IV. Competitive Impacts of the Merger Under Section 854(b)(3)

A. Framework for Assessing Competitive Impacts

1. Applicability of Section 854(b)(3)

Consistent with our analysis above relating to the sharing of net benefits under §§ 854(b)(1)and (2), we likewise find that that this transaction is subject to § 854(b)(3) requirements that competition must not be adversely affected. In accordance with § 854(b)(3), as a prerequisite for authorizing the merger, the Commission must find that applicants' proposal does not adversely affect competition. For the reasons previously discussed above, we reject Applicants' arguments that this transaction is not subject to § 854(b)(3) merely because the utility transfer is being structured around holding companies.

It would elevate form over substance to conclude that the Legislature was more concerned with competition if the utility was a party to the transaction absent the holding company structure, but was less concerned about competition when a holding company was involved. We therefore determine that § 854(b) applies to this acquisition even though it is configured merely as a holding company transaction. Accordingly, we proceed with our analysis of competition in accordance with § 854(b)(3).

In the Southern California Edison Company (SCE)/San Diego & Gas Company (SDG&E) merger proceeding (D.91-05-028; A.88-12-035), we set forth analytical precedents and tools for interpreting whether a party's proposal "adversely affects competition" within the meaning of § 854 (b)(3). We noted therein that the more familiar merger analysis is whether "the effect of such acquisition may be substantially to lessen competition or tend to create a monopoly" under Section 7 of the Clayton Act. (Id, 40 CPUC2d at 182.) Precedent developed under Section 7 of the Clayton Act provides a framework for analyzing competitive effects under § 854(b)(3), as well as subsequent proposals, under the federal antitrust laws.

While we are guided by federal antitrust law (e.g., Section 7 of the Clayton Act) in analyzing the SBC/AT&T proposed merger, we do not need to find a technical violation of that law in order to deny the proposed merger.⁶⁴ Rather, under § 854, we may disapprove a merger where the impacts are harmful, but less than "substantial" under the Clayton Act. (D.97-03-067, 71 CPUC2d 351, 379.) In analyzing a proposal under § 854, we are not limited to a determination that the proposal violates standards set forth in the relevant antitrust statutes. We may also rely, as appropriate, on the body of common law regarding competition that existed before 1989, when the required standard of review for mergers meeting the specified criteria was codified for utilities in §854.

Independent of § 854, however, the Commission still has an obligation to assess the antitrust impacts of matters before us. Northern California Power Agency v. Public Util. Com. 5 Cal3d 379-380 (1971) requires that the Commission take into account the antitrust aspects of applications before us, but based on a balancing test, "plac[ing] the important public policy in favor of free competition in the scale along with the other rights and interests of the general public."

Section 854(b)(3) obligations are more specific, however, and do not provide for a balancing test. For mergers that come under § 854(b)(3), the Commission must make a finding that as a basis for approval that competition will not be adversely affected. The Legislature further mandated certain, specific outcomes if it is determined that such a merger will adversely affect competition. Thus, the Legislature required that mitigation measures be adopted to avoid adverse impacts, or else that authorization for the merger be denied.

2. Methodology for Assessing Competitive Impacts

The Department of Justice/Federal Trade Commission Horizontal Merger Guidelines (Merger Guidelines) provide a well-developed and widely accepted process for factually evaluating how a proposed merger will affect competition.⁶⁵ The Merger Guidelines set forth a sequence of analysis beginning with a definition of relevant markets followed by an assessment of whether the merger would increase market concentration in the relevant markets. (Merger Guidelines § 0.2.) Accordingly, we shall proceed with our analysis by referring to the Merger Guidelines, as appropriate.

As an initial step in analyzing whether the merger will have adverse effects on competition, we must relate potential impacts to the relevant markets within which a firm might exercise market power to the detriment of competition. For purposes of assessing potential competitive effects of the merger, SBC witness Aron broadly delineates the mass market (i.e., residential and small business customers) and the business market (other than those within the mass market) with the latter including an enterprise segment.

TURN witness Murray provided a more granular definition of the relevant markets for purposes of assessing potential competitive impacts of the merger. On the retail side, Murray presented evidence of the following distinct markets in SBC California's service area: (1) primary network access connections for residential customers; (2) all other residential services, including additional lines; (3) services for small businesses; (4) services for mid-sized businesses; and (5) services for very large (enterprise) business customers.⁶⁶ On the wholesale side, TURN recommends that the wholesale and interconnection services be considered both for traditional circuit-switched voice and IP-based services.

Applicants' own business practices typically treat each of these markets separately, and each market has the potential to be affected in different ways by the merger. For purposes of our analysis, we will therefore assess the effects of the merger with respect to each of more granular markets, as delineated by TURN.

Our inquiry focuses on evidence as to whether or not this proposed merger increases or otherwise enhances market power with reference to the relevant markets as identified below. Applicants' existing level of market power is the base from which our competitive analysis begins. We recognize, however, that the existing base is only a starting point, and that prospective developments expected in the competitive landscape must be considered and weighed in an appropriate manner.

We thus consider whether or not the proposed merger will adversely affect competition with respect to each of the relevant markets, considering the effects of AT&T as an actual or potential competitor. We also consider the appropriate weight to give the Advisory Opinion of the Attorney General.

3. Jurisdiction to Address Impacts Involving Federally Regulated Services

Since both federal agencies and this Commission are reviewing the proposed merger's public interest aspects, certain jurisdictional questions have been raised. Parties disagree concerning whether Commission review of competitive impacts under § 854 (b)(3) properly includes consideration of impacts that may involve services subject to federal regulation or review. Applicants argue that competitive impacts of such services are beyond the jurisdiction of this Commission, and are more properly left for review by federal agencies.

We conclude that even to the extent that certain competitive effects of the merger may relate to services subject to federal regulation, our authority under § 854 (b) and (c) is sufficiently broad to encompass consideration of such effects. Section 854 (b) (3) requires, as a basis for approving this transaction, that we consider whether the proposed acquisition will adversely affect competition, as well as conditions to mitigate adverse impacts. The statue does not carve out exceptions to this requirement only for certain categories of services or competitive impacts.

We previously confirmed our jurisdiction to review competitive impacts and adopt mitigating measures under § 854(b), even where our review may involve federally regulated services. For example, in D.91-05-028 involving the SCE merger with SDG&E, the applicants there argued that the FERC had jurisdiction over transmission and sale of electric energy in interstate commerce, and that federal jurisdiction is plenary. SCE claimed that this Commission may not act in a manner that would conflict with a federal determination. Since the FERC had chosen to exercise authority to determine the competitive impacts of that merger on such federally regulated services, SCE argued, this Commission's review must be limited to state-regulated services which FERC did not regulate.

In D.91-05-028, however, the Commission rejected SCE's interpretation, stating that:

"This Commission's statutory authority to determine whether the proposed merger should be authorized, based upon the assessment of competitive impacts and their potential mitigation (§ 854(b)(2)) is meaningfully exercised only if this Commission is free to engage in the full extent of the merger's impacts on California ratepayers. The statute requires that we assess whether the merger will impact competition. If that assessment requires us to take into account certain issues regarding interstate transmission and bulk sales, then that is what we must do. Furthermore, as an administrative agency created by the Constitution, we have no power to refuse to enforce § 854(b)(2) on the basis of federal preemption, unless an appellate court has made a determination that enforcement of the statute is prohibited by federal law or federal regulation. (Cal. Const. Act. 3, § 3.5. (40 CPUC 2d, 159, 179.) (Emphasis added.)

Applicants here raise the same argument as that raised by SCE. Although the SCE proceeding involved a different industry, the same principle is involved. Consistent with D.91-05-028, therefore, we find that the statutory mandates under § 854(b)(2) require consideration of the full extent of competitive impacts of the merger, including impacts that involve federally regulated services and prices.

Moreover, Joint Applicants cite no appellate court determination that the Commission's enforcement of § 854(b)(3) is prohibited by federal law or regulation. Thus, consistent with D.91-05-028, the Commission has no power to refuse to enforce § 854 based merely on Applicants' claims of federal preemption.

To the extent that we impose conditions on approving this proposed merger, we do so only within the context of our obligation to assure that the merger is in the public interest pursuant to § 854. If the Applicants decided not to go forward with the merger, they would not be required to implement the mitigation measures we adopt. Thus, we are acting within the scope of the Commission's jurisdiction under § 854(b)(3).

4. Relevance of Market-Share and HHI Data in Assessing Merger Impacts

For assessing market concentration, the Guidelines rely upon calculations utilizing the Herfindahl Hirschman Index (HHI) as an analytic `starting point' in all merger reviews. (AG Opinion, at p. 16, citing Merger Guidelines § 90.) The HHI is a measure that is used to draw inferences concerning the correlation between market concentration and lack of market competitiveness. Under DOJ guidelines, if the HHI for a market is greater than 1800 and if the proposed merger increases the HHI by more than 100, the rebuttable presumption would be that there is an increase in market power associated with the merger.

a) Parties' Positions

Applicants did not provide market share statistics as the basis for its claims that competition will not be adversely affected by the merger, and did not perform an analysis of market concentration utilizing the HHI.⁶⁷ Although Dr. Aron points out what she views as weaknesses to the conventional market share calculations submitted as evidence by other parties, she does not perform any such calculations herself. (Ex. 79C, p. 22, SBC/Aron.) Witness Aron claims that there is no value to calculating market shares because such statistics are not meaningful in this marketplace at this time. (Aron Rebuttal, page 22.)

AT&T is the single largest competitor of SBC in all three major segments of the California telecommunications market - local residential and small business services, long distance, and services to large business, government and institutional "enterprise" customers. ORA argues that SBC's acquisition of AT&T translates into significant escalations in the HHIs applicable to the SBC California local and long-distance markets.⁶⁸ These increases exceed the thresholds specified in the Merger Guidelines.⁶⁹ ORA views these increases in market concentration as creating the opportunity for post-merger SBC to implement a "significant and non-transitory increase in price."

SBC witness Aron disagrees with ORA witness Selwyn that the HHI analysis should be controlling in assessing the competitive impacts of this merger. Even where the HHI analysis is otherwise applicable, Dr. Aron characterizes it as only a preliminary screen to identify those cases where further analysis is warranted. Particularly in the case of the mass market, Aron believes that market share data is not meaningful here because AT&T has already withdrawn from competing for mass market customers. Aron therefore believes that there would be no effect on market concentration as a result of AT&T being absorbed by SBC since AT&T is no longer actively competing in the mass market. Dr. Aron likewise argues that because the HHI is a summary of market share data, the HHI suffers from the same shortcomings as market shares themselves.

TURN presents evidence that SBC has a highly concentrated share of the market, particularly for mass market customers. TURN witness Murray performed a detailed market share analysis, set out at Exhibit 136C, pp. 75-110. Murray identified a number of relevant product markets.

SBC does not deny that current statistics indicate a highly concentrated market share, but argues that such statistics are not meaningful indicators of the effects of the merger on competitiveness of the market. SBC witness Aron criticizes intervenor witnesses' testimony on market concentration, arguing that they have misapplied the DOJ Merger Guidelines by focusing on a "backward-looking, formulaic `checklist'." SBC witness Aron argues that such historic data on market concentration portrays an unrealistic profile of the competitiveness of the market based upon forward-looking information. In particular, Dr. Aron points to trends in intermodal competition and the rapid pace of technological development in the industry as more relevant indicators of the extent of market competition.

b) Discussion

We conclude that the proper approach to a competitive analysis requires recognition of recorded data on market concentration, including HHI measures, as a necessary starting point.⁷⁰ We disagree with Dr. Aron to the extent that she claims historic data on market concentration has no value whatsoever. Dr. Aron did not perform her own market concentration analysis. We find her analysis incomplete in this respect.

Once a traditional calculation of market share has been calculated, other prospective factors, such as those considered by Dr. Aron, are taken into account. For example, changing market conditions are considered "in interpreting market concentration and market share data," but not as a reason to discount such data entirely. (Merger Guidelines § 1.521.) Similarly, the possibility that new firms might enter the market is to be considered either when a market is defined, or after a market concentration analysis has been performed. (Merger Guidelines §§ 0.2, 1.132 3.2.)

As discussed in further detail below, we generally find that as a starting point for further analysis, the HHI measures for each of the markets reviewed by ORA and TURN indicate a high degree of concentration. In those markets in which SBC and AT&T are active competitors, the HHI measures indicate that market concentration will increase sufficiently to warrant concerns about the potential for competition to be impacted. With the HHI findings as the starting point, the next step is to consider whether other forward-looking measures of competition lead to a different conclusion concerning the competitive effects of the merger.

With respect to forward-looking competition from traditional wireline carriers, we generally find little evidence that such competition can be relied upon to mitigate increased market power as a result of the SBC/AT&T merger. SBC witness Aron claims that because of the "impetus" caused by the phase-out of UNE-P, facilities-based competition will increase. Yet, the UNE-P phase-out led AT&T to exit the mass market rather than to compete by constructing more facilities. (Ex. 14, p. 5, Polumbo/AT&T). Likewise, SBC preferred to buy AT&T rather than to build its own facilities to compete against AT&T. (Tr. 10: 1045; SBC/Rice). These actions by the two largest competitors in California raise serious doubts as to whether traditional wireline carriers with less financial resources than SBC or AT&T will have the incentive to build their own network facilities to compete against the merged company.

The remaining question is whether we can rely on forward-looking competition from newer intermodal alternative technologies to conclude that the merger will not pose competitive problems. We consider this question in detail below. We then consider what conditions may be warranted to mitigate the potential adverse competitive effects of the merger.

5. Weight to be Given the Attorney General's Advisory Opinion

a) Background

As directed by § 854(b)(3), the Commission requested an advisory opinion from the California Attorney General (AG) concerning whether competition will be adversely affected by the merger, and, if so, what mitigation measures might be adopted to avoid this result. While the AG's opinion is not controlling, we shall accord it due weight in our deliberations.⁷¹

The AG Advisory Opinion was filed on July 22, 2005. In analyzing the competitive effects of the merger, the AG employed the approach embodied in the antitrust laws, including the DOJ and FTC 1992 Horizontal Merger Guidelines and the April 8, 1997 revisions. Following traditional analysis, the Guidelines analyze the effect of a consolidation upon the "relevant markets" within which the parties do business. A relevant market is described in terms of its product and geographic dimensions.

In summary, the AG expresses concern that the merger may adversely affect competition for two types of special access, namely, DS1 and DS3 services. The AG concludes that the merger may have the effect of raising average rates for DS1 and DS3 service. As a mitigating condition of merger approval, the AG thus recommends that rates paid by current AT&T customers receiving DS1 or DS3 private line network service be frozen for a one-year period. On the other hand, the AG concludes that the competitive effects of the proposed merger will be minimal for other relevant markets, including those for mass-market local and long distance, enterprise, and Internet backbone services.

The AG Opinion relied primarily upon written FCC materials, on testimony submitted in this proceeding and on materials provided by Applicants with no opportunity for ORA, TURN or competitors to reply. (Tr. Vol. 8, p. 1045 AT&T/Giovannucci.)⁷² The AG's Opinion was released before evidentiary hearings, and thus did not consider evidence resulting from the hearing, including additional information produced as exhibits, the results of two depositions, and cross-examination of witnesses. In addition, it is unclear whether the AG had the benefit of reviewing the documents provided by Applicants to the FCC Staff.

The AG Opinion concludes that SBC and AT&T mainly compete in different telecommunications markets or in entirely different sectors of the same market.⁷³ This conclusion is a result of the AG Opinion's assumption that it should only analyze facilities-based competition between SBC and AT&T in certain markets. (AG Opinion, at p. 14.) These markets include the residential and small/medium business markets for both local exchange service and long distance service.⁷⁴ Even though both AT&T and SBC, "offer local, access and toll service within SBC service regions.... includ[ing] information services, business switched access, and long distance services," (AG Opinion, at p. 6.) the opinion does not consider the effects of this competition.

b) Discussion

We conclude that, by focusing its analysis on facilities-based competition, the AG Opinion did not fully address the overall markets for telecommunications services. In addition, because AT&T and SBC pursue different business strategies, only looking at facilities-based competition pre-determines the results of the analysis for mass market local exchange and long distance services. The analysis for other markets is also affected by the opinion's assumptions.

Because it focused only on facilities-based competition, the AG Opinion determines that the lack of overlap in facilities between SBC and AT&T allows it to avoid a "precise determination" of Applicants' market shares. (AG Opinion, at p. 16.) As a result, the AG Opinion does not calculate the changes to the HHI as a result of this transaction. In analyzing only facilities-based competition between SBC and AT&T, the AG relies on a technical theory derived from the FCC's decision approving the MCI/WorldCom merger.⁷⁵ Thus, the AG Opinion can only be relied upon to show the results of applying the FCC's WorldCom/MCI standard to the transaction. In this respect, we find the AG Opinion relatively incomplete compared to testimony provided by other witnesses who did perform the required analysis set forth in the Merger Guidelines.

The AG Opinion does not define product markets to include the products actually offered to customers, but analyzes the markets for the "inputs" from a "vertical dimension" that make up the services offered. The AG's opinion analyzes these inputs because they may be "more limited than the end product." In this case, the AG Opinion concludes that only one so-called "input," services offered by carriers using their own facilities need be analyzed to determine this transaction's competitive effects. By declining to analyze the broader market where telecommunications companies compete for customers limits the scope of the AG Opinion's analysis.

We conclude that the facts underlying the WorldCom/MCI decision are not sufficiently analogous to warrant the adoption here of such a restrictive approach. A competition analysis determines if a transaction has the ability to create or to enhance market power. The Merger Guidelines suggest that market power be measured by defining specific product markets that could be monopolized. (Merger Guidelines §1.1.) Defining a product market involves identifying alternatives that should be included in the relevant market, and product markets should not be defined too narrowly.

An exercise in market definition should take into account products whose presence could make price increases unprofitable. (Ibid.) As a result, focusing only on competition for facilities-based services defines the market too narrowly. When a dominant facilities-based local exchange carrier absorbs the market share of another carrier, it is not clear that the dominant carrier's resulting increase in market share is irrelevant simply because the absorbed carrier was a reseller. Similarly, if a carrier that resold long distance was able to obtain a significant share of the market at the expense of a facilities-based carrier, the competition between those two carriers should not be discounted simply because one is a reseller. The AG Opinion does not explain how its chosen market definition accounts for the fact that the bulk of the competition in California's local exchange and long distance markets occurs between carriers who use different strategies.

The AG Opinion appears to equate facilities-based competition with competition at a wholesale level. The AG describes products combining "a range of inputs" in support of its conclusion that readily available inputs need not be analyzed. (AG Opinion at p. 14.) The Opinion focuses on a "commercial level" to assess "supply constraints," and discusses "output levels" that are determined by the market conditions facing "suppliers". (AG Opinion, at p. 17.) Facilities-based carriers, however, do not necessarily compete with each other to supply resellers, but may prefer to use their facilities to supply their own customers. SBC has overwhelming dominance of the local exchange distribution ("last mile") and local interoffice transport facilities. (Ex. 126C, at p. 73 ORA/Selwyn.) SBC has only been reselling those facilities as a result of a regulatory mandate that was rescinded following United States Telecom Ass'n v. FCC (2004) 359 F.3d 554. Thus, correlation between facilities-based services and services available at wholesale is not always apt.

Moreover, by excluding CLECs using UNE-P or long distance resellers from the analysis, the AG Opinion does not analyze the effect this merger will have on the potential for new entrants in the facilities-based market. Because AT&T currently serves this market via UNE-P, the AG Opinion reaches its conclusion about the effect of removing AT&T from the market without analyzing AT&T's potential as a facilities-based entrant. "Because we conclude that the relevant market is for facilities-based services, we do not consider...whether [AT&T] can still be considered an active supplier of...services." (AG Opinion, at pp. 17-18.)⁷⁶

The AG Opinion's focus on facilities-based services also does not address the fact that SBC will increase its market shares. SBC controls much of the critical last mile infrastructure in California. Because of SBC's already-dominant position, the elimination of its largest competitor should not be minimalized simply because AT&T uses UNE-P for its local exchange services.

Accordingly, we will not rely primarily on the AG Opinion, but will also give substantial weight to parties' expert testimony proposing further conditions.

B. Effects of the Merger on Specific Markets

1. Effects on the Mass Market

a) Parties' Positions

Applicants argue that the merger will have no affect on competition with respect to mass market customers. As one line of evidence supporting this claim, Applicants contend that AT&T withdrew from the mass market for economic and competitive reasons that were independent of its decision to merge. Although AT&T continues to serve its existing mass market customers, it has stopped competing for new mass market wireline customers. Thus, Applicants argue that market concentration statistics are not relevant with respect to the competitive effects of the merger on the mass market, since AT&T would not have been an active participant in the mass market "absent the merger." (Ex. 78C, p. 57, SBC/Aron, Ex. 79C, p. 34, SBC/Aron.)⁷⁷ Applicants further argue that in any event, SBC's mass market prices will continue to be constrained by existing and emerging active competitors whose competitive activities are unaffected by the transaction.

ORA and TURN disagree with the claim that actual data on market concentration has no value in assessing the competitive effects of the merger. TURN witness Murray presented evidence that market power within the mass market is highly concentrated. Murray separately segmented the mass market into more granular market segments, and calculated concentration statistics for each segment. Murray thus separately calculated HHI measures both for the residential mass market for primary service connections and for secondary lines. Murray calculated that in the market for primary connections, SBC's pre-merger HHI increases significantly. The HHI increase calculated by Murray significantly exceeds the 100-point threshold in the Merger Guidelines beyond which it is "presumed that mergers...are likely to create or enhance market power or facilitate its exercise."⁷⁸ Murray testified that regulators should be very concerned about likely adverse effects on consumers and competitors when a merger results in such a large HHI increase, particularly in a highly concentrated market.

TURN acknowledges that the market for secondary telephone lines for "all other residential services" is more competitive than the market for primary network access connections. Unlike the primary line market, participants in this market may include the full spectrum of intermodal competitors, including cable-based telephony, VoIP, and cellular. Applicants provided no factual data regarding the HHI or other measures of concentration for this market. Although TURN was unable to locate quantitative data for this market sector, TURN presented evidence to suggest, based on the closest available data, that this market is also likely to remain significantly concentrated.⁷⁹

TURN also observes that as competition becomes increasingly focused on offering high-end bundles of services, competition will further slow because "bundled" customers may be unwilling or unable to switch carriers in response to price changes. In other words, multiple products are "sticky" and it is much more work for customers to switch companies once they have moved multiple services into a single bundle, as compared to the ease of switching stand-alone long distance carriers.

Applicants do not dispute the mathematical accuracy of the HHI calculations performed by TURN, but claims that such statistics are not relevant here because AT&T had already exited the mass market independently of the merger. Thus, Applicants argue that SBC's acquisition of AT&T would cause no net change in market concentration. Applicants also fault the use of HHI data as being "backward-looking." Murray testified, however, that even if "forward-looking" market shares were as low as 43%, the market for primary network access connections still would be highly concentrated. Murray claims that no evidence has been brought forward suggesting that SBC's post-merger market share would drop that low in the foreseeable future.

ORA and TURN question the claim that AT&T exited irrevocably from the mass market independently of the merger. ORA argues that no one knows for certain how AT&T would have behaved "absent the merger." At the time it withdrew from the Mass Market, AT&T had a highly profitable mass market business. In response to regulatory changes, AT&T was considering various options, including mergers. In other contexts, Dr. Aron considered other companies of a similar level of profitability to be entrants or competitors in the market. (Tr., Vol. 12, p. 1789, SBC/Aron.)

ORA claims that absent the merger, AT&T's business profitability would give it a clear incentive to compete. When AT&T decided to stop marketing its "consumer services" products, it appeared to be a relatively healthy business. AT&T witness Polumbo confirmed that at "the time point when AT&T made the decision to stop marketing to the mass market, that was, in fact, the peak, of AT&T's all-distance customer base." (Tr., Vol. 9, p. 1241, AT&T/Polumbo.) He also confirmed that the business was profitable and would have continued to be so. (Tr., Vol. 9, pp. 1241-1242, AT&T/Polumbo.) Polumbo agreed that the consumer services arm of AT&T was more profitable than the business arm (although he tried to explain this as an artifact of accounting). (Tr., Vol. 9, p. 1238, AT&T/Polumbo.)

ORA believes that AT&T's decision to stop marketing its consumer services products at the height of their success was based on a strategic evaluation of AT&T's perception of the future of its business. AT&T appeared to have considered a number of different business approaches. (Tr., Vol. 9, p. 1215, AT&T/Polumbo.) At the same time AT&T was actively considering "every opportunity, every option" to acquire, merge or be merged into another company. (Tr., Vol. 9, p. 1230, AT&T/Polumbo.)

ORA notes that two decisions were made by AT&T at a July 21, 2004 board meeting: (1) to withdraw from the mass market and pursue a "harvest" strategy,⁸⁰ and (2) to seek a merger with SBC. (Tr. Vol. 9, pp. 1234-1235, AT&T/Polumbo.) ORA views these as contingent decisions made by seasoned board members and executives in real-time, and if the underlying facts were different, their decisions might have been different. SBC witness Kahan stated that AT&T could, successfully, have built a local loop network. (Tr., Vol. 11, p. 1581, SBC/Kahan.) ORA thus challenges Applicants' claim that AT&T's exit from the mass market would have necessarily occurred absent the merger.

b) Discussion

We conclude that the mass market, particularly for residential primary connections, was already highly concentrated even prior to the merger, and will remain so after the merger. As discussed in detail in Section V.B.3, we do not find that the residential market, particularly for primary connections, is robustly competitive as a result of intermodal service options. Particularly for the underserved sectors of the SBC customer base, the market is not highly competitive due to intermodal options.

On the other hand, we agree that at least the residential and small business market for secondary lines and services is somewhat more competitive through intermodal options. Nonetheless, even here, while intermodal competition is growing, its effects are not presently widespread enough to mitigate all of the competitive concerns of the merger. We find that ubiquitous intermodal competition remains a future hope rather than a present reality. Dr. Aron agreed that her analysis did not focus on whether firms are offering service today. (Tr. 12:1789/ SBC/Aron). Instead, her analysis looks to the future potential of a firm to offer competitive services. Yet, to the extent the hoped-for expansion of intermodal options is a future event, we must address the need for mitigating conditions in the interval between now and the future when such competition may be fully realized.

At the same time, while we find that SBC already has a highly concentrated share of the market, we acknowledge that the acquisition of AT&T will not significantly change the degree of concentration, at least for the mass market, since AT&T effectively withdrew from actively competing for this market independently of its decision to merger. Although ORA and TURN raise questions as to whether AT&T might have theoretically resumed competing for the residential mass market absent the merger, we find the evidence reasonably persuasive that AT&T did not intend to reenter the mass market in any event.

Nonetheless, we find it significant that a company with the resources of AT&T chose to withdraw from the mass market rather than compete against SBC. Such a withdrawal by AT&T does not paint a picture of robustly competitive conditions for remaining competitors of SBC. Thus, given the high degree of preexisting market concentration, we agree that regulatory measures are needed to assure that such customers with few or no competitive options benefit from the merger, or at the very least, are not disadvantaged through rate increases to fund the implementation of the merger.

2. Effects on the Business Market

a) Parties' Positions

Applicants claim that the merger will not adversely effect competition in the business segments of the market.⁸¹ Applicants claim that SBC's and AT&T's services are complementary, rather than overlapping. SBC's market focus is on small and medium-sized businesses with a high percentage of their locations in SBC's 13 in-region states.⁸² AT&T's focus is on large multi-location businesses nationwide and globally.⁸³ Applicants argue, therefore, that the merger of SBC and AT&T does not remove a significant competitor of the other in these business segments.⁸⁴ SBC claims it has encountered difficulty expanding its out-of-region sales to enterprise customers, including enterprise customers with a national reach, and lags behind the enhanced and differentiated offerings that competitors in the enterprise market are able to provide.⁸⁵

Even in instances where AT&T and SBC may compete for the same customers, Applicants claim that customers will still have other firms competing to meet their communications needs,⁸⁶ including traditional carriers and newer entrants with alternative networks including wireless, broadband Internet, cable telephony, and VoIP.⁸⁷

Applicants do not define separate markets for residential and small business customers, and do not separately address how the merger will affect the small business sector. Yet, Applicants do not deny that both SBC and AT&T are both currently major active competitors for these customers. Although Applicants likewise declined to present an HHI analysis, TURN used data obtained from SBC to develop its own HHI analysis separately for the local small business market sector.⁸⁸ TURN defines the small business category as comprised of customers spending less than $500 per month on telecommunications services. AT&T, however, has defined "small business" customers more broadly as those spending $2,500 or less on such services.

Witness Murray testified that the degree of post-merger concentration in the small business market and the magnitude of the increase in competition from the Applicants' pre-merger market shares suggest that the proposed merger would be "likely to cease or enhance market power or facilitate its exercise" even if AT&T had a considerably smaller market share than it currently does.⁸⁹ In the small business market, Murray computed that SBC's HHI increases significantly as a result of the merger. In medium business market, HHIs also increase by significant amounts. (Ex. 136C, Exhibit TLM-3.)

As noted by TURN in its brief, Applicants own data suggest that the proposed merger will materially decrease competition for services to mid-sized businesses.⁹⁰

TURN argues that the evidence indicates that SBC can more than "hold its own" when competing in the large business customer (i.e., enterprise) market absent the proposed merger. Both ORA and TURN present evidence that SBC and AT&T are currently competing head-to-head for enterprise business throughout the SBC footprint, and extensively in California. ORA contends that the merger will virtually eliminate competition for retail enterprise customer business within California and the other twelve SBC in-region states.⁹¹ In its response to FCC Staff data request No. 4, Applicants provided data on situations where SBC and AT&T were in direct competition for specific enterprise customer business covering a period of approximately seven months, from October 2004 through April 2005. In those seven months, SBC and AT&T competed to provide service to several thousand enterprise customers, including several hundred in California. In the overwhelming majority of these sales situations, AT&T and SBC were the only competitors identified as having submitted a proposal for the requested services.

b) Discussion

We conclude that the merger, without mitigating conditions, will increase the market power of the SBC in the business market. As with the residential market, we conclude that the market concentration for small and medium business customers was already high before the merger, and will continue to be high after the merger. While AT&T has ceased competing for mass market customers, they still compete for medium and large business customers. The HHI measures computed by TURN witness Murray are informative as to the potential for the merger to increase market concentration in the business sectors of the market. Although Applicants claim that there is abundant competition for enterprise customers from other possible competitors, they have not presented convincing evidence demonstrating that any of those competitors are able to capture any significant portion of the market now, or in the future once AT&T is eliminated as a separate competitor.

We examine below the claims made by parties concerning whether, or to what extent, intermodal competition serves as a sufficient market force to neutralize any adverse anticompetitive effects that might otherwise result from the elimination of AT&T as a major competitor. As discussed in further detail below, however, we are not convinced that intermodal competition is yet sufficiently developed as an adequate market force to constrain ILEC pricing in the medium business or enterprise markets. SBC has reiterated its desire to be allowed to immediately increase basic business service rates in the concurrent Uniform Regulatory Framework proceeding, arguing that it should be allowed to do so with only one-day notice to the Commission. TURN thus infers that SBC is aware that it already possesses sufficient power in this market to impose a general rate increase without losing ground to competitors. The only evidence offered by Applicants to suggest that competition will not be harmed for this market segment are extracts from press releases and web sites suggesting that certain competitors claim they would like to offer service to mid-sized business customers.⁹² Accordingly, we agree that certain mitigating conditions are warranted in order to mitigate any adverse competitive effects of the merger. We consider in further detail in Section IV.C the specific proposals for mitigating conditions for different market segments, and decide which ones are appropriate to adopt. In the following section, we review the evidence concerning claims of intermodal competition.

3. Intermodal Competition as a Mitigating Factor

a) Overview

SBC argues that it faces robust competition from intermodal carriers in California, and as a result, competition will not be adversely impacted by its acquisition of AT&T. As evidence of intermodal competition, SBC witness Kahan testified that SBC has experienced a decline in access lines due to various forms of intermodal competition over the past five years.

Intervenors dispute SBC's claims of intermodal competition as speculative and anecdotal. TURN witness Murray argues that Applicants' claims about intermodal competition relate to projections five or more years in the future, but do not demonstrate a serious competitive threat in the next two or three years, particularly for the small business and low-volume residential market.

SBC has made similar claims for nearly a decade which have yet to come true. (Ex. 136C, p. 68, TURN/Murray.) In the 1995 NRF review, Pacific Bell's expert testified about intermodal competition, relying "on the same type of data Dr. Aron relies on today...analyst...and company [statements] that cable and wireless competition was just about to sway in." (Ex. 136C, p. 69, TURN/Murray.)

CTFC Witness Braunstein testified that wireline residential and business voice access are in distinctly different markets from wireless telephony and VoIP. Braunstein testified that wireline and wireless markets provide different mixes of features and serve different sets of users. While some customers may choose to subscribe both to wireline and wireless services, or even to substitute one for the other in some cases, Braunstein claims that does not automatically place them in the same market.

Dr. Aron presented broadly based testimony on intermodal comption, but did not assess relevant differences in how the merger will affect competition for intermodal services available to small and medium businesses in second and third tier markets within different geographic markets within the state. Aron defends the qualitative data she presents as commonly accepted in antitrust and merger analysis. She offered no information, for example, as to which carriers, including AT&T, operated at the retail and/or wholesale level in second and third tier markets in the California Central Valley or Central Coast regions.

As discussed in further detail below, we remain unconvinced that Applicants have made the case that intermodal technologies offer a competitive substitute for SBC wireline customers. It is not sufficient merely to count allegedly competing entities or the subscriber shares of intermodal entities in confirming the existence of competition. The relevant test of competition from intermodal sources is whether those sources have had an effect on SBC's wireline pricing or demand. We do not find that evidence of such pricing effects has been shown. Accordingly, we find that SBC's increased market power from the acquisition of AT&T is not mitigated by intermodal competition.

b) Competition from Cable Telephony

(1) Parties Position

Applicants claim that intermodal competition from cable telephony will be a significant factor in assuring that the telecommunications markets remain competitive even with the acquisition of AT&T. SBC witness Aron testified that cable companies already have made a significant sunk investment in upgrading their networks for telephony, and/or have investment activities already in progress. Thus, where such investment has been made, Aron reasons, the economic motivation of cable-based telephony is to grow its telephony business rapidly to turn the sunk investments into revenue streams. Aron testified that cable companies have told their investors that they intend to seek substantial telephony penetration, and are rolling out service nationwide. While different cable companies may expand telephony offerings at different rates, Aron believes, based on industry analyst reports, that cable telephony offerings are here now, and will only increase.

(2) Discussion

We are not persuaded that competition from cable telephone is sufficiently developed to mitigate competitive concerns.

The two largest cable providers in California are Comcast and Cox. In her rebuttal, Aron provides a map of California showing the areas covered by cable modem service with overlays indicating SBC wire center territories and areas in which cable modem service is available. Comcast is, by far, the largest cable operator in the SBC California service territory. Aron conceded, however, that Cox, a cable provider whose use of VoIP she relied upon in testimony, has a small presence in California's Central Valley. (Tr. Vol. 12, pp. 1787-788 SBC/Aron.) Dr. Aron also did not know if Cox offers business services in the Central Valley, but only that the company was "interested and eager," and had been successful in the past. (Tr. Vol. 12, p. 1788, SBC/Aron.) With respect to Comcast, another large cable provider, Dr. Aron stated on cross-examination that it intended to provide a VoIP service in the residential market "within a year or so from now." (Tr., Vol. 12, p. 1894, SBC/Aron.) Aron conceded that even the initial deployment of a business service from Comcast would take twice as long.

Aron disputes Selwyn's claim that any "stalling" of cable telephony would indicate reduced future competition. Aron believes any such stalling merely reflects a strategic change from relatively less efficient circuit-switched cable telephony to more efficient VoIP telephony.

A study from Deutsche Bank anticipates major growth in cable telephone service within a decade, with penetration of 20 to 25 million subscribers nationwide. Analysts at USB Securities predict 1.6 million new cable telephone subscribers during 2005 and expect Cox to achieve close to a 25% telephony penetration among cable subscribers where it offers cable service. Kahan testified that Cox has subscribed 40% of the households that it serves in its San Diego service territory to its Cox Digital Telephone service.

Yet, cable's role as competition to SBC is essentially limited to those geographic markets already served by cable companies with an interest in competing with local exchange services. Cable companies moreover generally deploy their facilities to reach only residential customers. (Ex. 78C, p. 62, SBC/Aron.) Also, cable companies that do intend to provide communications service to business are subject to certain geographic limitations, as noted above. Dr. Aron acknowledges that cable companies can only reach commercial customers in "suburban areas" because "cable assets have been traditionally deployed with residential customers in mind." (Ex. 78C, p. 62, SBC/Aron.) Aron's analysis, however, did not address the limitation of intermodal competitors within specific markets, in particular cable companies. As a result, we do not view cable competition as ubiquitous at the present time, especially for the business segment. As ORA witness Selwyn testified, even to the extent that cable-based competition were to become widespread throughout California, a cable/ILEC duopoly would not provide sufficient competition to constrain SBC from using its market power in pricing its services.⁹³

c) Competition from Independent VoIP Providers

(1) Parties Position

Applicants' Witnesses Kahan and Aron testified that the rapid development of broadband connections has facilitated the emergence of independent VoIP service providers. These independent VoIP service providers are presently adding about 400,000 subscribers per quarter and are projected to accelerate their growth to 4 million next year. TeleGeography predicts roughly a doubling of VoIP subscribers during 2005.

Kahan testified that cable companies, some of which started offering traditional telephony services around 2000 are also offering VoIP telephony. The major cable operators have either launched a VoIP product or announced deployment plans and are promoting VoIP as a replacement for ILEC wireline telephone service. Cox, for example, serves approximately 40 percent of existing Cox cable television customers with telephone service in its Orange County, California service territory.⁹⁴ Although cable voice service was traditionally provided over circuit-based switches, major cable operators are moving into VoIP and other IP-based services.⁹⁵ Analysts predict that the "introduction of VoIP, especially by cable companies, represents the largest long-term threat to the Bells."⁹⁶ Forecasts show that VoIP consumer connections nationwide are forecast to rise from approximately one million residences in 2004 to more than 17.5 million in 2008.⁹⁷ Analysts also estimate that by the end of 2005, cable-provided VoIP will be marketed to more than 40 percent of all U.S. households,⁹⁸ and that nearly two-thirds of American homes will have cable telephony (either VoIP or circuit-switched) available to them.⁹⁹

Witness Aron also points to competition from VoIP services from providers like Vonage, Packet8 and Skype.¹⁰⁰ These VoIP services are generally available anywhere a customer has a broadband connection, and the provision of service is not dependent on the underlying broadband provider.¹⁰¹ In the first quarter of 2005, Vonage added 200,000 subscribers, and already serves nearly 600,000 subscribers.¹⁰² Aron testified that such VoIP offerings exert competitive pressure on traditional telephone services.¹⁰³

(2) Discussion

We conclude that while use of VoIP is growing, it is not yet sufficiently developed to serve as a competitive check against ILEC wireline offerings. As of the end of 2004, there were fewer than 1 million residential VoIP subscribers nationwide,¹⁰⁴ constituting less than 1% of residential voice lines. Also, AT&T is one of the major providers in this market through its Call Vantage service. Thus, VoIP competition from that source will be eliminated through the merger.

ORA points out, moreover, that customers of pure play VoIP providers must have a broadband connection at high rates.¹⁰⁵ To the extent the broadband connection comes from SBC, it will be bundled with a land line. (Ex. 126C, p. 93, ORA/Selwyn.) If the broadband connection comes from a cable firm, the extent of the competition provided will be limited to the geographic footprint of the cable television franchise. AT&T currently offers a VoIP product. (Tr. Vol. 9, p. 1273, AT&T/Polumbo) Post-merger, the combined entity will also offer VoIP. (Ex. 12C, pp. 61-62, ORA/Tan.) ORA witness Tan also points out that revenue SBC-California lost to VoIP would in fact be earned by an unregulated affiliate of SBC in this scenario. SBC can leverage its last mile facilities to compete more effectively for customers in unregulated areas. (Ex. 12C, p. 63, ORA/Tan.) Currently, it is not possible to obtain broadband access (a necessary prerequisite for VoIP) from SBC without maintaining a wireline from SBC. Similarly, SBC's wireless and wireline operations include combined sales channels. AT&T's own witness Polumbo provided evidence that VoIP still suffers from limitations as a competitive alternative to wireline service. Polumbo testified that VoIP was a different service from wireline, as opposed to a substitute. (Tr., Vol. 9, p. 1274, Polumbo/AT&T.) Polumbo pointed out that VoIP was "limited" by the amount of broadband penetration, which he estimated to be 30% of customers. (Tr. Vol. 9, p. 1275, AT&T/Polumbo.) He also pointed out that it cost three times as much to market VoIP as compared with wireline. He explained that the service was so complex customers were confused and needed extensive-and expensive-hand-holding from customer support. (Tr., Vol. 9, p. 1275, Polumbo,AT&T.) Questions about E911 services, and various surcharges are still to be resolved for VoIP. (Ex. 126C, p. 126, ORA/Selwyn.)

d) Competition from Wireless Technologies

(1) Parties Position

Applicants also point to wireless carriers as an additional source of intermodal competition which will mitigate any competitive concerns regarding the acquisition of AT&T. SBC Witness Kahan testified that the migration of customers from wireline to wireless service providers constitutes evidence of a significant source of competition. As a result of wireless competition, Kahan argues that customers will continue to have competitive choice even with SBC's acquisition of AT&T.

Applicants argue that industry observers expect wireline access lines to continue to decline on a national basis during the next several years. Kahan believes this trend will hold true for California as well. Between 1999 and 2004, SBC California reported a loss of about 22% of its residential and single-line business lines, and its multi-served business lines decreased by nearly 26%.¹⁰⁶ In view of the overall growth of California's economy and population over the same period,¹⁰⁷ Kahan attributes these declines in the number of SBC's access lines to competition from wireless providers. While wireline access lines has been declining in number, wireless subscribers in California has been growing_from 8.5 million in December 1999 to 21.6 million by June 2004.¹⁰⁸ In addition, the average price per minute for wireless service has declined from $0.18 to $0.08 on a national basis.¹⁰⁹ Recent trends indicate that for every three additional wireless connections there is the loss of one wireline access line. The number of wireless connections now exceeds wireline access lines in California.¹¹⁰ About 5-6% of the U.S. population has "cut the cord."¹¹¹

ORA's witness introduced evidence, however, that these line losses were merely attributable to customers' decision to buy broadband service instead of dial-up connections to the internet. (Ex. 126C, p. 122, ORA/Selwyn.) Dr. Selwyn also explained that the analyst report cited by Applicants was not authoritative. (Ex. 126C, pp. 105-107, ORA/Selwyn.)

In addition to displacing access lines, wireless has siphoned revenues off the wireline network. Nationally, wireless customers make 60 percent of their long distance calls on wireless phones rather than on their "landline," and wireless customers substitute their wireless phones for 36% of local calls.¹¹² While the bulk of the research on these trends reflects national data, Kahan believes that California trends would not be materially different.

TURN disputes Applicants' claims, however, concerning wireline losses. TURN claims that much of the wireline loss merely reflects a reclassification of the line from regulated basic exchange service to nonregulated broadband Digital Subscriber Line (DSL) service. Such line loss would therefore not reflect the effects of competition, but merely the transfer from use of one technology to another by a single company, and consolidates market power. TURN argues that SBC's statistics on line losses do not indicate a mass defection of business customers to competition, but, in large measure, merely a migration from switched access lines to high-speed, high-volume special access lines.

SBC witness Aron concedes that the current numbers attributable to wireless substitution are "modest." (Ex. 78C, pp. 22, 23, SBC/Aron (2%).) Dr. Aron believes, however, that there is evidence of robust competition from wireless (Ex. 78C, p. 23, SBC/Aron.) from a so-called "flow analysis." Flow analysis relies on the potential future effect if a current situation persists over time.

Aron presented the results of a study by Deutsche Bank estimating that nearly half of primary residential lines lost by ILECs are going to wireless. Analysts at UBS have made similar observations. Thus while conceding that the overall percentage of customers who have "cut the cord" may be relatively small, Aron argues that the competitive impacts in terms of the rate of outflow of customers to wireless is a full order of magnitude greater. Thus, Aron claims that to focus merely on the percentage of wireless-only customers is misleading by understating the impacts of the rate of customer loss to wireless. Aron believes that the rate of migration to wireless is of sufficient magnitude to concern wireline managers in making their pricing decisions.

Dr. Aron attests to the legitimacy of this form of flow analysis by referring to the FCC's proceedings in the ATT/Cingular merger. (Ex. 79C, p. 27, SBC/Aron.) Aron admitted, however, that the FCC declined to use "flow share approach" and instead used a modified HHI calculation in the ATT/Cingular case. (Tr. Vol. 12, p. 1885, SBC/Aron.) Reliance on flow analysis is also called into question by the fact that the trend in line loss is downwards. SBC witness Kahan admitted that "SBC California's losses of retail residential primary lines have decreased substantially." (Tr. Vol. 11, p. 1566, SBC/Kahan.) He stated that such line loss "peaked in the fourth quarter of '02." (Ibid.) Dr. Aron's claims rest on the potential of wireless service to eventually compete with wireline services. Yet, we find it significant that the trend in line loss is different from the trend line upon which Dr. Aron relies.

(2) Discussion

We conclude that "wireless substitution" has not yet developed for landline telephone service sufficiently to rely upon it to neutralize any concerns as to the elimination of AT&T as a competitor. (Ex. 126C, pp. 95-101, ORA/Selwyn.) ORA witness Selwyn testified that Dr. Aron's theories of wireline-to-wireless substitution were inaccurate because she had not shown any cross-elasticity of demand between the two services. (Ex. 126C, pp. 109-111, ORA/Selwyn.) The AG Opinion likewise concluded that "we are not persuaded that the cross-elasticities of demand between wireless and landline services are particularly high."¹¹³ Selwyn showed these cross-elasticities were extremely small. (Id., at pp. 98-101.)

Dr. Aron's testimony on wireless service focused on residential customers (Tr., Vol. 12, p. 1789, SBC/Aron.), although she did state that business customers were, "increasingly interested in both mobile wireless and fixed wireless service to enhance and provide for their telecommunications needs." (Tr. Vol. 12, pp. 1789-1790, SBC/Aron.) Aron, however, makes no attempt to break out the extent to which business is interested in "enhancing" rather than replacing its wireline service with wireless products.¹¹⁴ The Attorney General, TURN witness Murray, CTFC witness Braunstein, and ORA witness Selwyn all concur that wireless services should not be included in the same product market as wireline services, at least for primary access lines.

Applicants state that there were 21.6 million wireless connections in California in June 2004. (Application, page 27). Yet, as pointed out by CTFC witness Braunstein, one cannot assume that all of these connections represent competition with Applicants' wireline service in general, or residential wireline service, in particular. The total reported wireline connections include an unspecified number within the territory of Verizon and other smaller ILECs that would not reflect competition within the SBC territory. The wireless data also fail to delineate connections attributable to large business customers that would still have wireline service on their desks and at the residences of their employees. The data also include an unspecified number of subscribers to Cingular and AT&T Wireless, entities that are owned, at least in part, by the Joint Applicants. For these reasons, we find the reported data on wireless connections does not provide persuasive evidence that wireless presently offers a viable competitive alternative to wireline service for a large cross section of SBC wireline customers.

Dr. Aron fails to take into account any negative factors that will limit the future development of intermodal competition. VoIP, and cable telephony all rely on an external power source and do not have the reliability track record of traditional wireline services, especially in emergencies and natural disasters. (Tr. Vol. 15, p. 2292, TURN/Murray.) In California, with its risks of earthquakes and/or fires, this is an important limitation. Wireless service has limited coverage, often hindered by terrain and other factors. (Ex. 104, 105.) Neither wireless service nor VoIP service includes fee listing in the white pages. (Tr., Vol. 12, p. 1913, SBC/Aron.)

Moreover, many of the services Dr. Aron identifies as evidence of intermodal competition will also be offered by the new merged entity and its affiliates. To that extent, transition to intermodal wireless technologies does not necessarily indicate competition from other companies, but may also simply indicate the movement of customers between technologies within the same company.

Line losses due to customers leaving SBC wireline service to subscribe to Cingular do not represent competitive losses, at least to the extent of SBC's ownership interest in Cingular. Customers migrating to wireless will not even leave the SBC umbrella of companies, but will simply be served by a different affiliate, such as Cingular. SBC's ownership interest in Cingular is 40%. Cingular, however, does compete with four other national wireless carriers within California statewide and with several other smaller wireless providers. SBC's marketing personnel do not track customers who migrate to a wireless provider to distinguish between customers that select Cingular versus another competitor. With the exception of Verizon Wireless, these other wireless carriers are independent of RBOCs.

Thus, intermodal wireless competition is not sufficiently developed in all markets, or throughout California, to the point where it can be relied upon to serve as an effective check against SBC's market power as a result of the merger.

C. Mitigation Measures to Address Adverse Competitive Effects of the Merger

1. Price Caps to Mitigate Resource Imbalance

a) Parties' Positions

Witness Gillan testified on behalf of both CALTEL and Cox. Witness Gillan testified that the removal of AT&T and MCI through the mergers will create a resource imbalance in bargaining power that will disadvantage SBC's competitors. Gillan characterizes the merger as essentially recreating the vertically integrated design of the pre-divestiture Bell System, except without the regulatory protections that existed before. The merger will result in a historically unprecedented concentration. Although the pre-divestiture AT&T once owned all of the Bell Operating Companies (and, therefore, arguably represented a greater concentration than SBC and Verizon have achieved), AT&T managed those resources through 22 separate operating companies that each enjoyed some measure of local autonomy.

Gillan claims that the resource imbalance created by this merger (together with that of Verizon-MCI) fundamentally disrupts a core assumption of the federal Act, namely, that entrants and incumbents would be able to arbitrate as equals. Gillan contends that with the loss of AT&T (and presumably MCI) as major independent advocacy voices, CLECs will no longer be able to adequately advocate for themselves, and that local competition will be undermined as a result without the mitigating protection of price caps.

Gillan therefore proposed that as a condition of approving the merger, the Commission adopt "price caps" for network elements that must be made available under both Section 251 and section 271 of the Telecommunications Act. CALTEL argues that such price caps will more efficiently regulate network element pricing and act as a transitional path to less regulation.

Applicants claim that CALTEL witness Gillan identifies no plausible rationale for his pricing cap proposals. Applicants deny that a "resource imbalance" will result from the merger with the elimination of AT&T as a regulatory advocate for CLEC interests. Applicants claim that this Commission will be fully capable of implementing its duties under the 1996 Act. Gillan argues that the revenues of ILECs outweigh the revenues of the so-called "competitive sector." See Gillan (CALTEL) Ex. 131, p. 14. Yet, in making this calculation, Gillan omits from the "competitive sector" the cable providers that offer telephony service over their ubiquitous networks.

Applicants claim that as applied to rates for network elements that must be made available pursuant to section 251, CALTEL's proposal is contrary to the 1996 Act's requirement that such rates be "based . . . on cost."¹¹⁵

Under CALTEL's proposal, UNE rates would be set initially at the levels the Commission has put in place today, and then be reduced automatically, year-after-year, to account for productivity improvements that SBC California might realize. Applicants argue that rather than being "based . . . on cost" as the 1996 Act requires, CALTEL's proposal would call for a percentage deduction applied each and every year to account for cost savings CALTEL asserts that SBC California will realize. Applicants argue that nothing in the 1996 Act or FCC rules countenances that result.

Applicants argue that CALTEL confuses the issue by interchanging the distinct principles behind price caps and those behind Total Element Long Run Incremental Cost (TELRIC) pricing. Under price caps, a regulator makes a calculation of actual, current costs, and then puts in place a formula for calculating the productivity improvements, with an offset for inflation, that are expected to occur over time.

Applicants argue that under TELRIC, by contrast, state commissions are charged with making a hypothetical determination of the forward-looking cost of a given element, using the most efficient technology available.¹¹⁶ Unlike in the price cap context, Applicants argue that there is no basis for imposing an annualized reduction. Applicants claim that it is impossible to know whether, under TELRIC, the most efficient technology will be any different (or cheaper) each subsequent year. Applicants argue accordingly that there is there is no basis for imposing a price cap regime in that context.

Applicants likewise argue that CALTEL's price cap proposal is equally unlawful, as applied to facilities that must be made available pursuant to 47 U.S.C. section 271 but not section 251. Applicants claim that state commissions have no jurisdiction to implement or enforce section 271. Congress granted "sole authority to the [FCC] to administer . . . section 271."¹¹⁷ Applicants argue that the only provision in the 1996 Act that contemplates state-commission ratesetting authority is section 252, and that provision does not authorize state commissions to establish rates for elements and services required under section 271. Section 252 authorizes state commissions to set rates only "for purposes of" section 251.¹¹⁸ As the FCC has explained, with respect to state commissions' authority to set rates for network elements, section 252 is "quite specific" and "only applies for the purposes of implementation of section 251(c)(3)."¹¹⁹ Applicants thus dispute CALTEL's basic contention that this Commission may establish rates for facilities that are required to be made available solely under section 271.¹²⁰

Applicants further argue that CALTEL's proposal conflicts with the FCC's substantive rules regarding the pricing of such facilities. CALTEL proposes that the Commission establish section 271 rates using the FCC's TELRIC-based transition rates - i.e., the rates the FCC has said apply to elements that, under the Triennial Review Remand Order, are no longer required under section 251, for the period until March 11, 2006 during which CLECs can use those elements to serve their existing customers.¹²¹

The FCC has stated, however, that facilities required only under section 271 are not subject to the TELRIC-based rates that apply under section 251. Rather, an element that is required only under section 271 is subject to the "basic just, reasonable, and nondiscriminatory rate standard of sections 201 and 202" of the Communications Act.¹²² The FCC has further held that, under sections 201 and 202, "the market price should prevail" - "as opposed to a regulated rate" of the type that CALTEL would have this Commission impose.¹²³

Thus, a Bell Operating Company may satisfy sections 201 and 202 by, among other things, "demonstrating that the rate for a section 271 network element is at or below the rate at which the BOC offers [any] comparable functions" under its federal tariffs, or "by showing that it has entered into arms-length agreements with other, similarly situated purchasing carriers to provide the element at that rate."¹²⁴ The D.C. Circuit affirmed the FCC on this point, explaining that there is "no serious argument" that the pricing requirements that apply to section 251 elements also apply to section 271, and that there was "nothing unreasonable in the [FCC's] decision to confine TELRIC pricing to instances where it has found impairment" under section 251."¹²⁵

Applicants argue that CALTEL would have this Commission mandate a regulated price based on the TELRIC-based rate that the FCC has held is available solely for the CLECs' "embedded base" of customers (and only for as long as necessary to effectuate the prompt transition mandated by the FCC's order), and then reduce that price from there. Applicants claim that approach would subvert the market-based mechanism for establishing rates contemplated by the FCC.

b) Discussion

We agree with CALTEL that the merger will increase the imbalance of resources between SBC and its competitors as a result of the acquisition of AT&T.

We do not agree with CALTEL, however, that its proposal for price caps on all network elements to be made available through Section 251 and 271 is an appropriate remedy to address this imbalance. As noted by Applicants, a price cap would be at odds with the broader market-based pricing policies that the FCC has adopted through the TRRO, at least for those UNEs offered under Section 251 for which TELRIC pricing has been eliminated. Capping the rates in the manner proposed by CALTEL for such UNEs would undermine the TRRO policy to phase out TELRIC-based pricing of such UNEs provisioned under Section 251. On the other hand, for those UNEs for which TELRIC-based pricing was not eliminated by the TRRO, we conclude that the CALTEL price cap proposal is an appropriate remedy. Accordingly,we shall adopt CALTEL's price cap proposal for those UNEs to be provided under Sec. 251 only to the extent that, pursuant to the TRRO, the FCC has not eliminated TELRIC-based pricing for it. We agree with Applicants, however, that in order to be consistent with TELRIC principles, the rate caps should not be reduced for a productivity factor. Accordingly, we shall adopt the rate caps for applicable network elements with no productivity offset.

We further conclude that Commission-imposed price caps on those UNEs provisioned under Section 271 could conflict with broader FCC "just-and-reasonable" principles relating to the pricing of such UNEs. Although we decline to impose price caps for such UNEs, as noted, we will adopt other mitigating remedies to address the resource imbalance, as discussed below.

CALTEL also contends that SBC California can be required to combine, or "commingle," facilities that must be made available pursuant to section 271.¹²⁶ The FCC, however, has held that, where an element is required under section 271 but not under section 251, the BOC is under no obligation "to combine" that element with others.¹²⁷ Although the Triennial Review Order originally listed section 271 elements in the context of commingling obligations in paragraph 584, the FCC subsequently removed this reference, thus confirming that commingling obligations do not extend to section 271 elements.¹²⁸ Accordingly, the New York Public Service Commission recently concluded, "[g]iven the FCC's decision to not require BOCs to combine 271 elements no longer required to be unbundled under section 251, it seems clear that there is no federal right to 271-based UNE-[Platform] arrangements."¹²⁹ Applicants argue that for this reason as well, CALTEL's proposals to require commingling is contrary to federal law.

We agree with Applicants that based on the TRO errata, the FCC does not require BOCs to commingle Sec. 271 facilities.

2. Proposal for "Opt-In" Rules

a) Parties' Positions

CALTEL witness Gillan argues that his proposed price cap plan, by itself, however, will not fully dilute the resource leverage gained by SBC if the proposed merger were to be approved without conditions. SBC will still have the opportunity to increase its rival's costs through serial arbitrations that re-litigate the same issue. To address this concern, Gillan proposes that SBC be required to follow certain interconnection agreement "opt-in" rules to avoid duplicative, unnecessary arbitrations.

Where, in the past, CLECs frequently could wait until AT&T (or MCI) had arbitrated an agreement and then "opt-in" to gain the benefit of those carrier's arbitration efforts, that "litigation umbrella" would be eliminated with the consummation of the planned mergers, eliminating AT&T and MCI as independent litigation counterweights to SBC. Gillan argues that the general resource imbalance further advantages SBC because the costs of arbitration (per customer) for a CLEC would far exceed its own. As a result, any express or implicit strategy by SBC that creates unnecessary litigation and/or arbitration costs would harm competitors far more than SBC.

To mitigate this adverse impact, Gillan proposes that except for state-specific prices and performance standards, SBC be required to allow any CLEC to adopt in California any agreement that SBC has negotiated in any other state; or any provision (or set of interrelated provisions) that SBC has included in an agreement as the result of arbitration in California.

Gillan patterns this recommendation after conditions applied to SBC and Bell Atlantic when they acquired Ameritech and GTE respectively, adjusted to reflect what he views as the greater threat to the bilateral negotiation/arbitration process presented by this merger. When SBC acquired Ameritech, it agreed to import any interconnection arrangement that it negotiated in another state, and did not require that the CLEC import the entire agreement. Gillan's recommendation in this proceeding is different because underlying federal opt-in rules have become more restrictive in that they now require CLECs to adopt an entire agreement, instead of individual parts.¹³⁰

Gillan also recommends that SBC be required to agree to include in any interconnection agreement any provision that was already arbitrated by the California Commission. This recommendation is intended to limit SBC's incentive to increase its competitor's costs in California by engaging in serial arbitration on the same issue. Gillan argues that the potential gains to SBC from serial litigation will increase as a result of this merger being approved. The behavior that these recommendations address - that is, arbitrating the same issue multiple times - is at odds with federal policy. Given the resource imbalance that will be created by the proposed merger, Gillan characterizes his proposal as a mitigating measure to prevent competitive harm.

Applicants object to this condition, arguing that it does not address any issue directly related to the merger, or any adverse consequence therefrom. Applicants argue that carriers do not need this condition in order for there to be fair competition.

b) Discussion

We adopt CALTEL's proposal to require SBC to follow "opt-in" rules. Particularly because we are not adopting most of CALTEL's price caps proposal for network elements under Section 251 and 271, we believe that competitors require the additional offsetting remedy of being able to opt in to any agreement negotiated in any other state, or any provision of any agreement in California. Gillan's proposal is consistent with federal rules by ensuring that SBC not leverage its resource advantage against CLECs in a more cost effective way than threatening SBC with enforcement action. Gillan argues that such action itself would increase CLEC costs and only apply after SBC had already increased costs in the first instance through serial arbitration.

SBC will not be required to import into California any arbitrated decision by any other Commission, but only any interconnection agreement provisions already ruled upon by this Commission. For agreements that SBC negotiated in other states, it would have to permit California CLECs the opportunity to adopt those agreements (except as to price and state-specific performance measures), but the CLECs would be required to adopt the entire agreement.

3. Mitigation Measures for Special Access

Multiple parties proposed that mitigation measures be imposed as a result of alleged effects of the merger on the market for local and intermediate distance transport services, also known as "special access." Special access services consist of dedicated digital facilities connecting individual (typically enterprise) customer premises with the serving SBC wire center ("channel terminals") and interconnecting the special access channel terminals with a CLEC or interexchange carrier point of presence ("interoffice transport"). Special access is the enterprise service equivalent of the "local loop" that connects a residential or small business customer to the local SBC wire center. These are "essential facilities" without which the competing local or interexchange carrier could not deliver its services to its end user enterprise customers. (ORA Opening Brief, page 55). Special access is critical to allow facilities-based competitors to provide both local and nonlocal services to California customers. (Qwest Brief, page 22.)

a) Parties' Positions

Level 3 witness Vidal testified that the special access market is highly concentrated with few companies owning the physical local networks required for connecting "long-haul" or "backbone" networks to customers' buildings or traffic aggregation points such as carrier hotels and RBOC central offices. ILECs, like SBC, are the dominant suppliers of transport services within their traditional service areas. AT&T and MCI are the largest nondominant carriers offering competitive access. Carriers express concern that, with the disappearance of AT&T and MCI, there will be no competitive alternatives from which to purchase these services. Without sufficient traffic volume, it may not be cost-effective for a competing carrier to build its own connecting networks in metropolitan and suburban areas. The next option available to such carriers would be to lease transport. It is common that the only facilities-based providers of transport from which to enter into a lease will be either SBC or AT&T.

ORA witness Selwyn testified that: "SBC is the only source of special access services to every customer location throughout the SBC footprint. As such, SBC has unique opportunities not available to other competitors." (Ex. 126/126-C, p.161, ORA/Selwyn.) ORA argues that AT&T has up to now been one of the strongest - if not the strongest - competitor to SBC in this sector. In 2002, AT&T had estimated that "of the approximately three million commercial/business customer locations nationwide, it was providing service to approximately 186,000 of these locations using some type of special access service or its equivalent. Of these, only about 6,000 locations were being served directly using AT&T-owned dedicated access facilities, another 3,700 were being served using dedicated access facilities being leased from other CLCs, and the remaining 176,300 were being served by ILEC special access services." (Id., at 171, footnotes omitted.)

ORA claims that AT&T's departure from the special access market - and the absorption of its fiber optic "last mile" facilities into the SBC asset base - will further strengthen SBC's market power over these essential services and facilities.

Level 3 argues that eliminating AT&T as the sole alternative provider of special access will make it unnecessarily expensive for competing carriers to reach Tier II and Tier III markets.

Level 3 argues that conditions should be imposed to ensure that special access prices are reasonable and nondiscriminatory. Qwest also submitted testimony claiming that the removal of AT&T and MCI from the market will diminish or, in some cases, possibly eliminate, the pricing pressure currently exerted on SBC's special access rates. Qwest argues that "AT&T and MCI exert pressure on SBC's pricing where they have alternative facilities that allow a consumer to bypass SBC's facilities."¹³¹ Level 3 similarly claims that "[i]n many instances, the only competition for SBC for competitive access is AT&T . . . [and] unless regulators take the appropriate steps, a carrier such as Level 3 will not have any competitive alternative from which to purchase services."¹³² SBC has discounted special access offerings under tariff which are available only to the largest carriers.¹³³ AT&T has been a major customer of these special offerings, and has served as a competitive balance to SBC by in turn reselling these offerings to others,¹³⁴ tending to hold SBC's prices in relative check in the special access market. Level 3 argues that the competitive check provided by AT&T is critical to smaller competitors who do not qualify for the SBC national discount tariffs.¹³⁵ Level 3 argues, in addition, that barriers to entry would prevent it from developing its own facilities to replace the special access services lost by AT&T's departure from the market.¹³⁶

Qwest and other competitors contend that AT&T has threatened to use its own facilities if it is unable to obtain favorable terms from SBC. Applicants respond that any significant purchaser of access services from SBC (or any other ILEC) can make the same threat, and the abundance of competitive fiber demonstrates that this threat is real. Level 3 contends that AT&T "has served as a competitive balance to SBC by in turn re-selling these offerings to others."¹³⁷

Similar to Level 3, Qwest asserts that AT&T "is actually engaged in providing wholesale access services in competition with SBC."¹³⁸ But Mr. Giovannucci testified that AT&T is only a bit player in offering wholesale special access.¹³⁹

Applicants argue that AT&T has no impact on SBC's special access pricing because it is not a competitor or constraining force on SBC's special access pricing.

Applicants further argue that the merger will have no effect on the current level of CLECs' competitive special access options, and that CLECs purchase virtually no private line services from AT&T. Applicants claim that AT&T has few commercial buildings directly connected to its own fiber facilities. Applicants argue that even those buildings are so specialized for specific customers as to be irrelevant in the special access market.¹⁴⁰ Applicants claim that CLECs can still obtain special access service using ILEC special access as the local transport vehicle and win customers after the merger.¹⁴¹

Witness Giovanucci testified that AT&T has a retail focus and uses its local network primarily to serve its retail customers. Giovanucci stated that AT&T's `fiber-to-the-floor' (FTTF) (i.e., fiber directly to the customer's proprietary area on its premise) building architecture used to serve the vast majority of its on-net buildings is not conducive to the widespread sale of wholesale services.¹⁴²

Giovannucci testified that AT&T is not a major wholesale provider, with fiber connections to very few buildings where it does have customers and an even smaller percentage where it doesn't.¹⁴³

AT&T only builds out to a new building when it sells retail service to a large enterprise customer.¹⁴⁴ When AT&T builds out to the new customer, it deploys its fiber and electronics directly to the customer's offices in the customer-provided space. As a consequence, Applicants argue that AT&T is in no position to sell wholesale special access service to other CLECs, but frequently purchases its own special access from another carrier to serve other enterprise customers in the same building.

Qwest also disputes Applicants' claim that AT&T is almost exclusively a long-haul carrier with almost no local facilities, and with almost no facilities overlap with SBC. Qwest points to statements made by AT&T in its March 15, 2004 Form 10-K Report to the effect that AT&T has "an extensive local network serving business customers" and provides "a broad range of ...wholesale transport services."¹⁴⁵ As additional evidence of AT&T's local facilities presence, Qwest points to AT&T's purchase of TCG in 1998, a competitive access provider that served over 20,000 buildings over 11,417 route miles of fiber.¹⁴⁶

Qwest points out, however, because SBC has a ubiquitous network, SBC necessarily serves the same customer premises as does AT&T, and SBC's special access facilities will overlap with those of AT&T after the merger. If AT&T's facilities are removed, SBC's network is already built to the same customer premise.

Applicants argue that Qwest (and other CLECs) can and do negotiate with SBC to encourage SBC to offer special access pricing that they would like to see in the market place. Applicants deny that AT&T has any unique influence over SBC's special access pricing today, arguing that the rates that SBC and AT&T negotiated were filed by SBC in tariff form and are thus "available to all carriers."¹⁴⁷ Applicants argue that even if AT&T is no longer negotiating for better prices, the Commission cannot assume that remaining competitors will not negotiate as aggressively and effectively to obtain favorable rates, terms and conditions.

b) Mitigating Conditions

We agree that the evidence shows that the merger will increase SBC's market power in the pricing of special access. AT&T's network witness Giovannuci admitted that following the merger, the continued availability of special access service from AT&T will be important for CLEC customers who currently purchase special access service from AT&T.¹⁴⁸ SBC, according to this witness, has market power in special access in California.¹⁴⁹ The removal of AT&T as a competitor and a prime discount reseller of SBC's large customer special access would give SBC additional opportunities to leverage its market power against CLEC competitors to the disadvantage of consumers.¹⁵⁰ Qwest argues that AT&T has been pivotal in disciplining the rates, terms, and conditions under which SBC offers interstate special access, both as an alternative source of supply and by its negotiating leverage through which it has obtained more favorable rate discounts, terms, and conditions as set forth in SBC's federal tariffs. Qwest claims that AT&T is uniquely positioned to negotiate favorable terms, citing internal documents about SBC's tariff,¹⁵¹ out of which Qwest itself buys service.¹⁵²

The concessions obtained by AT&T and MCI then become available to other carriers such as Qwest through the general applicability of SBC's tariff offerings. With the elimination of both AT&T and MCI as a discipline in the negotiation process, the rate discounts, terms, and conditions currently available in SBC's tariffed plans could disappear, not necessarily immediately, but over time.

Accordingly, we consider the mitigating conditions that have been proposed. To mitigate these concerns relating to SBC's increased market power over special access, Qwest and Level 3 thus ask the Commission to impose the following conditions:

· Require SBC to offer all customers intrastate and interstate special access at the lowest rates currently offered by either SBC or AT&T.

· Prohibit SBC from giving AT&T or Verizon/MCI better special access terms and conditions than those offered to others.

· Require SBC to offer competitors in California any services or facilities the post-merger entity purchases from other ILECs out-of-region at the same rates, terms and conditions the post-merger entity obtains from ILECs out-of-region.

· Require SBC to give its wholesale customers a "fresh look" right to terminate their contracts without incurring termination liability.

· Require public disclosure of all special access contracts between SBC and AT&T and its affiliates and to permit competitors to accept individual terms from these agreements without being required to accept all the terms.

Applicants object to the special access pricing mitigation measures. To the extent these proposed measures involve interstate special services, Applicants argue that such regulation is not within the jurisdiction of this Commission. Applicants also claim that none of the complaints raised by Qwest and Level 3 is specific to California, and thus bear no relation to "adverse consequences" under § 854.

Applicants further argue that a series of FCC proceedings will address special access services and competitive issues, including pricing, provisioning and discrimination, and market power at the wholesale level. Applicants argue that the FCC, not this Commission, is best positioned to deal with special access issues arising out of this merger. Applicants thus propose that this issue be deferred to the FCC.

As previously discussed above, we are obligated to consider the full range of competitive impacts even though federal authorities may also independently be reviewing them.

(1) Equal Access to Terms and Conditions

Level 3 proposes a requirement that any transactions between SBC and AT&T and other affiliates be negotiated at arms length and disclosed publicly. Level 3 also proposes that combined entity be required to offer the individual negotiated terms on a stand-alone basis without requiring an entity to adopt all of the terms and conditions of a contract.

We shall require public disclosure of transactions between SBC and AT&T. We will not approve of the Level 3 proposal to permit carriers to pick and choose individual terms, but we shall require that carriers be allowed to obtain the same complete package of terms and conditions.

(2) Access to Lowest Currently Available Rate

Qwest proposes that SBC be required to offer special access in California at the lowest rate currently available either from SBC or AT&T, and to keep those rates in place for a fixed period of time. Qwest further proposes that SBC should be required to offer special access and other services at the same rates, terms, and conditions that it receives when it purchases equivalent services outside the SBC region. We shall require SBC to make available to carriers the lowest rate available from SBC or AT&T to remain in place for a 5-year period. We shall impose a similar requirement for special access that SBC purchases out of region. Qwest argues that such a condition would allow the leverage exerted by the merged company in its out-of-region markets to serve as a proxy for the same or equivalent services in California where AT&T no longer would exert pressure to drive lower rates.

(3) Fresh Look Opportunity

Both Qwest and Level 3 further propose a "fresh-look" period following the closing of the merger for entities to terminate their contracts with AT&T without incurring any termination liability, to permit such entities to take advantage of any improved terms that SBC offers its affiliates.

Applicants argue that such "fresh look" provisions are contrary to law under the TRO. Qwest disagree, arguing that in the portions of the TRO cited by Applicants, the FCC was merely addressing whether a fresh look opportunity should be afforded to CLECs when transitioning from special access to UNEs.¹⁵³ Because a different context is at issue here, namely, conditions on approval of a merger, Qwest argues that there is no FCC prohibition against imposing a "fresh look" condition here.

We agree that the TRO does not specifically address the "fresh look" applicability in the context of reviewing and placing conditions on approval of a merger. Nonetheless, the FCC does set forth the general principle that the grant of a "fresh look" is "a very rare occurrence."¹⁵⁴ Thus, we conclude that a particularly extreme and specific harm would need to be shown in order to justify granting such a condition here. We shall permit a fresh look condition for the limited purpose of accepting the complete package of terms and rates that was negotiated between SBC affiliates. We do not find that the parties have made a sufficient showing here that a "fresh look" requirement is necessary for any other purpose in order to avoid an anticompetitive result from the merger, particularly in view of the other mitigating conditions we are adopting. Accordingly, we decline to adopt the "fresh look" as a condition of the merger, with the limited exception as noted.

4. Capping of Special Access Rates

In his Advisory Opinion issued in this proceeding, the AG proposes, as a mitigating measure, that "the Commission freeze for one year rates paid by current AT&T customers receiving DS1 or DS3 private network service."¹⁵⁵ The Attorney General proposes this condition to mitigate the concern that "the merger may enable SBC to raise the average rates paid for DS1 and DS3 private network services."¹⁵⁶ The FCC stated that where a building generates more than two DS3's of demand, a CLEC will have sufficient incentive and economic ability to provision its own access.¹⁵⁷ The AG notes in his Opinion that 58% of the buildings served in the four MSAs in which AT&T and SBC provide "overlapping" special access services have bandwidth requirements of two DS3s or greater.¹⁵⁸ The AG limited the duration of the proposed condition to one year so that "the relatively brief span of the transition period would minimize the distortions and disincentives resulting from the rate freeze."¹⁵⁹

CALTEL proposes that the Commission cap intrastate special access rates of SBC for a period of five years in order to limit SBC's ability to leverage its acquisition of AT&T in order to increase special access rates to higher levels. CALTEL also proposes that the Commission make a direct recommendation to the FCC that it cap SBC's interstate special access rates for a similar time.

We shall adopt a rate freeze on intrastate special access rates for both SBC and AT&T. We conclude, however, that limiting the rate freeze to only a one-year period is too short to serve as an effective mitigation tool. Consistent with the timeframe we have adopted for other mitigation measures, we shall require that the rate freeze last for a five-year period. The rate freeze will serve as a mitigation against excessive rate increases. We also believe that the FCC should take similar action to freeze interstate special access.

As noted above, we conclude that a period of 5 years should apply, during which carriers can obtain the lowest available rate both for SBC and AT&T special access rates.

5. Internet Peering Arrangements

a) Parties' Positions

SBC currently provides high-speed Internet access via its ADSL offering to more than 50% of California high-speed Internet service customers, but is not a Tier 1 Internet backbone carrier. SBC must therefore purchase access to the Internet backbone from nonaffiliated providers. AT&T, on the other hand, is a Tier 1 Internet backbone provider but, because it has no mass market local "last mile" facilities, is not a consequential player in the mass market high-speed Internet service market. There is no existing firm that offers both retail high-speed Internet access in the mass market and that is also a Tier 1 Internet backbone provider. Tier 1 internet backbone providers do not have to pay for transit due to peering arrangements with other Tier 1 providers.

When joined with AT&T, SBC will become both the largest provider of consumer high-speed Internet access services in California and a Tier 1 internet backbone carrier. By virtue of its Tier 1 status, SBC will be able to exchange traffic with other Tier 1 internet providers without paying for bandwidth. ORA witness Selwyn testified that this cost-free access to the Internet backbone will give SBC a cost advantage that no other high-speed internet service providers will be able to match. (Ex. 126C, pp. 156-158, ORA/Selwyn.)

Today there are six "Tier 1" Internet backbone providers (i.e., AT&T, MCI, Sprint, Level 3, Qwest and Global Crossing) that other carriers must pay for Internet transit. These carriers are able to charge other providers of Internet services because they alone interconnect with all other Internet backbones.

Currently, as a non-Tier 1 participant, SBC has agreed to peering arrangements with other non-Tier 1 providers (such as Cox) for the exchange of traffic on a settlement free basis. These arrangements exist among non-Tier 1 carriers because of the mutual benefit of peering. Once SBC acquires AT&T, however, it will (presumably) attain Tier 1 status and will no longer have the incentive to exchange traffic without fees.

SBC hopes to integrate its Internet Protocol (IP) network with that of AT&T to obtain greater network synergies.¹⁶⁰ Witness Gillan argues that these network gains, however, should not be used an excuse to "de-peer" other Internet providers with whom SBC exchanges IP traffic presently. Gillan thus recommends that SBC be required to honor all existing Internet peering arrangements and to offer extensions (if requested by the carrier) for an additional five-years at existing terms, conditions and prices.

Applicants also dismiss the claims that competitors will be adversely impacted by SBC's integration with AT&T's IP backbone. Applicants argue that this market segment is even less concentrated today than when the FCC approved the divestiture of MCI's Internet backbone facilities to the merging owners of the two top backbone providers, finding that Internet services were "competitive, accessible, and devoid of entry barriers."¹⁶¹ Applicants further argue that the protestants do not explain how and why "many Internet Service Providers (ISPs) successfully competed against MCI and other vertically integrated firms when the market was considerably more concentrated than it is today."¹⁶² Based on their claim that there is more competition today for these services than ever before, Applicants discount protestants' claims that SBC's integration with AT&T will result in any detriment to competition.

b) Discussion

We conclude that the merger will increase SBC's market power through the combination of becoming a Tier 1 Internet backbone carrier and being the largest provider of consumer high-speed Internet access in California. The merger will provide SBC both the incentive and the opportunity to engage in discriminatory treatment of nonaffiliated rivals, both with respect to upstream backbone services and downstream retail services. (Ex. 126, p. 83, ORA/Selwyn). We shall therefore adopt the proposal that, as a condition of finding that the merger is not anticompetitive, SBC agree to honor all of its existing Internet peering arrangements and to offer extensions, if requested by the carrier, at existing terms, conditions, and prices. This condition shall remain in effect for a five-year period from the effective date of this decision.

We find Applicants' argument unpersuasive that carriers such as Cox can switch to another Tier I provider. Gillan's testimony focuses on the peering agreement between Cox and SBC, both of which are non-Tier 1 providers. Cox cannot simply switch to either another non-Tier 1 provider or a Tier 1 provider without adverse consequence. If SBC were to de-peer Cox, it would have to pay transit fees on traffic that it is currently exchanging with SBC on settlement free basis.¹⁶³

Applicants also argue that the FCC has concluded that Internet services are competitive so that Cox can choose another Tier 1 provider,¹⁶⁴ and that ISPs can compete with vertically integrated firms.¹⁶⁵ Yet, Cox's proposed condition does not address "Internet services," but rather the relationship between the parties providing the underlying telecommunications. Arguments about ISPs competing with SBC and/or AT&T are not relevant to Cox's proposed condition. The proposed condition is not directed towards any consequences that the merger may have on ISPs, but addresses the concern that the merger would increase SBC's incentive and ability to engage in anticompetitive behavior towards other carriers.

Likewise, while Internet services are "subject to federal oversight and beyond the Commission's jurisdiction," Cox's proposed measure does not involve regulation of "the Internet." It addresses carriers' networks and underlying interconnection arrangements. Moreover, the Commission has authority to impose conditions pursuant to § 854 notwithstanding the fact that federally regulated services may be implicated, as previously discussed. We accordingly adopt the condition as noted above.

6. Transit Service at Cost-Based Rates

a) Parties' Positions

Gillan also proposes that SBC be required to offer transit services at cost-based TELRIC rates. Gillan claims that transit services are essential to competitive local exchange carriers (LECs) and wireless providers that cannot interconnect with all other carriers directly. Even a company like Cox, which has more than 100 interconnection agreements nationwide with non-incumbents, depends on transit service to reach most other carriers.

This merger will further increase the scale efficiency of the SBC exchange network. SBC has had an opportunity to gradually deploy network facilities in its role as the largest California ILEC and is the central network to which all other providers must interconnect. Gillan argues that the existing exchange network should facilitate new network deployment by enabling a network-of-networks to evolve in the most efficient manner.

Transit traffic arrangements are used routinely by LECs to allow their customers to complete calls to each other's customers. "Meet Point Billing" arrangements represent the standard methodology of the telecommunications industry governing how interexchange traffic is exchanged and how each carrier will bill other carriers for its part in carrying it. With the enactment of the Federal Act and the introduction of local competition, CLECs require transit for local traffic as well. CLECs also require the ability to efficiently interconnect with wireless networks and the networks of interexchange carriers.

Gillan proposes that as a condition of the merger, SBC not be permitted to charge transit rates to CLECs above cost. This condition will avoid creating an incentive for carriers to establish direct connections before it is efficient to do so. Section 251(c)(2)(A) requires incumbents to interconnect their networks with those of requesting carriers "for the transmission and routing of telephone exchange service and exchange access."¹⁶⁶ Nothing in this obligation limits a requesting carrier to interconnection with the incumbent to route traffic only to and from the incumbent's customers. Transit is as much a part of the "transmission and routing of telephone exchange service and exchange access" as other forms of interconnection.¹⁶⁷

It is unclear exactly how the post-merger environment will stabilize, and which carriers will have the traffic flows to justify dedicated connections once a new equilibrium is reached.¹⁶⁸ Gillan believes the best "transit policy" in response to this situation is to require SBC to offer the service at cost-based rates, with individual carriers deciding the point at which dedicated connections are the more efficient alternative. If the Commission adopts some limitation, however, then Gillan recommends using a proxy for the basic economic choice of traffic volumes sufficient to justify a dedicated connection. For instance, he suggests that a possible limitation that transit at TELRIC rates not be available when two providers are exchanging traffic at the level equivalent to what would be carried by ten DS-1s for three consecutive months.¹⁶⁹ If this transit threshold is exceeded, then SBC could charge higher than TELRIC rates for the transit traffic. In any case, Gillan argues that the interconnecting carriers must be allowed a reasonable period of time (e.g., he suggests six months) to engineer and install direct interconnection, and traffic exchanged indirectly via SBC transit services should remain at TELRIC rates to the degree that the amount of transit traffic falls below the threshold used to trigger direct interconnection.

Applicants oppose this condition, arguing that it does not address any issue or adverse consequence directly related to the merger that requires mitigation. Applicants claim the market will be competitive without this condition.

We find this condition reasonable for the reasons discussed above, and hereby adopt it. We conclude that this condition reasonably addresses the adverse consequences that may result from the inevitable change in traffic flows resulting from the integration of the SBC and AT&T network facilities by providing a degree of stability and certainty to carriers with respect to transit rates. It is unclear how the post-merger environment will stabilize with respect to identifying which carriers will have the traffic flows to justify dedicated connections once a new equilibrium is reached. Imposing this condition will promote competitive stability in traffic flows as the industry adjusts to the effects of the merger. We shall set require that this condition continue in place for a five-year period from the effective date of this decision. This time frame is consistent with the related conditions we are adopting for the extension of existing transport agreements.

7. Extension of Transport Agreements

Witness Gillan also proposes a requirement that AT&T extend existing transport agreements for five years at the same rates, terms and conditions to mitigate the elimination of AT&T as a competitor in the short-haul transport market. SBC and AT&T compete in the short-haul transport market in California, and AT&T is the only alternative provider to SBC on some routes. AT&T has an extensive transport network. Cox has transport agreements with AT&T on certain routes that only AT&T and SBC serve.¹⁷⁰ As the only competitor to SBC on at least certain routes, AT&T provides pricing discipline in the short-haul transport market. Once the merger is implemented, AT&T will no longer be a competitor to SBC and this will adversely affect competition in this market segment. Gillan testified that AT&T's pre-merger incentive to facilitate competitive entry is quite different than the incentives of the merged firm in that AT&T had little retail share to try and "protect" by increasing the costs of competitors. It had no incentive to help protect SBC's share. Gillan claims that the combined firm, however, cannot be expected to welcome the same competitive activity. Gillan thus recommends that SBC be required to offer to automatically extend, for a five-year period, any transport contracts between AT&T and another carrier for capacity at DS3 or greater. Applicants object to this condition, arguing that it does not address any issue directly related to the merger, or any adverse consequence therefrom. Applicants argue that carriers do not need this condition in order for there to be fair competition. We agree that requiring SBC/AT&T to maintain and extend existing transport agreements for a five-year period directly relates to the resulting consequence and hereby adopt this proposed condition. Adopting this condition will promote price stability in response to SBC eliminating its only competitor.

8. Rates Paid for Exchange of VoIP Traffic

Level 3 proposes that, as a condition of approving the merger, that SBC be required to exchange all VoIP traffic-defined as locally dialed calls where one end of the call originates or terminates on the Internet-at the local reciprocal compensation rate. Level 3 argues that, by doing so, the Commission will ensure that VoIP customers will be on the same footing as traditional telephone customers when making local calls, and that the underlying networks will be compensated for the use of their networks.¹⁷¹

Without this restriction, Level 3 argues that the combined entity will have excessive market power over ESP services, especially Voice Over IP, by applying higher rates such as access charges for calls that leave the SBC network.

In addition, in order to ensure that there is no discriminatory pricing between AT&T and SBC with respect to VoIP services, Level 3 argues that such transactions must be conducted at arms length, publicly disclosed and the prices in that agreement offered to all other providers without regard for any volume or term discounts.¹⁷²

Applicants object to this condition, arguing that it does not address any issue directly related to the merger, or any adverse consequence therefrom. Applicants argue that carriers do not need this condition in order for there to be fair competition.

We decline to adopt the proposed pricing restriction calling for the exchange of VoIP traffic at reciprocal compensation rates. Level 3 has not adequately justified that this sort of Commission intervention is warranted for into VoIP calls that originate or terminate on the Internet. We agree, however, that to ensure there is no discriminatory pricing, transactions between AT&T and SBC with respect to VoIP services shall be conducted at arms length and publicly disclosed, with similar prices, terms, and conditions offered to other carriers on a nondiscriminatory basis.

9. Access to Numbering Resources

Level 3 proposes that the combined entity be required to immediately return any unused 1000-number or 10,000-number blocks, and to assign numbers across the combined entity from the available inventory of the individual companies. Level 3 proposes that, going forward, SBC should seek additional numbering resources only as one entity and only when the appropriate number utilization thresholds are met as one entity.

Applicants object to this condition, arguing that it does not address any issue directly related to the merger, or any adverse consequence therefrom. Applicants argue that carriers do not need this condition in order for there to be fair competition.

We agree with Level 3 with respect to this condition. Applying number resource allocation rules to SBC and AT&T combined operations as a single entity will enhance the efficient utilization of number resources consistent with Commission policy.

10. Stand-Alone DSL

SBC bundles DSL with its wireline service and does not offer a stand-alone DSL product.¹⁷³ Stand-alone DSL refers to the offering of DSL, for high speed Internet access, to a customer without also requiring the customer to buy additional services, such as traditional local phone service or VoIP service, from the same provider.

ORA, Qwest, and Level 3 propose that as a condition of approving the merger, stand-alone DSL be provided by the merging entities, and that DSL be based on industry standards to be compatible with competing providers' VoIP and other advanced services. By tying together DSL service with its voice services, SBC discourages consumers from using VoIP competitors. SBC has not had a mass market VoIP product,¹⁷⁴ but has used this required DSL bundling as means to discourage SBC broadband customer migration to primary line VoIP service, by requiring a circuit-switched voice line purchase as a condition of getting and keeping SBC broadband.

Some consumers prefer to buy packages of multiple services, while others prefer to buy individual services from different providers. Competitively priced individual offerings from different providers, however, allow competitors to compete on a service-by-service basis and, as a result, consumers benefit from more choices and better prices.¹⁷⁵

SBC currently provides DSL service to subscribers in California only where the customer also subscribes to SBC voice service. Both the DSL and voice service is provided over a single cooper loop. SBC California provides the voice service over the low frequency portion of the loop ("LFPL") and SBCIS provides DSL transport over the high frequency portion of the loop ("HFPL").¹⁷⁶ Applicants claim that by requiring SBC California to offer standalone DSL would be in violation of federal authority that a loop constitutes a single network element that is not subject to further unbundling. SBC argues that such a requirement would entail the mandatory unbundling of the LFPL. SBC argues that the FCC preempted the states' ability to require such additional unbundling in its recent BellSouth Order.

Applicants claim there are numerous competitive alternatives to DSL, including ubiquitous cable modems, wireless broadband and other technologies, such that DSL unbundling is not necessary. Applicants argue that mandatory unbundling of DSL would actually impair competition by producing disparate regulatory treatment of the various modes of broadband connections.

We agree that in order to mitigate SBC's market power in this area, SBC should be required to offer DSL on a stand-alone basis, without tying DSL to a requirement also to take SBC voice service. We disagree with Applicants' claim that the requirement for SBC to offer DSL on a stand-alone basis constitutes a violation of federal authority that the low frequency portion of the local loop is not subject to further unbundling.

We conclude that SBC's current practice of refusing to offer stand-alone DSL harms competition by making it more difficult for competitors to provide voice service to customers subscribing to broadband Internet access over SBC's DSL facilities. The potential for this practice to harm competition will be amplified with the merger. We shall therefore adopt as a condition of the merger that SBC must offer DSL to consumers on a stand-alone basis without being tied to SBC voice service.

Applicants have not presented any valid objections to this condition. We disagree with Applicants' claim that a requirement to offer stand-alone DSL is the equivalent of a requirement to unbundle the loop through line sharing. On the contrary, SBC will continue to control the entire loop element, and will continue to be able to provide DSL to retail customers. SBC will be precluded, however, from forcing its DSL customers to also purchase intrastate local exchange service from SBC. Customers will thereby have the option of purchasing local voice service, including VoIP, from a competing carrier.

11. Prohibiting Preferential Access Rates Between SBC and Verizon

Qwest proposes that SBC and Verizon should be required to agree not enter into reciprocal arrangements to provide each other with more favorable access rates, whether based on "volume" or other factors, that would facilitate two segregated telecom monopolies within California. Qwest argues that if SBC continues to require customers to purchase its traditional wireline local voice product in order also to receive its broadband product, VoIP providers will be competitively disadvantaged in the marketplace.

Applicants object to this condition, arguing that it does not address any issue directly related to the merger, or any adverse consequence therefrom. Applicants argue that carriers do not need this condition in order for there to be fair competition.

We agree with Qwest that this condition is warranted to mitigate the risk of anti-competitive preferential arrangements. SBC shall be prohibited from engaging in reciprocal arrangements with Verizon to provide each other with more favorable access rates than either company offers to other competitors. Such a reciprocal arrangement would be discriminatory and anticompetitive.

12. Divestiture of Overlapping In-Region Facilities

a) Parties' Positions

Qwest and Level 3 advocate the "divestiture" of "overlapping" California in-region transport facilities.¹⁷⁷ Level 3 defines California In-Region Transport facilities as tangible assets (such as conduits, pole attachments, manholes, building entrance facilities, right of way agreements, fiber, transport equipment, support infrastructure equipment and collocation space), and intangible assets (such as AT&T's off-net transport purchase agreements or rights within the California service territories of SBC). In-Region Transport Assets would not include AT&T's long-haul intercity backbone, but would include its intermediate distance network.

Level 3 argues that the combined effect of this merger with the Verizon/MCI merger significantly increase the risks of coordinated anti-competitive effects from the merged entities. After closing of the mergers, Level 3 doubts that MCI will continue as a significant competitor in SBC's territory (nor that AT&T will be a significant competitor within Verizon's territory) for the provision of transport services on a wholesale basis. Thus, mergers could mean the effective loss of both of the best-positioned alternative providers in the local transport market in SBC and Verizon territories.¹⁷⁸

The divestiture proposed by Level 3 involves three components: The first component requires the conveyance of the California In-Region Transport Assets to a third party. The second component requires a purchase commitment from the sellers to continue to use those assets for a stated period of time. And in the final component, customer contracts, at the time of the closing of the transaction, would be retained by SBC and AT&T.¹⁷⁹

For the purchaser of the In-Region Assets to be able to compete effectively going forward, Level 3 argues that the purchaser needs to obtain the scale benefits that such traffic volumes create. Level 3 thus proposes that the sellers of the California in-region assets be required to continue to purchase services from the new owner. The cost of maintaining AT&T's California In-Region Transport Assets is amortized over large volumes of voice and data traffic over shared circuits as well as circuits dedicated to particular customers.

Level 3 acknowledges that divestiture of all of AT&T's customer relationships is infeasible. Level 3 believes it may be feasible, however, to require divestiture of some subset of AT&T's and MCI's existing customer agreements, such customer agreements where wholesale customers purchase basic transport services from AT&T or MCI.¹⁸⁰ If the merged entities desire to retain customers, however, Level 3 proposes that they be required to keep existing traffic on the divested California In-Region Transport Assets for some minimum period of time (with payment to the buyer for continuing to carry such traffic). Level 3 argues that this purchase commitment would also allow the purchaser sufficient time to build a customer base on the California In-Region Transport Assets so that it could compete with the incumbent even after expiration of the purchase commitment.¹⁸¹

Level 3 argues that a divestiture at the transport facilities level of these networks allows users of transport services to have an alternative access option other than the incumbent RBOC and to ensure that redundant physical facilities remain owned by different companies than the monopoly ILEC for the offering of competitive services.¹⁸²

Applicants oppose such divestiture, arguing that it would undermine a key benefit of the merger, that is, the ability to provide end-to-end service to enterprise customers with enhanced features and services. The DOJ requires divestiture as a condition of its approval of a merger only when it finds that, absent such divestiture, the proposed merger would violate Section 7 of the Clayton Act, which prohibits mergers that are likely to lessen competition substantially in any line of commerce.¹⁸³ Applicants deny there is any network overlap or "significant adverse consequences" as referenced in § 854(c)(8). Applicants claim that AT&T is not in the wholesale special access business, and does not build local facilities either on speculation or to the common areas of commercial buildings to provide a competitive special access business. Applicants claim that AT&T has a retail focus and only provides fiber-to-the-floor (FTTF) building architecture (i.e., directly to the customer) to serve the customer's proprietary space in on-net buildings after it has won the business of an enterprise customer.¹⁸⁴ As a result, Applicants claim, the equipment that AT&T installs can only be used to meet that specific customer's requirements.¹⁸⁵ Even if AT&T were to win another customer's business in the same building, or even on the same floor of a building, it might have to purchase special access from SBC to serve that customer.¹⁸⁶ AT&T only very rarely builds local access to common areas of a commercial building or floor of a building.

Applicants claim that Qwest witness Axberg provides no evidence of overlapping facilities in California, and does not substantiate the premise for her divestiture request, namely the elimination of concentration of special access facilities in California.¹⁸⁷ Axberg has no idea how many Competitive Access Providers ("CAPs") exist in California or the number of CLEC route miles or fiber miles in California.¹⁸⁸ Ms. Axberg has no idea whether there is any concentration of special access facilities in California that would warrant a divestiture of Applicants' facilities. She believes that the majority of Qwest's special access purchases in California are for interstate services.¹⁸⁹

Level 3, however, presented evidence of overlapping facilities. AT&T's own SEC public documents which it filed in support of this case show that the company has a large amount of fiber transport, and that it is in the business of leasing that transport capability to competitive providers.¹⁹⁰ This business segment was important enough to merit special mention in AT&T's SEC filing.¹⁹¹

In addition, AT&T indicates that it has "an extensive local network serving business customers in 91 U.S. cities. [Its] local network now includes 158 local switches and reaches more than 6,400 buildings with over 8,200 metropolitan SONET rings."¹⁹²

In California, AT&T acquired SONET rings and metropolitan fiber designed to serve multiple customers in its acquisition of TCG, a competitive access provider and CLEC, in four major metropolitan areas: Sacramento, San Diego, San Francisco and Los Angeles, all of which are in SBC's California service area.¹⁹³ AT&T has fully integrated those TCG facilities into its own network.¹⁹⁴

Applicants further argue that that divestiture would harm rather than benefit customers, and that any such customer divestiture would frustrate the rights and interests of customers by forcing them to deal with suppliers they have not chosen, and who may lack the ability to deliver the same levels of service and proprietary features for which the customers have contracted.¹⁹⁵

Despite the desire of many enterprise customers for end-to-end service by one carrier, divestiture would force them to rely on a new facilities operator. AT&T's local facilities are mainly used to provide retail services to enterprise customers that have chosen AT&T over many other competing suppliers, and that it "is infeasible" to "convey[]" these customers "involuntarily" to new suppliers.¹⁹⁶

b) Discussion

We conclude that Level 3 and Qwest have not provided sufficient justification to warrant adopting their divestiture proposal.

We decline to require the divestiture of overlapping in-region facilities. We agree that there is evidence that AT&T and SBC have some degree of overlapping facilities, particularly through AT&T's acquisition of its TCG affiliate. Yet, some of the evidence presented regarding overlapping facilities relates more to AT&T's national network, without specific delineation of the extent to which the overlap applies within California territory. In any event, we are not persuaded that the degree of overlapping facilities within California is sufficient to justify divestiture as a remedial condition. We conclude that the potential disadvantages of implementing such a complicated proposal outweigh any possible advantages that might be realized. Although the sponsoring parties have set forth broad outlines, they have not adequately explained in detail how the relevant facilities would be identified or the administrative processes required for implementing such divestiture. Vidal identifies overlapping facilities as "In-Region Transport Assets" and provides a very general, high-level explanation of these assets.¹⁹⁷ Mr. Vidal, however, doesn't explain how such assets would be identified, how the divestiture process would work, what vehicle the Commission would use to accomplish the divestiture or a timetable to accomplish divestiture. Qwest's witness Axberg provides a different but equally high-level claim of "overlapping" facilities "including, but not limited to fiber rings, collocation facilities, entrance facilities and building entrance loops."¹⁹⁸

Like Mr. Vidal, Ms. Axberg provides no explanation of how these facilities would be identified or divested, or how the Commission would accomplish the divestiture. Moreover, the divestiture would have the potential to be disruptive to customers served by the divested facilities. Applicants note that any California-specific facilities divestiture order would force multi-state companies which had purposely contracted for a single provider to serve locations in multiple states to restructure their telecommunications services, either in the short term, by agreeing (potentially against its will) to use multiple providers where previously it had used only one, or in the longer term, by finding an entirely new provider able to serve its needs in all states. Either result would cause additional costs and inefficiencies for the customer.

Level 3 claims that such problems would be avoided by requiring Applicants to separate AT&T's network between its intercity "backbone" and its local facilities, and requiring divestiture of only the local facilities. Vidal (Level 3) Ex. 13, p. 15-17. Level 3's witness Vidal argues that customers would enjoy the full benefits of their bargains if AT&T continues to serve them, but is required to purchase access services from the new owners of the divested facilities. Level 3's plan, however, could create the very customer disruptions and inefficiencies that are improper, and that many customers - including many who specifically wish to have an end-to-end solution and believe the proposed merger is in the public interest for precisely this reason, among others - would prefer to avoid. Divestiture would require that the combined company pay the new carrier for services, increasing the cost of service, and would eliminate Applicants' ability to use their existing systems fully to provision, monitor, and restore services on an end-to-end basis.¹⁹⁹ In addition, we conclude that the other conditions that we are adopting to mitigate SBC's market power are sufficient without resorting to the extreme measure of divestiture.

ORA has also proposed divestiture of AT&T's consumer local and long distance business. As part of its divestiture proposal, ORA proposed that the purchaser of the divested services would need to be able to obtain UNE-P at TELRIC-based rates. We likewise do not believe that divestiture as proposed by ORA is a practical remedy to mitigate perceived adverse competitive impacts. One of the basic reasons for the merger is to achieve synergies from combining AT&T's business operations with those of SBC's. Divestiture of AT&T business components would undermine the very sorts of synergistic benefits that the merger is aimed at producing. Moreover, ORA's proposal would envision that the purchaser of divested facilities obtain UNE-Ps at TELRIC-based rates. Such a condition, however, would be contradictory to the TRRO calling for the elimination of UNE-P. Accordingly, we decline to order divestiture of AT&T assets.

13. Pac-West Proposal Regarding Packet-Switched Interconnection

a) Parties' Positions

Pac-West proposes that as a condition of the merger, that SBC certificated public utility affiliates in California consent to participate in arbitration proceedings conducted by this Commission pursuant to Section 252 of the Communications Act to establish terms and conditions of interconnection to include all technologies and network architectures deployed by SBC affiliates in California, including but not limited to all packet-switched network technologies. Pac-West further proposes that SBC waive any claims that such interconnection obligation involving all of its deployed network architectures exceeds the scope of Section 252 permissible arbitrations.

Pac-West argues that this condition is required to mitigate potential harm to competition from the merger, specifically in view of SBC's position that its obligations under Section 251 and 252 of the Communications Act to interconnect its network with competitors on a non-discriminatory basis do not apply to its "packet-switched" network.²⁰⁰ SBC believes that its statutory interconnection obligations are limited only to the circuit-switched portions of its network even if packet-switched portions of that network are used to provide regulated telecommunications services.

Pac-West thus argues that the lack of nondiscriminatory interconnection between competitors' packet-switched networks with SBC facilities will make intermodal competition with SBC telecommunications services impossible. Although the trend from circuit-switched to packet-switched technology is expected to continue irrespective of the merger, Pac-West claims that the pace of transition will accelerate as a result of the merger. Pac-West points to the accelerated transition schedule as a merger-related problem for which remedial mitigating conditions are warranted to prevent adverse merger impacts particularly regarding impediments to intermodal competition. Moreover, Applicants have pointed to intermodal competition as evidence that the merger will not be anticompetitive. Yet, Pac-West argues that intermodal competition cannot succeed without nondiscriminatory interconnection for packet-switched networks.

b) Discussion

We conclude that an appropriate condition of the merger is that SBC agree to include packet-switched networks within the scope of interconnection rights and obligations subject to negotiation and arbitration with other telecommunications carriers. A primary claimed benefit of the merger is that it will lead to acceleration of the conversion of Applicants' combined networks to a unified and completely packet-switched architecture. This packet-switched conversion will provide advanced forms of service more efficiently. At the same time, Applicants have pointed to intermodal competition as a significant factor that will mitigate any potential concerns that the merger will give SBC increased market power. Yet, in order for intermodal²⁰¹ competition to be effective over time, each competing telecommunications network must be able to exchange traffic originated on its own network, but destined for a called subscriber on a different competing network, on fair and nondiscriminatory terms. Pac-West's proposed condition accomplishes this result.

Pac-West witness Taplin testified about the ability of packet-switched network operators to discriminate against packets of competitors. Thus, the mitigating condition proposed by Pac-West is appropriate to prevent SBC, by converting to packet-switched network technology, from being able to degrade the performance of calls made to or from customers of carriers such as Pac-West.

Applicants provide no convincing evidence to refute the claims made by Pac-West concerning the potential harm from SBC's refusal to include packet-switched technologies within the terms and conditions subject to its interconnection agreements. Applicants do not refute Pac-West's claim concerning the potential for competitive harm. Instead, Applicants base their opposition on the claim that Pac-West's proposal would constitute unlawful Internet and IP network connection obligations. In making this claim, Applicants cite to an order of the FCC indicating that the various obligations and entitlements under the Act attach only to entities providing telecommunications services, not information services.²⁰² Yet, Pac-West's proposed condition does not address information services, and does not require that any individual services offered by means of interconnected packet facilities be regulated by this Commission versus the FCC. Pac-West's condition only applies to telecommunications services exchanged between certificated carriers. AT&T and SBC would remain free to commercially negotiate peering arrangements with non-common carrier participants in the Internet marketplace, as well as to provide Internet services on an unregulated basis. ²⁰³

Applicants also object to a requirement that SBC "consent" to state arbitration proceedings to establish the terms and conditions of interconnection to SBC's networks, that "include[s] all technologies and network architectures deployed by the SBC affiliates in California, including but not limited to all packet switched network technologies." Applicants claim that Pac-West's condition would have SBC expressly "waive" its rights concerning the proper scope of arbitrations under the Telecommunications Act. Applicants claim that it would be unlawful for the Commission to impose such a condition.

We disagree with Applicants' claim that it would be unlawful to impose this condition. Section 251(c)(2) imposes network interconnection obligations on ILECs and Section 251 is subject to the negotiation and state commission arbitration requirements of Section 252. State commissions have primary regulatory oversight responsibilities for all network interconnection obligations arising under Section 252. Moreover, packet-switched facilities can and are used to provide services which the FCC has expressly found to be basic telecommunications services.²⁰⁴ Accordingly, we find this condition to be lawful and necessary in order to mitigate the adverse effects, as noted above.

14. Telscape Proposal

Telscape proposes that as a condition of approving the merger, AT&T and its affiliates provide access to rights-of-way, conduit space, interoffice transport, and fiber loop facilities at the same rates and terms that would apply if those facilities were owned by SBC-CA.²⁰⁵ Telscape asks that the AT&T/TCG networks be subject to ILEC interconnection obligations. Applicants respond that federal law precludes the imposition of ILEC interconnection obligations on CLECs and IXCs.²⁰⁶

Telscape also proposes a requirement that SBC California timely repair any substandard residential copper loop facilities reported by CLECs in order to ensure that these legacy facilities are available to continue to serve the interests of end-users in economically disadvantaged areas. Telscape further proposes a requirement that SBC California charge mechanized service order charges for all electronically-submitted service orders for basic two-wire residential loops in order to ensure that SBC California continues to make necessary improvements to its OSS following the acquisition of AT&T.

Applicants oppose the Telscape proposal relating to OSS improvements, noting that Telscape raised and lost this issue in a complaint proceeding in which it sought to eliminate all semi-mechanized charges on electronically submitted local service requests.²⁰⁷ Applicants claim that Telscape has not provided any valid legal basis for rehearing or petition for modification as required by the Commission's rules.²⁰⁸

Applicants argue that Telscape's proposal is also contrary to federal law in seeking a "requirement that SBC-CA offer a basic two-wire residential loop product on a commercial wholesale basis at a price at least 50% below the TELRIC rate ...."²⁰⁹ Federal law establishes a pricing standard for UNEs and specifies that rates shall be based on the cost of providing the network element.²¹⁰ Under 47 U.S.C. section 252(d)(1), ILECs may charge a "just and reasonable rate" for unbundled network elements identified by the FCC, and the FCC has adopted "total element long-run incremental cost," or TELRIC, as the applicable pricing standard.²¹¹

We are not persuaded that the conditions proposed by Telscape are necessary to mitigate merger effects. We previously denied Telscape's arguments regarding OSS improvements in the above-referenced complaint proceeding leading to D.04-12-053. We likewise decline to adopt it here.

⁶⁴ See D.97-03-067, 71 CPUC2d 351, 379; also see D.91-05-028, 40 CPUC2d 159, 182.

⁶⁵ Ex. 136C, Murray Testimony, pp. 64-66.

⁶⁶ Ex. 136, Murray Testimony, § III.D.

⁶⁷ The HHI is a measure of market concentration calculated as the sum of each firm's squared market share, with higher HHI values representing more concentrated markets.

⁶⁸ Ex. 126C, Table 1, p.51, Selwyn/ORA.

^{69 .} Merger Guidelines, at §1.5(c). The Merger Guidelines consider a market with an HHI greater than 1800 to be "highly concentrated," and state that "[m]ergers producing an increase in the HHI of more than 50 points in highly concentrated markets post-merger potentially raise significant competitive concerns ..."

⁷⁰ Ex. 79C, p. 8, SBC/Aron.

⁷¹ D.97-03-067, 71 CPUC2d 351, 420, footnote 31. Also see Attorney General's Opinion, page 3, citing Moore v. Panish (1982) 32 Cal.3d 535, 544, and Farron v. City and County of San Francisco, (1989) 216 Cal.App.3d 1071.

⁷² The staff of the AG's office held on-site meetings and conference calls with the Joint Applicants and with several of their witnesses, but did not hold similar meetings or telephone conferences with ORA or TURN. (Counsel of ORA is only aware of several telephone conversations between ORA and the AG's office, on the topic of obtaining documents being withheld by Applicants. The staff from the AG' Office also attended a presentation by XO to ORA.) Some of the material supplied to the Attorney General's office by Joint Applicants was admitted as Exhibits 5C, 6C and 7C.

⁷³ The AG Opinion makes one exception to this conclusion: the DS1 and DS3 special access markets.

⁷⁴ The AG Opinion uses this theory in its discussion of the special access markets as well.

⁷⁵ Re Application of WorldCom, Inc. and MCI Communications Corporation for Transfer of Control, etc. (1998) 13 FCC Rcd. 18,025 ("WorldCom/MCI").

⁷⁶ The record on AT&T's withdrawal from the mass market was significantly augmented after the AG Opinion was issued in the deposition of AT&T witness Polumbo, and at the hearing. The AG Opinion, however, was unable to consider the effect of this transaction in determining the amount of new facilities-based competition that might develop

⁷⁷ Aron (JAs) Ex. 78, pp. 59-61; Aron (JAs) Ex. 79, pp. 30-61.

⁷⁸ Merger Guidelines, Section 1.51

⁷⁹ Ex. 136C, Murray Testimony p. 89, and Ex. 2, Attachment to Applicants' Response to TURN 1-t at 003603-003606.

⁸⁰ The decision to withdraw from the mass market was a decision to stop marketing those services, not a decision to abandon existing customers. The term "harvest" strategy refers to a plan to retain mass market customers while at the same time increasing prices so the revenue those customers generated increased. (Tr., Vol. 9, p. 1229, AT&T/Polumbo.)

⁸¹ Aron (JAs) Ex. 78, pp. 59-73; Aron (JAs) Ex. 79, pp. 61-81.

⁸² Kahan (JAs) Ex. 43, pp. 11-12, 16.

⁸³ Polumbo (JAs) Ex. 14, pp. 16-17; Kahan (JAs) Ex. 43, p. 12.

⁸⁴ Aron (JAs) Ex. 79, p. 79.

⁸⁵ Kahan (JAs) Ex. 43, pp. 14-16.

⁸⁶ Aron (JAs) Ex. 78, pp. 64-72; Aron (JAs) Ex. 79, pp. 65-73.

⁸⁷ Aron (JAs) Ex. 78, pp. 64-72.

⁸⁸ Ex. 136C, Murray Testimony, Ex. TLM-4

⁸⁹ Ex. 136C, Murray Testimony, Ex. TLM-2, Applicants' Response to TURN 1-36.

⁹⁰ TURN Opening Brief, page 90.

⁹¹ Exhibit 126.1-C.

⁹² Ex. 79, Aron Rebuttal Testimony, pp. 67-73.

⁹³ Ex/ 126C. Selwyn Testimony, p. 121.

⁹⁴ Aron (JAs) Ex. 78, p. 29, n.63.

⁹⁵ Aron (JAs) Ex. 78, pp. 25-31.

⁹⁶ Aron (JAs) Ex. 78, p. 27, n.49 (citing Morgan Stanley).

⁹⁷ Aron (JAs) Ex. 78, p. 27.

⁹⁸ Aron (JAs) Ex. 78, p. 28.

⁹⁹ Kahan (JAs) Ex. 43, p. 9. Analysts expect that approximately 81% of American homes will have cable telephony available to them by the end of 2006.

¹⁰⁰ Aron (JAs) Ex. 78, p. 28, 31-33.

¹⁰¹ Aron (JAs) Ex. 78, pp. 28, 31-32.

¹⁰² Aron (JAs) Ex. 78, p. 28-29.

¹⁰³ Aron (JAs) Ex. 78, pp. 31-32.

¹⁰⁴ Ex. 78, A.16

¹⁰⁵ The prevailing monthly broadband rates are $42.95 for cable (see Ex. 95) or $49.95 for SBC DSL (See Ex. 71). Although SBC offers a $14.95 introductory rate for DSL, this rate is only for one year for new customers who also sign up for SBC local voice service.

¹⁰⁶ Aron, Ex. 78, p. 42

¹⁰⁷ California's population grew 6% from 2000 to 2004. U.S. Census Bureau, 2004 Population Estimates. Its economy grew 20% over the same period. U.S. Department of Commerce, Bureau of Economic Analysis.

¹⁰⁸ FCC, "Local Telephone Competition-Status as of June 30, 2004," rel. Dec. 2004, Table 13.

¹⁰⁹ FCC, "Trends in Telephone Service," May 2004; Deutsche Bank, "US Telecom Data Book 3Q-04," Nov. 2004.

¹¹⁰ Competitive Enterprise Institute, "Wireless Substitution and Competition," Dec. 2004, p. 9; FCC, "Local Telephone Competition: Status of June 30, 2004," rel. Dec. 2004.

¹¹¹ FCC, "Ninth Annual CMRS Competition Report," Sept. 9, 2004, ¶ 212 and fn 575; The Yankee Group, "Youth Market Will Drive Wireless-Only Households," Dec. 2004.

¹¹² The Yankee Group, "The Success of Wireline/Wireless Strategies Hinges on Delivering Consumer Value," Oct. 2004

¹¹³ AG Opinion, at 17.

¹¹⁴ This statement also merges fixed wireless (a data service) into wireless voice service. Combining such different services overstate the interest of business customers in "cutting the cord."

¹¹⁵ 47 U.S.C. § 252(d)(1).

¹¹⁶ See 47 C.F.R. § 51.505.

¹¹⁷ Memorandum Opinion and Order, Application for Review and Petition for Reconsideration or Clarification of Declaratory Ruling Regarding US West Petitions To Consolidate LATAs in Minnesota and Arizona, 14 FCC Rcd 14392 at ¶¶ 17-18 (1999) (hereinafter "InterLATA Boundary Order").

¹¹⁸ See 47 U.S.C. § 252(d)(1); 47 U.S.C. § 252(c)(2).

¹¹⁹ Triennial Review Order, 18 FCC Rcd at 17386, ¶ 657 (emphasis added).

¹²⁰ See Gillan (CALTEL) Ex. 131, pp. 34-35.

¹²¹ See Gillan (CALTEL) Ex. 131, p. 41.

¹²² Triennial Review Order, 18 FCC Rcd at 17389, ¶ 663.

¹²³ UNE Remand Order, 15 FCC Rcd at 3906, ¶ 473.

¹²⁴ Triennial Review Order, 18 FCC Rcd at 17389, ¶ 664.

¹²⁵ USTA II, 359 F.3d at 589.

¹²⁶ See Gillan (CALTEL) Ex. 131, pp. 25-27. "Commingling" means the connecting, attaching, or otherwise linking of a UNE, or UNE combination, to one or more facilities or services that a requesting carrier has obtained at wholesale from an incumbent LEC pursuant to any method other than unbundling under Sec. 251(c)(3) of the Act, or the combining of a UNE or UNE combination with one or more such wholesale services.

¹²⁷ See Triennial Review Order, 18 FCC Rcd at 17386, ¶ 655 n.1990; see also United States Telecom Ass'n, 359 F.3d at 589-90 (affirming FCC's no-combinations holding).

¹²⁸ See Errata, Review of the Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers, 18 FCC Rcd 19020, ¶ 27 (2003).

¹²⁹ Order Implementing TRRO Changes, Case No. 05-C-0203, at 22 (N.Y. PSC Mar. 16, 2005). See also Arbitration Decision, Docket No. 04-0371, at 18 (Illinois Commerce Comm'n Sept. 9, 2004).

¹³⁰ Review of the Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers, WC Docket 01-338, Second Report and Order, 19 FCC Rcd 13494, FCC 04-164, (rel. July 13, 2004) ( "All or Nothing Order").

¹³¹ Stegora Axberg (Qwest) Ex. 119, p. 12.

¹³² Vidal (Level 3) Ex. 13, p. 11.

¹³³ Exhibits 10, 11, 76, 77.

¹³⁴ AT&T claims that it buys from SBC most of the special access which it uses in California, in part because other CLECs have so little to offer in the way of special access facilities. Tr. Vol. 8, pp. 1107-1108, AT&T Giovannucci. Therefore, both AT&T and the other CLECs which buy special access through it depend on AT&T's special access tariff pricing for which the other CLECs do not qualify. See Exh. 10 and 11 and Tr. Vol. 8, pp. 1113-1121, AT&T Giovannucci.

¹³⁵ Axberg Reply Testimony, Qwest Exh. 119, pp. 12-14.

¹³⁶ Vidal (Level 3) Ex. 13, p. 11.

¹³⁷ Level 3 Opening Brief, p. 24.

¹³⁸ Qwest Opening Brief, p. 25.

¹³⁹ See JAs Opening Brief, pp. 84-87

¹⁴⁰ Giovannucci (JAs) 8 Tr. 1052.

¹⁴¹ Giovannucci (JAs) 8 Tr. 1057.

¹⁴² Giovannucci (JAs) Ex. 2, pp. 2-3.

¹⁴³ Giovannucci (JAs) 8 Tr. 1105.

¹⁴⁴ Giovannucci (JAs) Ex. 2, p. 2.

¹⁴⁵ Ex. 66 (AT&T Form 10-K).

¹⁴⁶ AG Opinion at 24

¹⁴⁷ Qwest Opening Brief, p. 27.

¹⁴⁸ Tr. Vol. 8, p. 1134, AT&T Giovannucci.

¹⁴⁹ Tr. Vol. 8, pp. 1147-1148, AT&T Giovannucci.

¹⁵⁰ Reply Testimony of Dr. Lee Selwyn, Exh. 126, pp. 152-156, 159-182.

¹⁵¹ Qwest Opening Brief, pp. 27-32.

¹⁵² Qwest Opening Brief, p. 21.

¹⁵³ TRO at Parg. 693

¹⁵⁴ TRO at Parg. 694

¹⁵⁵ Attorney General's Opinion, p. 27.

¹⁵⁶ Attorney General's Opinion, p. 23.

¹⁵⁷ TRRO, ¶ 154, 177.

¹⁵⁸ Attorney General's Opinion, p. 12.

¹⁵⁹ Attorney General's Opinion, p. 27.

¹⁶⁰ See, for instance, Rice Declaration, Federal Communications Commission Docket WC Docket No. 05-65, February 21, 2005.

¹⁶¹ In re Application of WorldCom, Inc. and MCI Communications Corp. for Transfer of Control of MCI Communications Corp. to WorldCom, Inc., Memorandum Opinion and Order, 13 FCC Rcd. 18,025, ¶ 142 (1998).

¹⁶² Attorney General's Opinion, pp. 28-29.

¹⁶³ Exh. 116, p. 14.

¹⁶⁴ JA Brief, p. 66.

¹⁶⁵ Id.

¹⁶⁶ 47 U.S.C. § 251(c)(2). (Emphasis added).

¹⁶⁷ Likewise, nothing in the definitions of "telephone exchange service" and "exchange access" limits those terms to exclude transit traffic. Section 153(47) of the Act defines "telephone exchange service" as: "(A) service within a telephone exchange, or within a connected system of telephone exchanges within the same exchange area operated to furnish to subscribers intercommunicating service of the character ordinarily furnished by a single exchange, and which is covered by the exchange service charge or (B) comparable service provided through a system of switches, transmission equipment, or other facilities (or combination thereof) by which a subscriber can originate and terminate a telecommunications service." 47 U.S.C. 153(47). Section 153(16) of the Act defines "exchange access" as: "the offering of access to telephone exchange services or facilities for the purpose of the origination or termination of telephone toll services." 47 U.S.C. 153(16) (2002).

¹⁶⁸ For instance, consider the wasted cost that a CLEC would have incurred had it reconfigured its network to "avoid SBC" by connecting directly with "AT&T."

¹⁶⁹ When engineering a new direct interconnection between LECs, carriers generally build or obtain an efficient transmission vehicle, such as DS-3 over fiber optic cable, for such purpose. Depending on its source, the cost of a single DS-3 connection is typically equivalent to the cost of between eight and twelve individual DS-1s. The use of ten DS-1s as a triggering mechanism represents a point where deployment of direct interoffice facilities between two LECs makes economic sense. In prior interconnection agreement arbitrations, the Commission has required parties to include provisions on their interconnection agreements that state a CLEC will seek to establish direct connection with third parties when the traffic level reaches three DS1 level for three consecutive months

¹⁷⁰ Exh. 116, p. 15.

¹⁷¹ Reply Testimony of Ron Vidal, Level 3, Exh. 13, pp. 27-28.

¹⁷² Reply Testimony of Ron Vidal, Level 3, Exh. 13, p. 28.

¹⁷³ Tr. Vol. 9, pp. 1298-1299, AT&T Polumbo; Tr. Vol 11, p. 1746, SBC Kahan.

¹⁷⁴ Tr. Vol. 10, p. 1498, SBC Rice.

¹⁷⁵ Reply Testimony of Ron Vidal, Level 3, Exh. 13, p. 31.

¹⁷⁶ SBC Internet Services is an unregulated entity that is separate from SBC California.

¹⁷⁷ Vidal (Level 3) Ex. 13, p. 15; Stegora Axberg (Qwest) Ex. 119, p. 17.

¹⁷⁸ Reply Testimony of Ron Vidal, Level 3, Exh. 13, pp. 19-20.

¹⁷⁹ Reply Testimony of Ron Vidal, Level 3, Exh. 13, p. 15.

¹⁸⁰ Reply Testimony of Ron Vidal, Level 3, Exh. 13, pp. 16-17.

¹⁸¹ Reply Testimony of Ron Vidal, Level 3, Exh.13, pp. 16-17.

¹⁸² Reply Testimony of Ron Vidal, Level 3, Exh. 13, pp. 15-16.

¹⁸³ See 15 U.S.C. § 18 (prohibiting mergers when "the effect of such [merger] may be substantially to lessen competition, or to tend to create a monopoly'). See also, e.g., Application of AT&T Wireless Services, Inc. and Cingular Wireless Corporation For Consent To Transfer Control of Licenses and Authorization - File Nos. 001656065, et al., 19 FCC Rcd. 21522, ¶ 42 (2004) ("AT&T-Cingular Order") (describing standard of review DOJ applies to mergers).

¹⁸⁴ Giovannucci (JAs) Ex. 2 , p. 2.

¹⁸⁵ Giovannucci (JAs) Ex. 2 , p. 2.

¹⁸⁶ Giovannucci (JAs) Ex. 2 , p. 2.

¹⁸⁷ Stegora Axberg (Qwest) Ex. 119, p. 20.

¹⁸⁸ Stegora Axberg (Qwest) 14 Tr. 2178-2179.

¹⁸⁹ Stegora Axberg (Qwest) 14 Tr. 2171.

¹⁹⁰ Exhibit 66; Tr. Vol. 11, pp. 1657-1659, SBC Kahan. See also Reply Testimony of Qwest witness Pam S. Axberg, Ex. 119, p. 4 (Qwest, as a California CLEC, purchases special access and transport from SBC in California).

¹⁹¹ Tr. Vol. 11, p. 1660, SBC Kahan.

¹⁹² Ex. 66

¹⁹³ Tr. Vol. 8, pp. 1126-1127, AT&T Giovannucci; Tr. Vol. 10, p. 1369, SBC Rice.

¹⁹⁴ Tr. Vol. 8, pp. pp. 1126-1127, AT&T Giovannucci.

¹⁹⁵ Vidal (Level 3) Ex. 13, p. 18 ("many of the more sophisticated enterprise customers receive proprietary services or service level agreements from AT&T that would be difficult for a competitor to quickly replicate"); id. at 17 ("Customers will find th[e] compelled transfer of their agreements to be unattractive").

¹⁹⁶ Vidal (Level 3) Ex. 13, pp. 16-18.

¹⁹⁷ Vidal (Level 3) Ex. 13, p. 15.

¹⁹⁸ Stegora Axberg (Qwest) Ex. 119, p. 20.

¹⁹⁹ Giovannucci (JAs) Ex. 1, pp. 2, 5.

²⁰⁰ In a traditional circuit-switched telephone network, a fixed communications path is established between calling and called numbers through a hierarchical system of switches connecting dedicated transmission paths. In a packet-switched network, however, no such dedicated path exists. Instead, the message content is broken into "packets" of data, each of which is transmitted individually through the packet-switched network, to be "reassembled" near the end of the destination point, and delivered to the called party by a "router."

²⁰¹ Ex. 110, Testimony of Taplin (Pac-West) at 2

²⁰² Applicants' Opening Brief at 66, note 311, citing "in the Matter of IP-Enabled Service, WC Docket NO. 04-36, Notice of Proposed Rulemaking, FCC 04-28, ¶¶ 24-27) rel. Mar. 10, 2004 (IP Enable Services NPRM).

²⁰³ Pac-West Opening Brief at 26.

²⁰⁴ Pac-West's Opening Brief at 8, citing Petition for Declaratory Ruling That AT&T's Phone-to-Phone IP Telephony Services are Exempt form Access Charges, 19 FCC Rcd 7457, 7465-67 (2004)

²⁰⁵ By this request, Telscape also asks that ILEC interconnection obligations be imposed on AT&T's IP backbone.

²⁰⁶ See US West Communications, Inc. v. Jennings, 304 F.3d 950, 960 (9th Cir. 2002) (recognizing that only ILECs must provide access to poles, ducts, conduits, and rights-of-way); US West Communications, Inc v. Hamilton., 224 F.3d 1049, 1052-55 (9th Cir. 2000) same); AT&T Communications of the Midwest, Inc. v. US West Communications, Inc, 143 F. Supp. 2d 1155, 1162 (D. Neb. 2001) (upholding FCC regulations requiring only ILECs to provide access to poles, ducts, conduits, and rights-of-way); Compare 47 U.S.C. § 224 and § 251(b) with 47 U.S.C. § 251(c).

²⁰⁷ Opinion Resolving Complaint, D.04-12-053 (Dec. 16, 2004) ("We conclude that Telscape has not demonstrated that its broad objections to the functioning of SBC-CA's operational support systems (OSS) are well founded..." at p. 3).

²⁰⁸ See, e.g., Rules 47 and 86.1 of the Commission's Rules of Practice and Procedure.

²⁰⁹ Condition no. 47.

²¹⁰ See 47 U.S.C. § 252(d)(1)(A (rates "shall be...based on the cost ... of providing the interconnection or network element").

²¹¹ 47 C.F.R. §§ 51.503(b) and 51.505(b)(1). The Supreme Court upheld this standard in Verizon Communications v. FCC, 535 U.S. 467 (2002).