II. Background
In D.99-11-050,1 the Commission adopted prices for the unbundled network elements, or UNEs, that Pacific sells to competitors who use portions of its network. One aspect of the prices adopted in that order involved a percentage markup over the forward-looking cost of UNEs to recover Pacific's "shared and common costs."2 The Commission adopted a markup percentage of 19% based on a calculation of Pacific's shared and common costs divided by the total direct costs of UNEs and total non-recurring costs of UNEs.3 This means that for each UNE that Pacific sells to competitors, the cost of that UNE is increased by 19% to establish a UNE price.
In D.99-11-050, the Commission noted the need to review the status of the UNE prices it was setting. Therefore, the order established a process for an annual reexamination of the costs of no more than two UNEs, but limited the scope of the review to bar requests to reconsider the 19% markup percentage.4 The Commission's first annual reexamination proceeding commenced in February 2001, when AT&T Communications of California, Inc. and WorldCom, Inc. (hereinafter referred to as "Joint Applicants") filed applications nominating specific UNEs for review.5
In the fall of 2001, AT&T Communications of California, Inc., MCI Worldcom Network Services, Inc. and MCImetro Access Transmission Services LLC (jointly "Plaintiffs") filed a suit in U.S. District Court seeking to overturn aspects of D.99-11-050 related to the shared and common cost markup. Plaintiffs argued that the Commission improperly determined Pacific's firm-wide shared and common costs and unreasonably allocated these costs only to UNEs. (Remand Order, p. 23.)
In a cross-motion, Pacific argued, among other things, that the Commission had double-counted non-recurring costs in its calculation of the shared and common cost markup. Specifically, Pacific claimed that the denominator used in the markup calculation was unreasonably inflated because the Commission added non-recurring costs of $375 million, as adopted in D.98-12-079, despite Pacific's assertions that non-recurring costs were already included in Pacific's original estimate of direct UNE costs. (Id., p. 18.) Pacific explained that its original cost study claimed a total of $4.83 billion in direct UNE costs, which included both recurring costs and a $583 million estimate of non-recurring costs. In D.98-02-106, the Commission adopted a total direct UNE cost amount of $4.814 billion. According to Pacific, it is mathematically impossible to subtract $583 million from $4.83 billion and arrive at a result of $4.814 billion, even with the other adjustments ordered by the Commission to Pacific's original cost estimate.6 Because none of the adjustments ordered by the Commission dealt with removal of non-recurring costs, Pacific reasons that the Commission failed to remove the $583 million in non-recurring costs despite the Commission's assertions that the $4.814 billion adopted in D.98-02-106 did not include non-recurring costs. (Id.) To correct the situation, Pacific suggests the Commission should have substituted the $375 million non-recurring cost amount adopted in D.98-12-079 for the earlier $583 million estimate.
On August 6, 2002, the U.S. District Court issued its Remand Order. The court denied all of Plaintiffs' claims and denied all but one of Pacific's claims. The court agreed with Pacific that the Commission had double-counted non-recurring costs when it calculated Pacific's total direct costs of UNEs. Specifically, the court concluded that the Commission had failed to remove Pacific's original $583 million estimate of non-recurring costs when it added $375 million to Pacific's cost of providing UNEs. In the Remand Order, the Court essentially agreed with the reasoning offered by Pacific and found that the Commission's arguments that it had not engaged in double-counting failed based on simple arithmetic. (Id., p. 37) As part of its analysis, the Court noted that the Commission adopted the $4.814 billion amount from Pacific's revised cost studies after making adjustments that did not include removing the non-recurring cost estimate. (Id., pps. 37-38.) In effect, the court found that the denominator of the markup calculation was inflated, and the markup percentage thereby lowered, due to this error. The order states, "The [Commission's] determination of Pacific's direct cost of providing UNEs (the denominator of the common cost markup), and any decision which relies on this determination, must be vacated and remanded, so that the double-counting can be remedied." (Id., p. 38.)
On August 22, 2002, the Commission issued D.02-08-073 in the UNE Reexamination Proceeding, removing the restriction contained in D.99-11-050 that precluded review of the 19% shared and common cost markup in annual cost reexamination proceedings. The decision directed the Commission to review the shared and common cost markup within the scope of this 2001/2002 UNE Reexamination Proceeding to comply with the Remand Order.
On August 15, 2002, the assigned ALJ in the UNE Reexamination Proceeding issued a ruling in anticipation of the issuance of D.02-08-073 that initiated the comment process ultimately directed by that order.7 Specifically, the ruling requested comments on the correct methodology to adjust the denominator of the markup calculation given the Court's finding of double-counting. Further, the ruling requested comments on what decisions the Commission needed to vacate and/or adjust in order to comply with Court's Remand Order. Finally, the ruling also asked whether any adjustments to the markup calculation should be made on a retroactive basis, or only on a prospective basis.
In response to the August 15th ruling, Allegiance Telecom of California, Inc. (Allegiance), Joint Applicants, Pacific, and XO California, Inc. (XO) filed comments. Joint Applicants, Pacific, and XO filed reply comments.
1 D.99-11-050 was issued in the Commission's Rulemaking and Investigation to Govern Open Access to Bottleneck Services and Establish a Framework for Network Architecture and Development of Dominant Carrier Networks (Rulemaking 93-04-003/Investigation 93-04-002) ("OANAD proceeding"). 2 Shared and common costs are defined in Appendix C of D.95-12-016. According to page 6 of Appendix C, shared costs are defined as "costs that are attributable to a group of outputs but not specific to any one within the group, which are avoidable only if all outputs within the group are not provided." Common costs are defined as "costs that are common to all outputs offered by the firm." The Federal Communications Commission (FCC) has defined "forward-looking common costs" as "economic costs efficiently incurred in providing a group of elements or services (which may include all elements or services provided by the incumbent [local exchange carrier]) that cannot be attributed directly to individual elements or services." (47 C.F.R. 51.505(c)(1).) 3 Specifically, the Commission found that to calculate the markup percentage, the $996 million total of shared and common costs for all UNEs should be divided by the sum of (a) the total direct TELRIC costs for all UNEs of $4.814 billion (as approved in D.98-02-106 and related compliance filings), plus (b) total non-recurring costs of $375 million (adopted in D.98-12-079). (D.99-11-050, mimeo., p. 72, and p. 257.) TELRIC refers to the "total element long run incremental cost" methodology. 4 The Commission based this prohibition on the logic that reexamination of the markup would require reconsideration of all of Pacific's TELRIC costs and would be a "daunting task." (D.99-11-050, p. 169, n. 155, and p. 272.) 5 The original applications (A.01-02-024 and A.01-02-035) were later consolidated with four applications filed in 2002. These six applications comprise the current "2001/2002 UNE Reexamination Proceeding." 6 As Pacific explained to the District Court, compliance filings provided by Pacific to the Commission between the January 1997 Cost Study and D.99-11-050 identify those few instances in which Pacific adjusted the total direct cost of UNEs used in the denominator of the markup. Pacific claims that none of these adjustments required Pacific to remove, or even addressed, non-recurring costs. The required adjustments involved reducing loop-related repair expenses, adjusting Pacific's fill factor, correcting errors in the modeling of switching investment and switch vendor prices, revising the loop study to include unintentionally omitted wire centers, and adjusting Pacific's product management expenses. (See Pacific Comments, 8/28/02, p. 5, n. 17.) Pacific also argued to the District Court that if the Commission had excluded non-recurring costs from Pacific's original estimate, it would have begun with $4.2927 billion and would have had to order more than $521 million in increases to Pacific's total cost figure. Yet the adjustments the Commission ordered involved a net decrease of $17 million. (See Pacific Reply Comments, 9/4/02, p. 6, n. 13). 7 See, "ALJ's Ruling Requesting Comments on Remand of the Shared and Common Cost Markup," August 15, 2002.
