The FCC Wants to Hide All Controversial Cross-Subsidies and Manipulations of AT&T, Verizon and CenturyLink’s Financial Accounting.

04/17/2017 10:21 pm ET

NOTE: FREE REPORTS: The Hartman Memorandum and The History & Rules of Setting Phone Rates in America are written by telecommunications experts for regulators and interested parties and specifically submitted to the FCC to start to investigations into the cross-subsidies.

In a very inside-baseball proceeding, (the Jurisdictional Separations and Referral to the Federal-State Joint Board) that has not gotten any attention, the FCC has requested an 18 month extension to examine the cost allocation rules that are applied to revenues and expenses of AT&T, Verizon and CenturyLink’s state utilities, which they control.

The problem is that the FCC has been taking extensions in the same, exact proceeding for 16 years (which we will discuss). This takes the phrase “kicking the bucket down the road” to a whole new level of government cover-up.

And this proceeding is critical. In a meeting scheduled for April 20th, 2017, the FCC is steam-rollering and doing a hatchet job on upcoming proposals that will be discussed. From Broadband Data Services, (BDS), to the shutting off the copper networks, or the IP Transition, the FCC plans to gut all customer protections, block competition, and harm all businesses that rely on these data services, (formerly called “Special Access”).

So, how can the agency, then, attempt to shut down and delay examination of the accounting rules that are directly tied to these other items?

On April 17th, 2017 we filed comments with the FCC to start immediate audits and investigations of the cross-subsidies of the incumbent phone companies, AT&T, Verizon and CenturyLink. As we document, Verizon’s own financial accounting revealed massive manipulations of the financial books created by the FCC’s “Big Freeze” and negligence. But this is happening in every state because the FCC rules are federal, not state-based.

What Is the FCC Hiding? Massive Financial Cross-Subsidies and Data Manipulation which are Caused by the FCC’s Own Accounting Rules – The “Big Freeze”.

EXAMPLE: This financial excerpt is taken directly from the Verizon Massachusetts’ financial accounting for the year 2014. It shows that Local Service has paid the majority of all expenses and cross-subsidized all of the other lines of business, including construction budgets.

Local Service revenues are mostly from the copper-based “POTS”, “Plain Old Telephone Service”, lines. Verizon has stated it is no longer upgrading and maintaining these lines, the retail copper lines.

However, Local Service:

  • Paid 60% of All “Corporate Operations” Expense — At $558 million, this is $81 million — 119% — more than the revenues. Corporate Operations includes lawyers, lobbying, executive pay, and even the corporate jets - all aimed at pushing Verizon’s agenda nationwide.
  • · Paid 53% of All “Marketing”— When is the last time you saw a Verizon advertisement for basic phone service?
  • · Paid 43% of All “Network (Plant)” Costs — even though the company stopped upgrading most of the copper-based Local Service networks.
  • · Verizon Local Service Expenses Were Over $1 Billion in Just 2014 — yet it is all a manipulated financial accounting scheme. Local Service shows claimed losses (of just these specific major expenses) of $604 million on $1.1 billion in expenses.
  • · Verizon Massachusetts Showed Overall Losses of $814 Million for 2014 — Because of all of the manipulation of accounting, Verizon MA, overall, has been showing losses in most years. In fact, Verizon MA paid no income taxes and had multiple tax benefits from these losses.

In short, Verizon Massachusetts’ financials shows that Local Service was overcharged over $600 million dollars in just 2014. There should be no marketing costs and little or no network costs, as most of the copper wires are not being upgraded or maintained. And charging Local Service excessive Corporate Operations expenses would not have been allowed if there was oversight by the state regulators.

  • How did this Happen? The FCC’s Big Freeze — 16 Years of Regulatory Neglect

This is happening in every state and the impacts are caused by the FCC’s “freeze” on accounting rules that were set in the year 2001. While there are multiple questionable acts, at the core, the fact is that the losses of Verizon MA were created, in large part, by the FCC, which sets the rules about the incumbent phone companies' accounting.

Simply put:

In 2001, the FCC “froze” the calculations of expenses that are used in every state, based on the year 2000 — and this freeze has continued through the year 2017. And now the FCC, instead of auditing the financial books and investigating the cross-subsidies, (which we have been filing about for the last 5+ years) wants to punt for another one and a half years.

  • Verizon New York’s Corporate Operations Expense Charges to Local Service Via the FCC’s Big Freeze are Obscene.

In our previous reports we used Verizon New York’s financials; the Freeze can best be seen by this detail of Corporate Operations expense of Verizon NY, the state utility, from 2003-2014.

Corporate Operations expenses are a massive garbage pail fund of corporate expenses (mostly from the parent holding company) for executive pay and the corporate jets to the lawyers and lobbyists defending Verizon’s position.

In 2003, then, expense allocations were based on revenues, but the “freeze” froze the percentage of expenses for the year 2001. However, this also meant that the other lines of business paid a fraction of what they should have been paying.

From 2003 through 2014, Verizon NY, the state utility, had Local Service pay about 60% of all Corporate Operations expenses, even though the revenue of Local Service went from 65% to 27.6%. By 2014 this caused Local Service to pay 119% of revenues, causing losses.

And, if you notice, Verizon MA and Verizon NY used what appear to be identical ‘Freeze’ calculations for Corporate Operations expenses, having the Local Service category pay 60% of all expenses.

  • The Big Freeze Impacts on Special Access: A Mockery of the Principles of a Utility and Public Obligations.

Corporate Operations expense is only one area where the Big Freeze slapped the local phone customers in the financial face. Specific parts of the state networks have been deemed “interstate” and profitable, such as “Special Access”, as they aren’t paying their fair share of the expenses, while the local networks have been allowed to deteriorate. And this is not simple conjecture but based on publicly available data, such as Verizon NY’s financial reports or the current ongoing investigation of Verizon New York by the NY State Public Service Commission.

  • Verizon New York’s 2015 Annual Report Shows the Big Freeze Financial Manipulation of the Construction Expenses, Making Special Access Extremely Profitable.

How can Local Service be paying the majority of network expenses? And how can Special Access services have a 66% EBITDA, (Earnings Before Interest, Taxes, Depreciation and Amortization), for mostly copper-based services while the same exact wires have massive losses?

According to Verizon NY’s 2015 Annual Report, Local Service brought in $1.3 billion and had an EBITDA of -132%. This is in contrast to Special Access fees, which were $2.5 billion in revenue and had an EBITDA of 66%. (Special Access was $2 billion and represents 80%+ of the total.)

One would say that ‘Local Service’ was losing money until one examines the network costs (“Plant Specific and Non-Plant Specific”) and notices that Local Service paid $1.47 billion, which is in contrast to Special Access services only paying $716 million, literally half of what Local Service paid. i.e., Local Service paid 117% of its revenue while Special Access paid 29% of its revenue.

These financial analyses are based entirely on Verizon’s financial annual reports and the findings directly impact not just the Big Freeze but every upcoming FCC decision.

Summarizing the FCC’s negligence in examining the Big Freeze:

  • Special Access of Verizon has obscene profits and is not paying its fair share of the expenses.
  • Local phone customers have been overcharged thousands of dollars to pay for the expenses of Special Access and Verizon’s other services.
  • Local phone customers have paid the majority of Corporate Operations expense, which includes charging customers for executive pay and lawyers to protect Verizon and to harm consumer protections.
  • If Local Service customers are paying the capital expenditures, then all of the FCC and phone companies’ Business Data Services models, not to mention all of the paid ‘experts’, are wrong as none of them bothered to use actual available financial information.
  • Verizon NY’s financial Annual Reports are public and available, so there is no excuse to create meaningless mathematical models. However, it appears that virtually all of the phone companies and their paid analysts fall into the same trap. These financial excerpts from the actual incumbent phone companies shows that Verizon’s Business Data Services are NOT paying what a mathematical model claims; i.e., the construction expenses in the model are not being paid by the incumbent’s actual service, but are paid, in large part, by local phone customers.
  • The Hartman Memorandum Rips Apart the FCC’s Proposed New Regulations Pertaining to the IP Transition, Shutting Off the Copper Networks and Special Access.

The Hartman Memorandum proves that the FCC can never create “just and reasonable” pricing for Business Data Services because the FCC’s own cost allocation rules created massive financial cross subsidies between and among the state-based wired utilities, and the companies’ other lines of business, such as BDS or the wireless service.

How it Works: (See the Report for full detail.)

In order to make sure that the different lines of business paid their fair share to use the networks, a system was created so that both state and federal regulators were on the same page:

  • Uniform System of Accounts (USOA) (also called “Part 32”) was created. It itemized the tens of thousands of expenses, revenues, taxes, and put them into a database/catalog with hundreds of separate categories.
  • Separations Manual (Part 36) was created to be able to allocate these expenses to the different lines of business.

Local ‘POTS’ or plain old telephone service would be listed in specific revenue categories using the USOA and the expenses would be charged based on the Separations Manual. Originally, the expenses were based mostly on revenues (with caveats).

And in one of the first acts to erase all obligations, in 2017 the FCC has erased the Part 32 obligations, claiming it is just too burdensome for companies to deal with.

  • 75-25% Rule Allocates Costs to Local Service vs “Interstate”

And, as mentioned previously but worth repeating, around 1984 the Separations Joint Board recommended and the FCC ruled that the ‘interstate’ portion would only pay 25% of expenses for a majority of the network costs. ‘Intrastate’ would pay 75% of these expenses associated with such loop investments as Cable and Wire Facilities.

This means that on top of the failed cost allocations, a second whammy is in place: Local phone service (the majority is “Intrastate”), would pay the majority of the capital expenditures.

This rule was created in 1984 and has not been adjusted or replaced for 32 years despite the increase of fiber in the loop, which was NOT placed to benefit the local service customer but rather to benefit advanced services. Per the cost causer philosophy of the FCC, local service customers should only be paying a fraction of these costs, not the majority of expenses.

  • Timeline: 16 Years of Extensions that Even Use the Same Wording.

We collected for the reader this embarrassing timeline of 16 years of extensions. This same phrase has appeared in some form since 2000— “until comprehensive reform could be achieved”.

Time Line:

  • 2000: “On July 21, 2000, the Joint Board issued its 2000 Separations Recommended Decision, recommending that, until comprehensive reform could be achieved, the Commission should freeze the expenses.
  • 2001: “The Commission ordered that the freeze would be in effect for a five-year period beginning July 1, 2001, or until the Commission completed comprehensive separations reform, whichever came first.
  • 2006: “On May 16, 2006, in the “2006 Separations Freeze Extension and Further Notice”, the Commission extended the freeze for three years or until comprehensive reform could be completed, whichever came first. The Commission concluded that extending the freeze would provide stability to LECs pending further Commission action to reform the... rules, and that more time was needed to study comprehensive reform. The freeze was subsequently extended by one year in 2009, 2010, and 2011 and by two years in 2012.”
  • 2010: “March 30, 2010, the State Members of the Joint Board released a proposal for interim and comprehensive separations reform... On September 24, 2010, the Joint Board held a meeting with consumer groups, industry representatives, and state regulators to discuss interim and comprehensive reform...
  • 2011: “In addition, in 2011, the Commission comprehensively reformed the universal service and intercarrier compensation systems and proposed additional reforms. The Joint Board is considering the impact of the reforms proposed by the USF/ICC Transformation Order and any subsequent changes on its analysis of the various approaches to separations reform.”
  • 2014-2017: “On March 27, 2014, the Commission sought comment on extending the freeze once more. We extend through June 30, 2017.... We conclude that extending the freeze will provide stability to carriers that must comply with the Commission’s jurisdictional separations rules while the Joint Board continues its analysis of the jurisdictional separations process.

Conclusion

  • The FCC must audit the financial accounting books of the incumbent state utilities immediately and stop all proceedings until it actually does the proper analysis of Business Data Services, (formerly called “Special Access” services), revenues and profits, as well as the treatment of the copper utility networks, or the financial impacts of the IP Transition.
  • We object to the extension on the grounds that it is being done as a cover-up so that actual financial data is excluded from the FCC rulemaking process.
  • The FCC has been negligent in examining the harms that its Big Freeze has caused for over a decade, and it is clear it will continue to do so by allowing this extension to go forward.
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