IX. Comments on Draft Decision

The Commission mailed the draft decision of the ALJ in this matter to the parties in accordance with Section 311(g)(1) and Rule 77.7 of the Rules of Practice and Procedure. Comments were filed by Joint Applicants, Pacific, TURN, ORA, Z-Tel, Tri-M, and Anew Telecommunications Corporation d/b/a "Call America" (Call America).⁴⁸ Reply comments were filed by Joint Applicants, Pacific, TURN, ORA and Z-Tel. In this section, we will address comments that pertain to the overall decision. We have already addressed technical comments on specific details of the loop and switching cost analyses throughout the text of the order where appropriate.

A. General Comments of Pacific

Pacific claims that the decision to grant interim relief commits legal error. For the most part, Pacific reargues the same positions it has already taken such as criticism of the HAI model, claims that its own cost filing met the Commission's cost model criteria, and other due process arguments. The decision already addresses these points and dismisses them. We do not agree that our decision to grant interim relief commits legal error. Pacific argues that interim relief is not warranted because we have not shown competitive local exchange carriers (CLCs) cannot compete at current prices. As we have already stated, the fundamental issue in this matter is whether Pacific's current UNE prices are cost-based. The scope of this case does not include a review of the current status of local exchange competition. When we dismissed Pacific's request to defer this UNE Reexamination, we noted the preliminary evidence of cost declines and our obligation under the Act to set cost-based rates. While we are, of course, deeply concerned with the effects of non-cost-based rates on competition, the impetus for our action today to set interim rates is the undisputed evidence presented thus far, which we cannot ignore, that many input costs have decreased.

Pacific argues that the interim rates will harm competition because the interim rates are below cost and will bring inefficient competition to the market. We do not agree with these assertions primarily because we have no evidence that these interim rates are below cost, as Pacific suggests. Indeed, as stated in the order, we have attempted to adopt conservative interim rates based on a trend analysis that incorporates undisputed changes in DLC costs and switching investment as well as increases in call volumes and lines served. Given that these interim rates are subject to adjustment at a later date, Pacific will not face financial harm from the interim rates. If anything, the greater risk lies with the CLCs that must make strategic business decisions based on temporary rates. With this in mind, we will attempt to expedite the next phase of this case to finalize UNE loop and switching rates.

B. Inflation Adjustment

The draft decision contained a section describing the conversion of the HAI model results from nominal dollars to real dollars. Specifically, the draft noted that the Joint Applicants had compared the nominal outputs of the 1994 and 2000 model runs to derive a percent change in loop rates over that time frame, but they had provided a switching analysis that compared HAI model runs after adjusting for inflation. To maintain consistency between the loop trend analysis and the switching trend analysis, the draft decision converted the revised HAI loop results into real dollar terms in order to compare the results in constant dollars and eliminate the influence of inflation over that time period.

Pacific claims that the draft decision errs in accounting for inflation by converting the HAI model results from 1994 from nominal into real dollars. Pacific maintains that because UNE prices have been held constant at 1994 levels, it is inappropriate to adjust costs for inflation unless UNE prices are adjusted for inflation as well. According to Pacific, the nature of a forward-looking cost exercise obviates any need to adjust for inflation when adjusting OANAD results and the Commission already made significant downward adjustments to Pacific's forward-looking costs when it adopted costs in 1998 based on data from 1994 to 1997. Joint Applicants respond that a pure time trend analysis should state all dollars in the same "real" base year and that the Commission should not eliminate this inflation adjustment.

Based on the comments, we will no longer convert the 1994 HAI model runs for either loops or switching into real dollar terms. The section describing this change has been removed from the decision. Although we have not changed our view that a pure trend analysis should be done in constant dollars, it appears that UNE cost comparisons are more problematic. First, it is not clear whether all of the 1994 model inputs are in 1994 dollars and the 2000 model inputs are in 2000 dollars. We do not necessarily have a pure starting point from which to adjust. Second, it is unclear whether inflationary adjustments were already incorporated in the prior OANAD proceeding. Third, Pacific is correct that the UNE prices the Commission adopted in 1999 have not been adjusted for inflation since the time they were adopted. Any inflation from 1999 to 2002 has made these prices decline in real terms. When we consider that UNE prices have declined in real terms and the underlying costs we are comparing are not necessarily in purely 1994 or 2000 dollars, we find that including an inflation adjustment may not be reasonable. Therefore, we will remove the inflation adjustment that was included in the draft decision.

Although we agree to remove the inflation adjustment from our trend analysis, we reject Pacific's suggestion that the Commission should annually adjust UNE prices for inflation. Many rates that the Commission sets are not annually adjusted. A decision on whether or not to provide an inflation adjustment is a policy choice that has never before arisen in the context of setting forward-looking costs for UNEs. Because the purpose of this decision is to set interim UNE rates while we press forward with an update of forward-looking costs for unbundled loops and unbundled switching, we will not include an inflation adjustment at this time.

C. Alleged Error Regarding Shared and Common Costs

Pacific maintains that the draft decision errs in applying a discount to UNE loop and switching prices rather than applying the discount to underlying costs. In the OANAD pricing order (D.99-11-050), the Commission adopted a 19% shared and common cost "mark-up" that was added to TELRIC costs to set UNE prices. Pacific now claims that this 19% mark-up should be removed from the applicable UNE price before any interim discount is taken. In other words, the discount should be applied only to the direct TELRIC cost for the UNE. Once an interim cost is calculated, Pacific suggests that the original amount of the mark-up should be added back, leaving the absolute dollar amount of the shared and common cost unchanged.⁴⁹

Joint Applicants, TURN and ORA respond that the Commission did not set an absolute dollar amount for shared and common costs in D.99-11-050 and that Pacific is wrong to suggest that it do so now. Instead, consistent with D.99-11-050, a UNE's price should be determined by adding 19% to the underlying TELRIC cost. Indeed, Joint Applicants point out that Pacific itself suggested this method when it stated that "whatever the updated cost is found to be in this proceeding (either the interim or permanent phase) must be increased by 19%." (Pacific Loop Comments, 10/19/01, p. 3.) Further, Joint Applicants contend that it makes no difference mathematically whether the percentage reduction is applied before or after the shared and common costs are added to the underlying cost.

Joint Applicants, TURN and ORA are correct that the Commission did not set an absolute value for shared and common costs in D.99-11-050. If we were to adopt Pacific's newest approach, which appears inconsistent with its earlier statements in this case, we would increase the percentage of shared and common costs as a component of the interim UNE rates and violate the edict in D.99-11-050 that the Commission would not consider the 19% mark-up in the annual reexamination proceedings. Therefore, we do not agree with Pacific that the draft contains a technical and legal error in how it computes an interim discount. Rather, Pacific's proposal would amount to legal error by adjusting the 19% mark-up. Furthermore, Joint Applicants are correct that there is no mathematical difference in taking the interim percentage reduction before or after the shared and common cost mark-up.⁵⁰ We make no changes to the draft in this area.

D. True-Up Comments

Z-Tel comments that the Commission should consider the interim rates as a ceiling and only allow for adjustments to these interim rates if the final rates are lower. If the final rates are higher, Z-Tel suggests that Pacific should absorb the loss as a sanction for failure to produce a useable model thus far in the proceeding. Z-Tel contends that competitive carriers cannot effectively compete under the risk of a true-up should the Commission set final rates higher than these interim ones. Z-Tel also suggests that CLCs have overpaid for UNE loops and switching for some time. Therefore, Z-Tel requests that the Commission retroactively adopt the interim rates in this order as of July 26, 2001, the date Z-Tel contends Pacific filed its latest loop and switching cost-studies.

We decline to make any changes based on Z-Tel's comments. This decision already extensively explains why interim relief should be subject to adjustment. In addition, we will not adjust UNE rates as of July 2001 as Z-Tel suggests because this would entail retroactive ratemaking.

E. Use of Synthesis Model

TURN expresses concern that the draft decision may discount the usefulness of the FCC's Synthesis Model in the next phase of this proceeding. TURN points out that all parties to this proceeding have found uses for the Synthesis Model to support their various positions. Thus, TURN suggests that the Synthesis Model can be adjusted to serve UNE costing purposes and the decision should not foreclose this option. Based on TURN's comments, we have clarified the draft on this point because, at this time, we do not intend to limit the modeling choices of parties in the next phase of this case.

F. Sanctions Against Pacific

TURN and ORA comment that the "issue sanction" against Pacific for failure to comply with discovery rulings does not go far enough. TURN and ORA ask that that the Commission apply a harsher sanction and grant Joint Applicants' request for an interim switching rate equal to rates proposed in Illinois. Joint Applicants' comments mirror these remarks and claim that the draft does not punish Pacific adequately. They claim the draft ignores evidence they presented that switching costs do not vary from state to state. They urge the Commission to consider SBC's Illinois switching rate proposal as a "judicial admission" that its switching costs in California are no higher than the Illinois rates. At the very least, TURN, ORA and Joint Applicants request that the Illinois switching rates be used as a benchmark to gauge the accuracy of the Commission's own proposed interim switching rates.

We agree with TURN, ORA, and Joint Applicants that we could have decided the matter against Pacific and awarded the Joint Applicants' full interim rate request. We certainly do not intend to reward Pacific for its noncompliance. Our aim in this case is to set a reasonable and somewhat conservative interim rate based on the record available. While it is unfortunate that parties feel Pacific is "getting off easy," it would be equally unfortunate to adopt a rate that might have no relationship to costs in California and that might result in competitors bearing the burden of an excessive true-up.

The decision explains that even with certain switching cost similarities and trends across states, the Commission prefers to exercise discretion and set interim rates based on its own analysis using the HAI model and California specific data rather than rates that are plucked from another state. It is our hope that in exercising this discretion, we are adopting interim rates that are more tailored to California and that, while somewhat conservative, should avoid the necessity of a large true-up once final rates are determined. At the same time, we agree that we can use the Illinois rates as a point of reference for determining whether our interim rates are reasonable. We have modified the draft accordingly to reflect this.

Also on the subject of sanctions, Pacific maintains there was no basis to impose sanctions for noncompliance because Pacific had appealed the rulings. Pacific states that "any prejudice [Joint Applicants] may have experienced was due to the length of time taken to resolve SBC Pacific's appeal." (Pacific's Comments on Draft Decision, 3/19/02, p. 15). We are offended with Pacific's suggestion that the Commission is somehow to blame for the effects of Pacific's noncompliance with two ALJ rulings. The Commission never granted Pacific's request for a stay of the prior rulings. Pacific alone must accept responsibility for its actions in this case and the sanction imposed.

G. Deaveraged Loop Prices

Joint Applicants contend that the draft decision errs in not adopting deaveraged loop prices in accordance with FCC requirements. They request the Commission apply the interim loop discount to the deaveraged prices recently adopted in D.02-02-047. Pacific responds that Joint Applicants' motion for interim relief never made this deaveraging request and it is procedurally improper to raise this request now in comments on the draft order.

Joint Applicants motion for interim relief did indeed include a brief, one sentence request that the Commission deaverage any interim loop rate "in the same manner as the pending settlement of the deaveraging proceeding." (Motion for Interim Relief, 8/20/01, p. 1) The settlement was ultimately adopted by the Commission in D.02-02-047, and it explicitly stated that it was intended to last only "until superseded by Commission action in the review proceeding for unbundling issues established in D.99-11-050 of the OANAD proceeding." (D.02-02-047, Appendix A at A-1.) From the very words of the settlement, parties anticipated a change to deaveraged rates in this UNE Reexamination proceeding. We also note that the cost filings accompanying the August 20 motion included a calculation of loop costs by geographic zones. (Mercer Declaration, 8/20/01, p. 7.)

Pacific's failure to comment on the deaveraging request in the motion for interim relief does not mean that we should ignore the request entirely as well as the federal mandate requiring deaveraged rates. (See 47 Code of Federal Regulations, Section 51.507(f).) We will apply the 15.1% interim loop discount to the deaveraged rates adopted in D.02-02-047. The interim deaveraged loop rates are set forth in Appendix A and supersede the rates adopted in D.02-02-047. These interim rates are subject to adjustment in the same manner as all other rates adopted by this order.

H. ISDN and Centrex Ports

Tri-M and Call America comment that the draft order fails to set an interim reduced rate for Centrex ports. Tri-M and Call America claim that the Commission ignores evidence that Centrex port costs are similar to basic port costs, particularly the fact that the proposed Illinois switching rates make no distinction between basic and Centrex port prices. Joint Applicants echo this same request that the Commission should adopt interim prices for all port types, including ISDN and Centrex ports.

Pacific responds that it was never put on notice that ISDN port prices were at issue in the interim phase, and that Joint Applicants' amended switching proposal referred only to the basic port price. Pacific contends there is no evidence on the record regarding the current costs of ISDN and Centrex Ports. Therefore, the Commission cannot set interim rates for anything other than the basic port.

It is true that Joint Applicants' motion for interim relief requested one rate for both basic and Centrex ports based on proposed Illinois rates. ISDN ports are not mentioned. We have declined to adopt interim rates equivalent to the Illinois proposal. Furthermore, the HAI model that we have used for a trend analysis to arrive at interim switching rates calculates only a basic port rate and we have no basis on which to set interim rates for any other port types. Pacific was not given notice that we were considering an interim rate for anything other than the basic port, although all ports are subject to reexamination in the final phase. Therefore, we cannot adopt a different outcome without adequate notice and an opportunity for parties to comment on application of the port discount adopted in this order to other port types. We will direct the ALJ to solicit comments on this issue by further ruling.

Findings of Fact

1. In D.99-11-050, the Commission established a process by which carriers with interconnection agreements with Pacific Bell could annually nominate up to two UNEs for consideration of their costs by the Commission.

2. In February 2001, the Commission received four requests to nominate UNEs for cost re-examination and a motion by Pacific to defer the cost re-examination proceeding.

3. On June 14, the Assigned Commissioner and ALJ issued a joint ruling denying Pacific's motion to defer any cost re-examination and finding sufficient justification to begin a reexamination of the costs of two UNEs, namely unbundled switching and unbundled loops.

4. On July 11, the Assigned Commissioner and ALJ issued a joint ruling identifying three criteria that Pacific's cost model filing must adhere to in order to be used for this cost re-examination proceeding.

5. Pacific's cost filings in this matter do not perform new runs of the SCIS model, the Cost Proxy Model, or other expense and support investment models.

6. Pacific's cost filings involve adjustments to the outputs of the prior OANAD models and it is not possible to provide the previously adopted models with new inputs.

7. On August 20, Joint Applicants filed a motion requesting interim UNE prices for unbundled loops and unbundled switching.

8. On September 28, the Assigned Commissioner and ALJ ruled that Pacific's August 15 cost filing did not meet the criteria set forth in the earlier ruling and that interim relief would be considered.

9. In Turn v. CPUC, the California Supreme Court held that the Commission could set interim rates as long as the rate is subject to refund and sufficiently justified.

10. Pacific and Joint Applicants agree that DLC equipment prices have fallen in recent years from the levels used in the prior OANAD cost proceeding.

11. Publicly available ARMIS data indicates declines in switching investment costs, declines in switch expenses, growth in the number of access lines served, and growth in call volume.

12. Pacific purchases switches under an SBC-wide agreement and can obtain switches in California at prices that are as favorable as, or more favorable than the prices it pays for switches in Illinois.

13. Pacific's cost filing does not allow parties or staff to test the effects of switching investment changes, DLC equipment declines, line growth, or call volume changes.

14. Commission staff have been able to understand how the HAI model derived its results for unbundled loops and switching and have modified HAI model inputs and assumptions to produce varying results. Although the HAI model does not exactly replicate the costs adopted in prior OANAD decisions, staff have been able to replicate Joint Applicants' HAI model runs.

15. Section 252(d) of the Telecommunications Act requires the Commission to set UNE rates based on cost.

16. On January 7, 2002, Joint Applicants and Pacific jointly requested the Commission take notice of a decision by the D.C. Circuit Court in Sprint Communications Company v. FCC.

17. On October 9, Pacific filed an Appeal to the Full Commission of the September 28 ruling and on October 19, Pacific filed a motion to vacate the September 28 ruling.

18. On August 13 and again on October 3, the assigned ALJ and the Law and Motion ALJ directed Pacific to produce material relevant to the issues in this proceeding.

19. On October 12, Pacific filed an appeal and stay request regarding the ALJs' discovery rulings, which has not been acted on by the Commission.

20. Pacific did not comply with the August 13 and October 3 ALJ rulings ordering it to produce certain documents until the Assigned Commissioner issued a ruling imposing sanctions on Pacific.

21. Pacific produced documents and witnesses of SBC and SBC-Ameritech in the course of this proceeding.

22. The Commission does not generally entertain interlocutory appeals of ALJ rulings.

23. The Assigned Commissioner issued a ruling on February 21, 2002 imposing sanctions on Pacific for failure to comply with the ALJ's earlier discovery rulings.

24. Joint Applicants request a 36% discount from the current statewide-average loop rate of $11.70 based on a trend analysis of 1994 and 2000 data input into the HAI model.

25. In their trend analysis for loops, Joint Applicants have attributed 24 lines to each DS-1 line and 672 lines to each DS-3 line because these lines, respectively, carry 24 and 672 "voice grade equivalent" channels.

26. A DS-1 line consists of two copper loops and a DS-3 line is provisioned over fiber and does not involve any copper loops.

27. The record of this case is disputed on whether 70% of growth involves plant extensions and whether plant extension costs offset other loop cost reductions because of certain demographic, line growth, and ARMIS investment data.

28. The prior OANAD cost models assumed that all remote terminals (RTs) were above ground.

29. Although Pacific asserts that underground CEVs are replacing RTs in many locations, the record is disputed on whether CEVs are more or less expensive than RTs on a per line basis because both Pacific and Joint Applicants mix costs and line capacities from various size CEVs in their calculations.

30. The current record of this case does not support changing the original OANAD assumptions regarding RTs.

31. The HAI model uses expense to investment ratios to replicate forward-looking expense adjustments.

32. ARMIS data indicates an increase in total loop expenses from 1994 to 2000.

33. Joint Applicants request interim UNE switching rates equivalent to one of two alternative switching rates that SBC-Ameritech has proposed in Illinois.

34. In the September 28 ruling, the Assigned Commissioner and ALJ required Joint Applicants to reformulate their interim switching request to entail a percentage reduction from the current switching rate structure.

35. Joint Applicants filed an analysis of switching costs for 1994 and 2000 using the HAI model.

36. A trend analysis for switching using Klick's 1994 HAI model run and Mercer's 2000 HAI model run indicates a decline in port costs from 1994 to 2000 of 35.8%, a decline in usage-related costs over the same time period of 50.8%, and a decline in tandem switching costs of 41.9%.

37. The HAI model does not calculate separate feature charges because it includes feature hardware in costs in total switch investment, which is then assigned to port and usage price elements.

38. Pacific's analysis based on its run of the FCC's Synthesis Model is flawed because Pacific did not re-run the model with correct usage volumes.

39. When the Synthesis Model is re-run with correct usage volumes, it shows switching rates for California lower than those suggested by Pacific, and it shows less disparity in state switching rates between California and other states than Pacific has suggested.

40. Joint Applicants requested interim UNE rates subject to "true down," meaning that if final rates are lower than interim rates, Pacific should provide refunds to UNE purchasers, but not vice versa.

41. The Commission adopted deaveraged loop rates in D.02-02-047 until superseded by action in this proceeding.

42. Joint Applicants have presented a summary of evidence indicating a reasonable presumption of cost declines for unbundled loops and unbundled switching based on declining DLC equipment costs, SBC-wide switching purchases, ARMIS data indicating declines in switching investments and expenses, and growth in access lines and call volume.