Second Computer Inquiry/Final Decision/10

Chairman Ferris
Separate Statement of Chairman Charles D. Ferris

April 7, 1980

Re: Second Computer Inquiry

Today we have removed the barricades from the door to the information age. The supply of communications products and services will be limited only by the ingenuity of businessmen and scientists. Government will no longer be a barrier that prevents or delays the introduction of innovations in technology.

We have all read a great deal about the marvelous inventions that the convergence of computer and communications technology will make possible. Consumers and businessmen will have highly intelligent communications products and services in their homes and offices that will increase productivity, save energy and improve the quality of life.

As long as the development of new telecommunications products was subject to the whim of the regulatory process, however, the evolution of this industry was subject to uncertainty. Now communications business entrepreneurs can be sure that the marketplace and not the government will decide their fate. They will be willing to invest more money, and the communications market will develop more rapidly.

In a very real sense this proceeding began in 1966 with the initiation of the First Computer Inquiry. The rules developed there were intended for the world of the large capacity central processing unit, accessed by telephone lines from remote unintelligent terminals. In that world, a line between communications and data processing was defensible.

The advent of distributed data processing, however, made the Computer I rules obsolete. With the minicomputer it became possible to process data accessed from a central computer memory. The new "smart" terminals were both data processors and communications devices. Smart networks, such as Telenet's packet switched service, were next.

It became clear that the Commission would be called upon more and more to make arbitrary decisions. These decisions were made more difficult by the desire to allow AT&T to participate in the evolving communications/data processing markets in spite of the 1956 Consent Decree. It became clear that there was a very real danger that in extending the grasp of regulation to allow AT&T to compete, its competitors would be ensnarled in needless regulation.

Moreover, AT&T was subjected to inevitable delays in introducing new products and services along the boundary line. Clearing the regulatory hurdle was only the first step. Appeals from competitors inevitably followed.

Thus, to deal with these problems, we have today's Final Order in the Second Computer Inquiry.

In brief, we have decided to free all of the new, enhanced services

from Title II regulation. We accomplish this result by recognizing that the new products made possible by the convergence of computers and communications are outside the scope of Title II of the Communications Act. Indeed, the "rapid, efficient, nation-wide" communication service "at reasonable prices" called for in Section I of the Act is most likely to be fostered by limiting our traditional regulatory activities to the basic transmission and switching activities that are the building blocks upon which the new products and services will be erected.

Just as I am convinced that this result is in the public interest, I am convinced that the Commission's charter is flexible enough to allow it.

I believe the line we draw today between basic and enhanced services is a sound one that will stand the test of time. It comports with marketplace and technological realities. Moreover, it does not affect the provision of basic service by any existing basic carrier, because AT&T does not offer enhanced services and GTE-Telenet already complies as a result of the GTE-Telenet decision. If future developments dictate a change, however, we will make it.

We began this proceeding in 1976 by recognizing that the boundary between data processing and communications that had been drawn five years earlier in our First Computer Inquiry was already obsolete. In our Tentative Decision last year we supported a distinction of a similar kind between simple customer premises telephone equipment that could continue to be regulated as a part of "basic service" and the more sophisticated equipment that embodies advanced technology and allows customers to do more than just engage in conversation.

The comments on the Tentative Decision convinced us that this distinction was no more useful than the computer/data processing dichotomy of the First Computer Inquiry. The realities of the marketplace and the likely evolution of technology simply do not support such a distinction.

Therefore, we have decided to deregulate all customer equipment, including the simple rotary dial telephone found in most homes.

State jurisdiction is preempted. Charges for equipment must be unbundled by all carriers. AT&T and GTE will be required to market customer equipment through a separate subsidiary. The scheduled date for deregulation is March 1, 1982. In the meantime a Federal-State Joint Board is to be convened to determine whether adjustments in other exchange plan allocations may be warranted in light of the deregulation of customer equipment.

The deregulation of terminal equipment can only benefit consumers. Consumers have benefitted by our 1968 Carterphone decision, which for the first time allowed home and business users to choose the supplier of their equipment. Deregulation will encourage even greater competition and innovation in telephone equipment.

We are taking steps to ensure that on the date customer equipment deregulation becomes effective, no consumer will be required to change his or her relationship with the local telephone company.

Consumers can, if they wish, continue to be billed by their telephone company for existing equipment. It is our expectation and intent that a customer's total bill for communications equipment and service will not increase.

We will take up the issue of access charges in just two days time. That item is designed, in part, to solve many of the transitional issues related to terminal equipment deregulation. Over time, because of competition, we anticipate that consumers, in general, will pay less than they otherwise would and at the same time will have available a much broader array of products from which to choose.

We are also taking steps to ensure that competition in provision of this technology will be fair to all parties--to AT&T and GTE as well as their competitors. The ability of the two industry giants to cross-subsidize will be largely eliminated, because we are imposing some structural safeguards on them. But these safeguards are designed to be consistent with technological and marketplace realities so that the costs of these monopoly carriers will not rise.

We have carefully considered the costs and benefits of the structural separations we are imposing on AT&T and GTE. Many parties commented on this issue. On most issues the evidence in support of vertical integration advanced by AT&T was simply not persuasive. In those instances where it was persuasive, we do not require separation.

AT&T's subsidiary may, for example, rely on AT&T for administrative support and R&D not related to software. In other areas only AT&T has access to the detailed quantitative information needed to demonstrate economies from vertical integration. The fact that it was not offered by AT&T in this docket can only be used by us as evidence that those economies do not exist. It should be remembered that for all existing services, AT&T may deal with the general departments, Bell Labs, and Western Electric just as they do today.

It might be argued that our initial structural conditions should be loosened and then made more strict at a later date if conditions warrant. The problem with this approach is that the evidence of the need for stricter conditions might well be the corpses of competitors on the field of competition and higher ratepayer charges. We have proposed the minimum conditions necessary to prevent this result.

AT&T and GTE will, I am certain, have the incentive and ability to improve their basic networks. We do not prevent them from using any technology. Indeed, if AT&T wishes to be a supplier of the building blocks for enhanced services, it will be required to update its basic network. If it fails to do so, the competition we authorized in our Domestic Satellite and Specialized Common Carrier decisions will

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Domestic Communications Satellite Facilities, Second Report and Order, 35 FCC 2d 844 (1972).

Specialized Common Carrier Decision, 29 FCC 2d 890 (1971).

justifiably overwhelm AT&T. And if circumstances change, and we have not provided adequate flexibility to AT&T and GTE to meet them, we will not hesitate to revisit the structural conditions we impose.

Finally, I believe AT&T will be able to participate aggressively in markets where our traditional regulation is being withdrawn. I do not believe the 1956 Consent Decree prevents this. Participation by AT&T in these markets appears to be consistent with the language of the Decree and, given the structural safeguards we have imposed, it is certainly consistent with the spirit of the Decree. We will, of course, continue to subject the structural means we have adopted to allow AT&T to compete in these markets to regulatory scrutiny within the Communications Act. The public costs of a contrary interpretation of the Decree, requiring us to regulate these markets, and extending the government's reach into the data processing field, is far too high.

The Final Order in the Second Computer Inquiry is a giant step forward for consumers and for the industry. Faced with the choice of solving a problem by either extending or reducing government regulation, we have chosen to reduce regulation. As a result, I believe the information age will arrive sooner, and I welcome the changes it will bring.

Commissioner Quello
Concurring Statement of FCC Commissioner James H. Quello

In Re: Docket No. 20828 - "Second Computer Inquiry"

I believe that the Commission's approval of this Final Order was an important watershed in the process of moving the national telecommunications system into a new and exciting era. I must point out, however, that the Final Order is anything but final. It is a first step along the road to full participation of AT&T and GTE in the provision of "enhanced" telecommunications services. I share with the Chairman and my colleagues a commitment that the Commission will remain sensitive to the needs of the carriers who wish to participate fully in the competitive arena.

I am in full accord with the acknowledgement of the Staff that this is not a perfect document. I am confident that we can and will move closer to perfection as we all gain experience on this uncharted terrain. I regard as a keystone of the Final Order the premise that the Commission remains willing and able to change course should our perception of the future prove to be in error. I encourage the affected carriers to demonstrate where and how they perceive we have erred and to propose alternative courses where appropriate.

I share many of Commissioner Fogarty's concerns with regard to the degree of separation required and the extent to which information flow should be restricted. I believe that we, as regulators, bear a heavy responsibility to encourage the strongest possible competition in the provision of enhanced services. I suspect that--out of an abundance of

caution&mdash;we have erected too many structural barriers. While I recognize the need to protect the monopoly service ratepayers and the competitive environment, I continue to be concerned that we might be to some extent inhibiting the potential for innovative and efficient service.

To strike a proper balance between barriers to anti-competitive behavior and encouragement of full and fair competition requires an infinitely delicate touch. It requires a confidence that I believe we can and will develop as we move forward. I expect that we will choose to abandon some of our heavier weapons as we proceed through the jungle trails and become more familiar with the environment. Once we begin to distinguish shadow from substance, our perceptions are likely to change.

I am gratified that the Commission has agreed to broaden the language of the Order to permit affiliates of the competitive entities to provide the necessary firmware in both network and customer premises equipment. That concession relieved some of my concerns about restricted information flow. Some concerns remain, however, and I would hope and expect that they, too, will be eased in the months just ahead.

I look forward to the inquiry regarding code and protocol conversion. I assume that we can resolve questions about the appropriateness of including such services within the basic network quickly and in the best interests of the public.

The public should expect to reap great benefit in the near future from a range of services including many as yet undreamed of. I believe that the dominant carriers--through their subsidiaries--must play an important role in reaching those expectations. Since the Commission chose to forbear overt Title II regulation and to rely instead upon the forces of vigorous competition in the provision of enhanced services, I feel confident that we will be able and willing to remove any remaining barriers to full and fair competition as the need is demonstrated.

Therefore, I concur.

Commissioner Washburn
Statement of Commissioner Abbott Washburn Approving Final Decision and Concurring on Degree of Separation with Respect to Software Development and Information Flow

April 7, 1980

Re: Computer Inquiry II

I heartily approve today's action which will enable AT&T and GTE to actively participate in the dynamic new technologies of the future. The addition of their expertise, skill and strong tradition of service to these markets holds promise for significant public benefits. I fully realize that their entry also entails risks and I fully share the concerns set forth in today's Final Decision. In the area of information flows

and joint software development I recognize that vertically integrated rate regulated carriers have opportunities to gain anticompetitive advantages by virtue of their monopoly status. However, I do not agree that the mere opportunity for abuse is sufficient to spark governmental intervention in business judgments of private competing parties. Any future evidence of anticompetitive activity or other abuse would be quickly brought to our attention by the parties who were harmed. These abuses would be reachable by either an antitrust court or this Commission.

While I would have preferred deferring the imposition of regulatory constraints on information flow and software development, I find assurance in the fact that despite its title today's decision is not "final" but rather is a step in an ongoing Commission process. I will welcome additional data submitted on reconsideration, or later, whenever there are changes to the determinations upon which today's decision is premised. Change is the keystone of progress and adaptation to that change is the hallmark of enlightened regulation.

Commissioner Fogarty
Statement of Commissioner Joseph R. Fogarty Dissenting in Part

In Re: Computer Inquiry-II--Final Decision

This decision is a "landmark" in the history of telecommunications. Perhaps no other decision since the passage of the Communications Act of 1934 and the creation of this Commission is so momentous in terms of impact on industry, regulation, and the public interest. It represents in principal part significant progress and achievement in resolving the critical issues of telecommunications development in the computer age which have now confronted us for a decade and a half. The essence of the basic/enhanced service dichotomy and resale structure, together with dominant carrier structural regulation and forbearance from regulation for the rest of the competitive participants, is, I believe, well-conceived and supported by sound policy determinations. The unbundling and detariffing of CPE is also premised on strong legal and policy considerations.

While I join the Commission's decision to this extent, I am constrained to question the adequacy of the Commission's consideration and determination in several critical areas. Central to my dissenting views is the concern that while the majority's decision purports to implement an almost pristine devotion to economic theories of "marketplace competition," its actual effect will be anticompetitive in terms of denying certain entities and, most importantly, the public they serve, the benefits of "full and fair" competition. I am also concerned that in certain key areas the real-world consequences of the decision have not been perceived or anticipated in sufficient detail to give assurance that the public interest will be served in fact, as well as in theory, by these actions. I cannot emphasize too strongly that under

our existing statutory mandate, it is the public interest--the interest of consumers and ratepayers--which must be our paramount concern and responsibility.

This proceeding was initiated because technological developments which have taken place since our decision in Computer Inquiry-I have rendered the rule, which was adopted in that earlier proceeding, largely obsolete. The convergence of the technologies used to provide communications services, which we regulate, and data processing services, which have not been regulated, has continued at accelerated pace since 1971. The major issue now, as it was then, is the extent to which carriers subject to our jurisdiction can use computer and communications technologies to provide communications service or some combination of communications and data processing service.

The Former Rule

The former rule used a definitional structure to identify these network services:

1) Remote Access data processing

2) Hybrid Data processing

3) Hybrid Communications

4) Message and Circuit Switching

Items (1) and (2) were exempted from regulation under Title II, whereas we found that even if computers are used for the provision of (3) and (4), such services nevertheless are subject to our jurisdiction. The rule also stated that any common carrier who wishes to provide services (1) and (2) can do so only under a fully separated subsidiary. The rule permitted a separate unregulated subsidiary to acquire communications facilities from the parent, but did not place any limitations upon the ownership of transmission facilities. The rule did not permit carriers which own computer facilities used in communications to "sell, lease, or otherwise make available" such facilities to any other entity. The rule did not address the situation of implicit computer leasing or sharing when a communications service using a computer switching facility is resold.

The old rule thus established a regulatory boundary based upon the dichotomy between data processing services (Items 1 and 2) and communications services (3 and 4) which was delineated by the definitional structure.

The New Rule

The former rule, having been overtaken by technological advance, created a climate of ambiguity which has limited the participation of providers of these services. The rule adopted in this Final Decision

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Regulatory & Policy Problems Presented by the Interdependence of Computer & Communications Services & Facilities, 28 FCC 2d 291 (1970) (Tentative Decision); 28 FCC 2d 267 (1971) (Final Decision), aff'd in part sub. nom. GTE Service Corp. v. FCC, 474 F.2d 724 (2d Cir. 1973), decision on remand, 40 FCC 2d 293 (1973).

purports to "address these matters in a manner which gives clear direction to the marketplace, but without restricting the types of services that may be offered to consumers" (Para. 83). In addition, it seeks to extend this Commission's policy of encouraging meaningful competition in new technology areas by decreasing the regulatory burden where deemed appropriate.

This Final Decision presents a marked and substantial departure from the Tentative Decision and the Commission consensus which supported it. While I agree with a large part of this decision as a significant and well-conceived step in the right direction, I do not believe that the new rule has wholly succeeded in giving a clear direction to the marketplace. Moreover, from a public policy and consumer-oriented point of view, I believe that the new rule raises serious questions which unfortunately the Final Decision does not answer.

The Structural Solution

The new rule forbears from regulation of enhanced services and deregulates the provision of CPE. In order to compete in these markets, only AT&T and GTE are required to establish separate subsidiaries operating on an arm's length basis. Any other carrier now subject to our jurisdiction can offer these services without such restrictions. In addition, any AT&T and GTE subsidiary must acquire its facilities on a tariffed basis from an underlying carrier and thus operate as a resale entity. The resale subsidiaries are prohibited, furthermore, from owning their own transmission plant.

If we look further into the significance of these structural requirements, we can see that they impact AT&T more significantly than they do GTE. AT&T is a vertically integrated entity which is now the major supplier of interstate digital and analog transmission facilities. GTE is a less vertically integrated entity whose primary communications investment is in its local operating companies. GTE's separate Telenet subsidiary already obtains most of its digital transmission facilities from AT&T. It is of necessity a resale carrier.

In addition to the resale requirement, the following degree of separation is required of AT&T and GTE resale and CPE subsidiaries:


 * Separate maintenance of records, accounting


 * Separate operating personnel and officers


 * Separate marketing


 * Separate installation and maintenance


 * No sharing of computer capacity


 * Limited joint software development

Further,


 * A subsidiary providing enhanced services and/or CPE may not provide communications hardware used in a network. Such subsidiaries must also deal at arm's length with any other affiliated equipment manufacturers.


 * Marketing information made available to the subsidiary by the parent must also be disclosed to non-affiliated competitors.


 * Information relating to changes in network design and technical standards must be disclosed to the public.

The necessity of separate subsidiaries for the provision of enhanced services and CPE was designated a key issue in the Tentative Decision and Further Notice of Inquiry. In a separate statement, I indicated the concern that "[w]e have never assessed the critical cost benefit trade-offs inherent in these various degrees of separation, nor have we examined the question of whether the economies which may flow to the ratepayer from vertical integration outweigh potential abuses ... Certainly, we owe it to the ratepayer to conduct this analysis before we reach a final decision in this inquiry."

I regret that such an analysis has not been performed in reaching this decision. The Commission's Final Decision purports to find the "middle ground" of "compromise." However, the proposed specific degree of separation reflects an approach in which all assumptions pertaining to the benefits of separation are treated as givens whereas any countervailing arguments pertaining to the benefits of vertical integration are treated as unproven hypotheses subject to considerable doubt. In particular, Paragraph 206 states:

We have tried to assess the benefits and disadvantages of permitting or prohibiting each [of the important production and distribution functions] to be performed on an integrated basis. With those functions that weighed heavily in the process [i.e., those whose manipulation would produce the greatest gains to a dominant common carrier inclined toward anticompetitive activity]--the sharing of operating personnel or of facilities for example--we inclined toward disallowing integrated activities altogether; with those functions that seemed less decisive, the sharing of research and development, for example, we inclined toward assuming the risk vertical integration poses.

In other words, wherever substantial risk of anticompetitive abuse is perceived in vertical integration, the decision opts for complete separation. However, this calculus totally fails to give any comparative weight to the substantial benefits of vertical integration as against the competitive risks perceived. This calculus presents no rational cost/benefit balancing at all; instead, it indulges in wholly presumptive preference. In doing so, it egregiously ignores the Commission's paramount responsibility under its existing statutory mandate--that is, to protect and promote the public interest of the ultimate consumer

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72 FCC 2d 358 (1979).

Id., Separate Statement of Commissioner Joseph R. Fogarty, 72 FCC 2d 450, 452; See also GTE-Telenet Merger Authorization, 72 FCC 2d 111 (1979), Concurring Statement of Commissioner Joseph R. Fogarty, Id. at 194, modified 72 FCC 2d 516 (1979), Concurring Statement of Commissioner Joseph R. Fogarty in which Commissioners James H. Quello and Anne P. Jones Join, Id. at 531, recon. denied-- FCC 2d-- (1979), Concurring Statement of Commissioner Joseph R. Fogarty in which Commissioners James H. Quello and Anne P. Jones Join, Id. at--.

of telecommunications, not merely the private interests of individual competitors.

In this connection, the main thrust of the degree of separation prescribed by the item appears to be directed at severing all joint and common costs. Yet it is precisely in joint and common costs that significant economies are realized. The Final Decision concedes that the benefits of separation are "not susceptible to precise quantification," but are expected to be substantial. The same courtesy of speculation is not extended to the benefits of vertical integration despite the volumes of industrial organization literature to the contrary.

For example, the case for innovation through vertical integration is no less "problematical" or "ambiguous" than the case against, and yet it is the latter that is given a presumptive preference by the Commission's decision. In this regard, the decision generally cites Dr. Alfred Kahn's treatise on The Economics of Regulation in support of the propositions that "... while AT&T has mounted a significant defense of vertical integration, it does not take into account the likely contributions which competition can bring, and has brought, to innovation," and that "the generalized case for vertical integration by a monopolist is not without serious dangers, particularly where the company is rate-regulated and seeking to engage in unregulated activity." However, fuller reference to Dr. Kahn's work is more instructive:

But, in the last analysis, the plunge into competition is inescapably a plunge into the unknown. The essence of the case for competition is that the potential performance of an industry is unknowable; it is the rivalry of independent suppliers that offers the greatest possible assurance that all economically feasible avenues for cost reduction and service innovation will in fact be explored and their results subjected to the impartial test of the marketplace.

This is not, however, a sufficient guide to public policy in all times and places, as the institution of regulated public utility monopoly itself indicates.

It remains possible that the manufacture of equipment for the central core of the natural monopoly, the communications network, is a "natural" part of that monopoly. This writer would find it extremely difficult himself, in the face of the objective record of good performance and the qualitative arguments that provide at least a highly plausible basis for attributing those results in important measure to vertical integration, to recommend the plunge into the unknown.

It is also worthwhile to examine recent antitrust law doctrine as a guide to a proper resolution of the degree of separation issues presented. In Berkey Photo, Inc. v. Eastman Kodak Co., the Court of Appeals for the Second Circuit addressed the question of what restraints should be placed upon a monopoly firm's activities in non-monopoly markets. While the court concluded that a firm may not use

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A. KAHN, THE ECONOMICS OF REGULATION (1971), 305 (Emphasis added).

603 F.2d 263 (1979), cert. den., U.S. (Feb. 19, 1980).

its monopoly market position as a lever to create or attempt to create a monopoly in another market, it also held that&mdash;

[A] large firm does not violate Section 2 [of the Sherman Act] simply by reaping the competitive rewards attributable to its efficient size, nor does an integrated business offend the Sherman Act whenever one of its departments benefits from association with a division possessing a monopoly in its own market. So long as we allow a firm to compete in several fields, we must expect it to seek the competitive advantages of its broad-based activity--more efficient production, greater ability to develop complementary products, reduced transaction costs, and so forth. These are gains that accrue to any integrated firm, regardless of market shares and they cannot by themselves be considered uses of monopoly power.

While we are here engaged in forging communications policy, not antitrust law, the Commission's public interest standard and, indeed, this proceeding carry a heavy antitrust policy component. The Commission would be well-advised to pay closer attention to this fundamental teaching.

The separation requirements adopted by the Commission have been imposed ostensibly to prevent any possible subsidization of the competitive entities by the so-called "monopoly services," this theme appearing throughout the Commission's decision. It should be noted, however, that as a result of the Execunet decisions, interstate MTS and WATS are no longer monopoly services. If the Commission's ultimate decision in the MTS/WATS Market Structure Inquiry affirms the desirability of what is now the status quo, we can expect vigorous competition to develop in this "monopoly service" marketplace. Under these circumstances, it will make much less sense to invoke the cross-subsidy argument as the case in chief for the degree of separation required by this decision.

I am well aware of the serious continuing potential for cross-subsidization and predatory pricing implicit in the dominant carriers' position in the MTS/WATS market. However, I believe that it would be far wiser policy for the Commission to balance the potential for cross-subsidization and the potential benefits of vertical integration in favor of cost-accounting systems and continuing Commission surveillance, rather than in favor of the rigid and total separation approach adopted by the decision. Our primary purpose here should be to reconcile the competing policy values in such a way as to maximize the ultimate benefits accruing to the consumer public from both competition and vertical integration. While I recognize a dispute exists as to the efficacy of accounting mechanisms in checking cross-subsidization and anticompetitive abuses, I believe we have an obligation to try less

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603 F.2d at 276.

MCI Telecommunications Corp. v. FCC (Execunet I), 561 F.2d 365 (D.C. Cir. 1977), cert. denied, 434 U.S. 1040 (1978); MCI Telecommunications Corp. v. FCC (Execunet II), 580 F.2d 590 (D.C. Cir. 1978) cert. denied, 439 U.S. 980 (1978).

Notice of Inquiry and Proposed Rulemaking, CC Docket 78-72, 67 FCC 2d 757 (1978); and Supplemental Notice of Inquiry and Proposed Rulemaking, 73 FCC 2d 222 (1979).

drastic safeguards first where significant economies may be present. I concede that the task of developing adequate accounting systems is a heavy one; however, I believe the effort should be required before we sacrifice benefits of vertical integration to which the public is entitled.

Our dedication to "full and fair" competition should mean that all competitors--not just the small and the weak--are entitled to compete as vigorously as possible. It is a curious kind of "pro-competition" policy that frees one class of competitor and hobbles another. To refer again to the Berkey Photo decision of the Second Circuit Court of Appeals:

"... it would be inherently unfair to condemn success when the Sherman Act itself mandates competition. Such a wooden rule ... might also deprive the leading firm in an industry of the incentive to exert its best efforts. Further success would yield not rewards but legal castigation. The antitrust laws would thus compel the very sloth they were intended to prevent. We must always be mindful lest the Sherman Act be invoked perversely in favor of those who seek protection against the rigors of competition."

The formulation and implementation of our pro-competitive communications policies should be no less consistent.

Network Services

The new rule abandons a definitional scheme based upon the communications service/data processing service dichotomy and, instead, establishes a dichotomy between basic communications services and enhanced services. The two problem areas which concern me here are the interactions between: (1) the definition of the basic/enhanced regulatory boundary, and (2) the effect upon AT&T and GTE (and ultimately upon the consumer) of the structural and separation requirements--in particular those relating to: (i) the requirement that transmission facilities be acquired on a resale basis coupled with a prohibition against the ownership of these facilities; (ii) the various corporate separation requirements.

The enhanced service/basic service boundary definition would preclude AT&T and GTE from offering protocol and code conversion in conjunction with basic service, except under the resale and corporate separation principles. It is not clear, however, whether certain other computer-provided enhancements, such as multiple addressing, which are related solely to the communications process, would be permitted to be offered in conjunction with a basic service. In this respect, Section 64.702(a) of the new rule is inadequate. The relevant paragraphs of the Final Decision (86-118) not only do not shed much light but also contain contradictions. For example, Paragraph 95 classifies

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603 F.2d at 273.

A vertically integrated entity could offer basic service within that corporate structure subject to Title II regulation. Thus the application of the definition determines the circumstances under which the separation requirements will be invoked.

message switching as a basic service; Paragraph 97 classifies one of its intrinsic features, "mail box," as an enhanced service. The classification of "mailbox" as an enhanced service seems, however, to be in conflict with the definition of enhanced service as set forth in the proposed Section 64.702(a). Mailbox can be provided without acting upon either the "format, code, content, protocol, or similar aspects of the subscriber's transmitted information." Nor does mailbox provide a subscriber with "additional, different, or restructured information."

With further regard to proposed Section 64.702(a), I think that this provision somewhat arbitrarily removes protocol and code conversion from the ambit of basic service. It is difficult for me to see why protocol or code conversion is an enhancement to a communications service. It is, rather, as much a necessity to the provision of any communications service at all, for customers who happen to have disparate terminals, as is the presence of a local loop. In this connection, I endorse the proposal, as set forth in Paragraph 99 of the Commission's Order, to consider issuance of a Notice of Inquiry to examine the matter of permissible levels of protocol conversion. This proposal should be a commitment.

A possible serious consequence of the new regulatory boundary could be its effect upon the provision of inexpensive, nationwide digital core network service by underlying carriers. For example, the proposed AT&T ACS service, even in rudimentary form, would have to be offered as an enhanced service. This could lead to two problems: first, significant cumulative diseconomies could result if such a system were not provided on a nationwide core network, but had, instead, to be replicated on a separate resale network. In fact, these restrictions might even discourage the construction of a nationwide, digital core network. Second, an unfavorable interpretation of the Consent Decree would totally preclude AT&T from offering these services even as an enhanced carrier.

In light of these observations, I think that it is critical that the Commission: (1) rethink the matter of the definitional boundary; and (2) clarify the definition of enhanced service--in order to resolve ambiguities. Terms such as "format," "content," "similar aspects of subscriber's transmitted information," and "restructured information" are not defined--either in the Appendix or in the text; nor are sufficient examples given to illuminate their meaning.

I also believe that we should re-examine the prohibition relating to the procurement of software and software development. I concur with the statement in Paragraph 244 that the resale subsidiary may purchase, from the underlying carrier and its affiliates, the software and software development which is intrinsic to CPE and other hardware used in the provision of enhanced network services. The rationale for maintaining a prohibition against the provision of applications program software to the resale entity, and the provision of any software service by the resale subsidiary to its affiliates, evades

me. Given that any kind of hardware, as well as operating system software, can be purchased by the resale entity, the arguments set forth in Paragraph 243 are not convincing.

Provision of Customer Premises Equipment (CPE)

The Final Decision in Computer Inquiry-I did not address the provision of CPE, even implicitly, because of the rudimentary state of the art of CPE technology in 1971. Subsequently, the attempt by AT&T to provide the DataSpeed 40/4 terminal under tariff, coupled with the untariffed marketing of a similar device by IBM (IBM 3270), introduced the issue of whether or not the provision of so-called "smart" terminals by a carrier, constitutes an unregulated data processing service within the context of Section 64.702 of the Rules. Since little regulatory guidance in this matter could be provided by that rule, the Commission was forced to make an ad hoc decision in the DataSpeed 40/4 matter (ruling that DataSpeed 40/4 is a communications device). At that time, we quite properly incorporated the terminal issue into the then on-going Computer Inquiry II.

The Commission's decision here will now require the provision of all CPE--from black telephones to super terminals--on a deregulated basis. Carriers may provide these only on an un-bundled, de-tariffed basis. In addition, AT&T and GTE may only offer CPE through separate subsidiaries.

I agree in principle with the position reached on CPE. However, I am not sure that the Commission has addressed properly a serious problem which might ensue--the upward rate pressures on local exchange rates due to the removal of terminal equipment revenue requirements from the separations process.

The Order would require all interstate revenue requirements now attributable to CPE to be removed from the separations process by March 1, 1982. By that time, if local exchange rates are to remain un-affected, it will be necessary to have arrived at some remedial action to compensate for the loss of toll service revenue contributions. This action of the Commission will have a domino effect in the state jurisdictions. The CPE investments of the local operating companies will also have to be removed from the intrastate rate base. Local operating companies will thus lose toll service revenue contributions from both jurisdictions. The amount involved is formidable. In 1978, the Bell System total revenues attributable to the provision of CPE were approximately $4.4 billion. Of this amount, $1.2 billion came from the assignment of CPE costs to the interstate jurisdiction. The remainder came from the assignment of costs to the intrastate toll jurisdiction and from local service revenues. Under terminal deregulation, a local operating company would, in the short run, probably retain the local service revenue component. On the other hand, the carrier

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DataSpeed 40/4 Order, 62 FCC 2d 21 (1977).

would no longer be able to obtain the interstate and intrastate toll contributions. The loss of these toll service contributions will, in most circumstances, lead to an upward pressure on local exchange rates.

It should be noted that this effect will be most pronounced in those states (e.g., New York, California, and others) where the state commissions require that CPE be priced to the local exchange user at 100 percent of its revenue requirement. Under these circumstances, the toll pool revenues attributable to these terminals can be used as a direct subsidy to reduce local exchange rates by the amount of these attributable toll revenues.

The disallowance of CPE toll revenue requirements will also result in a reduction in toll rates equivalent to the upward pressure on local exchange rates. This occurrence does not, however, have a break-even impact on all consumers. Those consumers who make infrequent toll calls will indeed see higher total monthly telephone bills. Those consumers who now are heavy users of toll service will see lower total telephone bills.

In recognition of this possible effect, the Final Decision would have the Commission convene a Joint Board to investigate the possibility of remedial action involving changes in the separations procedures. However, I see a substantial question as to whether such a Board could lawfully re-insert these lost revenue requirements into the interstate pool by arbitrarily changing the allocation of the remaining non-traffic-sensitive plant. The record built in the Joint Board proceedings in Docket Nos. 20981, 21263, and 21264, as well as actions already taken by those Joint Boards, indicates that efforts to rely upon a separations-oriented approach to counteract potential or actual economic harms may be fruitless.

I therefore believe that the scope of the proposed Joint Board should be broadened to include the consideration of remedies based on access charges and exchange maintenance fund concepts--or, alternatively, that this issue be specifically incorporated into our access charge proceeding in CC Docket No. 80-198.

The Consent Decree

I believe the Commission has set forth a construction of the 1956 AT&T/Department of Justice (DOJ) Consent Decree which is persuasive and compelling from the standpoint of both antitrust law and telecommunications policy. The fact remains, however, that if this interpretation does not prevail, it is possible that AT&T would be precluded from providing either enhanced services, or CPE, or both,

____________________

A change in the allocation of traffic sensitive plant might be inconsistent with the principles of Smith v. Illinois, 282 U.S. 133 (1930), since such plant is now allocated under unambiguous relative use principles.

See Impact of Customer Provision of Terminal Equipment on Jurisdictional Separations, 63 FCC 2d 202 (1976); Puerto Rico/Virgin Islands Rate Integration, 64 FCC 2d 1033 (1977); and Hawaii/Alaska Rate Integration, 64 FCC 2d 1036 (1977).

given the new industry structure which is now prescribed. Here, it must be observed that the comments of DOJ and, to a certain extent, AT&T, who are the parties to the Decree, dispute our interpretation. The Commission's decision acknowledges the "uncertainty" of the profferred interpretation, but states that removal of the uncertainty rests primarily with AT&T, should AT&T deem it necessary.

This assignment of responsibility for the impact of the Consent Decree is technically correct, as far as it goes. However, I believe in a more fundamental sense the larger public interest in a fully competitive telecommunications marketplace would be grossly disserved if AT&T were estopped from being an active and full participant in that competitive marketplace. In a real sense, these implications are our responsibility. The Commission's decision takes some pains to observe that an adverse Consent Decree ruling will trigger a re-evaluation of the structure, terms, and conditions for telecommunications competition which are now prescribed. And, the prospect for the clearest possible resolution of the critical Consent Decree issues--that is, for legislation--may be brightening. Nonetheless, we must address the situation as it now exists and be guided by our own interpretation of our existing public interest mandate. Therefore, I believe the Commission must foresee and minimize the risk of uncertainty to the fullest extent possible, and to this end, I would: (1) give AT&T the option of tariffing in the provision of enhanced network services, or modify the definition of enhanced service to broaden the scope of basic service, and (2) give AT&T the option to tariff terminal equipment which would be supplied to basic services or tariffed enhanced services.

In summary, the following points have not been adequately addressed and treated by the majority's decision:

(1) Without a more adequate cost/benefit analysis, there is no assurance that the proposed separate subsidiary structure, with the recommended degree of separation and information flow requirements, will not force the public to obtain enhanced services and CPE at substantially higher cost than if such services and equipment were provided by a more vertically-integrated entity;

(2) The deregulation of CPE may lead to significant upward pressure on local exchange rates, pressure which may not be effectively alleviated by a Joint Board established to investigate separations changes only;

(3) The proposed industry structure and deregulation could totally preclude AT&T from offering either CPE or enhanced services if the proposed interpretation of the Consent Decree is not accepted; and

(4) The basic/enhanced dichotomy may be a serious disincentive or impediment with respect to the construction of a nationwide digital core network; and we may be faced with the prospect of a myriad of interconnected sub-networks,

owned by many entities, with no one entity in a position to assert overall technical planning authority.

I am certain that the Commission will have the opportunity--if not also the duty--to reconsider the Final Decision and to attend to these deficiencies. Specifically, I believe the Commission should consider the following alternatives:

(1) The degree of separation proposed by the item for the enhanced service/CPE subsidiaries should be relaxed in favor of cost-based, fully-compensatory, auditable contract/accounting systems with respect to installation and maintenance and software development. Subject to resale and accounting requirements, sharing of transmission computer capacity should be permitted. The separate marketing requirement should make an exception for institutional advertising and subject to the resale requirement, the subsidiary should be allowed to market the facilities of the parent when they are combined with the services of the subsidiary. These modifications would permit the more efficient and competitive provision of CPE and enhanced services by carrier subsidiaries to the benefit of the consumer public, while at the same time guarding against potential cross-subsidization or other anti-competitive conduct;

(2) The jurisdictional impacts of the proposed CPE deregulation (unbundling and detariffing) should be examined in detail. In particular, we should indicate a better understanding of the possible limitations of the traditional separations and settlements procedures in dealing with these impacts and whether broader mechanisms, such as exchange maintenance fund concepts, are feasible and available to the Commission;

(3) Carriers and their subsidiaries should be afforded the option of continued tariffing of enhanced network services and provision of CPE, on an unbundled basis, in conjunction with basic service or enhanced services. This modification would assure that an adverse ruling on our Consent Decree interpretation will not preclude AT&T from offering ordinary, as well as sophisticated, CPE; and

(4) The definition of enhanced services should be clarified to resolve the ambiguity in the basic/enhanced dichotomy. The ambit of "basic" services should be expanded to include code conversion, protocol conversion, and other functions that are exclusively related to communications service. This alternative would allow the option of encouraging the formation and development of a nationwide, centrally planned, and economical digital core network; it would also ensure against an adverse ruling on the proposed Consent Decree

interpretation precluding AT&T from offering sophisticated digital network services.

As a final matter of not insignificant moment, I believe that the adopted effective date of March 1, 1982 for CPE deregulation and for the establishment of AT&T and GTE separate subsidiaries is unrealistic in the extreme. The necessary corporate, financial, and logistical transitions will be highly complicated and difficult enterprises. For example, the potential impact of the decision on over one million AT&T and GTE employees in terms of wage structure, benefits, pension rights, seniority and collective bargaining rights is substantial and has not been addressed thus far by the Commission. Similarly, I expect that the impact of the proposed CPE de-tariffing on the interests of bondholders will raise significant legal issues.

Obviously, the Commission must give the parties an opportunity to address the several substantial problems which remain unresolved before the Second Computer Inquiry can be terminated.

To the extent of these separate views, I dissent.

Commissioner Brown
Separate Statement of Commissioner Tyrone Brown

Re: "Second Computer Inquiry" (Docket No. 20828)

The decision and order we adopt today is probably the most important the Commission will issue during my time here. There have been days during the past 2 1/2 years when I feared that this agency lacked the machinery to reach a final decision in this very complex proceeding. I compliment the staff of our Common Carrier Bureau and the other offices that participated for presenting The Commission with an approach and order that will, in my judgment, serve the long-term interests of the two "dominant" carriers, AT&T and GT&E, the interests of their competitors in the enhanced services and equipment markets, and the interests of the consuming public.

1. What does today's decision accomplish? First, it establishes a clear line of demarcation between "basic" communications (or pure transmission) services and enhanced "communications" services, permitting traditional common carriers and their competitors in new enhanced offerings to know beforehand whether their service will be regulated by the FCC. Second, our decision, after a transition period, provides for uniform deregulation of customer premises equipment--ranging from the "plain old telephone" to the smartest of the "smart terminals"--so that the marketplace rather than this agency will decide what equipment and which providers will attract the consumer's dollars. Third, the decision frees AT&T to compete, on a nontariff basis, with other regulated and unregulated firms in the rapidly growing enhanced services and equipment markets, so long as AT&T's offerings fall within the broad subject-matter jurisdiction of this agency. Fourth, the decision requires AT&T and GT&E each to establish a separate subsidiary for their enhanced services and

equipment offerings, to assure customers of their monopoly services, and their competitors, that monopoly ratepayers will not fund their entry into the enhanced markets.

2. Do we possess authority to act as proposed? I recognize that today's decision involves novel interpretations at the outer boundaries of the Communications Act; we pour new wine into an old bottle. It is a measure of the wisdom of Congress that in 1934 we were given a mandate that has been sufficiently broad to permit a flexible approach to regulating a field that has been marked by an ever-quickening pace of technological innovation. Recent proposals that have come before Congress point in the same direction as our decision. Without the benefit of the debate that has occurred in the House and Senate Communications Subcommittees over the past two years, I doubt that the FCC would be ready to act. I would welcome congressional confirmation--or modification--of any aspect of our decision, particularly our construction of the 1956 Consent Decree. Without such confirmation, full implementation of our decision may be delayed by years of litigation. In any event, I wish to emphasize that my vote in favor of the decision rests in substantial part on the view that, as a legal matter, regulated carriers including AT&T can compete in unregulated fashion in the enhanced services and equipment markets.

Our action today raises several legal questions. Perhaps the most fundamental step we take is the assertion that, with respect to "compunications", our subject matter jurisdiction is broader than the sum of our jurisdiction under Title II and III of the Communications Act. This approach is not new. It was taken--and affirmed by the courts--when we asserted jurisdiction over cable television systems. Similarly, today we are saying that "compunications", when offered by an underlying carrier, though clearly within our subject-matter jurisdiction, need not be regulated as though such services were Title II offerings. I believe we possess sufficient discretion, based on an exhaustive record, to make this judgment.

A related issue involves our construction of the 1956 Consent Decree as it concerns the provision of Customer Premise Equipment. To date, we have asserted jurisdiction over, and required tariffing of, CPE on the theory that such equipment was regulable as an "instrumentality" incidental to transmission services within the meaning of Sections 3(a) and 3(b) of the Act. Our decision to require the unbundling and detariffing of such equipment should not be read as a retreat from our belief that CPE when offered by a carrier is regulable by this Commission. Nor do I view our decision not to require tariffing to mean that such equipment is not "subject to" our regulation. Definitive interpretation of the Consent Decree must be left to the Court that issued that decree. However, as a matter of communications law, we affirm that CPE is within our subject-matter jurisdication. We have chosen not to regulate CPE through tariffing, but it remains subject to our regulation.

3. Why the distinction between basic and enhanced services? For 14 years, this agency has been struggling with "regulatory and policy questions that appeared to be emerging from the growing interdependence of computers and communications services and facilities." First Computer Inquiry, Tentative Decision, 27 FCC 2d 291 (1970). For most of that time, we have attempted to draw a line between two classes of services which possess elements of both communications and data processing. Theoretically, on one side of the line, to be regulated under our tariff authority, we have placed "communications" services in which the communications component was the most significant; on the other side we have placed services in which the communications component was only "incidental."

This attempt at line-drawing, while theoretically the soundest approach, simply has not worked in practice. Under the regime we adopted in the First Computer Inquiry, we will be forced to adjudicate each major new offering of enhanced services on an ad hoc basis. The results would be that firms that heretofore have been free of FCC regulation would fall under our purview, that much of the battle among competitors will take place before us rather than in the marketplace, and that this agency's processes would to a large extent determine the timing of introduction of innovative offerings. Faced with this prospect, I believe the dominant carriers, their competitors and the general public will be much better served by the relatively bright line we draw today between basic transmission services on one side and all enhanced (or hybrid services) on the other.

4. Why deregulation of terminal equipment? For all practical purposes, natural monopolies exist today in local telephone transmission services. However, we have posited, at least since our Hush-A-Phone decision, 22 FCC 112 (1957), that meaningful competition is possible in the provision of terminal equipment. Ensuing years have proven the hypothesis. Rate-based regulation is at best a costly and cumbersome substitute for competition and consumer sovereignty. Given the actuality of competition as it exists today and the potential for much greater competition in the future, there is no longer a reason for the Commission to permit the joint tariffing of services and equipment, especially considering the risks of cross-subsidization that such joint tariffing entails. Under our interpretation of the 1956 Consent Decree, AT&T gains authority to compete for any enhanced equipment customer. But, importantly, consumers will be in a better position than they are today to determine what equipment offerings will best serve their needs. Finally, I am confident that during the transition period the Joint Board of FCC and State regulators will be able to arrive at a separations approach that will not mean a significant increase in telephone bills for any customer as a result of deregulation of terminal equipment.

5. Why permit regulated carriers to provide unregulated enhanced services? AT&T, GT&E and 1500 smaller telephone companies have

cooperated to assemble an integrated communications network that I consider to be a wonder of the modern world. For its universality, its versatility and its economy, our telecommunications network is unmatched by any in the world. I believe it would ill-serve the public interest if AT&T, GT&E or any other participant in the network were denied the opportunity and the challenge of bringing their financial resources, their tradition of universal service and importantly their in-place research capabilities to the rich new compunications field.

6. Why separate subsidiaries for AT&T and GT&E? While permitting AT&T and GT&E (and carriers under their direct or indirect common control) to provide enhanced services, we are requiring them to do so only through a separate subsidiary on a resale basis. In addition, we are prohibiting AT&T and GT&E from marketing, installing, servicing or maintaining CPE except through a separate corporate subsidiary, which itself may not provide transmission equipment. These steps are taken to protect the monopoly ratepayer from the potential evils of cross-subsidization and anti-competitive conduct. They are taken only with respect to AT&T and GT&E because they are the only two communications firms now in a position to exercise monopoly power in the national enhanced services markets. Given the ineffectiveness of accounting measures standing alone to monitor anti-competitive practices, the need for a separate subsidiary, in addition to accounting requirements, is obvious.

On the other hand, I recognize that we have little experience on which to structure such separate subsidiaries. For this reason, I would be surprised if, either by way of reconsideration or at a later date, the Commission does not make some adjustments in the separation conditions in the light of actual experience.

Further, in this connection it should be kept in mind that our action today is taken in the context of today's technology and the record now before us. The Commission has the ability and the obligation to respond to changing circumstances with a fresh examination of our policies and the means we have chosen to implement them. Congress intended this agency to be flexible in its responses under the broad mandate of the Communications Act. I am committed to this flexible and pragmatic approach to this rapidly evolving area of the law.

Commissioner Jones
Statement of Commissioner Anne P. Jones Dissenting in Part

April 7, 1908

In Re: Second Computer Inquiry Docket No. 20828

Because I firmly believe that it is in the public interest that AT&T and GTE be allowed to participate actively in the enhanced services marketplace, I agree with much of today's action by the Commission, including the basic decision to forbear from directly regulating the provision by Title II carriers of enhanced services and customer premises equipment.

To my mind the arguments advanced in this proceeding as to the stultifying effect of direct regulation of these highly competitive markets and the lack of any need for such regulation in the public interest are convincing. I am also persuaded that, in the absence of adequate accounting mechanisms to ensure that competition in these markets by AT&T and GTE does not involve unlawful cross-subsidies from their monopoly activities, the separate subsidiaries requirement is justified. I am not, however, satisfied that the degree of separation imposed on these companies is justified, and I dissent for that reason.

In its discussion of arguments made by AT&T, GTE, and others as to the virtues of vertical integration, the Commission seems to vacillate. For example, argument that the Bell System's integrated structure contributes to its role in innovative research and development is dismissed in paragraph 204 as "very problematical." On the other hand, it seems to be conceded in paragraph 223 that the provision of certain complementary goods or services by the same company may generate "efficiencies in the form of reduced operating expenses or other legitimate cost savings" and that consumers of telecommunications products and services "should not be required to forego such economies unless they are clearly outweighed by other costs which joint operation would impose." I suspect that this vacillation results from the fact that we do not really know to what extent, if any, the generally excellent performance of AT&T and GTE results from their high degree of vertical integration. For my part, I am inclined to give some credence to their arguments on this point.

On the assumption that operation by AT&T and GTE on a vertically integrated basis may benefit both them and their customers, I believe we should not now impose on their enhanced services and CPE subsidiaries the degree of separateness contained in today's decision. Two of the limitations which seem especially problematical are those on sharing of computer facilities and joint design and development of software. As to software, I agree with Commissioner Fogarty that there is no demonstrated rationale for denying a subsidiary the option of purchasing software development from a parent in addition to the options of performing it in-house. As to computer facilities, I find persuasive NTIA's argument that "separate computer facilities will be pure duplication" and that "inability to use computer facilities to provide enhanced services during off-peak hours could result in a great deal of wasted processing capacity."

I understand the argument that the limitations established by today's decision are required by the difficulty of correctly identifying and allocating costs involved in the proscribed activities. Since, however, it is precisely the difficulty of identifying and allocating such joint and common costs which underlies the separate subsidiary requirement, I fail to see why both that requirement and the prohibitions are necessary. In my view, the better and less costly approach would be to impose the barest minimum of prohibitions while

testing the adequacy of the separate subsidiary requirement. If experience demonstrates that additional safeguards are needed, prohibitions or limitations on joint and shared activities could then be added based on experience rather than conjecture.

In addition to my objections to the separations requirement, I have reservations about a number of other aspects of today's decision. Of these I will note here only my strong reservation concerning the March 1, 1982, deadline established for compliance with the requirement. It seems to me that 23 months is an unreasonably short period of time to allow for all that must be done to implement today's decision, including corporate reorganization by the carriers and the necessary Joint Board actions. It may be that the deadline can be met, but I doubt it, and I hope we will not be unduly insistent on it.

Despite my objections to portions of today's decision I am, as I have indicated, in agreement with much of it, and certainly with its basic purposes. I am also gratified by the express recognition in paragraph 200 of the decision that "some of these decisions may be mistaken" and that they will be reconsidered if experience teaches that we have "incorrectly struck the balance between the asserted danger of carrier participation and the supposed efficiency losses brought about by the conditions." If I am correct that some of today's decisions are indeed mistaken, I assume that we will not be slow to reexamine and correct them.