Cybertelecom Federal Internet Law & Policy An Educational Project

Notes: Computer I & II

These notes are not complete and there is no guarantee that they are accurate. They are presented simply as notes. Feel free to use them but as with all material on the Cybertelecom, you should consider them a beginning to your research and not an end.

Telephone Carriers Entrance into Enhanced Services Market

    The Commission has long sought to maintain appropriate safeguards for the provision by the BOCs of enhanced services.[9] Since its Computer I proceeding, the Commission has adopted a variety of regulatory tools to prevent improper cost allocation and access discrimination against ESPs in the provision of enhanced services, both by the BOCs, and, before divestiture, by their predecessor in interest, AT&T.[10] In the Computer II proceeding, the Commission required the then-integrated Bell System to establish structurally separate affiliates for the provision of enhanced services in order to address the concern over AT&T's incentive and ability to engage in anticompetitive activity.[11] Following the divestiture of AT&T in 1984,[12] the Commission extended the structural separation requirements of Computer II to the BOCs.[13] In Computer III, after reexamining the telecommunications marketplace and the effects of structural separation during the six years since Computer II, the Commission determined that the costs of structural separation outweighed the benefits, and that nonstructural safeguards could protect competitive ESPs from improper cost allocation and discrimination by the BOCs while avoiding the inefficiencies associated with structural separation.[14]

    [9] Basic services, such as Aplain old telephone service@ (POTS), are regulated as tariffed services under Title II of the Communications Act. Enhanced services use the existing telephone network to deliver services that provide more than a basic transmission offering. Examples of enhanced services include, among other things, voice mail, electronic mail, electronic store-and-forward, facsimile store-and-forward, data processing, and gateways to online databases. See, e.g. Bell Operating Companies' Joint Petition for Waiver of Computer II Rules, Memorandum Opinion and Order, 10 FCC Rcd 1724 n.3 (1995) (Interim Waiver Order); 47 C.F.R. ' 64.702(a); Amendment of Section 64.702 of the Commission's Rules and Regulations (Computer III), Report and Order, CC Docket No. 85-229, Phase I, 104 FCC 2d 958 (1986) (Phase I Order), recon., 2 FCC Rcd 3035 (1987) (Phase I Recon. Order), further recon., 3 FCC Rcd 1135 (1988) (Phase I Further Recon. Order), second further recon., 4 FCC Rcd 5927 (1989) (Phase I Second Further Recon.), Phase I Order and Phase I Recon. Order, vacated, California v. FCC, 905 F.2d 1217 (9th Cir. 1990) (California I); Phase II, 2 FCC Rcd 3072 (1987) (Phase II Order), recon., 3 FCC Rcd 1150 (1988) (Phase II Recon. Order), further recon., 4 FCC Rcd 5927 (1989) (Phase II Further Recon. Order), Phase II Order vacated, California I, 905 F.2d 1217 (9th Cir. 1990); Computer III Remand Proceedings, 5 FCC Rcd 7719 (1990) (ONA Remand Order), recon., 7 FCC Rcd 909 (1992), pets. for review denied, California v. FCC, 4 F.3d 1505 (9th Cir. 1993) (California II); Computer III Remand Proceedings: Bell Operating Company Safeguards and Tier 1 Local Exchange Company Safeguards, 6 FCC Rcd 7571 (1991) (BOC Safeguards Order), recon. dismissed in part, Order, CC Docket Nos. 90-623, 11 FCC Rcd 12513 (1996); BOC Safeguards Order vacated in part and remanded, California v. FCC, 39 F.3d 919 (9th Cir. 1994) (California III), cert. denied, 115 S.Ct. 1427 (1995) (referred to collectively as the Computer III proceeding); Filing and Review of Open Network Architecture Plans, 4 FCC Rcd 1 (1988) (BOC ONA Order), recon., 5 FCC Rcd 3084 (1990) (BOC ONA Reconsideration Order); 5 FCC Rcd 3103 (1990) (BOC ONA Amendment Order), erratum, 5 FCC Rcd 4045 (1990), pets. for review denied, California v. FCC, 4 F.3d 1505 (9th Cir. 1993), recon., 8 FCC Rcd 97 (1993) (BOC ONA Amendment Reconsideration Order); 6 FCC Rcd 7646 (1991) (BOC ONA Further Amendment Order); 8 FCC Rcd 2606 (1993) (BOC ONA Second Further Amendment Order), pet. for review denied, California v. FCC, 4 F.3d 1505 (9th Cir. 1993).
    [10] Regulatory and Policy Problems Presented by the Interdependence of Computer and Communication Services and Facilities (Computer I), 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).
    [11] Amendment of Section 64.702 of the Commission's Rules and Regulations (Computer II), 77 FCC 2d 384,475-486, && 233-60. (1980) (Computer II Final Decision), recon., 84 FCC 2d 50 (1980) (Computer II Reconsideration Order), further recon., 88 FCC 2d 512 (1981) (Computer II Further Reconsideration Order), affirmed sub nom. Computer and Communications Industry Ass'n v. FCC, 693 F.2d 198 (D.C. Cir. 1982), cert. denied, 461 U.S. 938 (1983).
    [12] United States v. AT&T, 552 F. Supp. 131 (DDC 1982), affirmed sub nom. Maryland v. United States, 460 U.S. 1001 (1983).
    [13] Policy and Rules Concerning the Furnishing of Customer Premises Equipment, Enhanced Services and Cellular Communications Equipment by the Bell Operating Companies, CC Docket No 83-115, Report and Order, 95 FCC 2d 1117, 1120, & 3 (1984) (BOC Separation Order), affirmed sub nom. Illinois Bell Telephone Co. v. FCC, 740 F.2d 465 (7th Cir. 1984), affirmed on recon., FCC 84-252, 49 Fed. Reg. 26056 (1984) (BOC Separation Reconsideration Order), affirmed sub nom. North American Telecommunications Ass'n v. FCC, 772 F.2d 1282 (7th Cir. 1985).
    [14] Computer III Phase I Order, 104 FCC 2d at 964-965, && 3-6. We discussed in detail the history of the Computer III proceeding in the Computer III Further Remand Notice, 10 FCC Rcd at 8362-8369, && 3-10.

AT&T - Consent Decree - Modified Final Judgment

The Modified Final Judgment (the MFJ), the antitrust consent decree which compelled AT & T to divest the BOCs, originally prohibited the BOCs from offering any "information services," a class of services that apparently is similar to enhanced services. United States v. AT & T, 552 F.Supp. 131 (DDC1982), aff'd sub nom. Maryland v. United States, 460 U.S. 1001 (1983). On March 7, 1988, the U.S. District Court for the District of Columbia that oversees the MFJ (the MFJ Court) issued an order removing that restriction for certain types of information services for which the BOCs subsequently filed CEI plans. U.S. v. Western Electric Co., Inc., No. 82-0192 (DDC filed Mar. 7, 1988) (March 7 Order).
-- In the Matter of Filing and Review of Open Network Architecture Plans, CC Docket No. 88-2, Phase I, MEMORANDUM OPINION AND ORDER ¶ 29 n 60 (December 22, 1988)
 

"For the reasons stated, the Court will exempt from the information services restriction the transmission of information generated by others in the manner and to the extent described above." United States v. Western Elec. Co., 673 F.Supp. 535, 597 (DDC 1987), affirmed in parted, reversed in part, 900 F.2d 283 (DC Cir 1990), cert denied MCI v. US, 498 U.S. 911 (1990).
 

B. Information Services
    The proposed decree prohibits the Operating Companies from providing information services, an umbrella description of a variety of services including electronic publishing and other enhanced uses of telecommunications. [237] This prohibition is necessary for reasons similar to those justifying the restriction on interexchange services, as well as for additional reasons not relevant to the interexchange problem.
    All information services are provided directly via the telecommunications network. The Operating Companies would therefore have the same incentives and the same ability to discriminate against competing information service providers that they would have with respect to competing interexchange carriers. Here, too, the Operating Companies could discriminate by providing more favorable access to the local network for their own information services than to the information services provided by competitors, and here, too, they would be able to subsidize the prices of their services with revenues from the local exchange monopoly. [238]
    There is also the effect on the configuration of the local networks to consider. Many of the competitive problems in the interexchange market resulted from the fact that competition was introduced after AT & T had designed the local networks to service only its own Long Lines department. If the Operating Companies are excluded from the information services market, they will have an incentive, as time goes on, to design their local networks to accommodate the maximum number of information service providers, since the greater the number of carriers the greater will be the Operating Companies' earnings from access fees. Thus, competition will be encouraged from the outset. If, however, the Operating Companies were permitted to provide their own information services, their incentive would be the precise opposite: it would be to design their local networks to discourage competitors, and thus to thwart the development of a healthy, competitive market. [239]
    The restriction on the provision of information services by the Operating Companies has been attacked on the ground that it will remove their incentive to upgrade the local networks and will cause them to become technological backwaters. [240] This claim underrates the role of the Operating Companies under the proposed decree. These companies will carry traffic between the information service providers and their subscribers; their networks will therefore have to be capable of carrying these technologically advanced services; and they will have a financial incentive to create this capability because they will earn access charges for providing this service. [241]
    For all of these reasons, the imposition of this restriction is fully consistent with the antitrust laws.

    FN237. For a full discussion of the meaning of this term see Part VI supra.
    FN238. For similar reasons, the Court rejects the argument that the Operating Companies can most efficiently provide information services by taking advantage of various economies (such as using the same equipment for exchange telecommunications and for information services). It would be impossible to determine at any time whether the Operating Companies' advantages were due to inherent efficiencies, or to efficiencies created by structuring the network so as to hinder competition. The experience with AT & T's activities with regard to interexchange competition indicates that the latter is a possibility which would be difficult to detect or prevent.
    FN239. The reasons underlying the ban on provision of electronic publishing services by AT & T provide further support for restricting the Operating Companies from this activity. See Part VI supra.
    FN240. It cannot be claimed that this restriction will result in rate increases: the Operating Companies do not now provide such services on any large scale, and it is not at all clear that they would be a great source of profit to them in the future.
    FN241. Entry of the Operating Companies into this market is not necessary to provide competition for AT & T. The large amount of interest generated by this growing industry indicates that there will be a number of competitors. See Part V(A) supra.

 24. In 1974, the United States Department of Justice (DOJ) filed an antitrust complaint against AT & T, alleging that AT & T had monopolized, or attempted to monopolize, a number of markets for telecommunications equipment and services in violation of Section 2 of the Sherman Act. ⁶²  In 1982, AT & T and DOJ settled the complaint by agreeing to the entry of a consent decree, which, after some significant modifications were made, was adopted by the United States District Court for the District of Columbia as a Modification of Final Judgment (MFJ). ⁶³  The MFJ required AT & T to divest itself of its wholly- owned operating companies, the BOCs, and most of the assets held by the BOCs. Pursuant to the MFJ, AT & T filed a Plan of Reorganization, which the Court also approved, that provided for this divestiture and the reorganization of the 22 BOCs into seven regional holding companies. ⁶⁴  As a result of divestiture, which took place on January 1, 1984, AT & T no longer provides local exchange service and, in some states, intra-LATA ⁶⁵ toll service.  It does, however, continue in its other major lines of business.  AT & T retained its CPE and enhanced services businesses as well as its research, manufacturing, and inter-LATA toll facilities.  The BOCs, as owners of local exchange facilities, were prohibited from manufacturing CPE or providing inter- LATA transmission services and were subjected to general line-of-business restrictions that limit the services and products they may provide.
 25. The MFJ treated AT & T and the BOCs in different ways with regard to the provision of "information services", which it defined as follows:
  The offering of a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information which may be conveyed via telecommunications, except that such service does not include any use of any such capability for the management, control or operation of a telecommunications system or the management of a telecommunications service. ⁶⁶
With respect to AT & T, the MFJ considered two general classes of information services:  1) "electronic publishing," in which AT & T would control the content of transmitted information, and 2) data processing and other computer- related services, which would involve no AT & T control of content other than for transmission purposes. ⁶⁷  The MFJ prohibited AT & T from engaging in electronic publishing for a period of seven years from the date of entry of the decree.  The Court concluded that such a restriction is necessary to avoid potential dangers to competition and First Amendment values. ⁶⁸  However, the MFJ formally freed AT & T from the general restrictions on its provision of data processing and other computer-related services imposed by the 1956 Decree, ⁶⁹ since the Court found that AT & T's unrestricted entry into such markets would likely "benefit the American consumer, American foreign trade, and national defense". ⁷⁰
 26. However, the MFJ prohibited the BOCs from providing any information services.  The Court found that such a prohibition would not only guard against potential discrimination and cross-subsidization, but also would motivate the BOCs to design their local networks to accommodate the maximum number of information service providers.  According to the Court, if the BOCs were permitted to provide information services, they would have incentives to design the local networks to discourage competition, ⁷¹ but with the prohibition in place, their incentives to increase their earnings from network access fees will lead them to implement network designs that encourage competitive entry into information services.
--In the Matters of: Amendment of Sections 64.702 of the Commission's Rules and Regulations (Third Computer Inquiry);  and Policy and Rules Concerning Rates for Competitive Common Carrier Services and Facilities Authorizations Thereof Communications Protocols under Section 64.702 of the Commission's Rules and Regulations, CC Docket No. 85-229, Report and Order (June 16, 1986)
 

 277.  While it has been argued by various parties that AT&T is foreclosed from engaging in activities which are not regulated, it is by no means clear that this is in fact so.  We note that Section IV of the decree describes permissible activities of Western Electric and Section V describes the permissible business activities of AT&T and all of its subsidiaries, except Western Electric and Western Electric's subsidiaries. [FN117]  Based on our reading of these sections we stated in the Tentative Decision, at para. 142, our belief that excluding CPE from tariff-type regulation would not foreclose Bell System participation in the CPE market.  We read Section IV of the decree as permitting Western Electric to sell or lease any type of equipment to the general public which it sells or leases to Bell System companies either for service to others or for their own use.  In addition, we perceived enhanced services as being incidental to the provision of common carrier communications services under Section V(g) of the decree.  Nothing has been presented to us in the course of this proceeding which would lead us to conclude otherwise. Nothing in Section V(g) requires that the incidental service be provided by the same entity which owns the underlying transmission facilities.  Indeed, we have found that the record supports our belief that both enhanced services and CPE are within our subject matter jurisdiction although that jurisdiction is of the 'reasonably ancillary' type rather than Title II jurisdiction.  As such, these services and equipment reasonably fall within the 'incidental to common carrier communications' language of the consent decree.  We therefore affirm our earlier conclusions.  See Tentative Decision at paras. 135-148.  But we do not believe it necessary to rely upon this 'incidental' proviso to Section V of the decree.  That Section plainly permits AT&T to furnish 'common carrier communications services' which are defined in Section II(i) as 'communications services and facilities . . . the charges for which are subject to public regulation under the Communications Act of 1934 . . .'  (Emphasis added.) Section II(i) does not require that the 'regulation' to which it refers take any particular form other than that it be 'public' and that it be 'under the Communications Act of 1934.'  Both criteria are satisfied by the regulatory regime which we impose in this decision.  The obvious purpose of the 'regulation' requirement is to ensure, through the scrutiny of an independent body, that AT&T neither destroys competition nor charges consumers excessive prices.  These purposes are fully achieved here, in our view, without the necessity for strict, tariff-type regulation.  Moreover, we believe that these purposes can be more fully realized under the separation structure and through the medium of competition than if AT&T were allowed to offer enhanced services as part of its regulated common carrier offerings.
 278.  We do not believe that the reference to 'communications' in the defined phrase 'common carrier communications services' was intended to have any separate prohibitory function so long as the services and facilities remain 'subject to' regulation under the Communications Act.  If the services and facilities are a proper regulatory subject of that Act in the eyes of the expert agency charged with enforcing that Act, it should make no difference to an antitrust court, inclined to avoid duplicating or interfering with that agency's judgment, that some of the services 'subject to' regulation may include a larger element of data processing than basic transmission.  So long as the service is not wholly data processing and devoid of any communications elements, the Commission's jurisdiction reaches it.  GTE Service Corp. v. FCC, 474 F.2d 724 (2d Cir. 1973).
 279.  In coming to these conclusions we are guided by the principles of consent decree construction.  We understand that the 1956 AT&T consent decree is to be construed as one would a written contract, such that any command of the decree must be found within its four corners.  See United States v. Armour & Co., 402 U.S. 673 (1971); United States v. ITT Continental Baking Co. 420 U.S. 223 (1975).  We have previously indicated that DOJ's reliance on the 'regulation' criterion as a benchmark for permissible activity does not comport with actual practices of the Bell System. [FN118]  The courts have previously refused to accept any 'strained construction' by the Government that is inconsistent with the 'normal meaning' of the language used.  United States v. Atlantic Refining Co., 360 U.S. 19, 22-23 (1959).  In effect, DOJ would read 'tariff regulation' into Section II(i) of the decree in place of 'public regulation,' the term actually employed.  We believe our interpretation is the more consistent with the learning of Armour and ITT Continental. We believe our reading of the decree is similarly compatible with fundamental antitrust principles--the laws under which the judgment court took jurisdiction--which favor open entry.  See Northern Pacific Railway v. U.S., 356 U.S. 1, 4 (1958).  Moreover, such principles have increasingly gained critical significance in the communications regulatory environment.  See United States v. FCC, F.2d, slip op. at 73.  (D.C. Cir. No. 77-1249, Mar. 7, 1980). Further, we believe that the prohibition in the consent decree should be narrowly construed, because an expansive reading would be restrictive of a free economy.  Cf. United States v. McKesson & Robbins, 351 U.S. 305, 316 (1956). [FN119]
 280.  We recognize that companies of the Bell System are faced with making corporate decisions in the presence of uncertainty.  We obviously cannot guarantee that the consent decree does not impose some constraint on their activities in these areas.  At the same time, however, removal of the uncertainty rests primarily with AT&T, should AT&T deem it necessary.  As we perceive the situation, the choice rests with AT&T either to seek clarification from the judgment court as to the limits of permissible activity in these areas, or, weighing the risks, to proceed with its marketing plans for various types of CPE and enhanced services.
 281.  We believe that the purposes of both our regulatory statute and the antitrust laws are furthered by our adoption of a regulatory scheme requiring separation of basic telecommunication services and enhanced ancillary services and equipment so that customers in both markets are given the benefit of the best service and the lowest cost.  It is a regulatory scheme that is conducive to the fullest exploitation of this county's telecommunications networks, and will best serve all segments of society.  Even though uncertainty may exist for the Bell System under this structure due to the consent decree, we believe that the costs to society in general would be too great were there to be regulation in these areas.  It would be far worse to subject CPE and enhanced services to regulation.  However, should a decision of the judgment court disagree with our reading of the decree and foreclose AT&T from the provision of enhanced services or CPE, we would feel compelled to reassess the situation to ascertain whether any revision to decisions made here would be warranted in light of our statutory mandate.  See Geller v. FCC, 610 F.2d 973 (D.C. Cir. 1979).
--In re Amendment of Section 64.702 of the Commission's Rules and Regulations (Second Computer Inquiry), Docket No. 20828, Final Decision, 77 FCC2d 384 (May 2, 1980) (Computer II Final Decision)

  . . . communications services and facilities, other than message telegram service, the charges for which are subject to public regulation under the Communications Act of 1934, or any amendment thereof, or would be subject to such regulation thereunder if such service or facility were furnished in interstate commerce; and shall also include any communications service or facility, other than message telegram service, the charges for which are or became subject to regulation under existing or future laws of any state, territory, or the District of Columbia, but only in the jurisdiction or jurisdictions in which the charges for such service or facility are subject to regulation.

² United States v. Western Electric Co., Inc., and American Telephone and Telegraph Company. (consent judgment). 13 RR 2143; 1956 Trade Cases 71,134 filed January 24, 1956, D.C.N.J. (See also Paragraph 43 herein.)

Purpose / Concerns

 9. In our Tentative Decision, we identified specifically the following areas of regulatory concern:
 (a) That the sale of data processing services by carriers should not adversely affect the provision of efficient and economic common carrier services;
 (b) That the costs related to the furnishing of such data processing services should not be passed on, directly or indirectly, to the users of common carrier services;
 (c) That revenues derived from common carrier services should not be used to subsidize any data processing services; and
 (d) That the furnishing of such data processing services by carriers should not inhibit free and fair competition between communication common carriers and data processing companies or otherwise involve practices contrary to the policies and prohibitions of the anti-trust laws. (Tentative Decision, para. 34).
--In The Matter Of Regulatory And Policy Problems Presented By The Interdependence Of Computer And Communication Services And Facilities, Docket No. 16979, Final Decision and Order, ¶ 9 (March 18, 1971) (Computer I).

Dangers

Reasons to Permit Carrier Offering of Enhanced Services

Maximum Separation / Structural Separation

Goals, Objectives

²  47 C.F.R. ss 64.702(c) and (d) require that a carrier establish a separate data processing entity having separate books of accounts, separate officers, separate operating personnel and separate equipment and facilities devoted exclusively to rendition of data processing services; and the carrier is prohibited from promoting the data processing services offered by the separate subsidiary.  Carriers with annual revenue less than one million dollars were exempt from the maximum separation requirement.

  . . . assure (a) that such services will not adversely affect the provision of efficient and economic common carrier services; (b) that the costs related to the furnishing of such services will not be passed on directly or indirectly, to the users of common carrier services; (c) that revenues derived from common carrier services will not be used to subsidize any data processing services; and (d) that the furnishing of such services will not inhibit free and fair competition between communication common carriers and data processing companies or otherwise involve practices contrary to the policies and prohibitions of the antitrust laws.  Tentative Decision at para 34.

  . . . we are not seeking to regulate data processing as such, nor are we attempting to regulate the substance of any carrier's offerings of data processing.  Rather we are limiting regulation to requirements respecting the framework in which a carrier may publicly offer particular non-regulated services, the nature and characteristics of which require separation before predictable abuses are given opportunity to arise.  Final Decision at para 30.

Outright Prohibition

Competitive Disadvantage

 For a relatively small capital investment, a service firm can be formed, computer equipment can be leased, and programmers can be hired. The factors which mark the difference between service bureau success or failure are imaginative innovation, quality programming, and useful service features, rather than the size of the staff or the computing installation. (para. 21).

Maximum Separation (Computer I) (All Carriers)

 12. Having determined not to impose outright prohibitions against carrier provision of data processing services, we now turn to a consideration of the questions raised regarding those safeguards we have proposed in order to obviate any derogation of carrier communication service obligations to the public, or to prevent any abuse or limitation with respect to free competition because of the carrier's access to customers as a provider of communication services. As we stated in our Tentative Decision:

 The dangers... relate primarily to the alleged ability of common carriers to favor their own data processing activities by discriminatory services, cross- subsidization, improper pricing of common carrier services, and related anticompetitive practices and activities. (para. 22).

Minimum Threshold

 36. Accordingly, we are hereby adopting a policy that communications common carriers shall furnish data processing services only through separate corporate entities. This requirement shall be applicable to all communications common carriers engaged in interstate or foreign communications services, including connecting carriers within the meaning of Section 2(b)(2)(3) and (4) of the Communications Act, where any such carrier itself has annual operating revenues exceeding $1,000,000 or any such carrier is directly or indirectly controlled by or is under common control with another carrier or carriers and the combined annual operating revenues of all such carriers exceed $1,000,000.⁵ Each such data processing entity shall be staffed with separate officers and operating personnel and shall use equipment and facilities devoted exclusively to the rendition of data processing and other non-common carrier services. We shall also require that the data processing affiliate maintain its own books of account and file with the Commission separate annual and other reports as may be prescribed by the Commission pursuant to Section 218 of the Communications Act. Further, we shall require the submission by the carrier (whether the carrier be a parent or subsidiary) of all inter-corporate agreements and memoranda of any arrangements between the carrier and its affiliate. When such separate corporate entity obtains communications facilities or services from its affiliated common carrier, (whether parent or subsidiary) it will be required to do so pursuant to the same tariff terms, conditions, and practices as are applicable to any other customer of the carrier, and specifically, on terms and conditions no more favorable than those offered to other unaffiliated entities. Moreover, we shall require that no carrier subject to the aforementioned conditions engage in the sale or promotion of data processing activities on behalf of its data processing affiliate. Finally, we will expect any affiliate of a common carrier to permit reasonable interconnection with facilities of the customer.
--In re Regulatory And Policy Problems Presented By The Interdependence Of Computer And Communication Services And Facilities, Docket No. 16979, Tentative Decision, ¶ 36 (April 3, 1970)
 

International Carriers

Carrier's Computers

 13. Western Union contends that certain economies and consequential public benefits would flow from the public sale, lease or other disposition of a common carrier's 'off-peak' or 'back-up' computing system capacity. While it may be true that costs allocated to the sale of such capacity would reduce the revenues required from communications services, we believe that the potential abuses inherent in operations of this nature outweigh whatever benefits might be achieved. First of all, a carrier's 'back-up' system should be designed to meet foreseeable breakdowns of equipment dedicated to public service and it should be available instantly for that purpose without the conflicting claims of other users. With respect to 'off-peak' capacity, it is clear, assuming sound systems analyses were employed by carrier personnel, that such capacity exists only during those hours when the communications flow is light, and that during peak hours, the systems' capacity approaches full utilization for communication services provision. It is characteristic of common carrier service that normal peaks shift and that abnormal or non-recurring peaks eventuate from time to time. The use of 'off-peak' capacity for data processing would derogate from the carrier's ability to accommodate these occurrences. Such arrangements could result in an unacceptable conflict with the vital public functions for which the carriers are licensed.
 14. Aside from these considerations, there are also other problems inherent in joint use of facilities or personnel. Our experiences with attempting to allocate investment and costs between and among communication services provided by fungible plant and operated by the same personnel of a common carrier convince us of the great difficulties which could be involved in allocation procedures between communications and data processing activities. The potential for abuse and the difficulty of preventing or promptly remedying improprieties convince us that we should not alter our tentative conclusions as to the desirability of the type of separation contemplated by or Tentative Decision.
 15. Under these circumstances, any economic benefits that might accrue to the carrier or its customers by permitting the commingling of regulated and data processing activities are, in our judgment, more than offset by the potential adverse effects of such an arrangement. We conclude that a carrier's computer system or systems should be dedicated exclusively to its public communication services or to its 'inhouse' data processing requirements incidental thereto.
--In The Matter Of Regulatory And Policy Problems Presented By The Interdependence Of Computer And Communication Services And Facilities, Docket No. 16979, Final Decision and Order, ¶ 11 (March 18, 1971) (Computer I).
 

Cross Promotion

Services to Carriers by Affiliate

Service to Affiliate from Carrier

Discrimination

 We expect that under no circumstances will carriers give any preferential treatment to their data processing affiliates and that carriers will scrupulously administer the terms and conditions of tariffs in making their facilities and services available to affiliates and non-affiliates on a non- discriminatory and non-preferential basis. (Tentative Decision, par. 37.)

Hybrid Service

 31. It is contended by several parties in this proceeding that this Commission is obligated by statute to regulate the 'hybrid service', as defined, [FN11] insofar as such service contains a communication component. We cannot agree. As we have indicated in our  Tentative Decision:

It is our position that where message-switching is offered as an integral part of and as an incidental feature of a package offering that is primarily data processing, there will be total regulatory forebearance with respect to the entire service whether offered by a common carrier or non-common carrier... (Emphasis added). (Tentative Decision, para. 41).We believe that we are granted discretionary latitude, under the Communications Act and relevant judicial interpretations  hereof, to refrain from subjecting a marginal activity to our regulatory process where it is clear that the public interest will be served by such a course. (See para. 28, supra.)

39. We turn now to those offerings of service which combine data processing and message-switching to form a single integrated service we have defined hereinbefore as a hybrid service. We have already made it clear that it is not our intention to assert direct regulatory jurisdiction over the sale of data processing whether engaged in either by conventional communication common carriers or other entities despite the employment of communications facilities to accomplish the data processing.When, however, data processing is combined with message-switching, a different question is presented. This is because message-switching is, in essence, an operation which is inherent in the process of transmitting, by wire or radio, intelligence of data from point of origin to point of destination. As in the case of remote access data processing, user terminals are linked to the central computer by communications channels. Thus, it is possible for users not only to have on-line communication with the computer for data processing purposes, but it is also possible for such users to have the means of communicating with each other when the computer is programmed to switch messages of one to another. Unlike data processing, however, the computer, when and if used for message-switching, does not alter the content of the intelligence transmitted. It simply performs the function of storage and either immediate or delayed forwarding of the message to its addressed destination. In this respect the computer takes the place of the manual or electro-mechanical switching or relay operations which are typically involved in the transmission of intelligence for hire by communications common carriers.
 40. The specific question presented is, under what circumstances should a message-switching capability, when offered in combination with data processing services, be treated as a sale of communication for hire subject to regulation under the Communications Act as are other communications services offered for hire by common carriers? There is no pat formula which provides the answer to this question because of the wide range of service arrangements that are possible and actually obtain. However, we believe that we can state certain general principles that will apply in the determination of these questions in particular cases.
 41. It is our position that where message-switching is offered as an integral part of and as an incidental feature of a package offering that is primarily data processing, there will be total regulatory forebearance with respect to the entire service whether offered by common carrier or non-common carrier, except to the extent that common carriers offering such a hybrid service will do so through affiliates and will be subject to regulatory safeguards as discussed above.
 42. If, on the other hand, the package offering is oriented essentially to satisfy the communications or message-switching requirements of the subscriber, and the data processing feature or function is an integral part of and incidental to message-switching, the entire service will be treated as a communications service for hire, whether offered by a common carrier or non- common carrier and will be subject to regulation under the Communications Act. One applicable test will be whether the service, by virtue of its message- switching capability, has the attributes of the point-to-point services offered by conventional communications common carriers and is, basically, a substitute therefor. Another test will be the extent to which the message-switching feature of the service facilitates or is related to the data processing component, or whether such message-switching is essentially independent of such data processing. In effect, we shall address ourselves to the facts surrounding a package offering with a view toward determining the primary thrust of the service offered.
 43. We deem it important that these distinctions be carefully applied and that the essential nature of the service as primarily data processing or communication not be artifically obscured. In the case of AT&T and related Bell System companies, these distinctions are significant since such companies are foreclosed by the AT&T Consent Judgment (supra) from rendering non-tariffed services. Insofar as data processing is incidental to communications within the meaning of Paragraph V(g) of the Consent Judgment, as well as our policy statement herein, AT&T, and its affiliated operating companies are free to furnish such a service. We intend to maintain a careful and continuous observation of the activities of the Bell System companies in their use and application of computer technology for both communications and administrative purposes, to the end that such companies shall not offer data processing which is not clearly incidental to communications within the meaning of the Consent Judgment and this policy statement.
 44. Similarly, in the case of Western Union, we have already had occasion to consider the status of its SICOM and INFOCOM services. We determined in 1967 that both of these services were common carrier communications offerings in which computers were being used to provide a transmission service that included the kind of message-switching function traditionally performed by communications common carriers, as well as other functions directly related to switching, such as error checking, format control, and the like (In the Matter of SICOM, supra, at 9-12). We stated further that if the services were broadened to include an offer to perform data processing services other than the aforementioned message-switching or related functions, the tariffs might be subject to rejection as offering non-common carrier, non-communications services (In the Matter of SICOM, supra, at 12). Under our decision herein, Western Union would be permitted to continue to offer these services as tariffed common carrier communications services. However, we shall expect any changes in the SICOM or INFOCOM services to be reflected in appropriate tariff revisions which shall thereupon be closely scrutinized by the Commission in order to determine whether the modifications have altered the status of these services under the Communications Act. If our examination reveals services of primarily data processing, we would require Western Union to withdraw its tariffs and provide such revised offerings through a separate corporate entity under our safeguard rules.
 45. We have heretofore deferred action on the question of whether certain computerized switching services for airlines offered by two existing common carriers, RCA and ITT, should be covered by tariffs filed with us. (See Letters from the Federal Communications Commission to RCA Communications, Inc., and ITT World Communications, Inc., December 20, 1967 (FCC File No. 9510.)
 Our decision herein would require tariffs for such services to be filed since they are not hybrid offerings exempted from regulation. However, if the switching services were broadened to include substantially data processing, they would be treated by the Commission in the same manner as would an altered SICOM or INFOCOM service.
--In The Matter Of Regulatory And Policy Problems Presented By The Interdependence Of Computer And Communication Services And Facilities, Docket No. 16979, Tentative Decision (April 3, 1970)

Computer II Structural Separation

Not Small Telcos

Structural Separation (BOCs was ATT and GTE)

⁸⁰Id. at 468, para. 219.
⁸¹Id. at 469-70, 473-74, paras. 223-24 and n.228.

    3. In 1980, the Commission issued Computer II, which adopted a regulatory scheme with two categories of communications services: basic and enhanced. Basic services, such as "plain old telephone service" (POTS), are regulated as tariffed services under Title II of the Communications Act. Enhanced services use the existing telephone network to deliver services other than basic transmission, such as voice mail, E-Mail, voice store-and-forward, fax store- and-forward, data processing, and gateways to on-line databases.
    4. In Computer II, the Commission concluded that enhanced services should not be regulated under Title II of the Communications Act. [FN7] The Commission established rules to govern the provision of enhanced services, including a requirement that the then-integrated Bell System establish separate subsidiaries for the provision of enhanced services. [FN8] Following the divestiture of AT & T in 1984, [FN9] the Commission extended the structural separation requirements of Computer II to the BOCs. [FN10]
-- In The Matter Of Computer III Further Remand Proceedings: Bell Operating Company Provision Of Enhanced Services, CC Docket No. 95-20, Notice of Proposed Rulemaking, ¶¶ 3-4 (February 21, 1995)
 

"The FCC has found that a BOC is eligible for relief from the structural separation requirement of Computer II when: a) it becomes technically able to offer each of its initial ONA access services to ESPs; b) its federal tariffs for each of its initial ONA access services are in effect; and Commission) it has filed state tariffs for each of its intrastate ONA access tariffs . . . In June 1992, Bell Atlantic became the first RHCs to be grated relief from the structural separation requirement."  --Henry M. Rivera and Laura Johnson, Patents, Copyrights, Trademarks and Literary Course Handbook: Panel on Developments in Manufacturing and Information/Enhanced Services, 352 PLI/Pat 27, 47 (Dec. 3-4, 1992).
 

 14. Under the Computer II structural separation rules, the AT & T separate subsidiary was prohibited from providing basic services or owning any network or local distribution transmission facilities, while its basic services affilates were prohibited from offering enhanced services or CPE.  Those rules also strictly limited the interactions of the separate subsidiary with its basic services affiliates. ³³  We required the separate subsidiary to obtain all transmission facilities necessary for providing enhanced services under tariff. ³⁴  We required it to elect separate officers;  maintain separate books of account;  employ separate operating, installation, and maintenance personnel;  and perform its own marketing and advertising.  We further required it to deal with any affiliated manufacturing entity only on an arms-length basis and to utilize separate computer facilities in providing enhanced services.  Moreover, the separate subsidiary was required either to develop its own software or to contract with non-affiliates for such software, except that it was permitted to obtain generic software embedded within equipment that its affiliate sold off-the-shelf to any interested purchaser (the Software Rule).  AT & T subsequently established AT & T Information Systems, Inc. (AT & T-IS) as its separate subsidiary for enhanced services and CPE.
--In the Matters of: Amendment of Sections 64.702 of the Commission's Rules and Regulations (Third Computer Inquiry);  and Policy and Rules Concerning Rates for Competitive Common Carrier Services and Facilities Authorizations Thereof Communications Protocols under Section 64.702 of the Commission's Rules and Regulations, CC Docket No. 85-229, Report and Order (June 16, 1986)

"Basic transmission services would be regulated under Title II while enhanced services would not. Carriers affiliated with the American Telephone and Telegraph Co. (AT&T) and General Telephone and Electronics Corp. (GTE) would be required to offer enhanced services through a separate subsidiary on a resale basis such that underlying transmission facilities are obtained pursuant to tariff.  "
--In the Matter of Amendment of Section  64.702 of the Commission's Rules and  Regulations (Second Computer Inquiry),  Docket No. 20828, MO&O, 79 FCC2d 953   ¶ 5 (July 22, 1980) (resolving requests for  partial stays of final decision)

     229.  The thrust of applying the resale structure to AT&T and GTE is to establish a structure under which common carrier transmission facilities are offered by them to all providers of enhanced services (including their own enhanced subsidiary) on an equal basis.  Inherent in the resale structure is the fact that the separate corporate entity may not construct, own, or operate its own transmission facilities.  In essence, the resale subsidiary must acquire all its transmission capacity from an underlying carrier pursuant to tariff.  This means that the same transmission facilities or capacity provided the subsidiary by the parent, must be made available to all enhanced service providers under the same terms and conditions.  Requiring the subsidiary to acquire its transmission capacity from other sources pursuant to tariff provides a structural constraint on the potential for abuse of the parent's market power through controlling access to and use of the underlying transmission facilities in a discriminatory and anticompetitive manner.
     230.  The separate subsidiary for enhanced services and CPE also provides a structural mechanism for the separation of these carriers' regulated and nonregulated activities, thereby lessening the potential that the communications ratepayer will be subsidizing their unregulated ventures.  While we discuss below the relationship between the subsidiary and affiliated entities, the subsidiary itself is not regulated.  Thus the subsidiary may not provide basic transmission services for to do so would subject it to regulation and negate the structural separation of regulated and non regulated activities.
--Final Decision, In re Amendment of Section 64.702 of the Commission's Rules and Regulations (Second Computer Inquiry), 77 FCC2d 384, ¶ 229 (1980)

Purpose

⁸ Basic communications services are regulated under Title II of the Communications Act.  Basic services, such as "plain old telephone services (POTS)," provide pure transmission capability over a communications path that is virtually transparent in terms of its interaction with customer-supplied information.  Id. at 420.
⁹   Id. at 474-75, para. 231.
¹⁰   Id.

"the absence of traditional public utility regulation of enhanced services offers the greatest potential for efficient utilization and full exploitation of the interstate telecommunications network Significant public benefits accrue to the Commission's regulatory process, providers of basic and enhanced services, and consumers under this approach."
--Final Decision, In re Amendment of Section 64.702 of the Commission's Rules and Regulations (Second Computer Inquiry), 77 FCC2d 384, ¶ 7 (1980)

Application to AT&T (BOCs) and GTE

⁸. United States v. AT&T, 552 F.Supp. 131 (DDC 1982), affirmed sub nom. Maryland v. United States, 460 U.S. 1001 (1983).
^9. Policy and Rules Concerning the Furnishing of Customer Premises Equipment, Enhanced Services and Cellular Communications Equipment by the Bell Operating Companies, CC Docket No 83-115, Report and Order, 95 FCC 2d 1117, 1120, para. 3 (1984) (BOC Separation Order), affirmed sub nom. Illinois Bell Telephone Co. v. FCC, 740 F.2d 465 (1984), affirmed on recon., FCC 84-252, 49 Fed. Reg. 26056 (1984) (BOC Separation Reconsideration Order), affirmed sub nom. North American Telecommunications Ass'n v. FCC, 772 F.2d 1282 (7th Cir. 1985).

 12.  Weighing the public interest benefits of our objectives and the economic tradeoffs inherent in a separate subsidiary requirement, we have determined that limited imposition of the requirement will best serve the communications ratepayer and the public interest more generally.  There is little need to subject carriers to the resale structure if such entities lack significant potential to cross-subsidize or to engage in other anticompetitive conduct.  We find that only AT&T and GTE present a sufficiently substantial threat such that they should be required to establish separate corporate entities for the provision of enhanced services and customer-premises equipment.  We will not require any other underlying carrier to form separate entities for the provision of these services and CPE.  Accordingly, we are removing the maximum separation requirements for all carriers except those under direct or common control of AT&T or GTE.  In reaching this conclusion we recognize that a reasonable balance can be struck only following a weighing of all appropriate circumstances bearing upon the risks that largely captive monopoly ratepayers will be burdened by anti-competitive conduct on the one hand and that opportunities for economic efficiencies redounding to their benefit may be lost on the other.  The locus of the balance changes with circumstances. Because we have the flexibility under the Communications Act to adjust the balance as circumstances change or additional evidence is brought to light, we opt for a solution in which only AT&T and GT&E must form separate subsidiaries to offer ENHANCED service or CPE. Similarly, in establishing guidelines governing the relationship of the separated entities with their affiliates, we opt for a pragmatic approach which we can adjust when and if necessary.
. . . . .
215.  In ascertaining which carriers should be subject to the resale structure the decision must be based not only on a carrier's ability to engage in anti- competitive activity but also on its resources.  The latter is relevant because we have no desire to foreclose entry into the enhanced services and CPE markets by any carrier.  Hence, we must give due recognition to the ability of carriers to cover the costs of separation.  Such costs include not only the capital expenditures involved, but also some increased risks associated with separation which would presumably be greater for the small carrier.  For these smaller carriers, separation may also result in more limited access to capital markets.  Another important factor is that if separation does cause some economic inefficiency, the measure of this inefficiency will decrease as the size of the firm increases.  This is so because greater size corresponds to greater flexibility in effectuating the separation, thus permitting closer approximation to an economically efficient outcome. [FN85]
. . . . .
   218.  To the extent that all firms offering enhanced services and CPE are not yet marketing their services on a nationwide basis, we believe this is largely a function of the infant yet promising nature of these markets. Regional markets, centering around large urban industrial cities where the large business users are located may currently be another appropriate area in which competition for these services can be measured.  But here, too, we note that only AT&T and GTE appear to have significant abilities and incentives to engage in anticompetitive conduct, since it is in these areas where they control the local facilities.  In contrast, the rural telephone companies would be hard pressed to attempt to bankrupt competitors in their local areas where such competitiors may flourish in the major metropolitan areas, or throughout the nation generally. Again, we believe that the unlikely prospects of their success will in turn diminish their incentives to attempt predation, leaving the local ratepayer at much less risk than those captive to AT&T and GTE local services.
. . . . .
     220.  The need, then, does not exist to subject carriers to the resale structure if such entities lack the potential to cross-subsidize or to engage in anticompetitive conduct to any significant degree.  We believe that with the changes taking place in the competitive makeup of the communications industry our regulatory concerns which give rise to the need for structural separation should be directed at monopoly telephone companies exercising significant market power on a broad geographic basis.
     221.  Non-telephone carriers do not have the kind of market power we are concerned with here.  Specialized carriers, such as MCI and SPCC, lack local distribution facilities entirely, and have no reservoir of monopoly ratepayers from which to extract the excess profits necessary to cross- subsidize other services.  Such carriers would be in a position to deny access on only a limited number of interexchange transmission systems.  Any private advantages from such conduct would be short-lived, as customers could readily avail themselves of alternative suppliers.  Domestic satellite carriers also have no local distribution plant, and no ability to monopolize interexchange transmission systems.  They are in competition not only with terrestrial systems, but also with each other, and thus, with the possible exception of their video service offerings, their market power is limited.  Similarly Western Union does not possess local monopoly facilities which could be employed to deny or reduce access to enhanced services competitors nor does it generate profits or cash flow comparable to that of the larger telephone holding companies which could be employed as a source of cross-subsidies. Moreover, we would expect our recent PMS decision to result in a further diminution of any capacity Western Union might possess to engage in anticompetitive conduct on a substantial basis. [FN88]
     222.  Weighing the competitive changes which have occurred in the communications sector since the First Computer Inquiry, we do not believe that broad application of the resale structure is necessary to satisfy the regulatory objectives set forth there. Moreover, we have been able to monitor the development of new and innovative services, and conclude that the potential for these services to reach a greater segment of society would be substantially increased if we exercised restraint in the exercise of our discretion in applying the resale structure.  Weighing these factors, and recognizing the risks involved, we find that the separation requirement should be applied only to those telephone companies having sufficient market power to engage in effective anti-competitive activity on a national scale and which possess sufficient resources to enter the competitive market through a separate subsidiary.
     223.  An objective standard upon which a determination can be made as to which telephone companies possess these characteristics is not easily established. However, when we examine Table 1, we see that only four companies have more than 1% of industry revenues, and a fifth is above the 1% level in terms of number of telephones.  As the Table exhibits, there is a sharp distinction with respect to these shares between AT&T and the rest of the industry and between GTE and the rest of the independents.  The companies ranked 3, 4 and 5 in terms of revenues form an approximate group of their own.  The remaining companies possess a combination of size, geographic service area(s), and monopoly revenue base (which is typically a small fraction of the total operating revenues shown in Table 1) such that we are not convinced that the benefits of separation outweigh the costs.  Even when we consider the market penetration of the top five carriers listed in Tabel 1, a fairly clear distinction can be drawn between AT&T and GTE on the one hand, and the other telephone companies on the other hand.  Because of the relative size of AT&T and GTE and the diverse national markets they serve, we conclude that, at present, the resale structure should be applied to AT&T and GTE.  We realize that an argument could be made for subjecting other telephone companies to this structure, but we conclude that it would better serve the public interest to take a restrictive approach at this juncture in applying the resale structure and wait to see if competitive abuses develop which warrant further application of this structure for either enhanced services or CPE.
. . . . .
     227.  The rationale for imposing a separation requirement only on AT&T and GTE has even greater force when considering CPE.  Only these two U.S. telephone companies have basic manufacturing operations producing large quantities of a wide range of telecommunications equipment.  Both AT&T and GTE hold substantial market positions, if not market power, in the provision of certain kinds of CPE.  Their significant participation in these markets indicates that these companies have substantial incentives to sustain their market positions by thwarting the provision of such equipment on a competitive basis.  Their local monopoly positions, in turn, provide the opportunity (without maximum separation) to engage in such anticompetitive conduct--with the monopoly ratepayer being forced to subsidize below cost pricing of CPE.  United and Continental, on the other hand, have shown little inclination to participate in the equipment manufacturing market, apparently due to the cyclical nature of profits in that market.  Continental Supply and Service Corporation does provide centralized purchase and distribution of equipment and parts for Continental's operating telephone companies, and Continental Telephone Laboratories tests and recommends practical applications for equipment; but the carrier sold its primary manufacturing subsidiary (Vidar Corporation) in 1975, explaining to stockholders that '[T]he cyclical nature of manufacturing operations and other considerations have led to the conclusion that the Company and its stockholders would benefit by withdrawal from the field of manufacturing and by concentration of investment and manpower in telephone operations.' [FN96]  The following year Continental completed its divestiture of manufacturing operations with the sale of the Cable Division of Superior Continental Corporation, and again cited the 'volatility of earnings inherent in the cyclical nature of these operations.' [FN97]  Similarly, United's subsidiary, North Supply Company, an international distributor of telecommunications products with more than a quarter of a billion dollars in annual sales, was formerly a division of North Electric Company.  United sold the manufacturing division of North Electric in 1977, incurring a $2.3-million loss on the transaction, and notified stockholders that the sale, together with the 1978 sale of Central Kansas Power Company, left 'United Telecom's resources concentrated in three activities--telephone service, computer services and distribution services.  All are strong markets and United is well positioned in each of them.' [FN98]
     228.  Thus we believe that continued application of our maximum separation policy to all carriers is inappropriate in the face of the present and foreseeable market applications of computer processing technology and increased competition in the provision of regulated communications services. Contrary to the approach in the Tentative Decision, we conclude that not all carriers owning transmission facilities should be required to provide enhanced services through a separate corporate entity.  Separation is appropriate in those cases in which there is a substantial threat of injury to the communications ratepayer and where other regulatory tools would not suffice. Both AT&T and GTE provide franchised monopoly telephone service and competitive services.  Moreover, both are vertically and horizontally integrated with affiliated equipment manufacturers which supply the preponderant share of the equipment needs of the affiliated telephone companies.  Thus, both AT&T and GTE have significant market positions in various equipment product lines as well as certain service categories in certain large geographic markets.  We are thus concerned that both companies could exploit their dominance in these product lines to support below cost prices in more competitive markets.  Weighing the public interest benefits of our objectives and the economic tradeoffs of the separate subsidiary requirement, we have determined that restricting the requirement to AT&T and GTE will best serve the monopoly and other communications ratepayers and the public interest more generally.  Accordingly, we are removing the maximum separation requirements for all carriers except those under direct or indirect common control of AT&T or GTE.
--Final Decision, In re Amendment of Section 64.702 of the Commission's Rules and Regulations (Second Computer Inquiry), 77 FCC2d 384, ¶¶ 218, 220 (1980)
 

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