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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported) November 10, 1994
ROCHESTER TELEPHONE CORPORATION
(Exact name of registrant as specified in its charter)
NEW YORK 1-4166 16-0613330
(State or other (Commission File Number) (IRS Employer
jurisdiction of Identification No.)
incorporation)
180 SOUTH CLINTON AVENUE 14646
ROCHESTER, NEW YORK (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code (716) 777-7100
ITEM 5 OTHER EVENTS
The New York State Public Service Commission issued an order on November 10,
1994 approving the Joint Stipulation and Agreement relating to the Registrant's
"Open Market Plan." A copy of the order is filed as an Exhibit to this Report
on Form 8-K.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf of the
undersigned hereunto duly authorized.
Rochester Telephone Corporation
/s/ Barbara J. LaVerdi
Dated: November 18, 1994 By:-----------------------------
Barbara J. LaVerdi Assistant
Secretary
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EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
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<C> <S> <C>
99 Opinion and Order of the New York State Public Service
Commission approving the Joint Stipulation and Agreement
</TABLE>
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EXHIBIT 99
STATE OF NEW YORK
PUBLIC SERVICE COMMISSION
COMMISSIONERS:
Peter Bradford, Chairman
Lisa Rosenblum
Harold A. Jerry, Jr.
William D. Cotter
Raymond J. O'Connor
+++
+
Petition of Rochester Telephone +
Corporation for Approval of + Case 93-C-0103
Proposed Restructuring Plan +
++
+
Petition of Rochester Telephone +
Corporation for Approval of a + Case 93-C-0033
New Multi Year Rate Stability +
Agreement +
+++
OPINION NO. 94-25
OPINION AND ORDER APPROVING
JOINT STIPULATION AND AGREEMENT
(ISSUED AND EFFECTIVE NOVEMBER 10, 1994)
BY THE COMMISSION:
INTRODUCTION
On May 16, 1994, a Joint Stipulation and Agreement (the Joint Stipulation or
the Agreement) embodying an Open Market Plan (OMP) proposed by Rochester
Telephone Corporation (Rochester Telephone or the company) for the development
of telecommunications competition in the Rochester area was submitted for
consideration. Signatories to the Joint Stipulation when submitted were the
company, Department of Public Service staff (staff), Time Warner
Communications (Time Warner) and the Communications Workers of America, AFL-
CIO (CWA). Since its submission, the New York State Telephone Association
(NYSTA), the New York State Department of Economic Development (DED), and the
Public Utility Law Project of New York, Inc. (PULPNY) have joined as
signatories. A copy of the Joint Stipulation is attached.
The agreement represents the culmination of over a year of negotiations
among Rochester Telephone, staff, and other interested parties, coupled with
extensive efforts to foster public involvement in the regulatory process. It
resolves these proceedings and provides a regulatory framework for addressing
three major areas: implementation of a corporate restructure for Rochester
Telephone; the establishment of a multi-year rate plan for the period January
1, 1995 through December 31, 2001; and enhancement of the competitive market
in the Rochester area.
Evidentiary hearings with respect to the Joint Stipulation were held in
Rochester before Administrative Law Judge Vincent P. Furlong on August 9 and
10, 1994. Presentations in support of the agreement were made by the company,
staff and Time Warner. Presentations in opposition were made by AT&T
Communications of New York, Inc. (AT&T), Sprint Communications Company, L.P.
(Sprint), MCI Telecommunications Corporation (MCI), ICS/Executone Telecom,
Inc. (ICS), LDDS Communications, Inc., d/b/a LDDS Metromedia (LDDS), and
Associated Communications Corporation (Associated Communications)./1/
- --------
/1/Associated Communications is the parent entity of Albany Telephone Company,
Buffalo Telephone Company and Genesee Telephone Company, non-wire cellular
carriers in Albany, Buffalo, and Rochester, respectively.
<PAGE>
In addition to the parties presenting testimony, PULPNY, ACC Corporation
(ACC), Ogden Telephone Company (Ogden) and the Cable Television Association of
New York, Inc. participated in the hearings.
Commissioner Lisa Rosenblum and Judge Furlong presided over a public
statement hearing (preceded by a public forum) in Rochester on August 11, 1994
to receive comments on the record from members of the public who would be
affected by the OMP. Approximately 20 persons were in attendance, of whom six
spoke. In addition, several persons have submitted written statements to the
Secretary in lieu of comment at the public statement hearing.
Judge Furlong's Recommended Decision was issued on September 21, 1994. He
recommended approval of the Joint Stipulation concluding that the agreement
"strikes a fair balance of the interests of the ratepayers, investors,
competitors and the public . . . is consistent with the Commission's
competitive policies and . . . in the public interest."/1/ Exceptions to the
Recommended Decision have been filed by the company, MCI, Sprint, ICS, ACC,
Associated Communications, and LDDS./2/
BACKGROUND
THE ROCHESTER TELEPHONE PETITION
On February 3, 1993, Rochester Telephone filed a petition for approval of a
corporate restructuring plan. Under the proposal, the existing local exchange
company would have been restructured into two distinct entities: R-Net, which
would have continued to provide all the network services currently provided by
Rochester Telephone (basic network access, local and toll calling, etc.) but
only on a wholesale basis to retailers who, in turn, would provide the
services to the public; and R-Com, which would assume the roll of a retail
provider. Also proposed was the formation of an unregulated parent holding
company, R-HC, which would have held the stock of R-Net and R-Com and
succeeded to all ownership interests of Rochester Telephone./3/ R-Net would
have remained subject to full regulatory oversight, while R-Com would have
been lightly regulated as a reseller. R-Com would have been one of any number
of providers of local and intraLATA toll service to end users and would have
competed with other potential providers such as long distance carriers, other
resellers, or large business customers buying service in bulk. Customers would
have chosen their local service provider by ballot under an arrangement
similar to that used to open the long distance market to competition.
Rochester Telephone also proposed a multi-year rate stabilization plan as
part of its restructuring plan. Under this plan, flat rates for residential
service would have been frozen at their current levels through December 1994.
Thereafter, through 1998, those rates would have been adjusted annually only
to reflect inflation (less productivity) and exogenous cost changes./4/ This
rate cap would have applied to R-Com as well as other resellers of R-Net
services. The overall rate for R-Net's other full interconnection services
would have been similarly capped through 1998. Within the constraint of that
price cap, R-Net would have been permitted to adjust individual prices, but
not below marginal costs.
ROCHESTER TELEPHONE'S CURRENT RATES
In instituting these proceedings we stated that, before considering the
adoption of any corporate restructuring proposal, we would need to be
satisfied that Rochester Telephone's existing rate levels were just and
reasonable./5/ Therefore an investigation was instituted to provide for a
detailed examination of the company's rates and earnings. After extensive
negotiations among the parties to the rate investigation, a proposed
resolution of all pre-restructuring revenue requirement issues, with the
exception of depreciation
- --------
/1/Cases 93-C-0103 and 93-C-0033, Recommended Decision (issued September 21,
1994) mimeo p. 72.
/2/PULPNY filed a letter in lieu of exceptions endorsing Judge Furlong's
recommendation and urging its adoption. Rochester Telephone also endorses
Judge Furlong's recommendation and its exceptions are limited to a request
for assurances that, in case of future controversy the language of the
Joint Stipulation rather than Judge Furlong's summary thereof will be the
basis for resolving the controversy. The company's fears in this respect
are unwarranted.
/3/The names "R-Net", "R-Com", and R-HC are intended for descriptive purposes
only and would not be the names assigned upon implementation of the
reorganization.
/4/Defined as cost changes resulting from mandatory regulatory, legislative,
or accounting changes beyond the company's control, provided the company
met any conditions imposed on telephone companies generally for the
reflection of such cost changes in rates.
/5/Cases 93-C-0103 and 93-C-0033, Order Instituting Proceedings (issued April
1, 1994) mimeo p. 7.
2
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issues, was submitted for consideration (the September 1993 Agreement). The
September 1993 Agreement was approved on February 17, 1994./1/
Based on a 10.9% return on equity, the agreement reduced Rochester
Telephone's 1993 and 1994 pre-restructuring revenue requirements by $8.5
million and $9.5 million, respectively, subject to adjustment to reflect any
changes in depreciation rates and accruals that were being litigated
separately. In lieu of lowering rates at that time and running the risk of a
number of rate changes in quick succession, the excess revenues were credited
to the ratepayers.
The September 1993 Agreement was intended to serve as a platform from which
to analyze the restructuring proposal and make rate adjustments for the post-
restructuring period. As such it has been used as a starting point for fixing
R-Net's rates under the multi-year rate proposal contained in the Joint
Stipulation.
NEGOTIATIONS AND PUBLIC INVOLVEMENT
Recognizing the myriad of complex issues and the potential conflicting
interests of the parties involved in these proceedings, we encouraged a non-
adversarial approach toward reaching a consensus. With the assistance of
mediators from Conflict Management Group, negotiating meetings, on notice to
all parties, began in November 1993 and culminated in May 1994 with the
submission of the Joint Stipulation. In addition to most of the signatories to
the agreement and the parties participating actively in the hearing and
briefing phases of these proceedings, the New York State Commission on Cable
Television and the New York State Consumer Protection Board also participated
in the negotiations.
In keeping with our increasing emphasis on public involvement in regulatory
proceedings, a number of opportunities for public participation were extended
over the period of the investigation. In July 1993, a workshop was held in
Rochester to inform the public about Rochester Telephone's proposal and its
implications, and to hear the public's views on the many important issues
raised by the company's petition. Public statement hearings with regard to the
company's current rates and its restructuring proposal were held in Rochester
in September and November 1993. At those hearings, the public was informed of
our settlement procedures and the then impending negotiations. As noted
previously, a further opportunity for public involvement, after submission of
the Joint Stipulation, was provided at the August 11, 1994 forum and public
statement hearing. Staff has said that the input from the public weighed
heavily in its analysis of the proposal, and the concerns raised at the public
statement hearings have been considered in the resolution of these matters.
In addition to these efforts to educate and involve the public, Rochester
Telephone initiated its own public involvement process to inform interested
persons about and to elicit reactions to the proposed restructuring and the
OMP. The company's activities included contacts with local public officials,
the Chamber of Commerce, and various trade organizations; meetings with
business customers to explain and discuss the OMP concept; informational
meetings for other customers; and a radio and print educational advertising
campaign.
OVERVIEW OF JOINT STIPULATION
The Joint Stipulation, in principle, but with certain significant
modifications, endorses the original proposal filed by Rochester Telephone.
Among the major changes from the plan as originally proposed are the retention
of retail service responsibility by R-Net, reductions in current rates, and the
extension of the multi-year rate stability plan to at least five and
potentially seven years.
- --------
/1/Cases 93-C-0103 and 93-C-0033, supra, Opinion No. 94-5 (issued February 17,
1994).
3
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The Joint Stipulation can be divided into two major components: (a) a
corporate restructuring including the creation of a holding company (R-HC) and
the split of existing telephone services provided by Rochester Telephone
between separate entities (R-Net and R-Com); and (b) a regulatory plan for the
period January 1, 1995 through December 31, 2001. While the two components are
presented as an inseparable package, their merits should be assessed as if
they were separate proposals because the restructuring is a permanent change
and the regulatory plan is not.
The regulatory plan is further divided into four subcomponents: (1) rates
(including revenue requirement); (2) service quality (network and customer
service); (3) service availability (including infrastructure improvement); and
(4) enhancement of competition.
RATES
The rate/revenue requirement portion of the Joint Stipulation provides for a
seven year rate plan,/1/ reducing annual rates by $21 million in several steps
and stabilizing rates over the term. Only rate increases permitted under
existing flexible tariffs would be allowed. The rate reductions would
eliminate charges for Touchtone (called Touchphone in Rochester) and reduce
local usage, toll, and carrier access charges over the term of the Agreement.
There would be no cap on earnings and, in return, Rochester Telephone would
absorb (in addition to the rate reductions) inflationary and exogenous costs,
reduce its rate base by $17 million, maintain depreciation at least at current
levels, and be prohibited from deferring costs. The rate/revenue requirement
provisions resolve all outstanding revenue requirement matters including the
issue of the appropriate level of royalty computations, currently the subject
of court litigation, for the period of the rate plan.
SERVICE QUALITY
The Joint Stipulation specifies a floor for service quality. If service
quality, as determined by traditional measures, customer complaints, and yet-
to-be developed customer satisfaction surveys, fell below that floor,
penalties of up to 0.5% of local service and intraLATA toll revenues
(approximately $1 million annually) would be assessed. Additionally, if
service quality fell below the floor for traditional measures, or if more than
one surveillance level failure occurred in any one year, dividend payments by
R-Net to the holding company would be suspended until the poor service quality
conditions were eliminated.
SERVICE AVAILABILITY
With the exception of certain specified competitive services that will, (or
in some cases may at R-Net's option), be transferred to R-Com upon
implementation of the OMP, R-Net would continue at the outset of the plan to
provide all services now provided by Rochester Telephone. The normal
regulatory process would continue to apply to the introduction of the new
services or the modification of existing services. In addition, the Joint
Stipulation provides for the expansion of Lifeline service enrollment efforts
by R-Net and a commitment, applicable to both R-Net and R-Com, to specifically
consider the needs of rural customers, economically disadvantaged areas, and
physically challenged customers in their plans to develop and deploy new
services.
ENHANCEMENT OF COMPETITION
The Joint Stipulation contains a number of provisions intended to enhance
the potential for competitive development in Rochester Telephone's service
area. R-Net is committed to full inter-connection, collocation, access to data
bases and other functionalities, unbundled services and network components,
reciprocal compensation arrangement with competitors, interim number
portability (and development of full number portability), and NXX code
assignment. The agreement also provides for resale, at wholesale rates, of all
of
- --------
/1/The rate plan could be cut from seven to five years by the initiation of a
rate proceeding, either by us or by the company.
4
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R-Net's Telephone services and contains provisions aimed at creating and
maintaining a level playing field for competitors and the holding company
affiliates.
CORPORATE RESTRUCTURING
Under the Joint Stipulation, as in the original proposal, the ownership of
all Rochester Telephone subsidiaries would be transferred to R-HC, and the
existing telephone services now provided by the monopoly company would be
placed in two fully-owned subsidiaries, R-Net and R-Com. An additional newly
created holding company facility, Distributed Solutions, Inc. (DSI), would
provide computer billing and other services to R-Net and R-Com, and to other
providers choosing to avail themselves of those services. Corporate management
and administrative functions (e.g., legal and tax services and corporate
finance services) would be provided by R-HC for R-Net and R-Com as well as for
the other New York State telephone companies (NY Telcos) currently owned by
Rochester Telephone.
HOLDING COMPANY
In the past, we have favored holding company ownership of a utility only in
limited circumstances, particularly where the utility is small and benefits
from affiliation with others through increased ability to raise capital and
increased opportunity for cost savings through economies of scale. In general,
however, we have concluded that stand-alone operation of a utility is superior
to a holding company structure./1/
The primary disadvantages of a holding company structure from a regulatory
standpoint are: (1) potentially increased utility costs due to affiliate
transactions; (2) potential diversion of utility capital resources to non-
utility affiliates with resultant degradation of service quality and
availability; and (3) diversion of managerial attention from utility operations
toward enhancement of holding company operations. The Joint Stipulation
contains a number of provisions directed at overcoming or minimizing these
disadvantages. These provisions may be grouped into three categories: (1)
general provisions; (2) protections related to product and service transactions
among the affiliates; and (3) protections related specifically to transactions
with DSI.
1. GENERAL PROVISIONS
The general provisions are aimed at protecting R-Net's (and other NY Telcos')
financial stability, precluding opportunities for financial manipulation, and
providing incentives to the proper management of R-Net. The general protection
provisions include the following:
. A requirement that R-Net's initial capital structure remain in balance
with the current capital structure.
. Restriction on R-Net's dividend payments to R-HC if R-Net's senior debt
rating falls to certain levels or is placed on a credit watch for
possible downgrading to such levels.
. Restriction of R-Net's dividend payments if its service quality falls
below a certain level.
. Provision for quarterly Board of Director certification that payment of
R-Net's dividend will not impair R-Net's service quality nor its ability
to maintain a debt rating target of "A."
. Requirements that a majority of R-Net's Board of Directors be outside
members, that only one director be a holding company or affiliate
officer or employee, and that new directors be nominated by outside
members of the Board.
. A requirement that annual compensation of officers and employees of R-
Net be based on R-Net's performance only and prohibiting R-Net officers
and senior managers from collectively owning more than 10% of R-HC's
stock.
- --------
/1/See e.g., Case 27015, Rochester Telephone Corporation--Corporate
Restructuring, Opinion No. 78-5 (issued May 27, 1978).
5
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. Provision for at least annual review with staff of R-Net's activities
and plans relating to capital attrition, dividends and financial
performance.
. A prohibition on the pledge of R-Net assets for debt obligations other
than R-Net's own.
. A prohibition against the transfer of R-Net services, functionalities or
data bases to affiliates without Commission approval.
. A requirement that R-Net's total debt, fund transfers to affiliates,
customer deposits and preferred stock not exceed 45% of total capital.
The Joint Stipulation provides for a cash management arrangement among the
affiliates wherein the holding company would be the cash manager. Specific
protections against potential financial manipulation of the cash management
fund include a requirement that R-Net's (and other NY Telcos') fund transfer
balances not exceed 5% of total capital, and authority for us, if necessary, to
modify the cash management arrangement.
2. AFFILIATE TRANSACTIONS
The Joint Stipulation provides for full access by staff upon request (and, in
some instances, without notice), to the books and records of the holding
company and its affiliates having a direct or indirect relationship to R-Net
and the other NY Telcos. Also, staff will have access, upon a showing of need,
to the books and records of affiliates not having an obvious relationship with
the NY Telcos.
Other affiliate transaction provisions, described by Judge Furlong in his
Recommended Decision, include monetary caps on non-tariffed transactions unless
otherwise authorized by us; a requirement that all non-tariffed transactions be
subject to arms-length bargaining and written contracts; a requirement, where
common costs are to be allocated, that allocation procedures be filed with and
approved by us; and a requirement that R-Net's managers certify their
familiarity with our affiliate transaction rules. In addition, the Joint
Stipulation provides that R-Net and the other NY Telcos shall bear the burden
of justifying continuation of transactions with affiliates at the end of the
rate plan.
3. DSI TRANSACTIONS
After restructuring, Rochester Telephone's existing billing and other
computer services will be performed by a separate affiliate, DSI. Monetary caps
similar to those imposed on other non-tariffed affiliate transactions would be
applicable to transactions with DSI. However, continuation of DSI transactions
would be subject to review during the term of the rate plan as well one year
prior to the end of the plan. Any products or services developed by DSI upon
the request of any NY Telcos would remain the property of the requesting Telco
and no Telco would pay for DSI development costs not used by it: DSI products
and services would be provided to affiliates and non-affiliates on the same
terms and conditions.
R-NET AND R-COM
The Joint Stipulation continues the two-company setup of the original
proposal, but with a much diminished role for R-Com--at least at the outset of
the OMP. Under the Agreement, R-Net would provide all telephone services to the
public and also provide those services on a wholesale basis to other retailers.
R-Com would exist as a lightly regulated service provider (i.e., regulated only
to the extent that other similarly situated providers are regulated) and, at
the outset of the OMP, would provide only a handful of competitive services
transferred to it by R-Net. All transfers would be at net book cost or market
value, whichever is greater. Additional services might be transferred to R-Com
with our approval as they become competitive in the future. The agreement
provides for a valuation procedure applicable to one specific service (Voice
Mail) and, while not required by the agreement, this process could be viewed as
a potential mechanism to value the price of future transfers.
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DISCUSSION
Judge Furlong concluded that our concerns with regard to holding companies
are "virtually neutralized" by the protective provisions contained in the Joint
Stipulation. He further concluded that the provisions of the Joint Stipulation,
considered in their aggregate and coupled with the changing of the marketplace
to a more competitive environment, warrant our approval of the proposed
corporate restructuring.
We concur generally with Judge Furlong's recommendation but some
clarification of the Joint Stipulation and elaboration on Judge Furlong's
conclusion is required. While Rochester Telephone is currently a stand-alone
company, it is by no means a stand alone utility operation. Over the years,
Rochester Telephone has been permitted to form or acquire other companies as
subsidiaries, some of which are other telephone utilities, both within and
outside of New York, and some of which are non-utility operations. As a result,
myriad affiliate transactional relationships now exist among the subsidiaries
and Rochester Telephone. Accordingly, the advantages and disadvantages of the
holding company proposal must be assessed against the current structure of
Rochester Telephone, and not against a theoretical stand alone utility
operation.
1. AFFILIATE TRANSACTIONS
The Agreement includes a comprehensive set of provisions designed to
safeguard against improprieties with respect to affiliate charges, cost
allocations, and access to books and records. The provisions include caps on
the level of affiliated transactions, access to holding company and affiliate
books and records, requirements for written contracts for non-tariffed
transactions, asset valuation requirements, and the filing and review of cost
allocation procedures. The provisions strengthen our ability to ensure against
improper affiliate transactions, a perennial regulatory issue.
These protections, are adequate and may be seen as an improvement over the
current situation. Moreover, while improper affiliate transactions have raised
perennial regulatory issues, movement away from cost based regulation toward
price regulation, coupled with increasing competitive pressures, should reduce
the regulatory significance of affiliate transactions.
2. DIVERSION OF CAPITAL RESOURCES
The continued availability of adequate capital resources is a significant and
continuing regulatory concern. The holding company proposal, in the absence of
further safeguards, would increase the risk that capital resources would be
diverted to non-utility operations. Rochester Telephone now has subsidiaries
that compete for capital resources, but we possess and have exercised
regulatory control over the amount of investment the company can make in its
subsidiaries. The holding company structure provides for no similar authority
over investment decisions, and the regulated service provider could be short
changed through excessive dividend payments to, or lack of equity infusion
from, the parent company.
The Joint Stipulation, however, includes protections that reduce such risks.
These include quarterly certification by R-Net that dividend payments will not
impair service quality or its ability to finance its capital needs; dividend
suspension provisions related to service quality and senior debt ratings; a
prohibition against using R-Net assets to support debt obligations of others;
and cash management program controls that would limit R-Net's total and short
term debt. These provisions are in addition to construction program filing
requirements that are already in place. These provisions effectively eliminate
any increase in the risk of capital diversion and may even reduce that risk
below its current level.
3. DIVERSION OF MANAGERIAL ATTENTION
Diversion of managerial attention from utility operations is likewise of
increasing regulatory concern. While the potential for such diversion already
exists under the current Rochester Telephone structure, it can be expected to
increase somewhat, due not to the holding company structure per se but to the
likely increase in the number of affiliates.
7
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The protective provisions in the Joint Stipulation, however, will
effectively eliminate any additional risk of managerial diversion and may
reduce the existing level of risk. These provisions include limitations on
membership on R-Net's Board of Directors, the requirement that R-Net's officer
and employee compensation be based on R-Net's performance only, a limitation
on holding company stock ownership by R-Net officers, a requirement for
separate legal counsel serving R-Net only, and the dividend restriction
provisions referred to earlier.
CONCLUSION
No party has excepted specifically to Judge Furlong's conclusion that the
Joint Stipulation adequately addresses our on-going concerns regarding holding
companies./1/ On balance the proposed holding company structure, assessed
against the existing company structure and regulatory concerns over utility
holding companies in general, would not be disadvantageous to the regulated
telephone operations (including those of the other NY Telcos) and may result
in improved regulatory protections.
One aspect of the Joint Stipulation regarding the holding company structure
requires clarification. Unlike the other provisions of the Joint Stipulation,
the formation of a holding company is, for all practical purposes, a permanent
change./2/ The parties apparently intend as well that the various protective
provisions will likewise survive the five-to-seven year term of the Joint
Stipulation. But that is not entirely clear from a reading of the Agreement.
Because these protections (including the service quality-related dividend
restriction) are vital to our approval of the restructuring, we will condition
our approval upon Rochester Telephone's agreement that the protective
provisions in the Joint Stipulation aimed at eliminating or minimizing
potential improprieties under a holding company structure will remain
permanent unless modified by us.
REGULATORY PLAN
RATES AND REVENUE REQUIREMENT
Judge Furlong found the lack of a cap on R-Net's earnings during the term of
the Joint Stipulation to be justified for a number of reasons. These include:
(1) the fact that rates for the most part would be decreased or frozen during
the period of the agreement; (2) R-Net's assumption of the full risk of
earnings erosion; (3) the resulting incentive to achieve greater efficiencies
and encourage the development and marketing of new services; and (4) savings
in the cost of regulatory oversight. In addition, Judge Furlong also pointed
out that the Joint Stipulation recognizes the reservation of our authority to
intervene if earnings reach unreasonable levels.
MCI excepts, claiming a cap is required because R-Net will not be subject to
effective competition for all of its services for some time to come, a
situation MCI believes will lead to excess earnings. MCI says the existence of
excess earnings may lead to uneconomic investment decisions by R-Net and
claims that a properly calculated earnings cap would not violate the incentive
to cut costs.
MCI's position rests on the premise that the rate plan relies solely, or at
least heavily, on the existence of effective competition to keep R-Net's
earnings in check during the term of the Agreement. This is not the case. As
Judge Furlong points out, the rate plan itself cuts R-Net's rates
substantially at the outset and commits the company to further cuts over the
term of the plan. Additionally, as considered by Judge Furlong, R-Net would be
required to absorb inflationary and other cost increases with no recourse to
rate increases. There is no built-in potential for excess profits that would
be triggered by the absence of competition. Indeed, development of effective
competition should serve to increase pressure on R-Net to achieve even greater
- --------
/1/Associated Communications raises the specter of potential anti-competitive
behavior if the "fiction of separate entities" is implemented. We will
address this exception in our discussion of competitive enhancements.
/2/In fact, the Agreement specifically states that nothing therein shall be
construed as conferring authority to reverse the authorization of the
reorganization.
8
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efficiencies and even further price cuts. The absence of effective competition
may be a disappointment, but it is in no way a precursor to excess earnings.
The severing of earnings from the price equation, as proposed in the Joint
Stipulation, is intended to provide a regulatory structure conducive to
efficient operations as well as to provide the proper economic signal for
effective future investment decisions. If R-Net's revenues rise to levels that
might be considered excessive, such an increase would not come at the expense
of customer rate increases. And we see no basis for concern that such an
excess earnings condition, if indeed one did develop, would lead to the
uneconomic investment decisions prophesied by MCI. High earnings or low, R-
Net's investment decisions will be driven by the likelihood of additional
earnings garnered from the business generated by those investments.
SERVICE QUALITY/CUSTOMER SERVICE
No party has objected to the service quality provisions of the Joint
Stipulation. Rochester Telephone has a record of excellence in service quality
performance. In light of this, setting a floor, rather than establishing
specific service quality achievement targets, is generally acceptable.
Nevertheless, because the service quality floor is an aggregate of several
traditional service quality measures, performance in one of those measures
could deteriorate without triggering a penalty or other remedial action.
Moreover, even if a penalty is triggered, there is no provision in the Joint
Stipulation (other than the penalty provision itself) to ensure restoration of
service to acceptable levels. Finally, the service quality measures are
predicated on our existing rules and regulations and there is no provision in
the Joint Stipulation to recognize potential revision of those rules.
The Joint Stipulation does not specifically preclude us from taking action
with respect to Rochester Telephone's service quality, but neither does it
provide for such action. We emphasize therefore that service quality must
remain at objective levels and that the Joint Stipulation does not limit our
authority to take appropriate action to improve service quality, if found
necessary, irrespective of whether the company's service quality is above the
Joint Stipulation's floor level.
In addition, in furtherance of the emphasis on high quality service and to
avoid potential controversy over future rule revisions, we will require, as a
condition of our approval of the Joint Stipulation, that Rochester Telephone
consent to revisions of the floor levels of service quality contained in the
Agreement as necessary to reflect any changes made in our service quality
rules during the term of the Agreement.
The Joint Stipulation's provisions related to customer service, for the most
part, are aimed at protecting and assisting customers during transition to
increased local service competition. These provisions are both necessary and
adequate and need no clarification or revision. We stress again, however, the
importance of treating customers fairly during the often confusing transition
to competition, and we expect the company to put serious effort into carrying
out the Agreement's customer service protection and enhancement provisions.
SERVICE AVAILABILITY AND INFRASTRUCTURE
The major thrust of the New York Telecommunications Exchange (the Exchange)
recommendations/1/ is centered on public policies necessary to ensure that
technological advances are available to all segments of the State's
telecommunications users and that basic telephone service remains universally
available and affordable throughout the state. The Exchange Report concluded
that a fully competitive telecommunications "network of networks" represents
the best means of achieving those goals but pointed out that specific state
action may be needed to ensure that technology is diffused throughout all
segments of society and throughout all geographic areas.
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/1/Connecting to the Future, Greater Access, Services and Completion in
Telecommunications, Report of the New York Telecommunications Exchange,
December, 1993.
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Overall, the Joint Stipulation's provisions support the Exchange's and our
goals for service availability and infrastructure advancement. Two specific
provisions are aimed at making service available to customers with special
needs--the Lifeline provision and the technology diffusion provision.
The Lifeline provision reaffirms a previous Rochester Telephone commitment
to increase Lifeline enrollment through increased outreach efforts and
automated eligibility matching with social service information bases. But,
while the provision is beneficial, the automatic eligibility matching
undertaking will not reach the many households in the Rochester area that
currently are without telephone service. Therefore, we will direct staff to
explore with Rochester Telephone a program to focus on those households.
The Joint Stipulation states that R-Net and R-Com expect to aggressively
develop new services and that both will consider the needs of rural customers,
economically disadvantaged areas, and physically challenged customers. A
Committee on Standards and Cooperative Practices established under the Joint
Stipulation also will take into consideration the special technical
requirements of disabled individuals and other customers with special needs.
Both of these provisions are in harmony with the Exchange's and our policy
goals, and would benefit from further elaboration. We will require that
Rochester Telephone formulate and file for our review a plan for the diffusion
of technology and for meeting the needs of its rural, economically depressed,
and physically challenged customers. We will also monitor Rochester
Telephone's activities in this area and reserve the authority to take steps to
ensure those needs are being met during the term of the Joint Stipulation.
COMPETITIVE ENHANCEMENTS
The Joint Stipulation preserves most of the competitive enhancements
contained in Rochester Telephone's original proposal and adds to them. It is
this area of the Joint Stipulation that has engendered the most controversy,
especially with respect to the wholesale/retail price differential to be
established by R-Net.
WHOLESALE PRICING
The Joint Stipulation calls for R-Net to offer all its retail service to
resellers at wholesale rates. The Agreement does not specify the amount of the
wholesale discount, but, in testimony, Rochester Telephone stated that it
would implement a 5% discount applicable to all services. In response to
claims that the discount is inadequate or, at best, arbitrary, Rochester
Telephone said that it had considered larger discounts under its original
proposal, where R-Net would not have been in the retail business and would
have had a far greater opportunity to shed costs. However, because R-Net would
remain in the retail business under the provisions of the Joint Stipulation,
the company claimed a margin greater than 5%--admittedly a judgmental figure--
cannot be supported until such time as competition is developed and further
costs are avoided. Judge Furlong accepted Rochester Telephone's rationale and
a number of parties have excepted.
Sprint and ICS question the propriety of the 5% wholesale discount./1/
Sprint contends that the figure is unsupported by cost studies, and ICS
contends that other companies have offered much deeper discounts for
particular services. LDDS discusses the importance of a wholesale price
structure to the ultimate success of competitive entry. It views the 5%
discount as a first cut at setting a discount rate but asks that we now
establish, as a principle, that avoidable costs will be considered the proper
measure for the discount. LDDS also wants the door left open for further
revision of the discount level.
LDDS correctly notes the importance of proper competitive pricing to the
ultimate development of effective competition, and avoided costs should be a
major factor in the establishment of wholesale/retail price differentials. The
company itself conceded that the discount could be revised as experience is
gained with competition. The 5% discount should be seen as a starting point
which will begin the transition to a more
- --------
/1/ICS also complains that Judge Furlong improperly characterized ICS as a
marketer of Centrex and claims that this is not true. We take note of Judge
Furlong's apparent error.
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competitive environment. Staff should periodically review the pricing
structure in view of marketplace experience and advise the Commission if
changes in price structure should be made. With this understanding, Sprint's
and ICS' exceptions are denied.
WHOLESALE PRICE STRUCTURE FOR RESIDENTIAL SERVICE
Judge Furlong accepted the wholesale rate structure for residential flat
rate and measured service provided for in the Joint Stipulation. LDDS excepts.
LDDS charges the structure is discriminatory in that resellers would have to
pay a premium if a flat rate customer's monthly usage exceeded 750 minutes and
would have to pay per minute rather than per message charges for the resale of
measured service. In contrast, R-Net, in its retail capacity, would not pay
the premium and would sell message rate service on a per message basis. LDDS
requests that we require that the pricing of the wholesale product to parallel
the pricing of the retail product and that the wholesale structure for
residential flat rate and measured service be revised accordingly.
We see no sound reason, without further experience with the competitive
market, for mandating at this juncture that R-Net's wholesale price structure
mirror the structure applicable to its retail prices for similar services.
Resellers, as a matter of course, have purchased services from carriers under
those carriers' price structures and have used them to provide services to end
users under completely different pricing arrangements. Resellers would be free
to do the same under the proposed R-Net wholesale structure. Staff will review
this structure in light of market experience and advise the Commission if
changes are warranted.
The different structures for residential wholesale and retail sales does
raise the question of whether the prices charged to resellers would have a net
effect on the overall discount they realize, but the structure need not be
adjusted now. As in the case of the 5% discount discussed above, the
residential resale structure is subject to further review and revision once
experience is gained under the Joint Stipulation.
PRICE OF RESIDENTIAL LINKS
Because residential service is subsidized by other services, R-Net's monthly
charges for residential access to the network would be lower than the cost of
the links used to provide that access. Judge Furlong conceded that this
situation could impede the ability of a facilities-based competitor relying on
R-Net links (priced at cost) to hook customers up to the competitor's own
network. However he recommended that consideration of this issue be deferred
to the Competition II proceeding./1/ ACC excepts and requests us to address
the question now. One solution to the problem, according to ACC, would be to
significantly reduce the charges it would pay to R-Net to terminate traffic on
the latter's network.
We agree that the Joint Stipulation does not fully resolve the problem of
how to develop a competitive framework that accommodates the existing
residential service pricing structure in an equitable manner. However, it is
the resolution of this problem, among others, that is the primary purpose of
Competition II. The Agreement provides for further revisions emanating from
that proceeding if they are found to be in the public interest.
Moreover, ACC paints only a partial picture of the situation by positing use
of a full cost link to provide residential access service priced below cost.
It fails to recognize the contribution to costs the competitor itself would
generate by providing network service. Rochester Telephone currently bears the
full cost of the links and yet has been able to generate sufficient revenues
from its network services to fund the below cost pricing of residential
service. A competitor would have similar sources available once it wooed
customers away from R-Net.
- --------
/1/Case 94-C-0095, Transition to Competition in the Local Exchange Market.
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TERMINATING ACCESS PRICING
The Joint Stipulation provides for reciprocal compensation arrangements
between R-Net and other local service providers. Under this arrangement, a
local service provider would pay R-Net for traffic it delivers to R-Net for
termination at a customer served by R-Net. Conversely, R-Net would pay the
local service provider for traffic to be terminated at a customer served by
that provider. If the traffic is in balance, i.e., equal in both directions
within a 10% tolerance band, no payments would be made by either entity for
local transport. Carriers would compensate each other only for local switching.
Judge Furlong declined to recommend reduction of carrier access and cellular
interconnection rates beyond what is contemplated in the Joint Stipulation.
Associated Communications and ACC except. Associated also seeks elimination of
any limitations on interconnection or reciprocal compensation with respect to
cellular carriers. Associated Communications provides no specific rationale for
either of its requests. Moreover, the charges for carrier access and cellular
interconnection are already being reduced significantly over the term of the
rate plan.
ACC excepts from Judge Furlong's asserted failure to recognize that a "price
squeeze" can occur where the terminating access fees are higher than the local
usage rates. Like Associated Communications, ACC proposes that terminating
access fees be lowered. While Judge Furlong recognized the potential for a
pricing problem under certain circumstances, he agreed with the company that
this problem did not reach the level of a "price squeeze." His position was
based on ACC's failure to show that the terminating access fee would be higher
than the local usage rates for a significant number of potential calls.
Moreover, while ACC may have demonstrated the potential for limited pricing
problems it fails to recognize that it is just as likely that an R-Net customer
will call an ACC customer in which case R-Net would be required to pay the
terminating access fee. And, if traffic were in balance between the two
competitors, the net terminating access fees would be limited to just local
switching charges paid on the difference in access minutes exchanged between
the two. Staff will monitor closely the development of competition under the
Joint Stipulation and report to the Commission if further action is warranted.
RELATIONSHIP OF JOINT STIPULATION TO THE COMPETITION II PROCEEDING
Judge Furlong deferred a number of issues to the Competition II proceeding,
among them issues related to asserted barriers to effective competition posed
by Rochester Telephone's subsidized rate structure. Sprint and Associated
Communications except, contending that any approval of the Joint Stipulation
should await a decision in the Competition II proceeding.
Associated Communications claims that the staff Interim Report in the
Competition II proceeding contains intercarrier compensation approaches that
differ so significantly from those established in the Joint Stipulation as to
warrant deferral of the implementation date of Rochester Telephone's proposed
OMP. Similarly, Sprint claims many of the provisions contained in the Joint
Stipulation would most likely require revision after Competition II is decided.
Sprint also seeks delay in approval of the Joint Stipulation until Competition
II is completed or, at a minimum, a mandate that Competition II findings be
incorporated into the OMP when that proceeding is decided. However, if the OMP
is approved at this time, Sprint urges that approval be limited to a two-to-
three year trial period, after which the impact of the plan can be assessed.
Competition II may indeed produce a different approach to competition or
different terms and conditions than set forth in the Joint Stipulation.
However, the Joint Stipulation specifically provides that it may be modified by
the resolution of Competition II or in subsequent proceedings if such
modification is found to be in the public interest. The competitive provisions
of the Joint Stipulation have sufficient potential to further the development
of competition and there is no reason to delay their implementation pending
further revision and refinement in the Competition II proceeding. The
exceptions of Sprint and Associated Communications are denied.
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OTHER ISSUES
1. Full Number Portability and 1+ IntraLATA Presubscriptions
Sprint excepts to Judge Furlong's failure to take into consideration the
numerous unresolved 1+ intraLATA presubscription technical and
implementation issues and the fact that there is no schedule for the
implementation of full number portability. Both of these are critical
elements in the effective competition equation, according to Sprint.
There is no doubt that 1+ intraLATA presubscription and full number
portability are important aspects of a fully competitive market. However,
intraLATA presubscription is subject to a separate proceeding,/1/ whose
requirements need not be reiterated here. As to unresolved technical and
implementation issues, Sprint provides no detail as to what these might be
nor explains why the OMP cannot be implemented without their final
resolution.
With regard to number portability, the Joint Stipulation contains a
provision that would solve the portability issue for the time being and
facilitate competition for R-Net's customers. The longer term portability
questions are a matter not of willingness but of network capability. The
Joint Stipulation commits R-Net to pursue full number portability and to
permit others to administer the data bases necessary to effectively route
calls in a full number portability environment. Nothing is to be gained by
waiting for yet-to-be-developed technology before approving the Joint
Stipulation. Sprint's exception is denied.
2. Service Packaging
The Joint Stipulation would require R-Com to price its services at the
tariffed prices paid to R-Net for components of each service plus R-Com's
own incremental cost of providing the service. Judge Furlong found this
language sufficient to prevent any potential anti-competitive practices on
the part of R-Com.
Associated Communications excepts, claiming the separation of R-Com, R-
Net and R-HC is a fiction and that Rochester Telephone will continue to act
as it has always acted for the good of its stockholders--despite the
separation of its activities. Associated Communications calls for
"asymmetrical regulation" of Rochester Telephone and modification of the
language of the Joint Stipulation to require Rochester Telephone to price
each product or service sold in a package (bundled) at the price that would
be charged for the product or service if it were sold separately.
The objections to bundling are unpersuasive, for volume and package
discounts are common in a competitive environment and there is no reason to
prohibit R-Com from engaging in these marketing practices. The existing
language in the Joint Stipulation would prevent R-Com from pricing below
its incremental costs plus any tariff charges paid to R-Net under any
packaging combination. These considerations, in our view, are sufficient to
prevent the arbitrary price manipulation that seems to concern Associated
Communications.
We do not share Associated Communication's concern that the restructuring
is somehow fictional. As discussed previously, there are adequate
protections in place to satisfy our regulatory concerns over the
consequences of the holding company structure. Associated Communication's
exception, accordingly, is denied.
3. Reseller Penalties
The Joint Stipulation contains a prohibition against the resale of
residential services to other than residential customers. There are stiff
penalties for the violation of this provision, including a restriction
- --------
/1/Case 28425, IntraLATA Presubscription, Opinion No. 94-11 (issued April 4,
1994).
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on the further purchase of wholesale service. Judge Furlong declined to
recommend that this provision be eliminated or amended, concluding that it
was only intended to apply only in the case of clearly intentional sales of
residential service to business customers. LDDS excepts.
LDDS claims the penalty is unduly harsh and would be imposed only on
Rochester Telephone's competitors. However, LDDS says, if it is concluded
that a penalty is appropriate, it should be made clear that the penalty
will be incurred only for the intentional sale of residential service to
business customers and that it will be applied on a non-discriminatory
basis to R-Net as well.
The misuse of resold residential services is a serious matter and some
form of penalty should be available to prevent any such abuses. As Judge
Furlong found and LDDS argues, the penalty should apply only in extreme
cases, where resale of residential services to business customers is
intentional; and any reseller affected by this provision should have the
right to appeal the imposition of a penalty to the Commission under this
provision. However, LDDS has shown no reason why such a penalty provision
should apply equally to R-Net, for R-Net already has a strong incentive to
prevent improper use of residential service. Consistent with the foregoing
discussion LDDS's exception is granted in part and otherwise denied.
CONCLUSION
The proposed Joint Stipulation represents a significant step toward achieving
our regulatory goals as well as the policy recommendations of the Governor's
Telecommunications Exchange. The rate plan within the Joint Stipulation
provides for significant rate reductions consistent with previously established
rate design objectives and for basic rate stability during the transition to a
more competitive industry. Assurances of continued high service quality are
contained in the agreement and the Joint Stipulation establishes a framework to
ensure that all customer needs are considered by the company in the development
and deployment of new services.
Provided the extensive protections against potential holding company abuses
are deemed to survive the term of the Joint Stipulation, the holding company
structure is acceptable, given that Rochester Telephone has committed to long-
term rate stability and to open its market to competition. Moreover, the
removal of earnings from the regulatory equation is a positive and timely step
that will provide the proper economic signals by shifting risk to the company
and advance the development of the telecommunications infrastructure.
The Joint Stipulation would significantly enhance the development of
competition in Rochester's service area. It establishes a comprehensive
foundation conducive to the development of both facilities-based competition
and competition through resale of Rochester Telephone's services. The retention
of retail service responsibility by R-Net, and the gradual transfer of services
to R-Com as they become increasingly competitive, offer a sound means for the
transition to a fully competitive local service market in the Rochester area.
Given the lack of experience with a competitive local telephone market,
further adjustments may be needed to ensure a price structure consistent with
the development of full, fair competition. Approval of the Joint Stipulation
will be conditioned on the acceptance by Rochester Telephone of our continuing
authority to implement further revisions with regard to competitive pricing as
found necessary and justified. The Joint Stipulation requires staff to submit
an annual report to the Commission as a means of monitoring the effectiveness
of the OMP. The company is directed to work with staff to develop a formal,
monitoring plan directed toward assessing the effectiveness of the OMP against
the various pricing issues raised during the proceeding. Parties will have an
opportunity to provide input into the plan.
Finally, there is a possibility that state tax reform legislation may be
enacted during the rate plan period which would transfer the burden of lifeline
funding from the company's costs to the general tax base. While
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this would be an exogenous cost change and thus exempt from reflection under
the terms of the Joint Stipulation, a failure to reflect such a cost change
would be inconsistent with the purpose of such legislation-- to transfer the
cost of lifeline service from the customers to the population as a whole.
Therefore, approval of the Joint Stipulation will be further conditioned upon
the acceptance by Rochester Telephone of a potential adjustment to reflect such
a tax change.
Subject to the clarification and conditions stated in the foregoing opinion,
the Joint Stipulation is in the public interest and will be approved.
THE COMMISSION ORDERS:
1. The Joint Stipulation and Agreement attached to this opinion and order is
approved subject to the clarifications and conditions contained in the
foregoing opinion.
2. No later than seven days from the issue date of this opinion and order,
Rochester Telephone Corporation (the company) shall file with the Secretary of
the Commission, a statement of whether it accepts the conditions and agrees to
the clarifications referred to in Paragraph 1 of this order.
3. Not later than November 28, 1994, the company shall file tariff revisions,
to take effect on January 1, 1995, consistent with this opinion and order and
with the model tariffs filed as Exhibit JS29 in the record of this proceeding.
The tariffs submitted in the compliance filing shall not become effective on a
permanent basis until approved by the Commission, but shall take effect on a
temporary basis on January 1, 1995, subject to refund in the event they are
found not to be in compliance with this opinion and order. The tariffs shall
supersede those currently in effect for Rochester Telephone Corporation, and
shall indicate, on the title page of each, the tariff schedule which it
supersedes. The company shall file with the Commission, not later than February
1, 1995, proof that a notice of the tariffs required here and their effective
date has been published once prior to the effective date of the tariffs and at
least once thereafter in a newspaper having general circulation in the counties
affected by the amendments.
4. The company shall notify its customers of the proposed tariff changes in
bill inserts to be included in each customer's bill not later than the second
billing cycle following the effective date of the temporary schedules.
5. The company shall file copies of its compliance filing on all active
parties to this proceeding on the date that the filing is submitted to the
Secretary. Those parties shall have 15 days from the date of service to comment
on any portion of the filed schedules. Any comments on the compliance filing
shall be filed with the Secretary of the Public Service Commission, Three
Empire State Plaza, Albany, New York 12223-1350.
6. The company and staff are directed to explore a program to focus efforts
to increase Lifeline service to households not currently having telephone
service and to propose such a program within 90 days of the date of issue of
this opinion and order.
7. Within 90 days of the date of issue of the opinion and order, the company
is directed to file a specific plan for the diffusion of technology and the
meeting of the needs of the rural, economically depressed, and physically
challenged customers within its service territory, consistent with this opinion
and order.
8. The company and staff are directed, in consultation with the parties, to
develop and file within 90 days of the date of issue of this opinion and order,
a formal plan for the monitoring of the implementation of the Joint Stipulation
and Agreement with emphasis on the competitive aspects thereof. Pursuant to
this plan, and consistent with the monitoring responsibilities set forth in
this order regarding pricing structure issues, the company shall file a report
with the Commission evaluating the plan on an annual basis, and hold a public
session with all parties to set forth and receive comment on their evaluation
study.
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9. To the extent it is consistent with this opinion and order, the
recommended decision of Administrative Law Judge Vincent P. Furlong, issued
September 21, 1994 is adopted as part of this opinion and order. Except as
herein granted, all exceptions to the recommended decision are denied.
10. Rochester Telephone Corporation is directed to comply with all of the
provisions of the Joint Stipulation as clarified and approved in this opinion
and order, and the Joint Stipulation and Agreement shall have the same force
and effect, pursuant to Section 23 of the Public Service Law, as if promulgated
as an order issued by the Commission.
11. This proceeding is continued.
By the Commission,
_____________________________________
John J. Kelliher
Secretary
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