II. Background and Procedural History

The Commission opened this rulemaking, commonly known as the "OANAD proceeding," almost ten years ago with the intent of setting rates for the "basic network functions," or BNFs, now more commonly known as UNEs, that make up the network of California's two largest incumbent local phone companies, Pacific Bell Telephone Company (Pacific) and GTE California (GTEC), now known as Verizon.³ The Commission achieved its intent with respect to Pacific Bell, but has encountered numerous obstacles in its efforts to set rates for Verizon.

In D.95-12-016, the Commission adopted principles to govern the development of cost studies for the unbundled BNFs of the local exchange networks of Pacific and GTEC. These principles, known as the Consensus Costing Principles (CCPs), are based on the Total Service Long Run Increment Cost (TSLRIC) methodology for performing cost studies.⁴ In D.96-08-021, the Commission adopted TSLRIC cost studies for Pacific, but found that GTEC's cost studies, which were filed in December 1995 and January 1996, did not adequately conform with the TSLRIC principles adopted by the Commission in D.95-12-016. (D.96-08-021, mimeo., p. 91.) Specifically, the Commission stated:

...GTEC chose not to make enough forward-looking adjustments to its models and data bases to conform its studies to the Consensus Costing Principles.

In order to deal with this shortcoming, we have decided to order specific but broad-ranging adjustments to GTEC's studies to approximate conformance with the Consensus Costing Principles. We recognize that, given sufficient time, GTEC can perform new cost studies that will conform with our adopted TSLRIC principles more closely than the existing studies with the adjustments we order. In fact, we are ordering GTEC to file new cost studies conforming to TSLRIC principles within one year after the effective date of this decision. However, if tariffs for unbundled BNFs and services are to be in place during the first quarter of 1997, there will not be time for GTEC to perform new studies. (D.96-08-021, mimeo., p. 70.) (Emphasis added.)

Thus, the Commission found the need to make modifications to GTEC's inadequate TSLRIC cost studies, using certain aspects of Pacific's studies as proxies, in order to meet a January 1997 deadline for having tariffs in place for competitors to purchase unbundled network components.⁵ Shortly thereafter, the Commission reviewed GTEC's compliance with these modifications when it approved an interconnection agreement between AT&T and GTEC in D.97-01-022. Appendix A to that order sets forth the UNE prices that are still in effect today for Verizon.

In September 1997, GTEC filed a new cost model, known as the Integrated Cost Model (ICM), to comply with D.96-08-021. GTEC's ICM was based on the Total Element Long Run Incremental Cost (TELRIC) methodology,⁶ set forth in the August 8, 1996 First Report and Order⁷ of the FCC. At the same time, AT&T and MCI Telecommunications Corporation (MCI,)⁸ competitors to GTEC, filed the Hatfield Model Release 4.0 as an alternative to ICM. Parties then reviewed the two models and filed extensive comments on ICM and Hatfield in May and June of 1998.⁹

In July 2000, the 8^th Circuit for the United States Court of Appeals cast doubt over the future of the TELRIC methodology when it vacated and remanded to the FCC its rule regarding the TELRIC methodology set forth in FCC Rule 51.505(b)(1). Shortly thereafter, the FCC and AT&T filed with the Supreme Court for review of the 8^th Circuit's decision. The Supreme Court granted review and in May 2002, the Supreme Court issued its decision upholding the FCC's TELRIC methodology.¹⁰

The Verizon UNE phase of OANAD was reassigned from Administrative Law Judge (ALJ) McKenzie to ALJ Duda in March 2000. Despite uncertainty at that time regarding the future of the TELRIC methodology, Assigned Commissioner Duque and ALJ Duda held a prehearing conference on August 1, 2000 to discuss the scope and schedule for moving forward with this phase. On November 6, 2000, Commissioner Duque and ALJ Duda issued a ruling on the scope for this phase and set technical workshops for further discussion of the ICM and Hatfield models. The workshops were held on December 12 and 13, 2000. The Commission took no further action on this case in 2001 due to competing telecommunications priorities.

On January 4, 2002,¹¹ Tri-M Communications Inc. (TMC) moved to intervene in this proceeding and requested a ruling establishing an expedited schedule for the case that would consider interim rates for Verizon's UNEs.

On May 31, Commissioner Duque and ALJ Duda issued a ruling granting TMC's request for an expedited schedule and inviting interim relief proposals. The ruling noted the unfortunate delays in the proceeding and stated that relief in the form of interim UNE prices was clearly in order given the five year delay in the proceeding and the ongoing need to set final rates for Verizon.¹² At a prehearing conference on June 28, parties discussed potential interim relief proposals and a schedule for filing them with the Commission. Commissioner Duque and ALJ Duda stated at the prehearing conference that they were not inclined to adopt rates from another Verizon state when other interim pricing options existed, such as use of the FCC's Synthesis Model. (Reporter's Transcript, 6/28/02, at 1673.)

On July 30, AT&T and WorldCom (collectively Joint Commenters) filed their proposal for interim UNE rates. On July 31, Verizon filed its own interim UNE rate proposal.¹³ Joint Commenters, M-Power Communications Corporation (M-Power), Z-Tel Communications Inc. (Z-Tel) and Verizon filed comments on these two proposals on August 20.

On August 23, Commissioner Duque and ALJ Duda issued a ruling reversing their earlier statements from the June prehearing conference limiting proposals based on UNE rates in other states. In their ruling, the ALJ and Assigned Commissioner noted the numerous objections to the two proposals filed in July and the need for further scrutiny of these objections. They also stated that in order to have a complete record from which to make a decision on interim rates, they were persuaded to lift their earlier limitation on proposals involving UNE rates from another Verizon state. The ruling specifically solicited comments on whether the Commission should consider rates recently adopted for Verizon in other states. In response to the ruling, Joint Commenters and TURN filed an additional proposal on September 9, based on Verizon rates in New Jersey. Joint Commenters, ORA, TURN and Verizon filed a final round of reply comments on all three proposals on September 20, and the interim phase of this case was deemed submitted.

On October 25, Verizon filed a petition to reopen the record in this proceeding for the limited purpose of taking official notice that the Florida Public Service Commission (PSC) had adopted new UNE rates for Verizon in Florida. Official notice of the UNE rates adopted by the Florida PSC is granted, and discussed further in Section IV below.

Despite the different approaches to interim ratemaking offered by the parties, the parties agreed that interim pricing should apply to the following UNE rate elements: 2-wire loops, 4-wire loops, 2-wire port, Centrex Port, DS-1 port, end office switching per minute of use, and tandem switching per minute of use. Parties were unable to agree on whether interim pricing should apply to switch features. Therefore, we will address this issue in our discussion of the three interim pricing proposals.

³ This decision refers to GTEC as the incumbent local exchange carrier (ILEC) that existed at the time this proceeding was initiated and prior to GTE's merger with Bell Atlantic. The decision refers to Verizon as the successor to GTEC, following the merger with Bell Atlantic in July 2000. ⁴ The CCPs state that: "TSLRIC means the cost of providing an entire function or output should be studied, not just the cost of serving some small increase in demand. TSLRIC requires that all necessary outputs to provide service are based on costs that reflect the entire quantity of outputs." (D.95-12-016, Appendix A, p. 2.) ⁵ For example, D.96-08-021 required GTEC to mirror Pacific's cost studies regarding cost of capital, asset lives, income tax rate, and utilization factors, as well as several other items. (D.96-08-021, mimeo, p. 92.) ⁶ The TELRIC of a network element is the "forward-looking cost over the long run of the total quantity of the facilities and functions that are directly attributable to, or reasonably identifiable as incremental to, such element, calculated taking as a given the incumbent LEC's provision of other elements." (47 CFR 51.505 (b).) TELRIC should be measured "based on the use of the most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent LEC's wire centers." (47 CFR 51.505 (b)(1).) ⁷ In the Matter of the Implementation of the Local Competition Provisions in the Telecommunications Act of 1996, First Report and Order, FCC 96-325, CC Docket No. 96-98, 11 FCC Rcd 15499, rel. August 8, 1996. (Hereinafter, "first Report and Order.") In the First Report and Order, the FCC directed the States to use the TELRIC rather than the TSLRIC methodology in determining the costs for UNEs. ⁸ MCI subsequently merged with WorldCom. Hereinafter, we will refer to the merged entity as WorldCom. ⁹ Comments were filed in May 1998 by AT&T and MCI, GTEC, the Commission's Office of Ratepayer Advocates (ORA), the Facilities-Based Coalition, and The Utility Reform Network (TURN). The Facilities-Based Coalition consisted of Teleport Communications Group, ICG Telecom Group, NEXTLINK California LLC, MGC Communications, Inc., and the California Cable Television Association. Reply comments were filed in June 1998 by AT&T/MCI, GTEC, the Facilities-Based Coalition, and ORA. ¹⁰ See Verizon Communications v. FCC, 122 S.Ct. 1646 (2002). ¹¹ All dates are 2002 unless otherwise noted. ¹² See Assigned Commissioner's and ALJ's Ruling Granting Motion of Tri-M Communications Inc. (TMC) to Intervene, Granting Motion of TMC in Part, and Scheduling Prehearing Conference, May 31, 2002, p. 4. ¹³ Verizon filed a motion requesting a one-day extension to file its proposal, which is herein granted.