Investigate the FCC’s Accounting Rule Scandal before They are Erased.

05/31/2017 12:36 am ET

This is a snapshot of the FCC’s Big Freeze Accounting Scandal. I’ll get back to this in a moment.

NOTE: On May 24th, 2017, the IRREGULATORS filed comments with the FCC and the Federal-State Joint Board on Jurisdictional Separations to investigate the current FCC accounting scandal. Click for the complete filing or read the summary below.

FCC Chairman Ajit Pai’s agenda as told by an interview with Re/Code, May 5th, 2017, is to use a weed-whacker to remove the accounting rules.

“Re/Code: “In the early days, you had said that you wanted to take a weed-whacker to remove the rules that are holding back investment. What did you mean by that?
Pai: “What I had in mind were some of the regulations that we’ve had on the books for a while that stand in the way of investment in networks. Our Part 32 accounting rules — exceedingly boring, I recognize — but just the fact that companies have to maintain two different sets of books, literally one for their business and one for the FCC’s purposes, and the FCC hadn’t relied on any of that paperwork in years. I asked our staff, ‘When was the last time you looked at these reports?’ They said, ‘Pretty much never.’ We wanted to relieve some of those. Those are the kinds of regulations I had in mind because I want every dollar that a company has to be spent on building out networks, not on paperwork or regulatory requirements that aren’t relevant in 2017, whatever relevance they might’ve had back in 1934 or 1996 or 2015 or whatever.” (Emphasis added.)

In fact, the FCC is wasting no time in whacking those weeds, as there have been at least four separate proceedings, two ongoing, to erase any remaining FCC rules or obligations on the companies, AT&T, Verizon and CenturyLink, who control the state utilities as well as the essential infrastructure for wireless.

And then there is the FCC’s “Big Freeze” scandal.

Above is a snapshot of how the FCC’s negligence (failing to examine the impacts of its own rules, “pretty much never”) has caused multiple financial harms.

In 2001, the FCC imposed rules and then never examined their impacts for over 16 years. This created a massive financial shell game that has overcharged customers billions per state.

The top blue line is flat and shows that from 2003 to 2014, Verizon NY’s local service networks paid the majority, about 60%, of the total “Corporate Operations” expenses (i.e.; expenses for the corporate jet fleet or even the lobbyists and the lawyers that defend removing net neutrality, for example). Based on local service revenues, (the pink line), which has been in decline, over $840 million was overcharged in just one year, 2014. The same thing has been happening in every state for over a decade. We will discuss this chart in a moment.

The FCC’s plan is not to fix the impacts that its mal-formed federal regulations have had on customers or cities or states, but to erase and therefore immortalize the overcharging and harms, while having the government help and protect the incumbent phone companies that control the wires: Verizon, AT&T and CenturyLink.

COMMENTS of the IRREGULATORS

On April 17th, 2017, the IRREGULATORS filed comments with the FCC calling for the Agency to do audits and investigations of the FCC’s “Big Freeze”. The FCC’s accounting rules were ‘frozen’ so that the expenses are allocated to different services based on the year 2000, 17 years ago. This ‘freeze’ has created massive financial cross-subsidies, making local phone customers pay the majority of expenses for all services, from the capital expenditures for the wireless companies, to Business Data Services (BDS). Auditing the impacts of the ‘freeze’ is important because it documents that the FCC has been negligent and is creating new public policies without accurate financial data.

With those comments we submitted a series of reports written by experts, forensic auditors and lawyers. This included “The Hartman Memorandum”, which was written with the assistance of a former FCC Assistant Chief of the Pricing Policy Division (PPD) who was also a member of the Federal-State Joint Board and a specialist in the cost allocation rules.

On May 15th, the FCC issued an order. The Reports were ignored and the comments made by the FCC about the work lacked sense as the FCC never dealt with any of the specific findings outlined in the reports or comments. Instead, the FCC decided to continue the freeze for an additional 18 months. This appears to be nothing but a cover-up to remove all of the accounting rules without any analysis, audits or investigations. However, it will immortalize the financial cross-subsidies that benefit the incumbent phone companies, especially AT&T, Verizon and CenturyLink.

The Federal-State Joint Board has asked:

  • Re: Federal-State Joint Board on Jurisdictional Separations Seeks to Refresh Record on Issues Related to Jurisdictional Separations, FCC 17J-1
  • Re: Federal-State Joint Board on Separations Seeks Comment on Referral for Recommendations of Rule Changes to Part 36 as a Result of Commission Revisions to Part 32 Accounting Rules, FCC 17J-2

To protect the Public Interest, the Joint Board must act – and stop the FCC’s plans from erasing the accounting rules, but instead implement a fix that stops the massive cross-subsidies that have been put into place and benefit the companies and their affiliates over the Public Interest.

The Freeze and the FCC’s accounting rules have distorted every aspect of telecom. From the proceeding to ‘shut off the copper’, where the FCC has neglected to mention that the wires are part of the state utility or that the networks are ‘unprofitable’ through a manipulation of the accounting of expenses, to the Business Data Services (special access) proceeding, where the FCC never acknowledges, again, that the wires are part of the state utility or that the services are paying a fraction of common costs because of the FCC’s freeze of the cost allocation rules. There has been no serious oversight for 16 years and the FCC has created a financial shell game that has gone hidden from view, but is making severely flawed and harmful public policies.

And there are other ‘freezes’ that are even more disturbing, such as the 75-25% rule: The Hartman Memorandum details how the FCC has never examined or fixed the 75-25% rule—which assigns 75% of much of the network expenses to “intrastate”, and this has been a rule since the dawn of the Digital Age.

In toto, all of these financial machinations make the local networks appear unprofitable, when they are not. They have made local phone customers defacto investors in the companies’ interstate and nonregulated businesses, which was not supposed to occur. And worse, through manipulations of the access line accounting, though the FCC wants to ‘shut off the copper’, it can’t tell America exactly how many total copper wires are used for services that are not being counted—everything from DSL and VOIP services to special access ATM and alarm services, or even the wires used by AT&T for its copper-to-the-home service, U-verse.

We are also concerned by recent comments of Chairman Pai during an interview with Re/Code, May 5th 2017, where he specifically singles out Part 32. He had asked his staff “When was the last time you looked at these (Part 32) reports?” They replied, “Pretty much, never”. The Joint Board must examine whether the FCC failed to properly review and analyze all of the implications of eliminating the Uniform System of Accounting (USOA) before the Agency’s action on February 23, 2017.

As if in some rush, now, the FCC wants to simply erase the rules as if they were a serious burden, and to keep the cross-subsidies in place, which will have no financial audit trail to follow. Considering that the companies have to prepare annual taxes and that with billions of dollars in revenues per state and expenses that are itemized, the only burden has been on communications customers and the economic growth of America.

We refresh this record, again, with “Fixing Telecom”, a report series done as an independent voice, without corporate or political financing, because sometimes the Public should come first.

Discussion Section: We have added a separate section to summarize and discuss the impacts of the Big Freeze, the mal-formed cost allocation rules, and why investigations and audits are an imperative, as compared to the FCC’s current plans to cover up and immortalize the financial shell game in place today.

We Highlight Five Basic Points.

Because of the FCC’s Freeze:

1) Local Service Customers Were Charged the Majority of All Expenses, Such as Marketing or Even Construction.

There are 3 major revenue categories related to the state utility:

  • “Local Service” are mostly regular copper-based phone lines and ancillary services.
  • “Access”, which are categorized as ‘interstate’ services, like Business Data Services, are business lines used for ATM machines or the wires to cell sites. And they use the same copper or fiber utility networks used for local service.
  • “Nonregulated”, are items that were previously or never regulated before; it includes DSL or parts of FiOS, and they, too, are part of and use the state utility wires.

In 2014, Local Service generated 28% of revenue, Nonregulated 27% and the rest, 45%, was for Access. But look at how the expenses are being charged to each area:

  • Local Service paid the majority of all expenses, 58%, and this is absurd. Why did Local Service pay 50% of the construction and maintenance when Verizon has specifically stated that it is not upgrading or maintaining the copper wires?
  • How can POTS, Plain Old Telephone Service, have paid 53% of the Marketing expense? When was the last time you saw an ad for a copper-based phone line?
  • The kicker is: Local Service paid the majority, 60%, of Corporate Operations.

In contrast:

  • Nonregulated services, including some of the revenues from the FiOS services, had the same revenues as Local Service but it paid 1/6th of the Corporate Operations expense and ½ of the Marketing expenses that Local Service paid; it also paid ½ of the construction expenses.
  • Access (Interstate), of which 80% are the Business Data Services, had the majority of revenues, but it paid ½ of what Local Service paid for CapEx.

NOTE: While this is from Verizon NY, we found almost identical breakouts for other Verizon states. And, as we detail, the last available data from the FCC (2007), showed an identical pattern—as these are federal rules.

2) The FCC’s Freeze Caused this Massive Cross-Subsidy Scheme.

Why does Local Service pay 60% of the Corporate Operations expense? In 2014, Local Service paid $1.6 billion of this expense, but it only brought in $1.4 billion – causing Local Service to look unprofitable. For just Corporate Operations, Verizon New York’s Local Service was overcharged $843 million dollars in just 2014, based on revenues. At the same time, Special Access services underpaid by $405 million dollars. Why?

This shows that in 2003, Local Service was 65% of the revenue and it paid about 65% of the expenses. By 2014, Local Service only brought in $1.4 billion, 28% of the revenues, yet it was still paying 60% of this expense.

Nonregulated, which had the same revenues, was paying a fraction of this expense and Access services were also paying a great deal less, though it brought in over $2+ billion in just NY in just 2014.

In short, the FCC’s freeze in 2001 kept the expenses charged to Local Service at the same level throughout the next 16 years, even though the expenses no longer had anything to do with the revenues. And it did this in every expense category.

3) Verizon New York Local Service has had Multiple Rate Increases – 84%, Starting in 2006, to Pay for “Massive Deployment of Fiber Optics” and Losses.

In New York, Verizon was granted three rate increases back to back; the 3rd occurred in June 2009. Verizon filed a 2-page letter, with attachments for the increase — that’s it. In the discussion, Verizon characterizes the FiOS build out as “an advanced voice/video/data network”. And, most important, Verizon does not mention it is losing money but quotes the NYPSC that addresses Verizon’s financials.

Excerpt from Verizon’s request for a rate increase:

The State’s analysis is scary because it, too, has ignored the actual cost causers of making Local Service unprofitable and granted increases, where the actual expenses had nothing to do with Local Service provisioning. In fact, this shows that local phone customers had rate increases to pay for fiber optic broadband.

It also shows that the losses are being created by the FCC’s freeze and these are for items that have nothing to do with Local Service, such as charging billions in Corporate Operations expense or marketing.

4) Verizon New York: Local Service Was Overcharged $1.7 Billion in Just 2014

Verizon NY’s expenses do not track with the actual cost-causing activities or even track to the revenues. If Local Service was paying expenses based on the revenues it brought in, then Local Service was overcharged $1.7 billion – in just New York, in just 2014. Conversely, Access (Business Data Services) underpaid by $1.3 billion in expenses while Nonregulated was undercharged $438 million.

But, this analysis leaves out a critical point – Local Service should not be paying most of the Marketing or for the ‘massive deployment of fiber optics’.

5) The FCC Rules Are a Burden to the Companies and the Economy—Not.

The FCC actually wrote:

“Reducing the cost and burden of these FCC rules will allow carriers to allocate scarce resources toward expanding modern networks that bring economic opportunity, job creation and civic engagement to all Americans… This can be costly, requiring additional training for accountants, a second set of customized software, and two sets of audits.”

The “scarce resources” and the burden of keeping financial books is contradicted by Verizon, which filed on March 7th, 2017 to request an extension for submitting the Verizon NY Annual Report for 2016 to the New York Public Service Commission (originally due on March 31, 2017). Verizon writes that there are only three individuals (and some support staff) that work on over 300 reports annually for New York and other states. I repeat three people.

“Verizon’s regulatory reporting team is comprised of three individuals who, together with their manager and a system administrator, have responsibility for preparing, reviewing, and filing over 300 reports annually, in New York and in other states. Well over half of those reports are due at the beginning of the year — between January 1 and April 15. None of the financial data that provides the basis for the reports is available until January 21 at the earliest. Thus, over half of the group’s annual workload is compressed into less than a quarter of the year.”

Verizon has about 161,000 employees, so this burden requires some ‘burden of proof’. The idea that the companies do not keep track of all of these financial details, especially when they have requirements to pay state and federal taxes, is simply ludicrous. Verizon NY had revenues of over $5 billion in 2014 – and getting all of the documentation for tax purposes alone would require the majority of the data collection needed to fulfill the cost accounting rules in place.

Conclusion: The FCC simply wants to dismantle all of the cost accounting rules and obligations and has punted to fix these problems. Yet, the FCC’s own accounting rules are responsible for this shell game. Dismantling or erasing the rules will simply result in a permanent freeze, immortalizing the cross-subsidies.

In short: It is time to investigate the FCC’s Big Freeze accounting rule scandal before they are erased. It may require taking the FCC to court to stop an agency that prides itself on its own ignorance, pretty much—all the time.

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