II. Background

III. Issues
The Payphone Marketplace
Compensation for Each and Every Completed Intrastate and Interstate Call Originated by Payphones
1. Payphone Calls Subject to this Rulemaking and Compensation Amount
2. Entities Required to Pay Compensation
3. Ability of Carriers to Track Calls from Payphones
4. Administration of Per-Call Compensation
5. Interim Compensation Mechanism

Reclassification of LEC-Owned Payphones
1. Classification of LEC Payphones as CPE
2. Transfer of Payphone Equipment to Unregulated Status
3. Termination of Access Charge Compensation and Other Subsidies
4. Deregulation of AT&T Payphones

Nonstructural Safeguards for BOC Provision of Payphone Service

Ability of BOCs to Negotiate with Location Providers on the Presubscribed InterLATA Carrier

Ability of Payphone Service Providers to Negotiate with Location Providers on the Presubscribed IntraLATA Carrier

Establishment of Public Interest Payphones

Other Issues
1. Dialing Parity
2. Letterless Keypads on Payphones
3. Oncor Petition

IV. Procedural Matters
1. Petitions for Reconsideration
2. Paperwork Reduction Act Analysis
3. Regulatory Flexibility Act Analysis

Conclusion

Ordering Clauses

Appendix A
Text of Section 276
Appendix B
List of Parties Filing Comments
Appendix C
List of Parties Filing Replies
Appendix D
Immediate Rules Adopted by This Order
Appendix E
Rules Adopted by This Order
Appendix F
Interim Compensation Obligations

Reclassification or Transfer of Payphone Equipment to Nonregulated Status

a. The Notice

152. In the Notice, we sought comment on the specific assets to be transferred, and tentatively concluded that the assets to be transferred should be defined generally in terms of CPE deregulation. Thus, we tentatively concluded that the assets to be transferred may include all facilities related to payphone service, including associated deferred income tax reserves and depreciation, but likely would not include the loops connecting the payphones to the network, or the central office "coin-service" or operator-service facilities supporting incumbent LEC payphones. We proposed to transfer the payphone equipment at undepreciated baseline cost plus an interest charge based on the authorized interstate rate of return to reflect the time value of money. We also tentatively concluded that a phase-in period for a transfer of payphone-related assets is not necessary, because payphone terminal equipment consists of less than one percent of total plant investment for the entire LEC industry. In the Notice, we also sought comment on whether our approach to asset transfer is consistent with the 1996 Act's definition of "payphone service" as the "provision of public or semi-public pay telephones, the provision of inmate telephone service in correctional institutions, and any ancillary services."

      

     b. Comments

153. Both USTA and MCI indicate that all public telephone terminal equipment, including associated assets and depreciation, should be transferred, but not loops or central office coin-service or operator-service facilities. GVNW argues that the assets to be transferred should include investment, depreciation, maintenance and overhead. Florida PSC asserts that loops and central office features should not be deregulated so that they will be available to all. GTE argues that only pay station investment should be transferred. The RBOCs list the assets that should be transferred to include: payphones, enclosures, pedestals, coin counting machines, vehicles, land, and buildings used solely for payphone services.

      

154. GPCA argues that location contracts associated with payphones should be assigned an economic value to recover ratepayer equity and achieve competitive equity. GPCA contends that the Commission can use present value, appraisals, or auctions to value the contracts. Peoples also argues that the contracts should be valued, noting that it had valued the location contracts and goodwill at approximately 70 percent in a recent purchase of payphone assets. SDPOA argues that the name brand associated with LEC payphones should also be valued in the transfer of assets. CPA asserts that LEC payphone assets should be valued at a going concern value and that a transfer at net book value would give the LECs a competitive advantage. Brill argues that BOCs should not be allowed financial and accounting advantages, and cites other competitive advantages that, it states, the BOCs have in some jurisdictions.

      

155. Ameritech and USTA argue that the accounting treatment for transferred assets should be governed by Section 32.27(c) of our rules regarding transactions with affiliates. USTA argues that there is no need to alter our Part 64 rules to create cost pools or to change current accounting practices. Ameritech states that Section 32.27(c) requires that assets be transferred at the higher of estimated fair market value or net book value and that the cost allocation manual process provides the mechanism for making the asset transfer. The RBOCs argue that the payphone assets should be valued at net book value, as the Commission has done in the past including the recent Inmate Services Order, and that the Commission should require LECs to transfer only those assets in their existing regulated accounts. They assert that location contracts are not in their regulated accounts and are intangibles that have never been recognized in Commission rate proceedings. The RBOCs also argue that establishing market value for payphone assets would be costly and cause delays. AT&T asserts that payphone assets should be valued at net book value in accordance with the Commission's existing rules.

156. The RBOCs contend that the asset transfer should occur within 12 months. GPCA opposes a delay of up to 12 months for asset transfers and elimination of access charge elements and subsidies, and argues that these requirements must be completed by November 8, 1996. GPCA recommends that the Commission implement requirements no later than 90 days after release of this Report and Order. Ameritech argues that there is no need for a phase-in period. MCI does not object to up to 12 months for transition, but argues that the Commission should set a specific date. USTA contends that the deregulation should be flash cut in order to eliminate subsidies.

      

     c. Discussion

157. As an initial matter, we have already determined that neither Section 276 nor our past experience requires the BOCs' competitive provision of payphone services to take place on a prospective basis through the use of structurally separate affiliates. Instead, in this Report and Order, we require that, if a BOC does not provide payphone services through a separate affiliate, it must provide these payphone services using nonstructural safeguards as described in our Computer III Orders and ONA proceedings and consistent with Section 276, because we conclude that, in the absence of structural separation, our nonstructural safeguards provide sufficient protection against the possibility of cross-subsidization of nonregulated activities. Those nonstructural safeguards include the cost allocation rules and affiliate transactions rules adopted in the Joint Cost Order. Under those rules, the BOCs and other incumbent LECs must classify each of their activities as regulated or nonregulated in accordance with our requirements. We now require that the BOCs and other incumbent LECs, subject to our joint cost rules, classify their payphone operations as nonregulated for our Part 32 accounting purposes. We note, however, that the BOCs or other incumbent LECs are free to provide these services using structurally separate affiliates if they choose to do so. Therefore, our discussion below will address two possible approaches a carrier may take in reclassifying its payphone activities as nonregulated: (1) a carrier may maintain its payphone assets on the carrier's books but treat the assets as nonregulated, or (2) a carrier may transfer its payphone assets to a separate affiliate engaged in nonregulated activities.

      

158. In the Notice, we sought comment on three primary aspects of the reclassification of payphone assets from regulated to nonregulated status. We solicited comment on the proper accounting treatment for the reclassification or transfer of the payphone assets from a regulated activity to a nonregulated activity. We also sought comments on the specific assets to be reclassified or transferred. We tentatively concluded that the assets to be transferred should be defined generally in terms of CPE deregulation and that this would include all facilities related to payphone service, including associated depreciation and deferred income taxes, but likely would not include the loops connecting the payphones to the network, the central office "coin-service," or operator service facilities supporting incumbent LEC payphones. We next tentatively concluded that a phase-in period was not necessary for the reclassification or transfer of the payphone assets to nonregulated status and sought comment on this tentative conclusion. We address these questions and tentative conclusions in the sections that follow.

      

     i. Specific Assets Reclassified or Transferred

159. We adopt our tentative conclusion, supported by numerous commenters, that the payphone assets to be reclassified or transferred include all facilities related to payphone service, including associated accumulated depreciation and deferred income tax liabilities. We do not agree with GVNW that related expenses, such as maintenance, should also be reclassified and transferred because expenses are period costs that should be associated with the status of the service at the time they were incurred. That is, expenses incurred during the period payphones were regulated remain as regulated expenses and expenses incurred after payphone deregulation should be classified as nonregulated expenses. We, however, do not include as payphone assets to be reclassified or transferred the loops connecting the payphones to the network, the central office "coin-service," or operator service facilities supporting incumbent LEC payphones because these are part of network equipment necessary to support basic telephone services.

      

160. In adopting our tentative conclusion, we disagree with commenters such as GPCA, Peoples, SDPOA and others who assert that, in all instances, the value of intangible assets that have not been capitalized on the books of the carrier, such as location contracts and brand names, should be included in the payphone assets reclassified to nonregulated status. We note that these assets are not recorded in the carriers' Part 32 accounts and, in fact, are not, without some triggering event such as a purchase or sale, required to be recorded by either generally accepted accounting principles or our Part 32 accounting rules. We do, however, discuss these intangible assets in more detail below as they relate to actual payphone asset transfers to separate affiliates or, in certain limited instances, to an operating division of the carrier.

      

     ii. Accounting Treatment for Assets Reclassified or Transferred

161. Our tentative conclusion in the Notice called for the transfer of the LECs' payphone assets to nonregulated operations to take place at the undepreciated baseline costs plus interest charges at the authorized rate of return for interstate services. The parties have correctly pointed out that this standard only applies in those circumstances where there has been an underforecasting of demand for nonregulated usage requiring a transfer to compensate ratepayers for the additional risks they have borne due to the underforecasting. Since the issue at hand does not involve an underallocation of payphone costs between regulated and nonregulated activities, we see no need to consider this approach any further.

      

162. The parties question whether the carriers should account for the transfer or reclassification of the payphone assets from regulated to nonregulated status at "fair market value" or the net book value of the assets. While Section 276 provides us with discretion to change our accounting rules to provide safeguards in excess of those provided by Computer III, we believe that our existing rules are sufficient to meet the requirements of Section 276. We conclude that our existing rules require that this determination be based on whether a carrier maintains the assets in its regulated Part 32 accounts or instead transfers the payphone assets to a separate affiliate or an operating division within the carrier that is treated as an affiliate.

      

163. Carriers that do not transfer the payphone assets to a separate affiliate make no reclassification accounting entries to their Part 32 regulated accounts. The reclassification of these assets to nonregulated status is accomplished instead through the operation of our Part 64 cost allocation rules. Accordingly, we conclude that payphone investment in Account 32.2351, Public telephone terminal equipment, and any other assets used in the provision of payphone service, along with the associated accumulated depreciation and deferred income tax liabilities should be directly assigned or allocated to nonregulated activities pursuant to our cost allocation rules. LECs should establish whatever Part 64 cost pools are needed and should file revisions to their cost allocations manuals within sixty (60) days prior to the effective date of the change. This will ensure that the provision of payphone service is separate and distinct from the provision of common carrier services in accordance with our rules.

      

164. On the other hand, carriers that transfer their payphone assets to either a separate affiliate or an operating division that has no joint and common use of assets or resources with the LEC and maintains a separate set of books in accordance with Section 32.23(b) of our rules must account for the transfer according to the affiliate transactions rules of Section 32.27(c) which require that the transfer be recorded at the higher of fair market value or cost less all applicable valuation reserves (net book cost). Fair market value has been defined as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts." We conclude, that in instances when the transfer of payphone assets is governed by Section 32.27(c), it is appropriate, as argued by CPA, that the going concern value associated with the payphone business be taken into consideration in determining fair market value. Such going concern value should, as asserted by GPCA and Peoples, include intangible assets such as location contracts that add value to the payphone business. These intangible assets would be considered in the theoretical purchase price negotiated by a willing buyer and seller. We do not believe, however, that the intangible asset value of BOC or LEC brand names should be included in the determination of going concern or fair market value because a BOC or a LEC would not transfer the right to use its brand name to a third party willing buyer.

      

165. The operation of our cost allocation rules and our affiliate transactions rules serve to protect ratepayers from different concerns. The cost allocation rules are used to provide guidance to carriers as to how joint and common costs are to be allocated among regulated and nonregulated activities that impact upon regulated activities. These rules are premised on the assumption that ratepayers benefit from the economies of scope associated with integrated operations of regulated and nonregulated activities. Since costs are recorded in regulated accounts, the Commission retains the ability to scrutinize costs associated with nonregulated activities. For example, carriers must file cost allocation manuals. These manuals are subject to public comment and must be audited annually by an independent auditor. The report of the independent auditor must also be submitted to the Commission. These procedures promote fair cost allocation and protect regulated ratepayers from absorbing the costs of nonregulated activities. In addition, as assets are retained on the books of the carrier, any resulting gains from a sale of those nonregulated assets accrue to the carrier and to the benefit of ratepayers and shareholders.

      

166. Our affiliate transactions rules also afford a level of protection to ratepayers. These rules first protect ratepayers by requiring that when an affiliate transfers to or performs a service for the carrier, those assets or services are not charged to regulated ratepayers at an inflated price. In addition, when the carrier transfers assets to an affiliate, the operation of our affiliate transactions rules effectively captures on the carrier's books any appreciation in value of those assets, thus ensuring that any eventual gains would accrue to the benefit of the ratepayers and shareholders.

      

167. The difference in accounting treatment for payphone assets either reclassified as nonregulated pursuant to our Part 64 cost allocation rules or transferred to a separate affiliate and accounted for in accordance with our Part 32 affiliate transactions rules stems primarily from the fact that in one instance there is no transfer, only a reallocation of assets to nonregulated status, and in the other instance, there has been an actual transfer. In addition, in the first instance our rules are designed to promote fair cost allocation between regulated and nonregulated activities; in the second instance, our rules are designed to protect against cross-subsidies between separate companies by capturing any appreciated value of assets transferred on the books of the carrier.

      

168. We note that some parties assert that, based on the holding of the Court of Appeals for the D.C. Circuit in Democratic Central Committee, the proper measure of value for an asset reclassified from regulated to nonregulated status is the asset's economic value, which would ordinarily be its fair market value. Democratic Central Committee involved the distribution of capital gains realized from the sale to a third party of property that had been transferred out of the rate base. Although Democratic Central Committee provided several general guiding principles on which the Commission fashioned its affiliate transactions rules, we note that the facts in that case did not involve affiliate transactions. Accordingly, we do not think that case is directly applicable either to the situation where a carrier retains the payphone assets on its books or transfers the payphone assets to a separate affiliate. In both instances, ratepayers are protected by the application of our accounting safeguards.

      

169. One of the primary goals of Section 276 is that a BOC shall not be allowed to subsidize its payphone operations directly or indirectly from its telephone exchange operations or its exchange access operations. In order to achieve this goal, Congress required that we adopt at a minimum the nonstructural safeguards of Computer III. In Computer III, the Commission reexamined its regulatory regime for the provision of enhanced services and established nonstructural safeguards for the provision of enhanced services on an integrated basis. These safeguards included the cost allocation rules and the affiliate transactions rules the Commission developed in the Joint Cost Order. These nonstructural safeguards include our Part 64 cost allocation rules and our Part 32 affiliate transactions rules. We also note that the Conference Report states:

      

     "[t]he BOC payphone operations will be transferred, at an appropriate valuation, from the regulated accounts associated with local exchange services to the BOC's unregulated books. The Commission's implementing safeguards must be at least equal to those adopted in the Commission's Computer III proceedings."

      

     We believe that, consistent with Computer III, our cost allocation rules and affiliate transactions rules, as discussed above, provide rules for the appropriate valuation of the reclassification or transfer of payphone assets and we see no compelling argument to deviate from those well-settled rules at this time.

      

170. APCC and GPCA argue that the legislative history cited in the previous paragraph makes clear that Congress intended that the assets be "transferred." We disagree. We have already stated that Section 276 does not require that a BOC establish a separate affiliate to hold the payphone assets. In fact, the Senate version of Section 276 authorized the Commission to determine whether to require Bell operating companies "to provide payphone service...through a separate subsidiary..." This authorization was deleted from the final version of Section 276. If Congress intended that there be a "transfer", we believe that Congress would have required the BOCs to establish separate affiliates for their payphone operations. Congress did not do so. Instead, Congress in the very next sentence of the legislative history states that the Commission's implementing safeguards must, at a minimum, be at least equal to those adopted in the Computer III proceedings. These safeguards include our cost allocation rules. Our cost allocation rules are applicable when a carrier maintains integrated regulated and nonregulated activities. To read congressional intent to require a "transfer" would effectively eliminate our cost allocation rules from application to payphone operations. This is contrary to Section 276 which states that the Commission shall prescribe regulations that prescribe a set of nonstructural safeguards for BOC payphone service which "at a minimum, include[s] the nonstructural safeguards equal to those adopted in the Computer Inquiry-III...proceeding." Computer III included our cost allocation rules as a part of the nonstructural safeguards and thus they are applicable to BOC payphone operations. To exclude the cost allocation rules would be contrary to Section 276's intent that they be included.

      

171. We also agree with the RBOCs that our cost allocation rules only require a reassignment of payphone assets from regulated to nonregulated status. In reality, carriers maintain these assets in regulated Part 32 accounts and do not establish "unregulated books." These accounts are considered "regulated" accounts even though a carrier may assign the entire amount in an account to nonregulated activities. Using regulated accounts serves the public interest by allowing Commission scrutiny of nonregulated activities as they potentially impact regulated activities, maintaining a minimal amount of regulatory burden while protecting regulated ratepayers from cross-subsidies and cost misallocations, and preserving economies of scope that accrue to ratepayers from integrated operations. We believe regulated ratepayers are better served by the requirement that carriers account for payphone operations in regulated accounts than if we required them to account for payphone operations in "nonregulated" accounts or "unregulated books."

      

     iii. Other Matters

172. We require the LECs to reclassify any pay telephone investments recorded in Account 32.2351, Public telephone terminal equipment, and other assets used in the provision of payphone service, along with the associated accumulated depreciation and deferred income tax liabilities, from regulated to nonregulated status pursuant to our Part 64 and Part 32 rules by April 15, 1997 when the associated revised tariffs are effective. We thus agree with Ameritech that we should adopt our tentative conclusion that a phase-in period is unnecessary.