Compliance with the Federal Communications Commission’s Universal Service Fund rules can easily increase a telecommunications company’s cost of doing business by 3% to 13%.  These enormous costs have driven carriers who are subject to the FCC’s USF regulatory regime to carefully scrutinize the rules and regulations governing the reporting of revenue which result in the imposition of FCC compliance costs.  Revenue reporting requirements are generally to be found in the instructions to FCC Form 499-A.  One of these “rules” – the so-called “carrier’s carrier” rule -- is garnering a great deal of attention these days, both by the industry and the FCC thanks to petitions for Review filed with the FCC by IDT Corporation and Global Crossing Bandwidth, Inc. (GX).  At their core, both petitions challenge Universal Service Administrative Corporation’s (USAC) imposition of vicarious contribution responsibilities on wholesale carriers who failed to verify the USF contribution status of their reseller customers.  IDT’s petition goes a step further by seeking an FCC ruling that all sales to any entity which does not, itself, consume the services purchased, constitutes a “wholesale” sale, the revenue from which is exempt from USF and other FCC fees.  A favorable outcome could save IDT as much as $60 million in unpaid regulatory fees and, invariably, would impact all other companies engaged in the prepaid industry. 



Background

The FCC requires all interstate communications carriers to contribute a portion of interstate and international end-user revenues to fund Universal Service and support other programs, such as the Telecommunications Relay Services fund.  USAC is a private non-profit organization that administers the USF.  In order to avoid duplicative USF contributions on wholesale and end-user revenue, USAC crafted what’s now known as the “carrier’s carrier” rule.  This rule exempts wholesale revenue from a carrier’s contribution base, thus ensuring contributions are based solely on end-user revenues.  However, to invoke the protection of this wholesale revenue exemption, carriers must verify that their reseller customers are contributing directly; failing to do so can result in USAC’s imposition of vicarious liability.  In other words, unverified wholesale revenue can, and will, be reclassified by USAC as end-user revenue, thereby subjecting an otherwise exempt wholesale carrier to liability for the unpaid contributions of its reseller customers.  These “verification” and “vicarious liability” provisions first appeared in USAC’s instructions to the 2004 Form 499-A, but are nowhere to be found in the FCC’s regulations.

In their petitions, IDT and GX contend the “carrier’s carrier” rule places unfair regulatory obligations on wholesale providers because the rule contradicts the FCC’s stated goal that providers of “end-user” services should shoulder the contribution load.  Both argue that USAC’s carrier’s carrier rule unduly burdens wholesale carriers with the responsibility of ensuring that their customers are in full compliance with USF obligations.  IDT also disputes USAC’s classification of all prepaid calling card revenues as end-user.  Both contend that USAC’s instructions are at odds with the actual, published FCC regulations and are therefore invalid.

Not all wholesale providers, however, agree with IDT and GX’s arguments, most notably, AT&T, which filed comments rebutting IDT’s petition.  AT&T argues that IDT would earn a windfall by circumventing the reseller customer verification requirement of the carrier’s carrier rule.  AT&T maintains that the only way to secure a balance between sufficient USF funding and fairness to contributors is for the FCC to uphold USAC’s verification and vicarious liability requirements.

Millions of dollars are at stake for IDT and GX, but there’s potentially even more at stake for wholesale carriers that did strictly comply with USAC’s instructions.  According to a USAC audit, during the past five years, IDT has classified the vast majority of its revenue as wholesale, thereby allowing it to avoid several years of regulatory fee payments.  In its 2007 SEC Annual Report, IDT stated that USAC’s re-classification of its wholesale services as end-user revenue would impose approximately $60 million in combined regulatory fees.  For its part, GX estimates in its petition that revenue re-classification in accordance with USAC’s audit directives would render it responsible for over ten times the amount it has contributed to the USF thus far.  If the “carrier’s carrier” rule is found to be invalid, IDT and GX would be excused from contributing on the re-classified revenue; moreover, similarly-situated wholesale carriers could be entitled to refunds of past contributions and fees. 

While it is unlikely that the FCC, itself, will allow wholesalers to completely abrogate their contribution obligations (because doing so would invalidate and reverse millions of contribution dollars that are desperately needed to support the already underfunded USF program), both IDT and GX would have the opportunity to appeal adverse FCC rulings to the District of Columbia Court of Appeals (DC Circuit) where favorable rulings are possible.  As such, both of the pending petitions for review should be evaluated and monitored by all operators in the prepaid calling industry.     



IDT Petition

IDT’s petition stems from a series of USAC audits of the company’s Form 499 reporting for the 2003 to 2007 timeframe.  On April 30, 2008, USAC issued an Audit Report concluding that IDT’s method of reporting revenue from unaffiliated distributors, retailers and resellers as wholesale revenue did not conform to the Form 499-A instructions.  USAC determined that the majority of IDT’s revenue should have been reported as end-user revenue because the instructions mandate that all “revenues from pre-paid calling cards provided either to customers, distributors, or to retail establishments” are contribution eligible.

On June 30, 2008, IDT filed its petition, wherein it argues that USAC’s audit conclusion was invalid for the following reasons:



1.    The relied upon instructions were not subject to notice and comment procedures as required by the Administrative Procedures Act (APA);

2.    The instructions conflict with existing FCC rules; and

3.    IDT is a wholesaler by definition. 

 

IDT’s first argument attacks the validity of the carrier’s carrier rule, as embodied in the Form 499-A instructions relied upon by USAC in its audits.  IDT argues that the “verification” and “vicarious liability” provisions of the current iteration of the carrier’s carrier rule are substantive rules created unilaterally by USAC and in violation of the APA.  IDT contends that, for this reason alone, the carrier’s carrier rule is invalid, unlawful, and unenforceable since only the FCC can promulgate substantive rules and only after it has complied with the APA.  If the FCC (or a reviewing court, the DC Circuit or Supreme Court) agrees that the Form 499-A “instructions” violate the APA, then neither the FCC nor USAC can force IDT to reclassify its wholesale revenue as end-user, thereby resulting in at least $60 million in saved contributions for IDT since 2002.

Even if the instructions are deemed interpretive rules, rather than substantive, IDT argues that the instructions are still invalid because they contradict existing FCC rules which clearly state that only “end user” revenue shall be used as the basis for determining a carrier’s USF contributions. 

Finally, IDT maintains that it is a wholesaler by definition because it sells its products to other carriers and VoIP providers.  IDT alleges that USAC’s imposition of vicarious contribution obligations for its resellers’ failure to contribute to the USF is an improper shift of these duties to IDT, which does not sell to “end users.” 



Global Crossing petition

IDT is not the only carrier to raise concerns regarding USAC’s treatment of reseller revenue with the FCC.  On June 22, 2007, GX appealed USAC’s imposition of contribution requirements on the revenue generated through GX’s sales to other carriers.  In its petition, GX identifies its primary customers as interexchange carriers, as well as information and enhanced service providers.  Similar to IDT’s petition, GX sought review of USAC’s methodology of categorizing wholesale revenue as “end user” revenue if GX did not obtain formal verification of its customer’s contribution status.

GX asserts that USAC lacks the authority to seek recovery from wholesale carriers for contributions actually owed by reseller customers.  In support of its argument, GX cites FCC precedent and regulations that establish (with limited exceptions) that resellers, not their underlying wholesale carriers, are responsible for USF contributions.  Further, GX notes that FCC regulations do not provide for enforcement action against underlying carriers for a reseller’s failure to make USF contributions – a stark contrast to USAC’s Form 499 instructions which impose “vicarious” liability. 

In addition, GX states that USAC’s reclassification of its wholesale revenue as end user revenue was based on a misinterpretation of the instructions USAC crafted.  The instructions provide that (i) underlying carriers must determine that the reseller “reasonably would be expected to contribute to support universal service” and (ii) “filers will be responsible for any additional universal service that result if its customers must be reclassified as an end user.”  GX asserts that USAC erroneously concluded that a customer’s failure to make USF contributions proved that GX could not reasonably have expected the customer to make the payments even before it had evidence the customer actually failed to pay.    

Like IDT, GX also maintains that the instructions provide no legal authority that could support USAC’s reclassification of wholesale revenue as end-user revenue.  Even if the FCC finds that USAC properly interpreted and applied the instructions, GX contends that the instructions are nevertheless void because USAC implemented them in violation of the APA.  



AT&T Counter-Argument (likely to be parroted by the FCC)

In comments filed with the FCC, AT&T directly refutes the legal positions carved out by IDT and GX regarding the obligation of wholesalers to verify downstream customer contributions.  AT&T’s counter-arguments can reasonably be expected to mirror the position the FCC will take on the issues. 

AT&T maintains that wholesale carriers should be responsible for ensuring that their reseller customers contribute to the USF.  Further, AT&T argues that if a wholesaler fails to conduct due diligence to establish with reasonable certainty that its resale customers have made the required contributions, the wholesaler should then be liable for its customers’ contributions.  AT&T also believes that the “rule” is not the equivalent of policing a customer’s activities, but merely providing adequate assurance that USF obligations have been fulfilled. 

In its comments, AT&T skewers IDT, stating that –

“Based on experience and IDT’s silence… AT&T doubts that any of IDT’s retailers have provided it with reseller certifications and/or are listed as current contributors on the Commission’s web site, and AT&T suspects that many, if not most, of IDT’s distributors are considered de minimis for contribution purposes…  If AT&T’s suspicions are correct, IDT erred in reporting almost all of its prepaid calling card revenue as carrier’s carrier revenue and the Commission should deny IDT’s appeal.  If true, the result of IDT’s actions were not only to have shifted contribution costs to other providers of interstate telecommunications but to have placed prepaid calling card competitors like AT&T, which did contribute to the fund based on its resold prepaid calling card revenues, at a significant competitive disadvantage.”

“Based on IDT’s appeal, it is clear that IDT is not contributing directly to the fund based on the majority of its prepaid calling card revenue. If (as appears likely) IDT has not obtained reseller certifications from its wholesale customers and has no other basis to conclude that its resellers are contributing to the fund, then any reseller certification that IDT may have provided to an underlying carrier for services that IDT incorporates in its prepaid calling card service was at best inaccurate, and likely fraudulent.”



Impact on the Wholesale Telecommunications Industry

The IDT and GX petitions shine a bright spotlight on the telecom industry’s uncertainty regarding over the application and consequences of non-compliance with the “carrier’s carrier.”  Until the issues are properly vetted before the full Commission and, more likely than not, litigated before the D.C. Circuit, carriers are left to deal with this uncertainty created on their own. 

Presently, neither USAC nor the FCC has altered the contribution obligations of either prepaid calling card providers or wholesale carriers in the wake of these petitions.  Indeed, GX has informed the FCC that USAC continues to invoice GX for the disputed amounts, despite GX’s notification to USAC of its intent to appeal USAC’s findings. The FCC has, however, requested public comment on IDT’s petition, so industry participants will have some opportunity to make their voices heard on these important issues. 

At this point, it is difficult to speculate on the ultimate outcome of these two petitions.   Affected industry participants should be aware of the issues and should consult with their legal counsel to evaluate current and prospective business and regulatory compliance practices in light thereof. 



Jonathan S. Marashlian is a partner at Helein & Marashlian, LLC, The CommLaw Group, a Washington, D.C.-area law firm specializing in federal and state telecommunications and technology matters. He can be reached at jsm@commlawgroup.com.