMPANY;
PEOPLES MUTUAL TELEPHONE COMPANY;
PEOPLES TELEPHONE COMPANY, INC.;
PIERCE TELEPHONE COMPANY, INC.;
PINE ISLAND TELEPHONE COMPANY; PINNACLE COMMUNICATIONS;
PRAIRIE GROVE TELEPHONE COMPANY;
PYMATUNING INDEPENDENT TELEPHONE COMPANY;
REDWOOD COUNTY TELEPHONE COMPANY;
ROANOKE TELEPHONE COMPANY, INC.;
ROBERTS COUNTY TELEPHONE COOP ASSOCIATION;
RONAN TELEPHONE COMPANY; SCHALLER TELEPHONE COMPANY;
SEARSBORO TELEPHONE COMPANY;
SHELL ROCK TELEPHONE COMPANY;
SOUTH CANAAN TELEPHONE COMPANY;
SOUTHERN MONTANA TELEPHONE COMPANY;
STATE LONG DISTANCE TELEPHONE COMPANY;
STATE TELEPHONE COMPANY;
STAYTON COOPERATIVE TELEPHONE COMPANY;
STOCKHOLM-STRANDBURG TELEPHONE COMPANY;
SUMMIT TELEPHONE COMPANY; SWAYZEE TELEPHONE COMPANY;

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SYCAMORE TELEPHONE COMPANY;
TRI COUNTY TELEPHONE COMPANY, INDIANA;
TRI-COUNTY TELEPHONE MEMBERSHIP CORPORATION;
VALLEY TELEPHONE COOPERATIVE, INC.;
VAN HORNE COOPERATIVE TELEPHONE COMPANY;
VENUS TELEPHONE CORPORATION;
VOLCANO TELEPHONE COMPANY;
WEST IOWA TELEPHONE COMPANY;
WEST LIBERTY TELEPHONE COMPANY;
WEST SIDE TELEPHONE COMPANY;
WEST SIDE TELEPHONE COMPANY-PENNSYLVANIA;
WEST TENNESSEE TELEPHONE COMPANY, INC.;
WESTERN TELEPHONE COMPANY-SOUTH DAKOTA;
WIKSTROM TELEPHONE COMPANY, INC.;
WILTON TELEPHONE COMPANY-NEW HAMPSHIRE;
YADKIN VALLEY TELEPHONE MEMBERSHIP CORPORATION;
YUKON-WALTZ TELEPHONE COMPANY;
and
UNITED STATES TELEPHONE ASSOCIATION,
Petitioners,
VERSUS
FEDERAL COMMUNICATIONS COMMISSION
and
UNITED STATES OF AMERICA,
Respondents.
_________________________
Petitions for Review of Orders
of the Federal Communications Commission
_________________________
January 25, 2000

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Before SMITH, WIENER, and
EMILIO M. GARZA, Circuit Judges.
JERRY E. SMITH, Circuit Judge:
This is a consolidated challenge to two or-
ders of the Federal Communications Commis-
sion (the “FCC,” the “Commission,” or the
“agency”)1 promulgated to satisfy the twin
Congressional mandates articulated in the Tel-
ecommunications Act of 1996 (the “Act”)2 of
providing universal telecommunications ser-
vice in the United States and injecting
competition into the market for local telephone
service. PetitionersSSlocal telephone service
providers who serve predominantly small
towns and rural areasSSchallenge the orders as
inconsistent with the statutory requirements of
the Act; arbitrary and capricious in violation of
the Administrative Procedure Act, 5 U.S.C.
§ 706(2)(A); violative of the Takings Clause,
U.S. CONST. amend. V; and in noncompliance
with the Regulatory Flexibility Act, 5 U.S.C.
§ 604. Having jurisdiction to review the or-
ders pursuant to 28 U.S.C. § 2342(1) and
47 U.S.C. § 402(a), we deny the petitions for
review.
I. THE STATUTORY MANDATES.
Universal service has been a fundamental
goal of federal telecommunications regulation
since the passage of the Communications Act
of 1934. Indeed, the FCC’s very purpose is
“to make available, so far as possible, to all the
people of the United States . . . a rapid,
efficient, Nation-wide, and world-wide wire
and communication service with adequate
facilities at reasonable charges.” 47 U.S.C. §
151 (as amended). See also Texas Office of
Pub. Util. Counsel v. FCC, 183 F.3d 393,
405-06 & n.2 (5th Cir. 1999) (“TOPUC”),
petition for cert. filed (Dec. 23, 1999) (No.
99-1072).
Specifically, the Act requires that universal
service support be “explicit and sufficient,”
47 U.S.C. § 254(e), and it articulates several
guiding principles to govern universal
serviceSSincluding, for example, that “access
. . . be provided in all regions of the Nation . .
. including low-income consumers and those in
rural, insular, and high cost areas,” that
services and rates be “reasonably comparable”
to those offered “in urban areas,” that “[a]ll
providers of telecommunications services . . .
make an equitable and nondiscriminatory con-
tribution to the preservation and advancement
of universal service,” and that universal service
support be “specific” and “predictable,” id.
§ 254(b)(2)-(5); Order ¶ 21. While the FCC is
required to obey statutory commands, the
guiding principles reflect congressional intent
to delegate difficult policy choices to the
Commission’s discretion. See TOPUC, 183
F.3d at 411-12.3
1 In re: Federal-State Joint Board on Universal
Serv.; Report and Order in CC Docket No. 96-45,
12 FCC Rcd. 8776 (1997) (“Order”); Fourth
Order on Reconsideration in CC Docket
No. 96-45; Report and Order in CC Docket
Nos. 96-45, 96-262, 94-1, 91-213, 95-72, 13 FCC
Rcd. 5318 (1997); Errata, 13 FCC Rcd. 2372
(1998) (“Fourth Reconsideration Order”).
2 Telecommunications Act of 1996, Pub. L.
No. 104-104, 110 Stat. 56 (to be codified as
amended in scattered sections of title 47, United
States Code).
3 The Act additionally states that “[i]t shall be
the policy of the United States to encourage the
provision of new technologies and services to the
public.” 47 U.S.C. § 157(a). Cf. 47 U.S.C.
§ 254(b)(2) (providing that universal service pro-
grams be guided by principle of providing access to
(continued...)

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(...continued)
advanced telecommunications and information ser-
vices in all regions). Petitioners argue that the
orders violate § 157(a).
Unlike the express statutory requirement of suf-
ficient support of universal service support im-
posed by 47 U.S.C. § 254(e), § 157(a) is merely a
broad statement of policy conferring substantial
discretion on the Commission to determine how
best to provide for new technologies and services.
To our knowledge, § 157(a) has never been used to
invalidate an FCC action. We conclude, therefore,
that a universal service program that satisfies the
specific statutory requirements of § 254(e)
necessarily satisfies the broad policy statement of
§ 157(a).

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Alongside the universal service mandate is
the directive that local telephone markets be
opened to competition. See 47 U.S.C. §§ 251-
253; AT&T Corp. v. Iowa Utils. Bd., 525 U.S.
366, 371; TOPUC, 183 F.3d at 406, 412. The
FCC must see to it that both universal service
and local competition are realized; one cannot
be sacrificed in favor of the other. The
Commission therefore is responsible for
making the changes necessary to its universal
service program to ensure that it survives in
the new world of competition.4 Because
Congress has conferred broad discretion on
the agency to negotiate these dual mandates,
courts ought not lightly interfere with its
reasoned attempt to achieve both objectives.
See Chevron U.S.A., Inc. v. Natural Resources
Defense Council, Inc., 467 U.S. 837, 842-44
(1984); 5 U.S.C. § 706(2)(A).
II. THE UNIVERSAL SERVICE ORDERS.
The orders under review make various
changes to universal service deemed necessary
achieve universal service within a competitive
environment. We describe the general
principles guiding the Commission’s judgment,
then detail the provisions specifically at issue
in petitioners’ various challenges.
A. COMMISSION PRINCIPLES.
To analyze the purpose and effect of the
FCC’s numerous regulatory changes to its uni-
versal service program, we find it useful first
to articulate three principles the Commission
has followed in making the transition from
monopolistic to competitive universal service.
First, rates must be based not on historical,
booked costs, but rather on forward-looking
costs. After all, market prices respond to cur-
rent costs; historical investments, by contrast,
are sunk costs and thus ignored.
[I]t is current and anticipated cost, rath-
er than historical cost[,] that is relevant
to business decisions to enter markets
and price products. The business
manager makes a decision to enter a
new market by comparing anticipated
additional revenues (at a particular
price) with anticipated additional costs.
If the expected revenues cover all the
costs caused by the new product, then a
rational business manager has sound
business reasons to enter the new
market. The historical costs associated
with the plant already in place are
essentially irrelevant to this decision
since those costs are ‘sunk’ and
unavoidable and are unaffected by the
new production decision. This factor
may be particularly significant in in-
dustries such as telecommunications
which depend heavily on technological
innovation, and in which a firm’s ac-
counting, or sunk, costs may have little
relation to current pricing decisions.
MCI Communications Corp. v. American Tel.
& Tel. Corp., 708 F.2d 1081, 1116-17 (7th
Cir. 1983).5
4 See Order ¶¶ 1-4, 20 (stating that it “ensure[s]
that this system is sustainable in a competitive
marketplace, thus ensuring that universal service is
available at rates that are ‘just, unreasonable, and
affordable’ for all Americans”).
5 See also TOPUC, 183 F.3d at 407 (stating
that “the FCC decided to use the ‘forward-looking’
costs to calculate the relevant costs of a carrier
(continued...)

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(...continued)
. . . . To encourage carriers to act efficiently, the
agency would base its calculation on the costs an
efficient carrier would incur (rather than the costs
the incumbent carriers historically have in-
curred)”).

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Second, the old regime of implicit
subsidiesSSthat is, “the manipulation of rates
for some customers to subsidize more
affordable rates for others”SSmust be phased
out and replaced with explicit universal service
subsidiesSSgovernment grants that cause no
distortion to market pricesSSbecause a
competitive market can bear only the latter.
TOPUC, 183 F.3d at 406.
For obvious reasons, this system of im-
plicit subsidies can work well only under
regulated conditions. In a competitive
environment, a carrier that tries to
subsidize below-cost rates to rural
customers with above-cost rates to
urban customers is vulnerable to a
competitor that offers at-cost rates to
urban customers. Because opening local
telephone markets to competition is a
principal objective of the Act, Congress
recognized that the universal service
system of implicit subsidies would have
to be re-examined.
Id. Indeed, the Act requires that all universal
service support be explicit. See 47 U.S.C.
§ 254(e).
Finally, the program must treat all market
participants equallySSfor example, subsidies
must be portableSSso that the market, and not
local or federal government regulators,
determines who shall compete for and deliver
services to customers. Again, this principle is
made necessary not only by the economic re-
alities of competitive markets but also by stat-
ute. See 47 U.S.C. § 214(e)(1) (requiring that
all “eligible telecommunications carrier[s] . . .
shall be eligible to receive universal service
support”).
The FCC additionally defends the orders as
reasonable interim regulations. The shift from
monopoly to competition is indeed dramatic.
Congress thus expressly contemplated that the
Commission would adopt an incremental ap-
proach to retooling universal service for a
world of competition.6 Because the
provisions under review are
merely transitional, our review
is especially deferential.7
6 It requires the Commission to adopt rules
opening the local services market to competition
“within 6 months.” 47 U.S.C. § 251(d)(1). By
contrast, the Commission need only adopt rules
establishing a “specific timetable for
implementation” of universal service, and even
then, it has “15 months” to do so. 47 U.S.C. §
254(a)(2). See also TOPUC, 183 F.3d at 436
(“By instructing the FCC to establish a ‘timetable
for implementation’ by the statutory deadline,
Congress assumed the implementation process
would occur over a transition period after the
fifteen-month deadline.”).
7 See TOPUC, 183 F.3d at 437 (“Where the
statutory language does not explicitly command
otherwise, we defer to the agency’s reasonable
judgment about what will constitute ‘sufficient’
support during the transition period from one uni-
versal service system to another.”); id. at 440 n.85
(acknowledging that “we extend the FCC greater
discretion in deciding what will be ‘sufficient’
during the transition period”); MCI Telecomm.
Corp. v. FCC, 750 F.2d 135, 140 (D.C. Cir. 1984)
(noting that “substantial deference by courts is
accorded to an agency when the issue concerns
interim relief”).

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B. PROVISIONS.
Telephone service is jointly
provided by two sets of
carriers. Local exchange
carriers (“LEC’s”) provide
local telephone service in a
given geographical calling area
through monopoly networks, or
“exchanges,” each comprising a
series of “local loops” al-
lowing for interconnection
within the exchange.8 Inter-
exchange carriers (“IXC’s”)
provide long distance service
by connecting callers served by
different LEC’s; such service
is called “exchange access.”9
Petitioners are LEC’s serving
predominantly small towns and
rural areas.10 Intervenor Bell
Atlantic, supporting the FCC
and opposing petitioners, is
also an LEC. Intervenor MCI is
an IXC and also supports the
FCC.
The FCC has established a
number of universal service
programs involving LEC’s and
IXC’s. The Order implements a
myriad of amendments to bring
those programs into compliance
with competition in the LEC
market, but petitioners object
to amendments to two of them.
First, they oppose various
changes to the universal
service support fund for high
cost loops. Second, before
issuing the Order, the FCC
allowed certain small,
generally rural LEC’s to weight
specially the amount of time
spent by their telephone
switching equipment on
switching long distance calls,
for purposes of calculating the
access charges those LEC’s may
collect from IXC’s. The Order
would eliminate this effective
subsidy and replace it with a
new, explicit support fund.
1. HIGH-COST LOOPS.
Rural LEC’s face special
obstacles. The cost of
providing telephone service
varies with population density,
because dispersed populations
require longer wires and permit
l e s s e r e c o n o m i e s i n
installation, service, and
maintenance. Also relevant are
geographic characteristics, for
climate and certain types of
terrain make service calls and
repairs more costly. Rural
areas where telephone customers
are dispersed and terrain is
unaccommodating are therefore
the most expensive to serve.
To meet its historic mandate
of universal service, the FCC
has established a universal
service fund to subsidize high-
cost rural LEC’s to reduce the
rates they must charge their
customers. An LEC is eligible
for a subsidy if its operating
expensesSSits “loop costs”SSare
fifteen percent or more above
the national average. Loop
8 See 47 U.S.C. § 153(26) (defining “local ex-
change carrier”); 47 U.S.C. § 153(47) (defining
“telephone exchange service”).
9 See 47 U.S.C. § 153(16) (defining “exchange
access”); 47 U.S.C. § 153(48) (defining “telephone
toll service”).
10 See 47 U.S.C. § 153(37) (defining “rural
telephone company”).

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costs include the costs of the
depreciated cable, wire, and
circuit equipment used to
provide local service, the
depreciation and maintenance
expenses associated with that
local plant, and the corporate
operations expenses related to
the provision of local service.
“Corporate operations ex-
penses” include the costs
incurred in formulating
corporate policy, providing
overall administration and man-
a g e m e n t , a n d h i r i n g
accountants, consultants, and
lawyers to understand and
comply with FCC, state, and
local regulations. To de-
termine the amount of corporate
operations expense that is
properly chargeable to the pro-
vision of local service (and
therefore included in total
loop costs for purposes of
determining eligibility for a
subsidy), an LEC must reduce
its total corporate operations
expenses to correspond to the
proportion of its entire plant
that is local exchange plant.
Petitioners object to a
variety of changes the Order
effects to the administration
of the fund. First, they
oppose the continued imposition
of a cap on growth in fund
expenditures, which cap limits
total available support to the
previous year’s level, adjusted
for growth in the number of
working loops. See Order
¶ 302. Second, they object to
a new cap on the amount of
corporate operations expenses
that can be included in the
loop cost calculation. The
Order allows LEC’s to report
corporate operations expenses
only up to 115% of the industry
average for LEC’s of like size.
See Order ¶¶ 283-285, 307.
Third, the Order makes the
subsidy portable, following the
customer who switches service
from one LEC to another.
Petitioners claim that
portability violates the
principle of predictable
funding. See Order ¶ 311.
Fourth, beginning January 1,
2000, the Order imposes an
annual inflation index on the
loop cost eligibility
benchmarkSSthe minimum amount a
loop must cost to be awarded a
subsidySSreplacing the former
approach of recalculating a
fresh benchmark periodically,
based on updated estimates of
industry averages. See Order
¶¶ 300-301; 47 C.F.R. §
36.622(d) (1997). Finally, the
Order disallows additional
universal service support when
a rural LEC acquires and
upgrades another exchange, see
Order ¶ 308, despite
petitioners’ claim that such
mergers are efficient and
should be encouraged.

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The cumulative result of all
these changes, petitioners say,
is that the Commission has ren-
dered LEC’s unable to earn a
fair return and has discouraged
f u t u r e i n v e s t m e n t i n
telecommunications, and thereby
has acted arbitrarily and
capriciously and has violated
the Act’s sufficient funding
requirement and the Takings
Clause.
2. SWITCHING COSTS.
IXC’s pay “access charges” to
LEC’s for the right to have
access to an LEC’s local
exchange to connect long-
distance calls to and from that
exchange. Jurisdiction to
regulate access charges is
shared between federal and
state governments. To
implement rate-of-return reg-
ulation, state and federal
regulators must allocate the
costs of operating an LEC
between the delivery of
intrastate, interexchange
telephone service (which is
regulated by state entities)
and the provision of interstate
service (which is subject to
the FCC’s jurisdiction). To
determine how the allocations
are to be made, the agency has
promulgated a number of cost
separation rules.
The separation rules for
costs associated with
connecting callsSSa process
known as “switching”SSare based
on “dial equipment minutes of
use” (“DEM’s”). Under the
rules, an LEC divides its total
DEM’s between those used to
switch interstate calls and
those used to switch intrastate
calls.
Before the orders under
review, the FCC allowed certain
small, generally rural LEC’s to
weight their DEM totals with a
“toll weighting factor,”
thereby providing LEC’s with a
higher cost basis on which
their federal access charge
would be based. Petitioners
maintain that the practice of
DEM weighting reflects the
higher cost of switching a long
distance or “toll” call than
that of switching a local call,
because certain network
functions required by inter-
exchange carriersSSsuch as
equal access, intra-LATA toll
dialing parity, toll screening,
toll blocking, Signaling System
7 (SS7), expanded carrier
identification codes, and 800
number portabilitySSrequire
additional central processing
hardware and software.
The FCC has long held,
however, that the disparity
between intrastate and
interstate call switching is a
relic of old, electromechanical
technology and that modern
digital switching equipment
largely eliminates the cost
differential.11 Toll-weighting
11 As the Commission stated in 1987,
The Mountain States Telephone and
Telegraph Company, Northwestern Bell
Telephone Company, Pacific Northwest Bell
Telephone Company (US West), which
originally supported the use of weighted
(continued...)

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13
continues today, not out of
adherence to principles of cost
causationSSwhich provide that
costs be charged to the source
of the costSSbut rather to
provide an implicit subsidy for
rural LEC’s.12
The Order replaces toll-
weighting with a new universal
service fund (separate from the
fund for high-cost loops). See
Order ¶¶ 303-304. Petitioners
object for three reasons.
First, they claim the Order
arbitrarily and capriciously
a b a n d o n s c o s t - c a u s a t i o n
principles. Second, because it
would be financed by all
telecommunications carriers,
including small LEC’s such as
petitioners, the new fund con-
stitutes an unlawful subsidy by
small LEC’s in favor of IXC’s
because it effectively saves
IXC’s from having to pay for
the more expensive cost of
switching their long-distance
calls. Finally, just as they
do with respect to the high-
cost loop fund, petitioners
object on the ground that
portability violates the
principle of predictability and
the statutory command of
s u f f i c i e n t f u n d i n g .
Specifically, they claim that
if just 25% of the revenue that
the FCC has made portable is
lost by a typical small LEC,
the annual rate of return for
interstate access service will,
in many cases, fall to minus
10.53%.
III. COMMUNICATIONS ACT AND
ADMINISTRATIVE PROCEDURE ACT
CHALLENGES.
Petitioners’ main challenge
is that the orders are
inconsistent with the statutory
mandates of the Act.
Therefore, they claim, the
orders constitute arbitrary and
capricious regulation.
A. STANDARD OF REVIEW.
Courts review agency conduct
in two ways. First, we review
agency interpretation of their
statutory authority under the
familiar Chevron two-step
(...continued)
DEM in its comments, changed its position
to support measured DEM in reply
comments because it believes the ongoing
process of replacing older technology with
digital switches will eliminate the need for
any toll weighting. We believe that modern
digital switching equipment has greatly re-
duced, if not eliminated, the additional cost
of toll switching. . . . [W]e believe that the
need for toll weighting will continue to di-
minish and will eventually be eliminated as
the exchange carriers continue to replace
older technology equipment with digital
switches.
In the Matter of Amendment of Part 67 of the
Commission’s Rules and Establishment of a Joint
Board, Recommended Decision and Order in CC
Docket No. 80-286, 2 FCC Rcd. 2551, ¶ 49
(1987). See also In the Matter of MTS and WATS
Market Structure, Amendments of Part 67 (New
Part 36) of the Commission's Rules and
Establishment of a Federal-State Joint Board,
Report and Order in CC Docket Nos. 78-72,
80-286, 86-297, 2 FCC Rcd. 2639, ¶ 5 (1987).
12 See TOPUC, 183 F.3d at 425 (noting “the
sorts of implicit subsidies currently used by the
FCC in its [DEM] weighting program”).

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14
inquiry. See Chevron, 467 U.S.
at 842-44.
Under step one, where
“Congress has directly spoken
to the precise question at
issue,” we must “give effect to
the unambiguously expressed
intent of Congress,” reversing
an agency’s interpretation that
does not conform to the
statute’s plain meaning. Id.
at 842-43. Under step two,
which addresses situations in
which the statute is either
silent or ambiguous, “the
question for the court is
whether the agency’s answer is
based on a permissible con-
struction of the statute.” Id.
at 843. We reverse only if the
agency’s construction is “ar-
bitrary, capricious or
manifestly contrary to the
statute.” Id. at 844. If, on
the other hand, the
interpretation “is based on a
permissible construction of the
statute,” we defer to the agen-
cy’s construction.
I n a d d i t i o n , t h e
Administrative Procedure Act
(“APA”) empowers courts to
reverse agency action that is
arbitrary and capricious. See
5 U.S.C. § 706(2)(A); Harris v.
United States, 19 F.3d 1090
(5th Cir. 1994). Chevron step-
two focuses on the agency’s
interpretation of its statutory
power, while APA arbitrary-and-
capricious review focuses on
the reasonableness of the
agency’s decision-making
process pursuant to that
interpretation. See TOPUC, 183
F.3d at 410. Like Chevron
step-two, APA arbitrary and
capricious review is narrow and
deferential, requiring only
that the agency “articulate[] a
rational relationship between
the facts found and the choice
made.” Harris, 19 F.3d at 1096
(quoting Motor Vehicles Mfrs.
Ass’n of the United States v.
State Farm Mut. Auto. Ins. Co.,
463 U.S. 29, 43 (1983)).
“[T]he agency’s decision need
not be ideal.” Id. Moreover,
our review here is especially
deferential, because the
provisions under review are
merely transitional, as
expressly contemplated by the
Act.13
B. ANALYSIS.
Petitioners assert two
general themes. First, the
challenges go directly to the
heart of FCC expertiseSSwhether
the Commission has sufficiently
and explicitly supported
universal service in an open,
competitive marketSSand thus
must overcome substantial
judicial deference. Examining
the Act through the lens of
Chevron, we note that Congress
obviously intended to rely
primarily on FCC discretion,
and not vigorous judicial
review, to ensure satisfaction
of the Act’s dual mandates. As
we noted in a prior challenge
to an FCC universal service
regulation,
[t]o be sure, the FCC’s
reason for adopting this
methodology is not just to
13 See note 7, supra.

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15
preserve universal service.
Rather, it is also trying
to encourage local
competition . . . . As
long as it can reasonably
argue that the methodology
will provide sufficient
support for universal
service, however, it is
free, under the deference
we afford it under Chevron
step-two, to adopt a meth-
odology that serves its
other goal of encouraging
local competition.
TOPUC, 183 F.3d at 412.
Petitioners do not satisfy the
high evidentiary standard
necessary to establish that the
Commission acted arbitrarily
and capriciously when it
produced its interim rules.
S e c o n d , p e t i t i o n e r s ’
s u f f i c i e n c y c h a l l e n g e
fundamentally misses the goal
of the Act. The Act does not
guarantee all local telephone
service providers a sufficient
return on investment; quite to
the contrary, it is intended to
introduce competition into the
m a r k e t . C o m p e t i t i o n
necessarily brings the risk
that some telephone service
providers will be unable to
compete. The Act only promises
universal service, and that is
a goal that requires sufficient
funding of customers, not
providers. So long as there is
sufficient and competitively-
neutral funding to enable all
customers to receive basic
telecommunications services,
the FCC has satisfied the Act
and is not further required to
ensure sufficient funding of
every local telephone provider
as well.
Moreover, excessive funding
may itself violate the
sufficiency requirements of the
Act. Because universal service
is funded by a general pool
s u b s i d i z e d b y a l l
t e l e c o m m u n i c a t i o n s
providersSSand thus indirectly
by the customersSSexcess
subsidization in some cases may
detract from universal service
by causing rates unnecessarily
to rise, thereby pricing some
consumers out of the market.
1. HIGH-COST LOOPS.
Petitioners fail to show that
the FCC’s various changes to
the universal service support
fund for high-cost loops
unreasonably fails to provide
sufficient funding for
universal service or otherwise
constitutes an arbitrary and
capricious regulation under the
Act. First, they object to
the agency’s continuation of a
cap on growth in the fund,
adjusted only for changes in
the total number of working
loops. The cap’s track record,
however, reflects a reasonable
b a l a n c e b e t w e e n t h e
Commission’s mandate to ensure
sufficient support for
universal service and the need
to combat wasteful spending.
The agency’s broad discretion
to provide sufficient universal
service funding includes the
decision to impose cost
controls to avoid excessive
expenditures that will detract
from universal service.

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16
Petitioners do not show how the
FCC has abused that discretion.
Second, petitioners object to
the introduction of a cap on
the amount of corporate oper-
ations expenses that may be
reported to determine
eligibility for high-cost loop
support. The Order limits
LEC’s to 115% of the industry
average for corporate
operations expenses accrued by
carriers of like size. See
Order ¶¶ 283-285, 307.
Petitioners claim that
corporate operations expenses
are already capped and that
there is no need for a second
cap.14 It is true that, even
before the Order, the amount of
reportable corporate operations
expenses was determined by
multiplying an LEC’s total
corporate operations expenses
by the percentage of its total
plant that is local exchange
plant. This is no cap,
however, but rather a
reasonable method of allocating
costs. The proposed 115% rule
is thus a wholly reasonable
exercise of the Commission’s
legitimate power to combat
abusive spending; absent the
proposed rule, the regulations
provide no incentive to keep
costs down. Moreover, given
its legitimate cost concerns,
the agency was well within its
discretion to impose a cap
rather than to undertake the
more costly alternative of
intensive auditing.
Petitioners additionally
claim that the cap on review is
excessively burdensome, driving
interstate rates of return to
2.81% for rural LEC’s. Even
assuming that this statistic
proves that customers have
failed to receive sufficient
universe service support, this
statistic is based on the
experience of only a single
providerSSthe Bay Springs
Telephone CompanySSand not a
statistically valid sample.
Petitioners’ evidence therefore
does not establish that the cap
unreasonably fails to provide
sufficient service; at most it
presents an anomaly that can be
addressed by a request for a
waiver.15
Moreover, the statistic
i g n o r e s t h e F o u r t h
Reconsideration Order, in which
the FCC responded to
petitioners’ concerns by, inter
alia, establishing a minimum
cap of $300,000. See Fourth
Reconsideration Order ¶¶ 85-
109. Petitioners present no
evidence disputing the suf-
ficiency of the currently
operative cap.
Third, the order provides
that the universal service
subsidy be portable so that it
moves with the customer, 14 See Alltel Corp. v. FCC, 838 F.2d 551, 561
(D.C. Cir. 1988) (“A regulation perfectly
reasonable and appropriate in the face of a given
problem may be highly capricious if that problem
does not exist.”).
15 See 47 C.F.R. § 1.3; Fourth Reconsideration
Order ¶¶ 93, 102, 108.

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17
rather than stay with the
incumbent LEC, whenever a
customer makes the decision to
switch local service providers.
Petitioners claim that
portability violates the
statutory principle of
predictability, see 47 U.S.C. §
254(b)(5), and the statutory
command of sufficient funding.
W e r e i t e r a t e t h a t
predictability is only a prin-
ciple, not a statutory command.
To satisfy a countervailing
statutory principle, therefore,
the FCC may exercise reasoned
d i s c r e t i o n t o i g n o r e
predictability. See TOPUC, 183
F.3d at 411-12.
Moreover, petitioners cannot
even show that portability
violates sufficiency or
predictability. The purpose of
universal service is to benefit
the customer, not the
carrier.16 “Sufficient”
funding of the customer’s right
to adequate telephone service
can be achieved regardless of
which carrier ultimately
receives the subsidy.17
The methodology governing subsidy
disbursements is plainly stated and made
available to LEC’s. What petitioners seek is
not merely predictable funding mechanisms,
but predictable market outcomes. Indeed,
what they wish is protection from competition,
the very antithesis of the Act.
To the extent petitioners argue that
Congress recognized the precarious
competitive positions of rural LEC’s, their
concerns are addressed by 47 U.S.C. § 214(e),
which empowers state commissions to regulate
entry into rural markets.18 Furthermore,
portability is not only consistent with
predictability, but also is dictated by principles
of competitive neutrality and the statutory
command that universal service support be
spent “only for the provision, maintenance,
and upgrading of facilities and services for
which the [universal service] support is in-
tended.” 47 U.S.C. § 254(e).
Fourth, rather than continue to determine
the eligibility threshold for high-cost loop sup-
port by recalculating the national average loop
cost, the FCC now simply will adjust the pre-
viously-calculated national average by an an-
nual inflation index. Even assuming, as
petitioners contend, that inflation adjustments
to historical averages in fact would render
fewer LEC’s eligible for universal service
subsidies than would be the case under the
former approach, petitioners nevertheless fail
to show how this interim approach is
unreasonable. Given the eventual transition
16 See, e.g., 47 U.S.C. § 254(b)(3) (stating that
“Consumers in all regions of the Nation” shall
receive comparable telephone service).
17 Petitioners estimate that the introduction of
competition will result in a loss of approximately
25% of the customer base. The FCC counters with
historical trends that would predict market share
losses of only 3%. Because we conclude that the
sufficiency requirement is intended to benefit the
customer, not the provider, we need not resolve this
particular dispute.
18 See 47 U.S.C. § 254(e)(2) (“Before
d e s i g n a t i n g a n a d d i t i o n a l e l i g i b l e
telecommunications carrier for an area served by a
rural telephone company, the State commission
shall find that the designation is in the public
interest.”).

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18
from historic cost to forward-looking cost, as
required by competition, the FCC reasonably
concluded that the effort of collecting historic
cost data no longer was justified.
Finally, petitioners claim that sales and
transfers of exchanges by rural providers are
efficient and ought to be encouraged and sub-
sidized. The Order, by contrast, denies
additional universal service support in cases in
which a rural LEC purchases another
exchange.
When the permanent rules for universal
access within the context of local competition
are in place, all exchanges will be governed by
uniform rules with respect to universal service
support, without regard to the rural or non-
rural status of the LEC. In the interim,
however, the rules continue to treat rural and
other LEC’s differently, in recognition of the
continued greater need of rural LEC’s. The
opportunity thus exists for gaming the
different universal service support regimes by
transferring ownership to a rural LEC. The
FCC acted within its discretion to combat such
gaming by keying regulatory treatment to an
exchange’s original ownership status, without
regard to any subsequent transfer in
ownership.
The Commission argues that, as a last re-
sort, the availability of waivers cures its orders
of any deficiency with respect to sufficiency
and predictability.19 Even if the waiver
provisions were debatable as a policy matter,
they are not an issue for judicial review. For
our purposes, a waiver provision is legitimate
if the underlying rule is rational, see National
Rural Telecomm. Ass’n v. FCC, 988 F.2d 174,
181 (D.C. Cir. 1993), and cannot save a rule
that on its own has no rational basis, see Alltel
Corp, 838 F.2d at 561-62. We therefore can
uphold these amendments relating to the high-
cost loop fund without addressing the wisdom
of allowing waivers.
2. SWITCHING COSTS.
Petitioners also fail to show that the FCC’s
various changes to the treatment of switching
equipment costs unreasonably fail to provide
sufficient and explicit funding for universal ser-
vice or otherwise constitute an arbitrary and
capricious exercise of agency powers under
the Act. First, petitioners claim that the
changes arbitrarily and capriciously abandon
cost-causation principles. They insist on re-
taining special weighting on the assumption
that it is in fact more costly to switch long-
distance calls than local calls. Therefore, un-
der cost-causative principles, IXC’s should
pay higher access charges, because they are
responsible for a greater proportion of
switching costs.
As we have said, however, the Commission
has long abandoned this assumption. Instead,
special weighting has been allowed to continue
solely to provide an additional subsidy to rural
LEC’s, an interest that would be equally
served by the new universal service support
fund. Indeed, the Order makes plain that the
new fund shall provide support “corresponding
in amount to that generated formerly by DEM
weighting.” Order ¶ 303. Moreover, by
mandating that all universal service support be
“explicit,” 47 U.S.C. § 254(e) requires that
this special weighting be eliminated.
19 See 47 C.F.R. § 1.3 (general waiver provision
for all FCC regulations); Fourth Reconsideration
Order ¶ 38 (providing for waiver of indexed cap on
growth in high cost loop fund); Id. at ¶¶ 93, 102,
108 (providing for waiver of cap on corporate
operations expenses).

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19
Petitioners’ second objection simply
misconstrues the requirement of “explicit”
funding. They argue that, because the new
fund would be financed by all
telecommunications carriers, including small
LEC’s such as petitioners, the new fund
constitutes an unlawful subsidy in favor for
IXC’s.
Again, petitioners rest their argument on
the same assumption deemed obsolete by the
FCCSSthat long-distance switching is more
costly than local switching. Even so, we made
clear in TOPUC that the implicit/explicit dis-
tinction turns on the difference between direct
subsidies from support funds and recovery
through access charges and rate structures.
“The statute provides little guidance on wheth-
er ‘explicit’ means ‘explicit to the consumer’
. . . or ‘explicit to the carrier’ . . . [but it] does
state, however, that all universal service
support should be ‘explicit.’ . . . By forcing
GTE to recover its universal service
contributions from its access charges, the
FCC’s interpretation maintains an implicit
subsidy for ILEC’s such as GTE.” 183 F.3d at
425.
Petitioners thus misconstrue the meaning of
the explicit funding requirement. The fact that
the fund is subsidized by contributions from all
telecommunications providers, including
LEC’s, does not make it an implicit subsidy
under § 254(e), even if it effectively
r e d i s t r i b u t e s r e s o u r c e s a m o n g
telecommunications providers.
Moreover, § 254(b)(4) requires “[a]ll pro-
viders of telecommunications services [to]
make an equitable and nondiscriminatory con-
tribution to the preservation and advancement
of universal service.” 47 U.S.C. § 254(b)(4)
(emphasis added); see also 47 U.S.C. § 254-
(d). The Commission reasonably applied the
principle of equitable and nondiscriminatory
contribution by requiring contributions from all
telecommunications providers.
Finally, petitioners object on the ground
that portability violates the principle of
predictability and the statutory command of
sufficient funding. Specifically, they claim
that, if just 25% of the revenue that the FCC
has made portable is lost by a typical small
LEC, the annual rate of return for interstate
access service will, in many cases, fall to minus
10.53%.

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20
As we have said, the Commission
reasonably construed the predi ctability
principle to require only predictable rules that
govern distribution of the subsidies, and not to
require predictable funding amounts. Indeed,
to construe the predictability principle to
require the latter would amount to protection
from competition and thereby would run
contrary to one of the primary purposes of the
Act.
Moreover, petitioners’ approach to the pre-
dictability principle would prohibit also the
current subsidy effect of weighting switching
costs. Under the current plan, LEC’s receive
the subsidy implicitly through access
chargesSScosts that are realized only when
customers make telephone calls. The old sys-
tem of implicit subsidies is no less portable
than is the explicit subsidies contemplated by
the new fund, for an LEC cannot assess access
charges against IXC’s for the costs of a
customer who has left that LEC for another
provider. We therefore uphold the Order over
petitioners’ APA and Chevron challenges.
IV. TAKINGS CHALLENGE.
Notwithstanding the above analysis,
petitioners request us to read the Act to avoid
a violation of the Takings Clause. See Edward
J. DeBartolo Corp. v. Florida Gulf Coast
Building & Constr. Trades Council, 485 U.S.
568, 575 (1988). We see no reason to invoke
the canon of avoidance, however, because we
are simply not presented with a constitutional
violation.
The Fifth Amendment protects utilities
from regulations that are “so unjust as to be
confiscatory.” Duquesne Light Co. v. Bar-
asch, 488 U.S. 299, 307 (1989). Petitioners
therefore must show that a regulation will
“jeopardize the financial integrity of the
companies, either by leaving them insufficient
operating capital or by impeding their ability to
raise future capital,” or they must demonstrate
that the reduced subsidies “are inadequate to
compensate current equity holders for the risk
associated with their investments under a mod-
ified prudent investment scheme.” Duquesne,
488 U.S. at 312.
It is not enough that a party merely
speculates that a government action will cause
it harm. Rather, a taking must “‘necessarily’
result from the regulatory actions.” TOPUC,
183 F.3d at 437 (citing United States v.
Riverside Bayview Homes, 474 U.S. 121, 128
n.5 (1985)). Such a showing cannot be made
here “until the administrative agency has
arrived at a final, definitive position regarding
how it will apply the regulations at issue to the
particular [property right] in question.”
Williamson County Regional Planning
Comm’n v. Hamilton Bank, 473 U.S. 172, 191
(1985).
At the very least, therefore, petitioners
must wait to experience the actual

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21
consequences of the Order before a court may
even begin to consider whether the FCC has
effected a constitutional taking. Until it is
known what level of universal service funding
each petitioner will receive under the Order,
and under what circumstances the Commission
will grant a waiver, we cannot seriously
entertain a Takings Clause challenge.
Furthermore, petitioners do not present
credible evidence that the Order ever will
cause the drastic consequences for rural LEC’s
articulated in Duquesne. The mere fact that,
“[f]or many rural carriers, universal service
support provides a large share of the carriers’
revenues,” Order ¶ 294, is not enough to
establish that the orders constitute a taking.
The Fifth Amendment protects against takings;
it does not confer a constitutional right to gov-
ernment-subsidized profits. The Takings
Clause thus erects no barrier to our Chevron
and APA analysis.
V. REGULATORY FLEXIBILITY ACT
CHALLENGE.
Under the Regulatory Flexibility Act
(“RFA”), final agency rules must contain a
“final regulatory flexibility analysis” (“FRFA”),
5 U.S.C. § 604(a), which must include
a description of the steps the agency has
taken to minimize the significant
economic impact on small entities
consistent with the stated objectives of
applicable statutes, including a statement
of the factual, policy, and legal reasons
for selecting the alternative adopted in
the final rule and why each one of the
other significant alternatives to the rule
considered by the agency which affect
the impact on small entities was re-
jected.
5 U.S.C. § 604(a)(5). In 1996, Congress
provided for judicial review of agency
compliance with the RFA. See 5 U.S.C. §
611(a)(1). We review only to determine
whether an agency has made a “reasonable,
good-faith effort” to carry out the mandate of
the RFA. Associated Fisheries, Inc. v. Daley,
127 F.3d 104, 114 (1st Cir. 1997).
Petitioners’ RFA argument amounts to little
more than a redressing of its earlier Chevron
and APA claims. The RFA is a procedural
rather than substantive agency mandate, to be
sure,20 but petitioners fail to articulate specific
procedural flaws in the FCC’s promulgation of
the orders. In fact, both orders are
accompanied by substantial discussion and
deliberation, including consideration and
reasoned rejection of significant alternatives
which, in the Commission’s judgment, would
not have achieved with equivalent success its
twin statutory mandates of universal service
and local competition. The RFA requires no
more.21
Petitioners come closest to stating a merito-
rious procedural objection when they assert
that the FCC failed either to undertake or to
present economic analysis. Even assuming
that that were so, the RFA plainly does not re-
quire economic analysis, but mandates only
that the agency describe the steps it took “to
20 See Associated Fisheries, 127 F.3d at 114
(stating that “section 604 does not command an
agency to take specific substantive measures, but,
rather, only to give explicit consideration to less
onerous options”).
21 See Associated Fisheries, 127 F.3d at 115
(noting that “section 604 does not require that an
FRFA address every alternative, but only that it
address significant ones.”).

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22
minimize the significant economic impact on
small entities consistent with the stated
objectives of applicable statutes.” 5 U.S.C. §
604(a)(5).
The RFA specifically requires “a statement
of the factual, policy, and legal reasons for se-
lecting the alternative adopted in the final
rule.” Id. Nowhere does it require, however,
cost-benefit analysis or economic modeling.
Indeed, the RFA expressly states that, “[i]n
complying with [section 604], an agency may
provide either a quantifiable or numerical de-
scription of the effects of a proposed rule or
alternatives to the proposed rule, or more
general descriptive statements if quantification
is not practicable or reliable.” 5 U.S.C.
§ 607.22 We therefore conclude that the FCC
reasonably complied with the requirements of
the RFA.
CONCLUSION.
Petitioners’ various challenges fail because
they fundamentally misunderstand a primary
purpose of the Communications ActSSto her-
ald and realize a new era of competition in the
market for local telephone service while
continuing to pursue the goal of universal
service. They therefore confuse the
requirement of sufficient support for universal
service within a market in which telephone
service providers compete for customers,
which federal law mandates, with a guarantee
of economic success for all providers, a
guarantee that conflicts with competition.
The FCC interim orders are reasonably tai-
lored to achieving universal service and
competition in local markets. They do not
effect a cognizable, unconstitutional taking.
And they were promulgated in reasonable
compliance with the requirements of the RFA.
We therefore DENY the petitions for review.
Judge WIENER concurs in the judgment
only.
22 See also Associated Fisheries, 127 F.3d
at 115 (“Section 604 prescribes the content of an
FRFA, but it does not demand a particular mode of
presentation.”).

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