DOT/hl2 5/21/2003

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Joint Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Switching in Its First Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 01-02-024 (Filed February 21, 2001)
Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Loops in Its First Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 01-02-035 (Filed February 28, 2001)
Application of The Telephone Connection Local Services, LLC (U 5522 C) for the Commission to Reexamine the Recurring Costs and Prices of the DS-3 Entrance Facility Without Equipment in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-02-031 (Filed February 28, 2002)
Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Interoffice Transmission Facilities and Signaling Networks and Call-Related Databases in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-02-032 (Filed February 28, 2002)

Application of Pacific Bell Telephone Company (U 1001 C) for the Commission to Reexamine the Costs and Prices of the Expanded Interconnection Service Cross-Connect Network Element in the Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-02-034 (Filed February 28, 2002)
Application of XO California, Inc. (U 5553 C) for the Commission to Reexamine the Recurring Costs of DS1 and DS3 Unbundled Network Element Loops in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-03-002 (Filed March 1, 2002)

ADMINISTRATIVE LAW JUDGE'S RULING

ON JOINT APPLICANTS' AND SBC PACIFIC'S MOTIONS TO STRIKE

This ruling addresses several motions to strike filed by AT&T Communications of California (AT&T), WorldCom, Inc. (Worldcom) (collectively, "Joint Applicants"), and Pacific Bell Telephone Company (SBC Pacific or SBC) with regard to opening, reply, and rebuttal declarations in this proceeding. The motions addressed in this ruling are:

1. Joint Applicants' Motion to Strike Portions of the October 18, 2002 Declaration of Dr. Debra J. Aron (filed 2/7/03) (Aron Motion)

2. Joint Applicants' Motion to Strike Certain Portions of the Declarations of Cheryl M. Bash and Ian McNeill (filed 4/10/03) (Bash/McNeill Motion)

3. Joint Applicants' Motion to Strike the Rebuttal Declaration of Donald G. Palmer Jr., the declarations of Jay M. Bishop, and certain portions of the declarations of Gary Mandella (filed 4/11/03) (Palmer/Bishop/Mandella Motion)

4. SBC Pacific's Motion to Strike Limited Portions of Mr. Landis' Declaration (filed 4/11/03) (Landis Motion)

Each of these motions is discussed in turn below.

ARON MOTION

Joint Applicants request an order striking portions of the October 18, Declaration of Dr. Debra Aron on behalf of SBC Pacific, particularly those portions involving an analysis of SBC Pacific's costs that Dr. Aron admits is not intended to reflect total element long run incremental (TELRIC) costs.¹ Joint Applicants explain that the Telecommunications Act of 1996 (the Act) and the FCC regulations implementing the Act require the Commission to establish rates for UNEs based on TELRIC. In contrast, Dr. Aron's declaration contains an analysis focused not on TELRIC, but on SBC Pacific's historic 2001 costs in an attempt to demonstrate that SBC Pacific's current UNE prices are below the costs actually incurred by SBC Pacific to provision UNEs. Dr. Aron also cites a number of investment bank studies to support her argument. Joint Applicants contend that most of Dr. Aron's arguments have already been addressed by the Supreme Court in Verizon Communications Inc. v. FCC, wherein the Court upheld the FCC's TELRIC standard for UNE ratesetting. (Verizon, 122 S. Ct. 1646, at 1679 (2002).) In Verizon, the Court expressly rejected alternatives to TELRIC, such as pricing based on historical or embedded costs methodologies, stating that:

As for an embedded-cost methodology, the problem with a method that relies in any part on historical cost, the cost the incumbents say they actually incur in leasing network elements, is that it will pass on to the lessees the difference between most-efficient cost and embedded cost. [Footnote and citation omitted]. Any such cost difference is an inefficiency, whether caused by poor management resulting in higher operating costs or poor investment strategies that have inflated capital and depreciation. If leased elements were priced according to embedded costs, the incumbents could pass these inefficiencies to competitors in need of their wholesale elements, and to that extent defeat the competitive purpose of forcing efficient choices on all carriers whether incumbents or entrants. The upshot would be higher retail prices consumers would have to pay. [Citation omitted.]

There are, of course, objections other than inefficiency to any method of rate making that relies on embedded costs as allegedly reflected in incumbents' book-cost data, with the possibilities for manipulation this presents. Even if incumbents have built and are operating leased elements at economically efficient costs, the temptation would remain to overstate book costs to rate making commissions and so perpetuate the intractable problems that led to the price-cap innovation. [Citation omitted] (Verizon at 1673).

Based on this citation and others, Joint Applicants maintain that several portions of Dr. Aron's declaration should be stricken because there is no question that TELRIC is the standard that the Commission must follow and Dr. Aron's declaration involves an embedded cost analysis that the FCC and Supreme Court have both rejected. Accordingly, they contend that any testimony, declarations or exhibits supporting a different method for establishing UNE prices is not relevant.

SBC Pacific responds that Joint Applicants have mischaracterized Dr. Aron's declaration because her central argument is not that TELRIC is the improper standard for setting UNE prices, but that SBC Pacific's current UNE prices reflect a misapplication of the TELRIC methodology. SBC Pacific states that Dr. Aron's declaration is directly relevant because she presents evidence that Joint Applicants proposed UNE prices represent a flawed application of TELRIC. According to SBC Pacific, Dr. Aron compares her estimates of SBC Pacific's current UNE costs to the interim UNE rates recently adopted and in place today. From this analysis, Dr. Aron concludes that current TELRIC rates are too low because they depart so dramatically from her estimates of SBC Pacific's current costs. SBC Pacific states that SBC Pacific's "current costs can and should be used to judge the reasonableness of any proposed UNE cost estimates" and that Dr. Aron's analysis "serves as a necessary validation check on the allegedly TELRIC rates proposed in the instant proceeding." (SBC Pacific Response, 2/24/03, pps. 4-5.) Her analysis of actual costs is meant to demonstrate that TELRIC has been improperly applied to SBC Pacific. SBC Pacific contends that Dr. Aron's analysis is entirely reasonable because it analyzes whether SBC Pacific's costs of providing UNEs deviate significantly from UNE rates and it provides specific information to demonstrate that UNE rates may be confiscatory.

Joint Applicants' motion to strike portions of Dr. Aron's declaration is granted in part, and denied in part. First of all, I agree that Dr. Aron's analysis is not based on TELRIC and therefore outside the scope of this proceeding. While SBC Pacific defends her analysis as focusing on the "application" of TELRIC rather than the reasonableness of TELRIC, the undisputed fact is that Dr. Aron has engaged in an analysis of SBC Pacific's costs and revenues that does not involve a TELRIC analysis. She essentially estimates SBC Pacific's costs based on 2001 historical ARMIS data and these estimates are of little value because the scope of the case centers on estimates of forward-looking costs, not actual ones. Dr. Aron implies that historical ARMIS data equates to or is indicative of SBC's forward-looking costs without offering any explanation to justify this implication. She acknowledges that there are "differences between forward-looking and historical costs" and that "my computations are not meant to replicate the FCC's TELRIC based pricing methodology." (Aron Declaration, 10/18/02, p. 14.) Overall, it makes little difference what the purpose of her analysis is if it uses a methodology, namely an analysis of embedded costs, that the FCC has told states not to use in setting UNE rates.²

While I agree with SBC Pacific that the level of its actual costs may be reasonable to consider within the context of setting UNE rates, I do not agree with the premise that any analysis involving actual costs is necessarily relevant to this proceeding. Actual costs might only be considered to the extent that they are found to be reasonable proxies for forward-looking costs. Dr. Aron's declaration contains an analysis performed at an aggregate level that makes assumptions from total historical company costs to derive costs of providing UNEs.³ Nowhere in her analysis does Dr. Aron suggest that her estimates of 2001 actual costs are reasonable proxies for forward-looking UNE costs. Dr. Aron concludes that current UNE prices are inadequate solely because they differ from SBC Pacific's actual 2001 costs without ever establishing a linkage between actual costs and forward-looking costs. For this reason alone, Dr. Aron's analysis should be stricken as outside the scope of the proceeding because the Commission must set UNE rates based on forward-looking rather than actual costs. Indeed, the record of this case is replete with SBC actual cost data that SBC proposes to use in its cost model in order to derive forward-looking UNE costs. While the Commission may want to consider using actual cost data as a proxy for forward-looking costs in the context of a cost-modeling exercise, it should only consider doing so after a reasonable justification has been supplied of why actual costs are the best proxy for forward-looking costs. Dr. Aron has not done this. Furthermore, it would not be prudent to rely on a manipulation of actual cost data outside of the cost modeling context to make conclusions about whether UNE prices are reasonable. Finally, the Commission cannot base conclusions about whether UNE rates are confiscatory on an embedded cost analysis, particularly when both the Supreme Court and FCC have cautioned that:

[C]ontrary to assertions by some [incumbents], regulation does not and should not guarantee full recovery of their embedded costs. Such a guarantee would exceed the assurances that [the FCC] or the states have provided in the past. (Verizon at 1681.)

Second, I agree that portions of Dr. Aron's declaration that involve analyses by investment analysts using financial information to make assumptions about UNE costs are not relevant to this proceeding. It is unclear how these investment analyses are indicative of SBC's actual costs. The analyses are performed at such an aggregate level using accounting data and filled with assumptions to translate accounting records into cost estimates that it is not clear whether the end results of these analyses bear any relationship to SBC's actual costs to provide UNEs. The analyses and other manipulations of financial data by investors may serve a valid purpose and be a very sound basis for financial decisions, but analysis of SBC's financial health is not the purpose of this proceeding. Investors may very well be concerned whether SBC Pacific's actual costs are higher than its UNE rates, but this is not probative of whether UNE rates, which are meant to reflect forward-looking costs, are reasonable. Thus, since the analyses relied on by Dr. Aron are performed by investors who are not using TELRIC methodologies, they are not relevant to this proceeding and references to them should be stricken.

Third, Dr. Aron's analysis is somewhat confusing in that she uses 2001 ARMIS data as a proxy for actual costs and compares this to 2002 UNE rates. Dr. Aron states on p. 11 of her declaration that "in 2001, [SBC Pacific] received on the order of $9.93 for its UNE loops" but, in fact, this $9.93 price was not adopted until May 2002. Thus, it is unclear whether Dr. Aron realizes she is comparing costs and revenues from different years. Further, since Dr. Aron does not justify her 2001 cost estimate as a reasonable proxy of forward-looking costs as required by TELRIC, it is unclear why the Commission should rely on a comparison of costs and revenues from different years.

Therefore, for the reasons discussed above, the portions of Dr. Aron's declaration concerning her estimate of actual UNE costs, her cost/revenue comparisons, and her discussion of investors analyses of UNE costs should be stricken. Certain portions of Dr. Aron's declaration that Joint Applicants requested be stricken should in fact be retained because they involve Dr. Aron's expert opinion of capital spending in a competitive environment, whether TELRIC permits compensatory prices, and the social costs and benefits of artificially low UNE prices. A copy of Dr. Aron's declaration is attached to this ruling, with the text that is stricken shown in strikeout format.

Bash/McNeill Motion and Palmer/Bishop/Mandella Motion

Joint Applicants request an order striking certain portions of the opening declaration of Cheryl Bash, the rebuttal declaration of Ms. Bash, and the Reply Declaration of Ian McNeill, both filed on behalf of SBC, on the grounds that (1) various statements within the declarations rely on evidence that SBC failed to produce, (2) various statements have no support in the evidentiary record, (3) the witnesses are unqualified to make these statements, (4) the statements are not appropriate for rebuttal testimony, (5) the statements are false, or (6) the statements are misrepresentations of Joint Applicants' position.

In a similar motion, Joint Applicants request an order striking the rebuttal declaration of Donald Palmer, the reply and rebuttal declarations of Jay Bishop, and certain portions of the declaration of Gary Mandella, all filed on behalf of SBC. Joint Applicants contend that the Palmer and Bishop declarations should be stricken entirely because neither witness was produced in response to Joint Applicants' notice of deposition, thereby prejudicing Joint Applicants' ability to prepare their case. With regard to Mr. Mandella's declaration, Joint Applicants ask that portions be stricken because various statements are not supported, Mr. Mandella is unqualified to make the statements, the statements are contradicted elsewhere by SBC, or the statements misrepresent Joint Applicants' position.

SBC responds that Joint Applicants' motions seek to strike proper and probative evidence and that exclusionary sanctions are not appropriate here. First, SBC maintains that Joint Applicants' notice of deposition did not require it to produce Mr. Bishop or Mr. Palmer because the notice only required the person most knowledgeable regarding its cost studies and/or models and on whom SBC "intends to rely to establish the validity of its cost stud(ies) and or models." According to SBC, at the time of the depositions it did not intend to rely on Messrs. Bishop or Palmer to support SBC cost studies/models. SBC later decided to use these witnesses only for reply and rebuttal to certain allegations in Joint Applicants' opening and reply filings. SBC could not have anticipated that it would later rely on Messrs. Bishop and Palmer to reply to and/or rebut Joint Applicants' arguments. SBC also explains that Joint Applicants had the opportunity to request further depositions of other persons if they felt they were warranted, and did not do so. SBC maintains that Joint Applicants themselves submitted declarations on behalf of individuals that they did not produce in response to an SBC notice of deposition.

Second, SBC responds that there is no basis to strike the various passages of the declarations of Messrs. Mandella, Bishop, McNeill and Ms. Bash. SBC contends that Joint Applicants' grounds to strike these passages are really improper surrebuttal arguments which take issue with the validity or quality of these witnesses' statements, Joint Applicants' declarations contain the same alleged problems, and all of the alleged problems are arguments the Commission can weigh in making its determination in this case. For example, SBC asserts that expert witnesses may properly rely on evidence outside of the factual record and are not required to produce all supporting documents along with their declaration. Nevertheless, in an abundance of caution, SBC filed an errata on May 1, 2003, including a CD with all supporting documents cited by its declarants. SBC also contends that any claims that the witnesses are not qualified does not support striking their statements, but merely goes to the weight of the evidence, not its admissibility.

I will deny both of these motions filed by Joint Applicants. First, I agree with SBC that it would be improper to strike the declarations of Messrs. Palmer and Bishop on the grounds that they were not produced for deposition. At the time the deposition notice was issued, SBC did not intend to rely on Palmer and Bishop and Joint Applicants could have later moved to compel their production for depositions after the filing of their reply and rebuttal declarations.

Second, I will not strike any of the numerous passages of the declarations of Messrs. Mandella, Bishop, McNeill and Ms. Bash, because I agree with SBC that overall, the objections go to the weight of this evidence rather than its admissibility. Joint Applicants' objections concerning these witnesses qualifications and whether their specific statements extend beyond the scope of their expertise are duly noted and will be weighed when considering the various declarations. Joint Applicants' additional objections--namely that certain portions of the declarations are improper rebuttal, are contradicted by other evidence, or misrepresent Joint Applicants' positions--also go to the weight to be afforded these declarations and not their admissibility. Indeed, vast portions of the motion on these points are essentially surrebuttal. Finally, Joint Applicants claim that certain passages in the declarations rely on evidence not produced by SBC. SBC responds that for each of these instances the evidence was either not requested, was publicly available, or was in fact produced. I will not strike any passages of the declarations based on this last argument, because I agree with SBC that the evidence was either not requested, was publicly available, or was already produced.

¹ The FCC has defined TELRIC as "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 [local exchange carrier's] provision of other elements." 47 CFR 51.505(b). Dr. Aron's declaration states on p. 12 that her analysis "is not intended to reflect TELRIC based costs...."

² See 47 C.F.R. 51.505 (d) which states, "The following factors shall not be considered in a calculation of the forward-looking economic cost of an element:

(1) Embedded costs. Embedded costs are the costs that the incumbent LEC incurred in the past and that are recorded in the incumbent LEC's books of accounts;..."

³ For example, at p. 7 of her declaration, Dr. Aron explains that the ARMIS data she uses represents only the interstate allocation of regulated costs. Therefore, she makes assumptions about the allocation of inter- and intrastate costs to translate ARMIS interstate costs into total loop costs. In addition, she makes assumptions regarding depreciation expenses and costs that may be avoided when moving from retail to wholesale in order to derive her estimate of UNE costs.