VI. Comments on Draft Decision

Pursuant to Rule 77.7(f)(9) of the Commission's Rules of Practice and Procedure, the Commission may reduce or waive the period for public comment on draft decisions when the public necessity to act in less than 30 days outweighs the public interest in the normal comment period. The Remand Order vacated the total direct cost of UNEs in D.99-11-050 and all decisions that rely on it. This has created uncertainty over the UNE prices contained in D.99-11-050, D.02-05-042, and interconnection agreements between Pacific and competitive local carriers. We find that the public necessity in resolving this uncertainty outweighs the public interest in the normal comment period. Therefore, we will reduce the standard time frame for comments on this order so that we can act on this matter at our next Commission meeting and resolve any uncertainty over UNE prices caused by the Remand Order. Parties shall have five days to comment on this order, and one day to file reply comments.

Comments were filed by Joint Applicants, Pacific, and XO. Reply comments were filed by Joint Applicants and Pacific.

Joint Applicants and XO

Joint Applicants claim that the draft decision denies them due process by ignoring the Commission's own rules and unnecessarily abbreviating the comment period on the draft decision. Joint Applicants contend that the draft decision dealing with the Remand Order does not meet the Commission's definition of an emergency because the Court set no deadline for Commission action. Therefore, Joint Applicants request the normal five days for filing reply comments.

Further, Joint Applicants contend the draft decision commits legal error because it sets a shared and common cost markup based on eight year old data rather than undertaking a fresh look at the markup using new information. They request that the Commission modify the draft decision to adopt a markup pursuant to the methodology they presented in comments, or expand the scope of the 2001/2002 UNE Reexamination to include updating of the markup. XO echoes this latter request for an immediate review of the markup using new information.

We disagree that Joint Applicants have been denied due process because of the shortened period for comments on the draft decision. Joint Applicants plead for more time to reply to Pacific's comments on the draft decision, but we are not persuaded by Pacific's comments and we leave the draft decision unchanged. Thus, we find Joint Applicants are not harmed by the shortened reply comment period. Indeed, Joint Applicants prevail in today's order with regard to their argument on the need for revisions to UNE recurring costs. We have made minor modifications to our rationale for why the Remand Order should be dealt with on an expedited basis, but we do not change our conclusion that a shortened comment period is warranted on this matter.

In addition, we disagree with Joint Applicants that it would be legal error to increase the existing markup from 19% to 21% rather than begin an entirely new review of the markup. The Remand Order affirmed the Commission's shared and common cost markup methodology used in D.99-11-050. Given this affirmation by the Court, it is not a violation of TELRIC to keep this methodology in place until a later date. Nothing in the comments persuades us we should undertake an immediate and fresh review of the markup in the UNE Reexamination proceeding.

Along with their reply comments, Joint Applicants filed a motion to strike the attachments to Pacific's September 16 comments on the Draft Decision. Joint Applicants contend that the attachments violate Commission Rule 77.3 because they contain 90 pages of appendices which far exceed the 15 page limit for comments, include documents outside the record or from unrelated phases of OANAD, and raise new information and arguments untested by cross-examination. According to Joint Applicants, all of these documents and arguments could have been submitted earlier during the comment cycle and prior to the issuance of the Draft Decision. If these attachments are not stricken, Joint Applicants request to supplement their reply comments so as to respond to the new information in Pacific's comments.

We agree that Pacific's attachments to its comments do not meet the requirements of Rule 77.3 because they exceed the page limit, contain new information, and contain information not clearly within the OANAD record. We will grant Joint Applicants' motion to strike in part and strike certain pages of Pacific's attachments, specifically the 1994 Total Operating Expense Report on addendum pages 18 through 53 and the deposition transcripts on pages 79 through 83, because Pacific has not shown that these pages were admitted to the OANAD record. Just as we cannot rely on the Scholl deposition provided by Joint Applicants, we cannot rely on these pages. On the other hand, we have dealt with this Remand Order under a very abbreviated time frame. Therefore, we are inclined to waive aspects of Rule 77.3 on this occasion, and we will not strike all of Pacific's attachments, particularly those that are merely attached for our convenience as copies or excerpts of documents already filed in earlier phases of OANAD. Although we will leave the information attached to Pacific's comments, this does not mean we will give it the same weight as other information, provided on a more timely basis.

Pacific

Pacific maintains that the draft decision erroneously concludes that recurring costs should be adjusted along with any changes to the denominator of the markup calculation. First, Pacific argues that the Remand Order is narrow and pertains only to the denominator of the markup calculation, as set forth in D.99-11-050. Pacific contends the Commission cannot use the Remand Order to justify modifying recurring costs adopted 21 months earlier in D.98-02-106. We find that Pacific merely reargues its earlier comments in this regard. We have already explained why the Commission cannot consider corrections to the $4.814 billion figure in isolation due to the substantial and direct impacts that corrections to that figure might have on other decisions. Further, it is inaccurate to claim that the $4.814 billion direct cost of UNEs was set in D.99-11-050 when it was actually adopted in D.98-02-106 and its compliance filings, and then merely used again in D.99-11-050 to calculate the markup.

Second, Pacific asserts in its comments that the record from OANAD makes clear that its 1997 recurring cost study does not include non-recurring costs. To support its claims, Pacific presents a 90 page addendum to its comments, purporting to show that non-recurring costs were not included in the recurring cost studies. Pacific claims that any adjustments to recurring costs conflicts with Commission precedents in D.98-12-079, where the Commission considered and rejected the same claim now made by Joint Applicants that the 1997 recurring cost study captured non-recurring costs. According to Pacific, the Draft Decision "fails to identify a single non-recurring cost that was included in the 1997 recurring cost study" and that no such costs exist. (Pacific Bell Comments on Draft Decision, 9/16/02, p. 6.) Pacific asserts that in moving from the 1994 Total Operating Expense report to the 1997 recurring cost study, Pacific removed all non-recurring costs. (Id., p. 5.)

We find Pacific's comments puzzling because as a whole, the comments attempt to demonstrate that there are no non-recurring costs in the $4.814 billion direct cost of UNEs. If so, then that would mean the Commission should not increase the markup by 2%. Pacific asserts repeatedly that non-recurring costs were removed from its 1997 recurring cost study that led to the recurring costs adopted in D.98-02-106 and its compliance filings. This directly contradicts Pacific's claims that the markup double counts non-recurring costs because the 1997 cost studies included them. Despite what Pacific claims is a clear chain of events, Pacific asks us to believe that in the time span between February 1998 and November 1999, the Commission staff intimately involved with these orders ignored or forgot this clear chain of events and left non-recurring costs in the $4.814 billion used in the markup calculation. If it were so obvious that non-recurring costs were removed from the 1997 cost studies, as Pacific asserts in its comments, why wouldn't the Commission have been able to use successfully this same line of reasoning to defend its markup calculation in Federal District Court?

Indeed, the Commission did try to use this same line of reasoning in Federal District Court and did not prevail. The Commission asserted that the original 19% markup was correct because it had stated in D.99-11-050 that D.98-02-106 only dealt with recurring costs and D.98-12-079 only dealt with non-recurring costs.²³ At the time, the Commission satisfied itself that its decisions adequately separated recurring and non-recurring costs and there was no double counting. This is the same argument that Pacific is putting forth now because it wants us to now rely on the findings and conclusions from D.98-12-079 and D.98-02-106 that we tried to rely on in defending the markup calculation. Yet the Court rejected the Commission's reasoning as circular because it failed in the face of simple arithmetic. (Remand Order, p. 37.) Similarly, we find that Pacific's assertions are not supported by any mathematical calculations. Just as the Court wanted a mathematical explanation of how non-recurring costs were removed from the $4.814 billion figure, we would need a mathematical explanation today to be satisfied that the $4.814 billion used to set recurring costs did not include $537.8 million in non-recurring costs. Pacific's comments have not provided this.²⁴

Pacific argues that it is unreasonable to assume the parties and Commission staff missed over half a billion dollars in non-recurring costs when adopting recurring costs. Yet, the Court was persuaded that an oversight of over half a billion dollars had indeed occurred in the calculation of the markup. Because we now rely on Pacific's 1997 cost studies as documentation of this oversight, we conclude that a corresponding adjustment needs to be made in the recurring cost studies.

We agree with Joint Applicants that statements by Pacific's witness Scott Pearsons in the non-recurring cost phase of OANAD do not resolve this controversy either. (See Pacific Comments on Draft Decision, 9/16/02, Addendum p.14.) In fact, the Pearsons declaration from that phase of OANAD merely contradicts once again Pacific's current stance that the markup needs correcting. We are reluctant to rely solely on the Pearsons declaration absent a mathematical showing of the removal of the non-recurring costs at issue from the $4.814 used to set recurring costs.

Pacific claims that the Commission has no evidence that non-recurring costs were included in the 1997 recurring cost study. But in fact, this order relies on the same evidence that Pacific used to convince the Court that the markup calculation was wrong. Pacific asks us to accept that non-recurring costs were not included in the 1997 recurring cost study, but it uses the same 1997 cost study to convince the Court and the Commission that non-recurring costs were included in the $4.814 total direct cost of UNEs. We cannot reconcile these two positions.

Pacific is merely expanding on its unsupported "subsequent cost study" argument that it made earlier. We cannot verify Pacific's assertions regarding the removal of non-recurring costs because Pacific provides no citation or reference showing how the calculations were performed. The Court agreed with Pacific that non-recurring costs were included in its 1997 cost study. By the same logic and based on the same evidence that the Court used to make this finding, we find that non-recurring costs are part of the $4.814 billion direct cost of UNEs used to set recurring costs.

Findings of Fact

1. The Commission adopted a shared and common cost markup of 19% in D.99-11-050.

2. In its Remand Order, the U.S. District Court found that the Commission had double-counted non-recurring costs in the denominator of the shared and common cost markup.

3. The Remand Order vacated and remanded to the Commission the $4.814 billion total direct UNE costs used in the denominator of the markup calculation, and any decision that relied on the $4.814 billion.

4. Pacific included $583 million in non-recurring costs in its original $4.83 billion estimate of total direct UNE costs.

5. The $583 million estimate was decreased to $537.8 million based on a labor rate adjustment.

6. Pacific's original $4.83 billion estimate of total direct UNE costs was revised to $4.814 billion through compliance filings with the Commission, and the revisions did not remove either $583 or $537.8 million in non-recurring costs.

7. The deposition testimony of Pacific's witness Scholl, in which he testified regarding PBON 001684 through PBON 001746 and stated that non-recurring costs were not included in the recurring cost study, was never introduced into the record of the OANAD proceeding.

8. Pacific's 1997 cost filing indicates PBON 001684 through PBON 001746 as the source for $4.139 billion in 1994 Total Regulated Operating Expenses.

9. 1994 Total Regulated Operating Expenses are comprised of recurring costs and $537.8 million in non-recurring costs.

10. 1994 Total Regulated Operating Expenses of $4.139 billion are a component of the $4.814 billion total direct UNE costs.

11. The $4.814 billion total direct UNE cost adopted in D.98-02-106 and related compliance filings was used to calculate the 19% shared and common cost markup and recurring charges in D.99-11-050.

12. In D.98-12-079, the Commission adopted $375 million in non-recurring costs, which was used to set Pacific's non-recurring charges.

13. Addendum pages 18 through 53 and 79 through 83 of Pacific's comments on the Draft Decision were not included in the record of OANAD.

Conclusions of Law

1. The Commission should subtract $537.8 million in non-recurring costs from the $4.814 billion total direct cost of UNEs in the denominator of the markup calculation.

2. Pacific's shared and common cost markup, originally calculated in D.99-11-050 (Conclusion of Law 19), should now be calculated by dividing $996 million in shared and common costs by $4.651 billion ($4.814 billion in total direct UNE costs minus $537.8 million in non-recurring costs plus $375 million in non-recurring costs (adopted in D.98-12-079). The result of this calculation, 21.4%, should be rounded to the nearest whole percentage point, which results in a markup of 21%.

3. Pacific's shared and common cost markup should be increased from 19% to 21%.

4. We should not rely on Scholl's deposition testimony because it was not introduced in the original OANAD record.

5. Because $537.8 million in non-recurring charges are included in $4.139 billion in 1994 Total Regulated Operating Expenses, and this $4.139 billion was used to calculate $4.814 billion in total direct UNE costs, $537.8 million in non-recurring costs are included in $4.814 billion total direct UNE costs.

6. In response to the Remand Order, the Commission should remedy any decision that relies on the $4.814 billion direct UNE cost, including D.98-02-106 and its compliance filings that used this figure to calculate UNE recurring costs.

7. Pacific is double recovering non-recurring costs because there are $537.8 million in non-recurring costs contained in the to $4.814 billion total direct cost of UNEs, and Pacific is also charging non-recurring prices based on non-recurring costs adopted in D.98-12-079.

8. The $537.8 million in non-recurring costs included in the $4.139 billion 1994 Total Regulated Operating Expenses (which is a component of the $4.814 billion total direct UNE costs), should be removed from Pacific's recurring UNE costs.

9. The Commission should calculate the amount that the expense component of recurring costs was overstated by dividing the $537.8 million in non-recurring costs by the $4.139 billion in 1994 Total Regulated Operating Expenses, which yields 12.9%, or 13%.

10. Pacific should reduce the expense portion of its recurring costs for each UNE by 13% to remove non-recurring costs included in the $4.814 billion total direct cost of UNEs.

11. The Commission has discretion to determine when and if to order retroactive rate adjustments in response to the Remand Order.

12. Bankrupt telecommunications carriers might have difficulty paying retroactive adjustments to UNE rates.

13. Retroactive UNE rate adjustments would be inconsistent with the Commission's duties under Pub. Util. Code § 709 because retroactive payments would be likely to cause regulatory and financial uncertainty and restrict access to capital.

14. Retroactive UNE rate adjustments would not be a good use of resources since the net adjustments are likely to largely offset each other.

15. The Commission should not make retroactive adjustments to rates in response to the Remand Order due to telecommunication carrier bankruptcies, the effect of uncertainty caused by retroactive payments and its effect on the struggling telecommunications sector, the recent findings regarding UNE rates in D.02-05-042 and the UNE Reexamination proceeding, and the fact that the net rate changes probably offset each other to a great degree.

16. The changes to the shared and common cost markup and recurring costs adopted in this order should be made on a prospective basis and be effective on the same date as this order.

17. The actual implementation of the increase to the markup should be stayed pending final determination by the Commission, through additional filings ordered herein, of changes to recurring costs based on the 13% adjustment to the expense portion of recurring costs.

18. The period for public review of the draft decision should be reduced because the public necessity in resolving uncertainty over UNE prices created by the Remand Order outweighs the public interest in the 30-day comment period.

19. Addendum pages 18 through 53 and 79 through 83 of Pacific's comments on the Draft Decision should be stricken.

ORDER

IT IS ORDERED that:

1. The shared and common cost markup that was originally adopted in Decision (D.) 99-11-050, and which is a component of Pacific Bell Telephone Company's (Pacific's) unbundled network element (UNE) prices, shall be increased from 19% to 21%.

2. The expense portion of Pacific's UNE costs adopted in D.98-02-106 shall be modified to incorporate a 13% reduction as set forth in this order.

3. Within 30 days of this order or as otherwise directed by the Administrative Law Judge (ALJ), Pacific shall submit a filing in this proceeding calculating a 13% reduction in the expense portion of each of the recurring costs adopted in D.98-02-106 and calculating the net impact on all of its UNE prices of the markup and recurring cost changes ordered herein. Pacific's filing should be fully supported with workpapers and appropriate documentation, and these workpapers and documentation should be made available to parties, subject to applicable nondisclosure agreements, upon request. Interested parties may file comments on Pacific's filing 20 days thereafter, unless a revised schedule is set by the ALJ.

4. The changes adopted by this order to Pacific's shared and common cost markup and to the expense portion of its UNE recurring costs shall be effective on the date this order is effective, but implementation of these rate changes shall be stayed pending final determination by the Commission of the actual rate changes.

5. In order to make the UNE price changes effective as of today's order, Pacific shall track UNEs purchased by interconnecting carriers from the date of this order until the Commission determines the net effect of the UNE price changes resulting from this order.

6. Pacific shall make all billing adjustments necessary to ensure that this effective date is accurately reflected in bills applicable to the UNE prices modified by this order.

7. The motion of AT&T Communications of California, Inc. and WorldCom, Inc. to strike Pacific's comments on the Draft Decision is granted in part, and denied in all other respects.

This order is effective today.

Dated September 19, 2002, at San Francisco, California.

LORETTA M. LYNCH

President

CARL W. WOOD

GEOFFREY F. BROWN

Commissioners

We will file partial dissents.

/s/ HENRY M. DUQUE

Commissioner

/s/ MICHAEL R. PEEVEY

Commissioner

Appendix A

Pacific's Calculation of $4.814 Billion Direct Cost of UNEs²⁵

Step 1:

Calculation of Total Service Long Run Incremental Cost (TSLRIC)

Total Capital Costs $3,077²⁶

Operating Expenses 3,900²⁷

6,977

Less Shared and Common 2,206